CME's Duffy Highlights Overlooked Tax Risk Associated with US Perpetual Futures

The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory risks if these products are ultimately deemed to be swaps rather than futures, warns CME Group Chairman and CEO Terry Duffy. In an interview with CoinDesk, Duffy pointed out that there is ambiguity surrounding the tax implications for US participants due to the lack of clarity on the classification of perpetual futures. This ambiguity stems from the ongoing legal dispute between CME and the Commodity Futures Trading Commission (CFTC) over the regulator's approval of perpetual futures contracts.

The outcome of this case could substantially influence how the US approaches the rapidly growing market of perpetual futures, particularly in terms of how the Internal Revenue Service (IRS) will tax these contracts. At the heart of the dispute is whether perpetual futures should be legally categorized as futures or swaps. Duffy argues that perpetual futures should be considered swaps due to the periodic funding payments exchanged between long and short positions, which aligns with the statutory definition of a swap under US law.

Unlike traditional futures, perpetual contracts do not expire and involve recurring funding payments intended to keep the derivative's price close to the underlying asset's price. If perpetual contracts are classified as futures, many institutional traders might receive a 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. However, if they are deemed swaps, they will be taxed under 'ordinary' taxation, which could lead to uncertainty for market participants who have been treating them as futures for tax purposes. Legal experts note that the issue is complex, with the textual structure of perpetual futures resembling swaps but their economic function similar to futures, making it a 'substance-over-form' question.

The definition of swaps is broad, leaving considerable room for interpretation, especially for novel financial products like perpetual futures. The resolution of this issue may depend on how the court interprets the law, given 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 and complex litigation process, with potential implications for tax treatment that may require separate guidance from the IRS.