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November 22, 2017

The Delaware Secretary of State (SOS) announced on September 29, 2017, that the Department of State will begin mailing notices to holders who have been identified as potentially non-compliant with Delaware unclaimed property laws. The notice requires holders to enter into the SOS’s Voluntary Disclosure Agreement (VDA) program within 60 days of the mailing of such notice or be referred to the State Escheator at the Department of Finance (DOF) for examination. Subsequently, on October 1, 2017, the DOF issued the anticipated finalized new unclaimed property examination regulations, which took effect on October 11, 2017, triggering a 60-day deadline for a qualified holder, currently under audit, to convert from an audit to either an expedited audit or a VDA.

Holders (including those qualified and currently under audit by the DOF or likely to be in receipt of the SOS’s forthcoming notice) have a relatively short timeframe to determine their procedural route for handling any potential historical unclaimed property risks. Accordingly, holders must be informed of the new legislation and should consult with unclaimed property advisors regarding their options for historical risks. This edition of Tax Advisor Weekly highlights (i) what led to the reform, (ii) key changes to Delaware’s unclaimed property laws and examination regulations, (iii) controversial examination policies and procedures that still exist despite new legislation and (iv) pros and cons of entering into a VDA or expedited audit.

Leading Up to Reform

“Priority rules” established by the U.S. Supreme Court provide that where the residence of the rightful owner of unclaimed property cannot be determined, the holder must remit such property to the holder’s state of incorporation. Because many companies are formed or incorporated in Delaware, unclaimed property has been a large revenue source for the state. Thus, Delaware has been one of the more aggressive states in the application and administration of its unclaimed property laws.

In 2016, Delaware came under fire for its aggressive unclaimed property audit practices in Temple-Inland Inc. v. Cook (192 F.Supp.3d 527 (D. Del. 2016)). The court primarily took issue with the state (i) waiting 22 years to audit the company and issuing an assessment for a 17-year lookback period, (ii) failing to provide a reasonable explanation for applying the state’s estimation methodologies retroactively, (iii) calculating an estimate on a 50-state basis and claiming the full amount for Delaware for periods where records did not exist (instead of limiting the extrapolation to only Delaware property), (iv) failing to give notice of its record retention requirements and (v) subjecting the company to potential multiple liability. The court determined that Delaware’s practices in Temple-Inland were so unconscionable that it raised a substantive due process violation.

Also in 2016, the Uniform Law Commission, an organization responsible for drafting and approving model legislation for uniformity purposes among the states, approved a new version of the Revised Uniform Unclaimed Property Act (RUUPA). As a result of both the Temple-Inland decision and the approval of RUUPA, Delaware began drafting its comprehensive legislative unclaimed property reform.

What Are the Significant Changes to Delaware’s Unclaimed Property Laws?

The Delaware Governor signed Senate Bill 13 (SB13) and Senate Substitute 1 for Senate Bill 79 (SS1/SB79) into law on February 2, 2017 and June 29, 2017, respectively. These laws amended Chapter 11 of Title 12 of the Delaware Code Related to Abandoned and Unclaimed Property. Prior to adoption of the DOF unclaimed property examination regulations (referred to here as the “DOF Regulations”), draft regulations were issued and made available for public comment in April 2017 and August 2017. (Note that SS1/SB79 primarily provided extensions for effective date requirements established in SB13. In addition, SS1/SB79 clarified rules regarding penalty and interest waivers. The DOF Regulations are substantially similar to the draft regulations issued in April 2017 and August 2017.)

The Starting Point: Overview of SB 13 and SS1/SB79

The passage of SB13 and SS1/SB79 brought about the following important changes to Delaware unclaimed property laws:

  • Statute of Limitations: The lookback period of all VDAs was reduced to 10 report years (establishing a 10-year statute of limitations), except in instances of willful or fraudulent reporting.
  • Record Retention: A 10-year record retention requirement was adopted, to be consistent with the statute of limitations period.
  • Audit to VDA Conversion: Companies currently under audit (commenced on or prior to July 22, 2015) can convert their audit into a VDA by notifying the State Escheator and the SOS of their intent within 60 days of the adoption of the DOF Regulations. (After the 60 days have expired, the SOS has no legal authority to accept a holder into the program.)
  • Expedited Audits: A company receiving a notice or currently under audit (commenced on or prior to February 2, 2017) is eligible for an expedited audit review process. The expedited process requires that the State Escheator issue an audit examination report within two years from the receipt of the holder’s written request, if the holder provides written request to the State Escheator within 60 days of the adoption of the DOF Regulations.
  • Interest and Penalties: The DOF has the ability to impose (i) interest on any late-filed unclaimed property and (ii) an additional civil penalty on any holder that enters into a contract or agreement for purposes of “evading an obligation under the law or otherwise willfully fails to perform a duty imposed under the law.”

Next Steps: DOF Regulations

Notable aspects of the DOF Regulations include:

  • Record Retention: The statutory record-retention requirement includes the “date, place, and nature of the circumstances that gave rise to the property right.” The regulations list various documents to be retained. In addition, upon request by the holder, Delaware will provide records of all previously filed Delaware unclaimed property reports.
  • Notice of Examinations/VDAs: A “Notice of Examination Letter” terminates the holder’s ability to enter into a VDA with Delaware until the examination is concluded. The regulations provide exceptions to the statute’s requirement that the State Escheator must notify a holder that they may enter into a VDA prior to initiating any new unclaimed property examination. Specifically, notification is not required if the holder provided false or fraudulent claims or is under a joint examination initiated by another state after consultation with the SOS.
  • Examination/Lookback Period: The lookback period is 10 report years (i.e., 10 years plus the dormancy period) from the date the holder receives an audit notification letter, unless otherwise agreed upon. A standard examination should be completed within 24 months, and if it is anticipated to go beyond that period, the audit manager is required to meet with the holder to expedite the process. Finally, the State Escheator has the authority to consider a holder’s proposed alternative calculations on a case-by-case basis.
  • Expedited Examinations: Certain holders may have the option of expediting the completion of a pending examination. The state shall publish a form “Intent to Expedite Completion of Examination,” which shall outline the expectations of the holder in that circumstance.
  • Abatement of Penalties and Interest: The State Escheator, in making the determination of “good cause shown” for purposes of interest and penalty abatement, may consider (i) whether the holder has a significant history of filing unclaimed property reports, (ii) the responsiveness of a holder during the exam and (iii) whether the holder used ordinary business care in its compliance efforts.
  • Indemnification: Delaware is required, at the holder’s request, to release the holder of all liability and indemnify any categories of the holder’s property where the examination is deemed to be complete from any claims by other states or individuals.

Adopted Legislation in Light of Temple-Inland

The above revisions to Delaware unclaimed property laws provide certain holder-friendly changes and address some concerns raised in Temple-Inland. These changes include guidance on record retention requirements, a shortened lookback period and indemnification from claims made by other states.

However, throughout the drafting process, Delaware’s regulations were criticized for failing to address the state’s problematic estimation techniques (i.e., calculating an estimate on a 50-state basis and claiming the full amount for Delaware for periods where records did not exist (instead of limiting the extrapolation to only Delaware property)). Because these estimation methods remain relatively unchanged in the DOF Regulations, additional challenges and litigation can be expected.

The Choice Between Audit, VDAs, Expedited Audit

For a holder considering a VDA, there are at least two things to consider. First, there are aspects of Delaware’s unclaimed property laws that are controversial and ripe for further litigation, which could affect a holder’s position under examination. Choosing to undergo an audit preserves the holder’s right to raise these legal challenges, whereas by entering into a VDA the holder forfeits the ability to challenge the state on its unclaimed property policies and procedures (e.g., estimation methods). Note that a holder may withdraw from a VDA at any time but would be referred to the State Escheator for examination. Second, VDAs can be costly. The process itself can be cumbersome, and it is generally recommended that a holder hire an unclaimed property specialist.

Despite these drawbacks to VDAs, there are also certain benefits to consider.

Benefits of a VDA

Under audit, there are four categories of penalties that Delaware can impose on a holder. In addition, Delaware can charge monthly interest for unclaimed property reported late (up to 50 percent of the value of the property). While penalties and interest may be waived during an audit, it is not required or guaranteed. Under the VDA program, however, all penalties and interests are automatically waived.

In a VDA, the holder gains more control over the process. Specifically, the holder/unclaimed property advisor can review company records and identify remediation methods in areas of exposure. In an audit, however, the auditor reviews all documentation considered within the scope of the audit with little or no input from the holder.

Benefits of an Expedited Audit

Delaware also offers an expedited audit as a third alternative. Generally, in an expedited audit, the State Escheator provides a schedule indicating the time and manner in which the holder must respond with requests for applicable records. (If the State Escheator determines that the holder has not responded within the time and in the manner established, the State Escheator may terminate the expedited examination, which is only subject to review by the Secretary of Finance.) The schedule also states that all document requests must be made no later than 18 months, and that the examination must conclude within two years, after the written notification. Like the VDA program, penalties and interest are automatically waived under an expedited audit. Unlike the VDA program, a holder retains the right to challenge Delaware’s unclaimed property policies and procedures under audit.

Alvarez & Marsal Taxand Says:

Delaware’s new unclaimed property laws and regulations provide more transparency into the state’s unclaimed property examination process. However, Delaware’s controversial estimation methodologies remain largely unchanged, and challenges to the constitutionality of such methodologies will continue. It also appears that Delaware’s audit-to-VDA conversion offer, which effectively removes a holder’s right to challenge the state’s examination methodologies, is an attempt to reduce potential challenges. Because there are both significant changes and significant unresolved matters in Delaware’s unclaimed property examination process, as well as various pros and cons for entering into a VDA, we recommend that holders carefully weigh their options with the assistance of an unclaimed property advisor.

Disclaimer

The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisers. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisers before determining if any information contained herein remains applicable to their facts and circumstances.

About Alvarez & Marsal Taxand

Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal (A&M), a leading global professional services firm, is an independent tax group made up of experienced tax professionals dedicated to providing customized tax advice to clients and investors across a broad range of industries. Its professionals extend A&M's commitment to offering clients a choice in advisers who are free from audit-based conflicts of interest and bring an unyielding commitment to delivering responsive client service. A&M Taxand has offices in major metropolitan markets throughout the United States and serves the United Kingdom from its base in London.

Alvarez & Marsal Taxand is a founder of Taxand, the world's largest independent tax organization, which provides high quality, integrated tax advice worldwide. Taxand professionals, including almost 400 partners and more than 2,000 advisers in 50 countries, grasp both the fine points of tax and the broader strategic implications, helping you mitigate risk, manage your tax burden and drive the performance of your business.

To learn more, visit www.alvarezandmarsal.com or www.taxand.com

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