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 risks if these products are ultimately classified as swaps rather than futures, according to CME Group Chairman and CEO Terry Duffy. In an interview with CoinDesk, Duffy noted that there is ambiguity surrounding the tax implications for US participants. 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 significantly influence how the US approaches the rapidly growing market of perpetual futures. A key consequence of this dispute is how the Internal Revenue Service (IRS) will ultimately tax these contracts.

The disagreement stems from whether perpetual futures should be legally treated as futures or swaps. Duffy argued that perpetual futures should be classified as swaps due to the periodic funding payments exchanged between long and short positions, which satisfies 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 close to the underlying asset.

If perpetual contracts are deemed swaps, they will be taxed under 'ordinary' taxation, whereas if they are classified as futures, many institutional traders could receive blended tax treatment under Section 1256 of the US tax code. Given the novelty of perpetual futures, the IRS has not provided specific guidance on their tax treatment. Legal experts, however, say the issue is complex, with the definition of swaps being extremely broad and encompassing a wide range of financial products.

The challenge lies in determining whether perpetual futures function more like swaps or futures, despite their structural similarities to swaps. The Supreme Court's 2024 Loper Bright decision has eliminated the Chevron doctrine, allowing federal courts to play a larger role in interpreting ambiguous statutes and deciding how existing derivatives laws apply to novel products like perpetual futures.

This may lead to a lengthy and drawn-out process, with potential litigation and a need for separate guidance from the IRS. Until regulators, tax authorities, or courts provide clarity, large institutions may face uncertainty over reporting trades involving perpetual futures, potentially leading to tax evasion risks and regulatory scrutiny.