Delaware Has Issued New Regulations for Unclaimed Property Audits – Some Provisions May Perpetuate the Procedures That “Shocked the Conscience” of a Federal Judge
And What About Legislative Changes For Other States’ Unclaimed Property Reporting?
By: Karen T. Syrylo, CPA
On April 1 (no fooling), the Delaware Department of Finance and the Delaware Secretary of State working collaboratively proposed rules and regulations to revise the current Voluntary Disclosure Agreement (VDA) Program and to replace the Abandoned and Unclaimed Property Reporting and Examination Manual. The state says in the documents that the changes are designed to make the examination (audit) process more “predictable, fair, and consistent” and to provide an easy-to-understand process for Holders of unclaimed property. As highlighted in our February issue of Current Happenings, the regulations come as a response to Senate Bill 13 (SB 13) which was enacted by Delaware’s legislature and subsequently signed into law by the Governor on February 2, 2017.
Although some of the regulations provide welcome detail for the businesses (Holders) that are subject to Delaware’s escheat laws (which is every entity in the U.S. that is organized under Delaware law), other aspects of the proposals invoke memories of the very same procedures that “shocked the conscience” of federal judge Gregory Sleet who denied (in part) the state’s motion for summary judgement in the Temple-Inland case (we’ve written about this case where, among other problems the judge found with Delaware’s audit of the company, one unreported unclaimed property item in the amount of $147 was extrapolated into an assessment of $1.4 million).
Particularly problematic is that the descriptions of the estimating and extrapolation techniques do not remove the possibility that Temple-Inland type calculations will result. For example, the regulations specify that property items for which the owner’s last address is known, i.e. to which state the item should be remitted, are still projected in the Delaware calculations for years for which detailed records do not exist.
Also, the required “representation” by the business about what records are available for the audit becomes an automatic “willful misrepresentation made with intent to mislead the State Escheator” if mistakes are made in the description. This seems like an unfair assumption and undue burden for an area as complex as unclaimed property.
Lastly, Holders under audit should be acutely aware of their options to either expedite the audit completion or, for audits initiated as of 7/22/15, convert the audit to the voluntary disclosure program. Holders under audit only have 60 days after the regulations are adopted to elect one of those options, and Delaware is required to adopt regulations on or before July 1, 2017. Absent an election, the audit will proceed as is with the Holder becoming subject to the now mandatory interest.
Here are some of the highlights of the current proposed regulations:
- Delaware will continue to use third-party auditors, and the contracts with the third-party auditors are available upon request. The regulations provide for confidentiality and non-disclosure agreements to be signed before information is produced. The sample agreement provided in the Department of Finance’s proposed regulations describes restrictions on the auditor’s use of the Holder’s confidential information solely for the purposes of the audit and the states participating in the audit, including not allowing the audit firm to use confidential information to solicit other states to initiate an audit.
- Holder Concerns: The confidentiality and non-disclosure agreement does not prohibit audit firms from using publicly available information to solicit other states to participate in the audit. States can and have joined audits in progress sometimes one or two years after an audit has been initiated.
- The regulations “are not discretionary and third party audit firms may not develop or utilize their own distinct applications of these standards and instructions.”
- Holder Concerns: While the state offers very specific guidelines for reviewing certain property types, such as uncashed checks or unapplied customer credit balances, for the purposes of completing the Voluntary Disclosure Program, the state fails to offer such defined guidelines for the audit firms to use during an examination. As a result, the regulations leave significant examination procedures unwritten and if fact, up to the auditor’s discretion.
- The state will not use collection goals or quotas in determining compliance. The state does offer “red flags” that may lead the state to select a Holder for examination including an inconsistent reporting history or reports that lack the required detail.
- Holder Concerns: Of concern is the state’s proposed comparison of reports filed by Holders of similar size or industry in their audit selection process. No two companies are alike in their accounting procedures or accumulation of unclaimed liabilities. Unclaimed property is not a tax liability generated as a function of sales or business activity, and such a comparison could lead to false assumptions by the state or unfair expectations of potential audit settlements.
- If an examination lasts longer than 24 months, the Abandoned Property Audit Manager will meet with the Holder to facilitate completion of the examination.
- Holder Concerns: Audits are currently averaging 5-7 years to complete. Meeting the 24 month timeframe will be a lofty goal for both the state and audit firms considering these regulations offer little in the way of change or reduction in the burden to Holders for the volume of work required under an examination.
- Processes are described for initial notification of an audit, the opening conference, records requests lists, records review and interviews of personnel, status reports, and the estimation/extrapolation calculations.
- Holder Concerns: Do not overlook this section or view it as relevant only if selected for audit. The states does not define the records that a Holder must retain within the general record retention guideline but offers extensive detail within the examination section of what records will be reviewed.
- At the conclusion of records production, the Chief Financial Officer or other officer of the Holder shall provide in a form amenable to the State Escheator, a representation of the Holder regarding what records are available, for which property types and what years. The Holder is bound by this representation, absent good cause in the determination of the State Escheator. A determination by the State of a false statement will be considered willful misrepresentation made with intent to mislead the State Escheator.
- Holder Concerns: A “willful misrepresentation” determination by the State Escheator could result in the imposition of steep interest and penalties. Delaware statues allow the state to impose interest that could accrue up to 50% of amounts reported late, a penalty for failing to file a report up to 50% of the unreported amount or a civil penalty up to $5,000, a penalty for failing to pay the amount due up to 25% of the property amount, a penalty for fraudulent under-reporting up to 75% of the unreported amount, and civil penalties up to $25,000 for evading or willfully failing to comply with unclaimed property reporting requirements.
- When available in electronic format, records shall be produced electronically and beginning March 1, 2018, all reports must be submitted via a web-based application.
- Holder Concerns: Given the current data-protection climate, some businesses may be uncomfortable with the idea of electronically sending confidential information, as well as the idea of such records leaving their premises.
- Holders may use a description or a code which contains “two out of the three” following data points to validate an owner of unclaimed property’s last known address: city, state, zip code.
- Holder Concerns: While this is an improvement from the prior practice of requiring a complete address sufficient for the delivery of mail, this regulation unnecessarily restricts the flexibility the state just implemented under S.B. 13. A zip code alone can offer the related city/state combination, and vice versa. This regulation fails to consider the myriad of scenarios that could result in identifying the appropriate reporting jurisdiction within a company’s current financial system, legacy system and historical records.
- “To the extent permitted by law, names and addresses identified in the base period shall not be used to determine which state has the priority claim to the abandoned property estimated to be due over periods where records of owners’ addresses do not exist.”
- Holder Concerns: The practice of paying all estimated liability to Delaware without any apportionment to other states, a practice identified as “troubling” by the court in the Temple-Inland case, will continue.
Delaware’s State Escheator in the Department of Finance and the Deputy Secretary of State are accepting public comments on the proposed regulations until May 3, 2017. We anticipate that many Holder businesses and advisors will want to submit comments, complaints and recommendations.
What About Other States Adopting Provisions Similar to Delaware’s?
Every state has unclaimed property reporting laws and the rules differ from state to state, e.g. in the definitions of reportable property (e.g. some states do not include unspent gift cards or business-to-business transactions) and in the dormancy periods (the amount of time after which the item should be remitted to the state). Delaware’s provisions apply to many Holder businesses because of the number that are organized under Delaware’s law. However, in addition to the new law and these proposed regulations for Delaware’s unclaimed property reporting, several other efforts have recently been finalized or are currently being proposed. More detail on these later:
- The Uniform Law Commission (ULC) spent about two years drafting the Revised Uniform Unclaimed Property Act (RUUPA) for the purpose of submitting the model for all states to consider adopting. RUUPA was finalized in July 2016 and portions were adopted and enacted in Delaware’s SB13 and Utah’s SB 175, and the legislation was introduced in other states such as Illinois, Minnesota, Nebraska, and Tennessee.
- The American Bar Association (ABA) recently made it known that because of several concerns its members have with the current ULC Final Act, the ABA has formed a group that will draft its own proposed model act
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Julia ColbusColbusbu-state-local-tax unclaimed-propertyhunt-valleySenior Director, State & Local Tax
Last updated on September 4th, 2019 at 04:18 pm