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, according to CME Group Chairman and CEO Terry Duffy. In an interview with CoinDesk, Duffy noted that 'there's a consequence that nobody's talking about' due to ambiguity from a tax perspective for all 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 the outcome could significantly influence how the US approaches the rapidly growing arena of perpetual futures, particularly in terms of how the Internal Revenue Service (IRS) taxes these contracts. The dispute centers on whether perpetual futures should be legally treated as futures or swaps, with Duffy arguing that they should fall under the definition of swaps due to the periodic funding payments exchanged between long and short positions. Unlike traditional futures, perpetual contracts never expire and instead involve periodic funding payments to keep the derivative's price close to the underlying asset.
Duffy believes these recurring payment exchanges satisfy the statutory definition of a swap under US law. The main issue with the current designation is that if perpetual contracts qualify as futures, many institutional traders could receive blended tax treatment under Section 1256 of the US tax code, which treats gains and losses as 60% long-term and 40% short-term capital gains. However, if these contracts are classified as 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 conclude that perpetual contracts are swaps rather than futures, market participants who have been treating them as futures for tax purposes could face uncertainty about how to report those positions to the IRS. Legal experts agree that the issue is complex, with the definition of swaps being extremely broad and encompassing a wide range of financial products.
The outcome will depend on how the court interprets the law, and it is likely to be a long and drawn-out process. Tax evasion concerns may also arise, and it is possible that the IRS may not adopt the CFTC's interpretation of financial instruments, leading to further uncertainty for traders and institutions.