The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory risks if these contracts are ultimately deemed to be swaps rather than futures, a concern voiced by CME Group Chairman and CEO Terry Duffy. In an interview, Duffy pointed out the ambiguity surrounding the tax implications for US participants, given the current lack of clarity on the matter. This issue has arisen amidst CME's ongoing legal challenge against the Commodity Futures Trading Commission (CFTC) regarding the regulator's approval of perpetual futures contracts.
The core of the dispute lies in whether perpetual futures should be legally categorized 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 contracts, perpetual contracts do not expire and instead involve periodic funding payments to maintain the derivative's price close to the underlying asset's price. Duffy's argument is based on the statutory definition of a swap under US law, which he believes is satisfied by the funding-rate mechanism used in perpetual contracts. A significant concern is that if perpetual contracts are classified as futures, many institutional traders might receive a blended tax treatment under Section 1256 of the US tax code, treating gains and losses 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, leading to potential uncertainty for market participants who have been treating them as futures for tax purposes. Legal experts emphasize that the issue is complex, with the textual structure of perpetual futures resembling swaps but functioning economically like futures, making it a 'substance-over-form' question.
The broad definition of swaps and the recent Supreme Court decision eliminating the Chevron doctrine add to the uncertainty, suggesting that courts may play a significant role in interpreting how derivatives laws apply to new financial products like perpetual futures. The process of resolving this issue is expected to be lengthy and may involve considerable litigation, with tax treatment potentially requiring separate guidance from the IRS.