As a part of the Anti-Money Laundering Act of 2020, within the National Defense Authorization Act for Fiscal Year 2021, the Corporate Transparency Act (the “CTA”) was enacted on January 1, 2021 to establish a federal reporting requirement in the United States to have a registry of beneficial owners of entities that are treated as “reporting companies.” On December 7, 2021, the Financial Crimes Enforcement Network (“FinCEN”) issued a notice of proposed rulemaking (the “NPRM”) to implement the CTA.
In some ways, the CTA replicates what is already done at the state level because states typically gather similar data such as information about managers or registered agents. However, the CTA is an entirely new regime of data reporting and information gathering at the federal level. The US federal government is implementing this new regime in order to gather and to understand activities of both US and non-US people over the border as a counter-terrorism measure, much like they did for the Foreign Account Tax Compliance Act (“FATCA”) and the Bank Secrecy Act (“BSA”). When the CTA was first introduced, we published an introductory article.
This article will highlight key provisions of the NPRM and specific issues that high-net-worth individuals, family offices, wealth management companies and trust companies should consider in connection with the new reporting requirements under the CTA. This article addresses the following items:
- Who reports?
- When do they report?
- What gets reported?
- Who is the Beneficial Owner?
- Who is the Company Applicant?
- Where to report?
- What are the penalties for failure to report?
- Specific issues that high-net worth individuals, family offices, wealth management companies, and trust companies should consider.
Definition of reporting company
Consistent with the CTA’s statutory language, FinCEN proposes to define a reporting company to include: (1) domestic reporting company and (2) foreign reporting company. A domestic reporting company is any entity that is a corporation, limited liability company (“LLC”), or any other entity that is created by the filing of a document with a secretary of state or a similar office under the law of a state or Indian Tribe. A foreign reporting company is any entity that is a corporation, LLC, or other entity formed under the law of a foreign country and registered to do business in any state or tribal jurisdiction by the filing of a document with a secretary of state, etc.
FinCEN believes the proposed definition of domestic reporting company would likely include limited liability partnerships, limited liability limited partnerships, business trusts (a/k/a 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.
The NPRM does not clarify whether general partnerships would be considered a reporting company because they are a product of common law rather than statutory law and filing requirements. General partnerships are typically found to exist in the US law when two or more individuals agree to run a business or carry on an endeavor together, holding themselves out as a unified group with the stated or implied intention to share income and profits as well as expenses, losses, and liabilities.
It seems clear that typical US estate planning trusts, whether established during a settlor’s lifetime or at passing, would not be reporting companies. This is consistent with the CTA’s statutory language and the NPRM because trusts are contractual arrangements between and among a settlor, fiduciaries (namely a trustee), and beneficiaries.
Exclusion from Reporting Company
The NPRM generally retains the CTA’s statutory language excluding twenty-three specified entities from the definition of a reporting company. Since publicly traded companies and heavily regulated entities already provide such ownership information to government agencies, these entities are exempted from the CTA’s reporting requirement.
FinCEN provides examples of the exempted entities such as “large operating company exemption,” “subsidiary exemption,” and “inactive entity exemption.” The large operating company is a company that employs more than 20 employees on a full-time basis in the United States, has filed in the previous year federal income tax returns in the United States demonstrating more than $4 million in gross receipts or sales in the aggregate, and has an operating presence at a physical office within the United States. The subsidiary exemption exempts a reporting company if its ownership interests are entirely owned or controlled (either directly or indirectly) by another exempted entity. The inactive entity exemptions exempt certain companies that existed for more than a year and satisfied certain other conditions.
The NPRM provides that an entity with an “operating presence at a physical office within the United States” would be one for which the physical office is owned or leased by the entity, is not a residence, and is not shared space (beyond being shared with affiliated entities)—in short, a genuine working office of the entity. However, it is not clear how a genuine working office of the entity can be defined, particularly in more modern businesses where, for example, the entity uses a blockchain contract and therefore establishes a decentralized autonomous organization, resulting in no need for a physical office to maintain books and records.
When do they report?
FinCEN confirms that the reporting companies formed or registered to do business in the United States before the final regulations’ effective date (the “Effective Date”) would have one year to file an initial report. Further, FinCEN confirms that the reporting companies formed or registered to do business after the Effective Date would have 14 calendar days after formation or registration to file an initial report.
Report update and correction
The NPRM provides that the reporting companies would have 30 calendar days to update a report after the date when there is any change with respect to any information previously reported to FinCEN. Also, the NPRM provides that the reporting companies would have 14 calendar days to correct inaccurately filed information after the date when the reporting companies become aware or have reason to know that any required information reported to FinCEN was inaccurate.
What gets reported?
Consistent with the CTA’s statutory language, the NPRM mandates that the reporting companies should provide 1) the full legal name; 2) the date of birth; 3) the current address; and 4) a unique identifying number from an acceptable identification document (i.e., a passport or driver’s license) of each of the reporting companies’ beneficial owners and company applicants.
The NPRM provides that the reporting companies should include certain information about themselves in the report to FinCEN. Those are 1) the full name of the reporting company; 2) any trade name or “doing business as” name of the reporting company; 3) the business address of the reporting company; 4) the jurisdiction of formation or registration; and 5) the taxpayer identification number (“TIN”), including an Employer Identification Number (“EIN”).
Who is the beneficial owner?
The CTA’s statutory language provides that a beneficial owner is any individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, exercises substantial control over the entity, or owns or controls not less than 25 percent of the ownership interests of the entity.
a. Definition of substantial control
The NPRM sets forth three specific indicators of substantial control. First, an employee serving as a senior officer of a reporting company should be treated as exercising substantial control over the entity. Senior officer means “any individual holding the position or exercising the authority of a president, secretary, treasurer, chief financial officer, general counsel, chief executive officer, or any other officer, regardless of official title, who performs a similar function.” The second indicator is authority over the appointment or removal of any officer or dominant majority of the board of directors (or similar body) of a reporting company. The third indicator of substantial control is 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.
The NPRM provides examples of an individual’s direct or indirect exercise of substantial control. Those include: board representation; ownership or control of a majority or dominant minority of the voting shares of the reporting company; rights associated with any financing arrangements or interest in a company; control over one or more intermediary entities that separately or collectively exercise substantial control over the reporting company; arrangements or financial or business relationships, whether formal or informal, with other individuals or entities acting as nominees; or any other contract, arrangement, understanding, relationship, or otherwise.
The NPRM mandates that every individual who meets the definition of substantial control must be identified and reported to FinCEN.
b. Definition of ownership or control of ownership interests
The NPRM provides that types of ‘‘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.
Ownership interests in the reporting companies can be owned or controlled, directly or indirectly, through a variety of means, including but not limited to: 1) through joint ownership; 2) through control of such ownership interest owned by another individual; or 3) through a trust or similar arrangement.
For a trust, the NPRM provides that an individual may own or control ownership interests by way of the individual’s position as 1) a grantor or settlor (who has the right to revoke the trust or otherwise withdraw the assets of the trust), 2) a beneficiary (who is the sole permissible recipient of income and principal from the trust, or has the right to demand a distribution of or withdraw substantially all of the assets from the trust), or 3) a trustee, or another individual with authority to dispose of trust assets.
c. Exception for beneficial owner
Consistent with the CTA’s statutory language, the NPRM provides a list of individuals exempted from the definition of beneficial owner. Those include: 1) a minor child; 2) nominee, intermediary, custodian or agent on behalf of another individual; 3) an employee of the reporting company, acting not as senior officers; 4) an individual whose interest in a reporting company is a future interest through the right of inheritance; and 5) a creditor of a reporting company.
Who is the company applicant?
The NPRM provides that a company applicant is defined as any person who files the document that forms the entity for domestic reporting companies and any person who files the document that first registers the entity to do business in the United States for foreign reporting companies.
Where to report?
The reporting companies will need to file the required information of their beneficial owners and company applicants with FinCEN. However, the NPRM does not clarify mechanism of reporting such as which form and instruction needs to be used, or how and where to report the required information. The final regulations of the CTA should provide clarification for the above-stated issues.
What are the penalties for failure to report?
The NPRM provides that any individual, in addition to the reporting companies, will be subject to the civil and criminal penalties if any person willfully provide, or attempt to provide, false or fraudulent information or willfully fail to report the required information to FinCEN. Pursuant to the current CTA, 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. The NPRM also clarifies that such penalties can be imposed to not only a reporting company, its beneficial owners and its company applicants, but also to a person who directly or indirectly provides false information or who directs or controls other person with respect to any such failure to report.
Specific issues that high-net-worth individuals, family offices, wealth management companies, and trust companies should consider
Trust owning reporting company
As discussed above, a trust itself would generally not be treated as a reporting company. However, in a fairly typical situation where a trust owns an interest in a reporting company, such as an LLC or corporation, FinCEN may treat certain individuals affiliated with the trust as the beneficial owners of the reporting company. Those individuals may include: 1) a trustee or other individual with the authority to dispose of the trust assets; 2) a beneficiary who is the sole permissible recipient of income and principal from the trust or who has the right to demand a distribution of or withdraw substantially all of the assets of the trust; or 3) a grantor or settlor who has the right to revoke the trust or otherwise withdraw the assets of the trust.
The NPRM does not clarify to what extent a fiduciary of a trust can be considered a beneficial owner of a reporting company owned by the trust, but includes the language, “a trustee or other individual with the authority to dispose of the trust assets” (emphasis added). Using the phrase “other individual” probably indicates the intent to include not just the trustee but other types of fiduciaries or individuals involved with trust activity as potential beneficial owners.
Consider the following familiar scenarios:
a. An Investment Advisor controls all investments of a trust and has the ability to generate or not generate income to be made available to the trust beneficiaries. Might FinCEN consider that Investment Advisor to have sufficient “authority” over the disposition of trust assets to be considered a beneficial owner?
b. A single Distribution Advisor in a trust has absolute discretion as to whether or not to make distributions to beneficiaries of a trust. Does that individual have sufficient “authority” to dispose of trust assets? What if, instead of a single Distribution Advisor, a trust has a Distribution Committee made up of various types of individuals? Would each Distribution Committee member have sufficient authority to dispose of trust assets to be considered a beneficial owner? What if distribution decisions are required to be made by unanimous consent of all members? What if distribution decisions are required to be made by majority and there are three members?
c. A Trust Protector has the broad power to remove and replace the Trustee, the Distribution Advisor, and the Investment Advisor in a particular trust. Does that individual, by virtue of his or her power to control the people who control the disposition of assets, have sufficient authority to dispose of assets, such that FinCEN would consider him or her to be a beneficial owner?
We are hopeful that the final regulations of the CTA will provide clarification for the above-stated issues.
Private trust company as beneficial owner and reporting company
Consider a Private Trust Company (a “PTC”), which is typically organized as an LLC or corporation. The PTC itself would likely be treated as a reporting company. In addition, a PTC is generally created in order to serve as a trustee of one or more trusts. If those trusts own any reporting companies, depending on the PTC’s role in the trust, FinCEN may treat the PTC as a beneficial owner of the reporting companies. Therefore, the PTC can be considered both as a reporting company and as a beneficial owner of other reporting companies pursuant to the current CTA and NPRM.
Additional considerations in estate planning
Individuals and service providers should consider a variety of questions in evaluating their CTA reporting exposure. These questions include: 1) whether or not the entity is necessary; 2) if so, what type of entity should it be? (e.g., corporation, LLC, general partnership, limited partnership, etc.); 3) who should be involved in the entity in terms of substantial control and ownership interest, and who should be a manager of the entity?; and 4) who should be involved in the entity’s formation or registration?
Registered agents such as CT Corporation should take note that their clients will have a CTA reporting obligation and that their information may be required to be reported to FinCEN in their capacity a company applicant. Therefore, they should carefully consider who directs and files the formation or registration documents of a given entity.
As discussed above, the NPRM leaves a number of outstanding issues such as: 1) to what extent a fiduciary of a trust (i.e., trustee, protector, investment advisor, distribution advisor, appointer, general trust advisor (Wyoming) or trust director (Connecticut)) is considered a beneficial owner; and 2) how a physical office can be defined for the reporting company exemption purpose. In addition, we are hopeful FinCEN will address some of the more practical issues involved in complying with these new rules, including identifying and gathering information about reporting companies that may have been formed decades ago, and for example, how to locate the company applicant for those older entities. The comment period for the NPRM is open until February 7, 2022 and we expect FinCEN to release its final regulations in order to effectuate the reporting obligation before the end of 2022. We recommend that companies, relevant individuals, and service providers assess their reporting exposure and begin gathering beneficial ownership information.