The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory uncertainty if these products are ultimately deemed to be swaps rather than futures, a concern that has received minimal public 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) over the regulator's approval of perpetual futures contracts in the US, with both sides awaiting a federal court decision that could significantly influence how the US approaches the rapidly growing arena of perpetual futures. One potential consequence, according to Duffy, is 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 futures 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 and instead involve periodic funding payments intended to keep the derivative's price close to that of the underlying asset. Duffy stated, 'When two parties exchange payments to each other, that is deemed a swap,' referring to the funding-rate mechanism used by perpetual contracts.
The main problem with this mismatched designation, according to Duffy, is that if perpetual contracts qualify as futures, many institutional traders could receive blended tax treatment 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 these 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 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, say the issue is more complex, with Rustin Diehl, a tax attorney, stating, '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. It's really a substance-over-form question … function versus text.' The definition of swaps is extremely broad, leaving room for interpretation regarding its application to new financial products such as perpetual futures.
Jason Gottlieb, partner and chair of Morrison Cohen's digital assets practice, stated, 'The statutory definition of swaps is so broad as to encompass … anything.' The outcome will depend on how the court interprets it, and the process is likely to be long and drawn out, with Gottlieb saying, 'My view is that there’s going to be a lot of litigation about it, and the Supreme Court has told courts that if there is ambiguity in the statute, they can ignore the CFTC and read the statute for themselves.' Even if litigation clarifies whether perpetual contracts are swaps or futures, tax treatment may still require separate guidance from the IRS, which is not obligated to adopt the CFTC's interpretation of financial instruments. Until regulators, tax authorities, or courts provide greater clarity, Duffy stated that large institutions could face uncertainty over how to report trades involving perpetual futures, saying, 'How would you like to be running a very large public company that trades a lot and hedges a lot, and all of a sudden you're in the news for not paying proper taxes.'