The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory risks if these products are ultimately classified as swaps rather than futures, according to CME Group Chairman and CEO Terry Duffy. This ambiguity could lead to uncertainty for US participants from a tax perspective. 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. The outcome of this challenge 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 due to the periodic funding payments exchanged between long and short positions. Unlike traditional futures, perpetual contracts do not expire and instead involve recurring funding payments to keep the derivative's price close to the underlying asset's price.
Duffy argues that these payment exchanges satisfy 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 provided specific guidance on their tax treatment, potentially leading to uncertainty for market participants who have been treating them as futures for tax purposes. Legal experts note that the issue is complex, with perpetual futures exhibiting characteristics of both swaps and futures, making it a 'substance-over-form' question.
The definition of swaps is broad, leaving room for interpretation regarding its application to new financial products like perpetual futures. The outcome will depend on how the court interprets the law, particularly in light of the Supreme Court's 2024 Loper Bright decision, which reduced the deference given to agencies' interpretations of ambiguous statutes. This could lead to a lengthy litigation process, with the potential for tax evasion concerns and the need for separate guidance from the IRS. Until there is greater clarity from regulators, tax authorities, or the courts, large institutions may face uncertainty over reporting trades involving perpetual futures, highlighting the need for careful consideration of tax implications in the trading of these contracts.