The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory uncertainties if these products are ultimately deemed to be swaps rather than futures, a concern voiced by CME Group Chairman and CEO Terry Duffy. In an interview, Duffy emphasized the ambiguity surrounding the tax implications for US participants, stating, 'There's a consequence that nobody's talking about.' 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. The outcome of this challenge could significantly influence the US approach to the rapidly growing arena of perpetual futures, particularly in how the Internal Revenue Service (IRS) taxes these contracts.
The core of the dispute lies in whether perpetual futures should be legally categorized as futures or swaps, with Duffy arguing they should be considered 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 but instead involve periodic funding payments to keep the derivative's price aligned with the underlying asset. If perpetual contracts are classified as futures, 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 they are deemed swaps, they would be taxed under 'ordinary' taxation, given the IRS has not provided specific guidance on the tax treatment of perpetual futures. This discrepancy could lead to uncertainty for market participants who have been treating these contracts as futures for tax purposes, potentially facing issues with the IRS if the classification changes.
Legal experts view the issue as complex, with the textual structure of perpetual futures resembling swaps but functioning economically like futures, posing a 'substance-over-form question.' The broad definition of swaps and the recent Supreme Court decision eliminating the Chevron doctrine, which reduces deference to agencies' interpretations of ambiguous statutes, add to the complexity and uncertainty. Experts anticipate a lengthy litigation process, with the potential for the Supreme Court to ultimately decide how existing derivatives laws apply to novel crypto products like perpetual futures. Until there is clarity from regulators, tax authorities, or the courts, large institutions may face uncertainty over reporting trades involving perpetual futures, highlighting the need for guidance from the IRS, which may not necessarily align with the CFTC's interpretations.