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 issue has garnered little public attention despite its significant implications. In an interview with CoinDesk, Duffy emphasized the ambiguity surrounding the tax perspective for all US participants. The comments come as CME continues to challenge the Commodity Futures Trading Commission (CFTC) in court over the regulator's approval of perpetual futures contracts in the US.
The outcome of this case could substantially influence the US approach to the rapidly growing market of perpetual futures. A key consequence of this dispute is how the Internal Revenue Service (IRS) will ultimately tax these contracts. The core issue stems from whether perpetual futures should be legally treated as futures or swaps. Duffy argues that perpetual futures should be categorized as 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; instead, traders make periodic funding payments to keep the derivative's price close to the underlying asset's price. Duffy believes this recurring payment exchange satisfies the definition of a swap. The main problem with the current designation is that if perpetual contracts are considered futures, many institutional traders could receive a blended tax treatment under Section 1256 of the US tax code, where gains and losses are treated as 60% long-term and 40% short-term capital gains. However, if these contracts are classified as swaps, they will be taxed under 'ordinary' taxation.
The IRS has not provided specific guidance on the tax treatment of perpetual futures, adding to the uncertainty. If regulators or courts ultimately decide that perpetual contracts are swaps, market participants who have been treating them as futures for tax purposes may face uncertainty about how to report these positions to the IRS. Legal experts note that the issue is complex, with the textual structure of perpetual futures resembling swaps but functioning economically like futures, posing 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, especially since the Supreme Court's 2024 Loper Bright decision reduced federal courts' deference to agencies' interpretations of ambiguous statutes. This could lead to a lengthy litigation process, with the possibility of the Supreme Court eventually weighing in.
Tax experts suggest that market participants may need to seek guidance from the IRS on how to report trades involving perpetual futures, as the IRS is not obligated to follow the CFTC's interpretation of financial instruments. Until there is greater clarity from regulators, tax authorities, or the courts, large institutions could face uncertainty over reporting trades involving perpetual futures, potentially leading to significant tax implications.