Corporate Transparency Act: Who Is a Beneficial Owner?

The Corporate Transparency Act (CTA), which takes effect January 1, 2024, requires certain entities to report “beneficial ownership information” (BOI) and other details. The Treasury Department’s Financial Crimes Enforcement Network (FinCEN)  uses the reported BOI in its fight against money laundering and terrorism. As part of the CTA informational series, we consider the question of what makes someone a beneficial owner.

 

Who Is a Beneficial Owner?

If an entity is a “reporting company” under the CTA, the reporting company will have to file a report with FinCEN providing certain information about the reporting company’s “beneficial owners.” Under the CTA, a beneficial owner is any individual (natural person) who, directly or indirectly:

• Exercises substantial control over the reporting company or
• Owns or controls at least 25 percent of the ownership interests of the reporting company.

 

What Is Substantial Control?

An individual will be considered a beneficial owner of a reporting company if he or she exercises “substantial control” over the reporting company. An individual exercises substantial control over the reporting company if:

• The individual serves as a “senior officer” of the entity,
• Has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body), or
• Directs, determines, or has substantial influence over “important business decisions” of the reporting company.

 

For purposes of the CTA, the term “senior officer” means any individual holding the position or exercising the authority of president/chief executive officer, treasurer/chief financial officer, secretary/general counsel, chief operating officer, or any other officer (regardless of title) performing a similar function.

 

Important business decisions of the reporting company include, but are not limited to, decisions regarding:

• Nature and scope of the company’s business
• Sale, lease, mortgage, or other transfer of principal assets
• Reorganization, dissolution, or merger
• Major expenditures or investments
• Issuance of equity or incurrence of significant debt
• Selection or termination of business lines or ventures or geographic focus
• Approval of operating budget
• Compensation and benefits of senior officers
• Entry into or termination of significant contracts
• Amendments to the company’s substantial governance documents (e.g., articles of incorporation, bylaws, shareholders agreement, etc.)

 

The Final Reporting Rule  issued by FinCEN set out a non-exhaustive list of examples of how an individual may exercise substantial control over a reporting company, including by way of:

• Board representation
• Ownership or control of a majority of the reporting company’s voting power or voting rights
• Rights associated with a financing arrangement or interest in the reporting company
• Control over intermediate entities separately or collectively exercising substantial control over the reporting company
• Arrangements (including financial or business relationships) with other individuals or entities acting as nominees
• Any other contract, arrangement, understanding, relationship, or otherwise

 

What Does Ownership Interests Mean?

In addition to exercising substantial control over a reporting company, an individual will be considered a beneficial owner if he or she directly or indirectly owns or controls at least 25 percent of the “ownership interests” of the reporting company.

 

• “Ownership interests” are defined broadly to include:
• Any equity, stock, or similar instrument
• Any preorganization certificate or subscription
• Any transferable share of (or voting trust certificate or certificate of deposit for) an equity security
• An interest in a joint venture
• A certificate of interest in a business trust

 

Additionally, “ownership interests” include:

• Any capital or profits
• Instruments convertible into any share or instrument described previously
• Any right to purchase, sell, or subscribe to a share or other interest
• Any put, call, or other option (except to the extent the option is held by a third party unknown to the reporting company)
• Any other instrument, contract, or arrangement used to establish ownership

 

Further, “directly or indirectly” is also broadly construed under the CTA to mean any ownership interest through any contract, arrangement, understanding, or relationship.

 

For CTA reporting purposes, debt instruments will be considered ownership interests if the holder of the instrument has the ability to exercise the same rights as a holder of one of the equity (or other) instruments described. For example, the holder of a convertible note would be deemed to have an ownership interest under the CTA, whereas the holder of a simple security interest would likely not.

 

How Do You Calculate Total Ownership Interests?

The challenging step in determining whether an individual is a beneficial owner of a reporting company is calculating the person’s ownership interests. The following standards will govern whether an individual has met the 25 percent ownership or control threshold to qualify as a beneficial owner.

 

First, total ownership interests owned or controlled are calculated as a percentage of the total ownership interests of the reporting company. At the time of calculation, any options or similar interests held by the particular individual will be treated as exercised.

 

If the reporting company is a corporation (as well as entities taxed as corporations and other reporting companies issuing shares) the individual’s ownership interest will be the greater of:

1. the total combined voting power of all classes of ownership interests of the individual as a percentage of the total outstanding voting power of all classes of ownership interests entitled to vote, and
2. the total combined value of the individual’s ownership interests as a percentage of the total outstanding value of all classes of ownership interests.

 

An important note when calculating ownership interests is that if the calculations cannot be made with reasonable certainty, an individual owning or controlling 25 percent or more of any single class or type of ownership interest will be deemed to have exceeded the 25 percent ownership interest threshold.

 

If the reporting company issues capital or profits interests (including if the reporting company is treated as a partnership for federal income tax purposes), the individual’s ownership interests will be calculated by taking their capital and profits interests in the reporting company as a percentage of the total outstanding capital and profits interests of the company.

 

What Are Special Ownership Rules for Trusts?

If an ownership interest in a reporting company is held through a trust, the following individuals are deemed to have an ownership interest in the reporting company:

• A trustee of the trust or other individual (if any) with the authority to dispose of trust assets.
• A beneficiary who:
  • is the sole permissible recipient of the trust’s income and principal; or
  • has the right to demand a distribution of or withdraw substantially all of the trust’s assets.
• A grantor or settlor who has the right to revoke the trust or otherwise withdraw the trust’s assets.

 

Which Individuals Are Exempt from Being Beneficial Owners?

The CTA provides five exemptions from the definition of “beneficial owner.”

 

The first is a minor, as defined by the laws of the state under which the reporting company was created or registered. Nonetheless, the company must report information for the minor’s parent or guardian and submit an updated report when the minor reaches the age of majority.

 

The next exemption is for nominees, intermediaries, custodians, and agents on behalf of another individual. The BOI of a nominee need not be reported, but the company will still need to report the BOI for the individual on whose behalf the nominee acts.

 

The third exemption from the definition of “beneficial owner” is for employees who—while they may exercise substantial control over or economic benefits from the reporting company—(i) have their control or benefits derived solely from their employment status and (ii) are not senior officers.

 

The fourth exemption is for individuals whose only interest in the company is a future interest through an inheritance right.

 

Finally, certain creditors of a reporting company will not be considered beneficial owners. These are creditors only holding a right to be paid a predetermined sum of money, who meet the “beneficial owner” definition only by way of a loan covenant (or similar right) associated with a right to repayment intended to secure such right or enhance the likelihood of the repayment of debt.

 

Beneficial Owner Identification Example

To illustrate how beneficial owners of a reporting company are identified, we will say Company X has determined it is a reporting company and needs to identify its beneficial owners to fill out its FinCEN BOI report. Company X is owned equally by two other companies, Company Y and Company Z. The individuals involved have the following attributes:

• Individual A is the CFO of Company X and owns 30 percent of Company Y and 25 percent of Company Z.
• Individual B is not an officer of Company X, but owns 70 percent of Company Y.
• Individual C is the CEO and president of Company X and owns 25 percent of Company Z.
• Individual D is not an officer of Company X but owns 25 percent of Company Z.
• Individual E is not an officer of Company X but owns 25 percent of Company Z.
• Individual F is on the board of directors of Company X but has no equity ownership of any company.

 

Here, Individuals A, B, C, and F are the beneficial owners of Company X.

 

We quickly identify Individuals A, C, and F as beneficial owners by virtue of their senior officer positions by which they exercise substantial control. However, Individual A is also a beneficial owner by way of his ownership interests in Company X. Because Individual A owns 30 percent of Company Y and 25 percent of Company Z, he indirectly holds 27.5 percent of Company X (given that Companies Y and Z own Company X 50-50).

 

 Individual B is also a beneficial owner by way of her ownership interests. She owns 70 percent of Company Y, and therefore, indirectly owns 35 percent of Company X.

 

Individual C, while a beneficial owner of Company X as CEO and president, is not a beneficial owner by ownership interest. Individual C holds 25 percent of Company Z, and therefore indirectly only 12.5% of Company X.

 

Individuals D and E are not beneficial owners of Company X. These two do not exercise substantial control, and their 25 percent ownership positions in Company Z only amount to 12.5 percent indirect ownership of Company X.

 

Finally, Individual F holds no ownership interest (directly or indirectly) in Company X but is nonetheless considered a beneficial owner since he directs important decisions for the company as a director.

 

Read more about the CTA, reporting companies, and other key elements of the law at Nyemaster’s Corporate Transparency Act Information Hub.

 

Review other elements of the CTA with each article in the series:

• What Entities Are Required to Report?
• Who Is a Company Applicant?
• What Information Needs to be Reported?
• When Are Filing Dates and What Are the Penalties?

 

For legal advice on the CTA and the obligations it imposes on businesses, please to contact your Nyemaster attorney.