Bye-Bye Shell Companies! Beneficial Ownership Reporting Now Required by the USA

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It’s finally here!  We now have a new law mandating creation of a national database of beneficial owners of US businesses (and foreign businesses registered to do business in the US).  It’s been a long time in coming and is being hailed as a huge anti-corruption and anti-money laundering reform .  There have been several past unsuccessful attempts by lawmakers for mandatory beneficial ownership registers in the USA (see the failed House “Corporate Transparency Act” (H.R. 2513) and the Senate’s failed “ILLICIT CASH Act” (S. 2563).

I blogged about the predecessor Corporate Transparency Act when it was first introduced two years ago; that version did not pass but many of its details have carried over into the recently enacted Corporate Transparency Act (the “Act”).   For the text of the Act, see Title LXIV commencing Section 6401 at page 1245 here.  So, the law has been a long time in coming and really should not be a surprise.  The corporate anonymity available in the US has been criticized by various justice networks and institutions as well as by many countries. With the recent financial scandals of the Panama and Paradise Papers, it was only a matter of time before the US would take decisive action.

The Act was part of the reconciled 2021 National Defense Authorization Act for Fiscal Year 2021 (H.R. 6395) (“NDAA”) . It was passed by the US Congress on December 11, 2020, only to be vetoed by President Trump.  His veto, however, was overridden by the US House of Representatives on December 28, 2020 and then by the US Senate on January 1, 2021.

The NDAA is an annual must-pass US military and defense spending bill. Often it is used as a way to slip in other provisos unrelated to national defense and get them passed as part of the deal. The 2021 NDAA contained a provision which will eliminate the anonymity of beneficial owners of entities incorporated in every US State and territory.  The Act is merely one set of provisions enacted with the NDAA as part of broad changes to US anti-money laundering laws. Today’s blog post will focus on the new beneficial ownership disclosure requirements of the Corporate Transparency Act.

Who Must Report?

If an entity qualifies as a “reporting company,” it must comply with the disclosure requirements revealing information about the entity’s beneficial owners. The definition of “reporting company” is very broad. It includes any corporation, limited liability company, or “other similar entity” created by the filing of a document with the secretary of state or similar office in any US state or territory.  It also includes an entity formed under the laws of a foreign country that is registered to do business in the US.

The rules are riddled with 24 exceptions, the most notable being an exception for an entity that employs more than 20 employees on a full-time basis in the United States, has a US presence and  files income tax returns in the United States demonstrating more than $5,000,000 in gross receipts or sales. Another important exception, especially for international families with privately held companies and the like, is an interest in the entity through a right of inheritance. Additionally, entities operating in certain already highly regulated industries are exempt from the reporting requirements (e.g., public accounting firms, banks, credit unions, registered brokers or dealers and others).

There is no exception for small businesses not meeting the aforementioned carve-outs.  Undoubtedly, the added compliance costs for the small business may tip the scale and cause such enterprises to close down.   Many smaller foreign businesses will probably also think twice about entering the US market if the regulatory requirements outweigh possible benefits.  It was reported that the National Federation of Independent Business estimated that the increased burden would add 12.2 million new initial paperwork hours at a cost of $531 million when numerous small businesses are already struggling with the effects of COVID-19 on their businesses.  The new rules will also cause serious privacy and security concerns.  Just imagine the chaos if (when) this national database is hacked.

What Must be Reported? Who is a “Beneficial Owner”?

Every reporting company will have to disclose information about its “beneficial owners.” The information required is the name, birth date, residential or business street address, and unique identifying number from an identification document (e.g., an unexpired passport or driver’s license).

This information is mandated for any “beneficial owner” — any individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise— exercises “substantial control” over the entity or owns or controls 25 percent or more of the ownership interest of the entity. The term “substantial control” is not defined and there is no clarification as to how the “25% or more ownership” threshold is to be measured.  Forthcoming regulations will likely clarify these  matters. Significantly this final version of the Act does not include in the definition of “beneficial owner” the controversial wording that included any person who “receives substantial economic benefits from the assets” of the reporting company. This language was previously contained in the House of Representatives version from October 2019, discussed in my earlier blog post.  For those wanting to see the full definition of “beneficial owner” as defined in the Act, I have copied it at the end of this post.

I can just see the clever legal minds trying to come up with ways around and out of the statutory language.

To Whom is the Information Given?

The information provided by reporting companies will not be publicly disclosed.  The information must be sent to the Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”). Many of my readers will know that FinCEN is the agency with primary power over the notorious FBAR, and the Act will provide the agency with yet another significant information gathering tool. FinCEN will retain the information in a confidential and “secure” database. FinCEN may release the information in limited prescribed circumstances including, for example, upon request from certain federal or state agencies engaged in national security, intelligence, or law enforcement activity for use in furtherance of such activity, or in certain requests from a federal agency on behalf of foreign authorities.

Effective Dates

Regulations will be issued by FinCEN within one year of the enactment date of the 2021 NDAA. Compliance is not required before regulations are adopted. Any entity formed or registered after the effective date of the regulations will be required to submit the required information report to FinCEN when the entity is formed/registered. An entity that is already in existence that qualifies as a reporting company must submit the information report within two years following the effective date of the FinCEN regulations.   Any changes in the entity’s beneficial ownership must be reported to FinCEN within one year from the change in ownership.

Penalties

Penalties for a willful violation of these reporting rules are harsh up to $500 per day civil penalties; up to $10,000 for criminal fines; and up to two (2) years imprisonment. Not only the reporting company and its applicants can be punished, beneficial owners can be subject to these sanctions as well.

It’s Not Perfect, But — We’ve Only Just Begun! 

The Act does not solve all of the money-laundering, financial crimes and tax evasion problems. The Act, while it clearly applies to corporations and limited liability companies (and to many partnerships if registered), does not clearly apply to trusts.  Partnerships are generally considered lower risk. Trusts, on the other hand, are prime vehicles for nefarious activities since the vast majority of trusts in the United States do not register with any State / government agency.

Only a handful of States have enacted provisions for registering trusts: Alaska, Hawaii, Michigan, Nebraska, Colorado, Idaho, Missouri, North Dakota, Florida, and Maine. Even with these provisions in place, registering a trust is not mandatory in some of them. There are other nuances as well (e.g., Colorado initially does not require the registration of a trust, but does require it once the grantor of the trust passes away. Registration is still not required if all of the trust property is distributed to the beneficiaries upon death).

The Act requires that studies be undertaken by the Department of the Treasury and submitted to Congress to determine the effectiveness of the provisions and identify other areas of risk.  Certainly, the risks posed by trusts will be on the agenda and we may see this issue addressed sometime soon.

DEFINITION of BENEFICIAL OWNER

(3) BENEFICIAL OWNER.—The term ‘beneficial owner’—
‘‘(A) means, with respect to an entity, an 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 not less than 25 percent of
the ownership interests of the entity; and
‘‘(B) does not include—
‘‘(i) a minor child, as defined in the State in which
the entity is formed, if the information of the parent or
guardian of the minor child is reported in accordance
with this section;
‘‘(ii) an individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual;
‘‘(iii) an individual acting solely as an employee of
a corporation, limited liability company, or other similar entity and whose control over or economic benefits
from such entity is derived solely from the employment
status of the person;
‘‘(iv) an individual whose only interest in a corporation, limited liability company, or other similar
entity is through a right of inheritance; or
‘‘(v) a creditor of a corporation, limited liability
company, or other similar entity, unless the creditor
meets the requirements of subparagraph (A).

Source: https://us-tax.org/