On January 1, 2021, the Senate overrode President Donald Trump’s veto of the National Defense Authorization Act for Fiscal Year 2021. This newly passed bill includes the Corporate Transparency Act (the “Act”). The Act requires many corporations, limited liability companies, and similar entities that are formed in the United States, or are foreign but registered to do business in the United States, to disclose information regarding their beneficial owners.
The Act is aimed at minimizing criminal actors’ ability to use shell corporations to move around dirty money. The Act notes that more than 2,000,000 corporations and limited liability companies are formed under United States law each year, but most or all States do not require information regarding beneficial ownership. With this lack of transparency, illicit activity threatening the national security interests of the United States, such as money laundering, the financing of terrorism, serious tax fraud, and human and drug trafficking, hide behind secret corporations. Those involved with the illicit activities intentionally conduct transactions through corporate structures in order to evade detection and will layer the corporate structures to further mask their identity and actions.
Who Is Covered?
The Act will require disclosure of four key pieces of information related to a reporting company’s beneficial owner(s). The Act defines reporting company as a corporation, limited liability company, or similar entity that (i) was created by filing a document with the secretary of state, or a similar office, under the law of a State or Tribe; or (ii) was formed under the law of a foreign country and registered to do business in the United States. The Act defines a beneficial owner as 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.
An individual who owns or controls an entity formed or registered to do business in the United States must disclose the following to the U.S. Treasury’s Financial Crimes Enforcement Network (“FinCEN”): his/her legal name; current residential or street address; date of birth; and identification number from a driver’s license or other specified government-issued document. The information must be submitted to FinCEN in a report at the time of formation for those companies formed after the Act’s rules come into effect, as discussed further below. If there is a change in the identity of the beneficial owner or in the information initially reported, the reporting company must update such information within a year of the change.
Who Is Not Covered?
The Act identifies a multitude of entities that are not considered reporting companies and are therefore exempt from the requirements of the Act. Generally, the Act does not require the following types of entities to make disclosures regarding their beneficial owners: banks; any entity registered with the Securities and Exchange Commission; 501(c) non-profits; and any entity that employs more than 20 people on a full-time basis, filed tax returns that demonstrate over $5 million in gross receipts, and has an operating presence at a physical office within the United States. The Act also does not cover any entity in which the ownership interests are owned or controlled, directly or indirectly, by an exempt entity.
The Act is unclear as to when entities that qualify as reporting companies must comply with the reporting requirements. The requirements of the Act will begin on the effective date of the regulations to be issued under the Act, which must be promulgated by the Secretary of the Treasury no later than one year after the enactment of the Act. If a reporting company was already in existence at the time of the effective date, it shall submit its report to FinCEN in a timely manner, which should be no later than two years from the effective date. If any entity that qualifies as a reporting company is formed or registered in the United States on or after the Act’s effective date that entity must file its FinCEN report at the same time as its formation or registration.
The Act puts the burden on the Secretary of the Treasury to, through promulgated regulations, minimize the burden on reporting companies associated with the collection of beneficial ownership information. The Secretary of the Treasury must also ensure the beneficial ownership information reported to FinCEN is accurate and complete. Also, due to the highly sensitive nature of the information to be gathered under the Act, the Secretary of the Treasury must maintain information security protections, including encryption, for the information reported to FinCEN. The information will be stored in a secure, private database and may only be accessed by FinCEN. If a federal agency engaged in law enforcement or national security efforts, State, local, or tribal law enforcement, or a financial institution conducting customer due diligence wants the information, they must submit a request. The Secretary of the Treasury will, by regulation, prescribe the form and manner in which beneficial ownership information shall be provided in response to such requests.
The Act also prescribes penalties for reporting non-compliance and unauthorized disclosures of the beneficial ownership information. Any person that willfully fails to report or provides fraudulent information will face a civil penalty of not more than $500 for each day the violation continues and may be fined no more than $10,000, imprisoned for not more than 2 years, or both. Any person that knowingly discloses beneficial ownership information obtained through a report submitted to, or a disclosure made by, FinCEN may face a civil penalty of not more than $500 a day and may be fined no more than $250,000, imprisoned for not more than 5 years, or both.
The Act’s goal is to force shell corporations to be transparent and give information regarding a natural person that controls or owns the entity. According to the Tax Justice Network’s Financial Secrecy Index, the United States ranks second in the world, only behind the Cayman Islands, on the list of the biggest enablers of financial secrecy. The Act is set to change this enabling by forcing corporate transparency and making it harder for criminals to hide and move stolen money through opaque entities.
While we await further details in the regulations, the reporting requirements in the Act itself are not extensive, and the Act exempts entities that already report similar information. The United Kingdom has a similar ownership directory and compliance by businesses costs an average of £2 ($2.50) a year. It is thought that the number of businesses owned by only one person is a similar figure in both the United Kingdom and the United States. Therefore, the United Kingdom’s operation of their beneficial ownership directory could be an indicator of how the Act will operate and affect companies in the United States.
Entities that may fall under the reporting company definition should keep a close eye out for regulations promulgated by the Secretary of the Treasury. The Secretary of the Treasury will have one year from January 1, 2021, the Act’s date of enactment, to promulgate regulations determining the effective date of the Act. Once the effective date occurs, the two-year clock will start ticking for existing reporting companies and a new obligation will be created for those who decide to form or register new reporting companies.