What is the CTA?
The CTA was part of the Anti-Money Laundering Act of 2020, which was passed as part of the National Defense Authorization Act of 2021 and became effective on January 1, 2021. The CTA requires the creation of a national database of information relating to the “beneficial owners” of businesses, which are referred to as “reporting companies”.
This law has been in effect since January 1, 2021. Why is the CTA relevant now?
Although the CTA has theoretically been in effect for almost two years, the national database of information has not yet been created. FinCEN, in conjunction with the Treasury Department, is still in the process of creating, implementing, and overseeing the database and the required regulations. FinCEN provided a notice of proposed rulemaking on December 8, 2021, and the comment period ended February 7, 2022. In a Corruption Advisory dated April 14, 2022, FinCEN acknowledged that it had “begun implementing” the CTA and the “beneficial ownership information database.”
Most recently, on September 29, 2022, FinCEN issued a final rule clarifying and implementing the standards for beneficial ownership and confirming the effective date of the CTA as January 1, 2024.
Which businesses may be required to report?
The CTA will require most corporations and limited liability companies (“LLC”) to report. The CTA will also likely affect any other domestic entity created by the filing of a document with a Secretary of State or similar office under the laws of a State or trial jurisdiction. Similarly, it will also affect any foreign entity registered to do business in any State or trial jurisdiction by virtue of a similar filing.
What about entities that are not “created” by the filing of a document with a Secretary of State or similar office?
Sole proprietorships, certain types of trusts, and general partnerships in many, if not most, circumstances are not created through the filing of a document with a Secretary of State or similar office. In such cases, the sole proprietorship, trust, or general partnership would not be a reporting company under the final rule. Moreover, where such an entity registers for a business license or similar permit, FinCEN believes that such registration would not generally “create” the entity, and thus the entity would not be created by a filing with a Secretary of State or similar office.
However, the details of a state’s registration and filing practices may be relevant to determining whether an entity is created by a filing. Based on the range of responses regarding state law corporate formation practices, there may be varying practices which make a categorical rule impracticable.
It is similarly difficult to craft a generally applicable rule for conversions or reorganizations of entities, given the range of possible scenarios for conversions or reorganizations under various state laws and the variety of outcomes in terms of an entity retaining certain attributes of its predecessor entity. In such cases, the touchstone is whether the successor entity is created by the filing of a document with a Secretary of State or similar office. Given the potential range of relevant facts, FinCEN has advised it will consider issuing guidance, on a case-by-case basis as necessary, to resolve questions on whether entities of particular types in particular circumstances are created by the filing of a document with the relevant authority.
In these types of uncertain situations, it is generally recommended that an entity retain or seek guidance from a law firm or business formation service which specializes in corporate formation and reporting issues.
What does the CTA require?
In the absence of an exemption, the CTA requires certain businesses/reporting companies and “company applicants” to maintain information on their “beneficial owners”. Importantly, those reporting companies are also required to file/report, and update, the applicable reporting information with FinCEN.
In turn, FinCEN is authorized to disclose the reporting information to:
- United States federal law enforcement agencies;
- Certain other enforcement agencies (with court approval);
- Non-US law enforcement agencies, prosecutors, or judges (based upon the request of a United States federal law enforcement agency); and
- Financial institutions and their regulators (with the consent of the reporting company).
Who is a “company applicant”?
FinCEN’s final rule specifies that the term “company applicant” in relation to U.S. entities means the individual who directly files the document to create or register the reporting company, and the individual who is primarily responsible for directing or controlling such filing, if more than one individual is involved in the filing. Similarly, with regard to Non-U.S. reporting company, it would be the individual(s) who file the document that first registers the foreign company, including any individual(s) who “direct or control” that filing.
This definition is designed to identify the individual who is responsible for the creation of a reporting company through the filing of formation documents, and the individual that directly submits the formation documents, if that function is performed by a different person, but it reduces potential burdens by limiting the definition of company applicant to only one or two individuals.
What does “directing or controlling” mean?
In many cases, company applicants may be employed by a business formation service or law firm. For example, there may be an attorney primarily responsible for overseeing the preparation and filing of incorporation documents and a paralegal who directly files them with a state office to create the reporting company. In this example, this reporting company would report two company applicants—the attorney and the paralegal—but additional individuals who may be indirectly involved in the filing would not need to be reported.
Who is a “beneficial owner”?
For any reporting company, a “beneficial owner” is every 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 at least 25% of the ownership interest of the entity.
What is considered “substantial control”?
There are generally three specific indicators of substantial control:
- Service as a senior officer of a reporting company;
- Authority over the appointment or removal of any officer (or dominant majority) of the board of directors (or similar body) of a reporting company; or
- Direction, determination of decision of, or substantial influence over, important matters of a reporting company.
How is a “25% ownership interest” defined?
FinCEN has revised the definition of “ownership interest” to focus solely on types of arrangements that convey ownership interests (e.g., equity, convertible instruments, stocks, etc.), rather than by reference to legal entities in which ownership interests are held. This reflects the wide variety of potential reporting company structures and the potential for evasion inherent in specifying detailed rules for each structure.
FinCEN has also amended the final clause of 31 CFR 1010.380(d)(2)(i)(A) to make clearer, as suggested by some commenters, that the listed forms of ownership (like equity or stocks) are independent of voting power or voting rights (which may be relevant to the related but conceptually distinct concept of substantial control).
The calculation of the 25% is based upon the ownership interests as they stand at the time of the calculation.
Which businesses are exempt?
First: Public companies, financial institutions including banks, registered money transmitting businesses, 1934 Act broker-dealers, registered investment advisors and investment companies, insurance companies, PCAOB accounting firms, public utilities, 501(c)s and certain political organizations. 31 U.S.C. §5336(a)(11)(B).
Second: Any “large operating company,” which (i) employs more than 20 full-time employees in the United States, (ii) shows more than $5 million of “gross receipts or sales in the aggregate” on its prior year’s federal tax return, and (iii) has “an operating presence at a physical office” in the United States. 31 U.S.C. § 5336(a)(1)(11)(b)(xxi).
What information is required to be filed with FinCEN?
Reporting companies are required to maintain and report personal identifying information for every “company applicant” and every reportable “beneficial owner”, including full legal name(s), residential and business addresses, current passport or driver’s license number, and an image of the identification document.
When must disclosures be made?
New businesses formed after the adoption of the regulations must report information within 14 days after filing. All other existing businesses must report information within one year of the effective date of the regulations, January 1, 2024.
Updated information must be reported within 30 days after the change of applicant or beneficial owner information, including, for example, a driver’s license change of address.
What are the penalties for non-compliance?
Penalties for non-compliance include civil fines of $500 per day while violations continue, up to $10,000, and criminal penalties including up to two years in prison.
What are the best practices for businesses without a clear exemption?
Past, current, and future clients may need to consider changes to operating agreements, including limiting confidentiality clauses, and obligations for members and managers to provide sufficient information for the entity to meet reporting requirements.
Please do not hesitate to reach out to TALG if you need assistance with complying with the CTA, or if you have any questions.