The approval of perpetual futures contracts in the US may put traders at risk of unforeseen tax and regulatory issues if these contracts are ultimately deemed to be swaps rather than futures, CME Group Chairman and CEO Terry Duffy has warned. In an interview, Duffy pointed out that there is ambiguity surrounding the tax implications for US participants due to the lack of clarity on the legal classification of perpetual futures. The comments come as CME continues to challenge the Commodity Futures Trading Commission's (CFTC) approval of perpetual futures contracts in the US, with a federal court decision pending.
The outcome of this case is expected to have a significant influence on how the US approaches the rapidly growing market of perpetual futures. A key issue at stake is how the Internal Revenue Service (IRS) will ultimately tax these contracts.
The dispute centers on whether perpetual futures should be legally treated as futures or swaps. Duffy argues that perpetual futures should be classified as swaps due to the periodic funding payments exchanged between long and short positions, which he believes satisfies the statutory definition of a swap under US law. If perpetual contracts are deemed to be futures, many institutional traders may be eligible for a blended tax treatment under Section 1256 of the US tax code, which treats gains and losses as 60% long-term and 40% short-term capital gains.
However, if these contracts are classified as swaps, they will be subject to ordinary taxation. The IRS has not provided guidance on the tax treatment of perpetual futures, adding to the uncertainty. Legal experts note that the issue is complex, with the textual structure of perpetual futures resembling swaps, but their economic function being similar to that of futures. The definition of swaps is extremely broad, leaving room for interpretation regarding its application to new financial products like perpetual futures.
The Supreme Court's 2024 Loper Bright decision has eliminated the Chevron doctrine, resulting in federal courts giving less deference to agencies' interpretations of ambiguous statutes. This means that judges may play a larger role in deciding how existing derivatives laws apply to novel crypto products. The resolution of this issue is likely to be a long and drawn-out process, with potential litigation and the need for separate guidance from the IRS.
Until regulators, tax authorities, or courts provide greater clarity, large institutions may face uncertainty over how to report trades involving perpetual futures, potentially leading to tax implications and regulatory issues.