Liquid Fund Taxation In India 2025: Tax Rules, Rates And How Investors Are Affected

Liquid funds are quite a popular choice for investors or businesses having extra or idle cash. Since you want your money to work as hard as you do, liquid funds are an excellent choice that ensures your parked funds earn a fair amount of returns, can be converted into cash quickly, and are quite safe. 

However, if you are an investor or a business owner who intends to invest, it is essential to be aware of all the liquid funds taxation rules and updates, so that you can make an informed decision. As capital gain tax regulations have evolved significantly in recent years, it is essential to stay informed. 

How Are Liquid Funds Taxed In India?

As mentioned earlier, the capital gains tax laws have undergone significant changes in the past few years, and hence, the liquid funds tax rules in India have also changed. Liquid funds are classified as debt mutual funds for taxation purposes. The application of long-term or short-term capital gains depends on the holding period of the debt mutual funds. Let us find out how are liquid funds taxed: 

Debt Funds Purchased Before April 1, 2023: Previously, the holding period for debt mutual funds was 36 months. However, with new regulations applicable after Budget 2024, this period was reduced to 24 months. 

This implies that any gains from debt mutual funds held for 24 months or less shall be considered as short-term capital gains. If the debt mutual funds are held for more than 24 months, they will be considered as long-term capital gains. 

However, with the latest regulations, there have been further changes in the liquid fund capital gains tax.

Also Read: https://www.gripinvest.in/blog/best-liquid-funds

Current Rules (2025)

With the latest regulations, the classification of short and long-term capital gains on debt mutual funds (and thus on liquid funds) has been revised. For any debt funds purchased on or after April 1, 2023, the gains shall be classified as Short Term Capital Gain (liquid fund short-term tax), irrespective of the holding period¹. Hence, tax will be calculated as per the applicable slab rates. No indexation benefits shall be available to such investors. 

Here is the summary of the capital gains tax regulations:

Source: Economic Times²

Maximising Tax Efficiency With Liquid Funds

While liquid funds are known for safety and convenience, they’re not entirely tax-proof. Optimising post-tax returns means being mindful of your holding period, entry date, and withdrawal strategy. Let’s break it down:

Frequent Withdrawals: Tax Impact Of Short-Term Holdings 

Liquid funds are often used like enhanced savings accounts, where money is parked today and withdrawn next week. But each redemption, no matter how small, triggers a capital gains event. If your units were bought on or after April 1, 2023, all gains are treated as short-term and taxed as per your income slab.

For high-income investors, this means a tax rate of up to 30% on gains. Even if your returns are stable, a 30% tax outgo on short-term gains can dent overall returns. Frequent withdrawals increase the number of taxable events, and compounding is disrupted. It’s smarter to plan redemptions strategically, hold investments till you genuinely need the funds and limit partial withdrawals.

Older Units (Pre-2023): Why Your Investment Date Matters 

If you invested in liquid funds before April 1, 2023, your tax treatment depends on when you redeem those units:

1. If you sold before July 23, 2024, gains after 36 months qualified as long-term and were taxed at 20% with indexation.
2. However, if you redeem after July 23, 2024, the new rule applies: gains held for more than 24 months are taxed at a flat 12.5%³. Indexation for liquid funds, however,  has been removed. 

Therefore, holding onto those older units longer might still provide a tax advantage over newer investments, especially if you originally benefited from inflation-adjusted indexation. Be sure to check your purchase date and match it with your holding period before redeeming, to avoid an unnecessary tax hit.

Smart Tax Tips: Use Direct Plans, Mind Your Tax Bracket 

Here are some tactical ways to reduce your tax outgo on liquid fund returns:

1. Choose Direct Plans: Direct plans of mutual funds come with lower expense ratios, which improve your net returns. While not a direct tax-saving tool, it increases the amount you keep after taxes.

2. Understand Your Tax Bracket: Investors in the 30% slab pay significantly higher short-term tax than those in the 5% or 10% brackets. If your income is expected to reduce next year (say, due to retirement or a break), consider postponing redemptions to a lower-tax year. 

3. Avoid Dividend Option: Since the dividend distribution tax was scrapped in 2020, dividends are added to your taxable income. Opting for growth plans ensures gains are taxed only at the time of withdrawal.

4. Track Your Units: Use capital gains statements to know exactly which units are being redeemed (FIFO method applies). This helps in planning redemptions that may be older and more tax-efficient.

5. Consolidate Withdrawals: Instead of withdrawing frequently, make fewer, larger redemptions to avoid multiple taxable events and preserve compounding.

Conclusion

Liquid funds continue to offer a safe and flexible investment avenue, especially for short-term goals. However, post-tax returns depend heavily on the investment date and holding period. With recent rule changes eliminating indexation and long-term benefits for new investments, tax efficiency now hinges on smart planning, such as using direct plans, tracking unit age, and timing withdrawals wisely. 

Whether you’re a first-time investor or holding pre-2023 units, staying updated with taxation norms is crucial. By aligning your strategy with current tax rules, you can maximize the benefits of liquid funds while keeping your tax liability under control.

FAQs On Liquid Funds Taxation

1. Are liquid fund gains taxed as short-term or long-term now?

For liquid funds purchased on or after April 1, 2023, all gains are taxed as short-term capital gains, regardless of how long you hold them.

2. Is there any tax benefit or indexation for liquid funds after 2023?

No, for investments made after April 1, 2023, there is no indexation benefit and no long-term capital gains classification—all gains are taxed at your applicable income tax slab rate.

3. How are dividends from liquid funds taxed?

Tax on mutual fund dividends (liquid funds) is added to your taxable income and taxed as per your individual slab rate. If the total dividend income exceeds INR 5,000 in a year, TDS at a rate of 10% is applicable.

References:

1. Bajaj Finserv, accessed from: https://www.bajajfinserv.in/investments/taxation-on-debt-mutual-funds

2. Economic Times, accessed from: https://economictimes.indiatimes.com/wealth/tax/mutual-fund-taxation-for-ay-2025-26-latest-capital-gain-tax-rules-for-equity-mutual-funds-debt-mutual-funds-international-mutual-funds-gold-mutual-funds-others/articleshow/122830380.cms?from=mdr

3. Tax Buddy, accessed from: https://www.taxbuddy.com/blog/new-capital-gain-tax?utm

Want to stay at the top of your finances? 

Join the community of 4 lakh+ investors and learn more about Grip, the latest financial knick-knacks and shenanigans that take place in the world of investing.

Happy Investing!

Disclaimer - Investments in debt securities are subject to risks. Read all the offer-related documents carefully. The investor is requested to take into consideration all the risk factors before the commencement of trading. This communication is prepared by Grip Broking Private Limited (bearing SEBI Registration No. INZ000312836 and NSE ID 90319) and/or its affiliate/ group company(ies) (together referred to as “Grip”) and the contents of this disclaimer are applicable to this document and any and all written or oral communication(s) made by Grip or its directors, employees, associates, representatives and agents. This communication does not constitute advice relating to investing or otherwise dealing in securities and is not an offer or solicitation for the purchase or sale of any securities. Grip does not guarantee or assure any return on investments and accepts no liability for the consequences of any actions taken based on the information provided. For more details, please visit https://www.gripinvest.in/. 
Registered Address - 106, II F, New Asiatic Building, H Block, Connaught Place, New Delhi 110001.