CME's Duffy Highlights Overlooked Tax Risk Associated with US Perpetual Futures

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, warns CME Group Chairman and CEO Terry Duffy. This ambiguity, Duffy notes, stems from the periodic funding payments exchanged between long and short positions in perpetual futures, which could satisfy the statutory definition of a swap under US law. Unlike traditional futures, perpetual contracts do not expire and instead involve periodic funding payments to keep the derivative's price aligned with the underlying asset. Duffy argues that these recurring payments should classify perpetual contracts as swaps, not futures, due to the exchange of payments between parties. This classification is crucial because if perpetual contracts are considered futures, institutional traders may receive a blended tax treatment under Section 1256 of the US tax code, treating gains and losses as 60% long-term and 40% short-term capital gains. However, if they are deemed swaps, they would be subject to 'ordinary' taxation, potentially leading to tax uncertainty for market participants who have been treating them as futures for tax purposes. Legal experts, such as Rustin Diehl and Jason Gottlieb, highlight the complexity of the issue, emphasizing that it is a 'substance-over-form' question where the economic function of perpetual futures resembles that of futures, despite their structural similarity to swaps. The broad definition of swaps and the recent elimination of the Chevron doctrine, which reduces deference to agencies' interpretations of ambiguous statutes, add to the uncertainty, suggesting that the outcome will heavily depend on court interpretations. This may lead to extensive litigation, with tax treatment potentially requiring separate guidance from the IRS, which may not align with the CFTC's interpretation. Until greater clarity is provided by regulators, tax authorities, or the courts, large institutions may face uncertainty in reporting trades involving perpetual futures, potentially leading to significant tax implications.