Bitcoin Futures Exposure for Taxable Accounts
June 15, 2022
Read Time 4 MIN
- C-Corps can carry forward and carry back capital losses and are not required to distribute long-term capital gains to investors. This may result in a deferral of tax and allow investors to keep more money continually invested in the fund.
- Investors in Bitcoin futures ETFs structured as a C-Corp may receive 16% more vs. RIC-structured ETFs in after-tax return in years when Bitcoin is up.
- VanEck Bitcoin Strategy ETF (XBTF) is structured as a C-Corp, which may offer long-term investors better after-tax returns compared to Bitcoin funds structured as RICs.
The VanEck Bitcoin Strategy ETF (XBTF) seeks capital appreciation by investing in Bitcoin futures contracts. The Fund is actively managed and offers exposure to Bitcoin-linked investments through an accessible exchange traded vehicle. The Fund does not invest in Bitcoin or other digital assets directly. In this blog, we will outline key differences between a regulated investment company (RIC) and C-Corporation (C-Corp) and potential tax implications of these two fund structures.
The Difference Between RIC and C-Corp
Generally, most ETFs and mutual funds elect to be treated as a RIC for tax purposes. Doing so allows the fund to avoid paying taxes at the fund level by distributing all of its income and capital gains to investors. In order to qualify as a RIC, the fund has to meet certain requirements for distributions, diversification of assets and earn income from sources that generate qualifying income for a RIC.
If a fund elects to be treated as a C-Corp for tax purposes, it does not have the same requirements for diversification and qualifying income. It will be required to pay taxes at the fund level and any distributions to investors are also taxable to investors. This potential for “double taxation” is generally something to avoid and why most funds elect to meet RIC requirements. However, the tax treatment of Bitcoin futures, and specifically how a fund structures its investments in order to meet the RIC requirements, may result in a C-Corp being more tax efficient, particularly for individuals in higher tax brackets and for corporations.
Tax Implication of C-Corp Fund Structure
We believe XBTF may be the preferred choice for taxable investors in Bitcoin futures ETFs, not only due to its category-lowest cost fee1, but also because of its inherently efficient tax structure and Bitcoin’s potential for dramatic price swings. While nuanced, the taxation differences can have a material impact on shareholder outcomes and are an important consideration for any taxable investor. Investors looking for Bitcoin futures exposure may find that an ETF structured as a C-Corp may offer better after-tax returns. Given this, XBTF was purposefully structured as C-Corp.
Investors in competing Bitcoin futures ETFs organized as RICs may actually receive 16% less in after-tax return in years when Bitcoin is up. C-Corps pay corporate taxes at the fund level yet offer the ability to utilize past capital losses to offset capital gains. In the event of a loss, a C-Corp can also reclaim taxes paid on gains in prior years. For investors with a bullish view on Bitcoin that want to own it in a taxable account, leveraging XBTF’s C-Corp structure makes sense, compared to funds structured as RICs.
C-Corp Taxes by the Numbers
If Bitcoin futures rise in a fund structured as a RIC utilizing a Cayman Subsidiary, 100% of gains are distributed to investors and taxed at their ordinary income rates, which can be as high as 37%. Additionally, losses in prior years cannot be used to offset those gains, unlike in a C-Corp.
Comparatively, XBTF is taxed at the corporate rate of 21% at the fund level. However, the fund only distributes 40% of the investment gain to investors and these distributions are taxed at the qualified dividend income rate of 20%. Additionally, investment gains can be offset by prior year losses, which can be a key benefit when investing in a volatile asset like Bitcoin. The corporate taxes on XBTF gains are accrued daily and will be reflected in the NAV.
Please see the tax considerations table below for more details on the analysis. Please note that fiscal year ends may not align with calendar year ends, and tax calculations are based on fiscal year ends.
|Tax Considerations of C-Corps vs RICs|
|Corp Tax Rate:||0%||22%|
|% of Gain Distributed:||100%||40%|
|OI vs QDI tax rate:*||48%||31%|
|After-Tax Gain: (shares still held)||$5,120||$6,794|
* Source: VanEck. Assumes highest Ordinary Income (“OI”) rate of 37%, Qualified Dividend Income (“QDI”) rate of 20% as well as 8% state tax and 3.8% Medicare tax. This is for informational purposes only and not to be considered tax advice. Speak to your tax professional.
1 Based on total fund operating expenses vs. Bitcoin-linked competitors as of 5/31/2022.
This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.
The Fund is classified for federal income tax purposes as a taxable regular corporation or Subchapter “C” corporation. As a “C” corporation, the Fund accrues a current and deferred tax expense. The deferred tax expense represents the future tax liability associated with the capital appreciation of its investments. The Fund’s accrued current and deferred tax liabilities, if any, will be reflected in its net assets value per share. An estimate of current and deferred income tax expenses/(benefit) is dependent upon the Fund’s net investment income/(loss) and realized and unrealized gains/(losses) on investments, and such expenses/(benefits) may vary greatly from year to year and from day to day depending on the performance of the Fund’s investments and general market conditions. Therefore, any estimate of current and deferred income tax expenses/(benefit) cannot be reliably predicted from year to year. Future actual income tax expense (if any) will be incurred over many years depending on if and when investment gains are realized, the then-current tax basis of assets and federal income tax rates, the level of net loss carryforwards and other factors. The above table assumes no current and deferred tax expenses as the Fund has not commenced operations and thus does not have sufficient operating history to accurately estimate anticipated current and deferred tax expenses.
The value of Bitcoin and the Fund’s Bitcoin Futures holdings, could decline rapidly, including to zero. You should be prepared to lose your entire investment. The Fund does not invest in Bitcoin or other digital assets directly.
The further development and acceptance of the Bitcoin network, which is part of a new and rapidly changing industry, is subject to a variety of factors that are difficult to evaluate, the slowing, stopping or reversing of the development or acceptance of the Bitcoin network may adversely affect the price of Bitcoin and therefore cause the Fund to suffer losses, regulatory changes or actions may alter the nature of an investment in Bitcoin or restrict the use of Bitcoin or the operations of the Bitcoin network or venues on which Bitcoin trades in a manner that adversely affects the price of Bitcoin and, therefore, the Fund’s Bitcoin Futures. Bitcoin generally operates without central authority (such as a bank) and is not backed by any government, Bitcoin is not legal tender and federal, state and/or foreign governments may restrict the use and exchange of Bitcoin, and regulation in the United States is still developing.
Futures Contract Risk. The use of futures contracts involves risks that are in addition to, and potentially greater than, the risks of investing directly in securities and other more traditional assets. The market for Bitcoin Futures may be less developed, and potentially less liquid and more volatile, than more established futures markets. Bitcoin Futures are subject to collateral requirements and daily limits that may limit the Fund’s ability to achieve its target exposure. Margin requirements for Bitcoin Futures traded on the Chicago Mercantile Exchange (“CME”) may be substantially higher than margin requirements for many other types of futures contracts. Futures contracts exhibit “futures basis,”” which refers to the difference between the current market value of the underlying Bitcoin (the “spot” price) and the price of the cash-settled futures contracts.
This risk may be adversely affected by “negative roll yields” in “contango” markets. The Fund will “roll” out of one futures contract as the expiration date approaches and into another futures contract on Bitcoin with a later expiration date. The “rolling” feature creates the potential for a significant negative effect on the Fund’s performance that is independent of the performance of the spot prices of the Bitcoin. A market where futures prices are generally greater than spot prices is referred to as a “contango” market. Therefore, if the futures market for a given commodity is in contango, then the value of a futures contract on that commodity would tend to decline over time (assuming the spot price remains unchanged), because the higher futures price would fall as it converges to the lower spot price by expiration. Extended period of contango may cause significant and sustained losses.
An investment in the Fund may be subject to risks which include, among others market and volatility, investment, futures contract, derivatives, investments related to Bitcoin and Bitcoin futures, derivatives, counterparty, investment capacity, target exposure and rebalancing, borrowing and leverage, indirect investment, credit, interest rate, illiquidity, investing in other investment companies, active management, new fund, non-diversified, operational, portfolio turnover, regulatory, repurchase agreements, tax, cash transactions, authorized participant concentration, no guarantee of active trading market, trading issues, fund shares trading, premium/discount and liquidity of fund shares, U.S. government securities, debt securities, municipal securities, money market funds, securitized/asset-backed securities, and sovereign bond risks, all of which could significantly and adversely affect the value of an investment in the Fund.
Unlike traditional mutual funds that are structured as regulated investment companies for U.S. federal income tax purposes, the Fund has not elected and has no current intention to elect to be treated as a regulated investment company under the Code because the extent of our direct investments in Bitcoin Futures would generally prevent the Fund from meeting the qualification requirements under the Code for regulated investment companies.
Cryptocurrency is a digital representation of value that functions as a medium of exchange, a unit of account, or a store of value, but it does not have legal tender status. Cryptocurrencies are sometimes exchanged for U.S. dollars or other currencies around the world, but they are not generally backed or supported by any government or central bank. Their value is completely derived by market forces of supply and demand, and they are more volatile than traditional currencies. The value of cryptocurrency may be derived from the continued willingness of market participants to exchange fiat currency for cryptocurrency, which may result in the potential for permanent and total loss of value of a particular cryptocurrency should the market for that cryptocurrency disappear. Cryptocurrencies are not covered by either FDIC or SIPC insurance. Legislative and regulatory changes or actions at the state, federal, or international level may adversely affect the use, transfer, exchange, and value of cryptocurrency.
Investing in cryptocurrencies comes with a number of risks, including volatile market price swings or flash crashes, market manipulation, and cybersecurity risks. In addition, cryptocurrency markets and exchanges are not regulated with the same controls or customer protections available in equity, option, futures, or foreign exchange investing. There is no assurance that a person who accepts a cryptocurrency as payment today will continue to do so in the future.
There may be risks posed by the lack of regulation for cryptocurrencies and any future regulatory developments could affect the viability and expansion of the use of cryptocurrencies. Investors should conduct extensive research before investing in cryptocurrencies.
Information provided by Van Eck is not intended to be, nor should it be construed as financial, tax or legal advice. It is not a recommendation to buy or sell an interest in cryptocurrencies.
Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of a Fund carefully before investing. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
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