In 2022, The Corporate Transparency Act (CTA) was the subject of ad nauseum discussion by business owners, CPAs, attorneys, and other tax practitioners who were mostly bemoaning its passage and implementation, as well as debating the pros and cons of what the Corporate Transparency Act meant for them and their clients. In September 2022, the Financial Crimes Enforcement Network (FinCEN) issued Final Rules for how and when businesses must comply with the CTA.
At its core, the CTA is a mechanism to deal with issues related to “dirty money”—i.e., guarding against money laundering, terrorism financing, and other forms of illegal financing—as well as the general lack of beneficial owner (i.e., “true owner”) information with respect to many domestic entity structures. The United States has not scored well with the Foreign Action Task Force (FATF) set up by the Organization for Economic Cooperation and Development (OECD) to grade countries on whether they have adequate disclosure of beneficial ownership information with respect to structures created in their jurisdictions. OECD is a forum where democratic governments of countries with market-based economies collaborate to collect and compare data and conduct analysis to inform and develop economic, social, and environmental policies. The FATF and OECD’s activities show that minimum levels of transparency concerning the beneficial owners of legal persons and arrangements are required for tax as well as for anti‑money laundering purposes. Jurisdictions which implement these higher international transparency standards, including beneficial ownership information disclosure rules, preclude a good portion of the aforementioned criminal activities.
In recent years, transparency and accountability initiatives have increased in both private and government sectors. This is in part a result of media exposure of governance practices and governmental and organizational leaders’ withholding of information: stakeholders feel they have been taken advantage of or blindsided by unfortunate events, revealing the need for tools to ensure transparency and accountability. It comes as no surprise that beneficial ownership transparency is increasingly recognized as an integral element of anti-corruption and tax justice efforts. Progress has been made with respect to some financial crimes, but alternative legal persons and arrangements are still frequently used in the U.S. to hide beneficial owners of assets. Transparency of beneficial ownership plays a key part in tax transparency and the fight against tax evasion, the integrity of the financial sector, and law enforcement efforts.
Tax evasion, corruption and moneylaundering are crimes made easier through the misuse of legal entities such as corporations, foundations, partnerships, and trusts. With the use of complicated chains of ownership of legal persons and arrangements across many jurisdictions, the identity of the beneficial owners of assets (including financial assets), the true purposes of the assets, and/or the origin of the funds or assets can be hidden. By design, the use of nominee shareholders or directors, or entities such as trusts, shell companies, inactive companies or similar structures strengthens the anonymity of beneficial owners. Ultimately, the identity of the beneficial owner(s) is concealed from tax authorities and other law enforcement agencies.
The CTA was born of the view that the availability of beneficial ownership information is a crucial tool in the fight against tax evasion, money laundering, corruption, terrorist financing and other financial crimes. From a tax perspective, knowing the identity of the natural persons behind entities not only helps a jurisdiction such as the U.S. preserve the integrity of its own tax system, but also provides the U.S.’s global treaty partners a means to better achieve their own tax goals.
The CTA was enacted January 1, 2021 as part of the National Defense Authorization Act, representing the most significant reformation of the Bank Secrecy Act and related anti-money laundering rules since the U.S. Patriot Act. CTA is expected to blaze a trail for FinCEN to develop a system of standardized reporting of companies being formed in the US and the disclosure of their beneficial ownership information. FinCEN is a bureau of the U.S. Treasury Department that collects and analyzes information about financial transactions to combat domestic and international money laundering, terrorist financing, and other financial crimes. Tax practitioners will need to understand the compliance and reporting obligations under the CTA that are reported to FinCEN.
It took almost a year following CTA’s enactment before issuance of a notice of proposed rulemaking on December 7, 2021, and it was almost another year before those proposed rules were published on September 30, 2022. Practitioners need to prepare themselves and their clients for the rules on reporting, what types of entities the rules apply to, what information is needed and the time deadlines for the reporting.
The CTA requires “reporting companies” to file with FinCEN reports that identify a company’s beneficial owners, as well as to report information about company applicants. The CTA applies to entities either created through a U.S. state filing or formed under the law of a foreign country and registered to do business in the U.S. That is, the primary requirement for an entity to be classified as a reporting company is the filing of a document with the applicable state jurisdiction to form the entity. For example, LLCs, LLPs, partnerships, corporations, and business statutory trusts are entities for which laws in each state require the filing of a document with the applicable state office to establish their existence.
There are, however, many exceptions to the definition of a reporting company. The regulations make it clear that entities or de facto entities that are created without the need for a state or jurisdictional document filing such as revocable living trusts, irrevocable trusts, sole proprietorships, and general partnerships are excluded from the definition of reporting companies and do not have to report beneficial owners to FinCEN. Categorical exemptions are established for certain other entities including banks or bank holding companies; federal or state credit unions; government entities; entities having publicly traded securities or that are otherwise registered with regular reporting requirements to FinCEN, the Financial Industry Regulatory Authority (FINRA) or the Securities & Exchange Commission; insurance companies; public accounting firms; public utilities; section 501(c) recognized tax-exempt entities; and tax-exempt political organizations. Qualified reporting exemptions are also established for large operating companies, which must have a physical office in the U.S., more than 20 U.S.-based full-time employees, and more than $5 million in gross receipts or sales in the U.S. as reported on prior year federal income tax returns.
Once a reporting company is identified, the practitioner must take a deeper dive into the company records to determine beneficial owners, defined based on a percentage of ownership or control. The party that is obligated to report requested information on the beneficial owners is the company itself, which is typically accomplished as a duty of one or more of the company officers. The term “beneficial owner” is defined as including the following: (i) people with substantial control, (ii) people with ownership interests, whether indirect or direct, equally at least 25% of the company’s equity interests, and (iii) company applicants. An owner in the CTA context is broadly defined: if the reporting company is owned by another company, the reporting company must look through the parent company to the human being that owns the parent company because CTA requires that a beneficial owner must be a natural person/human being.
The test for “substantial control” is a facts and circumstances analysis: (i) whether the person has the ability to merge or dissolve the company or (ii) whether the person controls major expenditures, the selection of business lines, compensation schemes, or entry into contracts; or other decisions of a similar nature. An individual with either of those powers to merge/dissolve or control will be treated as a beneficial owner for CTA reporting, whether or not that person has an ownership interest. An example of a person with substantial control is an officer or director of the reporting company.
The second test applies to parties who are direct or indirect owners of a quarter interest in the reporting company. This covers joint ownership, direct ownership of shares of stock, or ownership of a membership interest.
The third test covers the applicant that filed a formation document with the entity’s jurisdictional office to establish its existence. A company is obligated to report information on any person who signed a certificate of formation, a certificate of incorporation, or another document similar in nature as a beneficial owner.
FinCEN requires the reporting company to disclose the following information: (i) the jurisdiction and legal name of the beneficial owners as defined in the prior section; (ii) dates of birth; (iii) residential addresses for the beneficial owners and business addresses for the company applicants; (iv) a unique identifying number such as a driver’s license or passport number, including a scanned copy of the form of identification (if unavailable, FinCEN will assign an identifier number). Although those requirements may cause some concern regarding individual privacy and confidentiality, no financial information or details about the business purpose or operation of the company is required. New companies have 30 days from the effective date of formation to report the beneficial ownership information to FinCEN. If any of the information on the report is inaccurate when filed, the reporting company must file a corrected report within 30 calendar days after becoming aware of the inaccuracy.
Reporting companies already in existence have one year to prepare and complete the appropriate disclosure forms. This requires an existing reporting company to first identify its beneficial owners, including some that may be difficult to identify, such as indirect owners and company applicants. There are questions that older companies may struggle to answer. For example, how far back in time must a company go to identify its applicant beneficial owners to comply with the reporting requirements? What if the company is not able to identify or find these paralegals, attorneys or other administrators who assisted in filing the legal documents to form the entity? What waivers might be possible if a company cannot track this information? Clearly, there are unanswered logistical questions in implementation of the CTA reporting.
In summary, existing companies have from January 1, 2024 until January 1, 2025 to file the report with FinCEN. Reporting companies formed on or after January 1, 2024, must file the report within 30 days of company formation.
A company is subject to penalties by willfully providing, or attempting to provide, false or fraudulent beneficial owner information. There are exceptions for mistakes made in good faith. If a company is unable to prove a good faith mistake and FinCEN finds the inaccurate reporting was intentional, there is a penalty of $500 a day, up to $10,000, and possible imprisonment for up to two years. In cases where inaccuracies are due to reasonable cause and not willful negligence, the penalty may be waived with the permission of the Secretary of the Treasury.
There are also provisions for criminal penalties for the misuse or unauthorized disclosure of beneficial ownership information providing that a person can be fined up to $250,000 or imprisoned for not more than five years or both.
Agency: Financial Crimes Enforcement Network (FinCEN), Treasury.
Action: Final rule.
Summary: FinCEN is issuing a final rule requiring certain entities to file with FinCEN reports that identify two categories of individuals: the beneficial owners of the entity, and individuals who have filed an application with specified governmental authorities to create the entity or register it to do business. These regulations implement Section 6403 of the Corporate Transparency Act (CTA), enacted into law as part of the National Defense Authorization Act for Fiscal Year 2021 (NDAA), and describe who must file a report, what information must be provided, and when a report is due. These requirements are intended to help prevent and combat money laundering, terrorist financing, corruption, tax fraud, and other illicit activity, while minimizing the burden on entities doing business in the United States.
Dates: Effective date: These rules are effective January 1, 2024.
For Further Information Contact: The FinCEN Regulatory Support Section at 1-800-767-2825 or electronically at [email protected].
Final Rule Publication Date: 09/30/2022
Document Type: Rule
Document Federal Register Citation: 87 FR 59498
Page: 59498-59596 (99 pages)
CFR: 31 CFR 1010
