For more than a decade the federal government has complained to its allies and international trading partners that their business entities and financial institutions were not transparent enough and could be used to hide the identities of money launderers, terrorists, and criminals. These complaints were made despite the fact that the US had no laws at the federal level requiring states to ask for or keep records of the beneficial owners of entities formed in their jurisdictions. This means that as many countries changed their laws, under US pressure, to make beneficial ownership of trusts, partnerships, and corporations more transparent, the US became the jurisdiction of choice for those who wanted to launder money or hide questionable activity behind the anonymous corporate veil. However, change is coming, and it is going to affect everyone in the US business community.
In the waning days of the Trump administration, Congress passed the National Defense Authorization Act. The President vetoed the legislation, but Congress overrode that veto and the Corporate Transparency Act (“CTA”), incorporated within the National Defense Authorization Act, became law on January 1, 2021. The CTA requires the establishment of a database to create a public and private information sharing partnership among law enforcement agencies, national security agencies, financial institutions, and the Financial Crimes Enforcement Network (FinCEN) of the Department of the Treasury. This list is likely to expand over time.
The CTA requires what the legislation calls “reporting entities” (generally corporations, LLCs, business trusts, limited partnerships, and other similar entities that are formed in the US through a filing with a state agency, together with foreign entities with a presence in the US) to report details of the reporting entities’ beneficial owners to FinCEN.
“Reporting entities” includes the above list of specific business entities and a kind of catch-all of “other similar entities.” What is meant by “other similar entity”? Until regulations are issued, we are not going to know what the term “other similar entity” means. It is possible that the regulations might specify that general partnerships, trusts, and estates will fall within the definition of “reporting entities” even though the CTA is aimed at entities formed through filing documents with a state.
The CTA defines a beneficial owner of an entity as an individual who, directly or indirectly:
The definition excludes (i) creditors (but only in their capacity as such); (ii) agents, intermediaries, and custodians acting on behalf of another individual; and (iii) employees of a reporting company whose control or economic benefit with respect to the entity is derived solely from their employment.
Companies with multi-tiered stock classes or LLCs with multiple classes of interests with differing rights may not be able to fit neatly into a 25% ownership test and will need to wait for Treasury regulations (the “Regulations”) to be issued which provide more guidance. The CTA does not define “substantial control.” Will a third party such as legal counsel or lenders be able to exert the required level of control so as to make them a “beneficial owner”? There are many terms used in the CTA which the legislation does not define. The CTA requires the Treasury to issue Regulations which will hopefully clarify these terms and provide guidance. It is highly likely that the Regulations will require disclosure that clearly reveals individuals who control or own 25% or more of the reporting company, no matter how many levels of ownership have to be pierced and no matter how indirect that ownership may be. It seems likely that the Regulations will cast a wide net. These Regulations are required to be issued by January 1, 2022.
The CTA also requires a newly formed reporting entity to identify each of its “applicants.” “Applicant” is defined to include individuals who file the application to form the entity with the state. We do not currently know exactly who will fall within the term “applicant,” but it is likely to include the entity organizer. We will have to wait for the Regulations to see if this term includes an attorney or CPA who forms the entity for their client or whether such professionals are excluded as “agents, intermediaries, and custodians acting on behalf of another individual.”
Since entities with nominee equity holders and corporate officers and directors are often used to hide questionable activity, the CTA is intended to make questionable and often criminal activity more difficult by removing the corporate veil and other obstacles obscuring beneficial ownership and allowing government agencies to peer in. Sounds reasonable? Well yes, but its broad application will result in the loss, to some extent, of some reasonable commercial anonymity and privacy for entities going about their normal business activities which are carried on with zero criminal intent. For example, businesses benefit from the privacy of the corporate veil when engaged in activities such as acquiring real estate parcels through the use of anonymous companies in the hope of avoiding upward pressure on land prices in an area or property ownership by public personalities. These may be made more difficult notwithstanding the protections contained in the CTA.
The reporting requirement starts from the date that the Treasury adopts Regulations which, as mentioned above, it is required to do by January 1, 2022. Reporting companies formed after the Regulation adoption date must report the required information upon formation of a reporting entity. Already existing businesses will have two years from the Regulation adoption date to report and identify their beneficial owners. Reporting companies will need to update beneficial ownership information with FinCEN within one year of any change in the reported information.
Every reporting company will be required to submit four items of information to FinCEN on each beneficial owner of a reporting entity or applicant forming a new entity. This information is: 1) full legal name; 2) date of birth; 3) current residential or business street address; and 4) a unique identifying number. The identifying number could be a driver’s license or passport number, or the beneficial owner may request and use a FinCEN identifying number. A reporting company will need to update the information provided to FinCEN within one year of the date of any change in beneficial ownership.
This information will be stored by FinCEN in a private database and will not be accessible to the general public. The information will, however, be made available to federal law enforcement agencies and, with court approval, other law enforcement agencies. Foreign law enforcement agents may also obtain access to the database by requesting it from the appropriate federal agency. Outside of government agencies the information will, with the customer’s consent, be available to financial institutions for customer due diligence purposes. Although the customer’s consent is required, in reality the customer is likely to have little choice. If the customer refuses to give consent, it is probable that the financial institution will drop the customer, and in the case of loans, it is likely to be a condition of any lending transaction.
For Those That Do Not Report
The CTA provides for civil penalties of not more than $500 for each day that a violation continues or has not been remedied and fines of up to $10,000 and possible imprisonment of up to two years for any person who willfully (i) provides, or attempts to provide, false or fraudulent beneficial ownership information (including identifying photographs or documents) or (ii) fails to report complete or updated beneficial ownership information to FinCEN.
If you have any further questions regarding reporting and compliance requirements for corporate entities, please contact Ian Shane.