The approval of perpetual futures contracts in the US could lead to unforeseen tax and regulatory issues for traders if these products are ultimately deemed to be swaps rather than futures, a concern voiced by CME Group Chairman and CEO Terry Duffy. In an interview, Duffy pointed out the ambiguity surrounding the tax implications for US participants. This uncertainty arises as CME continues its legal challenge against the Commodity Futures Trading Commission (CFTC) regarding the regulator's approval of perpetual futures contracts. The outcome of this case could substantially influence the US approach to the rapidly growing market of perpetual futures, particularly in terms of how the Internal Revenue Service (IRS) will tax these contracts.
The core of the dispute lies in whether perpetual futures should be legally categorized as futures or swaps. Duffy argues that perpetual futures, due to the periodic funding payments exchanged between long and short positions, should be considered swaps under US law. Unlike traditional futures, perpetual contracts do not expire; instead, traders make periodic funding payments to keep the derivative's price aligned with the underlying asset. This mechanism, Duffy contends, aligns with the statutory definition of a swap.
A significant concern is the potential mismatch in tax treatment. If perpetual contracts are deemed futures, institutional traders might receive a blended tax treatment, with gains and losses treated as 60% long-term and 40% short-term capital gains.
However, if classified as swaps, they would be subject to 'ordinary' taxation, leading to potential tax reporting uncertainties for market participants. Legal experts acknowledge the complexity of the issue, noting that while perpetual futures structurally resemble swaps, they function economically like futures, posing a 'substance-over-form' question.
The broad definition of swaps and the recent Supreme Court decision eliminating the Chevron doctrine, which gives less deference to agencies' interpretations of ambiguous statutes, add to the uncertainty. This could lead to a lengthy litigation process, with tax treatment potentially requiring separate IRS guidance. Until there is clarity from regulators, tax authorities, or the courts, large institutions may face uncertainty in reporting trades involving perpetual futures, highlighting a significant risk that has not received adequate attention.