India taxed your mutual fund gain. Then the US taxed it again. Here is how to stop paying twice.

Start with the two rules that collide.

India taxes the gain because the mutual fund is Indian. Under the India-US tax treaty, capital gains are dealt with by Article 13, which lets each country tax gains under its own law. Unlike the treaties India has with the UAE or Singapore, the US treaty carries no clause that hands the gain to your country of residence. So India taxes your unit gain at the normal rates: 12.5 percent on long-term equity gains above 1.25 lakh under Section 112A, and 20 percent on short-term equity gains under Section 111A, with debt funds taxed at slab rates.

The US taxes the same gain because you are a US person. A US citizen, green-card holder or US tax resident is taxed on worldwide income, so the Indian mutual fund gain lands on your US return too. On top of that, an Indian mutual fund is a PFIC in US eyes, which brings its own harsher rules, covered further down.

So the same rupee of gain is inside two tax nets at once. The tool that is supposed to stop you paying twice is the foreign tax credit: the US gives you credit for the tax you paid India. The problem, and the reason people still end up double taxed, is that the credit often cannot reach the Indian tax at all.

The foreign tax credit has a catch built into it. It can only offset US tax on income that counts as foreign-source. And US law decides the source of a capital gain by looking at where the seller lives, not where the asset is. Under Section 865 of the US tax code, a gain on selling personal property, which includes stock and mutual fund units, is sourced to the seller's country of residence.

You live in the US. So the US treats your Indian mutual fund gain as US-source income, even though the fund, the rupees and the Indian tax are all in India. Because the gain is US-source in US eyes, there is no foreign-source income for the credit to sit against, and the credit for your Indian tax gets limited to zero. You have paid India, you owe the US, and the mechanism meant to bridge them comes up empty.

This is the step most people, and some preparers, miss. They assume that because Indian tax was paid, the credit is automatic. It is not. Left alone, this sourcing rule is exactly how you end up paying full tax on both sides.

The treaty has an answer, and it is the whole point of this article. Article 25 of the India-US treaty, the relief-from-double-taxation article, lets you re-source income so the foreign tax credit can work. When India has the right to tax a gain under the treaty, Article 25 treats that gain as arising in India, and US law lets you give that effect through an election under Section 865(h) of its tax code. That pairing converts your US-source gain into treaty-resourced foreign income, and now the Indian tax you paid has somewhere to land.

On the US return this shows up as a separate Form 1116 in the category for income re-sourced by treaty, kept apart from your other foreign income. You claim the Indian tax as the credit against the US tax on that re-sourced gain.

This is a recognised route, not a loophole, though the exact reach of the re-sourcing rule has been argued over. It matters enough that in early 2026 the IRS let several taxpayers who had missed the election make it late, in private rulings on sales of Indian company shares. Those rulings bind only the taxpayers who asked for them, are not precedent you can lean on, and did not settle every open question, so the real lesson is to make the election on time. Claim the re-sourcing on the return for the year of the sale, not as a rescue afterwards.

There is a second, sneakier problem: the two countries run different tax years. The US taxes on the calendar year, January to December. India runs its year from April to March. So the Indian tax on a sale can fall in one US tax year on paper and the US tax on the same sale in another. If the credit and the income drift into different years, the credit is wasted.

The rule to hold onto is that the credit follows the income. You claim the Indian tax as a credit in the same US year in which you report the gain, matching the two together, rather than in whatever Indian financial year the paperwork happens to show. US law lets you claim foreign taxes either when paid or when they accrue, but you must pick one basis and stay consistent across all your foreign taxes. On the India side, the credit for tax deducted is allowed in the year the income is assessable, under Rule 37BA, which helps you line the two up.

The practical habit: pin the US year to when you include the gain, then pull the Indian tax into that same year. Do not let a March sale and an April-year Indian record split your income and your credit across two returns.

Even after the re-sourcing election lines up the credit, one piece of pain does not go away. To the US, an Indian mutual fund is a Passive Foreign Investment Company, a PFIC, and PFICs carry a penalty regime the treaty does not switch off.

If you never made a special election, the US default for a PFIC is the Section 1291 method, and it does not even treat your profit as a capital gain. It recharacterises the gain as an excess distribution taxed at the highest ordinary income rate, spread back across your whole holding period with an interest charge on top, as if the tax had been owed and deferred all along. You also file a Form 8621 for each fund. So the India side sees a capital gain taxed at 12.5 percent while the US side sees ordinary income at a far higher rate. The foreign tax credit can offset US tax on the gain, but it does not erase the higher rate or the interest charge, so a residual US cost survives.

The way to soften this going forward is the mark-to-market election, open to fund units that count as marketable, which taxes the annual increase in value at ordinary rates but drops the interest charge. It is not free, and it needs planning, but it is usually less brutal than being stuck in the Section 1291 default. This is the honest limit of what the treaty can do: it relieves the double tax on the base gain, not the PFIC surcharge the US layers on top.

Put the two sides together into one sequence, and get one professional on each side of the ocean, because no single filer usually holds both rulebooks.

On the India side: pay the capital-gains tax on redemption, and keep the challan and the Form 26AS record with dates. Note that a TRC and Form 10F, now Form 41, do not exempt this gain, because the US treaty gives no capital-gains exemption. They still matter for lowering tax on your Indian interest and dividends, just not here.

On the US side: report the gain, file Form 8621 for the PFIC, decide between the Section 1291 default and a mark-to-market election, and, most importantly, re-source the gain under Article 25 so the Indian tax becomes a usable credit on a treaty-resourced Form 1116. Match the credit to the US year you report the gain.

This is one of the few NRI situations where a US CPA and an Indian CA genuinely have to talk to each other. The Indian tax, the US PFIC treatment, the re-sourcing election and the year-matching are four moving parts, and getting three right and one wrong still leaves you paying twice.