The approval of perpetual futures contracts in the US may lead to unforeseen tax and regulatory complexities for traders if these products are ultimately deemed swaps rather than futures, a concern highlighted by CME Group Chairman and CEO Terry Duffy. In an interview, Duffy noted 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, which could significantly influence the US approach to perpetual futures. A key consequence of this dispute is how the Internal Revenue Service (IRS) will tax these contracts.
The core issue revolves around whether perpetual futures should be legally treated as futures or swaps. Duffy argues that perpetual futures, due to their periodic funding payments, should be classified as swaps under US law. Unlike traditional futures, perpetual contracts do not expire but involve periodic funding payments to keep the derivative's price aligned with the underlying asset. This mechanism, Duffy believes, aligns with the statutory definition of a swap.
The misclassification could lead to institutional traders receiving a blended tax treatment under Section 1256 of the US tax code, which treats gains and losses as 60% long-term and 40% short-term capital gains. If perpetual contracts are deemed swaps, they would be taxed under ordinary taxation, potentially causing uncertainty for market participants who have been treating them as futures for tax purposes. Legal experts, such as Rustin Diehl and Jason Gottlieb, acknowledge the complexity of the issue, noting that while perpetual futures structurally resemble swaps, they function 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 larger role in interpreting derivatives laws for novel products like perpetual futures.
The process is expected to be lengthy, with potential litigation and the need for the IRS to provide separate guidance on tax treatment. Until there is clarity, large institutions may face uncertainty over reporting trades involving perpetual futures, potentially leading to tax complications.