QUESTION: Most mutual funds in India are now partnerships with US
companies like Merrill, Prudential, etc. and actively buying/selling
shares in the Indian stock market. If i have a bank account in India
and invest in these Mutual Funds, will these be considered PFIC
investments? If so, should one purchase the underlying securities
directly instead of the mutual funds?

REPLY: The definition of a passive foreign investment company (PFIC)
is that (1) it's a corporation and (2) 75% or more of its income is
from passive investments or 50% or more of its assets are held to
produce passive income. If a partnership (defined for U.S. tax
purposes as an entity that does not offer limited liability to the
partners) owns any investments that are PFICs, then the PFIC rules
apply to those investments and indirectly to the various partners.

Direct ownership of stocks, bonds or securities other than mutual
funds (PFICs) would not be subject to the PFIC rules unless the entity
meets the definition test. In some cases, an operating corporation
might have more than 50% of its assets invested in a money market fund
or other temporary investments and that could cause the entity to
become a PFIC.

However, if a PFIC is actively traded on a major national stock
exchange, the shareholders should be able to make a mark-to-market
election to treat any gain in the market price from year to year as
ordinary income and thereby avoid the punitive throwback tax under tax
code section 1291.

Vern

IRS Regulations require that I include the following statement with
any written explanation of the tax law. The comments in this
memorandum are not intended to constitute an opinion regarding any
specific tax issues because additional tax issues may exist that could
affect the tax treatment of the tax issues addressed in this memo.
This memorandum does not consider or reach a conclusion with respect
to those additional issues and was not written and cannot be used for
the purpose of avoiding penalties under code section 6662(d). For
further details see
http://www.offshorepress.com/vkjcpa/disclosurerules.htm