The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory uncertainty if these products are ultimately deemed swaps rather than futures, a matter that has garnered little public attention, as stated by CME Group Chairman and CEO Terry Duffy. 'There's a consequence that nobody's talking about,' Duffy mentioned in an interview, highlighting the ambiguity surrounding the tax perspective for all US participants. This statement comes 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 case could significantly influence how the US approaches the rapidly growing arena of perpetual futures, particularly in terms of how the Internal Revenue Service (IRS) taxes these contracts.
The core of the dispute revolves around whether perpetual futures should be legally treated as futures or swaps, with Duffy arguing they should be classified as swaps due to the periodic funding payments exchanged between long and short positions, which aligns with the statutory definition of a swap under US law. Unlike traditional futures, perpetual contracts do not expire but instead involve periodic funding payments to keep the derivative's price close to the underlying asset, a mechanism Duffy believes satisfies the definition of a swap. If perpetual contracts are deemed swaps, they would be taxed under 'ordinary' taxation, as opposed to the blended tax treatment available for futures under Section 1256 of the US tax code, where gains and losses are treated as 60% long-term and 40% short-term capital gains. Given the novelty of perpetual futures, the IRS has yet to provide specific guidance on their tax treatment, leaving market participants who have been treating them as futures for tax purposes facing potential uncertainty about how to report these positions to the IRS.
Legal experts, however, view the issue as more complex, emphasizing that while perpetual futures structurally resemble swaps, they function economically like futures, posing a 'substance-over-form' question. The breadth of the statutory definition of swaps, which could encompass a wide range of financial products, adds to the uncertainty. Ultimately, the court's interpretation will be pivotal, especially considering the Supreme Court's 2024 Loper Bright decision, which reduced federal courts' deference to agencies' interpretations of ambiguous statutes, potentially leading to a more significant judicial role in deciding how derivatives laws apply to novel products like perpetual futures. This ambiguity is likely to lead to extensive litigation, with experts suggesting that rather than immediately addressing the swap or future classification, courts may first examine the regulator's decision-making process, focusing on whether the CFTC reasonably considered public comments and adequately explained its decision.
Even if litigation clarifies the classification of perpetual contracts, tax treatment may still require separate IRS guidance, which may not align with the CFTC's interpretation. Until greater clarity is provided, large institutions may face uncertainty over reporting trades involving perpetual futures, highlighting the need for regulatory, tax, or judicial clarification to mitigate potential tax risks and ensure compliance.