The approval of perpetual futures contracts in the US could lead to unforeseen tax and regulatory challenges for traders, according to CME Group Chairman and CEO Terry Duffy, who warns of a looming issue that has received little attention. In an interview, Duffy stated that there is ambiguity surrounding the tax implications for US participants due to the unclear distinction between swaps and futures. The Commodity Futures Trading Commission's (CFTC) approval of perpetual futures contracts is currently being challenged by CME in a federal court, with the outcome likely to significantly influence the US approach to these rapidly growing financial products.
A key consequence of this dispute is how the Internal Revenue Service (IRS) will ultimately tax these contracts. The disagreement centers on whether perpetual futures should be legally classified as swaps or futures, with Duffy arguing that they should be considered 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 maintain the derivative's price close to the underlying asset. Duffy contends that these payment exchanges meet the statutory definition of a swap under US law.
The main issue with the current designation is that if perpetual contracts are deemed futures, many institutional traders may receive a blended tax treatment, while if they are classified as swaps, they will be taxed under ordinary taxation. As the IRS has not provided guidance on the tax treatment of perpetual futures, market participants may face uncertainty in reporting their positions. Legal experts consider the issue complex, with the definition of swaps being extremely broad and the economic function of perpetual futures differing from their textual structure.
The Supreme Court's 2024 Loper Bright decision has eliminated the Chevron doctrine, allowing federal courts to play a larger role in interpreting ambiguous statutes and their application to novel financial products. This may lead to a lengthy and drawn-out process, with potential litigation and the need for separate guidance from the IRS. Until regulators, tax authorities, or courts provide clarity, large institutions may face uncertainty in reporting trades involving perpetual futures, highlighting the need for careful consideration and potential consultation with the IRS.