The recent surge in the price of Bitcoin has many investors seriously looking at crypto-currency as a part of their SMSF investment portfolio.
So, can an SMSF invest in bitcoin and crypto currency, and if so, what must trustees and advisers be aware of?
There are a number of key areas that trustees need to consider and address if they are looking if invest their SMSF monies into Bitcoin and other crypto-currencies / crypto-assets.
Is it allowable under the SMSF trust deed?
For any investment to be allowed, it must specifically be enabled and included in the trust deed of the SMSF. As Bitcoin and other crypto-assets are part of a relatively new asset class, it is unlikely that most SMSF deed would include a provision for investing into these currencies.
The ATO’s view is the Bitcoin and other crypto-assets are NOT currencies:
“Our view is that bitcoin is neither money nor a foreign currency, and the supply of bitcoin is not a financial supply for goods and services tax (GST) purposes. Bitcoin is, however, an asset for capital gains tax (CGT) purposes.”
Most definitions of digital currency include both crypto-currencies as well as traditional fiat currency in digital format.
SMSF Investment Strategy
Like any SMSF investment, Bitcoin and crypto-currency must be included in the documented investment strategy of the SMSF.
SMSF investment strategies MUST consider the following:
1. Diversification (investing in a range of assets and asset classes)
2. The liquidity of the fund’s assets (how easily they can be converted to cash to meet fund expenses)
3. The fund’s ability to pay benefits (when members retire) and other costs it incurs
4. The members’ needs and circumstances (for example, their age and retirement needs). This includes risk and return considerations.
5. Whether to hold insurance cover (such as life insurance) for each member of your SMSF.
As with the SMSF trust deed, trustees would need to update their investment strategy document to include crypto-assets.
It is important to note that crypto-assets such as Bitcoin don’t generate income – so any investment is purely based on expected capital appreciation.
The Sole Purpose Test
The sole purpose test ensures that an SMSF is maintained for the sole purpose of providing retirement benefits to members, or to their dependants if a member dies before retirement.
This means the trustees or anyone else directly or indirectly cannot obtain a financial benefit when making investment decisions and arrangements (other than increase the return to your fund).
Provided other issues identified below are addressed (especially around verification of ownership and separation from personal assets) there should be no issues with the sole purpose test.
One potential item that may impact sole purpose is affiliate fees or commissions. Many crypto-currency exchanges provide investors with an affiliate system whereby a percentage of their trading fees are paid to the person who referred the account holder.
In context of an SMSF, if a trustee personally established and account and signed up as an affiliate, and then set up an SMSF account using that affiliate / referral code, the trustee personally would receive affiliate commission from the SMSFs investment activities and the sole purpose test would be breached.
If you can think of other scenarios with crypto-currencies that would breach the sole purpose test, please contact us.
Ownership and Existence of Bitcoin
Bitcoin and other crypto-assets don’t physically exist. They are intangible and created as a reward for mining which uses computer processing power. If a trustee wanting to invest their SMSF monies into Bitcoin doesn’t understand the previous sentence, they should question their proposed investment strategy.
Intangible assets can be owned. Intellectual property for example can be incredibly valuable – provided you can confirm you own and control it.
Crypto-assets are purchased via a coin exchange company using cash. Typically the process is that money is transferred from the investors bank account into an online cash ‘wallet’ with the exchange provider. The balance in the wallet is then utilised to purchase Bitcoin and other crypto-currency.
At this stage, most Australian based coin exchanges will only set up an account using the name and email address of an individual – there is no provision for SMSFs or other entities to open an account. Although this is restrictive, SMSFs can overcome this and utilise coin exchanges and remain compliant with the SIS Act and Regulations and also keep their auditors happy.
I personally (not my SMSF) have set up an account with an Australian based coin exchange and undergone their AML / KYC verification process. During a verification phone call with their customer service team, they asked me whether I was investing on behalf of a company, trust or SMSF. I informed them I was not, but I asked what if I said yes and how it would work. They said they would need to be provided with additional documentation for the entity and would expect that the linked bank account be in the name of the entity.
With the attention and growth of Bitcoin and other crypto-asset investments I would expect that coin exchanges would follow fintech business like BrickX and Stake and enable non-individual entity accounts including SMSFs.
Practical methods of confirming that Bitcoin or other crypto-assets are in fact held by an SMSF may include:
• Utilising a SMSF specific email address to register the coin exchange account (this also helps to show the assets are separate to any other accounts in the name of the trustees personally)
• DO NOT transact Bitcoin or other crypto-assets between the SMSF account and a personal account in the name of the members.
• Linking the correct SMSF bank account to the coin exchange account (I would strongly suggest a separate bank account is used to keep any trading and access separate from the primary transactional account of the SMSF).
• Completing a declaration of trust or other declaration accepted by the auditor of the SMSF confirming that the crypto-assets are held by the trustee on behalf of the fund and not used personally by the trustees (an example Declaration of Trust document can be found here).
• Ensure all trading transaction reports and tax invoices are saved and made available for both the SMSF administrator and the independent auditor (these should also be sent / forwarded to your SMSF administrator as they occur).
• Obtain a wallet balance report showing the holdings at 30 June each year (screenshot for example). This would need to be facilitated for both online wallets with a coin exchange as well as offline / cold storage wallets.
The above list is not exhaustive, but in most bases would provide an independent SMSF auditor with enough evidence to enable them to confirm that the Bitcoin or crypto-assets are held and controlled by the SMSF.
Exchanges, Wallets and Storage
Investors have the option of keeping their crypto-assets within the online wallets, or transferring them an offline wallet which are sometimes called a ‘cold storage’ device.
The following guides from bitcoin.com.au provides further information on wallet options: https://bitcoin.com.au/page/wallets/
Although probably an over-simplistic summary, and online wallet with a coin exchange holds both the public key (similar to an account number) and a private key (like a password that verifies you own the crypto-assets).
The security of the exchange provider is paramount. If the coin exchange you hold your crypto-assets with is hacked, your investment will be lost. There have already been widely publicised examples of coin exchanges being hacked.
Selecting a Coin Exchange
SMSF trustees should do extensive due diligence before investing via a coin exchange. As a minimum, trustees should consider the following:
• Ensure the coin exchange is based in Australia and has a physical office location and Australian based staff.
• Investigate how long the business has been in operation and who are the individuals behind the coin exchange (LinkedIn and Google searches useful here).
• Check to ensure the coin exchange detailed complaints handling procedures, comply with Anti-Money Laundering (AML) laws and conducts detailed Know-Your-Client (KYC) verification procedures.
• The coin exchange is a member of a self-regulating industry body such as the Australia Digital Commerce Association
• The business has strong customer support both via phone and online.
• The trading fees or commissions are fair and reasonable.
In summary, potential crypto-asset investors should compare a coin exchange to a stockbroker and look for similar compliance and complaints handling procedures.
Practical Implications for SMSF Administration
As crypto-investments are so new, accounting and administering these assets are completely manual. SMSF software providers don’t have data feeds from exchanges and do not pull through a feed of values for the investments.
Investing into Bitcoin and other crypto-currencies would likely increase both the administration cost and audit cost to the SMSF. The amount of increase would depend on the administrator and type / frequency of trading and investment.
We suggest the following for trustees before investing in Bitcoin or other crypto-investments:
1. Update trust deed and investment strategy (as above)
2. Set up an NEW cash account to link to your online SMSF wallet and ensure all transaction go via that account
3. Speak to the administrator of the fund BEFORE commencing trading. Understand what information and documents will be needed to maintain the accounts and also what the independent auditor will require in terms of evidence at the end of the financial year.
4. Set up an auto-forwarding rule for any email trade confirmations from the coin exchange so your SMSF administrator receives a copy of the invoice / trade confirmation when it occurs.
The following are questions we’ve been asked about Bitcoin and crypto-assets:
Can I transfer Bitcoin I own personally to my SMSF?
• No. The ATO has deemed that Bitcoin and other crypto currencies are NOT money nor a foreign currency, hence they cannot be acquired from a related party (member).
• A member would need to sell the crypto-investment, transfer the cash to the SMSF, and then the SMSF could re-purchase the crypto-investment if necessary.
My SMSF owns Bitcoin, can I use it to make a pension or benefit payment?
• If you are eligible to receive a benefit payment from your SMSF you can transfer Bitcoin or a crypto currency as a lump sum payment, but pension payments still need to be cash.
Can my SMSF mine Bitcoin?
• Technically yes. Mining involves using computer processing power (a lot of processing power) to ‘win’ the right to time-stamp a transaction on the blockchain with the reward being some Bitcoin.
• The income (Bitcoin) generated by the mining activity would be assessable income to the SMSF and depending on income level GST is required to be remitted to the ATO. The ATO has provided information on the tax treatment of Bitcoin mining here: Mining Bitcoin.
• Expenses – namely electricity and depreciation of computer hardware – would also be deductible in relation to generating the income. Being able to accurately track and have the SMSF pay for these expenses is complex and advice should be sought from a specialist SMSF accountant or administrator.
• A better solution may be for members of the SMSF to establish a Bitcoin mining enterprise in their own names (or an trading entity) and use concessional super contributions (paid in cash – not Bitcoin – to the SMSF) as a legitimate tax deduction to offset income generated from mining activities.
Can I pay SMSF expenses or but other investments using Bitcoin?
• Yes. The ATO has confirmed that Bitcoin and other crypto-assets are similar in nature to barter transactions.
• Investments need to be made at arm’s length / market value and cannot be acquired from related parties of the SMSF unless they are one of the few exceptions (a listed security or business real property).
• For all Bitcoin transactions you need to keep a record of the date, the amount in Australia dollars, the purpose of the transaction and who the other party was (even if it’s just their Bitcoin address / public key).
How is Bitcoin in an SMSF taxed?
• Crypto currencies are taxed on capital account, meaning there is a capital gain or loss when the investment is sold.
• Any trading fees or commissions form part of the cost-base of the asset and cannot be claimed as a tax deduction.
Who can provide financial advice on Bitcoin and other crypto-currencies?
• Crypto-investments like Bitcoin are not a financial product, however any investment related to an SMSF is considered financial product advice.
• It is unlikely that any financial advisers would be specifically licensed to provide advice on Bitcoin so any advice would be limited to compliance with the relevant SIS Act and Regulations.