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 that has received minimal public attention, according to Terry Duffy, Chairman and CEO of CME Group. In an interview with CoinDesk, Duffy stated, 'There's a consequence that nobody's talking about. There's ambiguity right there, from a tax perspective, for all US participants now.' The comments come as CME continues its legal challenge against the Commodity Futures Trading Commission (CFTC) over the regulator's approval of perpetual futures contracts in the US. The outcome of this challenge could substantially influence how the US approaches the rapidly growing arena of perpetual futures, including 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 fall under the legal definition of swaps, not futures as categorized by the CFTC.
Unlike traditional futures, perpetual contracts do not expire; instead, traders periodically exchange funding payments to keep the derivative's price close to that of the underlying asset. Duffy contends that these recurring payment exchanges satisfy the statutory definition of a swap under US law, stating, 'When two parties exchange payments to each other, that is deemed a swap.' The main issue with the current designation, according to Duffy, is that if perpetual contracts are considered futures, many institutional traders could 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 provided specific guidance on their tax treatment.
If regulators or courts ultimately decide that perpetual contracts are swaps rather than futures, market participants who have been treating them as futures for tax purposes could 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 functioning economically like futures, posing 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 how the court interprets the law, especially considering the Supreme Court's 2024 Loper Bright decision, which reduced the deference given to agencies' interpretations of ambiguous statutes. This could lead to a lengthy process of litigation, with tax treatment possibly requiring separate guidance from the IRS, which may not adopt the CFTC's interpretation. Until there is greater clarity from regulators, tax authorities, or the courts, large institutions could face uncertainty over reporting trades involving perpetual futures, potentially leading to significant tax implications.