Many lawyers, accountants, trust officers and financial advisors in the United States may be unaware that buried deep in the National Defense Authorization Act for Fiscal Year 2021 (the Defense Bill), which became law on Jan. 1, 2021, was a new law that could have a profound impact on the private client community in the coming years. The Defense Bill includes the Corporate Transparency Act (the Act), which requires corporations, limited liability companies (LLCs) and “other similar entities” formed within any U.S. state (or territory) to disclose certain information regarding their beneficial owners (that is, someone with ownership rights to property although the title is in another name) to the U.S. Treasury. There’s historically been no requirement to provide information to the federal government concerning the ownership of a company or other similar entity formed under local state law.
The purpose of the Act is to prevent potential wrongdoers from exploiting U.S. corporations, LLCs and possibly partnerships and certain types of trusts for criminal gain and to assist law enforcement in detecting, preventing and punishing money laundering and other misconduct. The Act will become effective on the date that the Treasury issues regulations, which shall be no later than Dec. 31, 2021, one year after the Act’s enactment.
The Act will require any company covered by the new law (Reporting Company) to disclose to the Financial Crimes Enforcement Network (FinCEN) of the U.S. Treasury certain personal information of the beneficial owners of such Reporting Company. Disclosure will be required by completion of a beneficial ownership statement filed at the time an entity is formed or, if the entity was previously formed before passage of the Act (on Jan. 1, 2021), within two years after the effective date of the issuance by the Treasury Department of its final regulations. The information to be disclosed to the Treasury will include the full legal name, current residential or business street address, date of birth, identification number (such as driver’s license of passport number) of any beneficial owner of at least a 25% of ownership interest in a Reporting Company.
Once a Reporting Company has submitted its initial beneficial ownership statement, it will be required to file an updated ownership statement if there have been any change to the beneficial ownership statement of a 25% or more owner of the entity. Changes to the information of the beneficial owners (for example, change of name or address) or the identity of beneficial owners themselves will be considered changes that require updating. However, the language in the Act would suggest that a change in the percentage ownership interest of a beneficial owner in an entity isn’t considered a change requiring updating, provided the list of persons comprising the beneficial owners remains unchanged. The Act further confirms that a beneficial owner doesn’t include a minor child (the information of the parent must be reported instead), a nominee, intermediary or custodian for another individual.
Importantly, for all domestic and international families with closely held and private businesses in the United States, there’s an exception for individuals whose only interest in a Reporting Company is through an inheritance. There’s also an exception for companies with more than 20 full-time employees, gross receipts or sales of more than $5 million and a physical presence in the United States (for example an office). Finally, companies that operate in certain highly regulated industries such as banks, credit unions, registered brokers or dealers, registered exchange or clearing agencies, registered investment companies, insurance companies, public accounting firms, public utility companies and Internal Revenue Code Section 501(c)(3) organizations aren’t Reporting Companies.
The Treasury Department will store the beneficial ownership information submitted to FinCEN disclosing personal information, and that information won’t be made publicly available or available to the states (except perhaps to local law enforcement agencies). This is an important distinction from the current ultimate beneficial owner registers and rules of other non-U. S. jurisdictions, which allow a private third party access to beneficial ownership information if the third party can demonstrate a legitimate interest in getting access. The Act provides that the collected information will be used for law enforcement or national security purposes, as well as to confirm that the information provided by these individuals is consistent with their disclosures to financial institutions to facilitate such institutions’ compliance with anti-money laundering laws. FinCEN is required to hold such data until five years after the termination of the Reporting Company.
The Act reflects a growing international trend to require disclosure of beneficial ownership and creates compliance similar to that in place in almost every other country, including many former tax havens. Further, in 2016 FinCEN first issued so-called Geographic Target Orders (GTOs) that require U.S. title insurance companies to identify the individuals behind “shell companies” that are used to conduct certain all-cash real estate purchases. FinCEN introduced these GTOs to address foreign government concerns that individuals engaged in money laundering schemes were using U.S. LLCs or other “opaque” structures to hide ill-gotten funds in certain types of U.S. real estate.
There are many unanswered questions. The Act doesn’t define “substantial control” and doesn’t clarify how the “25% or more ownership” will be measured. In an attempt to more precisely define the term “beneficial owner,” it seems reasonable to apply the FinCEN customer due diligence rules under 31 C.F.R. Section 1010.230 as a model. If this approach were applied, a shareholder would be considered the beneficial owner of a corporation if the shareholder owned 25% or more of the equity interest in the corporation and had significant responsibility to control, manage or direct the corporation as an executive officer, senior manager or other individual who regularly performs similar functions; a partner would be considered the beneficial owner of a partnership if the partner owned 25% or more of the equity interest in the partnership and had significant responsibility to control, manage or direct of the partnership as listed above; a trustee would be considered the beneficial owner if a trust it served owned 25% or more of the equity interest in a company.
Also missing is specific guidance on the application of these disclosure rules to entities other than a “corporation, limited liability company or other similar entity,” which begs the question of whether certain beneficial owners of partnerships and various types of inter vivos types of trusts must also make personal disclosures to FinCEN.
Further, the Act doesn’t specifically address whether beneficial ownership information would be subject to the Freedom of Information Act (FOIA) request rules. The Act, however, does state that FinCEN may disclose the information only on the receipt from certain specifically listed agencies or regulators, and FOIA isn’t on the list. Disclosure of the beneficial ownership information on a FOIA request would likely invade the personal privacy of the beneficial owners, and it’s anticipated that a FOIA request would be considered to be outside the scope of the Act.