US-India Dual Taxation: Foreign Tax Credit (FTC) in Form 67, Article 25 Relief & PFIC Taxation on Indian Mutual Funds
Updated: Sep 28
For the more than 4.5 million Non-Resident Indians (NRIs), Overseas Citizens of India (OCIs), and Indian-origin tech professionals residing in the United States, managing cross-border finances involves navigating one of the most complex, aggressively enforced bilateral tax mazes in the world.
While India exercises tax jurisdiction primarily based on residential physical presence (Section 6 of the Income-tax Act, 1961), the United States operates an uncompromising system of citizenship- and Green Card-based worldwide taxation under the Internal Revenue Code (IRC). When an Indian citizen holds a US Green Card, H-1B, or L-1 visa, every rupee of income earned in India—from rental yields on ancestral properties to interest on NRO fixed deposits and capital gains on Indian mutual funds—is subject to simultaneous tax reporting before both the Indian Income Tax Department and the US Internal Revenue Service (IRS).
Without sophisticated dual-jurisdiction structuring, the unwary taxpayer faces devastating statutory traps: the IRS's draconian Passive Foreign Investment Company (PFIC) regime under IRC Sections 1291–1298 (which can confiscate over 50% of Indian mutual fund gains in penal taxes and interest), the strict electronic compliance mandate of Form 67 for Indian Foreign Tax Credits (Rule 128), and the intricate timing reconciliations required for 401(k) and IRA accounts under Section 89A.
At PGT & Associates, our cross-border private wealth and international tax practice advises US-based Silicon Valley founders, Wall Street executives, and returning diaspora families on eliminating double taxation and structuring tax-optimized Indian portfolios. Below is an exhaustive operational masterclass detailing the PFIC minefield, Form 67 electronic compliance, Article 25 DTAA foreign tax credits, and Section 89A retirement relief.
1. The US PFIC Trap: Why US NRIs Must Avoid Indian Mutual Funds
Under the US Internal Revenue Code, a foreign corporation is classified as a Passive Foreign Investment Company (PFIC) under Section 1297 if it meets either the 75% Passive Income Test or the 50% Passive Asset Test.
Because Indian Mutual Funds, Exchange Traded Funds (ETFs), and Alternative Investment Funds (AIFs) are structured as pooled investment trusts holding interest- and dividend-yielding securities, the IRS classifies every Indian mutual fund as a PFIC.
The Strategic Cure: Direct Equity & PMS Structuring
To completely bypass the PFIC trap, US-based NRIs should avoid Indian mutual funds entirely. Instead, deploy capital into:
Direct Indian Equity Portfolios: Purchasing shares of Indian listed companies directly via a Portfolio Investment Scheme (PIS) or Non-PIS account. Direct equities are NOT PFICs; they qualify for standard US long-term capital gains rates (0%, 15%, or 20%) plus the 3.8% Net Investment Income Tax (NIIT).
Discretionary Portfolio Management Services (PMS): Engaging a PMS where securities are held directly in the NRI's individual demat account, rather than through a pooled trust vehicle.
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2. Foreign Tax Credit (FTC) Architecture: Section 90 vs. IRC Section 901
To prevent genuine double taxation on income sourced in India, both jurisdictions recognize bilateral tax treaty credits under Article 25 (Relief from Double Taxation) of the US-India Double Tax Avoidance Agreement (DTAA):
3. Mandatory Electronic Filing of Form 67 (Rule 128)
Where an Indian resident or dual resident claims Foreign Tax Credit in India under Section 90 or 91 for taxes paid in the United States, strict procedural adherence to Rule 128 of the Income-tax Rules, 1962 is mandatory:
[!IMPORTANT]
Form 67 Filing Timeline (CBDT Amendment):
Historically, the department disallowed FTC if Form 67 was not filed on or before the due date of filing the return under Section 139(1). Following the CBDT amendment to Rule 128(9) (effective April 2022), Form 67 can now be filed on or before the end of the assessment year relevant to the previous year (i.e., by March 31 of the assessment year), or by the date of filing an updated return under Section 139(8A).
4. US Retirement Accounts: 401(k), IRA & Indian Section 89A Relief
A major point of friction for US NRIs returning to India is the tax mismatch on US retirement accounts:
The US Mechanism: 401(k) and Traditional IRA contributions are made pre-tax; taxation is deferred until actual distribution/withdrawal during retirement.
The Historic Indian Problem: Under regular Indian tax rules, once an individual becomes a Resident and Ordinarily Resident (ROR), India taxes global income on an accrual basis. The Indian tax department previously attempted to tax annual interest, dividends, and capital gains accruing inside the 401(k) each year, even though the NRI could not withdraw the funds without severe IRS early-withdrawal penalties.
The Section 89A & Form 10-EE Solution
To resolve this hardship, the Finance Act, 2021 inserted Section 89A read with Rule 21AAA:
Deferral Option: An Indian resident who opened a retirement account in the US while non-resident can elect to defer Indian taxation on income accrued in that account until the year of actual withdrawal.
Electronic Filing of Form 10-EE:
The election is exercised by filing Form 10-EE electronically on the Income Tax portal on or before filing the return of income for the relevant assessment year.
Once exercised, the election applies to all subsequent years and cannot be revoked.
When distributions are finally withdrawn in the US, India taxes the distributed amount, and the taxpayer claims credit for US taxes withheld under Article 25 of the DTAA.
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5. Frequently Asked Questions (US-India Cross-Border Advisory)
Q1: Does an NRI living in the US need to file an Indian Income Tax Return?
Yes, if the NRI's total gross income in India (before deductions) exceeds the basic exemption limit (₹2,50,000 under the old regime or ₹3,00,000 under the new regime), or if they wish to claim a refund of TDS deducted under Section 195 on NRO interest or property sale proceeds.
Q2: What is the DTAA withholding tax rate on NRO bank interest for US residents?
Under domestic Indian law, NRO interest is subject to 30% TDS plus cess (31.2%). However, under Article 11 (Interest) of the US-India DTAA, the withholding tax rate is capped at 15%. To avail of this 15% rate, the NRI must submit a valid Tax Residency Certificate (Form 6166 from the IRS), Form 10F, and a No-PE declaration to the Indian bank.
Q3: How are Social Security benefits taxed for an NRI returning to India?
Under Article 20 (Private Pensions and Social Security) of the US-India DTAA, Social Security payments paid by the US Government to a resident of India are taxable ONLY in the United States. India has no right to tax US Social Security benefits, providing complete exemption in the Indian return.
Q4: What is FBAR and FATCA reporting for US NRIs holding accounts in India?
FBAR (FinCEN Form 114): Mandatory if the aggregate maximum value of all foreign financial accounts (NRE, NRO, FCNR, demat) exceeds $10,000 at any time during the calendar year. Filed separately with the US Treasury by April 15 / October 15.
FATCA (Form 8938): Attached to Form 1040 if foreign assets exceed specified thresholds (e.g., $50,000 to $100,000 for single filers, $100,000 to $200,000 for married filing jointly).
Q5: Can an NRI gift money from an NRE account to parents in India without US gift tax?
Yes. Gifts to parents (relatives under Section 56(2)(x)) are completely tax-free in India. Under US tax law, an NRI who is not a US citizen or Green Card holder is not subject to US gift tax on transfers of intangible property (like cash wire transfers from an Indian NRE account). However, if the donor is a US citizen/Green Card holder, transfers exceeding the annual gift tax exclusion ($18,000 for 2024/2025) must be reported on IRS Form 709.
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