The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory challenges if these products are ultimately classified as swaps rather than futures, a concern that has received minimal public attention, according to Terry Duffy, Chairman and CEO of CME Group. 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) regarding the regulator's approval of perpetual futures contracts in the US. Both sides await a federal court decision, which could significantly influence how the US approaches the rapidly growing arena of perpetual futures, including how the Internal Revenue Service (IRS) will tax these contracts. The dispute centers on whether perpetual futures should be legally treated as futures or swaps.
Duffy argues that perpetual contracts 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. 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. Duffy's concern is that if perpetual contracts are deemed 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 guidance on the tax treatment of perpetual futures, given their status as newer innovations. 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 note that the issue is complex, with the challenge being that perpetual futures look like swaps structurally but perform like futures economically, making it a 'substance-over-form question.' The definition of swaps is extremely 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, and it is likely to be a long, drawn-out process with potential litigation. A federal judge may first examine whether the regulator 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 of financial instruments.
Until regulators, tax authorities, or courts provide greater clarity, Duffy warns that large institutions could face uncertainty over how to report trades involving perpetual futures, potentially leading to tax evasion concerns.