Tax & Finance

Making Sense of Internal Revenue Code Section 280E – Part II

Today, we’re picking up right where we left off last week, shedding more light on Section 280E by examining some of the noteworthy cases (and one memo) that have come to define it.

IRS Chief Counsel Advice Memorandum

In 2015, the IRS Office of Chief Counsel issued guidance on the application of Section 280E in the form of a memorandum. It’s a very technical document, but also very useful in understanding the statute, walking through the distinction between gross receipts and gross income (primarily, COGS) and discussing what constitutes COGS for purposes of Section 280E. The key takeaway from the Chief Counsel Advice Memorandum is that COGS should be determined under the Section 471 inventory rules, and that the Section 263A UNICAP rules have limited bearing, as they require capitalization of otherwise deductible expenses. Effectively, a cannabis business can’t use Section 263A to convert business expenses disallowed under Section 280E into COGS.

Alterman

Finally, on to some new case law. Alterman doesn’t offer any new issues to contend with. It is, in many ways, similar to Olive, but with somewhat more compelling facts. Alterman sold cannabis products, and in order to meet Colorado licensing requirements, also had … Keep reading

Making Sense of Internal Revenue Code Section 280E – Part I

It’s been a busy summer for cannabis business Section 280E controversy, with three published cases (Alterman v. Commissioner; Loughman v. Commissioner; and Alpenglow Botanicals, LLC v. U.S.) construing the statute, and generally not in favor of the taxpayer-cannabis business. The limitations of Section 280E and their effects on after tax profits should be fairly familiar to cannabis entrepreneurs, but to keep things fresh in your minds, the statute provides:

[n]o deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of Schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

What does that single, parens-laden sentence really mean? When it comes to the Internal Revenue Code, one sentence can leave much to unpack. Take Section 482, for example—not a very relevant Code section, unless you’re taking your cannabis business cross-border (maybe into Canada?), but, nevertheless, illustrative. One … Keep reading

This year is primed to be the cannabis industry’s biggest yet. Almost $3 billion of capital was raised in the first quarter of 2018, more than four times the amount raised in the first quarter of 2017. With the increase in capital investment comes an increase in the sophistication of investors, including institutional ones like venture capital and private equity sponsors.

As more institutional money pours into the cannabis industry, entrepreneurs are being held to higher standards of professionalism, and are now expected to understand basic venture finance and equity structures. Part of this understanding includes preferred equity, which is a general term used to describe any class of securities (e.g., stock, limited liability company [LLC] units, limited partnership [LP] interests, etc.) that has higher priority for distributions of a company’s cash flows or profits than common equity.

In its simplest form, the “preferred” component of the equity represents additional rights and privileges investors receive in return for their investment beyond owning a percentage of the company. In most instances, when a company takes on outside investors, it will have at least two classes of securities: common equity and preferred equity. The common equity will be that owned by … Keep reading

Momentum Grows for Capital Raises in MJ Markets

The capital raised in the first five weeks of 2018, alone, matched deals for all of 2016. And the feeding frenzy has not decelerated, with the overall first quarter of 2018 seeing almost $3 billion in capital raises—more than four times the amount raised in the first quarter of 2017. This is attributable to increases in both the number and size of capital raises: The cannabis industry saw over 160 capital raises (vs. about 100 in 2017) at an average raise size of roughly $15 million (vs. roughly $5 million for 2017), with more than a dozen of these raises bringing in $50 million or more.

The landscape of the cannabis capital markets is also changing. During the early years, investments were often made in the form of high-interest-rate loans, due to investors’ skepticism of industry growth and aversion to risk related to all things cannabis. Now, over 80% of capital raises are equity raises, as a result of investors seeing real potential in an industry where regulatory and other risks are becoming fewer, and public acceptance and support are growing wider. Smaller “cannabis-focused” venture capital funds are popping up around the country at a rapid pace. Mainstream … Keep reading

Cannabis in the Commonwealth: What Are People Saying?

I recently attended the New England Real Estate Journal’s “Cannabis: The Next Phase in Commercial Real Estate” summit, which brought together a number of local players for networking and a high-level discussion of where the industry stands in Massachusetts. In addition to being fantastic networking opportunities, events such as this allow attendees to get a sense of where the conversation on cannabis is heading, and for us, can be invaluable in terms of helping to anticipate concerns that clients will have and issues they’ll face.

Some of my takeaways:

  • Despite the Attorney General’s stance on marijuana, nothing has really changed. For now, the federal government seems content leaving it to state and local authorities to ensure that cannabis industry players adhere to state laws when establishing and operating their businesses.
  • When it comes to launching a cannabis business of any kind, it’s critically important to educate people about what your operation will entail, and what it won’t. You need to meet with municipal boards, with community groups, with public safety officials, to really drive home the message that: “Yes, we’re in the cannabis business, but we’re not the big, bad wolf. We’re just a dispensary, or a
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Following the Money: Analyzing Capital Flow into the Legal Cannabis Industry

At our recent cannabis conference, financial services experts gathered to discuss the evolution of cannabis-related investments. A panel consisting of Kyle Detwiler (Northern Swan Holdings), Jeff Finkle (ARC Angel Fund), Scott Greiper (Viridian Capital Advisors, LLC), and Harrison Phillips (Viridian Capital Advisors, LLC) talked about specific investor trends, and how these trends will shift as the industry begins to mature. Below are a few highlights from that discussion.

What are the current investor types? When will traditional VC and PE funds do more than “dip their toes?” 
Cannabis-related investments have grown exponentially since 2014, in large part due to the engagement of certain cannabis-focused venture capital funds, special-purpose vehicles, family offices, tech-focused VC funds ancillary to the cannabis industry, public companies, high net-worth individuals, professional angel investors, angel networks and funds, individual partners in VC and private equity funds, and even certain accelerators. While there has also been some traditional VC and PE fund activity over the last few years, this activity represents only 20% of the overall investments made, as the traditional VC and PE funds are still hung up on the obvious hurdles to the industry (e.g., regulation, legality, reputation, mature … Keep reading

As banks are learning to navigate the murky legal waters inherent to cannabis-related businesses, they are increasingly becoming open to housing cannabis-related business accounts, even with the substantial burden placed on them by the federal government to comply with their respective state laws.

In August 2013, then-Attorney General James M. Cole issued a memorandum to all U.S. attorneys, which was published by the Department of Justice, setting expectations for the federal government, state governments, and law enforcement on how to address state-implemented, legal-adult-use cannabis programs. In summary, the Cole Memo told states that, if they implement a strict regulatory framework; prevent diversion by employing a seed-to-sale tracking system to monitor the growth, distribution, and sale of regulated cannabis; and create a transparent, accountable market, the federal government will, essentially, leave them alone.

Almost six months later, Attorney General Cole issued further guidance as to how the original memo would impact certain cannabis-related financial crimes. He stated that the provisions of money-laundering statutes, the unlicensed money-remitter statute, and the Bank Secrecy Act remain in effect with respect to marijuana-related conduct, and that Section 1956 of Title 18, otherwise known as the federal anti-money laundering statute, makes it a criminal offense … Keep reading

One commonality for businesses across all industries, including those in the medical and adult-use recreational marijuana space (“cannabis companies”), is the importance of access to capital. Everyone knows that running a company requires a significant amount of money. However, cannabis companies specifically face distinct hurdles to raising capital, especially when it comes to deciding whether to go public.

The process of a private company offering and selling stock to the public typically begins with an initial public offering, which can trigger large payouts for management and ownership; a certain elevated level of credibility; and, most importantly, increased access to capital, which can better situate a company for both short- and long-term growth. For many entrepreneurs, taking a company public may be the ultimate accomplishment. However, despite the pros, there can also be plenty of cons for companies undergoing an IPO, especially those in the cannabis industry.

In general, taking a company public not only results in increased costs and more comprehensive (and burdensome) disclosure requirements, but also a much more aggressive and scrutinized focus on short-term growth for shareholders, which can limit the flexibility and freedom to which management may be accustomed. For cannabis companies, perhaps the biggest challenge … Keep reading

Here’s some food for thought: 29 states currently have laws broadly legalizing cannabis, in some form. Eight of those states – Alaska, California, Colorado, Oregon, Massachusetts, Maine, Nevada, and Washington, as well as the District of Columbia – have legalized the plant’s sale, for both medicinal and recreational use. These numbers continue to grow. In fact, many studies indicate that cannabis is the fastest-rising industry in North America.

For companies to capitalize on the many opportunities this industry presents, however, they need startup and growth capital. And among the myriad questions they must address before entering the space is: What is best for my company, debt or equity financing?

Below is a primer of the pros and cons of both.

What is debt financing? Debt financing is when a company borrows money from a lender, whether institutional or non-institutional, that it will eventually pay back, in addition to agreed-upon interest. Sometimes debt may be convertible, or may also provide warrants to the lender.

What are some of the pros and cons of debt financing? 

– Pros: The advantages of debt financing are many. For example, a company does not give away ownership interests to its lender, and is able … Keep reading

So…You Want to Start a Cannabis Company

Imagine: The state you live in now legally recognizes the recreational use of marijuana, and you’re eager to start a business that capitalizes on the law change. As an intelligent entrepreneur, you recognize that sound legal, business, financial, and tax advice are integral to your company’s success, so you seek out input from trusted advisors. Your jaw hits the floor when your attorney tells you that, depending on how your business operates, you may end up paying a substantial amount more in federal income taxes than you otherwise would if your business were not a cannabis-related concern. You wonder, “Why does it make a difference?”

Cannabis Laws Differ at the State and Federal Levels

Though it may be legal in your state, cannabis is still considered illegal by the federal government. As a result, cannabis companies aren’t eligible to claim the federal tax credits or deductions available to other types of businesses. This is outlined in Section 280E of the Internal Revenue Code, which states that:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such

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