What is the difference between a liquid fund and an arbitrage fund?
A liquid fund and an arbitrage fund are both types of mutual funds where a company can put its spare cash to earn while it waits, but they differ on tax rates and how quickly the money comes back to the bank. A liquid fund is built for speed and stability, while an arbitrage fund is often considered for its specific tax treatment.
Selecting between them is a matter of looking at your company's payment calendar and its tax priorities. To choose well, an owner needs to see how each one handles the trade between access and gains.
Why does the cash in your current account earn nothing?
In India, a current account pays no interest. This means any spare cash your company leaves there is effectively idle. For a business that collects money before it spends it, such as a consultancy, a school, or a firm with large periodic sales, these idle balances can be substantial.
This money is usually waiting for a job. It might be needed for salaries on the first of the month, GST by the twentieth, or vendor bills on a known future date. It might also be set aside for TDS or advance tax payments that fall due every quarter.
Between the time the money arrives and the day it is paid out, it sits in the current account. While it stays there, it earns nothing. To make that cash work, it has to move out of the account into a place where it can earn, without being locked away so tightly that it cannot be reached when the bills arrive.
How do liquid funds and arbitrage funds compare?
Both funds offer a way for a company to move spare cash out of the current account. However, they are suited to different needs. Here is how they compare on the four things that matter most to a company's finance operations.
| Liquid fund | Arbitrage fund | |
|---|---|---|
| Getting money out | Money comes back within three business days, usually sooner | Generally pays out more slowly than a liquid fund |
| Tax on gains | Taxed at the company's normal tax rate when units are sold | Taxed like equity: 20% if held under 12 months, 12.5% after |
| Safety | Not bank-guaranteed; value can move | Not bank-guaranteed; can dip over short periods |
| Early exit | Small charge if taken out within the first few days | Usually carries a charge for early exit |
Getting money out. This is the primary strength of a liquid fund. For a business that needs to move money back to the bank for an upcoming salary or GST payment, speed is often the most important factor. In a liquid fund, the money comes back within three business days, usually sooner.
Tax. This is where an arbitrage fund differs most. For a company, liquid fund gains are treated as normal income and taxed at the company's prevailing tax rate. Arbitrage funds are taxed like equity. This means the rate is 20% if the units are sold within 12 months, and 12.5% if they are held for longer. For many businesses, these lower rates are a significant consideration, provided the money can stay in the fund long enough for the tax treatment to be useful.
Safety. Neither fund is a bank deposit. An FD has a fixed rate and is a bank product, while these are mutual funds. A liquid fund is designed to be stable, but its value can move. An arbitrage fund can also move and may even dip over short periods. Neither is bank-guaranteed.
Early exit. Both funds can carry costs if money is moved out too quickly. A liquid fund might have a small charge if units are sold within the first few days. Arbitrage funds usually have their own exit charges. For any money that your company knows it will need within just a few days, keeping it in the current account is often the simpler path.
When does each fund fit your company's cash?
The choice of where to move spare cash depends on how your company prefers to balance speed against tax efficiency. Most companies find that different sums of money have different needs.
A liquid fund fits operational cash. If the money is waiting for payments that fall due in the next few weeks or months, such as salaries or vendor payouts, the liquid fund's speed is a fit. It allows the company to take out part or all of the money and have it back in the bank before the payment date. While the gains are taxed at the normal rate, the flexibility of access is the priority here.
An arbitrage fund fits cash with a longer wait. If a company has a larger surplus that it does not expect to need for several months, an arbitrage fund might be considered. The equity tax rates of 20% for short term and 12.5% for long term can make a difference to the final amount the company keeps. The trade is that the money comes back more slowly and the value can fluctuate more than a liquid fund.
In both cases, the governance remains the same. The units stay in your company's own name, and the approvers your board names sign off every movement. Whether your company uses liquid funds, arbitrage funds, or a mix of both for different needs is entirely the company's decision.
Idlewise is offered by Sigfyn Financial Services Private Limited, an AMFI-registered mutual fund distributor (ARN-254976). Sigfyn distributes mutual funds; it does not provide investment advice. Mutual fund investments are subject to market risks. Read all scheme related documents carefully. Past performance is not indicative of future returns.