Undoubtedly the Consumer Financial Protection Bureau (CFPB) will continue to publish guidance for years to come as the Section 1071 rules become effective and financial institutions begin to work through implementing the small-business lending rules. Recently, however, the CFPB published a series of Frequently Asked Questions (FAQs) specifically aimed at the Section 1071 topics of Institutional Coverage (14 FAQs) and Covered Credit Transactions and Small Businesses (7 FAQs).
Among the concepts discussed in the FAQs are consumer credit used for business purposes and sole proprietorships. According to the FAQs, an extension of consumer-designated credit is not a covered credit transaction, even if the funds are used for business purposes. An extension of credit is considered to be âconsumer-designatedâ if it is extended primarily for personal, family, or household purposes. Therefore, an extension of credit used for both personal and business purposes is not considered to be for business purposes unless the financial institution designates it as business purpose credit, meaning its primary purpose is for a business purpose.
A covered credit transaction is an extension of business credit that is not excluded pursuant to the small business lending rule. For this purpose, âbusiness creditâ includes credit used primarily for an agricultural purpose as well as credit primarily used for a business or commercial purpose. Thus, covered credit transactions include loans, lines of credit, credit cards, merchant cash advances, and other credit products used primarily for agricultural, business, or commercial purposes. However, factoring, leases, and consumer-designated credit are some examples of transactions that are not covered credit transactions because they do not satisfy the definition of business credit.
An individual or sole proprietorship can be considered to be a small business pursuant to the small business lending rule, and this is true regardless of whether the individual has formed an entity under applicable state law, whether the individual is doing business in the individualâs own name, or whether the individual is doing business using a trade name, such as a DBA. An individualâs personal income is not included when calculating a sole proprietorshipâs gross annual revenue because it is not revenue earned by the for-profit business applying for an extension of credit. Gross annual revenue for these purposes is the amount of money earned by the business itself, before subtracting taxes and other expenses.
A business is a small business for purposes of the small business lending rule if its gross annual revenue for its preceding fiscal year was $5 million or less. If a new or recently started business did not operate in the preceding fiscal year (and thus did not have gross annual revenue for its preceding fiscal year) and does not have affiliates with gross annual revenue exceeding $5 million in their preceding fiscal year, the new or recently started business is considered to be a small business under the small business lending rule.
If a new business states that its gross annual revenue exceeds $5 million and the financial institution does not verify gross annual revenue, the business is not considered to be a small business. However, if the financial institution obtains gross annual revenue information or verifies gross annual revenue, it must determine if the business is a small business based on the updated or verified information.
The questions on Section 1071 do not end here, and many more questions are likely to arise as we get closer to implementation. Feel free to reach out to us on the hotline if you have any questions about Section 1071 or small business data collection.