Terry Duffy, Chairman and CEO of CME Group, has expressed concerns that 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. This issue has garnered little public attention, despite its significant implications.
In an interview with CoinDesk, Duffy stated, 'There's a consequence that nobody's talking about... There's ambiguity right there, from a tax perspective, for all US participants now.' 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. The outcome of this challenge could substantially influence how the US approaches the rapidly growing market of perpetual futures, particularly with regards to taxation by the Internal Revenue Service (IRS).
The core of the dispute revolves around whether perpetual futures should be legally classified as futures or swaps. Duffy argues that perpetual futures, also known as 'perps,' 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. Traditional futures contracts expire, whereas perpetual contracts do not, and instead involve periodic funding payments to keep the derivative's price close to the underlying asset's price. Duffy emphasized that these recurring payment exchanges satisfy the definition of a swap, stating, 'When two parties exchange payments to each other, that is deemed a swap.' The main issue with the current designation of perpetual contracts as futures, according to Duffy, is the potential for institutional traders to receive 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.
If perpetual contracts are deemed swaps, they would be taxed under 'ordinary' taxation. Given the novelty of perpetual futures, the IRS has not provided specific guidance on their tax treatment. If regulators or courts ultimately decide 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.
Duffy highlighted the potential consequences for traders, saying, 'So if you file your tax return and this ruling comes back, where these products that you’ve been trading and filing government tax returns as 1256 contracts [futures], when it should be ordinary, I will be curious what the IRS has to say to you about how much they think you owe them because you didn't file your tax returns properly.' Legal experts, however, view the issue as more complex. Rustin Diehl, a tax attorney, noted, 'The challenge here is that textually, by the structure, perpetual futures look a lot like a swap, but economically they perform a lot like futures...
It's really a substance-over-form question… function versus text.' The broad definition of swaps adds to the uncertainty, with Jason Gottlieb, a partner at Morrison Cohen, stating, 'Basically, the statutory definition of swaps is so broad as to encompass… anything.' The interpretation of this definition will depend on the court's decision. The process is expected to be lengthy, with Gottlieb predicting, 'My view is that there’s going to be a lot of litigation about it, and the Supreme Court has told courts that if there is ambiguity in the statute, they can ignore the CFTC and read the statute for themselves.' A federal judge is likely to examine whether the CFTC reasonably considered public comments and sufficiently explained its decision before approving these contracts.
Even if litigation clarifies the classification of perpetual contracts, tax treatment may still require separate guidance from the IRS, which is not obligated to adopt the CFTC's interpretation. Diehl advised, 'I think people are going to want to maybe check with the IRS and see how they should report these.' Until there is greater clarity from regulators, tax authorities, or the courts, Duffy warned that large institutions could face uncertainty over reporting trades involving perpetual futures, potentially leading to issues with tax payments.