Understanding the Corporate Transparency Act and Ensuring Compliance

February 27, 2023Advisories

The Corporate Transparency Act (CTA) was enacted to prevent money laundering and promote a “know your customer” policy by imposing new disclosure requirements on “reporting companies.” It requires entities to provide company information in addition to personal identifying information about their beneficial owners (Beneficial Ownership Information or BOI). The CTA goes into effect on January 1, 2024, and will apply to companies formed both before and after the effective date. On September 29, 2022, FinCEN issued its final rule on the BOI reporting requirement. This report summarizes the major components and requirements of the CTA and the final regulations relating to BOI reporting (the BOI Reporting Rule), outlines which companies may be exempt, and specifies a list of action items that reporting companies must fulfill to ensure compliance.

  1. Which companies must report?

The act applies to both domestic and foreign companies. A domestic reporting company is a corporation, a limited liability company, or other entity that is created by the filing of a document with a secretary of state or any similar office under the law of a state or Indian tribe. Note this would generally exclude general partnerships and most trusts. A foreign reporting company is a corporation, limited liability company, or other entity that is formed under the law of a foreign country and that is registered to do business in the United States by the filing of a document with a secretary of state or equivalent office under the law of a state or Indian tribe.

There are, however, 23 categories of exempt entities. Most such entities are considered exempt because they are already subject to federal or state regulations which require the reporting of BOI and which would make CTA reports redundant. Exempt entities include public companies, banks, brokers or dealers in securities, investment company or investment adviser, venture capital fund advisor, pooled investment vehicles, tax-exempt entities, subsidiaries that are wholly owned, directly or indirectly, by certain exempt entities, and inactive entities. Large operating companies that have 20 or more full-time U.S. employees, a physical operating presence in the U.S. and more than $5 million in U.S.-sourced revenue are also exempt entities.

  1. What company information must be reported?

All reporting companies must provide their full legal name, all trade and d/b/a names, and the street address of their principal place of business (if the principal place of business is outside the U.S., this is defined as the primary U.S. location where the entity conducts business).

In addition, domestic reporting companies must report their jurisdiction of formation and TIN. Foreign reporting companies must report their jurisdiction of formation, jurisdiction of registration in the U.S., and either their TIN or, if they do not have a TIN, their foreign tax identification number and the number of the corresponding jurisdiction. 

  1. What is a beneficial owner?

A beneficial owner is any individual who (directly or indirectly) a) exercises substantial control over the company or b) owns or controls at least 25% of the company’s ownership interests. Each beneficial owner of a company must be reported.

a) Substantial Control: The CTA defines three primary indicators but also includes a “catch-all provision” as set forth below. Note that the trustee of a trust or similar arrangement can be deemed to exercise substantial control.

i) Service as a senior officer (includes in-house counsel but excludes ministerial functions like corporate secretary and treasurer).

ii) Authority over appointment or removal of any senior officer or a majority or dominant minority of board of directors.

iii) Control of direction, determination, or decision of, or substantial influence over, important decisions affecting company (this is not foreseen as applying to third party-professionals, such as lawyers, offering arms’ length advice).

iv) Any other form of substantial control.

b) An ownership interest can be controlled or owned directly or indirectly through any contract, arrangement, understanding, or otherwise. Convertible instruments are included as ownership interests. However, companies are not required to report options and derivatives that they are not aware exist. There are two ways to calculate percentage of ownership interest. For both methods, options and similar interests are treated as exercised.

i) Ownership interests are calculated by the “vote or value” approach for corporations, entities taxed as corporations, and other entities that issue shares. Under this approach the ownership interest is the greater of the individual’s voting power as percentage of total outstanding voting power and the individual’s ownership interest value as percentage of total outstanding ownership value.

ii) For entities that are not corporations and do not issue shares, ownership interest is calculated by comparing the individual’s ownership interest to the outstanding ownership interest in the company.

The Final Rule clarified that if an individual is a beneficial owner of a company exclusively by virtue of ownership interest in one or more exempt entities, that individual’s BOI must be reported.  

c) Beneficial Ownership through indirect control: An individual person can be deemed a beneficial owner through their direct or indirect possession or control of an ownership interest by virtue of “joint ownership with one or more other persons of an undivided interest in such ownership interest.”

d) Beneficial Ownership through trusts or similar arrangements: With respect to trusts and similar arrangements, the following individuals can be considered beneficial owners:

i) A trustee of the trust or other individual (if any) with the authority to dispose of the trust assets.

ii) 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 of substantially all of the assets from the trust.

iii) A grantor or settlor who has the right to revoke the trust or otherwise withdraw the assets of the trust.

e) There are a number of exemptions to the beneficial owner definition.

i) Minors (if their parent or guardian’s information is reported).

ii) An individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual (for example a lawyer or tax professional who works with a reporting company).

iii) An individual acting solely as an employee of a reporting company (but not if said individual is a senior officer).

iv) An individual whose only interest in the reporting company is through future right of inheritance. Such person becomes a beneficial owner when he or she inherits the pertinent ownership interest.

v) The creditor of a reporting company.

  1. What Beneficial Ownership Information must be reported?

For each beneficial owner, the company must report name, date of birth, and residential address (this address does not need to be in the U.S., but it cannot be a P.O. Box address). In addition, it must provide an identifying number and image from one of four acceptable identification documents: a nonexpired U.S. passport, a nonexpired state, local, or tribal identification document, a nonexpired state-issued document, or, if none of the prior three are available, a nonexpired foreign passport.

It should be noted that, upon request, FinCEN must provide a unique identifier to individuals who provide FinCEN with the same information as required from a beneficial owner, and to any reporting company who has provided its BOI. In some cases, companies can then provide FinCEN with this identification number instead of a full BOI.

Note that in recent loan agreements, lenders have begun asking borrowers to consent to the disclosure of the borrower’s future BOI reports by FinCEN to the lender. 

      5. Reporting Checklist for Entities Formed After January 1, 2024:

The CTA goes into effect on January 1, 2024. Companies formed after this date must provide the following information to FinCEN within 30 days of formation.

a)  Company Information: full legal name, all trade and d/b/a names, and the street address of their principal place of business (if the principal place of business is outside the U.S., this is defined as the primary U.S. location where the entity conducts business).

i) Additionally for domestic companies: jurisdiction of formation and TIN.

ii) Additionally for foreign companies: jurisdiction of formation, jurisdiction of registration, and TIN (if company does not have a TIN, use foreign tax identification number and the number of the corresponding jurisdiction).

b) BOI for all beneficial owners: name, date of birth, residential address, and one of four acceptable identification documents.

c) BOI for Company Applicant(s).

  •  A company applicant is defined as the individual who directly files to document to create or register the reporting company and the individual who is responsible for directing or controlling such filing if more than one individual is involved in the filing (e.g., the attorney directing the filing and an employee of a business formation service company). Up to two individuals may be reported as company applicants.
  • Note: Unlike for beneficial owner information and reporting company information, company applicant information does not need to be updated in case of a change (e.g., a change in address for said company applicant).

d) A certification from the reporting company that its report or application is true, correct and complete.

      6. Reporting Checklist for Entities Formed Before January 1, 2024:

Companies predating the CTA’s effective date have until January 1, 2025 to provide the following information.

a) Company Information: full legal name, all trade and d/b/a names, and the street address of their principal place of business (if the principal place of business is outside the U.S., this is defined as the primary U.S. location where the entity conducts business).

  • Additionally for domestic companies: jurisdiction of formation and TIN.
  • Additionally for foreign companies: jurisdiction of formation, jurisdiction of registration, and TIN (if company does not have a TIN, use foreign tax identification number and the number of the corresponding jurisdiction).

b) BOI (name, date of birth, residential address, and one of four acceptable identification documents) for all beneficial owners. Note: There is no requirement to report the BOI of company applicants.

c) A certification from the reporting company that its report or application is true, correct and complete.

  1. When must companies update their reports?

Companies must report any changes in their BOI information within 30 days of such change. “Changes” mean a change in the party or parties holding beneficial ownership, a previously exempt minor reaching the age of maturity, and a change to reported information, (for example a change in address). The expiration of the submitted identification document alone does not warrant an update in BOI, but of course, one must update the image if the identifying information on it changes. If companies submit an inaccurate report, they have a 90-day safe harbor within which to correct said report.

FinCEN does not require companies to file a report after their termination or dissolution. It also does not require companies to report changes to the BOI of their company applicant(s). 

  1. What are the consequences of reporting violations?

Both civil and criminal penalties are available for reporting violations, with both the company and individuals responsible for the violation subject to liability. An individual is considered to have “failed to report” complete or updated BOI if such person failed in their personal responsibility to report, directs or controls another person with respect to any failure to report, or is in substantial control of a reporting company when it fails to report. FinCEN will consider willfulness in considering enforcement penalties.

FinCEN has adopted 31 U.S.C. 5336 (h)(1) for its penalty guidelines. These specify that:

  • Violators shall be liable to the U.S. for a civil penalty not exceeding $500 for each day that the violation continues or has not been remedied; and
  • May be fined not more than $10,000, imprisoned for not more than 10 years, or both.
  1. Further Rulemaking

On December 15, 2022, FinCEN released the Notice of Proposed Rulemaking to implement the BOI access and safeguard provisions of the CTA (the Access Rule NPRM). The Access Rule NPRM proposes regulations that would establish who may request BOI that will be reported to FinCEN, who may receive it, how recipients may use the information, how they must secure it, and the penalties for failing to follow applicable requirements. It also provides more information regarding the non-public database where all the BOI information will be entered and stored. We will publish a separate advisory with more details regarding these access and safeguard provisions once the final rule is published. 

In addition to the BOI Reporting Rule and the Access Rule, FinCEN will release a third rulemaking to revise its customer due diligence rule no later than one year after the effective date of the BOI Reporting Rule (January 1, 2024). 

At the state level, there is also a push for greater ownership information and transparency. Last year, New York lawmakers introduced a bill called the LLC Transparency Act, which would create a public searchable database through which users could find which LLCs share common ownership (though certain information regarding individuals would be protected from public disclosure). The LLC Transparency Act did not pass last year and was re-introduced in the 2023 legislative section.