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 challenges if these products are ultimately classified as swaps rather than futures, a matter that has received limited attention, according to Terry Duffy, Chairman and CEO of CME Group. In an interview with CoinDesk, Duffy stated, 'There's an unaddressed consequence that nobody's discussing. From a tax perspective, there's ambiguity for all US participants.' These comments come 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 case could substantially influence how the US approaches the rapidly growing market of perpetual futures, including how the Internal Revenue Service (IRS) will tax these contracts. The dispute arises from the legal classification of perpetual futures as either futures or swaps. Duffy argues that perpetual futures should be legally treated as swaps due to the periodic funding payments exchanged between long and short positions, which he believes satisfies the statutory definition of a swap under US law. Unlike traditional futures, perpetual contracts do not expire; instead, traders periodically exchange funding payments to keep the derivative's price close to the underlying asset's price. Duffy emphasized that if perpetual contracts are classified as futures, many institutional traders might receive a blended tax treatment under Section 1256 of the US tax code, where gains and losses are generally treated as 60% long-term and 40% short-term capital gains. However, if these contracts are classified as swaps, they will be taxed under 'ordinary' taxation. Given the novelty of perpetual futures, the IRS has not issued specific guidance on their tax treatment. If regulators or courts ultimately conclude that perpetual contracts are swaps, market participants who have been treating them as futures for tax purposes may face uncertainty about how to report these positions to the IRS. Legal experts note that the issue is complex, with the textual structure of perpetual futures resembling swaps but their economic performance akin to futures, making it a 'substance-over-form' question. The definition of swaps is extremely broad, leaving considerable room for interpretation regarding its application to new financial products like perpetual futures. The outcome will depend on the court's interpretation, as the Supreme Court's 2024 Loper Bright decision has reduced federal courts' deference to agencies' interpretations of ambiguous statutes. This could lead to a lengthy and complex litigation process, with potential tax implications that may require separate guidance from the IRS.