Josh Sage discussed the Corporate Transparency Act (“CTA”) in his January 2021 article, and I wrote a follow-up summary last July. The CTA requires certain U.S. businesses, absent an exemption, to file beneficial ownership information with the Financial Crimes Enforcement Network (“FinCEN”). This could result in burdensome reporting obligations for those businesses. As I discussed previously, the reporting requirements established in the CTA are not set to take effect until the Secretary of Treasury issues implementing regulations. FinCEN is expected to promulgate such regulations pursuant to a delegation of authority from the Secretary of the Treasury. On December 8, 2021, FinCEN published proposed regulations (“Proposed Regulations”) which provide clarification on several key points not addressed by the CTA itself. While these regulations are not final, they do provide insight as to what final regulations might include such that practitioners and businesses alike can begin preparing.
Large Operating Company Exception
The reporting requirements under the CTA apply to those entities which fall under the definition of a “reporting company,” which is defined as any corporation, limited liability company, or other similar entity that is:
- created by the filing of a document with a secretary of state or a similar office under the law of a State or Indian Tribe; or
- formed under the law of a foreign country that is registered to do business in the United States.
One exception to the definition of a reporting company is for a large operating company that employs more than 20 full-time employees in the United States, reported more than $5 million in gross receipts or sales on the previous year’s federal income tax return, and has an “operating office at a physical office within the United States.” Under the Proposed Regulations, gross income sourced outside of the United States will not count towards the $5 million threshold. The Proposed Regulations also provide clarity on the phrase “operating presence at a physical office within the United States” requiring “that an entity regularly conducts its business at a physical location in the United States that the entity owns or leases, that is not the place of residence of any individual, and that is physically distinct from the place of business of any other unaffiliated entity.”
Reporting companies will be required to report certain identifying information about each of their “beneficial owners,” which includes any individual, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise who:
- exercises substantial control over the covered entity; or
- holds at least 25 percent of the ownership interests of the covered entity.
The CTA does not provide a definition for “substantial control.” The Proposed Regulations attempt to remedy this by first setting forth three specific examples of substantial control:
- service as a senior officer of a reporting company;
- authority over the appointment or removal of any 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, including, but not limited to:
- the sale, lease, or transfer of any principal assets of the company,
- the reorganization, dissolution, or merger of the company,
- major expenditures and investments by the company,
- the selection or termination of business lines or ventures of the company,
- compensation schemes for senior officers,
- the entry into or termination of significant contracts, and
- amendments of any substantial governance documents of the company.
The Proposed Regulations then include a catch-all provision that includes any other form of substantial control over the reporting company. Additionally, the Proposed Regulations state that an individual who has the right or ability to exercise substantial control will be deemed to exercise such, and that such exercise, whether deemed or actual, may be either direct or indirect through a variety of means, such as through:
- board representation;
- ownership or control of a majority or dominant minority of the voting shares of the reporting company;
- rights associated with any financing arrangement or interest in a company;
- control over one or more intermediary entities that separately or collectively exercise substantial control over a reporting company;
- arrangements or financial or business relationships, whether formal or informal, with other individuals or entities acting as nominees; or
- any other contract, arrangement, understanding, relationship, or otherwise.
This seems like a lot of guidance, but in actuality the information provided is so vague that it would be hard to call it a “definition.” For example, what is included in the language “direction, determination or decision of, or substantial influence over”? Does a 5 percent shareholder whose vote would determine whether the company enters into a “significant contract” (whatever that term might also mean) fall under this definition? Consider a 10 percent shareholder, who through cumulative voting, is able to elect one out of ten board members. Is that shareholder considered to exercise substantial control because they elected one board member? Would the fact that the other nine board members were all elected by a 90 percent shareholder change the conclusion? We can only hope that final regulations provide more specific guidance.
As with substantial control, the CTA does not define or provide details related to the term “ownership interests,” such as whether attribution rules apply. The Proposed Regulations define ownership interest as:
- any equity, stock, or similar instrument, certificate of interest or participation in any profit sharing agreement, preorganization certificate or subscription, transferable share, voting trust certificate or certificate of deposit for an equity security, interest in a joint venture, or certificate of interest in a business trust, without regard to whether any such instrument is transferable, is classified as stock or anything similar, or represents voting or non-voting shares;
- any capital or profit interest in a limited liability company or partnership, including limited and general partnership interests;
- any proprietorship interest;
- any instrument convertible, into (with or without consideration), any future on, or any warrant or right to purchase, sell, or subscribe to a share or interest described in 1, 2, or 3 above; and
- any put, call, straddle, or other option or privilege of buying or selling any of the items described in 1, 2, or 3 above, without being bound to do so.
Pretty broad “definition” here too. Harkening back to the approach taken with substantial control, the Proposed Regulations provide that ownership interests may be owned either directly or indirectly and include a non-exhaustive list of indirect ownership methods which include joint ownership, through control of ownership interests owned by another individual, or through a trust or similar arrangement.
With regard to trusts or similar arrangements, several parties are allocated ownership interests owned by the trust. First, any trustee or other individual with the authority to dispose of trust assets. Second, a beneficiary who is the sole permissible recipient of income and principal or has the right to demand a distribution of or withdraw substantially all of the assets from the trust. Finally, a grantor who has the right to revoke the trust or otherwise withdraw the assets of the trust, whether through ownership or control of one or more intermediary entities or through any other contract, arrangement, understanding, or relationship.
The Proposed Regulations also state that for purposes of determining whether the 25% ownership interest threshold is met, all of the ownership interests in the reporting company, regardless of class or type are to be aggregated. Each individual is to be allocated all such ownership interests which they own or control, and that amount is to be compared to the undiluted ownership interests of the company.
The Proposed Regulations create more questions than they answer. They do not specify how ownership interests are to be allocated among joint owners nor do they provide insight as to what the phase “control of such ownership interest owned by another individual” might entail. I would hazard a guess that it is meant to cover attribution between family members or other related/subordinated parties. Once again, hopefully final regulations will clarify.
Of special importance to practitioners is the addition of reporting requirements for a “company applicant,” which for a domestic reporting company is the person who files the document that forms the entity and for a foreign reporting company is the person who files the document that first registers the entity to do business in the U.S. Importantly, any individual who directs or controls such filings by another person is included in the definition. As discussed in the Section-by-Section Analysis provided by FinCEN accompanying the Proposed Regulations, this means that if a law firm is hired to form a new LLC and a paralegal is eventually tasked with filing the formation documents with the relevant authority, then the reporting company is required to file several pieces of identifying information and documents related to both the paralegal and any corresponding responsible attorney.
Timing of Disclosures and Updates
The CTA provides that upon a change in the beneficial ownership information of a reporting company, such reporting company must submit an updated report to FinCEN in a timely manner, but no later than one year after the date of the change. The Proposed Regulations take a much more aggressive approach, requiring that updated reports be filed within 30 calendar days of the change. For reports which contain inaccurate information, reporting companies have 14 calendar days after the date the inaccuracy is discovered, or it has reason to know of such inaccuracy, to correct the report. Practitioners will have to be on the ball to ensure that such updated reports get filed because the penalties under the CTA include a civil fine of up to $500 per day the violation has not been remedied (up to a maximum of $250,000) and criminal penalties of up to a $10,000 fine and/or imprisonment for up to two years.
The Proposed Regulations attempt to provide some much-needed guidance on several important elements of the CTA. Unfortunately, they seem to fall a bit short as much of the guidance is overly vague. Perhaps the comments FinCEN receives on the Proposed Regulations will ensure that the final regulations are more thorough. For now, practitioners and businesses should be aware of the upcoming changes discussed in the Proposed Regulations. Businesses should know the reporting deadlines, and those with a large amount of internationally sourced sales will need to consider whether they meet the exception for a large operating company without those international sales. Practitioners will need to consider a multitude of items when considering what an “ownership interest” is for an entity or whether an individual has exercised “substantial control,” and will need to take steps to ensure that they meet the new requirements related to company applicants in a timely manner.
While the CTA is intended to help prevent and combat money laundering, terrorist financing, tax fraud, and other illicit activity, the negative impacts might outweigh the benefits. What are the practical consequences to a small start-up or an operating “mom and pop” business without substantial resources, sophisticated advisers, etc.? Will it be a big gotcha? Will it substantially increase costs? These questions are broader than the Proposed Regulations but also relevant in how onerous compliance will be given the terms of regulatory guidance upon which the CTA relies.
 Josh Sage, “Pulling Back the Curtain with the Corporate Transparency Act” (Jan. 6, 2021).
 A full version of the proposed regulations can be found at: https://www.govinfo.gov/content/pkg/FR-2021-12-08/pdf/2021-26548.pdf.
 All citations to certain provisions of the CTA or the Proposed Regulations in this article are to the specific portions of the proposed addition of 31 U.S.C. § 5336 or 31 C.F.R. § 1010.380, respectively.
 31 U.S.C. § 5336(a)(11)(A).
 31 U.S.C. § 5336(a)(11)(B)(xxi).
 Prop. 31 C.F.R. § 1010.380(c)(2)(xxi)(C).
 Prop. 31 C.F.R. § 1010.380(f)(6).
 31 U.S.C. §§ 5336(b)(2)(A) and (a)(3)(A).
 Prop. 31 C.F.R. § 1010.380(d)(1).
 Prop. 31 C.F.R. § 1010.380(d)(1)(iii).
 Prop. 31 C.F.R. § 1010.380(d)(1)(iv).
 Prop. 31 C.F.R. § 1010.380(d)(2).
 Prop. 31 C.F.R. § 1010.380(d)(3)(i).
 Prop. 31 C.F.R. § 1010.380(d)(3)(ii).
 Prop. 31 C.F.R. § 1010.380(d)(3)(ii)(C).
 Prop. 31 C.F.R. § 1010.380(d)(3)(iii).
 Prop. 31 C.F.R. § 1010.380(e).
 31 U.S.C. § 5336(b)(1)(D).
 Prop. 31 C.F.R. § 1010.380(a)(2).
 31 U.S.C. § 5336(h)(3)(A).