Businesses Nationwide Watch as Staples Challenges Delaware's Aggressive Escheat Policies, According to Ryan

Jun 09, 2010, 16:11 ET from Ryan

DALLAS, June 9 /PRNewswire/ -- A lawsuit recently filed against the State of Delaware by Staples should be a warning to companies who decide to participate in voluntary compliance programs in the area of unclaimed property.

"There is a new trend of states aggressively focused on unclaimed property collections as a significant source of revenue," said Noel E. Hall, Jr., Ryan Principal and Abandoned and Unclaimed Property Practice Leader. "While voluntary compliance programs can benefit companies, the Staples litigation also demonstrates there may be substantial risks in participation."

Staples operates more than 2,200 stores in 48 states and the District of Columbia. In October 2000, Staples voluntarily came forward and, in good faith, entered into a Voluntary Disclosure Agreement (VDA) that calculated its past due unclaimed property in the amount of $137,412 (including $91,627 in unclaimed accounts payable). In exchange for the VDA, Delaware released all claims against Staples under the escheat law for reporting years prior to March 1, 2000. Rather than accepting the analysis Staples gathered from its own expert, Delaware came back with its own audit demanding a total of $3,962,750, payable within 30 days.

"Under the Delaware process, the VDA opened the door for an audit from a state known for its aggressive practices," said Mr. Hall. "Delaware uses contingency fee auditors who are heavily incentivized to find the maximum possible delinquencies. Currently, there is no requirement that the state justify its demands with a written explanation of how they arrived at their calculations."

It now appears to be an unwritten rule that Delaware seeks to receive a minimum of $1 million from any audit or VDA, regardless of the original amount offered by the taxpayer. If the current trend continues, corporations will have little incentive to participate in Delaware's VDA program.  Even with the use of contingent fee auditors by Delaware, the state may begin to experience difficulty in collecting funds it could have received under the voluntary compliance program as a result of corporations becoming more willing to litigate.

When Delaware first introduced its revised VDA program in the late '90s, there was a significant benefit for corporations to participate in the program, as Delaware established a "look-back" period of reporting to transactions occurring from 1991 and later. With the passage of time, Delaware, unlike many other jurisdictions, has not moved that look-back period forward, and instead, a company considering a VDA in the year 2010 would still have to account for transactions dating back to 1991.  In stark contrast, VDA programs for most other jurisdictions adhere to a policy of a rolling ten-year look-back.  Consequently, a company considering entering into a VDA with a non-Delaware jurisdiction in 2010 would most likely have to account for ten years of filings dating back to 2000 (transactions occurring from either 1995 or 1997, depending on whether the dormancy period is three or five years in the respective jurisdiction).  The trade-off in entering into a VDA with Delaware is the abatement of ten reporting years, as Delaware's policy under examination is to audit back to 1981. Therefore, in exchange for pursuing a VDA with Delaware, the corporation would receive a ten-year abatement (1981–1990) of transaction review.  Many believe that as we move further into the future, what was once a very attractive concession made by Delaware in the reduced look-back period has perhaps lost much of its luster.

Taxpayers are growing weary of the current practice undertaken by Delaware to allow significant lapses in time to pass before selecting a corporation for examination. With most companies adhering to a five- to seven-year records retention policy, a Delaware examination may place the company in an untenable position in defending itself, as detailed records may no longer exist to refute the often over-inflated assessments.

Staples has taken the State of Delaware to court over the issue. The lawsuit accuses the state of seeking property to which it is not entitled under Delaware law and property that does not qualify as unclaimed property. For example, in one instance, the state is seeking funds derived from a check payable to a Staples store by its parent corporation. The Staples suit calls the more than $807,000 in penalties the state assessed "arbitrary, capricious, and against the manifest weight of the evidence."  

The Staples litigation also points out one of the most onerous and unfair provisions of the Delaware escheat laws. The Delaware Division of Revenue demanded that Staples pay immediately; even though the state's current escheat law provides no procedure for appealing an assessment or obtaining a refund. Further, the Eleventh Amendment to the United States Constitution prohibits Staples from suing the State of Delaware. The lawsuit asks the court to prevent Delaware from collecting the money allegedly owed and assessing any additional penalties.

Many states have found that voluntary compliance programs are cost-effective for maximizing revenues with minimal expense.  As states consider their tax policies, they must weigh the value of voluntary compliance against aggressively challenging good faith voluntary disclosures.  In the Staples case, the amount of presumed past due unclaimed property was dramatically increased by the State of Delaware. The likelihood of having to then challenge the Delaware Division of Revenue in court makes the VDA even less attractive.  Depending on the outcome of the Staples case, Delaware could begin to experience a precipitous decline in corporations' willingness to enter into the state's VDA program for fear of what appears to be arbitrary increases in exposure amounts, which could result in a decrease in revenue for the state if challenged by corporations—the exact opposite of the state's goals.

About Ryan

Ryan is the leading tax services firm in North America, with the largest transaction tax practice in the United States and Canada. Headquartered in Dallas, Texas, the Firm provides a comprehensive range of state, local, federal, and international tax advisory and consulting services on a multi-jurisdictional basis, including audit defense, tax recovery, credits and incentives, tax process improvement and automation, tax appeals, and strategic planning. With a multi-disciplinary team of more than 800 professionals and associates, Ryan serves many of the world's most prominent Fortune 1000 companies.