The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory uncertainties if these products are ultimately classified as swaps rather than futures, a concern raised by CME Group Chairman and CEO Terry Duffy. In an interview with CoinDesk, Duffy pointed out the ambiguity surrounding the tax perspective for all US participants due to the current classification. This issue has garnered little public attention despite its potential consequences.
The comments come amidst CME's ongoing 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 arena of perpetual futures, including 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 that they should be considered swaps due to the periodic funding payments exchanged between long and short positions, satisfying the statutory definition of a swap under US law. Unlike traditional futures, perpetual contracts do not expire; instead, traders periodically exchange funding payments to keep the derivative's price close to the underlying asset's price.
Duffy believes this recurring payment exchange aligns with the definition of a swap. The main problem with the current designation is that if perpetual contracts are considered futures, many institutional traders could 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 classified as swaps, they will be taxed under 'ordinary' taxation, and given their novelty, 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 these positions to the IRS. Legal experts consider the issue complex, with the challenge being whether to prioritize the textual structure of perpetual futures, which resembles swaps, or their economic function, which is more akin to futures.
The definition of swaps is broad, leaving considerable room for interpretation, especially regarding new financial products like perpetual futures. The outcome will depend on the court's interpretation, particularly in light of the Supreme Court's 2024 Loper Bright decision, which reduced federal courts' deference to agencies' interpretations of ambiguous statutes.
This could lead to a lengthy litigation process, with experts anticipating that a federal judge will first examine whether the regulator reasonably considered public comments and sufficiently explained its decision before approving these contracts. Even if litigation clarifies the classification of perpetual contracts, tax treatment may still require separate guidance from the IRS, which is not obligated to adopt the CFTC's interpretation. Until there is greater clarity from regulators, tax authorities, or courts, large institutions could face uncertainty over reporting trades involving perpetual futures, potentially leading to significant tax implications.