Obligation to make public information on beneficial owners – will the business comply?

As part of October 2014 anti-corruption package the Parliament adopted the rule requiring all Ukrainian entities, save state and communal enterprises, to register with the state register of companies and entrepreneurs (the “Register”), open to the public, and keep up-to-date, information about their ultimate beneficiaries and ownership structure.

The stated purpose of the new measure is to simplify compliance with anti-money laundering (the “AML”) laws, significantly changed by new legislation, and to assist with fighting corruption. Indeed, should the law work as planned, accurate information about beneficiaries of Ukrainian businesses from a centralized register would help financial institutions with identification of the clients and their beneficiaries (including local politically exposed persons (PEP), the notion of which is newly introduced and whose operations are subject to higher scrutiny), and support the state in detection of certain other offenses, such as corruption, tax and anti-trust violations.

This article describes issues that the Ukrainian business will face in complying with the regulation. Apart from tax disincentives, this will include the fear of abuse, technical difficulties with rule interpretation and potential exposure of past breaches of the law (anti-monopoly, exchange control, transfer pricing, financial regulations, etc) that carry significant liability. The article further argues that, absent forgiveness of such past transgressions, and considering lack of effective, proportionate and dissuasive sanctions for violation of the new rule, the effect of the law will be limited to formal compliance.

1. Background

Under the new rules, the company must identify natural persons having ultimate control over it (so called “ultimate beneficiaries”), record this information (passport details, ID numbers, addresses, place of residence) and register it with the Register. Information about owners of substantial equity interests, and data on ownership structure going up the ultimate beneficiaries, which, starting from 2010, was filed at the date of incorporation and never updated after that, now has to be registered by all companies and kept up-to-date. For existing companies, the information must be submitted by 25 May 2015.

There is no clear requirement for the registrars to verify the information, nor are they qualified or have resources to do so. Thus, the Register will likely contain information as declared by the company, whether or not true, with minimum supporting documents reviewed.

The director of the company faces the fine of up to UAH 8,500 (USD 600) for failure to register information on the beneficial owners. No material liability is set for a person doing the filing, immediate shareholders of the company, its nominees or ultimate beneficiaries. Inaccurate disclosure of beneficiary is apparently not penalized, save where it qualifies as forgery. Nor is there liability for failure to disclose or inaccurate disclosure of owners of material stakes or true corporate structure, to the extent such actions do not raise to the level of criminal liability.

Pieces of information on ownership chain of Ukrainian businesses and their beneficiaries can be currently found in number of places, such as the Register, files of the registrars, tax authorities, NBU and financial services regulator, etc. More importantly, such data is collected by the financial institutions (FIs) and designated non-financial businesses and professions (DNFBPs) (lawyers, notaries, real estate agents) as part of their “know your client” procedure, i.e. mandatory process of identifying their client and its beneficiary. Depth of due diligence depends on the internal regulations of FIs and the position of DNFBPs, and is allegedly somewhat extended by the new AML laws. Still, the key assumption of the new rule is that it is better to have this information, updated, in centralized register, which, whether or not acceptable to public by search, may be used by FIs and DNFBPs, and that the truthfulness of the data declared will be enhanced by the liability of director.

2. Disincentives for compliance

• Abuse of information 

Save desire to keep secret the information deemed sacred, as may be needed for future flexibility, including for tax planning purposes, the key concern of business in connection with the new measure is possible abuse of the disclosure by the state or private interests.

It is not clear whether information on beneficiaries and corporate structures from the register will be accessible by search to public. Arseniy Yatsenyuk claims that now “any citizen of Ukraine will have access to … information on the final owner of a business entity”. However, usually, not all the data from the register and the registrar’s files appears on the extract. To the extent there are access limitations, the information may still be illegally bought from registrars or FIs and DNFBPs (which are granted the right of access), and, thus, abused, including for raider attacks or political blackmail.

• Lack of clarity  

From technical point of view, it is far from clear who the entity should register as its ultimate beneficiaries. The key test is qualitative, i.e. the individual should be able to exercise decisive influence over management and operations of the company.

The test is met if the person holds, alone or jointly with related parties, directly or indirectly, 25% or more of equity interest or votes in a company. FATF, in its Guidance on Transparency and Beneficial Ownership, suggests that the existence of shareholder agreements and similar arrangements should be considered in deciding on joint ownership and, should no natural person be identified as exercising control through ownership interests or other means, senior managing official should be identified and, thus, presumably registered as ultimate beneficiary.

Ukrainian law contains no similar rule. What should be done if no chain of ownership leading to natural person with decisive influence can be established? For example, a company is publically traded, the entity is a community organization or a fund? Or the ultimate owner benefits from operations but exercises no effective control over management of the group? Should the head of the entity be indicated in the register as ultimate beneficiary? What about an agent with broad powers under PoA?

Establishing control through means other than ownership chain is even trickier. The new Ukrainian law contains only one specific suggestion, namely lease of all or part of the assets. According to FATF Guidance, which is not binding, the natural person may also exert control (i) by participating in the financing of the enterprise, or (ii) because of close or intimate family relationships, historical or contractual associations, or, more alarmingly, (iii) if a company defaults on certain payments, or (iv) through positions held within a legal person other than positions as head of the company.

• Lack of insufficient instruments for identifying beneficiaries

For Ukraine based groups, where each entity is incorporated in Ukraine and ultimate shareholders are Ukrainians, establishing the complete chain of ownership and, thus, complying with the law at least formally, is easy. Not so if the company is controlled from abroad. The situation is worse if ownership is spread over jurisdictions, nominees are used or control is exercised through trust-like arrangements.

For the company, the owners are the key source of true information on ownership structure and beneficiaries. Exposed by the new law neither to legal duty to make the disclosure, nor liability for not doing so (save for hard to prove criminal liability for forgery), they have no incentive for real cooperation. It is further unreasonable to expect that a clerk doing the registration, even possessing insight as to the beneficiaries, would enter this information without explicit instructions from the owner.

Thus, the company, in order to protect itself and the director from liability, would develop internal procedures, similar to those employed by banks, for identification and verification of the information required. Having every reason to restrain its curiosity, the company is likely to limit the effort to sending information forms out to its owners going up the ownership chain, whether or not they are ever answered, and receiving articles of the association and trade register excerpts. Much like it is currently done by banks in their customers due diligence.

• Nominees and trusts problem  

True beneficiaries must be disclosed with full disregard of trust or nominee relations. However, the split of beneficiary and title ownership or similar trust alike relations are neither expressly recognized nor well understood by state authorities, even if widely used in practice.

This may pose practical difficulty for groups not opposing transparency for internal reasons. Any discrepancy between true information disclosed and what the company is able to confirm using the documents understandable to Ukrainian authorities and institutions may cause questions whenever ownership structure is subject to verification (e.g. anti-monopoly filing, opening a bank account with a new bank, receiving consent for acquisition of substantial interest, etc.).

• Past anti-monopoly violations may be a barrier to disclosure 

Full picture of the ownership structure, if disclosed, may hint at the past breaches of anti-monopoly law. The register information, coupled with cursory review of anti-monopoly filings by a particular beneficiary and analysis of financial reporting and tax information of companies under the joint control might suggest if the beneficiary ever failed to receive clearance for any past acquisitions. Fines for violations are severe (up to 10% of the annual income of the group or up to the amount of all illegally received profit multiplied by three).

Considering the unreasonably low thresholds triggering filing duty in Ukraine, the sins might have related to trivial deals and been unintentional. Even if not, curing them requires undergoing the full filing procedure. Thus, the 6 month period the new law gives to existing companies for disclosing beneficiaries may be insufficient for resolving past anti-monopoly problems. Absent their forgiveness, the past transgressions will be a barrier to disclosure.

• Implications of past exchange control and other violations 

One of the principal targets of the new rules is Ukrainian businesses, which, even though legally controlled from abroad, are managed and beneficiary owned by Ukrainian individuals.

Offshore holding structures are common for Ukraine. Tax avoidance may be the most common reason. Other, fully legitimate, reasons may have included IPO, issuance of bonds, more favorable and flexible terms for financing available to foreign companies, flexibility of corporate law offered by foreign jurisdictions, freedom of contract, better judicial and law enforcement system.

At the same time, creating such foreign holding structure by Ukrainian individuals is subject to tight exchange control regulations. Judging by the number of licenses issued by the NBU over the years for foreign investment, few opted for compliance.

Even though the business community does not treat as serious the risk of fines for investing without license, which in theory are significant but are not in practice applied, few would consider prudent voluntarily disclosing the structure that might be interpreted as created in breach of the law, given, in particular, that there are no way to remedy such breach.

Similarly, the information on beneficiaries may reveal beaches of tax legislation and violations in other areas, which has unfavorable implications.

3. Conclusion

The concerns raised above appear significant. If they are not addressed, at least to the extent possible, such as by giving explanations on the technical questions posed by new law, business will have every incentive to limit their efforts to formal compliance. To the extent it is not possible, for example where disclosure of the group structure requires documentary evidence, or officials involved fear criminal liability, the groups may artificially simplify ownership structure of business and retain points of control where they are currently less likely to be detected (i.e. via use of nominees, funds, informal arrangements, etc).