A new federal law aimed at combatting money laundering and other criminal activity will impose beneficial ownership reporting obligations on business entities and is expected to become effective soon, possibly in early 2023.
Business entities should be aware of the information that they will be required to report and the deadlines for reporting, after the effective date is designated.
The Corporate Transparency Act (“CTA”) is a new federal law that will impose a filing requirement mandating every corporation, LLC, or similar entity formed in or registered to do business in the U.S. to report beneficial ownership information to the Department of Treasury’s Financial Crimes Enforcement Network (“FinCEN”). Additionally, the CTA imposes severe penalties for failure to comply with this new reporting obligation.
The CTA is part of The National Defense Authorization Act of 2021 (“NDAA”), under Title LXIV. Although former President Trump initially vetoed the NDAA in 2021, Congress overrode his veto, and it went into effect on January 11, 2021, including the CTA. To facilitate finalizing the new law, FinCEN collected comments until February 7, 2022. FinCEN noted that the next step in the CTA rule-making process is the publication of the proposed regulations, which it expects to post later this year. The federal government will likely begin enforcing the NDAA, including the CTA, sometime in late 2022 or early 2023.
The Act’s Purpose and Significance
The CTA has flagged the issue of “malign actors” that engage in illegal activity by trying to conceal their ownership of business entities in the U.S. Such activity includes money laundering, financing terrorism, tax fraud, and other acts of foreign corruption that harm national security interests. Therefore, the CTA implements federal legislation that collects beneficial ownership information to better protect national security interests and better enable efforts to identify malign actors and illicit activities. The enforcement of the CTA means that the federal government will have a database of beneficial ownership information for unregulated entities that will be available to government authorities for law enforcement reasons.
While the CTA’s enactment is intended to make it more difficult to operate shell companies, it will significantly impact smaller companies. For the first time in U.S. history, the CTA will impose federal reporting requirements for smaller companies by requiring the annual collection of reporting of ownership. This is because the CTA’s exceptions generally exempt larger business entities, but not smaller entities set up by larger companies. It is estimated that the CTA will affect more than twenty-five million existing business entities and an annual estimated four million new entities.
Important Terms Defined in the CTA
The CTA has several important terms that are key to understanding the requirements. Some essential terms are “corporation” or “limited liability company,” “beneficial owner,” and “applicant.”
- “Corporation” or “limited liability company” is defined as “a corporation or limited liability company formed under the laws of a State or Indian Tribe,” including “any non-United States entity eligible for registration or registered to do business as a corporation or limited liability company under the laws of the applicable State or Indian Tribe.” This definition will be consolidated for this article and referred to as a “reporting entity.”
- “Beneficial owner” is defined as “a natural person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise–(i) exercises substantial control over a corporation or limited liability company; (ii) owns 25 percent or more of the equity interests of a corporation or limited liability company; or (iii) receives substantial economic benefits from the assets of a corporation or limited liability company.” However, a “beneficial owner” does not include: a minor child; a person acting as a nominee, intermediary, custodian, or agent on behalf of another individual; a person acting solely as an employee and whose economic benefits derive solely from their employment status; a person whose only interest is through a right of inheritance; and a creditor of the entity, unless it exercises substantial control or controls 25% or more of the interests in the entity.
- “Applicant” is defined as “any natural person who files an application to form a corporation or limited liability company under the laws of a State or Indian Tribe” or files an application to register a non-U.S. entity in the U.S.
Some entities are exempt from reporting. Currently, the CTA recognizes over twenty exempt entities, which are generally larger companies. Some of the most notable exempt entities include: publicly traded companies; heavily regulated companies that already provide ownership information to a government agency; most financial services institutions, including investment, accounting, and banking firms that report to government agencies (such as the SEC or FDIC); companies that have over twenty full-time employees or annual revenue exceeding $5,000,000 and have a physical presence in the U.S.; and nonprofit organizations such as churches and charities.
If an exempt entity has or will have a direct or indirect interest in a reporting entity, the reporting entity only needs to name the exempt entity and does not need to disclose any other information.
Timeline for Filing a Report
Filing requirements take effect on the regulation’s effective date prescribed by the Secretary of the Treasury. Once effective, new reporting companies must submit their reports to FinCEN at the time of their formation but no later than fourteen days after their creation. However, entities formed before the CTA’s enactment must submit their reports within one year of the regulation’s effective date to make their first reports.
If there are changes to the original CTA submission, the reporting entity must provide an updated report no later than thirty days after the date of the change. If there are errors in the reported data, they must be corrected within fourteen days of the error’s discovery. After companies submit their initial reports, they must annually update their reported data to reflect any changes of the reporting agency.
The scope of the CTA is intentionally broad by not defining various important terms and not providing clear details on the reporting process. Although it is currently unclear how each company will report under the CTA, it is anticipated that each state will administer the data collection required under the CTA. Hopefully, all uncertainties will be addressed in the regulations once they are released. Regardless, the CTA requires each qualifying business entity’s report, per the regulations prescribed by the Secretary of the Treasury, to contain certain data.
First, reports shall include the following company data: its legal name (including its “doing business as” name); the business street address; the jurisdiction where the entity was formed or registered; and tax identification number. Next, reports shall identify each beneficial owner of the applicable reporting company by: legal name; date of birth; residential address; and unique identifying number from an acceptable document with a picture of that document. An acceptable document with a unique identifying number can be a U.S. passport, driver’s license, or other state identification document, or a person may request and use a FinCEN identifying number. Additionally, the report shall identify teach applicant with respect to the reporting company by the following: legal name; date of birth; business address; and unique identifying number from an acceptable document with a picture of that document.
After the Report is Filed
After a reporting entity files its report, FinCEN is required to keep the reported information in a database that is not publicly accessible. The reported information will be retained in the database for at least five years after the reporting entity’s termination date. Filed reports may not be disclosed under the Freedom of Information Act or any other similar laws.
However, FinCEN may disclose the information, upon request, to: a federal law enforcement agency engaged in national security, intelligence, or law enforcement activity; a federal agency requesting information on behalf of a law enforcement agency, prosecutor, or judge of a foreign country; a state, local, and Tribal law enforcement agency pursuant to a court order; financial institutions, with the reporting company’s consent, for customer due diligence purposes; and a federal regulator or other regulatory agency authorized to determine the compliance of financial institutions with customer due diligence laws.
Reporting violations occur if any person or entity willfully fails to report completed or updated beneficial ownership information to FinCEN or if any person or entity knowingly provides, or attempts to provide, false or fraudulent beneficial ownership information. A violation may result in a civil penalty of up to $500 for each day the violation continues and criminal fines of up to $10,000 and/or imprisonment for up to two years.
Additionally, violations for unauthorized disclosures of beneficial ownership information by a government employee or third-party recipient are subject to similar civil penalties and criminal fines of up to $250,000 and imprisonment for up to five years.
What Entity Ownership and Management Should Do
Further guidance and review of FinCEN’s regulations, once published, is necessary to help better understand the scope and impact of the new law on reporting entities. Company owners, managers, legal advisors, and individuals who plan to form a business entity or register a non-U.S. entity should carefully review the CTA and consult with legal counsel to determine if their entity is a qualifying reporting entity. If the business entity is required to report to FinCEN, it may want to take the necessary steps to ensure compliance with its beneficial owner reporting obligation under the CTA.
Therefore, qualifying reporting entities should begin gathering beneficial ownership information that is currently available and review company documents to check if any confidentiality clauses or other obligations conflict with the CTA’s requirements. Further, entities should consider revising company documents to require owners to disclose required information as and when necessary. It is also crucial that entities work with company management, outside advisors, and lawyers to implement a process that meets the CTA requirements.
This article summarizes of some important provisions of the CTA. While we wait for FinCEN to review comments, promulgate the regulations, and build the infrastructure for maintaining reported information, business owners and management should consult with legal counsel to better understand what their potential reporting obligations might be under the CTA.
KingSpry’s Business Law Practice Group will continue to monitor developments as they relate to FinCEN and the CTA and will provide updates as new information becomes available.