On December 8, 2021, the Financial Criminal Enforcement Network (FinCEN) published proposed regulations that would implement the Corporate Transparency Act (CTA),[1] which became law as part of the National Defense Authorization Act for Fiscal Year 2021. The CTA requires certain legal entities to report information about their beneficial owners and those persons who filed applications to form the entities or to register the entities to do business in the United States (“company applicants”).

While these regulations are not final (and FinCEN has left open the timeframe for implementing any regulations even when they do become final), they do provide a useful window into FinCEN’s thinking on beneficial ownership reporting under the CTA. Here are some initial takeaways.

The proposed regulations would provide guidance for determining which legal entities would be required to file reports with FinCEN (“reporting companies”).

The CTA broadly defines a “reporting company” to include corporations, limited liability companies, and other companies that are created by filing a document with a secretary of state or similar office under the law of a State or Indian Tribe or that are formed under the law of a foreign country and registered to do business in the United States.[2] Exceptions to the definition of a “reporting company” include certain nonprofit organizations, entities already regulated by other law, and large operating companies.[3]

Other than matters of terminology (i.e., distinguishing between a “domestic reporting company” and a “foreign reporting company”), the primary guidance that the proposed regulations would provide in this area would be delineating what qualifies as a large operating company.

Under the CTA, the large operating company exception applies to an entity that employs more than 20 full-time employees in the United States, reported more than $5 million in gross receipts or sales on the previous year’s federal income tax return, and has an “operating office at a physical office within the United States.”[4] The proposed regulations would exclude an entity’s foreign source gross receipts in determining whether the $5 million dollar threshold is met.[5] The proposed regulations also would define “operating presence at a physical office within the United States” to mean “that an entity regularly conducts its business at a physical location in the United States that the entity owns or leases, that is not the place of residence of any individual, and that is physically distinct from the place of business of any other unaffiliated entity.”[6]

Observation: FinCEN appears to be trying to limit the application of this large operating company exclusion, sometimes in ways that the statute may not support. For instance, there is no indication in the statute that the $5 million threshold is to be determined by excluding foreign source gross receipts.[7] The preamble’s explanation that the exclusion is supported by the statute’s requirement that the reporting company file a federal tax return is unconvincing, since return filing requirements for domestic entities at least are not tied to the source of the entity’s gross receipts.[8]

What Needs to Be Reported?

The CTA requires a reporting company to file reports with FinCEN with information regarding its beneficial owners and company applicants.[9] A “beneficial owner” is defined as “an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise . . . exercises substantial control over the entity . . . or . . .owns or controls not less than 25 percent of the ownership interests of the entity.”[10]

The proposed regulations would provide guidance on what it means to have significant control over a reporting company. The proposed regulations state that “substantial control” includes:

• Service as a senior officer of the reporting company;
• Authority over the appointment or removal of any senior officer or a majority or dominant minority of the board of directors (or similar body);
• Direction, determination, or decision of, or substantial influence over, important matters affecting the reporting company . . . ;
• Any other form of substantial control over the reporting company.[11]

The proposed regulations go on to say:

An individual may directly or indirectly exercise substantial control over a reporting company through a variety of means, including through board representation; through ownership or control of a majority or dominant minority of the voting shares of the reporting company; through rights associated with any financing arrangement or interest in a company; through control over one or more intermediary entities that separately or collectively exercise substantial control over a reporting company; through arrangements or financial or business relationships, whether formal or informal, with other individuals or entities acting as nominees, or through any other contract, arrangement, understanding, relationship, or otherwise.[12]

Observation: The definition of “substantial control” in the proposed regulations is extremely vague (although, to be fair the statute fares little better). For the sake of easing compliance burdens, one would hope that the final regulations will provide greater specificity to this term.

In addition, the proposed regulations define what it means to have an “ownership interest” in a reporting company as:

• Any equity, stock, or similar instrument, certificate of interest or participation in any profit sharing agreement, preorganization certificate or subscription, transferable share, voting trust certificate or certificate of deposit for an equity security, interest in a joint venture, or certificate of interest in a business trust, without regard to whether any such instrument is transferable, is classified as stock or anything similar, or represents voting or non-voting shares;
• Any capital or profit interest in a limited liability company or partnership, including limited and general partnership interests;
• Any proprietorship interest;
• Any instrument convertible, with or without consideration, into any instrument described in . . . (A), (B), or (C) . . ., any future on any such instrument, or any warrant or right to purchase, sell, or subscribe to a share or interest described in . . . (A), (B), or (C) . . ., regardless of whether characterized as debt; or
• Any put, call, straddle, or other option or privilege of buying or selling any of the items described in . . . (A), (B), (C), or (D) . . . without being bound to do so.[13]

As with the definition of “substantial control,” the proposed regulations provide a variety of means whereby an individual would be considered directly or indirectly to have an ownership interest in an in reporting company, including through joint ownership of an ownership interest, “[t]hrough control of such ownership interest owned by another individual,” and as certain trustees, beneficiaries, and grantors of trusts.[14]

Observation: It is unclear what is meant by “control of such ownership interest owned by another individual.” Hopefully, final regulations will clear this up.

The proposed regulations generally would require a reporting company to file a report with certain identifying information about itself and, for each beneficial owner and company applicant:

• the person’s address (business address for company applicants engaged in the business of forming companies, residential address for everybody else);
• unique identifying number for the person from a non-expired U.S. passport, state-issued identification document or driver’s license, or passport from a foreign government; and
• a copy of such document.[15]

A person could avoid providing this information to a reporting company by obtaining a FinCEN identifier. However, the person would still be required to submit this information directly to FinCEN.[16]

What Are the Reporting Deadlines?

The proposed regulations would establish the following deadlines for reporting companies to file, correct, or amend reports with FinCEN:

• Reporting companies formed or registered to do business in the United States before the final regulations’ effective date would have one year to file an initial report.
• Reporting companies formed or registered to do business after the final regulations’ effective date would have 14 calendar days after formation or registration to file an initial report.
• For filed reports with inaccurate information, reporting companies would have 14 calendar days after the date the inaccuracy is discovered to correct the report.
• For reports with information that has changed after filing, reporting companies would have 30 calendar days after the date on which the change occurred to update the report.[17]

Observation: Considering how expansively beneficial ownership is defined and the difficulty reporting companies may have in finding out whether there has been a change in beneficial ownership (especially in cases where such ownership is indirect), 30 days after the change occurs may be too short a window for a reporting company to update a report. The better solution would be to tie the deadline to when the reporting company discovers the change, as is the case with inaccuracies in a report. However, this might need a statutory change to fix.[18]

Final Thoughts?

Again, these are just proposed regulations, and FinCEN is seeking comments on many the definitions and requirements contained therein.

[1] 31 U.S.C. § 5336.

[2] Id.  § 5336(a)(11)(A).

[3] See id. § 5336(a)(11)(B).

[4] Id. § 5336(a)(11)(B)(xxi).

[5] Prop. 31 C.F.R. § 1010.380(c)(2)(xxi)(C).

[6] Id. § 1010.380(f)(6).

[7] See 31 U.S.C. § 5336(a)(11)(B)(xxi)(II).

[8] See 26 U.S.C. § 6012(2), 6031.

[9] See 31 U.S.C. § 5336(b)(1), (2).

[10] Id. § 5336(a)(3).

[11] Prop. 31 C.F.R. § 1010.380(d)(1).

[12] Id. § 1010.380(d)(2).

[13] Id. § 1010.380(d)(3)(i).

[14] Id. § 1010.380(d)(3)(ii).

[15] Id. § 1010.380(b)(1).

[16] Id. § 1010.380(b)(5).

[17] Id. § 1010.380(a)(1)-(3).

[18] See 31 U.S.C. § 5336(b)(1)(D) (“[A] reporting company shall, in a timely manner, and not later than 1 year after the date on which there is a change with respect to any information . . . submit to FinCEN a report that updates the information relating to the change.) (emphasis added).

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