By Peter Wang
This alert updates our initial alert on the CTA published on March 1, 2021, to reflect the final rule published by the Financial Crimes Enforcement Network (FinCEN) bureau of the U.S. Department of the Treasury on September 30, 2022.
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.
FinCEN was tasked with adopting regulations detailing how the CTA would be implemented. On September 30, 2022 FinCEN published its final rule implementing the CTA’s requirements for reporting.
Who Must Report?
Companies that are required to report their beneficial owners and applicants to FinCEN under the CTA are:
- Any domestic corporation, limited liability company, or other entity (limited liability partnerships, limited liability limited partnerships, business trusts, and most limited partnerships and business trusts) that is created by the filing of a document with a secretary of state or similar office (including an American Indian tribal office).
- Any foreign corporation, limited liability company, or other entity (limited liability partnerships, limited liability limited partnerships, business trusts, and most limited partnerships and business trusts) that is formed under the laws of a foreign country and registered to do business in any state or tribal jurisdiction by filing of a document with a secretary of state or similar office (including an American Indian tribal office).
Legal entities that are not created by the filing of a document with a secretary of state or similar office, including certain trusts, are excluded from the reporting requirements.
Who is Exempt from Reporting?
Twenty-three types of entities are exempt from the reporting requirements, most of which are regulated entities already required to report beneficial ownership information to regulators. The 23 types of exempt entities are Securities Issuers; Domestic Governmental Authorities; Banks; Domestic Credit Unions; Bank Holding Companies and Savings and Loan Holding Companies; Registered Money Transmitting Businesses; Broker-Dealers; Securities Exchange or Clearing Agents; Other Exchange Act Registered Entities; Registered Investment Companies and Advisers; Venture Capital Fund Adviser; State-Regulated Insurance Companies; State-Licensed Insurance Producers; Commodity Exchange Act Registered Entities; Public Accounting Firms; Public Utilities; Financial Market Utilities; Pooled Investment Vehicles; Tax Exempt Entities; Entities Assisting Tax Exempt Entities; Large Operating Companies; Subsidiaries of Exempt Entities; and Inactive Entities.
Large operating companies may also be exempt. For the large operating company exemption, the entity must have:
- 20 or more full-time employees in the U.S.;
- Operating presence at a physical office in the U.S. (not including a residence or shared space, except spaces shared with affiliates); and
- Filed a tax return in previous year showing more than $5 million in U.S.-sourced gross receipts or sales.
Certain subsidiaries may also be exempt. For the subsidiary exemption, if a reporting company is directly or indirectly owned by one or more exempt entities and an individual is a beneficial owner of the reporting company exclusively by virtue of such individual’s ownership interest in the exempt entity, the reporting company’s report should list the name of the exempt entity in lieu of the beneficial ownership information of such individual.
What must be Reported?
Reporting companies must file a report with FinCEN containing the following information regarding its “beneficial owners”:
- Full legal name;
- Date of birth;
- Current residential or business address; and
- Unique identifying number and issuing jurisdiction from an acceptable identification document (and the image of such document), such as a driver’s license or passport.
For reporting companies formed or registered on or after January 1, 2024, the reporting company must also report the above information for “company applicants.”
Definitions of Beneficial Owner and Company Applicants
A “beneficial owner” is any individual who, directly or indirectly, either exercises substantial control over the reporting company or owns or controls at least 25% of the ownership interests of the reporting company.
An individual exercises “substantial control” over a reporting company if such individual:
- Serves as a senior officer (except for corporate secretary or treasurer);
- Has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body);
- Directs, determines, or has substantial influence over important decisions made by the reporting company; or
- Has any other form of substantial control over the reporting company, including as a trustee of a trust.
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 who is not a senior officer;
- An individual whose interest in an entity is only through a right of inheritance; or
- Certain creditors.
“Ownership interests” includes equity interests in the reporting company, as well as capital or profit interests, convertible instruments, warrants or rights or other options or privileges to acquire equity, capital or other interests in a reporting company. Any debt instrument is also deemed to be an “ownership interest” to the extent it enables the holder to exercise the same rights as one of the specified equity or other interests in the definition of “ownership interests.”
When determining whether an individual owns or controls 25% or more of the ownership interests, the individual’s ownership interests should be aggregated and should be compared to the “undiluted ownership interests” of the reporting company. If options or profits interests are outstanding, they are deemed to be exercised and “in the money” for purposes of the 25% ownership test. If there is more than one class of equity interests outstanding, the 25% threshold is determined as a percentage of all outstanding interests if possible, but, failing that, more than 25% of any class of equity interests triggers the reporting requirement.
An individual may directly or indirectly own or control an ownership interest of a reporting company through a variety of means, including through the following, among others:
- Joint ownership with one or more other persons of an undivided interest in an ownership interest;
- Control of such ownership interest owned by another individual; and
- With regard to a trust or similar arrangement that holds an ownership interest:
- acting as a trustee of the trust or other individual (if any) with the authority to dispose of trust assets;
- being a beneficiary of the trust who (a) is the sole permissible recipient of income and principal from the trust, or (b) has the right to demand a distribution of or withdraw substantially all of the assets from the trust; or
- being a grantor or settlor who has the right to revoke the trust or otherwise withdraw the assets of the trust: (a) through ownership or control of one or more intermediary entities, or ownership or control of the ownership interests of any such entities that separately or collectively own or control ownership interests of the Reporting Company, or (b) through any other contract, arrangement, understanding or relationship.
“Company applicants” are limited to two persons:
- The individual who directly files the document to create or register the reporting company; and/or
- The individual who is primarily responsible for directing or controlling such filing if more than one individual is involved in the filing.
For example, if an attorney oversees the preparation and filing of incorporation documents and a paralegal files them, the reporting company would report both the attorney and paralegal as company applicants.
When are Reports Due?
Reporting companies created or registered before January 1, 2024 will have until January 1, 2025 to file their initial beneficial ownership reports with FinCEN. Reporting companies created or registered on or after January 1, 2024, will be required to file initial beneficial ownership reports within 30 days of formation or registration.
If there is any change with respect to required information previously submitted to FinCEN concerning a reporting company or its beneficial owners, including any change with respect to who is a beneficial owner or information reported for any particular beneficial owner, the reporting company is required to file an updated report within 30 calendar days of when the change occurred.
How Will Companies Report?
FinCEN is developing a Beneficial Ownership Secure System (BOSS) where the reports will be submitted electronically through an online interface. The BOSS will be secured to the highest information security protection level under the CTA. FinCEN intends to issue additional regulations governing who may access the information and what safeguards will be required to ensure that the information is secured and protected.
FinCEN will also publish reporting forms and guidance documents that companies will use to comply with their obligations under the CTA in advance of the date the reports are due.
What Happens if a Reporting Company Fails to Report?
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. Beneficial owners and senior officers of the reporting company can be held liable.
What Should I do Now?
Management of companies should determine if they are a reporting company and start compiling the required information on all of the beneficial owners and company applicants. They should also consider including the following in their company’s operative documents:
- 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.
For questions, or to further discuss how to prepare your business to comply with the Corporate Transparency Act, please contact Peter Wang at pwang@coblentzlaw.com or any member of the Coblentz Corporate team.