Current as of 23 March 2021
Bitcoin, Ethereum, Litecoin just to name a few. The world of encrypted digital currency, commonly known as ‘cryptocurrency’ has been all the rage for quite some time, and most recently being the “in thing” for many SMSFs.
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 good 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. That is, the governing rules must allow the fund to invest in digital currencies such as cryptocurrency. If the rules are silent on this investment class and if there is no “catchall clause”, then it is not permissible unless the trust deed can be updated to one that does allow for it.
What other considerations need to be considered?
Is it trading or investing – what is the difference?
This can be a grey area just like whether an individual is trading shares or investing in shares. However, from a SMSF perspective, investing in shares (or any other asset class) as a business (ie. trading) is not permitted. This is because a SMSF cannot be running a business as these breaches the sole purpose test.
As such, the tax treatment of cryptocurrency in a SMSF will always be on capital account. That is, if the cryptocurrency is sold at a profit, then capital gains tax will be payable. If it is 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 capital gains.
The ATO will look at various factors below to determine whether shares, or in this case cryptocurrency, is 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 to only 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 a SMSF, the key responsibility when it comes to managing the fund’s investments is to always ensure that the investments do not contravene the sole purpose test. This is because SMSF’s 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 dependants if a member dies before retirement.
Another legal requirement of SMSF trustees is to formulate, regularly review and give effect to an investment strategy. As cryptocurrency is a high risk and highly volatile investment, trustees need to 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 can 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 custodially 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 right systems are being used to keep track of information such as transaction dates, values of the cryptocurrency etc.;
- Paying for expenses using 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 death of trustee? 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 into cryptocurrency, please contact us to help guide you into the right direction.