The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory uncertainty if these products are ultimately classified as swaps rather than futures, a matter that has garnered little public attention, as stated by CME Group Chairman and CEO Terry Duffy. In an interview with CoinDesk, Duffy emphasized, 'There's a consequence that nobody's talking about. There's ambiguity right there, from a tax perspective, for all US participants now.' These comments come amidst CME's ongoing legal challenge against the Commodity Futures Trading Commission (CFTC) regarding the regulator's approval of perpetual futures contracts in the US.
Both parties await a federal court decision, which could significantly influence how the US approaches the rapidly growing area of perpetual futures, including how the Internal Revenue Service (IRS) taxes these contracts. The dispute centers on whether perpetual futures should be legally treated as futures or swaps. Duffy argues that perpetual futures, also known as 'perps,' should fall under the legal definition of swaps due to the periodic funding payments exchanged between long and short positions, rather than how the CFTC categorizes them as futures. Unlike traditional futures, perpetual contracts do not expire; instead, traders periodically exchange funding payments intended to keep the derivative's price close to that of the underlying asset.
Duffy contends that these recurring payment exchanges satisfy the statutory definition of a swap under US law, stating, 'When two parties exchange payments to each other, that is deemed a swap,' in reference to the funding-rate mechanism used by perpetual contracts. The main issue with this designation mismatch, according to Duffy, is that if perpetual contracts qualify as futures, many institutional traders could receive the blended tax treatment available under Section 1256 of the US tax code, where gains and losses are generally 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. Given that perpetual futures are newer innovations, the IRS has not issued guidance specifically addressing their tax treatment. 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 those positions to the IRS. Legal experts, however, note that the issue is more complex, with the challenge being 'substance over form' and the need to consider the economic function of perpetual futures versus their textual structure.
The definition of swaps is extremely broad, leaving considerable room for interpretation regarding its application to new financial products such as perpetual futures. The outcome will depend on how the court interprets the law, especially considering the Supreme Court's 2024 Loper Bright decision, which eliminated the Chevron doctrine and now gives less deference to agencies' interpretations of ambiguous statutes. This could lead to a long, drawn-out process with potential litigation and the need for separate guidance from the IRS, which may not adopt the CFTC's interpretation of financial instruments.
Until there is greater clarity from regulators, tax authorities, or the courts, large institutions could face uncertainty over how to report trades involving perpetual futures, posing significant risks.