The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory uncertainty if these products are ultimately deemed swaps rather than futures, according to CME Group Chairman and CEO Terry Duffy. In an interview, Duffy pointed out the ambiguity surrounding the tax implications for US participants.
This uncertainty stems from an ongoing legal challenge by CME against the Commodity Futures Trading Commission (CFTC) over the regulator's approval of perpetual futures contracts. The outcome of this case could substantially influence the US approach to perpetual futures, including how the Internal Revenue Service (IRS) taxes these contracts. At the heart of the dispute is whether perpetual futures should be legally categorized as futures or swaps due to the periodic funding payments exchanged between long and short positions.
Unlike traditional futures, perpetual contracts do not expire; instead, traders make periodic funding payments to keep the derivative's price aligned with the underlying asset. Duffy argues that these recurring payments meet the statutory definition of a swap under US law. The main issue with the current designation is that if perpetual contracts are classified as futures, many institutional traders might receive a blended tax treatment under Section 1256 of the US tax code, treating gains and losses as 60% long-term and 40% short-term capital gains. However, if these contracts are deemed swaps, they would be taxed under ordinary taxation, given the IRS has not provided specific guidance on the tax treatment of perpetual futures.
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 considerable room for interpretation, especially regarding new financial products like perpetual futures.
The Supreme Court's decision in Loper Bright has shifted the interpretation of ambiguous statutes from regulatory agencies to federal courts, potentially leading to a protracted litigation process. Experts anticipate that rather than immediately deciding the classification of perpetual futures, a federal judge may first examine whether the CFTC reasonably considered public comments and explained its decision before approving these contracts. Even if litigation clarifies the classification, tax treatment may still require separate IRS guidance.
Until there is greater clarity from regulators, tax authorities, or the courts, large institutions may face uncertainty over reporting trades involving perpetual futures, potentially leading to significant tax implications.