The ‘beneficial ownership’ proposition undermines tax reform


Every year state governments recognize over two million new business entities. That’s over 5,000 new businesses every day. The speed with which they are founded strongly correlates with the strength of a country’s economy. This is one reason the World Bank compares countries based on regulatory red tape affecting business incorporation.

Legislation under consideration in Congress, the Counter Terrorism and Illicit Finance Act, risks tying entrepreneurs’ hands with even more red tape. In fact, it could destroy any benefit some small businesses stand to gain from the tax reform legislation passed last year.

It would require corporations and limited liability companies with fewer than 20 employees to file a form with the Treasury Department at the time of formation, and update it annually, listing the names of all beneficial owners and individuals exercising control.

{mosads}This proposal carries with it a criminal penalty of up to three years in prison. Given the substantial penalties, this will impose a massive regulatory tax on small businesses as they spend money on lawyers that should go toward workers’ pay.


Worse still, that cost may not actually bring any benefit. It is unlikely someone on a terrorist watch list would provide their real name on the required form, and Treasury will probably never have sufficient resources to audit names in real time. The 9/11 Commission report does not describe terrorist financiers using business entities, but rather a system of hard cash financing and informal “Hawaladar” networks. Ever since beneficial ownership reporting was first proposed by the Obama administration, the terrorism link has been a red herring.

When one Immigration and Customs official testified before the Senate Homeland Security Committee concerning beneficial ownership reporting, he argued it would help with investigations concerning corruption, fraud, tax evasion, visa fraud, and terrorism financing. Each of these crimes has a strong element of fraud, calling into question the efficacy of self-reporting and suggesting the costs will fall solely on legitimate businesses.

When the United Kingdom first considered a beneficial ownership requirement in 2002, it determined that it would do little to prevent terrorist financing and other money laundering, because those bad actors could easily submit false information. The U.K. later gave into political pressure after the Panama Papers scandal in a poorly informed fit of crisis management. The United States should not succumb to the same panic.

No doubt some individual money laundering investigations would be easier with a small business registry available. But IRS tax fraud investigations would be much easier with access to taxpayers’ bank account login information — would we tolerate the associated costs and privacy violations? The information in the beneficial ownership registry would be available to the same state attorney generals who have been criticized for fishing expeditions seeking to shame donors to conservative non-profits.

Supporters of the legislation argue that the cost of compliance is relatively light. They argue that it’s simply a form describing the names of the company’s owners during business formulation. It’s far more complicated.

How is the term “beneficial owner” defined? How is “control” defined? As a professor of corporate law, I have given multiple lectures on those very questions. What if your company is owned, in part, by another company? Or there is a chain of ownership through multiple intermediary companies? What if a creditor of the company, though not currently a shareholder or beneficial owner, obtains the contractual right to convert their debt contract into ownership equity at some point in the future?

The statute would include some exemptions and allow the attorney general to further exempt classes of businesses. Yet for the average small business owner, navigating those complexities against the backdrop of a potential three year prison sentence will often require legal counsel.

Companies affected by this legislation should conservatively expect to spend at least $5,000 on a corporate lawyer to help navigate the complexities of the new filing requirements. Some with more complex holdings will see even higher legal bills.

One source of support for this legislation is that Treasury will shortly require banks themselves to collect beneficial ownership information on small businesses. Rather than indulging the banking industry’s desire to force these compliance costs on small business, Congress’ attention would be better spent on staying the Treasury requirement, pending review of the issue by the Government Accounting Office (GAO). 

It is ironic that on the cusp of major tax reform designed to spur small companies’ growth, Congress would pivot to an onerous regulatory tax on the process whereby small businesses are created. The beneficial ownership provision in this legislation requires, at a minimum, more study by the GAO to weigh its costs and benefits.

J.W. Verret is an associate professor at the Antonin Scalia Law School at George Mason University and a senior scholar with the Mercatus Center.

Tags economy Financial regulation J.W. Verret Money laundering Offshore finance Panama Papers Tax reform Terrorism Terrorism financing

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