The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory issues if these products are ultimately deemed swaps rather than futures, a concern that has garnered little attention, according to CME Group Chairman and CEO Terry Duffy. In an interview with CoinDesk, Duffy stated, 'There's a consequence that nobody's talking about.
There's ambiguity right there, from a tax perspective, for all US participants now.' The comments come as CME continues its legal challenge against the Commodity Futures Trading Commission (CFTC) regarding the regulator's approval of perpetual futures contracts in the US. A federal court decision is pending, and its outcome could substantially influence the US approach to the rapidly growing area of perpetual futures, including how the Internal Revenue Service (IRS) taxes these contracts.
The dispute revolves around whether perpetual futures should be legally treated as futures or swaps. Duffy argues that perpetual futures, also known as 'perps,' should fall under the legal definition of swaps due to the periodic funding payments exchanged between long and short positions, rather than how the CFTC categorizes them as futures. Unlike traditional futures, perpetual contracts do not expire; instead, traders periodically exchange funding payments to keep the derivative's price close to that of the underlying asset. Duffy contends that these recurring payment exchanges satisfy the statutory definition of a swap under US law.
'When two parties exchange payments to each other, that is deemed a swap,' he said, referring to the funding-rate mechanism used by perpetual contracts. Duffy sees the main problem with this mismatched designation as the potential for institutional traders to receive blended tax treatment under Section 1256 of the US tax code if perpetual contracts qualify as futures.
This treatment generally categorizes gains and losses as 60% long-term and 40% short-term capital gains. However, if these contracts are deemed swaps, they will be taxed under 'ordinary' taxation.
Given that perpetual futures are newer innovations, the IRS has not issued 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, however, note that the issue is more complex. 'The challenge here is that textually, by the structure, perpetual futures look a lot like a swap, but economically they perform a lot like futures,' said Rustin Diehl, a tax attorney. 'It's really a substance-over-form question … function versus text.' The definition of swaps is extremely broad, leaving considerable room for interpretation regarding its application to new financial products like perpetual futures. The outcome will depend on how the court interprets it, particularly in light of the Supreme Court's 2024 Loper Bright decision, which eliminated the Chevron doctrine and now gives federal courts less deference to agencies' interpretations of ambiguous statutes.
This means judges could play a larger role in deciding how existing derivatives laws apply to novel crypto products. The process is likely to be long and drawn out, with potential litigation and the need for separate guidance from the IRS, which is not obligated to adopt the CFTC's interpretation of financial instruments.