If we jumped in a time machine and went back just six years to 2017, we would be at the start of a significant year for crypto. Bitcoin was experiencing a staggering surge, skyrocketing from AUD $1,246 to approximately AUD $27,710 and NFT projects like CryptoPunks were emerging.
In 2017, it would not have been uncommon to meet people diving headfirst into crypto in the hopes of riding to the peak of a bull run. Many taxpayers acquired these digital assets in their personal capacity and began trading often neglecting any thoughts of proper structuring.
Fast forward to the present, in 2023, and we witness a substantial shift in the landscape of crypto asset investments. Investments are larger, move more quickly (compare the uptake in CryptoPunks against that of the recent phenomenon of Mutant Ape Yacht Club in 2023) and the downfalls are more common (FTX anyone?).
When operating in this space whether as a trader or long term as an investor it is paramount to consider effective structuring strategies, which serve both asset protection and tax efficiency purposes. This article aims to shed light on some crucial considerations to keep in mind.
Can I acquire assets in my own name?
- Yes. However, the more appropriate question is – is acquiring assets in my personal capacity an effective way of investing? Often the answer to that question will be no.
- When holding assets in your personal capacity they are exposed to your risks. If a successful claim is made against you, for example by a creditor, it is possible to lose those assets. Additionally, if you hold the assets in your personal capacity and run a business (as a sole trader) then you will be fully exposed to the business risks. This puts not only your crypto assets at risk but also your personal assets such as your car and/or home.
- From a tax perspective all receipts will be subject to tax at your relevant marginal rate. This includes funds you intend to reinvest into the business. This can make it particularly inefficient.
I am a sole trader. Is it too late to fix my structure?
- No. Subject to the type of asset you hold, there may be opportunities to restructure your portfolio and in certain cases this can occur without triggering a tax liability. For example, capital assets may be rolled into a company or trust structure and (subject to conditions) capital gains tax (CGT) triggered may be deferred or disregarded. We recommend reaching out to one of our team members to explore your options.
Is it better to use a company?
- There is no perfect structure that works for all taxpayers. The structure that is right for you will depend on your particular circumstances.
- That being said, a company is a separate legal entity which bring with it certain advantages over sole traders such as limited liability for shareholders. It is likely that you may wish to act as director of the company and it is important to know that there are exceptions to the limit on a director’s liability, such as where insolvent trading has occurred or where certain tax debts are unpaid.
- There are increased costs of using a company, such as registration fees and ASIC fees. However, there are also several benefits. For example, profits can be retained in the company after tax is paid at the company level (which is often lower than marginal rates) and reinvested.
Should I use a trust?
- Utilizing a trust within your crypto investment structure offers asset protection and tax efficiencies. A discretionary trust, for example, may facilitate income splitting from a business amongst its beneficiaries. From an asset protection perspective, holding crypto assets in a trust ensures their legal separation from the personal assets of individual beneficiaries. This serves as a safeguard against personal liabilities and potential legal claims, shielding the crypto assets from such risks.
- The asset protection qualities of a trust are, however, limited where key roles in the trust are not appropriately filled. For example, the appointor controls the trust and therefore the person/persons or entity holding this role is key. Further succession of the role is a key discussion to have with your legal advisor.
- A key element of using trusts is ensuring you have an appropriate trust deed and make valid distributions. For example, the 50% CGT discount may apply to profits on the disposal of crypto assets held on capital account for longer than 12 months. A trustee can flow this discount through to beneficiaries (it is not available to shareholders in a company, being an advantage for trusts) provided the appropriate provisions exist in a trust deed and an effective resolution is prepared.
- Often in practice we see poorly drafted trust deeds and/or resolutions which prevent these distributions from being effectively made. An ineffective distribution may cause profits to be retained within the trust and subject to the highest tax rate (45%), underscoring the significance of making accurate distributions. We have a suite of comprehensive trust deeds available at KHQ and a great deal of experience in ensuring resolutions are correctly drafted. We encourage you to reach out to our team for assistance.
- Persons acting as trustees have fiduciary obligations to beneficiaries of the trust. Fiduciary obligations are a broad requirement to act in good faith and for the benefit of beneficiaries. There are many fiduciary duties including the duty to protect trust assets and the duty to account. These duties become increasingly difficult with crypto assets for example:
- Protection – where do you store private keys? Is an online wallet safe in light of the Coincheck Inc hack? How do you choose a safe and reliable exchange for trading on? The FTX and QuadrigaCx collapses demonstrate that it is clearly a difficult decision to make.
- Account – how do you account for assets, particularly NFTs where the value is often difficult to determine? Further, with ATO guidance changing, can you be certain your position is current?
- Careful consideration should be made by trustees prior to embarking on crypto investments to determine what and if it is a good choice for beneficiaries. In Breakwell v FCT [2015] FCA 1471 the Federal Court confirmed that no limitation exists on the period that claims can be brought by beneficiaries against trustees. This demonstrates the significant burden on trustees and the importance of being appropriately advised.
Can I invest using my Self-Managed Superannuation Fund?
- For Australian investors, utilizing a self-managed superannuation fund (SMSF) can prove to be a powerful tool for effectively managing crypto investments. Establishing an SMSF grants you greater control over your retirement savings, allowing for potential investment in cryptocurrencies within the framework of superannuation regulations, subject to the provisions outlined in the fund’s deed. However, it is of utmost importance to ensure strict compliance with regulatory requirements and trustees’ responsibilities.
- Given the volatility associated with crypto investments, it is essential to approach such decisions with caution, recognizing the inherent risks involved. Trustees of SMSFs bear a fiduciary duty as with trustees of other types of trusts.
- Regarding taxation, income earned from crypto investments within an SMSF is generally taxed at the concessional superannuation tax rate of 15%. Capital gains, on the other hand, are subject to a CGT discount of 33.33%.
Can I use a DAO?
- DAOs (or decentralised autonomous organisations) are blockchain’s answer to companies. Displaying the core traits of blockchain, they rely on community decision making (rather than a board), full transparency and shared power.
- With the technical complexities of coding aside, currently there are also legal complexities for using DAOs in Australia. Under Australian law DAOs are not recognised as having their own distinct legal personality. Arguably they would be treated as partnerships where there is an intention to carry on a business and make a profit (Partnership Act 1959 (Vic)). This would in turn somewhat unfavourably bring them under the Corporations Act 2001 (Cth).
- DAOs bring significant uncertainty with them and professional advice should be sought from the commencement of drafting the underlying smart contract. Advice will need to consider not only regulation but also tax and governance issues.
In summary
Whether you are an avid trader or casual investor, correctly structuring your crypto investments can have significant impact on your position. Whilst general structuring themes that apply to all businesses also apply to the crypto world, there are specific nuances attributable to blockchain assets which make tailoring the right structure pivotal. If you would like to discuss your current structure and potential opportunities to restructure, please contact our Tax & Structuring team.
This article was written by Sophie Barber (Lawyer), Laura Spencer (Senior Associate), and Harry Giannakidis (Principal Solicitor).
This article is part of the Blockchain Byte series by KHQ’s Tax & Structuring team. The series provides ‘byte-sized’ articles outlining key tax and structuring issues associated with crypto assets as well as updates in the Blockchain space which regularly occur. To register for the latest byte and other tax and structuring news, click here to subscribe.
