The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory risks if these products are ultimately deemed swaps rather than futures, according to CME Group Chairman and CEO Terry Duffy. This issue has garnered little public attention, despite its potential consequences. In an interview with CoinDesk, Duffy pointed out the ambiguity surrounding the tax implications for US participants.
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. A federal court decision is pending, and its outcome could significantly influence the US approach to the rapidly growing arena of perpetual futures, including how the Internal Revenue Service (IRS) taxes these contracts. The dispute centers on whether perpetual futures should be legally treated as futures or swaps. Duffy argues that perpetual contracts should fall under the legal definition of swaps due to the periodic funding payments exchanged between long and short positions, which he believes satisfy the statutory definition of a swap under US law.
Unlike traditional futures, perpetual contracts do not expire; instead, traders periodically exchange funding payments to keep the derivative's price close to the underlying asset's price. If perpetual contracts qualify as futures, many institutional traders could 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 these contracts are classified as swaps, they will be taxed under 'ordinary' taxation. Given that perpetual futures are newer innovations, the IRS has not issued specific guidance on 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 these positions to the IRS. Legal experts consider the issue complex, with the challenge being that perpetual futures structurally resemble swaps but function economically like futures, making it a 'substance-over-form question.' The definition of swaps is extremely broad, leaving considerable room for interpretation regarding its application to new financial products like perpetual futures. The outcome will depend on the court's interpretation, and the process is likely to be long and drawn out, 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.