The new year brings a paradigm shift in corporate transparency with new regulations to curb illegal activities like money laundering, corruption, fraud, and terrorism financing. Under the Corporate Transparency Act (CTA), effective January 1, 2024, smaller and previously unregulated companies will have to provide more information about owners. That will make it more difficult for bad actors to hide in the shadows of seemingly legitimate companies.
CTA reporting requirements will be phased in with deadlines based on when entities were formed. All companies should be aware of what is required and determine whether they are exempt.
The Corporate Transparency Act (CTA), enacted as part of the National Defense Authorization Act in 2021, introduces significant changes to the financial legal landscape, primarily aimed at preventing money laundering through the illicit use of anonymous shell companies. The CTA’s goal is to lift the veil of anonymity shrouding many legitimate business entities in the U.S. that has historically been exploited, with alarming frequency, by criminals, tax evaders, and money launderers to hide their identities and illegal activities.
To shed light on such identities, the CTA imposes new requirements on corporations, LLCs, and similar entities to disclose their beneficial owners to the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of Treasury. By requiring the disclosure of beneficial owners, the CTA strives to enhance the transparency of business entities and enable law enforcement and other authorities to better track and combat illicit financial activities.
The United States has faced international criticism for being a haven for anonymous shell companies even as it wields its own influence. The CTA brings the U.S. in line with coalescing international standards for financial transparency, improving its global reputation and compliance with international anti-money laundering guidelines.
Congress hopes the implementation of this Act will prevent the misuse of corporate structures for illicit purposes and align the U.S. with global standards in financial transparency. The opacity of corporate structures has long been exploited for illicit activities. By mandating transparency in entity ownership, the CTA aims to make it more difficult for individuals to use American entity structures for illegal purposes like money laundering, fraud, and financing terrorism. Further, law enforcement agencies, armed with tools to investigate and combat illegal activities, will be provided access to the beneficial ownership information crucial in tracing assets and uncovering the individuals behind suspect entities.
While the CTA imposes new compliance obligations on businesses, the overall intent is to fortify the integrity and transparency of the U.S. financial and corporate systems by helping financial institutions better understand those with whom they are doing business. Thus, the CTA can be viewed as partnering in compliance with existing know-your-customer (KYC) and anti-money laundering (AML) regulations.
“Reporting companies” including corporations, limited liability companies, limited liability partners, limited partnerships, and similar entities created “by the filing of a document with the secretary of state or any similar office under the state,” as well as foreign entities registered to do business in the U.S. must prepare a beneficial ownership information (BOI) report under the CTA.
However, if the entity did not file “a document with the secretary of state”, then it is not required to report. General partnerships formed in states that do not require a filing with the secretary of state will not be considered a “reporting company” for purposes of the CTA. Further, in most states, a trust can be formed without filing a document with the secretary of state; provided, however, some trusts such as statutory trusts (such as Delaware Statutory Trusts) are required to file a document with the state in which they are formed and therefore will be required to report to FinCEN.
There are 23 types of exemptions from the reporting requirements including:
Under the CTA, a reporting company filing its initial beneficial ownership report must include the following:
FinCEN defined “beneficial owner” as any individual who, directly or indirectly, either (a) exercises substantial control over the reporting company or (b) owns or controls at least 25 percent of the ownership interests of the reporting company.
An individual is a “beneficial owner” for purposes of the CTA if the individual meets either (a) the 25% ownership test or (b) the “substantial control” test, each as discussed in greater detail below.
25% Ownership Test
FinCEN provides several rules for calculating whether an individual owns or controls at least 25% of the ownership interests of a reporting company to assist in calculation of ownership interests.
In calculating ownership interests of a reporting company, the following rules apply for purposes of the CTA analysis:
Substantial Control Test
If an individual does not qualify as a beneficial owner under the 25% ownership test, such individual may be a beneficial owner if the individual directly or indirectly exercises “substantial control” over the reporting company. FinCEN defines “substantial control” through a facts and circumstances test that requires several factors to be considered.
An individual exercises substantial control over a reporting company if that individual:
Attributing Beneficial Ownership to Individuals
The CTA establishes the definition of “beneficial owner” is limited to “any individual” and does not include legal entities. However, FinCEN’s rule generically provides that “an individual may directly or indirectly own or control an ownership interest of a reporting company through any contract, arrangement, understanding, relationship, or otherwise.”
Therefore, if an interest in a reporting company is owned by another legal entity, the individual natural person who has the ultimate beneficial ownership of that interest will be reported to FinCEN. This is not difficult when an individual owns the interest but can get complicated when an interest in a reporting company is owned by one, more or even a series of entities (i.e., not individuals) and the reporting company’s beneficial ownership must be traced all the way down to the constituent individuals.
Where an interest in a reporting company is owned by more than one non-natural person, determining those natural persons who will be attributed ownership in the reporting company requires the reporting company to look “through ownership or control of one or more intermediary entities, or ownership or control of the ownership interests of any such entities, that separately or collectively own or control ownership interests of the reporting company.”
FinCEN also provides guidance on attribution when ownership of the reporting company is held by a trust “or similar arrangement.”
Excluded Individuals
FinCEN, through its final rule, provides that “beneficial owner” does not include the following “excluded individuals”:
Beneficial ownership information will be submitted to FinCEN’s database and will not be publicly available.
The information will be disclosed to the following:
It is unlawful for any person to willfully provide, or attempt to provide, false or fraudulent beneficial ownership information or to willfully fail to report complete or updated beneficial ownership information to FinCEN. The CTA provides civil and criminal penalties (up to a $10,000 fine and 2 years’ imprisonment) for willfully providing false information, failing to provide complete information, or failing to update information.
The CTA places the reporting requirements on companies; however, the enforcement provisions are directed at individuals. This led to the question during rulemaking – if a reporting company fails to file or files inaccurate information, what individuals are liable for such corporate reporting failure? FinCEN addressed the question in the final rule by establishing a “reporting failure” is the obligation of both the individual who “causes the failure … or is a senior officer of the entity at the time of the failure.”
A “senior officer” is defined as “any individual holding the position or exercising the authority of a president, chief financial officer, general counsel, chief executive officer, chief operating officer, or any other officer, regardless of official title, who performs a similar function.”
To protect the information provided, the CTA also provides civil and criminal penalties for unauthorized disclosure and use of beneficial ownership information.
Critics of the CTA focus on the enormous collection and individual compliance burdens created by the legislation as well as the potential for data security breaches. The goal of the CTA is worthwhile, but those in opposition argue that the burden of reporting outweighs the transparency that will be created. While the CTA aims to prevent illicit activities, it also raises potential concerns around privacy and data security, as FinCEN will be maintaining – and sharing - a significant amount of sensitive information. The data collected under the CTA will be the largest government data collection outside of the tax code. This underscores the importance of robust and secure data management practices within FinCEN.
The enactment of the CTA represents a significant move towards increased corporate transparency and the strengthening of anti-money laundering and anti-corruption measures. It substantially changes the reporting requirements for many U.S. and foreign entities doing business in the U.S., compelling all such entities to disclose information about their beneficial owners unless an appropriate exemption from compliance exists.
At the end of the day, the CTA will require many businesses to review and potentially modify their existing compliance programs. Entities subject to the CTA will need to ensure they have processes in place to identify and report beneficial ownership information, as non-compliance can lead to significant civil and criminal penalties. Each senior officer of the reporting company will be liable for any willful failure on the part of the reporting company to provide accurate information when required. Also, a beneficial owner or company applicant who willfully provides false or fraudulent information to a reporting company may be liable for the reporting company’s failure to provide accurate information when required.