It is widely accepted that illicit actors continue to create legal entities, masking beneficial ownership information in order to facilitate access to the financial system and conduct financial crimes. A number of developments have recently occurred that may help the United States make progress on requiring the identification of beneficial ownership of businesses and accountholders. First, a dedicated group of members of Congress, both in the House and Senate, have been working for many years to improve incorporation transparency in the United States. The recent introduction of bipartisan bills in both Houses of Congress may be an indication that the issue is getting more serious consideration. Second, as part of the Department of the Treasury’s efforts to enhance financial transparency in order to strengthen efforts to combat financial crime, including money laundering, terrorist financing, and tax evasion, the Financial Crimes Enforcement Network (FinCEN), a Treasury bureau, has been developing a regulation that would apply an explicit customer due diligence obligation on financial institutions. This would include the identification of beneficial owners of accountholders. Third, the Financial Action Task Force (FATF), the leading anti-money laundering/counter terrorist financing (AML/CFT) international standards setting body, revised its recommendations in 2012 and has incorporated an assessment of effectiveness of recommendation implementation into its next round of country evaluations. These standards include beneficial ownership recommendations. According to press reports, FATF is scheduled to begin its evaluation of U.S. compliance with its standards in 2015. Each development is discussed briefly below.
Senator Carl Levin (D-MI), the longtime chairman of the Permanent Subcommittee on Investigation (PSI) of the Senate Committee on Homeland Security and Governmental Affairs, has spearheaded the effort to improve incorporation transparency. In 2008, Senator Levin, then Senator Norm Coleman (R-MN,) and then Sen. Barack Obama (D-IL), introduced S. 2956, the Incorporation Transparency and Law Enforcement Assistance Act, to help law enforcement stop the misuse of U.S. corporations. The bill was reintroduced in March 2009 as S. 569 by Senators Levin, Charles Grassley (R-IA) and Claire McCaskill (D-MO). Most recently, bills with the same name have been introduced in both the House and Senate. Then Senator Levin introduced S. 1465 in August 2013 and Rep. Carolyn Maloney (D-NY) introduced HR 3331 in the House in October 2013. Both of these members of Congress introduced similar bills in 2010. The Senate bill has bi-partisan support--it is co-sponsored by a Senators Grassley, Diane Feinstein (D-CA) and Tom Harkin (D-IA). Supporters became more optimistic that progress may be made on moving the bills through Congress when Rep. Peter King (R-NY) signed on to the House bill in February 2013.
In their August press release the Senate sponsors said that the purpose of the bill is to combat acts of terrorism, money laundering, tax evasion, and other wrongdoing facilitated by U.S. corporations with hidden owners. The United States forms almost two million corporations and limited liability companies (LLCs) each year, more than the rest of the world combined, and does so without asking for the identity of the owners. The bill would require the states to add a single question to their existing incorporation forms requesting the names of the natural persons -- the beneficial owners – behind the corporations being formed. States would not be required to verify the information, but penalties would apply to persons who submit false information. Law enforcement would be given access to the information upon presentation of a subpoena or summons.
A summary of the bill states that the beneficial ownership provisions would:
In addition, paid formation agents would be required to establish anti-money laundering programs to guard against creating U.S. corporations for wrongdoers; however, attorneys using paid formation agents would be exempt from this requirement. The bill would provide $40 million over three years to States from existing Departments of Justice and Treasury asset forfeiture funds to pay for the cost of complying with the act. The bill specifies that funds may not be withheld from any State for failure to comply with the act but it requires a Government Accountability Office (GAO) study in five years identifying any States not in compliance so a future Congress can determine if additional steps are needed. It also requires GAO to complete a study of existing beneficial ownership information requirements for partnerships, charities, and trusts. This would not be the first time that GAO assisted Congress by conducting studies—in 2006, GAO provided PSI with a report entitled, “Company Formations: Minimal Ownership Information Is Collected and Available.” This GAO report reviewed the legal requirements in all 50 states to set up corporations and LLCs, found that most states failed to request beneficial ownership information, and reported that the absence of this ownership information impeded law enforcement investigations of suspect corporations. Earlier, in 2000, GAO prepared a report for PSI that examined an individual who set up over 2,000 Delaware shell companies, opened bank accounts for those companies, and then moved $1.4 billion dollars through those bank accounts, all without revealing who was behind these transactions.
FinCEN is charged with writing the U.S AML/CFT regulations for financial institutions. In March 2012, FinCEN issued an Advance Notice of Proposed Rulemaking (ANPRM) to solicit public comment on a wide range of questions pertaining to the possible application of an explicit customer due diligence (CDD) obligation on financial institutions, including a requirement for financial institutions to identify beneficial ownership of their accountholders.
In addition to a 90-day comment period, Treasury held five public hearings to invite additional comment on specific issues raised during the comment period. These hearings were held in Washington, DC and around the country and were attended by representatives from various financial services industries and non-governmental organizations, as well as members of the regulatory, law enforcement and legislative communities. Many attendees stated that the collection of beneficial ownership information was hampered by the fact that this information is not required in public listings and there are no state registries of beneficial owners of accounts formed in the various states. Further, attendees stated that the verification of beneficial ownership information would be made more efficient if federal legislation was enacted that required beneficial ownership information be provided through the company formation process.
The next step is for FinCEN to issue a Notice of Proposed Rulemaking (NPRM), which will provide the public the opportunity to comment on various aspects of its proposed CDD rule. This step will eventually lead to the issuance of a final rule. Once a final rule is issued and becomes effective, financial institutions will be required to comply with its requirements. According to information posted on OMB’s reginfo.gov web site, OMB received FinCEN’s proposed rule, Financial Crimes Enforcement Network: Customer Due Diligence Requirements for Financial Institutions, on April 11, 2014.
FATF Standards and Country Evaluations
The 2012 FATF standards include two recommendations pertaining directly to the transparency of beneficial owners. The first pertains to “legal persons” and states that countries should ensure that there is adequate, accurate and timely information on the beneficial ownership and control of legal persons that can be obtained or accessed in a timely fashion by competent authorities. The second states that countries should take measures to prevent the misuse of “legal arrangements” for money laundering or terrorist financing. In particular, countries should ensure that there is adequate, accurate and timely information on express trusts, including information on the settlor, trustee and beneficiaries, that can be obtained or accessed in a timely fashion by competent authorities. For both recommendations, countries should consider measures to facilitate access to beneficial ownership and control information by financial institutions and Designated Non-Financial Businesses and Professions (such as casinos, real estate agents, and legal professionals) undertaking the CDD requirements contained in other recommendations.
In June 2006, FATF issued a report, Mutual Evaluation of the United States, on how well the United States was complying with its recommendations. One of the criticisms was that the United States failed to adequately comply with the FATF standard requiring the collection of beneficial ownership information. The report urged the United States to correct this deficiency by July 2008. Specifically, the report said that customer identification requirements apply to most types of financial institutions; however, these could be strengthened, particularly in relation to the identification of beneficial owners. The United States will be undergoing a new mutual evaluation scheduled to begin in 2015 which will assess two components—technical compliance and effectiveness—for the first time. If no progress has been made in improving compliance with the beneficial ownership recommendations, this will be reflected in the final report.
One of the issues raised in the comments on FinCEN’s ANPRM was the fact that beneficial ownership information is not currently required in company incorporation documents. Without this information it is burdensome for financial institutions to collect and verify beneficial ownership information. The specter of the FATF evaluation may spur passage of legislation on the Hill requiring that the states collect beneficial ownership information as part of their company formation process. The implementation of such legislation would make it easier for financial institutions to identify beneficial owners and comply with whatever CDD requirements FinCEN eventually issues.
Bitcoin will be treated like property, not currency, the IRS declared in a Notice (http://www.irs.gov/pub/irs-drop/n-14-21.pdf) issued this week to address the tax implications of mining, spending or receiving virtual currencies. The need to track fair market value and basis adjustments to compute gains and losses for tax purposes introduces record-keeping realities to a virtual world that, until recently, managed to escape extensive regulation by not being controlled by any government.
While the tax treatment is welcomed by many investors who will benefit from paying a lower tax rate on capital gains than they would on ordinary income, the IRS has given fair warning to self-employed Bitcoin miners and independent contractors who may receive Bitcoins for payment that income from virtual currencies must be properly valued and included in gross income and self-employment taxes may apply.
In its Notice, the IRS used a FAQ format to convey the following sixteen pronouncements applicable to virtual currency:
• Property Rules Apply: General tax principles applicable to property transactions apply to transactions using virtual currency.
• No Foreign Currency Gain or Loss: Virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.
• FMV of Virtual Currency Included in Gross Income: A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value (FMV) of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.
• Basis is FMV of Virtual Currency: The basis of virtual currency that a taxpayer receives as payment for goods or services is the FMV of the virtual currency in U.S. dollars as of the date of receipt.
• FMV Determined on Date of Receipt: Taxpayers are required to determine the FMV of virtual currency in U.S. dollars as of the date of payment or receipt. If a virtual currency is listed on an exchange and the exchange rate is established by market supply and demand, the FMV of the virtual currency is determined by converting the virtual currency into U.S. dollars at the exchange rate, in a reasonable manner that is consistently applied.
• FMV and Adjusted Basis Used to Compute Taxable Gain or Loss: If the FMV of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the FMV of the property received is less than the adjusted basis of the virtual currency.
• Capital Gain or Loss Versus Ordinary Gain or Loss: The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in his hands (e.g., stocks, bonds and other investment property). A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in his hands (e.g., inventory and other property held mainly for sale to customers).
• FMV Determines Income for Miner: When a taxpayer successfully mines virtual currency, the FMV of the virtual currency as of the date of receipt is includible in gross income.
• Earnings from Mining May Be Self-Employment Income: If a taxpayer’s mining of virtual currency constitutes a trade or business, and the mining activity is not undertaken by the taxpayer as an employee, the net earnings from self-employment resulting from those activities constitute self-employment income and are subject to the self-employment tax.
• FMV Determines Income for Independent Contractor: The FMV of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax.
• FMV Subject to Withholding from Wages: The medium in which remuneration for services is paid is immaterial to the determination of whether the remuneration constitutes wages for employment tax purposes. Consequently, the FMV of virtual currency paid as wages is subject to federal income tax withholding.
• $600 Threshold for Information Reporting Applies: A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. For example, a person who in the course of a trade or business makes a payment of fixed and determinable income using virtual currency with a value of $600 or more to a U.S. non-exempt recipient is required to report the payment to the IRS and to the payee. Examples of payments of fixed and determinable income include rent, salaries, wages, premiums, annuities and compensation.
• $600 Threshold to Independent Contractor Triggers Form 1099-MISC: A person who in the course of a trade or business makes a payment of $600 or more – including by virtual currency – to an independent contractor is required to report that payment to the IRS and to the payee on Form 1099-MISC. Such payments in virtual currency should be reported using FMV of the virtual currency in U.S. dollars as of the date of payment.
• Backup Withholding Applies and TIN is Required: Payments made using virtual currency are subject to backup withholding to the same extent as other payments made in property. Therefore, payors making reportable payments using virtual currency must solicit a taxpayer identification number (TIN) from the payee. The payor must backup withhold from the payment if a TIN is not obtained prior to payment or if the payor receives notification from the IRS that backup withholding is required.
• FMV on Date of Payment Used by TPSOs: A third party that contracts with a substantial number of unrelated merchants to settle payments between merchants and their customers is a third party settlement organization (TPSO). A TPSO is required to report payments made to a merchant on a Form 1099-K if, for the calendar year, both (1) the number of transactions settled for the merchant exceeds 200 and (2) the gross amount of payments made to the merchant exceeds $20,000. When determining whether the transactions are reportable, the value of the virtual currency is the FMV of the virtual currency is U.S. dollars on the date of payment.
• Without Reasonable Cause, Underpayment and Failure to File Penalties Apply: Underpayments attributable to virtual currency transactions may be subject to penalties, such as accuracy-related penalties under section 6662. In addition, failure to timely or correctly report virtual currency transactions when required to do so may be subject to information reporting penalties under sections 6721 and 6722. However, penalty relief may be available to taxpayers who establish that an underpayment or failure to properly file an information return is due to reasonable cause.
Virtual currencies are different from traditional forms of legal tender because they are not backed by any government or central clearing house. Of the various virtual currencies, Bitcoin has received the most media attention with the focus most recently highlighting the collapse of Mt. Gox, a major Bitcoin exchange now under bankruptcy protection. Mt. Gox reported in February that it lost 850,000 Bitcoins with a value at that time of over $470 million and then a few weeks later, it reported that it found 200,000 of the missing Bitcoins in a digital wallet.
For background on the creation of Bitcoin and regulatory challenges posed by digital transactions, see Bitcoin Emergence Prompts FinCEN to Issue Guidance on Virtual Currencies (http://www.alacra.com/blog/bitcoin-emergence-prompts-fincen-guidance/).