Podcast - Understanding the Corporate Transparency Act

Alan Granwell: Welcome to the first episode of Corporate Transparency Talk. As you may be aware, the Corporate Transparency Act entered into force on January 1, 2024. The Corporate Transparency Act, known as the CTA, will impact millions of legitimate companies and constituents who will incur a new administrative burden to comply with the CTA's reporting requirements. In this podcast, I will provide a high-level overview of the Corporate Transparency Act.

This new act, which came into force just recently, requires certain types of companies to identify and then report to the federal government. The individuals that are required to be reported under this new regime are called the beneficial owners, and that means the individuals who directly or indirectly control or own the company, which is required to be reported. And why did the government institute this new act? The answer will make a lot of sense once you hear it, but as we will see, it has ramifications beyond the specific purpose of why the act was passed by Congress and came into law.

What the United States was trying to do was to identify bad actors — those individuals who formed corporations or limited liability companies for illicit purposes such as money laundering, terrorist financing, tax fraud, corruption and other illicit activity — in order to protect the United States financial system and to enable national security, intelligence and law enforcement to ferret out those individuals.

The reason this was so important to the United States is that since 2015 or 2016, the United States had become the prime jurisdiction for illicit actors and others to form shell companies within the United States. These shell companies can be formed without requiring the individuals who were behind the company to be disclosed, and since the company formed is a U.S. company, the company had a lot of credibility in terms of its dealings with others. Numerous organizations, such as the Financial Action Task Force, and countries around the world had for many years been urging the United States to take action, similar to what action had been taken in those countries, to provide a law that would identify the individuals who were behind these companies, because then law enforcement, national security, intelligence, could have the wherewithal, hopefully, to track down those individuals. A beneficial ownership regime was not in place, and the methodology to identify the individuals behind a shell company or a whole series of shell companies becomes very difficult and arduous because you have to go through various administrative court proceedings to get the information and so on. But by having the information on a centralized database in the United States, a lot of that difficult work could be avoided.

So what does the act do? The act, as I mentioned, requires reporting companies, which I'll go into detail in a moment, to report the individuals who stand behind that company. And that information then will be sent to a unit of the Treasury Department called FinCEN, who will place that information on a cloud-based secure database for use by law enforcement, national security, intelligence and, later on, certain banks with the consent of the reporting company and financial regulators. So there will be a centralized database of these individuals, plus all the individuals of legitimate companies who were required to be reported. As I mentioned, it cannot be selective, and just asking the illicit actors to report the information in order to make this database workable, you need to have full cooperation, and the impetus for reporting are various civil and criminal penalties, which we'll go into. So that's the background, and I think the background is important to understand because if you are a legitimate business, you might be asking, "Why do I have to report all of this information and go through what will be a very burdensome and continuing obligation?" not only to initially identify the individuals who are subject to reporting, but to keep track of changes. And the reason that is important is that law enforcement wants to know who was initially behind the company, and also those individuals who might later enter the picture. And it's not a static undertaking. In terms of what you will need to determine is as follows:

First, you will have to figure out if the company that you own, or control is what we call a reporting company. And a reporting company can be of two flavors. It can be either a domestic company, or it can be a foreign company.

If it is a domestic company, that is something formed under state law or federal law. And a domestic reporting company is in scope if entity creation requires the filing of a document with the Secretary of State or a similar office under the laws of the state or Indian tribe. And here, in terms of the laws of the state or Indian tribe, we're not only talking about the continental United States, but we're talking about all the parts of the world over which the United States has jurisdiction, which are commonwealths, possessions and territories. A foreign reporting company is an entity which is created under foreign law or non-U.S. law that has registered to do business in the United States by the filing of a document with the Secretary of State or similar office, under the laws of a state or Indian tribe.

So what this law is requiring is that the company, which is required to report the information of the individuals who ultimately owned or controlled the company, that within one of those categories, which means that there are certain types of entities which are not within scope.

And there are five categories of entities not within the scope. The first is a general partnership, because it doesn't required the filing of a piece of paper with the Secretary of State or similar office. The second is a sole proprietorship, because in that undertaking the individual doesn't have an entity and just performs a business. The third is an unincorporated association, again because there's no filing of a piece of paper. The fourth is a wealth planning trust, but not what we call a statutory trust. And a wealth planning trust, again, is not included within scope because there's no document filed with anybody. And then the fifth exception is a foreign entity that doesn't register to do business in a state.

Now, whether a non-U.S. entity or in fact a domestic entity has to register to do business in a state is a question of state law. And you have to consult state law to determine whether you fit within or without. But in terms of the application of this law to non-U.S. entities, the non-U.S. entity would have to register to do business to be within scope. The CTA also provided a number of exemptions, and an exemption permits the company, even though it has filed a piece of paper with the Secretary of State or the foreign company registered to do business, to avoid having to report. There are 23 exemptions, and these exemptions relate to situations where the company already is regulated by the federal government or the state government, and examples of entities that are subject to the exemption include publicly traded companies, banks, credit unions, insurance companies, various SEC registered individuals or entities. And then very importantly, what's called the large up company, which is a company which meets various requirements relating to employees, gross receipts and office. And that type of entity is exempt from reporting. We will be getting into those details in subsequent webcasts.

But for now, let us just say, in terms of determining whether you are required to report, you first have to determine whether the entity which you own or control is out of scope or, if it's in scope, whether it is exempt. And these 23 exemptions require detailed analysis because they contain a lot of requirements, which you need to closely read and see if they fit the situation. So if you have found that your entity, such as a limited liability company, is within scope, you then have to determine who is the beneficial owner or who are the beneficial owners through various tiers of entities. And there are two tests which I'm just going to overview. Very simply, there's a substantial control test, and there's a 25 percent ownership test. And if you satisfy either of those tests — and they're either/or tests — then the individual is a beneficial owner unless it is one of five categories of individual who is excluded from that category, which includes a minor child or creditor, an employee subject to certain conditions, and nominee. Or there's a right of inheritance the individual has. And again, we'll be going through how all that applies in later podcast.

So stepping back for the moment, what I am saying to you is if you own an entity, this law may apply to you. You first figure out if the entity is in scope. You then figure out who are the beneficial owners, and that could include U.S. or non-U.S. persons, and the entity could have been formed prior to 2024 or in 2024 going forward. So it doesn't make a difference. So all entities formed are potentially susceptible of being in scope.

Now, if you determined who the beneficial owners are, you then have to get certain information from the beneficial owners, which is put on a form, and the form is filed electronically with FinCEN. There's also a paper filing option, but generally the filing will be done electronically, and the information that might be disclosed on the form includes various details about the company itself, its name, its doing business, its address and its tax I.D. Generally, the information which is required for individuals is perhaps simpler because it's four bits of information. It is the individual's date of birth, the individual's full legal name, the individual's residential address and then a unique I.D. number containing that information, such as a driver's license, current passport or a state I.D., plus an image of that document. And so that information is filed with the government in an initial report.

And there are different filing dates for companies formed prior to 2024. The entity must file the report, which we call the initial report, by 1/2025. For entities that are within scope in 2024 or registered in 2024, there's 90 days to file the initial report. And then for entities created in 2025 and thereafter, it's a 30-day window to file the initial report. Now in terms of this, you're not done, because if there then is any change on the information filed on that initial report, the company has to file an updated report within 30 days. Similarly, if there's any information that was incorrect on the initial report, the entity must file that generally within 30 days.

As mentioned, there are both civil and criminal penalties for willful noncompliance or providing false information or not providing updates. So you can see the burden on the company is one, to figure out whether it is or not within scope of the legislation, but then determining the beneficial owners, which can be complex, and then gathering the required information, then filing the report, which has to be attested or certified as true, correct and complete. So you can't really budge on that. And then keeping up with the updates, the final point I'd like to make is that apart from that, all the documentation about the entity and its transactional documentation has to be updated to have the ability to obtain and keep track of the changes.

Please reach out to our team or your Holland & Knight contact if you have questions about the CTA. Our corporate transparency team has been closely following the CTA and its evolving requirements, and is familiar with the rules and regulations and how they can be practically applied. We stand ready to assist you in determining the impact of the new law on your structure and organization, and how to comply with the CTA. Please stay tuned for further episodes where we will discuss more specific facets of the CTA. So thank you. And until next time, have a good day.