The approval of perpetual futures contracts in the US may expose traders to unforeseen tax and regulatory risks if these products are ultimately classified as swaps rather than futures, according to CME Group Chairman and CEO Terry Duffy. This issue has garnered little public attention, despite its potential consequences.
In an interview, Duffy noted that the ambiguity surrounding the tax treatment of perpetual futures could have significant implications for US participants. The comments come as CME continues its legal challenge against the Commodity Futures Trading Commission (CFTC) over the regulator's approval of perpetual futures contracts in the US.
The outcome of this case could substantially influence the US approach to the rapidly growing market of perpetual futures. A key consideration is how the Internal Revenue Service (IRS) will ultimately tax these contracts. The dispute centers on whether perpetual futures should be legally treated as futures or swaps. Duffy argues that perpetual futures should be classified as swaps due to the periodic funding payments exchanged between long and short positions, which he believes satisfy the statutory definition of a swap under US law.
If perpetual contracts are deemed swaps, they will be taxed under ordinary taxation, rather than the blended tax treatment available under Section 1256 of the US tax code for futures. However, the IRS has not provided guidance on the tax treatment of perpetual futures, leaving market participants uncertain about how to report these positions. Legal experts acknowledge that the issue is complex, with the textual structure of perpetual futures resembling swaps, but their economic function akin to futures.
The definition of swaps is extremely broad, leaving considerable room for interpretation. The Supreme Court's 2024 Loper Bright decision has eliminated the Chevron doctrine, resulting in federal courts giving less deference to agencies' interpretations of ambiguous statutes.
This means that judges may play a larger role in deciding how existing derivatives laws apply to novel financial products like perpetual futures. The process of resolving this issue is likely to be lengthy and litigation-intensive, with tax treatment potentially requiring separate guidance from the IRS.