On Friday, January 1, 2021, the U.S. Congress voted to override President Trump’s veto in order to pass the National Defense Authorization Act (NDAA) for fiscal year 2021. This legislation approved certain annual spending by the Department of Defense and other agencies. Tucked into the defense authorization legislation this year was the Corporate Transparency Act (the “Act”).

The Act is a milestone, as it represents some of the most sweeping anti-corruption legislation enacted in decades and continues recent efforts to root out tax evasion, money laundering, terrorism financing, and other perceived threats to U.S. national security interests. The Act requires the Treasury Department to issue regulations within one year which will require certain entities (both new and existing) to file a report with the U.S. federal government which discloses information regarding certain beneficial owners of the entity. This alert highlights the information we know thus far regarding the required disclosures.

The Intent Behind the Act

Prior to the Act’s passage, disclosure requirements of beneficial ownership were left to the state in which an entity is formed or registered. Most, if not all, states are like Delaware (the most common state of formation) in that they require little information on the actual owners of companies formed or registered under state law. As a result, Congress believed that the system allowed malevolent actors to form “shell companies” with many layers of entities (similar to Russian nesting “Matryoshka” dolls) across various jurisdictions in order to avoid disclosure of the actual owners of the entities.

In order to address this, Congress passed the Act to set federal standards for required disclosure of beneficial owners, which brings the U.S. in line with similar international initiatives. The Act makes this information available only to authorized governmental authorities, subject to safeguards and controls, to facilitate law enforcement and national security activities, and to allow financial institutions to comply with existing customer due diligence requirements.

The Act, however, does not impose a requirement for business entities to file annual financial statements with any governmental agency (or make them public). This was surprising as it is a requirement in many countries.

While the Act deals with beneficial ownership of U.S. corporations and limited liability companies (LLCs), it also requires reporting by foreign entities that register to do business in the United States. When coupled with the Foreign Account Tax Compliance Act of 2010 (FATCA) which was enacted to target non-compliance by U.S. taxpayers using foreign accounts, the Act is expected by its backers to serve as an important deterrent to unlawful behavior.

Entities Subject to Reporting Beneficial Ownership

The Act generally would apply to corporations and LLCs (and other similar entities) formed under the laws of a state (including the District of Columbia and any territory or possession of the United States) and foreign entities that are registered to do business under the laws of any state. Foreign entities that do not register to do business under the laws of any state would not be covered by the Act.  Additionally, the Act does not require disclosure of beneficial owners from the following entities:

• Certain enumerated entities (including public companies, financial institutions, regulated accounting firms, public utilities, and tax-exempt entities);
• Entities that (1) employ more than 20 employees on a full-time basis in the United States, (2) filed United States income tax returns in the previous year showing more than $5 million in gross receipts or sales (including certain subsidiaries), and (3) have an operating presence at a physical office within the United States;
• Entities that are formed and owned by an entity that is exempt from the disclosure requirement of the Act; and
• Dormant entities that (1) have been in existence for over one year, (2) are not engaged in active business, (3) are not owned, directly or indirectly, by a foreign person, and (4) have not experienced a change in ownership in the last twelve months.

If an entity that is exempt from the disclosure requirement has a direct or indirect ownership interest in an entity that is required to file a disclosure, the reporting entity will be required to disclose the ownership interest.

Who is a Beneficial Owner and What Has to be Disclosed?

The Act requires the Treasury Department to issue regulations that will require the disclosure of an entity’s beneficial owners and applicants to the Financial Crimes Enforcement Network (“FinCEN”), a bureau of the Treasury Department.  For this purpose, a beneficial owner is an individual who, directly or indirectly, (1) exercises substantial control over the entity, or (2) owns more than 25% of the equity interests of the entity. However, it does not include persons that are acting on behalf of the economic owners (such as employees, nominees, intermediaries, custodians, agents) and creditors.

A&M Insight: In looking at who constitutes a beneficial owner, it is unclear whether a person that indirectly owns equity in an entity through other entities will be treated as a beneficial owner. For example, if an individual owns 100% of a corporation, which owns 100% of an LLC, it is not clear that the individual would be reportable as a beneficial owner of the LLC for purposes of the Act. We anticipate that the Treasury Department regulations will provide clarity on this issue.

While it is uncertain as to all of the information that will be required to be disclosed to FinCEN, the Act provides that the disclosure will include personal information of each beneficial owner (including a U.S. passport number or state driver’s license number), as well as the same information for the individual that files the formation application. Importantly, documentation (such as an unexpired passport) would also be required for foreign beneficial owners.

The statute generally only requires disclosures regarding individuals that are beneficial owners. It is possible that entities that do not have any such beneficial owners may not have much of a reporting burden. It is very possible that forthcoming regulations will expand the required information beyond the information on beneficial owners.

When Is the Disclosure Made?

Under the Act, once the Treasury Department regulations are finalized, the disclosure will need to occur at the time of the entity’s formation (or in the case of a foreign entity, upon registration to do business in a state).  Additionally, updated disclosures will be required upon any changes to the beneficial ownership thereof (within one year of such change).

The disclosure requirement will also apply to existing entities. Entities that have been formed or registered before the effective date of the regulations are required to file in a timely manner (but not later than two years after the effective date of the regulations).

Earlier versions of the Act would have made the disclosures available to the public. However, the final version of the Act generally only makes the disclosures available to Federal and state agencies and only for a designated reason. The disclosures will also be made available to financial institutions with respect to their obligations under the customer due diligence rules. However, the disclosures will only be made available to financial institutions to the extent the customer agrees to grant access to the financial institution.

Now All Eyes Turn to Treasury

The Act is now law, and so the Treasury Department has until January 1, 2022 to issue regulations, which implement the Act. In drafting the regulations, the Treasury Department has been instructed to minimize burdens on reporting companies to the greatest extent practical. An important issue to look out for in the forthcoming regulations will be the effective date.

The Act provides for significant civil and criminal penalties for willful non-compliance with the Act. This includes civil penalties of up to $500 a day for ongoing reporting violations and criminal fines up to $10,000 or imprisonment for not more than two years. There do not appear to be any penalties for non-compliance (or for filing late) if the omission is not willful.

A&M Taxand Says

Requiring information returns with FinCEN will not be new to many people. U.S persons are already required to file foreign bank account reports (FBARs) with FinCEN with respect to certain foreign financial accounts. Nonetheless, the Act is an important landmark for the U.S. in the continued fight to combat tax evasion, money laundering and the financing of terrorism. It will also help the U.S. to conform with global anti-secrecy standards.

It is important to note that the Act will mostly apply to investment companies and small businesses with fewer than 20 full-time employees. Additionally, the Act also has other restrictions companies should be aware of (e.g., it prohibits the practice of issuing shares (or other evidence of equity ownership) in bearer form, which is generally rare in the U.S.). 

We will be on the lookout for the Treasury Department’s regulations in relation to the Act. In the meantime, taxpayers with existing entities should consider the Act’s impact on their reporting requirements and anticipate any related increase in compliance costs associated with the new FinCEN disclosures, as well as consider measures in order to obtain the information that will be required to be disclosed.