The term cryptocurrency is generally used to describe a digital asset in which encryption techniques are used to regulate the generation of additional units and verify transactions on a block-chain.

Let’s break that down…

• Encryption techniques – a form of security to prevent online attacks and threats.
• Regulate the generation of additional units – the system defines whether new cryptocurrency units can be created and if so, the system defines the circumstances of their origin and how to determine the ownership of these new units.
• Verify transactions on a block-chain – a block-chain is a continuously growing list of records, referred to as blocks. By design, these blocks are a secure way of holding transaction data that cannot be altered.

Cryptocurrency in Australia operates independently of a central bank, central authority or government and is often not backed by a tangible asset- it isn’t physical currency like the money you would have in your wallet.

Bitcoin is the most well-known type of cryptocurrency, however, there are over 500 different types of cryptocurrencies and this number continues to increase.

Can an SMSF invest in cryptocurrency?

There is nothing directly preventing SMSFs from investing in cryptocurrency.  However, as with all SMSF investments, there are a number of regulatory considerations you need to take into account.

For example, the investment must:

• Be allowed for under your fund’s trust deed.
• Be in accordance with your fund’s investment strategy and governing rules.

Your fund’s deed should be reviewed to ensure it permits investments in cryptocurrency. In particular, given the speculative nature of cryptocurrency, your fund’s investment strategy should be updated to document the risks associated with the investment.

As with all investments, you need to be aware of the risks associated with investing in cryptocurrency and its often volatile nature. Care needs to be taken to ensure your fund is being run for genuine retirement benefits and that cryptocurrency fits in with your investment strategy.

Ownership and separation of assets

The use of block-chain technology offers alternatives to traditional payment models.  It removes intermediaries from the payment system and can make the system more efficient and cost effective.  While the anonymity of cryptocurrency was a draw card in its conception, it can make it difficult when compared to other assets for you to easily show ownership within your self managed super fund.

You need to ensure your fund’s assets are held separately from personal assets and your SMSF has clear ownership of the cryptocurrency.

In Australia, cryptocurrency is not considered to be money, rather it is classified as property for income tax purposes.   As SMSFs are prohibited from intentionally acquiring assets from related parties, SMSF trustees and members cannot make in specie contributions or other transfers of their cryptocurrency to the fund.^[1]  This means the fund must maintain and be able to provide evidence of a separate cryptocurrency digital wallet, not the same digital wallet where you may also have personal investments in cryptocurrency.  

All the normal record-keeping and valuation rules still apply.  The value in Australian dollars will be the fair market value which can be obtained from a reputable digital currency exchange or website that publishes its rates online.

The value of cryptocurrency can change constantly. For the purpose of calculating member balances at 30 June, the ATO will accept the 30 June closing value published on the website of a cryptocurrency exchange that reports on historical cryptocurrency values.

Risks

As the creation, trade and use of cryptocurrency is rapidly evolving and increasing in popularity, governments continue to regulate the use of the technology. This includes regulation around the tax outcomes of investing in and transacting with cryptocurrency.

As cryptocurrency is not guaranteed by any bank or government, yet, there are certain risks which need to be considered.

Some particular risks include the fluctuation in value, which is influenced by a number of factors including the number of people using it, the ease with which it can be traded or used, the perceived value of the currency and its underlying block-chain technology and the reach of marketing on social media.

Another risk is security, as cryptocurrency technology offers anonymity, it can be difficult to determine who issued the currency. When compared to other assets, you may have less protection if your digital wallet is hacked, you lose the key to your digital wallet or unauthorised debits are made from your digital wallet.

Your fund may be able to claim a capital loss if cryptocurrency is stolen or lost. This will only mitigate a percentage of the loss and only if your fund has any capital gains to offset.  

Income Tax consequences

As cryptocurrency is classified as property for tax purposes, any gains will be subject to capital gains tax (CGT) and included in your fund’s assessable income.  Superannuation funds are entitled to a CGT discount of one-third if the relevant asset had been owned for at least 12 months.

In some instances, cryptocurrency may be treated as a personal use asset and therefore any capital gains made from personal use assets acquired for less than $10,000 are disregarded for CGT purposes.  However, the sole-purpose test would prohibit funds holding cryptocurrency as a personal use asset.

A CGT event will therefore occur where your SMSF disposes of the cryptocurrency.  This will include trading or exchanging one cryptocurrency for another cryptocurrency.

Chain-splits

Where you receive new cryptocurrency as a result of a chain split (such as Bitcoin Cash being received by Bitcoin holders) the ATO viewpoint is that you do not derive ordinary income or make a capital gain at that time you receive the new cryptocurrency. Rather you will make a capital gain (or loss) when you dispose of the “new” currency.

Initial Coin Offerings

When a new cryptocurrency is being developed, developers may offer initial coin offerings (ICO’s) as a strategy for raising development funds.  These ICO’s can offer a number of rights such as a right to the share of the profits in a product or provide a right to access a software application. 

Not all ICO’s are an investment in digital currency.  Where the cryptocurrency is not subsequently developed or has limited success you may not be issued any currency.   Any tax outcomes will be dependent on what types of rights the fund is issued.

ICO’s often issue white papers outlining the benefits of the investments.  While these documents can be helpful in understanding the product offered, these documents do not meet the same requirements which are required for initial public offerings when a company offers shares to the public.

For further information on ICOs and the risks to consider see ASIC’s MoneySmart website.

Pensions or benefit payments

Where a member satisfies a condition of release, your SMSF can make an in specie lump sum payment by way of transfer of cryptocurrency. However, pension payments must be made in cash.

Therefore, you’ll need to consider whether there will be any CGT consequences as a result of converting cryptocurrency to cash to meet any pension payment requirements.

You don’t have to do it all yourself, seek help

SMSF does stand for self managed superannuation fund but you don’t have to do it alone. Cryptocurrency is an ever-changing and emerging asset class, especially within the SMSF sector. Assistance from an appropriately qualified SMSF Specialist is encouraged to ensure you are making the most appropriate choices for your specific circumstances.

^[1] Cryptocurrency will not fall into the exception for related party transaction as it does not meet the definition of a listed security.