By Jennifer Leung.
On January 1, 2021, Congress passed the Corporate Transparency Act (CTA) as part of the 2021 National Defense Authorization Act. The CTA requires most private companies formed in the U.S. or registered to do business in the U.S. to report beneficial ownership information to the Financial Crimes Enforcement Network (FinCEN) bureau of the U.S. Department of the Treasury. Although the CTA is intended to eliminate the anonymity of individuals that use shell companies for illegal activities, the reporting requirements will affect legitimate private companies. Companies should be aware of and prepare for the new reporting requirements to avoid civil and criminal penalties for failure to file the information when required.
Types of Companies Required to Report Beneficial Owners Under the CTA
Companies that are required to report their beneficial owners and applicants to FinCEN under the CTA are any corporation, limited liability company, or other similar entity that is either formed in the U.S. or formed under the law of a foreign country and registered to do business in the US. Certain companies are exempt from the reporting requirements, including:
- publicly-traded companies;
- banks, insurance companies, investment companies registered with the Securities Exchange Commission, and credit unions;
- public accounting firms;
- companies that employ more than twenty people, filed a tax return reporting gross receipts of more than $5 million, and have a physical presence in the US;
- nonprofit organizations; and
- any entity that is designated by Secretary of the Treasury to be exempt.
It is unclear whether the scope of “other similar entity” under the CTA will include partnerships (general or limited) or trusts until the regulations under the CTA have been adopted. The CTA regulations would be consistent with existing FinCEN’s customer due diligence rules if it includes limited partnerships and business trusts but excludes general partnerships and most estate planning trusts.
CTA Reporting Requirements
Reporting will not begin until the Secretary of the Treasury has adopted regulations detailing how the CTA will be implemented, which adoption is mandated by January 1, 2022.
FinCEN must also establish a registry to collect the identifying information on a reporting company’s beneficial owners and applicants. Reporting companies must file a report with FinCEN upon formation or registration, containing the following information regarding its beneficial owners and applicants:
- full legal name;
- date of birth;
- current residential or business address; and
- unique identifying number from an acceptable identification document, such as a driver’s license or passport.
Companies formed before the regulations are adopted will have a two-year period after adoption of the regulations to file their initial reports.
Companies will also be required to submit annual reports to reflect any changes to the identifying information.
Definitions of Beneficial Owner and Applicants
A “beneficial owner” is defined as an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise owns or controls 25% or more of the ownership interest of an entity, or exercises “substantial control” over an entity.
The CTA does not define “substantial control.” The regulations will likely contain complex rules for measuring ownership and determining who is in control, as well as how to treat multi-tiered companies and related parties.
The five exclusions from the definition of a beneficial owner include:
- minor children, if the child’s parent’s or guardian’s information is reported properly;
- individuals acting as a nominee, intermediary, custodian, or agent on behalf of another individual;
- an individual acting solely as an employee;
- an individual whose interest in an entity is only through a right of inheritance; or
- a creditor of a reporting person, if the creditor is itself not a “beneficial owner” based on substantial control or ownership or control of 25% or more of the ownership interests in the reporting company.
An “applicant” means any individual who files an application to form a reporting company or registers or files an application to register a reporting company to do business in the United States. This requirement is noteworthy because a reporting company would need to file identifying information for the individual who files the application to form the company even if that individual is not a beneficial owner. This could conceivably include individuals at law firms that act as agents to create the company.
Confidentiality of Identifying Information
FinCEN will hold the information that is gathered on beneficial owners and applicants in a confidential and secure database. Information will only be released in response to a request from law enforcement agencies engaged in national security, intelligence, or law enforcement activity, and if the reporting company consents, financial institutions subject to and in order to comply with customer due diligence requirements.
Companies or individuals who violate the CTA will be subject to civil penalties of not more than $500 per day, capped at $10,000, and imprisonment of up to two years if an individual willfully provides false information or fails to report.
Interim Planning Recommendations
Until the Secretary of the Treasury has adopted regulations, companies should assume that not only corporations and LLCs, but partnerships, trusts, and other entities, will be covered by the CTA.
Management of reporting companies should assess the requirements of the CTA, and determine whether their company’s operative documents should include:
- a representation by each shareholder, member or partner, as applicable, that it will be in compliance with or exempt from the CTA;
- a covenant by each shareholder, member or partner, as applicable, requiring continued compliance with and disclosure under the CTA or to provide evidence of exemption from its requirements;
- an indemnification by each shareholder, member or partner, as applicable, to the company and its other shareholders, members or partners, as applicable, for its failure to comply with the CTA or for providing false information; and
- a consent by each disclosing party for the company to disclose identifying information to FinCEN, to the extent required by law.
Investment funds should consider adding similar representations and covenants by their investors to their subscription and management agreements. Lenders should also consider adding similar representations and covenants by their borrowers to their loan documents.