The approval of perpetual futures contracts in the US may lead to unforeseen tax and regulatory issues for traders if these products are ultimately classified as swaps rather than futures, warns CME Group Chairman and CEO Terry Duffy. In an interview, Duffy pointed out the ambiguity surrounding the tax implications for US participants.
The comments come as CME continues to challenge the Commodity Futures Trading Commission's (CFTC) approval of perpetual futures contracts in the US. A federal court decision is pending, and its outcome could substantially influence the US approach to the rapidly growing market of perpetual futures, particularly in terms of 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, with Duffy arguing they should be considered swaps due to the periodic funding payments exchanged between long and short positions.
Unlike traditional futures, perpetual contracts do not expire and involve periodic funding payments to keep the derivative's price aligned with the underlying asset. Duffy contends that these recurring payments meet the statutory definition of a swap under US law. The main concern with the current designation is that if perpetual contracts are deemed futures, many institutional traders might receive a blended tax treatment 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 classified as swaps, they would be taxed under 'ordinary' taxation, given the IRS has not provided specific guidance on the tax treatment of perpetual futures. 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 definition of swaps is broad, leaving room for interpretation, especially with 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 courts potentially ignoring the CFTC's interpretation and reading the statute independently.
The tax implications may require separate IRS guidance, which is not obligated to align with the CFTC's interpretation. Until there is clarity from regulators, tax authorities, or courts, institutions may face uncertainty in reporting trades involving perpetual futures, potentially leading to tax issues.