What is a liquid fund and what are the tax implications?

Liquid funds are funds which can be liquidated easily. The duration of investment will be very less. It may be a single day investment also or for a period of thirty-six months based on our requirement and ability. But many people keep it for less time only that to a maximum of 91 days. You can redeem your funds within a short span of time. Today you submit your request tomorrow you will get it back. It is as simple as withdrawing money from your SB account. But the interest you get will be high. The financial advisers suggest these funds for short term investment only. You may get up 7 to 8% returns whereas an SB account will give you 3 to 4% interest only.
If the funds are redeemed before 36-months the profit you got will be added to your income. You have to pay the tax as per the income tax slabs. and taxed as per the income tax slab applicable to you. If you are not selling before 36 months, your gains will qualify for long-term capital gains tax.
There is no guarantee of return whereas there is a guarantee of return on fixed deposits. But people who want quick money will take some risk and invest in these funds. Generally, people will keep for a maximum of 91 days. Overnight funds are also coming theses days.

Liquid funds are a category of Mutual Fund. They are also known as debt Mutual Funds. These funds invest our money in short term financial instruments like Govt securities, treasury bills, call money etc. The credit rating of these investment avenues is high. The tenure of these financial instruments is very small going unto a maximum of 91 days instruments. The liquid funds earn money through the interest on these instruments. So there is not much fluctuation in their NAV except that due to addition of interest amount. They are less risky and people keep them up to their maturity period. In fact they are low risk low return type of investments. Still, there is a potential of earning more than the savings bank.

These funds are a good avenue for those who have surplus funds at their disposal and they want to park the money somewhere before investing in bonds or equity.

These funds can be liquidated as and when required but if they are sold before 3 years than the gain on the investment will be taxable. On the other hand if they are sold after 3 years then the benefit of indexation will be given for calculating the capital gain long term income tax. After indexation the gain, if any, will be taxed at 20%.

Liquidity - fund is an instrument attached with the mutual fund being operated by different operated by different Banks such as HDFC, ICIICI, Sundaram Debt Mutual funds etc. This fund offers an investor an attractive interest - rate not applicable in the SB accounts.
The SB accounts offers us an interest between 3 and 4 percent where as in the debt fund it may be as high as 8 percent.
Hence if an investor has some surplus money and wants to enjoy a high rate of interest for some specified period, this could be an ideal investment. At the end of maturity, the investor gets principal along with the interest prescribed for the fund. However, investors keep money on such funds below 36 months and after enjoying the interest component along with the principal, they would prefer to reinvest the same. At the exit of the fund, the income- tax will be deducted as per the prescribed rate for your total income.
Remain invested beyond 36 months would allow the investors a long term capital gain and while calculating income tax, long term gain would be suitably accommodated and then the taxation - rate will follow.

Liquid fund is a category of debt mutual fund. Such funds invest in money market instruments like certificate of deposits, treasury bills, commercial papers and term deposits. The maturity period of such instruments is very low, usually less than 90 days.

For common investors. such funds (liquid funds) have almost no risk and it gives return marginally more than the annual interest offered by the saving account in banks. The average annual return of liquid funds is around the tune of 6.74% (Source: Value Research Online). The risk is almost nil. So, the investors can park the money in liquid funds instead of doing so in saving account.

The tax treatment of liquid fund is like tax treatment of other debt funds. Liquid funds held for more than three years are eligible for long term capital gains tax with indexation. If the investor sells/redeems before three years, then he/she will have to pay tax as per the investor's own tax slab.