Are Gift Cards Really a ‘Gift’ for the Restaurant Industry?

Given the popularity of gift cards among both issuers and recipients, restauranteurs should understand the pros and cons of selling and issuing gift cards.

 

Gift cards benefit retailers, because buyersoften return to the venue and spend more money than the actual value of card’s actual value Cards also extend the holiday season and increase store traffic and revenue. For consumers, gift cards are one of the most requested gift items and represent a happy medium between outright cash and a gift.

 

However, the scope and implications of federal and state law related to gift card issuance and the reclassification of residual balances as income are not well understood.

 

All 50 states, and Puerto Rico and the District of Columbia, have adopted unclaimed property (or escheat) laws that require holders to report any abandoned, or presumed to be abandoned, intangible property to the states in accordance with state law. Most states define abandonment through a “dormancy period” of inactivity, typically three to five years after the liability was created. Common unclaimed property types include uncashed or voided accounts payable/payroll checks, credit balances in customer receivables, and residual balances in gift cards or related instruments.

 

The determination as to which state is entitled to receive the dormant funds is based on the following priority rules set out by the U.S. Supreme Court:

 

  • First Priority: The state of the owner’s last known address. For example, if an employee did not cash a payroll check in New York, this check would be escheatable to N.Y. three years after issuance.
  • Second Priority: In the absence of the owner’s name and address information, the dormant property is escheatable to the holder’s domicile (the company’s state of incorporation).

 

Why is this important and how does this dictate risk related to gift cards?
In most instances, complete customer name and address information is not available for issued gift cards. As a result, any unused/residual balances remaining on gift cards become escheatable in accordance with the second priority rule, as stated above, to the company’s state of incorporation.

 

This is particularly important because about 36 states offer a full or partial exemption for gift card reporting. However, approximately 16 jurisdictions, including Delaware, New Jersey, and New York, statutorily require the escheatment of unredeemed gift cards.

 

What can my company do to minimize our escheat liability?
Generally, 12% to 15% of all card balances are never fully redeemed, a concept referred to as “breakage.” This can result in a material benefit to some organizations if the escheatable property is legitimately determined to be exempt. Conversely, it can be a material detriment if the escheatable property is not exempt.

 

Companies need to understand the terms and conditions of their current gift card programs and decide whether the breakage is reportable. Some organizations have been able to avail themselves of reporting exemptions by creating special purpose entities, commonly referred to as “giftcos.” In those situations, companies create a separate legal entity, incorporated in a state that exempts residual gift card balances from the reporting requirement, to be the gift card issuer, thereby avoiding or mitigating the requirement to pay unused balances to a non-exempt jurisdiction. The concept is simple, but proper execution is not.

 

The giftco model has been subject to increased scrutiny in recent years. Unclaimed property auditors and state reviewers have sought to determine whether a giftco or its parent company (presumably in a non-exempt reporting state) is the true holder of the property.

 

This concept was recently challenged in the Delaware ex rel. French v. Card Compliant et al., qui tam lawsuit contesting the use of a third-party gift card structure. Issuers that use a gift card structure should validate the economic substance and purpose of the entity in conjunction with the factors argued in litigation, as well as factors commonly tested in state audits or reviews.

 

Key Takeaway
Like most other aspects of unclaimed property law, the issues related to gift cards can be complicated and impact many reporting jurisdictions. The laws around gift cards are not well defined and are rapidly changing. Any organization that issues, or intends to issue, gift cards should carefully plan and analyze the program to help mitigate any unclaimed property exposure that may be present.

 

Contact your Williams Overman Pierce professional to ensure your company is in compliance with state requirements and regulations, as well as to verify your corporate structures and controls are properly in place to mitigate escheatment exposure.

 

Written by Steven Michael Kenehan. Copyright © 2022 BDO USA, LLP. All rights reserved. www.bdo.com