The Delaware Secretary of State (SOS) announced that it will resume issuing Voluntary Disclosure Agreement (VDA) notices to businesses and organizations identified as holders of unclaimed property (hereinafter, Holders). The announcement follows the finalization of long-awaited regulations outlining administration and application of Delaware's recently overhauled unclaimed property law. Holders that do not enroll in the SOS's VDA program within 60 days of the mailing of the notice will be referred to the Delaware State Escheator and DOF for audit examination. If an audit notice is issued, the SOS will have no legal ability to accept a Holder into the VDA program.

Holders receiving these letters should consider entering into Delaware's unclaimed property VDA program to benefit from a self-review of its books and records and to have interest and penalties waived. Failure to respond will result in an examination, conducted by a third-party auditor and most likely joined by many other states.

Additionally, Holders currently under an audit that originated before July 22, 2015, may convert the audit into an SOS VDA, but must do so by December 11, 2017.

Background

On February 2, 2017, Delaware enacted SB 13 to amend the state's unclaimed property laws in response to the ruling in Temple-Inland, Inc., in which the US District Court for the District of Delaware concluded that Delaware's unclaimed property audit methodologies violated due process, failed to follow the fundamental principles of estimation and "shocked the conscience." Provisions of SB 13 also conform to several sections of the Revised Uniform Unclaimed Property Act, but explicitly reject others (see Tax Alert 2017-260).

Among other things, SB 13 gave certain Holders under audit the option of converting to the SOS's VDA program or requesting an expedited audit. The deadline for electing these options was 60 days after unclaimed property regulations issued by the Department of Finance (DOF) became effective.

Following enactment of SB 13, DOF proposed regulations intended to establish instructions and guidelines for the administration of the unclaimed property program by providing Holders with a clear and consistent understanding of the state's use of estimation, aging criteria for checks, and the definition what constitutes complete and researchable records (see Tax Alert 2017-675). Those regulations were finalized on October 1, 2017, and became effective October 11, 2017.

Contemporaneously with the finalization of the new DOF regulations, Delaware appointed a new State Escheator and Division of Revenue Director. Jennifer Noel, a deputy attorney general with the DOF since 2012, replaces David Gregor who retired after 30 years of state service.

Unclaimed property VDA terms and requirements

To participate in the VDA program, Holders must respond to the SOS's letter (if received) within 60 days after the request to enter the VDA program was mailed; otherwise, the Holder will be referred to the State Escheator for audit. After the properly executed VDA forms are returned to the SOS, the Holder must complete a review of its books and records and file reports of abandoned property.

The VDA look-back period extends 15 years, to encompass 10 reporting years, plus a five-year dormancy period. For Holders that enter into the Delaware unclaimed property VDA program during 2017, the look-back will be to transaction year 2002.

The SOS will not assess interest or penalties under the VDA program on late-filed unclaimed property unless the participant does not make a good-faith effort to complete the program's requirements.

The benefits of the VDA program as compared to a potential third-party audit include the following:

— The VDA program is designed to reach final agreement on past-due liabilities within two years after a Holder enters the program, while audits can take several more years to complete.

— Under a VDA, Holders that fail to retain sufficient records for dormant years for research will need to review a minimum of two years of non-dormant property items as a base period for purposes of calculating an escheat percentage to be applied to years in which transaction-level data is not available for review. For Holders under audit, a minimum of three years of transaction-level records must be researched to determine an escheat percentage.

— In a VDA, voided checks aged less than 90 days from issuance will not be subject to review. Holders under audit will have to research checks that are voided 30 days or more from issuance, thereby increasing the number of void items subject to review and increasing the time and effort required by Holder personnel to complete the research.

— The VDA program is designed to allow a Holder to conduct a self-review of its books and records with input from the SOS, while audit examinations are conducted by state-hired, third-party audit firms, often auditing on behalf of multiple states and compensated on a contingent fee basis.

— Holders that do not participate in the VDA program (and are therefore referred to audit) may be assessed 0.5% interest per month on unpaid amounts from the date the amounts or property were due until paid, with a cap of 50% of the value of unclaimed property due.

Existing audits

Under SB 13, Holders under audit since before July 22, 2015, may convert their DOF audit into an SOS VDA (Holders undergoing a securities audit, in which estimation is not required, may not convert). In contrast, Holders under audit since before February 2, 2017 (SB 13's enactment), may request an "expedited" audit. "Expedited" means that the ongoing exam will be completed within two years from the request date, with waiver of interest and penalties. All requests for information by the state or auditors must be issued within 18 months from the request date.

Eligible Holders must decide to convert into an SOS VDA or request an expedited audit by December 11, 2017.

Renewed audit activity

There has been a marked decrease in Delaware's audit activity over the past two years pending the finalization of proposed changes to the state's unclaimed property audit regulations, as well as findings in the Temple-Inland decision (see Tax Alert 2016-1158). A significant increase in the issuance of unclaimed property audit notices from the Delaware DOF is expected after the deadline for responding to the unclaimed property VDA notices lapses. Holders should take note of the following points:

— Because unclaimed property is not a tax, the SOS may send the VDA notice to a department other than the Holder's tax department. Holders should communicate across departments within their organization to timely identify any VDA invitation received from the SOS and make a prompt determination on an appropriate response to the VDA notice for compliance purposes. Most commonly, audit notifications are sent to the Chief Financial Officer of a Holder.

— Holders that have not yet received a VDA invitation from the SOS can approach the state for a VDA at any time (unless the Holder was put under audit post July 22, 2015).

— Under priority sourcing rules set forth in a series of rulings by the US Supreme Court, the state of incorporation can claim unclaimed property for periods for which the Holder does not have adequate books and records identifying the last known address of the owners. Thus, the periods of estimation or extrapolation that become significant in light of the length of the unclaimed property look-back periods under VDA or audit could be attributed to the state of incorporation of the Holder. If a legal entity within your organization is incorporated in Delaware, the risk of a compliance issue with the state is increasingly heightened.

Implications

Notified Holders should consider participating in Delaware's unclaimed property VDA program, because a failure to respond to the SOS's VDA letter will result in a third-party initiated audit and, in many cases, these audits will be performed ultimately for many other states as well. Moreover, Holders that fail to timely respond will lose the benefits offered by the VDA program, most importantly, waived interest and penalties and the ability to conduct a self-review. Holders should recognize that their own internal resource strain will be significantly greater under an audit, as opposed to the VDA program.

EY's unclaimed property team's own experience is that audit activity significantly increases as a direct result of state mailing campaigns. Holders can avoid an audit by entering into a VDA instead. Our team has years of experience and knowledge in assisting Holders with the Delaware VDA process. We understand the new required procedures and can help streamline the entire process for your organization.

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