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 Terry Duffy, Chairman and CEO of CME Group. This concern stems from the ambiguity surrounding the tax implications for US participants. Duffy's comments come as CME continues to challenge the Commodity Futures Trading Commission's (CFTC) approval of perpetual futures contracts in the US, with the outcome of the federal court decision potentially influencing the US approach to these rapidly growing financial products. A key aspect of the dispute revolves around whether perpetual futures should be legally treated as futures or swaps, with Duffy arguing that they should be considered swaps due to the periodic funding payments exchanged between long and short positions.
Unlike traditional futures, perpetual contracts do not expire and instead involve periodic funding payments to keep the derivative's price aligned with the underlying asset. Duffy believes this mechanism satisfies the statutory definition of a swap under US law. The main issue with the current designation is that if perpetual contracts are classified as futures, many institutional traders could receive a blended tax treatment, with gains and losses treated as 60% long-term and 40% short-term capital gains. However, if these contracts are deemed swaps, they would be subject to 'ordinary' taxation.
Given the novelty of perpetual futures, the IRS has not provided specific guidance on their tax treatment. Legal experts consider the issue complex, with the definition of swaps being extremely broad and the economic function of perpetual futures differing from their textual structure.
The Supreme Court's decision in Loper Bright has eliminated the Chevron doctrine, resulting in federal courts giving less deference to agencies' interpretations of ambiguous statutes. This could lead to a lengthy litigation process, with the potential for significant uncertainty regarding the tax treatment of perpetual futures. Ultimately, the classification of perpetual futures as swaps or futures may require separate guidance from the IRS, and until regulators, tax authorities, or the courts provide clarity, large institutions may face uncertainty in reporting trades involving these contracts.