The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory uncertainty if these products are ultimately classified as swaps rather than futures, a concern raised by CME Group Chairman and CEO Terry Duffy. In an interview with CoinDesk, Duffy pointed out the ambiguity surrounding the tax implications for US participants. 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. A federal court decision is pending, and its outcome could significantly influence how the US approaches the rapidly growing market of perpetual futures, including how the Internal Revenue Service (IRS) will tax these contracts.
The dispute centers on whether perpetual futures should be legally treated as futures or swaps. Duffy argues that perpetual futures, which involve periodic funding payments between long and short positions, should be considered swaps under US law due to these recurring payment exchanges.
Unlike traditional futures, perpetual contracts do not expire but instead involve traders exchanging funding payments to keep the derivative's price aligned with the underlying asset. This mechanism, Duffy believes, aligns with the statutory definition of a swap. The main issue with the current designation is that if perpetual contracts are classified as futures, many institutional traders could receive a blended tax treatment, with gains and losses treated as 60% long-term and 40% short-term capital gains.
However, if these contracts are deemed swaps, they would be taxed under 'ordinary' taxation, which could lead to uncertainty for market participants who have been treating them as futures for tax purposes. Legal experts note that the issue is complex, with the textual structure of perpetual futures resembling swaps but functioning economically like futures, posing a 'substance-over-form' question.
The definition of swaps is broad, leaving room for interpretation, especially for novel financial products like perpetual futures. The outcome will depend on the court's interpretation, given the Supreme Court's 2024 Loper Bright decision, which reduced federal courts' deference to agencies' interpretations of ambiguous statutes. This could lead to a lengthy litigation process, with experts predicting that courts may initially examine the regulator's decision-making process rather than immediately deciding on the classification of perpetual futures. Even if litigation clarifies the classification, tax treatment may still require separate IRS guidance, which may not align with the CFTC's interpretation.
Until there is greater clarity from regulators, tax authorities, or courts, large institutions may face uncertainty over reporting trades involving perpetual futures, potentially leading to significant tax implications.