On 1 October 2022, Act No. 245/2022 Coll.[1] (hereinafter as the “Amendment”), which is a substantial amendment to Act No. 37/2021 Coll., on the Register of Beneficial Owners, as amended (hereinafter as the “BO Act”), will enter into force.
Generally
The Amendment significantly changes the existing rules for registering the beneficial owner of legal entities and is adopted in response to criticism from the European Commission, which warned the Czech Republic about its insufficient implementation of the EU’s 5th AML Directive.[2],[3] The European Commission has objected to the existing Czech legislation mainly because of the use of an inaccurate definition of beneficial owner and the scope of private entities that have not been obliged to register their beneficial owner.
In response to this criticism, the Czech legislator adopted the Amendment which addresses these concerns and introduces relevant changes to beneficial owner registration, which we would like to inform you about further in this article.
New definition of beneficial owner
A fundamental change in the definition of beneficial owner is the abandonment of the use of the terms “ultimate beneficiary” and “person with ultimate influence” for the use of a single umbrella term “beneficial owner.”
The use of the term “beneficial owner” will reduce the indicative value of the register of beneficial owners as it will no longer be clear whether a particular person is in that position because of his or her benefit from the activities of the legal person or because of his or her influence on its functioning.
Thus, in general terms, a beneficial owner will be “any natural person who ultimately owns or controls a legal person or legal arrangement.”[4] The terms “owns” and “controls” need not be sharply distinguished and should be given an expansive interpretation that is consistent with the lay meaning of the words. In other words, the definition must be interpreted as meaning that the beneficial owner is the person who is in control of a particular legal entity.[5] This general definition is then further elaborated in the amended Section 4 of the BO Act for corporations and in the new Section 5a of the BO Act for foundations, institutes, benefit societies and legal arrangements (trusts).
The beneficial owner of a corporation (i.e., not only a business corporation – e.g., joint-stock company or LLC, but also other types of corporations – e.g., an association, a community of unit owners) according to the amended Section 4 of the BO Act will be a natural person who holds more than 25 % share of the (i) registered capital, (ii) voting rights, or (iii) profits, other own resources or liquidation balance.
Although it is typical that a person will simultaneously hold both a share in the registered capital and a share in the profits and voting rights in the same amount, it is sufficient to meet one of these requirements for the person to be considered a beneficial owner (e.g. if he or she holds a 26% share in the registered capital even though he or she has no voting rights or share in the profits). In the case of a right to a profit share, there must be a legally enforceable right for payment of the profit share, but it does not necessarily have to be a profit share paid to a shareholder – so a silent partner or a member of the executive body with a right to royalties under the executive service contract may also be a beneficial owner. However, the beneficial owner will only be a beneficial owner if this right is of a long-term nature and is not a one-off entitlement.
In addition to the persons mentioned above, persons who exercise a decisive influence in the corporation and who have a shareholding of more than 25 % in the (examined) corporation are also beneficial owners of the corporation. This case is a material extension of the circle of beneficial owners compared to the legislation prior to the Amendment, when a 40% shareholder of a corporation that owns a 26% share in the corporation under examination can now be a beneficial owner (under the previous legislation, the shares would be multiplied among themselves in this case and would not be a beneficial owner).
Decisive influence is exercised by a person who (i) in a corporation can make the decision of the supreme body conform to the his or her will, (ii) is a controlling person in the corporation under the Business Corporations Act,[6] (iii) can appoint or remove a majority of the members of the executive body[7] in a corporation, or (iv) in a corporation other than a business corporation (e.g., an association, a community of unit owners), a housing or social cooperative, an investment fund in the legal form of a SICAV (a joint-stock corporation with variable registered capital), is a member of the executive body or in a similar capacity.[8]
In addition to the above, a natural person who exercises a decisive influence in the corporation by other means may be the beneficial owner of the corporation. Other means may include, for example, the right to appoint more than half of the directors of the corporation, veto power, control through formal or informal agreements, ties to family members, or informal delegation arrangements.[9]
In all the above cases, moreover, this criterion need not be met directly (i.e., the beneficial owner would be only the individual who alone owns, for example, a 35% interest in the LLC), but also indirectly through other persons (i.e., the beneficial owner of Corporation A would include an individual who owns 100% of Corporation C who owns 100% of Corporation B who owns 100% of Corporation A).
For purposes of calculating this indirect interest, multiplication is used in the case of chaining (e.g., an individual has a 40% interest in the profits of Corporation A if such individual has a 100% interest in the profits of Corporation C, which has a 50% interest in the profits of Corporation B, which has an 80% interest in the profits of Corporation A) and addition in the case of branching (e.g., an individual has a total 20% interest in the profits of Corporation A if such individual has a 100% interest in the profits of Corporation C, which has a 100% interest in the profits of Corporation B, which has a 10% interest in the profits of Corporation A, while Corporation C also has a 100% interest in the profits of Corporation D, which also has a 10% interest in the profits of Corporation A).
As a result, the scope of beneficial owners has been expanded to include persons who control a business corporation that owns more than 25 % of the corporation under review. Thus, it is not necessary to have substantive control over the corporation under review (i.e., control), but to meet a formal condition regarding the size of the shareholding (i.e., a shareholding greater than 25 %). Thus, for example, an 80% shareholder of Corporation B that owns a 30% interest in Corporation A may be a beneficial owner of Corporation A, even though he does not control Corporation A indirectly through Corporation B.
The special rules in the new Section 5a of the BO Act for a foundation, institute, charitable company, or legal arrangement (trusts) provide that their beneficial owner is a natural person who exercises decisive influence, which is anyone who can make the executive body’s (or trustee’s) decision conform to its will.
Extension of the scope of persons obliged to register their beneficial owner
The Amendment also significantly changes the scope of persons who do not have to register the beneficial owner because they do not have one.
According to the amended Section 7(1)(a) of the BO Act, the state, a territorial self-government unit (typically a region or a municipality), a voluntary association of municipalities and a contributory organisation of the state or a territorial self-government unit never has a beneficial owner.
Furthermore, a Czech legal entity that meets needs of public interest, is not commercial or industrial in nature, and is predominantly financed by the Czech Republic, a region or a municipality, or in which such entity exercises decisive influence or appoints or dismisses a majority of the members of the executive or supervisory body (hereinafter as a „public benefit legal entity“) does not have a beneficial owner under the amended Section 7(1)(b) of the BO Act.
The Amendment to Section 7(2) of the BO Act lists the types of legal entities that are subject to a rebuttable presumption that they meet the above definition of a public benefit legal entity. These include, for example, public research institutions, state enterprises, state educational legal entities or legal entities established by law. In the case of these entities, the beneficial owner is not registered solely on the basis of a rebuttable presumption that they meet the general definition of a public benefit corporation. It is therefore possible that in certain cases, these entities will not meet the definition and will be obliged to register the beneficial owner. In the event of a dispute as to whether a particular entity meets this definition, the competent regional court will decide according to the new Section 33a of the BO Act, and the court will eventually make an entry in the register that it is a public benefit legal entity.
As a result of these changes, several types of legal entities have dropped out of the list of exemptions from the obligation to register the beneficial owner and therefore the beneficial owner will now be ascertained. These include, in particular, communities of unit owners, trade unions, churches, political parties, or hunting associations. Their beneficial owners will typically be members of the executive body. The legislator mitigates the new obligation to register the beneficial owner imposed on these persons by providing in the amended Section 38 of the BO Act for the automatic entry of members of executive bodies in the register of beneficial owners, whereby the data recorded about natural persons will be taken from the public registers and the register of persons.
Changes in sanctions for failure to register the beneficial owner
According to the current wording of Sections 53 and 54 of the BO Act, a beneficial owner not registered in the register loses the possibility of receiving the share in profits and at the same time cannot exercise the right to vote in the decision-making of the supreme body.
The Amendment provides clarification on the application of these prohibitions to persons who are substitute beneficial owners by virtue of their position as a person in the top management. Until now, it was not clear whether these rules should also apply to them. The Amendment explicitly addresses this ambiguity by providing that the rules do not apply to such persons. Thus, if the unregistered substitute beneficial owner is a person in the top management and is also a shareholder of the legal entity in question with a share and status not constituting the status of a beneficial owner under the amended Section 4 of the BO Act, his failure to be registered is not detrimental and such person may receive profit shares and exercise voting rights.
Furthermore, the Amendment extends the application of the exemption from the suspension of voting rights of a new beneficial owner who has not yet been entered in the register, according to the existing wording of Section 54(3) of the BO Act, for a period of 30 days after the emergence of its beneficial owner status. Thus, the Amendment extends this period from 15 to 30 days to give the new beneficial owner more time to update the information in the register of beneficial owners and to prevent the suspension of voting rights. Previously, if a legal entity was too lax to apply for registration, the new beneficial owner had to wait more than 15 days before he could apply for registration himself, which meant that his voting rights were suspended for a certain period due to the 15-day protection period. This shortcoming is thus remedied by the Amendment by extending this period to twice.
Changes to automatic entries and procedural policies
The Amendment introduces a certain extension of the scope of automatic beneficial owner entries, not only for newly registered persons (e.g., communities of unit owners, political parties), but also for structures of commercial corporations in which decisive influence is exercised on the basis of control. Thus, if there is a corporate structure where there is a presumption of control based on a 40% or greater shareholding, there will be an automatic transcription, even in the case of multiple chained structures. Beyond this, legal entities with a designated substitute beneficial owner or special types of corporations may, under the terms of the new Section 41(3) of the BO Act, request that the automatic entries be conducted for them as well.
In connection with the changes to the definition of beneficial owner, a new interface of the registration system will be implemented as of 1 October 2022, which will reflect the changes made by the Amendment. Thus, new forms will be used for the submission of registration proposals and the system should also have new functions (e.g., generation of a graphical representation of the structure of relationships according to the registration proposal submitted). In this context, a new manual of the Ministry of Justice on the registration of the beneficial owner will be issued, which should further elaborate the regulation of the registration of the beneficial owner according to the Amendment.
“Freezing” of the register in October
The Amendment also contains several transitional provisions governing the entry into the new legal regime and the new format of the registration interface. Applications for registration submitted before 30 September 2022 (i.e., before the Amendment enters into force) will be processed quickly still under the existing legal regime. However, in the period from October 2022, the registration will be frozen, whereby, although new applications for registration will already be processed under the Amendment, registrations under the Amendment will not be made until 1 November 2022 at the earliest. In the meantime, the registration will be transformed to comply with the legal regime of the Amendment, i.e., the existing automatic entries will be updated, new automatic entries will be made under the Amendment and changes in terminology will be automatically taken into account, whereby the concepts of ultimate beneficiary and person with ultimate influence will be replaced by the concept of beneficial owner.
Automatic changes and deadline for modifications
The changes made by the Amendment will thus be reflected to a significant extent in the registration without the need for activity of the registered persons. However, this cannot be fully relied upon, and it is necessary to check whether the registration is conducted in accordance with the Amendment once the system is fully operational in November 2022.
Legal entities that had a correctly registered beneficial owner under the current legal regime have until 1 April 2023 to adjust their registration to comply with the legal regime under the Amendment.
Legal entities that were not required to register the beneficial owner but are required to do so under the Amendment (e.g., communities of unit owners, political parties), also have until 1 April 2023 to ensure that their beneficial owner is registered.
Conclusion
Under pressure from the European Commission, the Czech Republic has adopted an amendment to the Act on the Register of Beneficial Owners that addresses the European Commission’s criticisms. Thus, the Amendment has (i) modified the definition of beneficial owner, (ii) changed the scope of persons deemed to be beneficial owners, (iii) abandoned the use of the concepts of ultimate beneficiary and person with ultimate influence, (iv) expanded the scope of persons who must register the beneficial owner (e.g., communities of unit owners), (v) made changes to the automatic entries and registration procedures, and finally, (vi) modified the penalties for failure to register a beneficial owner.
However, it cannot be concluded that the legislative development of the registration of the beneficial owner has ended by this Amendment and that the legislation in this respect should not be changed in the future. In fact, a draft EU regulation is already being drafted at the European Commission, which is intended to regulate the registration of the beneficial owner in an EU-wide and binding manner. In the context of this future EU system, the method of registering the beneficial owner and the related obligations for registered persons will undoubtedly change. Given the existing draft of this regulation, it can be expected that further changes to beneficial ownership registration are likely to take place within two to three years.
We are at your disposal in case of any questions concerning the issues of the Act on the Register of Beneficial Owners, its current Amendment, the correctness of the entries made in the register of beneficial owners or the area of beneficial owners’ registration in general. Please do not hesitate to contact us.
Mgr. Martin Heinzel, senior attorney – heinzel@plegal.cz
Mgr. Tomáš Jančar, junior lawyer – jancar@plegal.cz
12.09.2022
[1] Act No. 245/2022 Coll., amending Act No. 37/2021 Coll., on the Register of Beneficial Owners.
[2] Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purpose of money laundering or terrorist financing and Directives 2009/138/EC and 2013/36/EU (hereinafter as the “5th AML Directive”).
[3] See the explanation of the necessity of the proposal in the Explanatory memorandum to Act No. 245/2022 Coll.
[4] Section 2(c) of the amended version of BO Act.
[5] See the special part of the Explanatory memorandum to Act No. 245/2022 Coll., points 1 and 2 [§ 2(c) to (e)].
[6] Section 74 et seq. of Act No. 90/2012 Coll., on Commercial Companies and Cooperatives (Business Corporations Act), as amended.
[7] This is a rebuttable presumption, so it can be proven that due to the specific situation in the corporation, such a person does not have decisive influence despite this fact.
[8] It is also a rebuttable presumption.
[9] According to the 5th AML Directive, the definition of control by other means is based on Article 22(1) to (5) of Directive 2013/34/EU of the European Parliament and of the Council of 26 June 2013 on the annual accounts, consolidated accounts and related reports of certain types of undertakings, amending Directive 2006/43/EC of the European Parliament and of the Council and repealing Council Directives 78/660/EEC and 83/349/EEC.