Overnight funds: A detailed taxation guide

Overnight funds are debt funds that offer high liquidity and low interest rate risk to investors looking for short-term parking of funds. Like other debt funds, overnight funds are subjected to capital gains tax and dividend distribution tax as per prevailing tax laws. Read on to learn more about tax efficiency in overnight funds and tax planning with overnight funds.

• Table of contents

1. What are overnight funds?
2. Taxation on Income Distribution cum Capital Withdrawal
3. Taxation of capital gains from overnight funds

What are overnight funds?

An overnight fund is a type of low/low-to-moderate risk mutual fund that invests in very short-term debt instruments. The goal is to provide investors with a relatively stable avenue to park their money overnight or for a very short period, i.e., just one day. The investments that overnight funds make generally lasts only one business day. This means the debt instruments they buy will mature the very next business day. Typical investments include Treasury bills, commercial paper, certificates of deposit and repurchase agreements. All of these can be quickly bought and have the maturity date of the next business day thereby ensuring minimal risk of price fluctuation.

Although low risk, overnight funds aim to generate returns in the form of interest income. This interest return is usually very close to the overnight bank rate set by the government. Because of their low-risk strategy, overnight funds are considered almost equivalent to cash. Hence, investors use overnight funds as an alternative to bank deposits when they need a place to park funds temporarily. However, the returns from overnight funds aren’t guaranteed.

Taxation on Income Distribution cum Capital Withdrawal

The proceeds received from IDCW are taxed in the hands of the investors as per their tax slab rates. Additionally, for resident investors, the mutual fund company is required to deduct a 10% TDS if the dividend payout exceeds Rs. 5,000 in a financial year.

Taxation of capital gains from overnight funds

Capital gains arise when investors redeem or switch units of an overnight mutual fund scheme. The capital gains are classified as either short-term or long-term depending on the period of holding and the date of purchase of units. Overnight funds are treated as debt funds for taxation purposes.

Units purchased after April 1 ,2023 – Gains from overnight fund investments made after April 1, 2023, no longer receive indexation benefit and are considered to be short-term capital gains irrespective of the holding period. Therefore, they are added to the investor’s taxable income and taxed at the applicable slab rate.

Units purchased before April 1 ,2023 – Gains from overnight fund investments made before April 1, 2023 – and held for a period of 36 months or more – are considered long-term capital gains and taxed at 20% with indexation benefit.

Conclusion

Proper understanding of taxation rules is necessary to optimize the post-tax return potential from debt schemes like overnight funds. Investors can consider the Bajaj Finserv Overnight Fund to park their surplus cash. For scheme information, click here.

FAQs:

Can indexation benefit be claimed on overnight fund investments held for more than 36 months?

Yes, if the units were purchased before April 1, 2023, and held for more than 36 months before redemption, indexation benefit can be claimed on the long-term capital gains. However, no indexation benefit is offered for overnight fund investments made on or after April 1, 2023.

Is there a minimum lock-in period for investing in overnight funds?

No, overnight funds do not have any minimum lock-in period. Investors can redeem their units and exit the fund any time without any lock-in.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.