Understanding Taxation of Debt Funds

I am in 30 per cent tax bracket and need to park some money for three months. I am trying to decide whether I should go for a liquid fund, a short-term fund or a bank fixed deposit, based on the tax treatment. As far as I can see, my options are:
(1) Liquid Funds with a short-term capital gains tax (STCG) of 30 per cent and a dividend distribution tax of about 27 per cent.
(2) Short term income fund with the same STCG and a DDT of about 13 per cent.
(3) Fixed Deposit with the same 30 per cent STCG. Are my assumptions correct? If yes, then as the interest provided everywhere is almost same (8-9 per cent). So, shall I go for a fixed deposit then?
-Raghav Kapoor

Your assumptions about the taxation are correct. However, you are probably under the impression that in the mutual funds, you will have to pay the STCG as well as the DDT. This is not correct. If you take the growth option, then all the gains will accrue as capital gains and there will be no DDT.

Similarly, if you take the dividend option, all the gains will be paid out as dividends and there will be no STCG. Therefore, it's quite clear that the best option is to take dividends option in a short-term income fund. That way only 13 per cent will be taken away by the government as tax.

This article was originally published on March 18, 2014.