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, a matter that has garnered little public attention, as stated by CME Group Chairman and CEO Terry Duffy. 'There's a consequence that nobody's talking about,' Duffy said in an interview.
'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) over the regulator's approval of perpetual futures contracts in the US. Both sides await a federal court decision, which could significantly influence how the US approaches the rapidly growing arena of perpetual futures, particularly in terms of how the Internal Revenue Service (IRS) ultimately taxes these contracts. The dispute stems from whether perpetual futures should be legally treated as futures or swaps.
Duffy argued that perpetual contracts, 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 never expire; instead, traders periodically exchange funding payments intended to keep the derivative's price close to that of the underlying asset. Duffy contended that those 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. The main issue with this designation, according to Duffy, is that if perpetual contracts qualify as futures, many institutional traders could receive the blended tax treatment available under Section 1256 of the US tax code, where gains and losses are generally treated as 60% long-term and 40% short-term capital gains.
If those contracts fall under swaps, they will be taxed under 'ordinary' taxation. Given that perpetual futures are newer innovations, the IRS has not issued guidance specifically addressing the tax treatment of these contracts.
So, 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, noted 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 such as 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 longstanding Chevron doctrine, resulting in federal courts giving 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.