All you need to know about the Corporate Transparency Act

All you need to know about the Corporate Transparency Act

written by Esteban Fresno & Federica Magni.

Barakat + Bossa would like to inform you that a new law, known as the Corporate Transparency Act (“CTA”), will come into effect on January 1, 2024.

1. What is the CTA?

The CTA is part of the National Defense Authorization Act enacted on January 1, 2021, to provide transparency into business entities and assist law enforcement efforts to counter money laundering, tax fraud, and other illegal activities. It is designed to capture more information about the ownership of specific entities operating in or accessing the U.S. market.

The CTA requires “reporting companies” to provide the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) with certain information on individuals who find themselves under certain circumstances and are:

• • the “beneficial owners” of the entity, and
  • “company applicants” who have filed an application to create the entity or register it to do business.

FinCEN will use this information to create and maintain a national registry that will provide authorized users, such as law enforcement agencies and financial institutions, access to the identities of these individuals who directly or indirectly own or control a company.

2. Which entities qualify as “reporting companies”?

A “reporting company” is any corporation, LLC or other similar entity

• • created by filing a formation document with a secretary of state or any similar office under the law of a state or territory or with a federally recognized tribal government; or
  • that is formed under the laws of a foreign country and registered to do business in the United States.

Which entities are exempt?

Twenty-three (23) categories of entities are exempt from reporting, including public companies, registered broker-dealers, certain investment companies, banks, money-transmitting businesses, commodity trading companies, pooled investment vehicles, 501(c) tax-exempt entities, inactive business entities and insurance companies. A comprehensive list of the exempt entities is available in the Frequently Asked Questions on FinCEN’s website linked here.

Additionally, an entity is exempt if it:

• • is owned or controlled by an exempt entity (with some limited exceptions), or
  • (A) has more than 20 full-time employees in the United States,

(B) reported more than $5,000,000 in gross receipts or sales (including the receipts or sales of subsidiaries and other entities through which such entity operates) on its previous year U.S. tax returns; and

(C) operates at a physical office within the U.S.

Based on these exemptions, most small corporations or LLCs will need to comply with the CTA reporting requirements, while larger companies and their subsidiaries and companies that are subject to other regulatory oversight, may be exempt.

3. Who qualifies as a “beneficial owner”?

Any individual who directly or indirectly:

• • exercises “substantial control” over the reporting company, or
  • owns or controls at least 25% of the “ownership interests” of the reporting company.

What is “substantial control”?

Whether an individual has “substantial control” over a reporting company depends on the power the individual exercises. According to FinCEN’s example, an individual will have substantial control of a reporting company if they direct, determine or exercise substantial influence over the reporting company’s important decisions. This may include senior officers and directors.

More information about what qualifies as substantial control may be found in the Beneficial Ownership Information Reporting Regulations at 31 CFR Section 1010.380(d)(1).

What is an “ownership interest”?

The current FinCEN rule takes a broad and expansive view of what is considered an “ownership interest,” and includes typical equity interests such as stock, joint venture interests, LLC or partnership interests, and other similar instruments. It goes further, however, to include instruments that may be non-voting or that carry the right to convert or purchase equity securities or similar interests in the future, including capital or profit interests, convertible instruments, and rights or privileges to acquire equity, capital or other interests in a reporting company (including put rights, call rights, options and other contractual rights).

Under this expansive definition, both individuals who currently hold equity securities and those who have the potential to acquire equity securities in the future are treated as beneficial owners if the potential interest meets the required threshold amounts. Further, a catch-all category will include any individuals that may own or control an ownership interest through a contractual or less formal or an indirect arrangement, such as through joint ownership, through an intermediary or custodian, through a trust or through ownership of an intermediary entity. The full definition of “ownership interest” can be found at 31 CFR Section 1010.380(d)(2)(i).

4. Who qualifies as a “company applicant”?

A company applicant is:

• • the individual who directly files the document that creates or first registers the reporting company, and
  • the individual who is primarily responsible for directing or controlling the filing of the relevant document.

If only one person filed the relevant document, then only that person is the company applicant. A reporting company will not have more than two company applicants.

5. What information must be reported?

A reporting company is required to report:

• • its full legal name;
  • any trade or fictitious business names (DBAs);
  • its address;
  • the jurisdiction in which it was formed or first registered; and
  • its taxpayer identification number (TIN).

For each qualifying beneficial owner and company applicant, the reporting company is required to report the individual’s:

• • legal name;
  • birthdate;
  • address (in most cases, a residential address); and
  • an identifying number from the individual’s driver’s license, passport, or other approved document, as well as an image of that document.

6. Who has access to the reported information?

The information reported to FinCEN will be stored in a secure confidential national database. Will be maintained for at least 5 years after the termination of a reporting company, and will not be available to the public.

The only organizations that will have access to the reported information upon request are:

• • federal agencies engaged in national security, intelligence or law enforcement activity;
  • state, local or tribal law enforcement agencies (if authorized by a court order);
  • federal agencies on behalf of a foreign agency, prosecutor, or judge (if the request is pursuant to an international treaty);
  • financial institutions for customer due diligence purposes (if authorized by the reporting company); or
  • federal functional regulators.

7. When does the CTA take effect?

FinCEN will begin accepting reports electronically on January 1, 2024. All reporting companies created or registered before January 1, 2024, are required to report by January 1, 2025.

Reporting companies created or registered on or after January 1, 2024, are required to file within 30 calendar days of receiving an actual or public notice from the secretary of state or similar office that the company has been created or registered. However, FinCEN has proposed to extend the initial filing deadline for beneficial ownership information reports from 30 to 90 days for entities created or registered in 2024.

If at any time a reporting company discovers an inaccuracy in a previously filed report, or if there is a change to previously reported information, the reporting company must file an updated or corrected report with FinCEN within 30 days.

8. What are the penalties for failing to report under the CTA?

Civil and criminal penalties do not apply to negligent violations, but an individual who willfully fails to report or supplies false information may be subject to civil and criminal penalties, including fines of $500 per day not to exceed $10,000, and up to 2 years in prison. As a result, it will be important for reporting companies to capture valid and accurate information from its beneficial owners and company applicants to satisfy their reporting obligations under the CTA.

9. Takeaways

• The CTA largely applies to foreign-owned shell companies. However, all companies should review the definition of “reporting company” and all its related exceptions.
• We anticipate there will be several interpretative questions concerning the scope of the exceptions to the reporting obligations. Companies should thus pay close attention to the implementing regulations, which will likely be issued as proposed regulations with an opportunity for public comment.
• We expect that many industry or other groups, such as private investment funds or family offices, will want to ensure that they are covered by the exceptions, and may promulgate comments to proposed regulations in this regard.

This post is intended to provide you with general information regarding the CTA, yet its content does not constitute specific legal advice. We recommend reaching out to your attorneys at Barakat + Bossa if you would like our office to assist you, and do not hesitate to contact us if you have any questions about the CTA, its reporting requirements. and how it may apply to you.