IWTA | FinCEN’s New CTA Rule Creates a Roadmap for Domestic and Foreign Entity Tax Penalty Avoidance

Part one of a two-part series

Since the Corporate Transparency Act (CTA) was enacted in January 2021, there have been many questions about what kinds of companies will have to report under the law and how beneficial ownership will be defined. On September 30, 2022, after months of development, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued the final rule for beneficial ownership reporting under the Corporate Transparency Act. The final rule, which will ease compliance burdens on companies, notably extends some reporting deadlines and clarifies beneficial ownership definitions. The final rule incorporates feedback the Treasury received from hundreds of stakeholders after it released a proposed rule in December 2021.

FinCEN’s September 30th rule addresses reporting obligations for two classes of individuals: beneficial owners of entities, and individuals who have filed an application with specified governmental authorities to create the entity or register it to do business. This final rule is important for taxpayers because it describes who must file a report, what information must be provided, and when a report is due.

The final rule will touch millions of companies in the U.S. According to FinCEN, nearly 33 million companies will have to report beneficial ownership information under the final rule. This is the first of two articles outlining the final rule. This article will outline some final definitions under the rule, while the second article will address changes to reporting obligations under the rule.

Background

Congress passed the Corporate Transparency Act amidst growing global scrutiny. The law requires domestic and foreign “reporting companies” to provide FinCEN the names, addresses, dates of birth, and driver’s licenses or other identification of their beneficial owners with substantial control.

The CTA applies to corporations, LLCs, and “other similar entities”. Although the law doesn’t define “other similar entities,” under FinCEN’s final rule, a foreign reporting company is any entity formed under foreign law that is registered to do business within the United States. A domestic reporting company is any entity created by the filing of a document with a secretary of state or filed with a similar office within a U.S. jurisdiction, like a state.

Under the final rule, domestic reporting companies are defined as corporations, limited liability partnerships, limited liability companies, business trusts like statutory trusts and most limited partnerships, since they typically are created by a filing with a secretary of state or similar office.

There also are several exemptions, as the CTA exempts 23 different kinds of entities under 31 U.S.C. 5336(a)(11)(B)(i)-(xxiii). For example, under a large company exemption, any domestic company or foreign entity that is registered to do business in the U.S. is exempt from the CTA’s reporting requirements if it meets or exceeds the following thresholds:

• Over 20 full-time U.S.-based employees;
• More than $5 million in gross receipts or sales from sources inside the U.S., as reflected on a U.S. federal income tax or information return; and
• Operates a physical office in the U.S.

FinCEN declined to expand the exemption to additional entities.

Clarifying a Beneficial Owner and Substantial Control

The reporting obligations apply to any “beneficial owner” with “substantial control.” The final rule defines a “beneficial owner” as “any individual who meets at least one of two criteria:

(1) exercising substantial control over the reporting company; or

(2) owning or controlling at least 25 percent of the ownership interest of the reporting company.

This is unchanged from the proposed rule.

Based on a plethora of stakeholder feedback, the definition of “substantial control” is different under the final rule. FinCEN initially proposed the following definition:

• Service as a senior officer of a reporting company;
• Authority over the appointment or removal of any senior officer or dominant majority of the board of directors (or similar body) of a reporting company; and
• Direction, determination, or decision of, or substantial influence over, important matters of a reporting company.

FinCEN also proposed a catch-all provision to apply to other forms of substantial control not covered by the above three criteria.

Some stakeholders argued that certain officials like corporate secretaries, treasurers, and general counsel should not be defined as “senior officers” because they tend to have little control of a company. FinCEN agreed that corporate secretaries and treasurers should be excluded, but it refused to exclude general counsel, as it considers that role to be a substantial one.

Clarifying Ownership Interests

When FinCEN released its December 2021 proposed rule, it stated that the process of determining an ownership interest is a facts-and-circumstances inquiry that evaluates criteria such as: (1) equity in the reporting company and other types of interests –like capital or profit interests (including partnership interests), or convertible instruments; (2) warrants or rights; or (3) other options or privileges to acquire equity, capital, or other interests in a reporting company.

The proposed rule had also referred to proprietorship interests, but FinCEN deleted that from the final rule in response to stakeholder feedback that the reference was superfluous and unclear. Importantly, the final rule also adds a catch-all provision that includes: ’’[a]ny other instrument, contract, arrangement, understanding, relationship, or other mechanism used to establish ownership.’’

A Roadmap to Tax Penalty Avoidance

FinCEN’s final rule will give companies more clarity on their reporting obligations under the CTA. This is vitally important as the cost of complying with the CTA is low, but the cost of noncompliance is potentially steep. FinCEN estimates that it will cost most reporting entities about $85 to prepare and submit an initial beneficial ownership information report. Taxpayers that willfully fail to share beneficial ownership information with FinCEN face civil penalties of up to $500 per day. Criminal penalties can hit $10,000 per violation. These large penalties, combined with the large number of entities subject to the CTA means that taxpayers should carefully assess whether they have CTA reporting obligations. For resolving CTA reporting issues or preventing them before they start, the taxpayer is advised to seek the help of a seasoned cross-border tax and legal advisor.

Author:

• Jack Brister, Founder, International wealth Tax Advisors (IWTA)
• To schedule an introductory phone conference with IWTA  founder Jack Brister simply click here. Email IWTA at info@iwtas.com or call the IWTA New York City office at 212-256-1142

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