State and Local Tax Alert - February 2017

February 2017

Delaware Landmark Unclaimed Property Legislation as Remedy to Holding in Temple Inland v Cook with Eye Towards Friendly and Fair Compliance


On January 26, 2017, S.B. 13 was passed by both houses, and signed by Governor John Carney Jr. on February 3, 2017.  The bill makes numerous prospective changes to Delaware’s unclaimed property laws.  In essence, Delaware seeks to scrap its previous unclaimed property statute and replace it with a newer model act version with significant modifications.  Specifically, S.B. 13 enacts significant changes to Delaware’s unclaimed property audit and Voluntary Disclosure Agreement (“VDA”) program rules, including provisions permitting certain holders currently under audit to convert their audit to a Delaware Secretary of State (“SOS”) VDA filing or an expedited audit program.  S.B. 13 also changes the look-back periods for both audits and VDA filings.  The bill also authorizes the Delaware Department of Finance (“DOF”) to initiate compliance reviews upon receipt of unclaimed property reports and makes changes to the administrative review process for audit findings.  Finally, the bill adopts record retention requirements, enacts a statute of limitations period that matches the record retention period, includes due diligence letter requirements for holders, and directs the DOF and SOS to promulgate consistent regulations for unclaimed property administration, among other changes.


Significant Changes to Unclaimed Property Audits and VDAs
Audit Program:
Under S.B. 13, holders currently under audit with the DOF would be afforded several options which are highlighted in the chart below: 
 Option  Audit Notice  Issue Date  Look-Back  Period  Time to  Complete  Penalty &  Interest  Notification
 Notification  Deadline
 Convert to  SOS VDA  On or before  7/22/15 10 report years prior to the year holder received original audit notice  2 years +  extensions  Waived  SOS and DOF  notification  required  60 days from  adoption date  of regulations  under 1180(b)
 Expected date  to be on or  after 7/1/17
 Enroll in  DOF  Expedited  Audit Any examination authorized by the DOF up to the effective date of S.B. 13 10 report years prior to the year holder received original audit notice[1]  2 years  Waived[2] DOF notification required  60 days from  adoption date  of regulations  under 1180(b)
 Expected date  to be on or  after 7/1/17
 Remain in  DE DOF  Regular  Audit  N/A 10 report years prior to year holder received original audit notice[3]  Ongoing DOF has discretion to waive 50% of interest and any penalties for “good cause”  N/A  N/A
The conversion of audits to VDAs also presents certain unanswered questions that are important to the conversion process, and are expected to be answered by summer 2017.  For example, it is unclear whether a holder may convert in part, or must convert in whole.  This issue is of importance to holders that may be close to closing out audit examinations on certain property types, while other property types have not begun testing or are in preliminary stages of audit review.  The same question is also raised with respect to legal entities that are close to completion versus other entities that are in beginning stages of review. 
The second issue relates to the uncertainty regarding the process for securing and sharing full and complete data secured by third party audit firms in the course of the audit with the holder and SOS VDA representatives.  Some of these third party audit firms do not maintain records uploaded by holders to their portal sites after a certain period of time under their own firm record retention policies.  If this is the case, are these records available somewhere other than the auditor, or do holders have to reproduce all of this information?  Is this process automatic, or does a holder have to file a FOIA request to get the records?
Thirdly, holders that convert to VDA face another issue as to whether they will be required to follow the same process or rulings maintained by the auditor, or if there is flexibility for adjustments or changes in approach where appropriate?  This issue is of particular importance, especially with respect to base period years that in some cases were selected by the third party auditor, even though the holder could not research all records within that period. 
Finally,  holders that are in multi-state audits with a third party auditor face another issue on how they will handle other piggy-backed participating audit states as part of their decision to convert or not.  Logically, the holder would seek to comply with these state audits contemporaneously as they progress through the DE VDA they just converted into.  This begs the question whether such third party audit firms are even necessary for such compliance.  These and other questions will need to be addressed in evaluation of aforementioned options under S.B. 13.
VDA Program:
Similarly, S.B. 13 modifies the VDA look-back periods.  While the bill is somewhat convoluted in this regard, a representative of the SOS office confirmed the filing types and filing periods in summary fashion, below:
 Type  VDA Look-Back Period
 Open VDA with SOS or  DOF past 7/1/16

 1/1/xx, 10 report years (10 plus 5 years for 15 transaction years) prior to the  year in which the DE VDA-1 Form was accepted by DE SOS or DE DOF
VDA Closed with SOS or  DOF by 7/1/16
 1/1/96 – forward (transaction years)
DE DOF VDA Converted  to DE SOS VDA
 (permission required)
 10 report years (10 plus 5 years for 15 transaction years) prior to the year  in  which the originally filed DE VDA-1 Form was accepted by DE DOF
S.B. 13 generally would also provide that the SOS may not accept a VDA filing for holders that: (a) have previously withdrawn from the VDA program, (b) were previously removed from the VDA program by the SOS, or (c) received an audit notice. 
Additionally, S.B. 13 provides that “…the Secretary of State shall possess full and complete authority to determine and resolve all such claims consistent with this chapter and exercise such authorities as are granted to the State Escheator under this chapter…”  This language suggests that the SOS has the power to “settle” escheat issues and matters in its sole discretion so long as consistent with the law.  While the bill also seeks for consistency amongst the SOS and DOF, it may be possible now to get resolve on certain issues in the SOS VDA program that historically would have had to been approved by DOF before resolution.
Interest and Penalty Changes
S.B. 13 makes several interest and penalty provisions, including the following:
 Type of Interest/Penalty  Details  Discretionary Waiver
Unpaid property interest (mandatory  unless otherwise waived within the  statute)
 0.5% per month, maximum of 50%  of unreported property   Yes, up to 50%[4]
 Failure to report penalty  
5% per month, maximum of 50% of  unfiled amounts, or civil penalty of  $100 per day not to exceed $5,000
  Yes, in whole or in part
 Failure to pay penalty
 0.5% per month, maximum of 25%  of unfiled amounts
  Yes, in whole or in part
 Fraudulent filing penalty
 75% of the amount not paid or filed  due to fraud
  Yes, in whole or in part
 Evasion of unclaimed property law  penalty  
Civil penalty of $1,000 per day,  maximum of $25,000, plus 25% of  the amount not filed due to the  intent to evade unclaimed property  laws
  Yes, in whole or in part

Compliance Provisions
S.B. 13 also makes several compliance-related provisions that are important and could make compliance more burdensome for some holders in the future.  Particularly, the DOF compliance review process will permit the DOF to review the contents of a holder’s report or inquire regarding the non-filing of a report to determine if the holder underreported.  DOF must notify the holder of any deficiency in writing within one year from the authorization of the compliance review.  S.B. 13 permits the holder 90 days to pay the deficiency or risk DOF judicial action or referral to the SOS for entry into the SOS VDA program.   Moreover, holders will be required to comply with due diligence letter requirements.  Under the bill, holders are required to initiate due diligence if a holder maintains a valid mailing address for owners of unclaimed property where the amount is $50 or more (due diligences letters are required for unclaimed securities of all amounts).  Given the above, holders should review their process for unclaimed property compliance and adopt best practices for maintaining raw data to support filings, including A/R aging reports, check registers, etc. 
Statute of Limitations & Record Retention Periods
Additionally, the bill provides certain rules around the statute of limitations and record retention.   Holders are required to retain supporting records for 10 years after the date a report was filed.  Similarly, a statute of limitation period prohibits the DOF from initiating an audit more than 10 years after the duty to report the property arose (unless the holder is already under audit or filed a fraudulent report).  Accordingly, it is important to note that the Bill defines the term “record” as “…information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.” 
Moreover, Section 1139 of the bill defines “address of owner to establish priority” as “…the last-known address of an owner is a description, code, or other indication of the location of the owner on the holder’s books and records which identifies the state of the last-known address of the owner.”
These two definitions should be read in tandem with Section 1179 of the bill, which establishes that the DOF need only show evidence of an unpaid debt or undischarged obligation and passage of the requisite period of dormancy or presumed abandonment as prima facie evidence of unclaimed property.  A holder may overcome the burden of proof by establishing by a preponderance of the evidence that the obligation is no longer owed under one of six criteria listed in the bill.
There are three important takeaways from the above: (a) the Delaware look-back period on audit would extend to 15 transaction years (ten year audit limitation period, plus five year dormancy period), (b) a “record” as defined may not have to be both “available and researchable,” and (c) “address of owner to establish priority” appears to only need be sufficient to indicate the state of the apparent owner, not the apparent owners full mailing address.  
Thus, holders incorporated in Delaware will need to review their corporate record retention policies and conform to a 15 year retention period, as appropriate.  Likewise, holders should pay particular attention to what records are provided to the state to ensure that they can be researched appropriately.  The “record” term as defined in the Bill may encourage stronger audit requests, demands, and potentially subpoenas for address based records for longer base periods.  The result of which, if not researchable, could create much higher Delaware extrapolation rates and higher exposures to other participating states in the audit.  Moreover, holders should ensure that electronic and manual records maintain at a minimum “state” field or related code, indicator or description relating to a “state” in order to establish most accurate first priority rule property. 
Program Administration, Estimation, & Appeal Provisions
In an effort to create predictability and consistency in administration of VDAs and audits, the bill requires that the DOF and SOS promulgate consistent regulations regarding the administration of unclaimed property on or before July 1, 2017.[5]  While it is unclear what the exact regulations will provide, it should be noted that the SOS has published Implementing Guidelines, dated February 11, 2014, that provide many of the guiding principles for the administration of current VDA program.  The provisions in the Implementing Guidelines could serve as the basis for such regulations in whole or in part. 
While certain aspects of estimation methodologies are addressed in S.B. 13, it appears to require the SOS and DOF to address more specifically which items are to be included in the numerator of the extrapolation fraction and those included in the denominator of the fraction.  It is expected that the “gross method” of extrapolation and corresponding indemnification provisions under 12 Del. Code Section 1203 that have been used in the past will continue to be used in current and prospective audits and VDAs. 
Finally, S.B. 13 repeals the current internal administrative appeals process and permits holders under audit to file an action against the State Escheator in Chancery Court within 90 days after the date on which a DOF statement of findings is mailed.  Depending on a holder’s position in the audit process, certain holders may be required to exhaust administrative remedies applicable under the former process repealed by S.B. 13, while others do not.[6]  
Additional Provisions Included in S.B. 13
S.B. 13 contains various other changes that are related but not limited to definitions, the administration of unclaimed property for insurance companies, rules on use of third party audit firms, and provisions on the issuance of a subpoena duces tecum (a legal demand for documents) to holders in the course of an audit.

BDO Insights

As holders review the potential impact of S.B. 13 as applied to their current Delaware escheat posture, there are many things to consider and a number of questions to be answered: 
  • Most importantly, within 60 days of the passing of the regulations (expected to be some time after July 1, 2017), holders that are currently under audit must consider their options, as laid out above, and determine what course of action fits best with their current escheat posture, risk profile, etc.  It appears that a holder does not forgo any of its legal remedies at law (e.g, protest assessment in court, etc.) should it disagree with the state under any option, unless a final settlement is executed in a VDA, expedited audit, or regular audit.
  • Conversely, for holders that are not currently under audit and are VDA eligible, S.B. 13 will limit the look-back period to 15 transaction years and will continue to provide Section 1203 indemnification against claims by others on paid in amounts.[7]  Moreover, the Implementing Guidelines that are likely to be further revised under the Bill should provide even clearer guidance with respect to VDA expectations and processes for holders.  A holder that has received an invitation to participate in the DE VDA program should evaluate doing so before the expiration of its 60 day period.  Otherwise, the holder risks an audit with associated penalties and interest. 
  • Finally, all holders that are incorporated in Delaware or engage in business there should evaluate new guidelines and procedures relating to their annual unclaimed property compliance program.  Given the new “compliance review” program, holders will need to get ready to support their annual Delaware unclaimed property filings with raw data sources to avoid burdensome annual compliance reviews or referral to the SOS VDA program for single year periods.
Notwithstanding the above, and while an exhaustive analysis of all potential issues or questions presented by S.B.13 cannot be addressed here, BDO’s National Unclaimed Property Team of 20 plus professionals have extensive experience working with countless companies under DOF audits and has assisted more than 75 holders reach reasonable settlements under the Delaware VDA program.  Please contact one of the BDO contacts listed below to discuss any questions you have concerning unclaimed property and escheatment, how S.B. 13 may impact your company, and best practices for dealing with your escheat issues. 

For more information, please contact one of the following regional practice leaders:

West:   Atlantic:
Rocky Cummings
Tax Partner

  Jeremy Migliara
Tax Managing Director

Paul McGovern
Tax Managing Director
  Jonathan Liss
Tax Managing Director

Northeast:   Central:
Janet Bernier 
Tax Partner

  Angela Acosta
Tax Managing Director

Matthew Dyment
Tax Principal

  Nick Boegel
Tax Managing Director


  Joe Carr
Tax Principal

Ashley Morris
Tax Managing Director

  Mariano Sori
Tax Partner

Scott Smith
Tax Managing Director

  Richard Spengler
Tax Managing Director

Tony Manners
Tax Managing Director


Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
[1] Upon effective date of S.B. 13.
[2] All requests for records must be made by the auditor within 18 months, with an examination report provided within 2 years from the date the holder notified the DOF and SOS.  If the holder does not cooperate, the State Escheator can impose penalty and interest.  This DOF determination regarding holder cooperation is subject only to the review of the Secretary of Finance.
[3] Upon effective date of S.B. 13.
[4] S.B. 13 also specifically provides that interest shall be waived in full for property paid under SOS VDAs, and DOF audits and VDAs if paid by July 1, 2017.  For holders not covered by this group, the statute also provides for waiver where “good cause” is presented, however this term is not defined in the Act.
[5] Regulatory process will allow for a public commenting on the regulations by holder community. 
[6] It should be noted that notwithstanding the changes to the appeal process in S.B.13, holders may also have the option of directly filing an action in Federal District Court.  See Temple-Inland, Inc. v. Cook, No. 14-654-GMS (D. Del. June 28, 2016). 
[7] Section 1203 should also apply in audits and expedited audits as well.