The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory risks if these contracts are ultimately classified as swaps rather than futures, a matter that has garnered little attention, according to Terry Duffy, Chairman and CEO of CME Group. In an interview with CoinDesk, Duffy highlighted the ambiguity surrounding the tax implications for US participants. The comments come as CME Group continues its legal challenge against the Commodity Futures Trading Commission (CFTC) regarding the regulator's approval of perpetual futures contracts in the US. A federal court decision is pending, and the outcome could significantly influence the US approach to the rapidly growing market 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 due to the periodic funding payments exchanged between long and short positions. 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 argued that these recurring payments align with the statutory definition of a swap under US law, as they involve the exchange of payments between parties. The main issue with the current designation is that if perpetual contracts are classified as 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 deemed swaps, they will be taxed under 'ordinary' taxation, given that the IRS has not issued specific guidance on the tax treatment of perpetual futures. If regulators or courts ultimately conclude that perpetual contracts are swaps, market participants who have treated 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 textual structure of perpetual futures resembling swaps but performing economically like futures, posing 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 the court's interpretation, particularly in light of the Supreme Court's 2024 Loper Bright decision, which reduced federal courts' deference to agencies' interpretations of ambiguous statutes. This could lead to a lengthy litigation process, with the potential for the Supreme Court to ultimately decide how existing derivatives laws apply to novel crypto products.
The tax implications and potential for tax evasion are significant concerns, with institutions facing uncertainty over how to report trades involving perpetual futures until regulators, tax authorities, or courts provide clarity.