The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory uncertainty if these products are ultimately deemed to be swaps rather than futures, a concern voiced by CME Group Chairman and CEO Terry Duffy. In an interview, Duffy pointed out the ambiguity surrounding the tax perspective for all US participants, emphasizing a consequence that has not been widely discussed. This issue arises as CME continues its legal challenge against the Commodity Futures Trading Commission (CFTC) regarding the regulator's approval of perpetual futures contracts in the US.
The outcome of this challenge could significantly influence the US approach to the rapidly growing arena of perpetual futures, particularly in how the Internal Revenue Service (IRS) taxes these contracts. The core of the dispute lies in whether perpetual futures should be legally treated as futures or swaps. Duffy argues that perpetual futures, due to the periodic funding payments exchanged between long and short positions, should be categorized as swaps under US law, as these recurring payments align with the statutory definition of a swap.
Traditional futures contracts expire, whereas perpetual contracts do not, instead relying on periodic funding payments to keep the derivative's price aligned with the underlying asset. This mechanism, Duffy contends, satisfies the definition of a swap.
The primary concern with the current designation of perpetual futures as futures, rather than swaps, is the potential tax treatment. If classified as futures, many institutional traders could receive a blended tax treatment under Section 1256 of the US tax code, where gains and losses are treated as 60% long-term and 40% short-term capital gains. However, if these contracts are deemed swaps, they would be subject to 'ordinary' taxation, which could lead to uncertainty for market participants who have been treating them as futures for tax purposes. Legal experts, such as Rustin Diehl and Jason Gottlieb, note that the issue is complex, with the definition of swaps being extremely broad and the economic function of perpetual futures resembling that of traditional futures.
The resolution of this issue may depend on how the court interprets the statutes, given the Supreme Court's decision in Loper Bright, which reduced the deference given to agencies' interpretations of ambiguous statutes. This could lead to a lengthy litigation process, with potential implications for tax reporting and regulatory clarity. Until there is greater clarity from regulators, tax authorities, or the courts, large institutions may face uncertainty over the correct method for reporting trades involving perpetual futures, potentially leading to significant tax implications.