Attention has recently been given to the addition of non-traditional investments such as bitcoin in SMSF portfolios. Before doing so, SMSF trustees should take steps to understand the asset class and most importantly obtain professional advice on how they can safely implement digital assets into portfolios to ensure they meet all their fiduciary obligations as SMSF trustees and that no issues arise during annual audits.
Before discussing the intricacies of allocating bitcoin into an SMSF, allow us to establish a foundational understanding of this digital asset, and how it differs from traditional investments and currencies. In Monochrome Research’s piece titled The Origins and Evolution of Bitcoin, the team delves into why Bitcoin was created in the first place, as well as the blockchain technology underpinning its decentralised system. In short, Bitcoin is entirely digital and decentralised, meaning that transactions take place peer-to-peer (i.e. absent 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.
The Requirements for Bitcoin in an SMSF
SMSF Trust Deed
As alluded to earlier, SMSFs are tightly regulated. Since bitcoin is an asset for both investment and taxation purposes, the 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 (SISA) and Regulations 1994 (SISR). 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.
The 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; and
- not to profit from their position as trustees.
Note that trustees may be the individual members of the SMSF through what is called an ‘individual trustee structure’, or the trustee may be a corporate trustees 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.
So what does this all mean?
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.
Why Pathway Choice is Key to Exposure
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, one should earnestly consider the risks involved in regulated pathways vs unregulated pathways.
As part of the strict regulation of SMSFs, the SMSF auditor and Australian Taxation Office (ATO) require that all records and documentation of the transaction history of the asset are kept.
When obtaining bitcoin in an SMSF, the ATO requires that the asset is acquired at the “fair market value” - a value “which can be obtained from a reputable digital currency exchange or website that publishes its rates publicly.” Alternatively, the Australian Securities and Investments Commission (ASIC) outline requirements in Report 705 for reputable price benchmarks around which products may be built to meet acquisition requirements.
Digital Currency Exchanges (DCEs), often known as cryptocurrency exchanges, are largely unregulated and are susceptible to technical and human errors as well as hacking/theft. This poses an additional risk to an already speculative and high-risk investment.
Pursuing self custody (i.e. the bitcoin is stored in a wallet owned under the SMSF) contains many other risks of its own such as security and confidentiality, and risk of lost keys or passwords.
The 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 through self-custody. As a subset of ETPs, exchange traded funds (ETFs) are traded in a familiar, traditional stock exchange environment and provide investors with the opportunity to gain bitcoin exposure
ETFs also come with an added layer of protection for retail investors via a product disclosure statement (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, and the 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 ought to be conducted to ensure a product is considered carefully when looking to integrate it into a portfolio.
Regulated investment trusts are also another regulated pathway, whereby units can be purchased in a managed fund which can later be redeemed for cash. For example, the Monochrome Bitcoin Fund, which targets a near 100% allocation of bitcoin, is available for SMSFs which qualify as wholesale investors. You can contact the Monochrome team to further discuss how this may work within your SMSF. Like an ETF, the fund allows the SMSF to gain exposure via a traditional framework, whilst providing added security and addressing concerns regarding banking and cyber security risks.
Since 2014, the ATO has treated cryptocurrencies like any other CGT (Capital Gains Tax) asset, simply meaning it imposes a tax on realised capital gains. For SMSFs, this means a 15% tax rate on capital gains and a 10% tax rate for long-term capital gains (i.e. investments that were held for over a year). It then follows that once members of the SMSF are in the pension phase (i.e. retired) then capital gains made on the sale of bitcoin are not subject to any tax.
Ultimately, the current rules and regulations must be thoroughly considered to allow for bitcoin (or other crypto-assets) to be included in 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 advice should also be obtained to ensure all constituent documents allow the investment and to ensure trustees meet all fiduciary obligations and that no issues arise on annual audits.
This publication has been prepared by Monochrome Asset Management Pty Ltd ABN 80 647 701 246 (Monochrome) the Investment Manager of the Monochrome Bitcoin Fund (the Fund). Monochrome is a Corporate Authorised Representative No. 1286428 of Non Correlated Capital Pty Ltd ABN 99 143 882 562 AFSL 499882 (NCC). NCC is the Trustee of the Fund. This publication has been prepared by Monochrome to provide you with general information only. In preparing this publication, we did not take into account the investment objectives, financial situation or particular needs of any particular person. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on this information. Neither Monochrome, NCC nor any of their related parties, their employees or directors, provide any warranty of accuracy or reliability in relation to such information or accept any liability to any person who relies on it. You should obtain professional advice and consider the Information Memorandum before making a decision in relation to this product. Any forecasts and hypothetical examples are subject to uncertainty and are not guaranteed. Past performance is not a reliable indicator of future performance. You can obtain a copy of the Information Memorandum for the Fund by contacting Monochrome at https://monochrome.co.
Marketing & Content Manager
Monochrome Asset Management
Monochrome Asset Management (Monochrome) is proud to be a major partner at the Financial Review Cryptocurrency Summit 2023 on 16 October, in Sydney. Organised by The Australian Financial Review, it is the nation’s premier crypto-asset forum for investors, policy makers, regulators and tech innovators.