The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory uncertainties if these products are ultimately deemed swaps rather than futures, a concern that has received minimal public attention, according to CME Group Chairman and CEO Terry Duffy. 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. Both sides await a federal court decision, which could significantly influence how the US approaches the rapidly growing arena of perpetual futures, including how the Internal Revenue Service (IRS) ultimately taxes these contracts.
The dispute stems from whether perpetual futures should be treated as futures or swaps under the law. Duffy argues that perpetual contracts should fall under the legal definition of 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 never expire and instead involve periodic funding payments to keep the derivative's price close to the underlying asset.
If perpetual contracts are classified as futures, many institutional traders could receive a blended tax treatment, but if they are deemed 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 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 consider the issue complex, with one attorney stating, 'The challenge here is that textually, by the structure, perpetual futures look a lot like a swap, but economically they perform a lot like futures. It's really a substance-over-form question… function versus text.' 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, and the process is likely to be long and drawn out, with potential litigation and the need for separate guidance from the IRS.