Understanding the tax implications of liquid funds

Liquid mutual funds invest in debt and money market securities, treasury bills, etc. with maturity of up to 91 days only. Being a type of debt fund, liquid funds offer investors a relatively stable way of generating potential returns on spare cash or an emergency corpus.

However, like all investment avenues, returns from liquid mutual funds are subject to taxation.

Tax implications on liquid funds

Before the taxation changes implemented in 2023, investors enjoyed specific tax benefits on liquid funds. Capital gains were classified as short-term and long-term, with their respective tax implications. Short-term gains were taxed as per the individual's slab rate, while long-term gains, after the benefit of indexation, were taxed at a concessional rate of 20%.

For liquid fund units acquired before April 1, 2023

Short-term capital gains (STCG): If an investor sells their liquid fund units within three years of the purchase, the gains qualify as short-term. Previously, these gains would be added to the individual's taxable income, thereby getting taxed as per their respective income tax slab. This mechanism for liquid funds taxation remains unchanged for funds acquired before 1st April 2023.

Long-Term Capital Gains (LTCG): Gains arising from selling the liquid fund units after holding them for a period of three years are considered long-term. Before the new rules, these gains came with indexation benefits. Essentially, indexation adjusted the purchase price of the investment for inflation using a government-provided index, reducing the taxable amount. The long-term capital gains would then be taxed at 20% with indexation benefits or 10% without indexation. This rule continues to apply for funds purchased before March 2023.

For liquid fund units acquired after April 1, 2023

With effect from April 1, 2023, the tax on liquid funds has witnessed significant changes. This makes it essential for investors to stay updated and plan their investments in liquid funds accordingly.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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