29 September 2022 - Article
The National Defense Authorization Act (“2020 Defense Act”) became law with support from veto-proof majorities in both the U.S. House of Representatives and Congress, despite being vetoed by President Trump. One component of the 2020 Defense Act is the establishment of beneficial ownership information reporting requirements for companies formed or operating in the United States. These new rules are referred to as the Corporate Transparency Act (“Transparency Act”). The new Transparency Act mandates “reporting companies” in the United States to disclose their beneficial owners to the Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”).
These rules reflect a growing international trend to require disclosure of beneficial ownership and creates compliance similar to many other countries, including but not limited to Bahamas and Bermuda, for example.
Creating the Concept of a “Reporting Company” and Providing Some Exceptions
The 2020 Defense Act creates a new reporting requirement for legal entities (and also provides certain notable exceptions). The term “reporting company” means a corporation, limited liability company, or other similar entity that is (i) created or formed pursuant to the laws of a US state, or (ii) formed under the law of a foreign country and is registered to do business in the United States.
Exceptions to these rules are provided. For example, perhaps most importantly for international families with closely and privately held companies, there is an exception from reporting for an individual whose only interest in a corporation, limited liability company, or other similar entity is through a right of inheritance. There is also an exception for companies with more than 20 employees, gross receipt or sales of more than $5 million, and physical presence in the United States. Finally, companies that are operating in certain already highly regulated industries such as banks, credit unions, registered money transmitting businesses, registered brokers or dealers, registered exchange or clearing agencies, registered investment companies, insurance companies, public accounting firms, public utility companies, and 501© organizations and their operating companies are not required to make these new FinCEN reports.
Who is a “Beneficial Owner”?
There remains some question on the scope of who is included in the tem “beneficial owner”. We do know that the term “beneficial owner” is defined as an 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% of the ownership interests of the entity. We also know that the term “beneficial owner” does not include (i) a minor child, (ii) a nominee, intermediary, custodian, or agent on behalf of another individual, (iii) an employee of the reporting company, (iv) an individual whose only interest in the reporting company is through a right of inheritance, and (v) a creditor of the reporting company unless the creditor exercises substantial control over the entity, or owns or controls more 25% or more of the entity. However, the Transparency Act does not define “substantial control” and does not clarify how the “25% or more ownership” will be measured. Also missing is specific guidance on the application of these rules to entities other than a “corporation, limited liability company, or other similar entity” and therefore begs questions around partnerships and various types of trusts. Further guidance is needed.
In an attempt to more precisely define the term “beneficial owner” it seems reasonable to apply the FinCEN customer due diligence rules under 31 C.F.R. § 1010.230 as a model. If this approach were applied, a shareholder would be considered the beneficial owner of a corporation if the shareholder owned 25% or more of the equity interest in the corporation and had significant responsibility to control, manage, or direct the corporation as an executive officer, senior manager, or other individual who regularly performs similar functions; a partner would be considered the beneficial owner of a partnership if the partner owned 25% or more of the equity interest in the partnership and had significant responsibility to control, manage, or direct of the partnership as listed above; a trustee would be considered the beneficial owner if a trust it served owned 25% or more of the equity interest in a company.
The Scope of Reporting
These changes represent a significant change to current rules and requirements. While state law has not changed, these requirements create a federal overlay to existing state law. Under current law, in most US states, a corporation or an LLC can be formed simply by filing the articles of incorporation or certificate of formation with the secretary of state, with such forms executed by an organizer who need not be an owner or representative. There has historically been no requirement to provide information to the federal government with respect to the ownership of a company. The 2020 Defense Act changes that and will require each reporting company to provide four (4) key identifiers about the beneficial owners to FinCEN, first at the time of its formation and, subsequently, on an annual basis. These four identifiers are:
- (i) A “beneficial owner’s” full legal name;
- (ii) A “beneficial owner’s” date of birth;
- (iii) A “beneficial owner’s” current residential or business street address; and
- (iv) A government-issued identifying number assigned to that “beneficial owner” from an “acceptable identification document” (such as passport, driver’s license or other U.S. state-issued identification document).
In the Name of National Security
The purpose of the Transparency Act is to prevent potential wrongdoers from exploiting United States corporations and limited liability companies for criminal gain and to assist law enforcement in detecting, preventing, and punishing terrorism, money laundering, and other misconduct involving United States corporations and limited liability companies, and for certain other purposes.
The Transparency Act is not available to the public. As an important distinction from the ultimate beneficial owner registers and rules of other non-US jurisdictions, the current rules of the Transparency Act provide that the beneficial ownership information submitted to FinCEN would not be available to the general public.
FinCEN is limited use of the information received. FinCEN may only disclose the beneficial ownership information upon request by (i) a US federal agency engaged in national security, intelligence, or law enforcement activity, (ii) a State, local, or Tribal law enforcement agency, (iii) a federal agency on behalf of a law enforcement agency, prosecutor, or judge of another country, (iv) a financial institution subject to customer due diligence requirements, with the consent of the reporting company, or (v) a US federal functional regulator or other appropriate regulatory agency.
While the Transparency Act does not specifically address whether beneficial ownership information would be subject to the Freedom of Information Act (FOIA) request, the Act does state that FinCEN may disclose the information only upon the receipt from the listed agencies or regulators, and FOIA is not on the list. In addition, the disclosure of the beneficial ownership upon the FOIA request would invade the beneficial owners’ personal privacy, which we anticipate would result in being exempted from the disclosure subject to the FOIA.
Any reporting company that has been formed or registered before the enactment of the Transparency Act would need to report the information on beneficial ownership within 2 years after the effective date of the Transparency Act.
Recent proposals would require a filing similar to FATCA forms (Form 114) to FinCEN, which we anticipate would include information about beneficial owners (including their names, dates of birth, addresses, and passport or driver’s license numbers) and then update that information continuously during the lifespan of those businesses. Newly formed reporting companies would need to report the information on beneficial ownership at the time of formation or registration. Furthermore, reporting companies would need to file updated information not later than 1 year after the date on which there is any reportable change with respect to beneficial ownership.
Penalties for Non-Compliance Can Apply
Any person who willfully fails to report or provides false information is subject to a fine of up to $10,000 and possible imprisonment of up to two years.