U.S. rule on beneficial owners is tip of the iceberg

The Treasury Department issued a proposed rule in late July that will impose greater regulatory obligations on U.S. banks. Put forward by the Financial Crimes Enforcement Network (FinCEN) under the Bank Secrecy Act, the rule requires financial institutions to identify beneficial owners of legal entities.

If adopted, the rule will bring the United States one step closer to joining Europe’s high-tax nations as firmly opposed to financial privacy and tax competition. 

The proposed rule has been years in the making. FinCEN first suggested the requirement to identify beneficial owners in a March 2012 Advance Notice of Proposed Rulemaking. The Advance Notice was met with serious objections over its broad and costly requirements to identify the beneficial owners of legal entity customers. But in a rare move, regulators appear to have listened and the new proposed rule is less onerous than its predecessor.

However, they are careful to make clear that the rule represents the minimum standard and may be added upon.

Compared to that of the Advance Notice, the proposed rule offers a narrower definition of beneficial ownership, excludes certain types of legal entities, and provides a simplified procedure through use of a standard self-identification form for revealing owners.

The changes are no doubt a relief to the many institutions that were concerned about the cost of complying with the Advance Notice, but in the long run it may not matter. The current rules will more than likely serve as the proverbial camel’s nose under the tent, with future obligations – and associated compliance costs – growing ever higher through additional amendments and regulations.

Beneficial ownership reporting rules long sought

There have been efforts in the past to require identification of beneficial owners in the United States. These efforts often have come in the form of attacks on the efficient and attractive incorporation laws of states like Delaware and Nevada. Senator Carl Levin – a frequent opponent of tax competition and financial privacy – has repeatedly introduced the Incorporation Transparency and Law Enforcement Assistance Act, for instance, which was endorsed by then-Senator Barack Obama.

Levin’s legislation directly attacks U.S. states that make incorporation fast and convenient, citing disapprovingly the fact that “many States have established automated procedures that allow a person to form a new corporation or limited liability company within the State within 24 hours of filing an online application, without any prior review of the application by a State official.”

Accordingly, the legislation alleges, these states and offshore jurisdictions are “inviting terrorists and other wrongdoers to form entities.” Needless to say, no evidence is ever offered to show that these vehicles are systematically abused.

The notice of proposed rulemaking makes clear that it is intended to complement legislation, such as that proposed by Senator Levin, requiring collection of beneficial ownership information when legal entities are formed. It also cites U.S. obligations for information sharing under FATCA as a justification for the rule, which raises the possibility that information received by banks under the regulation will at some point be shared automatically with officials and without need for suspicion or regard for due process.

Deliberately undermining American competitiveness

The United States has long benefited from tax competition. In addition to hosting several states with favorable incorporation laws, it also exempts reporting and taxation of certain types of foreign income. These policies encourage economic growth by not subjected capital income to extra layers of taxation, which helps to attract $13 trillion in foreign indirect investment to the American economy. At the same time, these same policies have made it intellectually difficult for statist activists and politicians in America to attack foreign jurisdictions that use similar strategies to attract investment.

A desire to overcome the hypocrisy handicap on the part of American-based anti-tax competition campaigners is a large motivation behind Levin’s Incorporation Transparency bill, but there’s never been enough political support for eliminating such a significant source of growth to the U.S. economy. Achieving the same ends through regulation sidesteps the political obstacles and frees U.S.-based campaigners to more effectively attack offshore financial centers, such as through Senator Levin’s other anti-tax competition legislation, the Stop Tax Haven Abuse Act.

Adopting FinCEN’s beneficial ownership reporting rules also will in this way more closely align the United States with high-tax European nations and other large OECD members. The biggest threat it poses, in other words, might not come from additional U.S. legislation, but from greater American support for international rules designed to eviscerate financial privacy and hamstring low-tax jurisdictions.

The OECD’s efforts to undermine tax competition are well documented, and have recently reached fever pitch with proposed standards for automating information exchange between nations. Under the Bush administration, the United States generally stood opposed to the OECD campaign, and their opposition dramatically slowed the organization. The Obama administration, on the other hand, ideologically supports OECD efforts to indirectly harmonize tax rates by preventing individuals from benefiting from better tax policy in other nations.

With FinCEN’s proposed rules, Obama administration regulators are making clear their intent to bring the U.S. into better alignment with European tax collectors. Low-tax jurisdictions should take notice, as this will only further embolden the OECD to press harder in its quest to protect the fleeing tax bases of high-tax nations at the expense of the global economy.