The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory risks if these products are ultimately deemed to be swaps, according to CME Group Chairman and CEO Terry Duffy. This ambiguity surrounding the tax implications of perpetual futures has received little attention, Duffy noted in an interview. 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.
The outcome of this case could significantly influence the US approach to perpetual futures, including how the Internal Revenue Service (IRS) taxes these contracts. The core issue revolves around whether perpetual futures should be legally treated as futures or swaps, 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 involve recurring funding payments to keep the derivative's price aligned with the underlying asset. Duffy believes this mechanism satisfies the statutory definition of a swap under US law.
The main concern with the current designation is that if perpetual contracts are considered futures, institutional traders might receive a blended tax treatment, but if they are deemed swaps, they would 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 could face uncertainty and potential tax liabilities. Legal experts, however, emphasize that the issue is complex, with the textual structure of perpetual futures resembling swaps but functioning economically like futures. The definition of swaps is broad, leaving room for interpretation, especially with the Supreme Court's 2024 Loper Bright decision, which could lead to judges playing a larger role in deciding how derivatives laws apply to new financial products.
The resolution of this issue is likely to be a long and litigious process, with potential tax implications and the need for separate IRS guidance on the tax treatment of perpetual futures.