Mutual funds are defined as “an investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments, and similar assets.”

The logic behind investing in mutual funds is that, instead of placing money directly into the Stock Market and losing due to incorrect speculation, the investment is handled by efficient fund managers. Risks are lowered due to the diversification of the portfolio according to an individual’s risk tolerance. That’s what mutual funds are for those who didn’t know.

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The PFIC regime was not introduced until 1986. Prior to 1986, U.S. taxation of foreign corporations was strictly tied to control of the corporation held by U.S. persons. This allowed not only the foreign mutual fund to avoid U.S. taxation, but also U.S. persons who invested in the fund. How so?

For starters, the fund itself avoided U.S. taxation because it was a foreign corporation that derived only foreign-source income. The fund was able to avoid the taint of being classified as a controlled foreign corporation, or “CFC” because it was owned by a large number of U.S. and foreign investors, each of whom owned a relatively small percentage.

U.S. investors avoided U.S. taxation in two primary ways. First, the fund paid no dividends. Read More