Liquid Funds Taxation: Benefits & Overview

Introduction

Taxation of liquid funds is an important consideration for investors aiming to remain compliant with income tax regulations. These funds, valued for their high liquidity and low-risk profile, serve as a practical solution for short-term investment needs. They are particularly suitable for individuals with short-term financial goals or those seeking higher returns than traditional savings accounts. However, both capital gains and dividends from liquid funds are taxed differently, depending on factors such as the holding period and the nature of income. This article offers a detailed overview of how liquid funds are taxed, helping investors make well-informed financial choices

What Are Liquid Funds?

Liquid funds are a type of debt mutual fund that invests in short-term, fixed-income instruments such as commercial papers, treasury bills, government securities, and certificates of deposit with maturities of up to 91 days. Known for their low risk and high liquidity, they offer investors quick access to their money—usually within 24 hours. Their daily Net Asset Value (NAV) calculation and minimal interest rate risk make them a favored option for short-term investments or parking surplus cash

Key Benefits of Investing in Liquid Funds

High Liquidity: Investors can redeem funds within 24 hours, making them suitable for emergency needs or short-term financial goals.
Low Risk: Due to short-term maturities, liquid funds are less exposed to interest rate and market fluctuations.
Stable Returns: They offer consistent returns by investing in high-quality, short-duration instruments.
Higher Returns Than Savings Accounts: Typically, they yield better returns than traditional savings accounts.
Transparency and Safety: Investments are made in well-rated instruments, and regular disclosures ensure transparency

Who Should Invest in Liquid Funds?

Risk-Averse Investors: Ideal for those seeking safety over high returns.
Individuals with Short-Term Goals: Suitable for managing short-term expenses or emergency funds.
Surplus Fund Holders: Perfect for temporarily parking large sums from bonuses, asset sales, or inheritances.
Return-Conscious Savers: A good alternative for individuals aiming to earn more than savings bank interest rates

Tax Treatment of Liquid Funds

Understanding the tax implications is crucial for compliance and effective planning:

Short-Term Capital Gains (STCG): Gains from units held for up to 3 years are taxed as per your income tax slab.
Long-Term Capital Gains (LTCG): As per Union Budget 2024, gains from units held beyond 3 years are taxed at 12.5%, without indexation benefits.
TDS on Dividends (Indian Companies): A 10% TDS is deducted if the total dividend in a financial year exceeds ₹5,000.
Tax on Foreign Dividends: Taxed at a flat rate of 20% (plus surcharge and cess), or as per the individual’s slab rate, whichever is opted

How to Declare Income from Liquid Funds in Your ITR

Proper reporting ensures compliance with tax regulations. Here’s how:

Log in to the Income Tax e-Filing Portal.
Navigate to the ‘e-File’ section and select ‘File Income Tax Return.’
Select the relevant ITR form based on your income source and assessment year.
Enter Income Details:
- Report STCG or LTCG under ‘Schedule Capital Gains.’
- Enter sale proceeds and cost of acquisition (for STCG).
- For LTCG, provide details under Schedule 112A.
- Report dividend income under ‘Income from Other Sources.’
Review & Validate: Cross-check all entries and preview the return before final submission.
Submit & Verify: Complete the verification online or send a signed ITR-V within 120 days of filing

About the Author

Rohan

Rohan is a seasoned content writer with expertise in business registration, tax regulations, trademark laws, and corporate compliance. His well-researched articles offer practical insights and guidance, making it easier for businesses to navigate complex legal and regulatory landscapes

June 25, 2025