Entity classification determines the extent of CARF reporting obligations. Correctly classifying entity users is essential for proper due diligence and reporting.

Why Classification Matters

The classification of an entity determines:

  • Whether the entity itself is reportable
  • Whether controlling persons must be identified
  • What information must be collected
  • Reporting format and content

Entity Types

CARF recognizes three main entity categories:

Financial Institutions

Entities primarily engaged in financial activities:

  • Banks and custodial institutions
  • Investment entities
  • Insurance companies (certain types)
  • Other CASPs

Generally not reportable as users (they have their own reporting obligations).

Active Non-Financial Entities (Active NFEs)

Entities primarily engaged in active business:

  • Less than 50% of income is passive
  • Less than 50% of assets produce passive income
  • Publicly traded companies
  • Government entities
  • Holding companies of active subsidiaries

Only the entity is reported—not controlling persons.

Passive Non-Financial Entities (Passive NFEs)

Entities with primarily passive income or assets:

  • 50% or more of income is passive (dividends, interest, rents, royalties)
  • 50% or more of assets produce passive income
  • Investment holding companies
  • Trusts with passive income

Both the entity AND controlling persons are reported.

Passive NFE Impact

Passive NFE classification triggers significant additional due diligence requirements. All controlling persons must be identified and their tax residency determined.

Active vs Passive NFE

The active/passive distinction is crucial. Key tests:

Income Test

Calculate percentage of gross income that is passive:

  • Dividends and interest
  • Rents and royalties (unless active business)
  • Gains from financial asset sales
  • Insurance and annuity income

Asset Test

Calculate percentage of assets producing passive income:

  • Investments in securities
  • Rental properties (unless active management)
  • Cash and cash equivalents
  • Loans and receivables
50% Threshold

If either passive income OR passive assets exceed 50%, the entity is classified as Passive NFE. The test is applied to the preceding calendar year or fiscal year.

Financial Institutions

Identifying Financial Institution status:

  • Licensed banks and investment firms
  • Registered investment funds
  • Entities managing financial assets for others
  • CASPs themselves

Classification Process

  1. Obtain self-certification of entity type
  2. Review supporting documentation
  3. Apply income and asset tests
  4. Confirm classification is reasonable
  5. Collect controlling person information if Passive NFE
  6. Document classification rationale

Conclusion

Accurate entity classification requires careful analysis. When in doubt, treating an entity as Passive NFE ensures all required information is collected.

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