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Deep within the nearly fifteen-hundred pages of the 2021 National Defense Authorization Act resides an unlikely creature: The Corporate Transparency Act (CTA).
The CTA compels US corporations, Limited Liability Companies (LLCs) and other similar enterprises (the “Reporting Companies”) to register US and non-US Persons with substantial beneficial ownership stakes on a non-public registry administered by the Financial Crimes Enforcement Network (FinCEN) of the Department of the Treasury. Enacted by the US Congress on 1 January 2021, the CTA is being hailed by some transparency advocates as a major advance in the fight against tax havens and, at the same time, being criticized by others as porous. In parallel, the defenders of financial confidentiality also offer mixed reviews, lamenting the criminal enforcement provisions, while tacitly accepting that a change was going to come. How could a seismic shift in the US federal treatment of business enterprises established under state law produce such a tepid reaction? For both sides, it could be worse.
The efforts to convince the US Congress to legislate beneficial ownership disclosure requirements is not of recent genesis. Since the country cracked apart global banking secrecy for US taxpayers through FATCA, the hypocrisy of the dual role played by the US–leading tax enforcer against others, leading tax haven for itself–became less and less tenable. The Global Forum on Transparency Exchange of Information for Tax Purpose’s peer review of the US legislative and regulatory system in 2018 cited the lack of beneficial owner disclosure requirements in the corporate law of key US states as a critical defect. Nonetheless, with the federal legislative process paralyzed by partisan politics, significant change on a controversial topic seemed remote.
Therefore, to some surprise, the provisions of the new CTA follow many of the recommendations on beneficial ownership disclosure contained in the Global Forum‘s peer review report. Amongst other features, the CTA roughly aligns the definition of beneficial owner for a Reporting Company with the one set out in the Financial Action Task Force’s 2012 recommendations (the “FATF Recommendations”). Accordingly, a Beneficial Owner is any natural person–
In the absence of any party exercising control by ownership, the Reporting Company is obligated to nominate at least one natural person who exercises “substantial control” over the Reporting Company, even if that person does so as an executive officer of the Reporting Company, rather than as an owner of any kind. In this manner, the definition of a Beneficial Owner under the CTA tracks the cascading approach for company and partnership ownership set forth in the FATF Recommendations and adopted as the standard for Beneficial Owner identification under the OECD‘s Common Reporting Standard (CRS) and Mandatory Disclosure Rules (MDRs), the EU’s DAC6 and other multinational regimes.
In line with the adherence to the general FATF standard, the exceptions for both Reporting Companies and the natural persons who otherwise qualify as Beneficial Owners do not seem excessive. The definition of a Reporting Company excludes–
The definition of a Beneficial Owners excludes natural persons who otherwise qualify as Beneficial Owners if they are–
In short, the CTA did not create an effective disclosure system only to riddle it with exemptions. Instead, the exceptions–as written–seem proportionate and reasonable.
When a Reporting Company is not on the exemption list, however, it must disclose the following for each of its natural persons qualifying as a Beneficial Owner–
The CTA‘s mandatory disclosures must be made at the time of formation for Reporting Companies established on or after the effective date of the forthcoming CTA regulations. Reporting Companies already in existence at the time must submit the disclosure within two years from the effective date of the regulations. Going forward, the information on the Reporting Company must be updated within one year of a change in circumstance to the beneficial ownership information originally submitted.
Much of the above squarely matches the wish list of the advocates for enhanced ownership disclosure, so why is the CTA not an unalloyed triumph for transparency? Because of what’s missing. First of all, the Senate deleted from the final bill a third prong for qualification as a Beneficial Owner, which had been approved by the House of Representatives. This prong added any natural persons who receive “substantial economic benefits” from the Reporting Company. While the language of this clause was justifiably criticized as vague and overbroad, it did have a performative role: To thwart the foreseeable efforts to circumvent the other two prongs. As evidenced by the need for certain CRS anti-avoidance measures in the MDRs and the EU‘s DAC6 Directive, holding structures are ripe for reconfiguration so that beneficial owners of the assets can escape treatment as reportable. The absence of the deleted substantial economic benefits‘ prong will cede space for artful non-compliance with the registration rules.
Secondly, certain types of entities are out of scope based solely on their corporate form, not how they are or could be used to conceal the identities of their beneficial owners. The CTA applies to entities that must undergo a registration process under state law in order to be established. Uniformly, corporations, LLCs, limited liability partnerships (LLPs) and many other less common forms will meet this standard, but, crucially, most trusts and general partnerships do not. As such, privacy enthusiasts can contemplate how to stack their holding structures with entities that can make and safeguard investments, but do not qualify as Reporting Companies under the CTA. Nevertheless, proponents of transparency express optimism that the accompanying regulations, which must be promulgated by the Treasury Department within the year, will enlarge the scope of reporting in order to cut off this foreseeable mode of avoidance.
Finally, the Act applies only to US companies and non-US companies that register to do business in the US. Thus, many non-US entities may continue to invest freely in US businesses, earn US-source income and hold US-based assets outside the effect of the CTA.
Despite these alluring exceptions, the CTA will displease non-US Persons who–having invested into the US in conformity with the legal and regulatory landscape at the time–are now subject to registration. The consequences of this unwanted disclosure may be minimal. The registry is non-public (except for banks fulfilling certain due diligence obligations with the consent of the Reporting Company) and the penalties for unauthorized disclosure are an adequate deterrence. However, the information is not off-limits to all outsiders. US federal agencies may access the information for national security purposes and state agencies may access it with a court order. Further, and of significant interest to non-US Persons, non-US governmental agencies may obtain access to the information in pursuit of certain investigations. Theoretically, this provision could be construed broadly enough for the US to share information collected under the CTA as part of its future duties of reciprocity under FATCA Model 1 IGAs. Currently, the most extreme gap between the information exchanged on US Persons by reciprocal Model 1 IGA jurisdictions and received in return on their own taxpayers is the exemption on entity account holder reporting for US Financial Institutions (US FIs). If mined, the information from the CTA registry could substantially close that gap on many entity account holders at US FIs, while helping the US deflect claims that it benefits from–but does not contribute to–the worldwide system of financial information exchange it helped establish.
If you wish to discuss the incoming CTA rules in further detail, please contact me at firstname.lastname@example.org.