Cannabis businesses have long struggled with Internal Revenue Code Section 280E, which addresses the tax consequences of cannabis’s federally illegal status and severely limits which expenses cannabis operators can deduct when filing their federal tax returns.
While companies cultivating, manufacturing and selling marijuana-based products can only deduct the cost of goods sold under 280E, hemp operators don’t have the same limitations since the 2018 Farm Bill federally legalized industrial hemp. In fact, according to Sanjay Agarwal, an international and corporate tax partner of MGO | ELLO’s National Cannabis Practice, everything, generally speaking, is deductible for a company operating in the legal CBD/hemp industry.
“You also have the ability to sell CBD/hemp across state lines, which is beneficial,” Agarwal tells Hemp Grower. “Rather than just looking at your state where you’re headquartered, you’re able to sell your product into all the other 49 states, and you’re also able to sell internationally, too, for the most part, which is beneficial.”
Here, Agarwal outlines three guiding principles for hemp operators this tax season, from the structuring of the business to incentives to sell products to a broader global market.
1. Separate your hemp business from any marijuana operations.
Many marijuana companies are expanding their operations into the newly legal industrial hemp and CBD markets, and Agarwal says it is critical for these businesses to separate those operations into two entities.
While it may seem easiest to integrate a newly launched hemp business into an existing marijuana operation, allowing the same employees and supply chain to manage both sides of the business, this can quickly create tax headaches, Agarwal says.
“That might lead to some issues upon an IRS audit because they may view the so called ‘good expenses’ that should be fully deductible with respect to CBD/hemp as non-deductible,” he says. “It’s really important that any company that’s moving into CBD/hemp consult with a tax advisor and structure things appropriately. If you have the CBD/hemp operations separate—if you have them not reliant too much on the main cannabis operating functions—then you can generally take the position that the expenses attributable to the CBD/hemp business are deductible and potentially creditable, as well, as it relates to research and development.”
Along those lines, some investors may want to invest in the CBD/hemp side of the business, but not the marijuana side. Keeping both entities separate will allow these investments to be allocated appropriately, Agarwal says.
2. Take advantage of incentives to sell abroad, when regulations allow.
Many of Agarwal’s clients have an established parent company in the U.S. that houses the business’s CBD/hemp operations, but also separate subsidiaries in other jurisdictions around the globe in order to take advantage of certain incentives to enter the international market and sell abroad.
A UK subsidiary could sell CBD/hemp products directly to the European market, for example, whereas a Columbian subsidiary could reach the Latin American market. And under current federal law, a U.S. corporation selling to a foreign distributor or directly to foreign customers can qualify for a reduced tax rate.
“There are a lot of different arrangements that you can put into place,” Agarwal says. “One would be where a finished CBD product is sold from the U.S. parent company to a subsidiary and then further distributed to customers in the EU and/or Latin America. Or, you even have the flexibility to sell directly from the U.S. if there are no restrictions in the customers’ country, where they’re receiving the product. … That might run into more regulatory issues, so that’s why our preferred structure would be to set up local country distributors or at least have third-party distributors in your major markets to help you distribute the CBD/hemp products.”
3. Take advantage of this year’s tax deadline extension, and any other relief efforts.
Last week, the IRS announced an extension of this year’s tax deadline to July 15 in the wake of the COVID-19 pandemic, so all individuals and corporations that would have otherwise had to file tax returns or extensions by April 15 have an extra 90 days to file and pay their tax bills.
“We’re also noticing that most of the states are conforming to that, for the most part,” Agarwal says. “California, for example, has conformed and is deferring those filing and payments until July 15, and we’re expecting New York and a lot of other states to take the same position, as well. That’s good relief for companies operating currently.”
Agarwal also expects cannabis sales and excise taxes to be deferred at the state level, and Congress is actively working on a bill that includes tax reform efforts, which could have additional benefits for hemp and marijuana companies.
“Negotiations are ongoing, and we would expect to see more relief for cannabis companies and just companies in general,” he says.
In the meantime, even though cannabis sales are largely up amid coronavirus concerns, 280E will still have a direct impact on many companies’ cash position, Agarwal says, and businesses should be actively planning and structuring their businesses to reduce this burden.
“The easy part is just reviewing your allocations and your indirect production costs and seeing what can be taken advantage of there, and assessing the degree of risk in taking certain positions as it relates to tax,” he says. “I always encourage companies to consult with tax advisors … to really look at their structure, operations, supply chain and five-year projections to see what can be done from a tax perspective to help reduce their overall tax bill."