Posted In: Business Transactions & Corporate Counseling

Business Blog: The Corporate Transparency Act: Reporting Requirements for Business Entities; Burdens for Small Businesses

on December 30, 2021

The new federal Corporate Transparency Act (CTA) imposes significant new reporting requirements for foreign and domestic business entities in the United States. The CTA represents an effort by the federal government to update and strengthen the country’s anti-money laundering laws. However, these new requirements will impose a considerable burden upon small businesses in the form of additional administrative work, compulsory disclosure and loss of anonymity, and compliance costs.

Background and Purpose

The CTA is a component of the overall National Defense Authorization Act (NDAA) enacted by Congress on January 1, 2021. The NDAA includes the Anti-Money Laundering Act of 2020 (AMLA), which gives rise to the CTA. The Secretary of the Treasury is required to prescribe the implementing regulations for the CTA by January 1, 2022. 

Through the CTA, Congress aims to correct the U.S.’ deficient existing laws and more effectively detect and prevent money laundering.  Congress has articulated concerns with bad actors who utilize shell companies to conceal their ownership of business entities, which entities are used to conduct illegal activities such as money laundering, financing of terrorism, drug and human trafficking, and securities fraud.

National Registry; FinCEN

The CTA calls for the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) to establish a national registry of beneficial owners of entities that meet the CTA’s definition of “reporting companies.” Congress’s goal in creating the registry of reporting companies is to overcome the lack of state reporting requirements and to aid federal agencies in detecting and preventing the use of business entities to facilitate illegal activities. 

Reporting Companies; Beneficial Owners

The CTA broadly defines “reporting company” to include any corporation, limited liability company, or other similar entity created by filing a document with the secretary of state or similar office in any state or territory or with a federally recognized Indian Tribe or formed under the laws of a foreign country and registered to do business in the United States. While the CTA does not specifically mention limited partnerships in the definition of reporting company, owners of limited partnerships should expect the obligation to comply with the CTA unless excused by the final implementing regulations. 

While the CTA does provide exceptions to the reporting requirement to certain types of entities, these exceptions will not apply to small businesses. Publicly traded companies, investment vehicles operated by investment advisors, nonprofits, and government entities are not required to report under the CTA. “Public utilities” are also exempt from the reporting requirements of the CTA. In addition, entities engaged in certain heavily regulated industries, in which the existing regulations already require reporting of beneficial ownership (e.g., banks, domestic credit unions, securities issuers, money transmitting businesses, registered investment advisors, insurance companies), are exempt from the reporting requirements. Exceptions also apply to “large operating companies” that (1) employ more than 20 employees; (2) filed in the previous year a tax return demonstrating more than $5 million in gross receipts or sales; and (3) have an operating presence at a physical office within the United States. Entities that are subsidiaries of these excluded companies are also exempt from these reporting requirements. 

The CTA defines a “beneficial owner” of an entity as any individual who, directly or indirectly, (1) exercises substantial control over the entity or (2) owns or controls not less than 25 percent equity in the entity. The CTA does not define the term “substantial control,” so the forthcoming regulations are expected to clarify its meaning. The CTA (and NPRM, discussed below) expressly excludes certain individuals from the definition of beneficial ownership, including (1) a minor child (as long as the child’s parent’s or guardian’s information is reported); (2) an individual acting as an intermediary or agent on behalf of another; (3) a person whose control over a reporting company derives solely from their employment; (4) an individual whose only interest in a reporting company is through a right of inheritance; or (5) a creditor of a reporting company (unless they qualify as a “beneficial owner” through substantial control or equity ownership).

Proposed Regulations Concerning Beneficial Ownership Reporting

On December 7, 2021, FinCEN issued a Notice of Proposed Rulemaking (NPRM) setting forth proposed regulations with respect to beneficial ownership information reporting. Those proposed regulations will not take effect until after the comment period expires on February 7, 2022. However, the proposed regulations provide a clearer understanding of what constitutes beneficial ownership and what information must be disclosed in a beneficial ownership information (BOI) report. 

The recently proposed regulations set forth three specific indicators of "substantial control”:

1. Service as a senior officer of a reporting company.
2. Authority over the appointment or removal of any officer or dominant majority of the board of directors (or similar body) of a reporting company.
3. Direction, determination or decision of, or substantial influence over, important matters of a reporting company, including, for example, the sale, lease or transfer of any principal assets of the company, the entry into or termination of significant contracts, major expenditures and investments by the company and compensation schemes for senior officers.

According to the NPRM, each of these indicators “supports the basic goal of requiring a reporting company to identify the individuals who stand behind the reporting company and direct its actions.” In addition, the proposed regulations include a broad, catch-all provision defining "substantial control" to include “[a]ny other form of substantial control over the reporting company,” thereby clarifying that “substantial control can take additional forms not specifically listed” in the regulations and to prevent individuals from evading identification by “hiding behind formalisms.” Furthermore, the NPRM clarifies that there can be more than one person who exercises "substantial control" over a reporting company, and the rule will require the identity of each person to be disclosed. 

Similarly, the proposed regulations take a broad view of what constitutes an "ownership interest." Under the proposed regulations, "ownership interests" would include both equity in the reporting company and other types of interests, such as capital or profit interests (including partnership interests) or convertible instruments, warrants or rights, or other options or privileges to acquire equity, capital or other interests in a reporting company. An "ownership interest" would also include any ownership interest by another person that an individual can control. The language contained in the proposed regulations reminding reporting companies that entities can be owned or controlled directly or indirectly or "through a variety of means" (e.g., a trust agreement), further reveals the breadth of FinCEN’s analysis of “ownership interest.”

Reporting Requirements

The CTA requires a reporting company to make reports and disclosures to FinCEN. In each report, the reporting company must disclose (1) each beneficial owner’s name, (2) date of birth, (3) residential or business address, and (4) a unique identifying number from an acceptable identification document, such as a driver’s license, passport, or other government issued identification document or a FinCEN identifier.

Once the CTA implementing regulations become effective, all new reporting companies will be required to report their beneficial owners’ information at the time of formation of the entity. All existing entities will be required to report their beneficial owners’ information within two years from the effective date of the implementing regulations. Further, a reporting company must report updated information within one year of any change in its beneficial ownership.   

As noted by the NPRM, the CTA "does not specify when or whether one type of address should be used in preference to another or resolve more specific questions regarding secondary addresses or whether addresses should be domestic, if possible, or can be foreign." To address this issue, the proposed rule would require individual beneficial owners and company applicants who do not act as formation agents to report their residential address for tax residency purposes.

With respect to company applicants, the regulations propose a "bifurcated approach." Company applicants who provide a business service as a corporate or formation agent would need to report their business address. According to the NPRM, such applicants are "of particular interest" to FinCEN because of their role in creating or registering reporting companies.  For all other company applicants, the reporting company would need to report the residential street address that the individual uses for tax residency purposes.

While the CTA specifies what constitutes an "acceptable identification document" for purposes of the BOI report, it does not specify how an entity is to be identified by such a document. FinCEN has taken the position that it has authority to require reporting companies to provide scanned copies of identification documents to the agency in connection with reporting the unique identifying number.

Although not specified by the CTA, under the proposed rule, reporting companies must also provide certain information about themselves to FinCEN. The proposed rule requires reporting companies to include the following information in a BOI report: 1) name and any alternative names, 2) business street address, 3) jurisdiction of formation or registration and 4) a unique identification number. For purposes of the unique identification number, reporting companies may submit their taxpayer identification number (TIN) – including an Employer Identification Number (EIN) – or if a TIN is not yet issued, a Dun & Bradstreet Data Universal Numbering System (DUNS) number or a Legal Entity Identifier (LEI). 

Use of Information

FinCEN will be responsible for secure storage of all information collected from reporting companies pursuant to the CTA. The FinCEN database will not be publicly accessible; rather, beneficial ownership information will be available upon request only by (1) a federal law enforcement agency; (2) a state, local, or tribal law enforcement agency, if authorized by court order; (3) a federal agency on behalf of a foreign country if the request is pursuant to an international agreement; or (4) a financial institution for customer due diligence purposes and if authorized by the reporting company.   

Penalties

A reporting company that willfully provides false information or fails to report complete information to FinCEN can face fines up to $10,000 and imprisonment for up to two years. The CTA contains a safe harbor provision from such liability for submission of false information if the person submitting the report voluntarily corrects it within 90 days.

Burdens

While the CTA represents an important step in Congress’s effort to prevent financial crimes, the sweeping nature of the legislation will have the unfortunate effect of burdening small, everyday businesses with new compliance obligations. When read together, the definitions of reporting company and beneficial owner, along with the lack of available exceptions, place small business entities squarely in the center of the CTA. 

The Corporate Transparency Act brings about significant new compliance obligations and costs for small businesses. We recommend that our small business clients contact an attorney for a review of their entity and to evaluate their reporting obligations. The attorneys at Brouse McDowell are skilled in the practice of corporate law and can assist you with your entity’s compliance needs. Please contact our Business Transactions & Corporate Counseling Group for more information. 

This blog is intended to provide information generally and to identify general legal requirements. It is not intended as a form of, or as a substitute for legal advice. Such advice should always come from in-house or retained counsel. Moreover, if this Blog in any way seems to contradict advice of counsel, counsel's opinion should control over anything written herein. No attorney client relationship is created or implied by this Blog. © 2023 Brouse McDowell. All rights reserved.

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