In a globalized economy, foreign investment plays a pivotal role in driving economic growth and innovation. For years, the United States has been a beacon for international investors seeking lucrative opportunities. However, concerns surrounding transparency and accountability have often loomed large, creating barriers for foreign investors navigating the complex landscape of American business.
Enter the Corporate Transparency Act (CTA), a landmark piece of legislation designed to enhance transparency in corporate ownership and combat financial crimes such as money laundering and terrorist financing. Signed into law in January 2021, the CTA represents a significant shift in the regulatory framework governing various entities in the United States. While primarily aimed at combating illicit financial activities, the CTA also has profound implications for foreign investors looking to enter or expand their presence in the US market.
At its core, the CTA requires certain entities referred to as “Reporting Companies” to disclose beneficial ownership information to the Financial Crimes Enforcement Network (FinCEN), a bureau of the US Department of the Treasury. As more fully discussed below, Reporting Companies include various entities, not just corporations and the reach of the CTA is not limited to only US entities. Even if a foreign entity is not doing business in the US, or otherwise registered in the US, it may still be required to give up beneficial ownership information under the CTA. The CTA looks for “substantial control” and this can result from contractual or non-contractual relationships. Foreign families are particularly vulnerable since many have family businesses that rely on patriarch or matriarch dominance. The CTA has very far reaching implications for foreigner investors. Today’s post sets it out.
CTA – Is it Unconstitutional?
While the CTA demonstrates the United States’ commitment to upholding international standards of transparency and combating financial crimes, the law has now been challenged as unconstitutional with one district court already striking it down. My earlier blog post discussed National Small Business United v. Yellen, No. 5:22-cv-01448 (N.D. Ala.), the Northern District Court of Alabama decision that enjoined all relevant US government agencies from enforcing the CTA against certain parties. Another district court, the US District Court for the Western District of Michigan, is now poised to consider its consitutionality as well. A description by the Small Business Association of Michigan (SBAM), the plaintiff in the case, can be found here. SBAM represents over 32,000 small business owners across the state. It argues that the CTA violates constitutional protections guaranteed in the Fourth Amendment against unreasonable search and seizure. Court documents here.
By shining a light on ownership structures, the CTA aims to prevent bad actors from hiding behind opaque corporate entities to engage in illicit activities. (Bad actors are bad actors though. Why wouldn’t a bad actor provide false CTA information? Surely they will).
Who Must Comply with the CTA? What is Required?
The CTA requires US entities (including for example, US LLCs, corporations, partnerships), and certain foreign entities (e.g., that register to do business in a state) to disclose to FinCEN, the identity of their beneficial owners by providing their name, date of birth, unexpired passport or driver’s license number and current address.
The breadth and far-reaching effects of the CTA are evidenced by its definitions. For example, the CTA definition of beneficial ownership includes anyone with an ownership interest of 25% or more; a majority of voting ownership; or someone who exerts “substantial control” over the entity, such as executives, senior officers and board directors — even if they do not hold an ownership stake in the entity. If an individual is an “important decision-maker” he or she is considered to have substantial control over the Reporting Company. This is someone who has substantial influence over important decisions such as the company’s business, finances, or structure.
“Ownership interest” includes equity, stock, voting rights, capital interests, profits interests, convertible instruments, options or any arrangement, understanding, relationship, or mechanism used to establish ownership.
FinCEN estimates that the CTA applies to 32.6 million currently existing entities and 5 million new entities formed each year from 2025 to 2034.Annual filing and updating of the information would be required. Without doubt, the CTA provides FinCEN with yet another significant information gathering tool. More on the CTA at my blog post here.
Foreign Investors – Your Name Please!
Many foreign investors have created US LLCs, or are involved in US partnerships, or US corporations and thus will be impacted by the CTA. Others are doing business in the US through foreign entities registered to transact business in a US State or States. In these cases, the CTA requires beneficial ownership disclosure.
Even if a foreign entity is not registered or otherwise doing business in the US it may still be required to give up beneficial ownership information under the CTA if the foreign entity “substantially controls” a Reporting Company or owns or controls at least 25% of the “ownership interests” of a Reporting Company whether or not the Reporting Company is a US or foreign entity. When an entity, rather than an individual, owns 25% or more of the ownership interests of a Reporting Company, the Reporting Company should report the individual or individuals who are the direct or indirect Beneficial Owners of the entity. See IRS FAQ D12. Since substantial control can result from contractual or non-contractual relationships, it seems that there will be ramifications for foreign families that rely on patriarch or matriarch dominance. I doubt foreign families are aware of these implications.
Overall
For foreign investors, the impact of the CTA is twofold. On one hand, the increased transparency brought about by the legislation can foster a more conducive environment for foreign investment by enhancing trust and confidence in the integrity of the US market. By requiring disclosure of beneficial ownership information, the CTA may help mitigate the risks associated with investing in opaque entities, providing foreign investors with greater clarity and assurance.
However, the CTA also presents challenges and considerations for foreign investors seeking to navigate the US market. Compliance with the new reporting requirements will impose additional administrative burdens and costs on businesses, particularly smaller enterprises with limited resources. Foreign investors must familiarize themselves with the intricacies of the CTA and ensure that their structures are in full compliance with the law to avoid potential penalties or legal repercussions. The increased scrutiny on beneficial ownership information could potentially deter certain foreign investors, particularly those operating in jurisdictions where privacy and confidentiality are highly valued.
FinCEN has released a “Small Entity Compliance Guide” and has published FAQs to assist. Happy Reading!
Posted: April 4, 2024
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