Bitcoin Futures ETF Sidesteps the Character Questions Through Structuring

November 25, 2021

As the popularity of cryptocurrency continues to soar, investors are looking for creative ways to invest. Ryan Reneau and Kevin Sweeney of Chamberlain Hrdlicka take a look at the structure and tax implications of a newly created exchange-traded fund (ETF) designed to provide investors exposure to Bitcoin.

Last month, ProShares Trust launched an exchange-traded fund (ETF) to provide investors exposure to Bitcoin (the Fund) with the ticker symbol BITO. It is the first of its kind. The Fund invests indirectly in Bitcoin through futures traded on the Chicago Mercantile Exchange (CME). Significantly, the Fund intends to qualify as a registered investment company (RIC) under subchapter M of the Internal Revenue Code. It achieves this goal through a creative structure, which comes at the cost of increased complexity and potentially unfavorable treatment of its taxable shareholders. James C. Row, founder of Entoro Capital, LLC, advised, “we expect the BITO structure to become standard as more funds expand into digital assets and investors should quantify its impact on them before investing.”

Basic Requirements

A fund must be registered under the Investment Company Act of 1940 and satisfy three elements to qualify as a RIC.

  • First, 90% of the fund’s gross income must be from a statutory list (e.g., dividends, interest, loan payments, gains from disposition of stock or foreign currencies, income from qualified publicly traded partnerships, etc.).
  • Second, the fund must meet the asset diversification tests. At least 50% of the fund’s investments by value at the close of each quarter must be represented by cash, cash items, government securities, securities of other RICs, and other securities of which the fund owns less than certain thresholds. Additionally, not more than 25% can be invested in the securities of any one issuer, securities of issuers under the control of the fund, or publicly traded partnerships.
  • Third, the fund must distribute at least 90% of the sum of its taxable income and tax-exempt income each year.

The Big Question

As always with cryptocurrency, “what is a Bitcoin?” surfaces as the big question. All tax consequences flow from that answer. The status of Bitcoin as a security or currency determines the fund’s ability to meet the income and diversification RIC elements. Although Bitcoin has been determined to be a commodity in other contexts, IRS guidance to date merely states that Bitcoin should be considered personal property and not a currency for federal tax purposes. Investing directly in Bitcoin and Bitcoin futures results in significant risk to funds if they desire RIC status.

The Fund avoids the question by contributing up to 25% of its assets to a Cayman subsidiary that will engage in the business of trading bitcoin futures. The structure transmutes trading income from bitcoin futures into subpart F or GILTI inclusions and “property” into securities in a subsidiary issuer.

With regard to the income element, the foreign subsidiary will be treated as a controlled foreign corporation (CFC). The CFC will block recognition by the fund of income earned from the underlying bitcoin future trading operations. The income, however, will be subject to the subpart F and GILTI anti-deferral regimes and actual distributions are mandatory from the CFC to meet requirements under the Treasury regulations. The fund anticipates that the gains will be included in its annual taxable income based on these rules. The key is that the income recognized under these regimes takes on the character of a dividend. As a result, the Fund can be certain the character of the income will satisfy the income element.

With regard to the diversification element, the stock of the CFC will be considered a security of an issuer that the Fund controls. The Fund intends to adjust its investment in the subsidiary prior to the close of each quarter to meet the 25% limitation. The remaining 75% will be invested in qualifying securities, including equities in companies engaged in cryptocurrency-related businesses such as mining. As a result, the Fund can be certain how the economic investment in Bitcoin will be classified when calculating the percentages tested to satisfy the diversification element. Again, the structure transmutes an asset of uncertain properties into a known element in the RIC rules.

The Rule of Equivalent Exchange

Alchemy requires an equivalent exchange, and the structure is not without costs. The 25% limitation for investment in the CFC means that the Fund must either engage in leveraged futures strategies or settle for less than a one-to-one exposure of the Fund’s investment to Bitcoin futures. Leveraged futures strategies are complex, increase margin cost, and increase the risk of error in operation. They approximate results of larger investment positions and are imperfect at replicating the desired positions.

Further, the subpart F and GILTI regimes are one-sided and impose an additional cost to the fund. They require the inclusion of gains in the Fund’s income, but they do not allow the Fund to deduct losses. For example, the CFC may lose $100 in Year 1 and gain $100 in Year 2. The Fund, and its shareholders who recognize the income due to the pass-through treatment of a RIC, will not recognize a $100 loss in Year 1, but they will recognize a $100 inclusion in Year 2. The $100 loss may ultimately be recognized as a capital loss at an indeterminable date in the future when a shareholder disposes of the fund or the fund liquidates the CFC. Accordingly, a shareholder may pay tax on $100 of income despite no growth in economic value over the two-year period.

Finally, subpart F and GILTI inclusions are not qualified dividends subject to the preferential rates. Taxable shareholders will likely recognize taxable income subject to ordinary rates, instead of the potential long-term capital gains rates that might be achieved by acquiring and holding Bitcoin over a year.


The structure implemented by the Fund avoids significant uncertainties plaguing the blockchain fund community concerning the federal tax characterization and treatment of cryptocurrency investments. However, the creative structure employed is not without costs, due to its complexity and interaction with the U.S. international tax regime. In addition to the financial impact, investors should consider that laws and regulations concerning these international tax regimes often change. As such, the reporting and valuation principles underlying the Fund’s current strategy may one day change, which could render the Fund a taxable entity outside the RIC regime.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Ryan Reneau is a senior counsel in the San Antonio office of Chamberlain Hrdlicka. He focuses his practice on international tax planning, corporate structure optimization, and transaction efficiency. Reneau can be reached at or (210) 278-5805.

Kevin Sweeney is a shareholder in the Philadelphia office of Chamberlain Hrdlicka focusing in civil and criminal tax controversy and litigation. He may be reached at or call (610) 772-2327.