Digital currencies are an asset class where professional advice is essential.
Does crypto belong in an SMSF?
The role of non-traditional investments such as bitcoin in SMSF portfolios has garnered attention recently. But before adding bitcoin to an SMSF, trustees need to understand the asset class, ensure they meet all their fiduciary obligations and that no audit issues arise. Professional advice is recommended.
Bitcoin is entirely digital and decentralised, meaning that transactions take place peer-to-peer (without a third party such as a bank) irrespective of time or location. It does not generate any form of income and as an investment, is a speculative asset in which investors are typically concerned with capital gains.
Check the SMSF trust deed
Since bitcoin is an asset for both investment and taxation purposes, an SMSF must ensure investment in this asset is permitted in the trust deed and is aligned with the fund’s investment strategy. It is common for trust deeds to have a clause that permits the SMSF to “invest in any other type of asset permitted by the Superannuation Industry (Superannuation) Act 1993 and Regulations 1994”. If this is the case, the deed may allow an investment in bitcoin, but trustees should always obtain a legal sign-off to confirm this.
Fiduciary responsibility of a trustee
As a part of SMSF regulation, trustees are obligated to:
- Not place themselves in a situation of conflict between their self-interest and their duty to the members
- Not to profit from their position as trustees
Trustees may be the individual members of the SMSF through an individual trustee structure, or the trustee may be a corporate trustee with the members as directors of the trustee through a corporate trustee structure.
This does not imply that trustees who owe a fiduciary responsibility to themselves can simply act in their own interest however, since the term “beneficiary” can also extend to the members’ dependents and/or legal personal representative who might one day benefit from the SMSF. For example, if a member of the SMSF passes away, their partner and children may become beneficiaries.
Sole purpose test
An especially important principle of SMSF investments is that they must pass the sole purpose test – the sole purpose being to provide retirement benefits to its members and other potential beneficiaries.
This means that the investment must not be intertwined with personal assets and must be solely owned by the SMSF, meaning it is distinguishable from personal or business assets. Otherwise, it would be in violation of the sole purpose test.
In other words, if a trustee intends to hold bitcoin as a part of the SMSF, they would need to hold it in a digital wallet separate from personal funds. Co-mingled wallets would probably not pass the sole purpose test.
A potential solution to resolve this issue, given the fiduciary nature of the obligation to hold SMSF assets on trust, may be to use a crypto-asset custodian.
Pathway choice is key
Investor protection is arguably one of the most important considerations given the unregulated nature of the asset class. By recording the ownership of assets separately in accordance with the sole purpose test, the fund’s assets are protected from legal complications with respect to the test. However, as a largely unregulated industry, it is necessary to weigh up the risks of regulated pathways versus unregulated pathways.
The ATO requires all records and documentation of the transaction history of the asset are kept. When obtaining bitcoin in an SMSF, that means it must be acquired at “fair market value” – a value “which can be obtained from a reputable digital currency exchange or website that publishes its rates publicly”.
Alternatively, ASIC outlines requirements in Report 705 for reputable price benchmarks around which products may be built to meet acquisition requirements.
Digital currency exchanges – cryptocurrency exchanges – are largely unregulated and susceptible to technical and human errors as well as hacking or theft. This poses an additional risk to an already speculative and high-risk investment.
Pursuing self-custody (where the bitcoin is stored in a wallet owned under the SMSF) contains hazards of its own such as security and confidentiality, and risk of lost keys or passwords.
Benefits of regulated pathways
Alternatively, the fund can gain bitcoin exposure through regulated investment vehicles that outsource risks traditionally associated with holding bitcoin as an investment.
For example, exchange-traded products (ETPs) that track the price of bitcoin allow investors to gain regulated exposure without requiring the SMSF to own the bitcoin itself.
As a subset of ETPs, exchange-traded funds (ETFs) offer bitcoin exposure and trading in a familiar, traditional stock exchange environment.
ETFs also come with an added layer of protection for retail investors via a PDS. As a requirement from ASIC, “a PDS is to contain sufficient information so that a retail client may make an informed decision about whether to purchase a financial product and to allow for comparison of financial products”.
The document aims to provide consumer protection and includes important information such as the fees involved, tax implications, risks, benefits and significant characteristics of the product. A PDS must be provided to an individual either before or when offering a financial product to them.
Not all ETF products offer the same risk profile, however. Due diligence relating to product structure, service providers and licensing of issuer should be conducted.
Regulated investment trusts are also another regulated pathway, whereby units can be purchased in a managed fund that can later be redeemed for cash.
Like an ETF, a fund allows the SMSF to gain exposure via a traditional framework, while providing added security and addressing concerns regarding banking and cyber-security risks.
Since 2014, the ATO has treated cryptocurrencies like any other CGT asset. For SMSFs, this means a 15 per cent tax rate on capital gains and a 10 per cent rate for long-term capital gains (investments that were held for over a year). Once SMSF members are in pension phase, capital gains made on the sale of bitcoin are free of tax.
The rules and regulations need to be thoroughly considered before adding bitcoin (or other crypto assets) to an SMSF portfolio. It is treated much like any other asset with respect to the trustee’s obligations and the trust deed, as well as taxation.
However, due to the nature of the asset class, it is important to make use of regulated pathways such as a regulated fund or an ETF to best manage investor protection.
Professional advisers need to ensure all constituent documents allow the investment, that trustees meet fiduciary obligations, and no audit issues arise.
Craig Hobart is head of distribution for Monochrome Asset Management.