Mutual Funds of foreign nations come under the category of Passive Foreign Investment Company (PFIC). According to Vinay Navani, CPA and Director of Tax at Wilkin & Guttenplan, says, "PFIC rules were introduced by the Internal Revenue Service (IRS) in order to discourage the practice by US citizens and residents of parking money in offshore tax havens and deferring the U.S. tax liability.” He adds, “At the time of sale, while capital appreciation would be tax free in the Cayman Islands, the U.S. citizen/resident would still have to pay tax in the U.S. since he is taxed on his global income. By doing this, he could defer his U.S. tax liability till the time of actual sale.” He further says, “Broadly speaking, according to the PFIC rules, the citizen will face some harsh tax consequences unless he chooses one of the options described below."

If an NRI wants to file tax returns for income earned from sale of MFs, (s)he will have to follow either of the following 2 given options in order to avoid penalty.