Using Companies Limited by Guarantees to Circumvent CRS or CARF?

A company limited by guarantee (CLG) is a legal entity where the members’ liability is limited to a specific amount if the company is wound up. CLGs are often used by charities, social enterprises, and membership organizations, but not all are charitable. 

Here are some characteristics of CLGs:

• No share capital: CLGs typically don’t have share capital, and members are known as guarantors instead of shareholders. 
• Limited liability: Members agree to contribute a set amount of money to the company if it faces financial difficulties. 
• Protected personal finances: The personal finances of the guarantors are protected. 
• Reinvested profits: Surplus income is reinvested to further the organization’s objectives. 
• Similar to companies with share capital: CLGs are subject to the same rules and regulations as companies with share capital, such as filing accounts, annual returns, and appointing directors. 
• Directors: CLGs must have at least two directors, one of whom can be the company secretary. 

Advantages of Companies Limited by Guarantee:

• They have legal identities separate from its members
• Individual members are almost totally protected against liability
• They can buy and sell property in the name of the organisation
• They can take or defend legal proceedings in its own name
• Companies are generally democratic organisations – they have a membership

Can CLGs be used to circumvent CRS or CARF?

CLG is controlled by its members although it has no shareholders 

A company limited by guarantee does not have shareholders or share capital. Instead, it has guarantors – usually known as ‘members’ – whose personal liability is limited to the guarantee amount they agree to contribute towards the debts of the company. This guarantee, which applies if the company is unable to pay bills or is wound up, is most often nominal: the most common guarantee amount is $1. Except in cases of fraud or negligence, the liability of individual members is therefore strictly limited.

So who are the Controlling Persons of a CLG 

Although they do not “own” the company in quite the same sense and generally have no rights to profits from it, they control any changes to the constitution of the company and will influence the most important decisions made in its name. Members have one vote each. 

1. CRS page 57 paragraph (D)(6)  – The term “Controlling Persons” means the natural persons who exercise control over an Entity. 
2. The term “Controlling Persons” must be interpreted in a manner consistent with the Financial Action Task Force Recommendations. 
3. CRS Commentary page 198 paragraph 132 – For an Entity that is a legal person, the term “Controlling Persons” means the natural person(s) who exercises control over the Entity.
4.  “Control” over an Entity is generally exercised by the natural person(s) who ultimately has a controlling ownership interest in the Entity. A “control ownership interest” depends on the ownership structure of the legal person and is usually identified based on a threshold applying a risk-based approach, e.g. any person owning more than a certain percentage of the legal person, such as 25%. Where no natural person(s) exercises control through ownership interests, the Controlling Person(s) of the Entity will be the natural person(s) who exercises control of the Entity through other means. Where no natural person(s) is identified as exercising control of the Entity, the Controlling Person(s) of the Entity will be the natural person(s) who holds the position of senior managing official.

Members of the CLG are the Controlling Persons 

As the guarantors of the CLG, otherwise known as members, they control the entity through their voting, and thus they are the controlling persons of the CLG, even if they are not entitled to any profits (e.g. for a charity). This is standard throughout the world in the beneficial owner registers for companies limited by guarantee. Don’t think that hybrid companies limited by guarantee such as the Turk and Caicos hybrid TLC which has a genuine shareholder as well, changes anything here

What if the members are each under 25%?

The Financial Action Task Force (FATF) is an independent inter-governmental body that develops and promotes policies to protect the global financial system against money laundering, terrorist financing and the financing of proliferation of weapons of mass destruction.  The FATF Recommendations are recognised as the global anti-money laundering (AML) and counter-terrorist financing (CFT) standard. For more information about the FATF, please visit www.fatf-gafi.org

The application of an ownership threshold is not the only way that beneficial ownership should be determined under the FATF definition, which encompasses both concepts of ownership and control over a legal person. The following considerations may also be relevant: 

• Differential voting rights: Different classes of shares may give certain shareholders more control than others, for example through differential voting rights. Thus, even a shareholding that falls well below a specified threshold may in fact give a minority shareholder control over the company. Recent reforms in some jurisdictions (UK; Singapore; Hong Kong, China) have made such dual class share arrangements more common. 
• Power to appoint the majority of senior management: Control over a legal person may be exercised if an individual has the power to appoint the majority of senior management directly or indirectly (e.g., if the power is vested in a company which in turn is wholly owned by an individual). However, the right of minority shareholders or certain stakeholders to appoint one representative to senior management does not by itself confer control over a legal person.
• Control through debt instruments: Control can also be exercised through debt instruments or other financing arrangements, for example where a lender or creditor can control a legal person via the provisions of the lending agreement (such as debt that is convertible into voting equity), or by a third party who can otherwise influence a shareholder by means of a financial or other relationship. However, a bank providing financing to a legal person will rarely be considered as exercising control over the legal person by the act per se. 
• Control through positions held within a legal person: Natural persons who exercise substantial control over a legal person and are responsible for strategic decisions that fundamentally affect the business practices or general direction of the legal person may be considered a beneficial owner under some circumstances. Depending on the legal person and the country’s laws, directors may or may not take an active role in exercising control over the affairs of the entity.
• Control through informal means: Furthermore, control over a legal person may be exercised through informal means, such as through close personal connections to relatives or associates. Further, when an individual is using, enjoying or benefiting from the assets owned by the legal person, it could be grounds for further investigation if such individual is in the condition to exercise control over the legal person.35  • However, these cases are harder to detect and will in practice be less relevant with routine collection of beneficial ownership information by a registry, agency, or other body.

Beneficial ownership in respect of different types of legal persons

• Companies without shares: Beneficial owners of companies that do not issue shares will not be captured by any ownership threshold expressed in share ownership. This includes for example non-stock companies in the United States, or companies limited by guarantee in Britain. These types of companies are commonly used by not-for-profit entities, but they can also be used by forprofit entities. Furthermore, companies may be able to switch from stock to non-stock, or vice versa. In some cases, companies without shares have been marketed by TCSPs (Trust and Company Service Provider) as a means to defeat beneficial ownership disclosure and tax rules applicable to a foreign company that is either directly or indirectly controlled by a resident taxpayer (generally known as Controlled Foreign Company). These entities would require an alternative approach (in looking into control of the entity) for determination of beneficial ownership through ownership. 
• Partnerships: Limited and unlimited liability partnerships have legal personality distinct from their partners, but in some countries, they do not have shares and are thus not captured by any share threshold. In some countries (e.g., British Virgin Islands) those forming a partnership can choose whether or not the partnership will have legal personality. In the absence of a share threshold, an individual can have control over a partnership if he/she has the right to exercise (or actually exercises), significant influence over the running of the activities of the partnership. This could include, for example, the right to appoint or remove any partner, to direct or veto the investment decisions, profit share or capital returns of the partnership’s funds or assets, to direct amendments to the partnership’s constitutional documents (e.g., the partnership agreement) or to dissolve or convert the partnership.  
• Foundations: A variety of other legal persons have legal personality but are not companies and do not have shares, and hence will not be captured by any share threshold. This requires an alternative approach (in looking into control of the entity) for determination of beneficial ownership. For example, foundations have no owners and are controlled by a board. Where foundations are similar to trusts, individuals holding the positions of founders, beneficiaries and members of the management may be considered to exercise control over the foundation. Furthermore, an individual can have control if he/she has the right to exercise (or actually exercises) significant influence over the running of the activities of the foundation. This could include, for example, the right to appoint or remove any of the board members, to direct or veto the distribution of the foundation funds or assets or its investment decisions, to wind up or convert the foundation.

Beneficial Ownership through Control/Other Means (“beyond the threshold”)

The application of an ownership threshold is not the only way that beneficial ownership should be determined under the FATF definition, which encompasses both concepts of ownership and control over a legal person. The following considerations may also be relevant: 

• Differential voting rights: Different classes of shares may give certain shareholders more control than others, for example through differential voting rights. Thus, even a shareholding that falls well below a specified threshold may in fact give a minority shareholder control over the company. Recent reforms in some jurisdictions (UK; Singapore; Hong Kong, China) have made such dual class share arrangements more common. 
• Power to appoint the majority of senior management: Control over a legal person may be exercised if an individual has the power to appoint the majority of senior management directly or indirectly (e.g., if the power is vested in a company which in turn is wholly owned by an individual). However, the right of minority shareholders or certain stakeholders to appoint one representative to senior management does not by itself confer control over a legal person. 
• Control through debt instruments: Control can also be exercised through debt instruments or other financing arrangements, for example where a lender or creditor can control a legal person via the provisions of the lending agreement (such as debt that is convertible into voting equity), or by a third party who can otherwise influence a shareholder by means of a financial or other relationship. However, a bank providing financing to a legal person will rarely be considered as exercising control over the legal person by the act per se. 
• Control through positions held within a legal person: Natural persons who exercise substantial control over a legal person and are responsible for strategic decisions that fundamentally affect the business practices or general direction of the legal person may be considered a beneficial owner under some circumstances. Depending on the legal person and the country’s laws, directors may or may not take an active role in exercising control over the affairs of the entity.  
• Control through informal means: Furthermore, control over a legal person may be exercised through informal means, such as through close personal connections to relatives or associates. Further, when an individual is using, enjoying or benefiting from the assets owned by the legal person, it could be grounds for further investigation if such individual is in the condition to exercise control over the legal person.
• However, these cases are harder to detect and will in practice be less relevant with routine collection of beneficial ownership information by a registry, agency, or other body.  

What about loans from CLGs?

Often the reason why most companies are set up as limited by shares, is that the shareholders have the right to share in the profits of the company, by way of receiving a dividend payment. With companies limited by guarantee, any profits stay in the company and are not paid to members.

Members not being able to take a profit from the company work well for non-profit organizations such as charities, clubs, and property management companies.  These organizations operate to benefit a particular group, or for a charitable purpose, and do not intend to distribute profits to members.

It is less likely to be used by a normal trading business, as profits cannot be distributed to members by way of a dividend.

What about a loan to non-guarantors? What’s the collateral?

It makes no sense if someone is just trying to circumvent CARF / CRS.  The structure is still reportable and not invisible CRS Commentary page 200 Par 39  139. A person, other than a Financial Institution, holding a Financial Account for the benefit or account of another person as agent, custodian, nominee, signatory, investment advisor, intermediary, or legal guardian, is not treated as holding the account according to subparagraph E(1). Instead, such other person is treated as holding the account. For these purposes, a Reporting Financial Institution may rely on information in its possession (including information collected pursuant to AML/KyC Procedures), based on which it can reasonably determine whether a person is acting for the benefit or account of another person.

Some insurers allow a client to set up a charitable CLG which settles a trust or subscribe directly for a policy

The trust then subscribes to a cash value policy which pays out the member’s family upon death. The CLG is an Active NFE charity if it’s an NFE that meets all of the following requirements:

1. it is established and operated in its jurisdiction of residence exclusively for religious, charitable, scientific, artistic, cultural, athletic, or educational purposes; or it is established and operated in its jurisdiction of residence and it is a professional organization, business league, chamber of commerce, labor organization, agricultural or horticultural organization, civic league or an organization operated exclusively for the promotion of social welfare; 
2.  it is exempt from income tax in its jurisdiction of residence; 
3. it has no shareholders or members who have a proprietary or beneficial interest in its income or assets; 
4. the applicable laws of the NFE’s jurisdiction of residence or the NFE’s formation documents do not permit any income or assets of the NFE to be distributed to, or applied for the benefit of, a private person or noncharitable Entity other than under the conduct of the NFE’s charitable activities, or as payment of reasonable compensation for services rendered, or as payment representing the fair market value of property which the NFE has purchased; and 
5. the applicable laws of the NFE’s jurisdiction of residence or the NFE’s formation documents require that, upon the NFE’s liquidation or dissolution, all of its assets be distributed to a Governmental Entity or other non-profit organization, or escheat to the government of the NFE’s jurisdiction of residence or any political subdivision thereof.
6. The use of a charitable CLG to buy an insurance policy directly or indirectly which will pay out mortality cover to the member’s family ensures the condition number (iv) above for CRS charitable status is broken.

Therefore the CLG is not a charity Active NFE for CRS purposes. It may still be a charity in its domestic jurisdiction for tax purposes, but it is not an Active NFE type charity for CRS purposes.

Summary

Firstly, it seems that some FIs are confusing the term beneficial owner with controlling persons, which are the members. 

Secondly, although CLGs are usually established as charities, the use of CLGs to buy insurance which pays out individual beneficial owners revokes its status as an Active NFE charity for CRS purposes.