The recent 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, emphasizing that the consequence of this misclassification has not received adequate attention.
The legal dispute between CME and the Commodity Futures Trading Commission (CFTC) over the regulator's approval of perpetual futures contracts is pending a federal court decision, which could substantially influence the US approach to these rapidly growing financial instruments. A key aspect of this dispute is whether perpetual futures should be legally categorized as futures or swaps, with Duffy arguing that they should be considered swaps due to the periodic funding payments exchanged between long and short positions, thus satisfying the statutory definition of a swap under US law. This distinction is crucial as it affects the tax treatment of these contracts.
If perpetual contracts are deemed futures, many institutional traders could be eligible for the blended tax treatment provided 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 they are classified as swaps, they would be subject to 'ordinary' taxation.
The IRS has not provided specific guidance on the tax treatment of perpetual futures, adding to the uncertainty. Legal experts acknowledge the complexity of the issue, noting that while perpetual futures structurally resemble swaps, they function economically like futures, making it a 'substance-over-form' question.
The broad definition of swaps and the recent Supreme Court decision eliminating the Chevron doctrine, which gives less deference to agencies' interpretations of ambiguous statutes, further complicate the matter. This could lead to extensive litigation, with the Supreme Court potentially playing a significant role in interpreting how existing derivatives laws apply to novel financial products like perpetual futures.
The outcome may necessitate separate guidance from the IRS, which is not obligated to adopt the CFTC's interpretation, potentially leaving market participants uncertain about how to report their positions to the IRS. Until there is greater clarity from regulators, tax authorities, or the courts, large institutions may face uncertainty over reporting trades involving perpetual futures, highlighting the need for careful consideration and potentially seeking guidance from tax authorities.