Background and Development
On December 7, 2021, the Financial Crimes Enforcement Network (“FinCEN”) published a Notice of Proposed Rulemaking (“NPRM”) for the Corporate Transparency Act (the “CTA”). FinCEN announced that this NPRM would be the first of three proposed rules, which are designed to finalize the regulations under the CTA.
The CTA was initially passed on January 1, 2021, to enhance corporate transparency in the United States by requiring that certain entities formed or registered to do business in the country provide certain beneficial ownership information to the United States government, as further discussed in one of our earlier publications. FinCEN is charged with collecting this information and storing it in a secure database.
An entity that falls under the definition of a “reporting company” must submit to FinCEN information about itself, all of its beneficial owner(s), and company applicant(s). This article highlights the analysis, based on the first NPRM, for entities to determine if they must report, and, if so, when and how much information they should report. If entities fail to timely comply with the CTA, monetary fines and criminal charges may be imposed.
Entities Required To Report
When analyzing whether the CTA applies, the first question an entity doing business in the United States must ask itself is whether it falls under the broad definition of a “reporting company.” A reporting company includes any domestic corporation, limited liability company, or other similar entities, which are created by filing a document with a secretary of state or similar office under state or Tribal law. A reporting company also includes any corporation, limited liability company, or other similar entities, which are formed under the law of a foreign country and are registered to do business in the United States by filing a document with a secretary of state or similar office under state or Tribal law.
While the NPRM does not define “other similar entity,” the phrase does seem to reflect FinCEN’s interpretation that it captures any entity that is created or is registered to do business, in the United States by filing a document with a secretary of state or similar office. Generally, FinCEN believes the proposed definition of domestic reporting company would likely include limited liability partnerships, limited liability limited partnerships, business trusts (e.g., statutory trusts or Massachusetts trusts), and most limited partnerships because such entities appear typically to be created by a filing with a secretary of state or similar office.
If an entity falls under the broad definition of a “reporting company,” it must next ask whether it may be excluded from the reporting requirements by meeting any of the 23 exemptions proposed by the CTA and NPRM. These exemptions generally aim to exclude any company that is already subject to heavy state or federal regulation.
The NPRM clarified the requirements necessary for an entity to fall under the exemption for “large operating companies.” An entity falls into this category, and therefore is not a reporting company, if it:
(1) employs more than 20 employees on a full-time basis in the United States;
(2) filed in the previous year Federal income tax returns in the United States demonstrating more than $5,000,000 in gross receipts or sales in the aggregate, including the receipts or sales of other entities owned by the entity and through which the entity operates; and
(3) has an operating presence at a physical office within the United States.
The NPRM clarified that an employee employed on a full-time basis includes anyone employed an average of at least 30 service hours per week or 130 service hours per month, with adaptations for non-hourly employees. The NPRM also clarifies that the $5,000,000 in gross sales does not include gross receipts or sales from sources outside the United States, and an operating presence in a physical workspace owned or leased by the entity as a genuine working office of the entity.
Along with “large operating companies,” the CTA includes 22 other exemptions, which generally exclude the following from the definition of a “reporting company”: any entity, broker, or dealer registered with the Securities and Exchange Commission; 501(c) non-profits; any entity that exercises governmental authority on behalf of the United States; banks; a “money transmitting business” registered with FinCEN; insurance companies or state-licensed insurance produces; futures commission merchants; public accounting firms; certain public utilities, including financial market utilities; pooled investment vehicles; and certain inactive entities.
An “inactive entity” includes any entity that was in existence on or before January 1, 2020; is not engaged in active business; is not owned by a foreign person; has not experienced any change in ownership in the preceding 12-month period; has not, in the preceding 12-month period, sent or received an amount greater than $1,000; and does not hold any assets, whether in the United States or abroad, including but not limited to any ownership interest in any entity.
The CTA does not require beneficial ownership reporting for any entity in which the ownership interests are wholly owned or controlled, directly or indirectly, by an exempt entity. FinCEN has the authority under the CTA to add more exemptions but did not choose to do so in this NPRM.
When Reports Are Due
If an entity finds that it meets the requirements of any of the 23 exemptions, then it is not required to file any information with FinCEN under the CTA. FinCEN did invite public comment under the NPRM on whether it should permit-exempt entities to voluntarily file an exemption certificate. If an exempt entity no longer meets the exemption criteria, it must file a report with FinCEN within 30 calendar days after the date it no longer qualifies as exempt.
Those entities that qualify as reporting companies and are formed or registered to do business in the United States before the effective date of the CTA will have 30 days from the effective date to file their beneficial ownership report with FinCEN. Any reporting company that is formed or registered to do business in the United States on or after the effective date of the CTA will have 14 days from the date of formation or qualification to file its report with FinCEN. The CTA authorizes FinCEN to determine the effective date of the CTA, but FinCEN did not propose an effective date in the NPRM. Instead, FinCEN is currently seeking public comment on the timing of the effective date and any potential factors to be considered.
If a reporting company realizes that it filed any inaccurate information with FinCEN, it has 14 days after such realization to file a report to correct the information. The CTA also includes a safe harbor for companies that correct inaccurate information they inadvertently filed if the corrected report, filed within 14 days of realization, was also filed within 90 days after the date that the inaccurate report was filed. A reporting company must also provide an update to FinCEN within 30 days of any change to its beneficial ownership information. The CTA, therefore, creates an ongoing obligation for a reporting company to monitor the identity of its beneficial owners.
Information Required For Reports
Reporting Company Information
Under the CTA, a reporting company must report certain information about itself, its beneficial owner(s), and its company applicant(s). To ensure that reporting companies can be identified from the beneficial ownership information report, FinCEN proposes that each reporting company report its name, any alternative names through which the company is engaged in business (“d/b/a names”), its business street address, its jurisdiction of formation or registration, as well as a unique identification number. The unique identification number must be a TIN (including an Employer Identification Number (EIN)), or where a reporting company has not yet been issued a TIN, a Dun & Bradstreet Data Universal Numbering System (DUNS) number, or a Legal Entity Identifier (LEI).
Beneficial Ownership and Company Applicant Information
The CTA also requires each reporting company to submit to FinCEN a report identifying each beneficial owner of the reporting company and each company applicant by (1) full legal name, (2) date of birth, (3) current residential or business street address, and (4) unique identifying number from an acceptable identification document; or, if already obtained, a FinCEN identifier. The NPRM indicates that identifying photographs or documents would also be submitted to FinCEN to verify the identifying number. However, as with the other rules, FinCEN welcomes comments on the proposed collection of a scanned copy of an identification document.
An individual or a reporting company may obtain a “FinCEN identifier” from FinCEN by reporting the information required of such person or entity under the CTA. The individual or entity can then use its FinCEN identifier, instead of the information usually required for beneficial ownership information reports, for any future reports filed with FinCEN.
- Beneficial Owner Definition
The CTA defines a beneficial owner, with respect to a reporting company, as “any individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise: (i) exercises substantial control over the entity; or (ii) owns or controls not less than 25% of the ownership interests of the entity.” FinCEN expects that a reporting company would identify at least one beneficial owner under that definition regardless of whether (1) any individual satisfies the ownership component, or (2) exclusions to the definition of beneficial owner apply.
The NPRM set forth the following 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 senior officer or a dominant majority of the board of directors (or similar body) of a reporting company; or (3) direction, determination, or decision of, or substantial influence over, important matters of a reporting company. A person who meets any of these three indicators is most likely a beneficial owner. However, the ordinary execution of day-to-day managerial decisions with respect to one part of a reporting company’s assets or employees typically should not, in isolation, cause the decision-maker to be considered in substantial control of a reporting company, and therefore a beneficial owner.
The NPRM provides that “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. The NPRM identifies ways in which an individual may “own or control” interest, including direct or indirect ownership. The NPRM also specifies that an individual may directly or indirectly own or control an ownership interest in a reporting company through a trust or similar arrangement. An individual’s ownership interests of the reporting company shall include 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.
The NPRM describes five exceptions to the definition of beneficial owners that are included in the CTA. These exceptions relate to minor children, nominees or other intermediaries, employees, inheritors, and creditors.
- Company Applicant Definition
Under the CTA, a company applicant is defined as any individual who files a document that creates a domestic reporting company or who first registers a foreign reporting company with a secretary of state or similar office in the United States. The proposed definition of a company applicant would also include any individual who directs or controls the filing of such a document by another person.
The additional requirement regarding directing or controlling the filing is designed to ensure that the reporting company provides information on individuals that are responsible for the decision to form a reporting company given that, in many cases, the company applicant may be an employee of a business formation service or law firm, or an associate, agent, or family member who is filing the document on behalf of another individual.
FinCEN believes that the burden of this reporting requirement is minimal because the identity of any individual that meets the definition of “company applicant” (both the person submitting the report and the person directing it) should be readily available to reporting companies. However, FinCEN welcomes comments on this proposal. For company applicants that provide a business service as a corporate or formation agent, the reporting company would need to report the business address of any company applicant that files a document in the ordinary course of such individual’s business.
Consequences Of Inaccurate Reports
The CTA makes it unlawful for any person to “willfully provide, or attempt to provide, false or fraudulent beneficial ownership information . . . to FinCEN” or to “willfully fail to report complete or updated beneficial ownership information to FinCEN.” The CTA imposes civil and criminal penalties for any person who willfully violates its beneficial ownership information reporting obligation. Such person shall be liable for a civil penalty of up to $500 for each day a violation continues or has not been remedied, and may be fined up to $10,000 and imprisoned for up to two years, or both, for a criminal violation.
The NPRM clarifies certain terms used in the violations provision of the CTA. The term “person” includes any individual, reporting company, or other entity. The term “beneficial ownership information” includes any information provided to FinCEN under the CTA, and a person “provides or attempts to provide beneficial ownership information to FinCEN,” if such person does so directly or indirectly, including by providing such information to another person for purposes of a report or application under the CTA. While only reporting companies are directly required to file reports or applications with FinCEN, beneficial owners or company applicants who provide false information about themselves to those reporting companies can also be held liable.
The CTA, once effective, will completely change the landscape of entity formation and qualification in the United States. An entity must first determine whether it is exempt or qualifies as a reporting company. If a reporting company, the entity must next identify any individuals that might be beneficial owners or company applicants of the reporting company. Once those individuals are identified, the reporting company must submit a report identifying the four pieces of information for each individual, as well as identifying information about the reporting company itself. The willful failure to meet this reporting obligation may result in civil or criminal penalties.
Attorneys and other agents should pay close attention to the reporting obligations and deadlines required by the CTA. Attorneys and other agents should consider whether an entity they represent may be a “reporting entity” and whether the engagement would classify such attorney or other agent as a “company applicant.” While the reporting companies are the only ones directly obligated to report to FinCEN, attorneys and other agents that prepare reports for reporting companies may be exposed to liability if the reports submitted contain inaccurate information. Attorneys and other agents working on behalf of reporting companies should consider putting procedures in place to ensure the beneficial ownership information reports inevitably submitted to FinCEN contain accurate and up-to-date information.
While the NPRM filled in some open gaps regarding the procedures related to the CTA, it still posed 40 questions to the public to further shape the proposed rules. The notice and comment period for this NPRM will close on February 7, 2022.
FinCEN also announced that the next two NPRMs will propose rules, which will be open to public comment, for the (i) implementation of the CTA’s protocols for access to and disclosure of beneficial information from FinCEN’s secure database; and (ii) revisions to FinCEN’s current regulation concerning customer due diligence requirements for financial institutions (the “CDD Rule”), to make the requirements of the CDD Rule consistent with and non-repetitive to the CTA.
While companies have been given more guidance on how the CTA will affect their obligations, it will be necessary to stay up-to-date on the CTA once the rules from each of the NPRMs become final and the effective date for the CTA is set.