The approval of perpetual futures contracts in the US may lead to unforeseen tax and regulatory issues for traders if these contracts are ultimately deemed to be swaps rather than futures, warns CME Group Chairman and CEO Terry Duffy. In an interview, Duffy pointed out the ambiguity surrounding the tax implications for US participants. The comments come as CME challenges the Commodity Futures Trading Commission's (CFTC) approval of perpetual futures contracts, with the outcome potentially influencing the US approach to these rapidly growing financial products. A key aspect of the dispute is whether perpetual futures should be legally considered as swaps or futures, with Duffy arguing that they should be classified as swaps due to the periodic funding payments exchanged between long and short positions.
Unlike traditional futures, perpetual contracts do not expire and instead involve recurring funding payments to keep the derivative's price aligned with the underlying asset. Duffy believes this mechanism satisfies the US legal definition of a swap. The main issue with the current designation is that if perpetual contracts are considered futures, many institutional traders may receive a blended tax treatment, while if they are deemed 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 classify perpetual contracts as swaps, market participants who have been treating them as futures for tax purposes may face uncertainty and potential tax liabilities. Legal experts note that the issue is complex, with the textual structure of perpetual futures resembling swaps but their economic function akin to futures, making it a substance-over-form question. The definition of swaps is extremely broad, leaving room for interpretation regarding its application to new financial products like perpetual futures.
The outcome will depend on the court's interpretation, and the process is likely to be lengthy and involve considerable litigation. Ultimately, tax treatment may require separate guidance from the IRS, which is not obligated to adopt the CFTC's interpretation.