The world of encrypted digital currency, commonly known as ‘cryptocurrency’ including Bitcoin, Ethereum, and Litecoin, has been a popular investment choice for many SMSFs lately, highlighting the importance of having a well-defined SMSF investment strategy.
So what exactly is cryptocurrency?
In a nutshell, it is a virtual currency or online cash. It is an encrypted unit of currency that uses digital files as money that can be bought, sold, or exchanged for goods and services.
Can my SMSF invest in cryptocurrency?
Maybe. Just like any other allowable investment that the trustees of an SMSF can invest in, it must be permissible by the fund’s trust deed. The governing rules must allow the fund to invest in digital currencies like cryptocurrency. If the rules are silent on this investment class and there is no “catchall clause”, then it is not permissible unless the trust deed can be updated to one that allows it.
What other considerations need to be considered?
Is it trading or investing – what is the difference?
This can be a grey area, like whether an individual is trading or investing in shares. However, from an SMSF perspective, investing in shares (or any other asset class) as a business (ie. trading) is not permitted. This is because an SMSF cannot be running a business as these breaches the sole purpose test.
As such, the tax treatment of cryptocurrency in an SMSF will always be on a capital account. If the cryptocurrency is sold profitably, capital gains tax will be payable. If sold at a loss, it is seen as a capital loss and can only be used against capital gains or carried forward to offset future gains.
The ATO will look at various factors below to determine whether shares or in this case cryptocurrency, are being held as an investment or as trading stock:
- How much capital has been invested?
- What is your motive for the investment? Is the sole purpose only to generate a profit, or are there other intentions, such as generating cash flow to fund retirement income stream payments?
- The repetition, volume, and regularity of the transactions.
- Is there organisation of the trading in a business-like manner?
SMSF Sole Purpose Test
As a trustee of an SMSF, the critical responsibility when managing the fund’s investments is to ensure that the investments do not contravene the sole purpose test. SMSFs are concessionally taxed compared to personal tax rates or other tax structures.
The sole purpose test of an SMSF must be to provide retirement benefits to its members or their dependents if a member dies before retirement.
SMSF Investment Strategy
Another legal requirement of SMSF trustees is to formulate, regularly review and give effect to SMSF investment strategy. As cryptocurrency is a high-risk and highly volatile investment, trustees must have a written investment strategy documenting why the SMSF has invested in cryptocurrency. This includes how this asset class fits in with the fund’s overall investment strategy, their understanding of the risk and return noted that only capital growth could be derived from cryptocurrency, the fund liquidity and investment diversity, and how the investments of the fund can meet its existing and future liabilities.
Practical issues of owning cryptocurrency
Apart from the above legal issues of owning cryptocurrency in an SMSF, other practical issues may include:
- Keeping the assets separate – if an exchange platform and/or digital wallet is being used to hold the cryptocurrency is in the name of the SMSF trustees personally, even though it may be held custodial for the SMSF, and no further documentation can be provided to evidence ownership is solely in the name of the SMSF, this may result in the SMSF auditor having to qualify part of their audit report;
- Acquisition from a related party – if the fund trustee has personally invested in cryptocurrency and now wants to “transfer” it to their SMSF, this is not permissible as digital currency is a prohibited asset for an SMSF to acquire from a related party (i.e. in specie contributions of cryptocurrency are not permitted);
- Charge over fund assets – the assets of an SMSF cannot be used for collateral for a loan or a margin requirement for a trade, including a cryptocurrency exchange adopting hedging activities;
- Pension payments cannot be made in specie via a transfer of cryptocurrency;
- Recordkeeping for cryptocurrency is paramount, and ensuring the suitable systems are being used to keep track of information such as transaction dates, values of the cryptocurrency etc.;
- Paying for expenses using the cryptocurrency – this will result in a disposal of cryptocurrency to obtain the goods or service, and as such, a CGT event will occur; and
- Death of the SMSF trustee – what happens to the private key access to the digital wallet upon the trustee’s death? Can this information be accessed by other trustees of the fund?
For more information on SMSF investing in cryptocurrency by the ATO – click here.
If you have any questions regarding your SMSF investing in cryptocurrency or your SMSF investment strategy, please contact us to help guide you in the right direction.
Kreston Stanley Williamson Team
*Correct as of 23 March 2021
*Disclaimer – this article has been produced by Kreston Stanley Williamson as a service to its clients and associates. The information contained in the article is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas in this article, you must seek specific advice relating to your particular circumstances. Liability is limited by a scheme approved under professional standards legislation.
