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Last month, the US Treasury finalised a long-awaited rule for beneficial ownership reporting requirements which is expected to hit more than 30m small businesses. VIXIO speaks with an ex-Treasury official to discuss the impact and potential areas of abuse.

In late September, the US Treasury’s Financial Crimes Enforcement Network (FinCEN) issued a final establishing reporting requirements for beneficial ownership information (BOI).

The rule, created under the Corporate Transparency Act (CTA), establishes who must file a BOI report, what information must be reported and when a report is due.

The register is intended to end shell companies, which typically exist only on paper and have no office or employees. As exposed by investigative journalist groups, these companies are often used by high net-worth individuals to evade taxes and bad actors to launder ill-gotten gains in the US.

The final rule is intended to address this gap and, as a result, most reporting companies “are likely to be small entities”, as noted by the agency.

Treasury secretary Janet Yellen welcomed the rules as “a major step forward” that “builds on years of bipartisan work by Congress”.

However, Republican Congressmen Patrick McHenry and Blaine Luetkemeyer called the rule “overly broad” which “injects unnecessary complexity by taking 10 pages of legislative text and turning it into a more than 300-page final rule”.

Who is in and out?

Specifically, the rule requires reporting companies to file reports with FinCEN that identify the beneficial owners and the company applicants of the entity.

Reporting companies include domestic and foreign corporations, limited liability companies (LLC) and any entities that are created or registered to do business in any state by filing a document with a secretary of state.

The rule exempted 23 types of entities from the definition of the reporting company, such as large operating companies, while noting that all reporting companies “are likely to be small entities”.

“One area to keep an eye on is the exception for reporting from large operating companies," Jamal El-Hindi, counsel at Clifford Chance and former deputy director of FinCEN, told VIXIO.

Large operating companies, those that employ more than 20 full-time employees, have an operating, physical presence in the United States, and have more than $5m in annual gross sales receipts, are not required to report their beneficial owners to FinCEN.

“Smaller entities that fit within this exception could be used as fronts for illicit activity and their beneficial owners would not be included in the database,” El-Hindi noted, adding that the rule nonetheless “had to have some parameters” and “once you set those up, illicit actors can figure out ways around them.”

Similar concerns have been raised throughout the rulemaking process, with some commenters suggesting that this exemption “could be particularly susceptible to abuse” and will require “ongoing monitoring”.

FinCEN eventually decided to keep the provision this way and said it will take it seriously to ensure that “no exemption is misused” and will “remain vigilant against potential abuses”.

Throughout the rulemaking process, top Democratic lawmakers pushed FinCEN to implement the rule as broadly as possible, while senior Republicans cautioned against adopting an “overly broad and unnecessarily complex” rule.

“You can find balance in FinCEN's approach as it attempts to address both concerns,” the former FinCEN deputy director said.

According to El-Hindi, the final rule maintained some “fairly broad exemptions” so that not all companies have to file reports and, at the same time, it provides for more transparency with respect to the beneficial owners of legal entities that do have to report.

One particular area of uncertainty that FinCEN resolved was the number of beneficial owners that would be reported, El-Hindi explained.

For instance, some argued that FinCEN should require firms to report an individual with substantial control as a beneficial owner.

“Some members of the Congress were concerned that requiring reporting at a 25 percent ownership level and not lower, and identifying only one person with substantial control over the company would not provide enough transparency,” El-Hindi explained.

As a result, FinCEN maintained the 25 percent threshold but finalised the rule to require the reporting of any individual that has substantial control over the reporting company.

Regulatory impact on businesses

The rule will become effective on January 1, 2024.

Reporting companies created or registered before the effective date will have one year until January 2025 to file their initial reports, while reporting companies created or registered after the effective date will have 30 days to file their initial reports.

According to FinCEN’s own regulatory impact analysis, 32.6m companies are estimated to report their BOI in the first year of implementation and additional 5m companies each year afterwards.

It estimates that the cost of the initial report will be $85 per entity.

Meanwhile, the combined government and industry costs for the reporting regime and the database will be roughly $23bn in the first year and roughly $6bn per year after that.

“We all have an interest in making sure that this system is used effectively by law enforcement to go after the illicit actors that use business entities for money laundering and other criminal purposes,” El-Hindi stressed.

Although the BOI register imposes a new reporting requirement on many businesses, it is expected to ease the burden on financial institutions which so far have had to use their own resources to identify beneficial owners of private banking accounts.

“The financial sector also hopes that increased reporting of this information directly to the government may lead to less burden on the private sector in connection with their requirements to collect beneficial ownership information on legal entity customers,” El-Hindi noted.

After finalising reporting rules for the BOI, FinCEN is now working on the second set of rules under the CTA that aims to describe who may access the BOI register, for what purposes, and what safeguards will be required to ensure that the information is secured and protected.

Until the database is set up, figuring out whether particular businesses fit within certain exemptions will be an initial focus of many companies and their lawyers, El-Hindi said.

“There will likely be headaches involved in updating reported information when the addresses of companies and beneficial owners change over time.

“FinCEN has a big challenge in terms of educating smaller businesses about the rule and the importance of compliance,” the ex-FinCEN official said, pointing out that the agency generally undertakes such outreach with the cooperation of trade associations, while private service providers may also help businesses comply.