With a stated goal of enhancing transparency of business ownership, the federal Corporate Transparency Act (CTA) mandates various types of businesses – such as corporations, limited liability companies, and limited partnerships operating in the United States – to provide certain information to the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN).
The Bottom Line
Under the CTA, businesses (called “reporting companies”) that do not qualify for specific exemptions must submit a confidential online report to FinCEN known as the Beneficial Ownership Information Report (BOI Report), which includes essential identification details regarding the reporting company’s “beneficial owners.” The CTA defines beneficial owners as individuals who either own or control at least 25% of the company’s ownership interests or exercise substantial control over the company. The ownership and substantial control thresholds can be triggered directly or indirectly, including through “intermediary entities, contracts, arrangements, understandings, relationships or otherwise.”
The reporting obligations under the CTA bear some resemblance to the beneficial ownership disclosures that corporate and other business entity borrowers already undertake in order to comply with commercial lenders’ recent “know your customer” (KYC) requirements in the form of a Certificate of Beneficial Ownership (often called a CBO or BOF). However, reporting companies must exercise care in adhering to the differing details of reporting on the BOI Report form to FinCEN under the CTA.
Non-compliance with the CTA can lead to civil and criminal penalties, including imprisonment for individuals and fines for companies. To facilitate compliance, FinCEN has published guidance and interpretations in the form of FAQs and a Small Entity Compliance Guide.
Reporting Deadlines
The reporting deadlines of reporting companies vary depending on the business’s formation date. Domestic U.S. reporting companies in existence on December 31, 2023 are required to submit their initial BOI Reports no later than January 1, 2025 (and no earlier than January 1, 2024). Domestic U.S. reporting companies created after December 31, 2023 must file their initial BOI Report within 90 days following their formation date and non-exempt domestic U.S. reporting companies formed after December 31, 2024 are subject to a reporting deadline of 30 days after their date of organization.
CTA Compliance and Private Equity
Private equity (PE) funds and their affiliates will face unique challenges in evaluating the implications of the CTA due to three defining characteristics:
- Diversified Ownership. PE funds are, by their very nature, held by both active (general partner entities) and passive investor groups (limited partner investors).
- Variety and Scope of Entities within Fund Family. PE fund structures include a number of individual business entities and subsidiaries, including but not limited to operating portfolio companies, general partner entities, blocker corporations, management companies, and investment funds.
- Diversity of Investment and Ownership Structure of Portfolio Investments. In addition to the inherent complexity in fund families, individual portfolio investments vary widely in both ownership and management. For example, de novo joint ventures, rollover equity, convertible debt, preferred equity, creative governance structures and subsidiary arrangements that are frequently used in PE investment will need to be considered through the broad CTA regulatory lens.
Some of these compliance challenges are mitigated by statutory reporting exemptions prescribed both by the express CTA text, together with FinCEN regulations and related guidance. PE principals should take care to closely evaluate each entity within the fund family for one or more available exemptions. Each entity within the PE fund framework that does not qualify for one of the exemptive categories will be subject to CTA reporting.
CTA Exemptions for Funds and their Investments
The CTA prescribes 23 categories of entities that are exempt from beneficial ownership reporting obligations. For PE sponsors, their investment funds and portfolio companies, the most noteworthy of these statutory exemptions related to CTA compliance evaluation will likely include the following:
- The “Large Operating Company” Exemption
- Securities and Exchange Commission (SEC) Registered Investment Adviser Exemption
- Pooled Investment Vehicle Exemption
- The “Subsidiary” Exemption
The Large Operating Company Exemption
To be eligible for the Large Operating Company exemption, a business entity must satisfy all of the following three conditions:
- Employ more than 20 persons in the United States. on a “full time” or equivalent basis.
- Generate more than $5 million of annual revenues from U.S. operations.
- Have a physical location in the United States.
Although the CTA provides that a tax-filing entity can include U.S.-based revenues of “other entities owned by the entity and other entities through which the entity operates” in its calculation toward the revenues condition, the CTA Rule (and confirmed by the Small Business Compliance Guide) apparently limits this aggregation to an affiliated group of corporations filing a consolidated U.S. corporate tax return. The extent to which a limited liability company or a limited partnership may aggregate revenues with affiliated entities that it “owns” or “through which” it operates in order to satisfy the Large Operating Company exemption revenue standard may need to await further FinCEN regulatory clarification.
While the CTA allows certain affiliated entities to aggregate revenue, at this time there is no comparable ability for businesses to aggregate employees to meet the required exemption threshold of 21 or more full-time employees. As a result of these current prohibitions on employee aggregation, alongside the current regulatory ambiguity of revenue attribution, the Large Operating Company exemption will likely not be a viable alternative for many smaller business entities even within a larger PE fund family.
SEC Registered Investment Advisor Exemption
An SEC Registered Investment Advisor (RIA) is exempt from the CTA’s beneficial ownership reporting requirements.
In many cases, this RIA exemption will apply to both the PE-affiliated management company directly registered as an RIA as well as to each general partner or similarly functioning entity (GP) of the investment funds that a GP manages under common affiliation. Even though a particular GP is not directly registered on the PE sponsor’s management company Form ADV, the RIA exemption would be available provided that each of the following GP-specific conditions is met:
- Formed as a special purpose vehicle.
- Qualifies as an “investment adviser” under the Investment Adviser Act (IAA) and is listed on an affiliate’s Form ADV.
- All investment advisory activities are subject to the IAA and therefore subject to SEC examination.
The third GP criteria described above derives from a 2012 SEC no action letter and the SEC’s Form ADV 2017 amendment, which essentially attributes the RIA management company’s SEC-registered investment adviser status to affiliated GPs under a common “umbrella” without the need for individual filing of each GP so long as the applicable GP is subject to the IAA. Note that this exemption only applies to the actual registered entity with the SEC and associated registration-exempt GPs listed on the Form ADV. Any portfolio investments and upstream affiliates must be separately evaluated as to whether a statutory exemption will apply. Similarly, family offices that are not required to register with the SEC would not have the RIA exemption as a viable alternative.
Pooled Investment Vehicle Exemption
Certain larger, regulated PE funds will likely qualify for the statutory exemption for Pooled Investment Vehicles (PIV) if they satisfy each of the following two conditions:
- The fund satisfies either (A) the “Section 3(c)(1) exemption” (less than 100 investors, typically accredited investors, or less than 250 investors in the case of a “venture capital fund”) or (B) the “Section 3(c)(7) exemption” (comprised exclusively of “qualified purchasers”) under the Investment Company Act.
- The fund is managed either by (A) a management company entity registered with the SEC as an investment adviser that controls over $150 million of portfolio assets or (B) a venture capital adviser.
Note that this exemptive category does not include non-venture capital type “private funds” (typically with an investment portfolio of less than $150 million) operated by a management company entity not registered with the SEC as an investment adviser. As a result, a number of smaller PE funds will not be eligible for this particular statutory exemption.
Subsidiary Exemption
An entity whose “ownership interests” are “controlled or wholly owned, directly or indirectly, by one or more” entities described in at least one of 18 specified CTA statutory exemption categories qualifies for the “subsidiary” exemption. However, this exemption has certain unique conditions and limitations.
As an initial matter, a PIV is not one of the 18 CTA categories of exempt entities eligible for the subsidiary exemption. Accordingly, an entity that is a subsidiary of an exempt PIV entity must qualify for another CTA exemption category to avoid CTA reporting, such as being the subsidiary of an exempt RIA or an exempt large operating company or separately qualifying for the Large Operating Company exemption based on the size of its own operations.
The subsidiary exemption will not apply if the ownership interests in the entity are not “controlled or wholly owned” by one or more entities included within the 18 designated exempt categories. Ownership by an exempt entity of all the equity interests of a company is not necessary to establish the company’s qualification for this exemption. “Control” of a company’s equity ownership or “control” of a portion of a company’s equity interests combined with ownership of the balance of a company’s equity ownership by the same or another exempt entity would be sufficient to satisfy the “subsidiary” exemption.
Some frequently utilized portfolio investment (Portco) structures are outlined below, along with a high-level analysis of the applicability of the “subsidiary” exemption. Note that each of these examples assumes that the Large Operating Company exemption is not available for the applicable Portco.
Portco is 100% owned by one or more PIVs and its ownership interests are deemed to be “controlled” by one or more upstream RIAs.
Although a Portco 100% owned by one or more PIVs cannot qualify for the CTA’s subsidiary exemption by virtue of the PIVs’ direct ownership, Portco can qualify for the subsidiary exemption if one or more upstream GP entities both: (1) qualify for the RIA exemption (see “SEC Registered Investment Advisor Exemption” above); and (2) are deemed to “control” Portco’s ownership by virtue of how such GPs, singularly or collectively, exercise “controlling” governance and managerial power over the PIVs and thus over the PIVs’ ownership of the subsidiary Portco. Note that this analysis would apply to a Portco jointly owned by two unrelated PIV investors so long as each of the PIVs is managed by an RIA and such exempt RIA is deemed to exercise “control” over Portco’s equity interests by virtue of each RIA’s control over its respective PIV.
Portco is majority-owned by a PIV, is deemed “controlled” by an upstream RIA, and has one or more non-exempt investors (NEI) collectively owning less than 25% of Portco equity interests and without any control rights.
Unlike the first scenario, Portco here is partially owned by an NEI; however if the RIA is deemed to exercise “control” over Portco’s equity interests as a result of the RIA’s control over the PIV and some affiliation of the RIA with the minority NEI owners or the RIA’s contractual rights over the NEI’s equity interest in Portco, Portco should be able to qualify as a “subsidiary” of the exempt RIA and thus be exempt from CTA reporting obligations.
Portco is majority-owned by a PIV, is deemed controlled by an upstream RIA, and has NEIs holding less than 25% of Portco ownership but in possession of some control rights.
This illustration is a common rollover equity scenario, whereby the NEIs (in this case, the rollover sellers) hold some ability to influence Portco’s activity but with the majority of decision-making vested with the upstream RIA. The extent and scope of the NEIs’ management rights and the independence of its ownership of its equity interests in Portco could be the determining factors in evaluating whether Portco qualifies under the “subsidiary” of an RIA exemption. Without robust regulatory guidance this illustration will likely result in Portco being subject to CTA reporting and ineligible for the “subsidiary” exemption.
Portco is majority-owned by a PIV, deemed “controlled” by an upstream RIA, with a single NEI holding more than 25% of Portco ownership and some control rights.
Similar to the previous illustration, providing a significant minority NEI with some modest influence over Portco activity (e.g., selective approval rights) is a frequent occurrence in PE investment. However, unlike the prior example, the minority NEI owns more than 25% of Portco’s equity interest, and the likelihood of concluding that the RIA exercises sufficient dominating “control” for purposes of satisfying the “subsidiary” exemption standard is more remote unless the upstream RIA exercises control over the NEI as a result of contractual or other affiliation between the RIA and the NEI. (In this example, the NEI will be a certain reportable beneficial owner as the holder of a 25% or more equity stake unless the Portco qualifies for a CTA exemption from reporting company status.)
Certain characteristics of a Portco’s governance, including but not limited to the composition of the applicable board of directors, board of managers and officers, may impact the “control” analysis above. PE sponsors should take a thoughtful approach in evaluating each Portco under the “Subsidiary” exemption framework, as certain frequent PE structures, such as the use of rollover equity, joint ventures and portfolio-level management, will likely require unique CTA exemption analysis. It will likely take an individual fact-specific analysis to ascertain whether the Subsidiary exemption may be available to any particular Portco in reliance on an upstream exempt RIA.
Other Considerations
Although the CTA and its implementing regulations have specifically identified exemptions for subsidiaries, PE principals should take care to note that there is no corresponding exemption available in the case of parent entities. As such, some funds may face CTA reporting for the ultimate upstream parent company, holding company or general partner even if lower tiers are exempt through other statutory means.
Foreign entities doing business in the United States and foreign individuals with substantial control over non-exempt reporting companies should be aware of the reporting requirements and exemptions. Special reporting rules apply to foreign reporting companies and beneficial owners, and the CTA’s “substantial control” test is separate from other regulatory requirements, like those under the Committee on Foreign Investment in the United States (CFIUS).
Further details regarding the CTA may be found in our firm’s recent report and additional information will be monitored by our dedicated CTA task force, with periodic updates accessible at our CTA webpage. If you have any questions or need advice about filing the BOI Report, please contact one of the authors, or your primary Bass, Berry & Sims attorney.