Can SMSF invest in Bitcoin?

EXPERT OBSERVATION

While there are a large number of cryptocurrencies in existence (currently over 1600), this article will focus on Bitcoin for simplicity. Our comments contained here may apply to other cryptocurrencies with the same characteristics as Bitcoin.

What is Bitcoin?

As a very basic explanation, the Bitcoin network is a peer-to-peer payments network that uses public key cryptography to validate transactions involving Bitcoin and to generate new Bitcoins. This network is ‘decentralised’ in that it is not controlled by any government or other central authority.

Bitcoins are created via ‘mining’. This is a process where computer processing power is used to verify Bitcoin transactions and add to the public Bitcoin ledger, known as the block chain. By performing this task the miners may receive new Bitcoin.

Bitcoins in existence may be sent and received via an ‘address’, a unique alphanumeric identifier. A person proves their ownership of a Bitcoin using a public/private key pair. While the public key is known to all and corresponds to a specific Bitcoin, the corresponding private key is kept secret within a digital wallet. The use of the public/private key allows a person to transfer Bitcoin to another address. These transactions are verified by others in the network and added to the public ledger.

Generally, a person would purchase Bitcoin using their own address/wallet privately or via an exchange using a broker (similar to a share trading broker) and if needed transfer the purchased Bitcoin to their own address/wallet.

Can an SMSF invest in Bitcoin?

Any SMSF investment is subject to the regulations under the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’) and the Superannuation Industry (Supervision) Regulations 1994 (Cth) (‘SISR’). This article does not intend to determine if any specific investment is permissible under superannuation law but generally discusses areas that may need to be considered prior to an investment in Bitcoin. Broadly, there is no specific prohibition on an SMSF investing in Bitcoin but certain factors must be considered.

Investment Strategy

Under s 52B of the SISA and reg 4.09 of the SISR, the trustee of an SMSF is required to formulate, review regularly and give effect to an investment strategy that has regard to the whole of the circumstances of the fund including, but not limited to, the following:

(a)         the risk involved in making, holding and realising, and the likely return from, the fund's investments, having regard to its objectives and its expected cash flow requirements;

(b)         the composition of the fund's investments as a whole including the extent to which the investments are diverse or involve the fund in being exposed to risks from inadequate diversification;

(c)         the liquidity of the fund's investments, having regard to its expected cash flow requirements;

(d)         the ability of the fund to discharge its existing and prospective liabilities; and

(e)         whether the trustees of the fund should hold a contract of insurance that provides insurance cover for one or more members of the fund.

The SISA and SISR do not specify a particular level of risk that is acceptable for a fund’s investment strategy. This would ultimately depend on the risk tolerance of the trustee and members.

If a person suffers loss or damage as a result of a contravention of a covenant imported in an SMSF deed by the SISA, such as the requirement to formulate an investment strategy, they may take action against a person involved in the contravention to recover the amount of the loss or damage. In an SMSF context, it may not be viable for a member to take action against themselves or the corporate trustee. If an adviser assists a client to invest in Bitcoin while the SMSF governing rules do not authorise such an investment and a member suffers loss, the adviser could be exposed to legal liability.

Further, it should be understood that SMSF trustees are in a fiduciary relationship in respect of fund members and any other beneficiaries of the fund. Due to the nature of a fiduciary relationship, SMSF trustees are under the highest of duties to act in the best interests of the SMSF’s beneficiaries. In addition to the various state and territory trustee Act obligations which may apply, s 52B(2)(b) of the SISA places the following covenant on an SMSF trustee:

to exercise, in relation to all matters affecting the fund, the same degree of care, skill and diligence as an ordinary prudent person would exercise in dealing with property of another for whom the person felt morally bound to provide.

The investment strategy for an SMSF must allow for investing in Bitcoin. However, the question of whether such a strategy is prudent for an SMSF will depend on the circumstances of the fund. Considering the volatility of Bitcoin and the fact that it appears (currently) to offer only speculative capital growth opportunities there is clearly a high risk inherent to any Bitcoin investment. On that basis a prudent SMSF trustee may decide that only a small component of a fund’s overall investment portfolio should be made up of Bitcoin or other cryptocurrencies. What is prudent in any situation would depend on the particular circumstances of the fund, such as how close the members are to retirement.

While the DBA Lawyers SMSF deed specifically excludes the rules regarding prudent trustee investment considerations under the various state and territory trustee Acts, not all SMSF deeds will do this. If these provisions haven’t been excluded under a Fund’s deed the Trustee may find them difficult to comply with when investing in Bitcoin.

Governing rules of the fund

As well as the regulations contained in the SISA and the SISR an SMSF trustee will be bound by the governing rules of the fund relating to investment. An SMSF trustee should ensure the governing rules expressly allow them to invest in Bitcoin. As older SMSF deeds are unlikely to provide for this, a variation of the fund’s governing rules may be required prior to such an investment.

Requirement to identify trust assets

A possible issue with SMSFs investing in Bitcoin is the requirement for a trustee to be able to identify the assets of the fund. The Bitcoin market ultimately allows anonymous holdings of Bitcoin. Accordingly, processes should be put in place to ensure that a trustee can evidence any Bitcoin is held as trustee of the SMSF. This could include using the fund’s bank account when purchasing, passing relevant trustee resolutions, ensuring any exchange account is in name of the SMSF trustee acting as trustee, creating a fund-specific email address, completing statutory declarations and otherwise ensuring good documentary evidence exists to satisfy an auditor and the ATO. Prospective advice should be obtained on these requirements prior to investing in Bitcoin. 

SMSF trustees should also ensure they take appropriate action to secure the fund’s property. In relation to Bitcoin, this could include ensuring private keys are kept securely.

Acquisitions from a related party

Section 66 of the SISA prohibits an SMSF trustee from acquiring an asset from a related party of the fund. While s 66(2)(a) provides an exemption for the acquisition of a listed security acquired at market value, any Bitcoin holdings will not meet the definition of a listed security in the SISA and so care should be taken to ensure this provision is not contravened.

Further, while ‘acquiring an asset’ does not include accepting money, the ATO has stated that it does not consider Bitcoin to be money nor Australian or foreign currency.

Hedging/Derivatives and Bitcoin

A Bitcoin exchange may allow a user to hedge their Bitcoin against normal currencies or other cryptocurrencies which could involve giving a charge over the Bitcoin holdings. An SMSF trustee is prohibited from giving a charge over the assets of the fund. However, an SMSF is able to give a charge over assets when investing in derivatives if it is in compliance with the SISR. This exemption is only available to SMSFs obtaining derivatives through an ‘approved body’ (subject to a number of other requirements). As no Bitcoin exchange is an ‘approved body’ for the purposes of the SISR, any derivative instrument or hedging that involved a charge over the fund’s assets would be in breach of the SISR.

Valuations and superannuation caps

As has been shown in recent times, the price of Bitcoin can fluctuate widely and rapidly. Trustees and members should be aware of the value of a member’s interest in the fund to ensure relevant superannuation caps aren’t breached. Sharp rises in the value of Bitcoin could result in a member’s total superannuation balance being over the total superannuation balance cap and a member not being eligible to make any further non-concessional contributions to the fund and may affect other caps such as the $500,000 cap for unused concessional contributions (applying from 1 July 2018).

Tax treatment of Bitcoin

This article does not consider the tax treatment of Bitcoin and other cryptocurrencies. The ATO have released a number of tax determinations on the treatment of Bitcoin. Broadly, the ATO’s position is that Bitcoin is a CGT asset for capital gains tax purposes. Specific tax advice should be obtained as part of any investment considerations.

Conclusion

An SMSF trustee is not specifically prohibited from investing in Bitcoin or other cryptocurrencies. However, as reflected above, there are numerous compliance aspects which must be considered. Ultimately, a trustee should act prudently and in accordance with the fund’s governing rules and investment strategy.

Clients should obtain written advice before investing in Bitcoin to ensure they obtain clearance on all of the compliance aspects.

Naturally, for advisers, the Australian Financial Services Licence obligations under the Corporations Act 2001 (Cth) and tax advice obligations under the Tax Agent Services Act 2009 (Cth) need to be appropriately managed to ensure any advice is appropriately provided.

This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.

DBA Lawyers hold SMSF CPD training at venues all around Australia and online. For more details or to register, visit www.dbanetwork.com.au 

Shaun Backhaus, Lawyer and Daniel Butler, Director, DBA Lawyers