The ATO has remained silent on whether a non-fungible token (NFT) is a collectable and personal use asset (“collectable”) or an allowable asset that an SMSF can purchase.
Regarding collectables, the answer requires a review of the NFT facts and circumstances in line with r13.18AA SISR.
And in the end, the ATO may rule otherwise.
What is an NFT?
An NFT is a smart contract that lives on the Ethereum blockchain, stored differently from Ethereum (the coin) because it contains additional information required to prove digital ownership. While other blockchain platforms have also implemented their version of NFTs, Ethereum NFTs are the most common (see previous NFT article).
NFTs prove that an SMSF has ownership of a digital asset represented by a file such as a JPG, GIF or MP3. As the NFT is a smart contract, it contains the file’s location but does not contain the file itself.
It gives the fund a digital certificate of ownership that is traceable on the blockchain and comes with the right to sell the asset. It can be anything from a digital image of a pet rock that went for US$46,000 to a video by Beeple, a US digital artist, sold for US$6.6million.
Where is the Digital Asset Stored?
Typically, the file gets stored on the web in a decentralised NFT marketplace, providing security and safety. The SMSF will never physically own the digital asset because the NFT is just a series of “0”s and “1”s with unique properties that point to the file location.
It is difficult to determine what an NFT represents without understanding the smart contract details. Does it mean one out of fifty copies of the file? Is it the only copy of the file? Or does it refer to ownership of physical property such as a strand of pearls purchased from a Pearl trader in Broome?
From a SIS perspective, the NFT is not digital art because it refers to a file, physical property, or other legal rights embedded in the smart contract proving ownership.
Similarly, is the purchase contract from Christie’s for a Monet painting valuable? One would argue it is the painting itself.
Definition of r13.18AA SISR
In 2011, the Government introduced r13.18AA SISR and tightened the restrictions to ensure collectables did not give rise to a current-day benefit. Allowable assets include:
(a) artwork (within the meaning of the Income Tax Assessment Act 1997);
(e) coins, medallions or bank notes;
(f) postage stamps or first-day covers;
(g) rare folios, manuscripts or books;
(i) wine or spirits;
(j) motor vehicles;
(k) recreational boats;
(l) memberships of sporting or social clubs
In terms of digital assets, only artwork comes close, defined within the Income Tax Assessment Act 1997 as:
- a painting, sculpture, drawing, engraving or photograph; or
- a reproduction of such a thing; or
- property of a similar description or use.
While “property of a similar description or use” could loosely define digital artwork, the NFT refers to the smart contract containing the file’s location.
Technically, an NFT cannot be a collectable and personal use asset.
Requirements of r13.18AA
Even if an NFT met the definition of a collectable, how would the fund meet the requirements of r13.18AA? An SMSF auditor will be unable to confirm whether the NFT is:
- Stored in the private residence of a related party on a USB stick
- Displayed in the private residence of a related party on a digital photo frame
- Insured within 7 days of acquisition (insurance companies are not underwriting NFTs and an exemption from the ATO would be required to comply, similar to social memberships)
- Valued by a qualified independent valuer before being transferred to a related party (as they do not currently exist)
Until there is clarity from the Regulator, an SMSF trustee investing in NFTs should be carefully scrutinised and questioned thoroughly by SMSF auditors.
Value of NFTs
While the value of an NFT upon acquisition is the cost, the value afterwards is unclear. Unlike cryptocurrency, no NFT price checkers exist to confirm the value.
Determining the market value on June 30 will be next to impossible, especially given the high-risk nature of NFTs due to price volatility, liquidity issues, lack of authentication, being traded in an unregulated market and multiple scams.
SMSF auditors cannot meet their professional obligations under r8.02B SISR where acceptable, appropriate audit evidence is lacking. It will result in a Part A qualification of the audit report where the value is material and a breach of r8.02B SISR.
The real question is how to classify the NFT on the fund’s financial statements. The ownership of the underlying digital asset is what the fund has paid for, not the NFT itself.
SMSF auditors are not required to understand ERC721, the standard code used to create an NFT deed or contract.
How can an SMSF auditor sign the audit report when they have no way of knowing what the NFT contains, whether it is secure, or if any vulnerabilities exist?
A similar situation exists when a fund purchases property overseas, and the documents are in a different language. The trustee must engage a qualified and certified interpreter who can provide a version the SMSF auditor can read.
One solution is that SMSF trustees could provide an independent NFT audit report to confirm the contents of the NFT and to ensure security and functionality.
There are many questions and not enough answers on how to treat NFTs in an SMSF. But one thing is clear: in its purest form, an NFT smart contract does not meet the requirements of a collectable under r13.18AA SISR.
Given that most SMSF trustees have no idea what an NFT is, where the value is, why they should own one and what to do with them, the real question is whether an NFT will provide benefits to members in their retirement.