The Corporate Transparency Act of 2020 (the “CTA”) was enacted as part of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021. At the core of the CTA are reporting requirements imposed on substantially every small business organized or registered to conduct business in the United States through any type of limited liability entity. Reporting companies will be required to submit identifying information regarding their owners and individuals who participate in the formation and domestic registration of those businesses. Implementation of the CTA is largely deferred. Its reporting requirements take effect on the date regulations prescribed by the Secretary of the Treasury become effective. No indication has been given as to when final regulations may be issued, although the proposed regulations discussed later in this article suggest the guidance necessary for implementation is being assembled.
Who Is Required to Report?
Domestic or foreign companies may be required to report under the CTA. Domestic entities subject to reporting requirements include corporations, limited liability companies, and any other entity “that is created by filing of a document with a secretary of state or any similar office under the law of a State or Indian tribe.” Thus, domestic reporting companies will also include limited partnerships, limited liability partnerships, limited liability limited partnerships, business trusts, and any other entity offering limited liability to its owners by virtue of a State or Tribal charter. Foreign entities that have registered to do business by filing with a secretary of state or similar office of any State or tribal jurisdiction are subject to the same reporting requirements as domestic entities.
What Companies Are Not Subject to Reporting Requirements?
The scope and purpose of the CTA is best understood by recognizing the types of companies that are exempt from its reporting requirements. The proposed regulations identify more than 22 different types of exempt entities. The vast majority of these exempt entities are subject to state or federal supervision, such as companies that report to securities, investment, insurance, and banking regulators. Exemptions are also extended to public companies issuing securities under § 12 of the Securities Exchange Act of 1934, governmental authorities, venture-capital fund advisors, public utilities, pooled investment vehicles, tax exempt entities, and entities assisting tax exempt entities. Also exempt are “large operating companies,” defined as any entity that:
- employs more than 20 full-time employees in the United States,
- has an operating presence at a physical office in the United States, and
- filed a federal income tax return or information return for the prior year reporting more than $5 million in gross receipts or sales, excluding gross receipts or sales outside the United States.
In the case of an entity that reports as part of an affiliated group under a consolidated return, the $5 million threshold applies to the amount reported on the consolidated return for the entire group. Thus, any privately-held, for-profit business operating through a limited liability entity in the United States will be subject to the reporting requirements of the CTA unless it satisfies the definition of a “large operating company” and or qualifies for another exemption.
Generally, existing entities get no relief and, as explained below, are subject to the same reporting requirements as newly formed entities. However, certain inactive entities are exempt from the reporting requirements of the CTA. Entities are considered “inactive” if such entities were in existence on or before January 1, 2020, and such entities:
- are not engaged in active business,
- are not owned by a foreign person (directly or indirectly, wholly or partially),
- have not experienced any change of ownership in the preceding 12-month period,
- have not sent or received any funds in an amount greater than $1,000 either directly or through any financial account in which the entity or any affiliate of the entity has an interest in the preceding 12-month period, and
- do not otherwise hold any kind or type of assets (including an equity interest in any limited liability entity).
What Information About the Company Must Be Reported?
The CTA requires reporting companies to disclose:
- the full name of the reporting company,
- any trade name or “doing business as” name of the reporting company,
- the business street address,
- State or Tribal jurisdiction of formation (or, in the case of a foreign entity subject to CTA reporting, the State or Tribal jurisdiction in which the foreign company first registered), and
- the taxpayer identification number (TIN) under which the reporting company reports to the Internal Revenue Service. If the reporting company has not yet been issued a TIN, it may instead use the Dunn and Bradstreet Data Universal Numbering System Number of the reporting company or Legal Entity Identifier.
Which Individuals Are Subject to Disclosure by the Reporting Company?
In addition to the information regarding the reporting company that must be disclosed under the CTA, the reporting company must also provide information regarding every individual who is a beneficial owner and every individual who is a company applicant. The proposed regulations define a beneficial owner as “any individual who, directly or indirectly, either exercises substantial control over such reporting company or owns or controls at least 25 percent of the ownership interests of such reporting company.”
How Is "Substantial Control" of a Reporting Company Determined?
For purposes of defining a “beneficial owner,” substantial control over a reporting company is defined to include:
- 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 members of the board of directors (or similar body),
- direction, determination, or decision of, or substantial influence over, important matters affecting the reporting company as more specifically set forth in the proposed regulations, and
- “[a]ny other form of substantial control over the reporting company.”
The proposed regulations further clarify the circumstances in which an individual’s authority will be viewed as sufficiently substantial as to require reporting information regarding that individual. Regardless of office or title, substantial control over a reporting company includes the ability to direct, determine, decide, or exercise substantial influence over important matters affecting the reporting company. Such matters include
- the nature, scope, or attributes of the business conducted by the reporting company, including mortgage, lease, sale, or other transfers of its principal assets, reorganization, dissolution, or merger of the reporting company,
- major expenditures or incurring significant debt,
- issuance of any equity interests by the reporting company,
- approval of the operating budget of the reporting company,
- selection or termination of business lines or geographic areas in which the reporting company does business,
- approval of compensation schemes,
- adoption of incentive programs for senior officers,
- approval, performance, or termination of important contracts,
- amendment of any substantial governance documents of the reporting company, including the articles of incorporation, other formation documents,
- amendment of important polices or procedures of the reporting company, or
- exercise of any other form of substantial control over the reporting company.
The person executing the foregoing authority with respect to a reporting company will be subject to the disclosure requirements of the CTA. The means through which such control is exercised by an individual is irrelevant and such control may be direct or indirect, formal or informal, including simple business relationships. An individual may be deemed to have substantial control for purposes of the CTA if the ability to exercise substantial control (as set forth in the CTA) exists, even if such control is never actually exercised.
Disclosure of information regarding non-controlling owners is required if their ownership of the reporting company equals or exceeds 25 percent. Ownership interest is broadly defined to include a variety of interests. Any type of equity interest — whether financial or simply voting — including “participation in a profit-sharing arrangement” is sufficient to be measured and considered to identify beneficial owners. In the case of non-corporate entities, any proprietary interest, any interest in capital or profits including limited and general partnership interests must be accounted for. Less direct interests are also considered ownership interests, including convertible debt, warrants, rights to purchase or subscribe to equity interests, and any “put, call, straddle, or other option or privilege of buying or selling” any ownership interest.
Measuring whether an individual owns or controls 25 percent of the ownership interests of a reporting company requires accounting for “all ownership interests of any class or type, and the percentage of such ownership interests that an individual owns or controls shall be determined by aggregating all of the individual’s ownership interests in comparison to the undiluted ownership interests of the company.”Consistent with the statute, the proposed regulations are clear that certain equity owners will be exempt and, therefore, not subject to reporting, including:
- minor children (provided the reporting company discloses the required information regarding the parent or legal guardian of the minor child);
- individuals acting as nominees, intermediaries, custodians, or agents;
- employees of reporting companies “acting solely as an employee and not as a senior officer, whose substantial control over or economic benefits from such entity are derived solely from the employment status of the employee”;
- individuals whose only interest is an expectancy through a right of inheritance; and
- creditors of the reporting company.
With respect to creditors, the proposed regulations make it clear that creditors who are not required to be disclosed are individuals whose beneficial ownership is derived “solely through rights or interests in the company for the payment of a predetermined sum of money…and the payment of interest on such debt.” If the right or interest in the value of the reporting company is a right or interest in its value or profits, such an obligation is not one “for payment of a predetermined sum” even if it takes the form of a debt instrument. This means participating debt must be accounted for as an ownership interest.
Must the Ownership Interest in the Reporting Company Be Owned by the Beneficial Owner?
An individual may be deemed a beneficial owner in a reporting company without holding an ownership interest in such reporting company. Not only are the equity and other interests described above sufficient to establish beneficial ownership, whether owned directly or indirectly, but beneficial ownership may also exist when the beneficial owner shares ownership or does not directly or indirectly hold the ownership interest. Specific examples set forth in the proposed regulations include:
- joint ownership,
- control of an ownership interest owned by another, and
- holding an interest as a settlor, trustee, or beneficiary of a trust or similar arrangement that holds the ownership interest.