liquid fund - Definition / Legal Terminology - Income Tax

Explanation.(e) - As per section 115T of the Income tax Act 1961, For the purposes of Chapter XII-E (special provisions relating to tax on distributed income) - liquid fund means- a scheme or plan of a mutual fund which is classified by the Securities and Exchange Board of India as a liquid fund in accordance with the guidelines issued by it in this behalf under the Securities and Exchange Board of India Act, 1992 or regulations made thereunder. Meaning of liquid fund A liquid fund is a type of mutual fund that primarily invests in short-term debt instruments and money market securities. These funds are designed to provide investors with high liquidity, meaning they can easily redeem their investments without significant loss in value. Key Features of Liquid Funds: The primary factor influencing the tax treatment of your liquid funds is the holding period, which indicates how long you hold the investment before redeeming it. In India, there are two classifications for holding periods: Short-Term Capital Gains (STCG) : If you redeem your liquid fund units within 3 years of purchase, any gains are classified as STCG. Long-Term Capital Gains (LTCG) : If you hold your liquid fund units for more than 3 years, the gains are classified as LTCG. Tax Implications of each category- Short-Term Capital Gains (STCG): STCG from liquid funds is added to your total income and taxed according to your income tax slab rate. This means the tax rate you pay depends on your overall income for the financial year. For instance, if you fall into the 30% tax bracket and earn a short-term capital gain of ₹10,000 from your liquid fund, you would owe ₹3,000 (₹10,000 * 30%) in tax. Long-Term Capital Gains (LTCG): For investments made on or after April 1, 2023 : LTCG from liquid funds will be taxed at a flat rate of 20% without the benefit of indexation. This means you will be taxed on the full gain, which could result in a higher tax liability compared to earlier investments. For investments made before April 1, 2023 : These investments can still take advantage of indexation for LTCG, which helps reduce the taxable gain and potentially lowers your tax burden. Dividends: Dividends received from liquid funds are taxed at your applicable income tax slab rate. If the dividends exceed ₹5,000, a Tax Deducted at Source (TDS) of 10% applies.