The approval of perpetual futures contracts in the US could expose traders to unforeseen tax and regulatory complexities if these contracts are ultimately deemed swaps rather than futures, a concern raised by CME Group Chairman and CEO Terry Duffy. In an interview, Duffy pointed out the existing ambiguity from a tax perspective for all US participants. This concern arises as CME continues to challenge the Commodity Futures Trading Commission (CFTC) over its approval of perpetual futures contracts, awaiting a federal court decision that could significantly influence the US approach to perpetual futures.
A key consequence of this decision, according to Duffy, is 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, with Duffy arguing they should be considered swaps due to the periodic funding payments exchanged between long and short positions, which satisfies the statutory definition of a swap under US law.
If perpetual contracts are classified as swaps, they would be taxed under 'ordinary' taxation, unlike the blended tax treatment available for futures under Section 1256 of the US tax code. Given the novelty of perpetual futures, the IRS has not issued specific guidance on their tax treatment, potentially leading to uncertainty for market participants if the contracts are ultimately deemed swaps. Legal experts, however, view the issue as more complex, emphasizing it as a 'substance-over-form' question where the economic function of perpetual futures resembles that of futures, despite their structural similarity to swaps.
The definition of swaps is broad, leaving considerable room for interpretation, especially with the Supreme Court's 2024 Loper Bright decision reducing federal courts' deference to agencies' interpretations of ambiguous statutes. This could lead to a lengthy litigation process, with tax treatment potentially requiring separate IRS guidance.
Until there is greater clarity, large institutions may face uncertainty over reporting trades involving perpetual futures, highlighting the need for regulatory, tax authority, or court guidance to resolve the ambiguity.