Jennifer Whetzel

Eating Your Words: How to Avoid Legal Issues Marketing Cannabis Consumables

By Jennifer Whetzel
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Jennifer Whetzel

Selling in a grey market isn’t for the faint of heart. You have to deal with the stigma surrounding your products and services, the potential for legal troubles, along with bureaucratic hurdles that all businesses face.

Acceptable marketing language surrounding consumable THC and CBD products encapsulates all of these issues, and it’s why everyone in the industry needs to pay close attention to what they’re saying. One innocent turn of phrase could have the Food & Drug Administration (FDA) shut down your business faster than you can say, “Oops.”

Avoiding this fate means making some adjustments to how you think about your marketing language, but this knowledge quickly becomes rote. Take a moment to learn how to protect yourself so that you can run your business rather than run afoul of the law.

Food, Drugs and Dietary Supplements

Scroll through Instagram for a few minutes and you’ll encounter a deluge of companies making claims about cannabis and CBD products. Many, if not most, are going about it incorrectly. Part of the confusion surrounds the fact that under the FDA’s rules, foods, drugs and dietary supplements are treated differently.

FDAlogoHow does the FDA decide what’s what? Based on how you advertise the product. If labeling suggests the substance is “intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease, or is an “article” (other than food) intended to affect the structure or any function of the body of man or other animals,” the FDA will regulate it as a drug.

The language and regulations surrounding drugs are extremely strict. On December 20, 2018, the FDA put out a statement reiterating that these rules are in effect for cannabis products. In other words, you can only make a drug claim if you have received approval from the FDA on your New Drug Application (NDA). Since approval requires hundreds of millions of dollars worth of clinical trials, this option is out of reach for most companies.

The rule states that you may not say that your product diagnoses, cures, mitigates, treats or prevents any disease, or any recognizable symptom of a disease. Disease is defined as: damage to an organ, part, structure, or system of the body such that it does not function properly (e.g., cardiovascular disease), or a state of health leading to such dysfunction it (e.g. hypertension). Examples of diseases would include cancer, multiple sclerosis, epilepsy, autoimmune diseases, Lyme disease and more. In other words, you couldn’t say your product “prevents memory loss due to Alzheimer’s” or “treats symptoms of fibromyalgia.”

If you’re making any claims about curing anything in your cannabis business name, product name, packaging, web copy, advertising or marketing materials, you are at risk for breaking these rules and getting caught. The FDA’s regulations dovetail with the Federal Trade Commission’s truth-in-advertising laws, which state that your claims must be backed by legitimate research (such as peer-reviewed journal articles or double-blind studies) and must not mislead consumers. These rules are already being enforced within the cannabis industry, so pay close attention to what you’re putting out there.

An example of a warning letter the FDA sent to a CBD products company making health claims

However, you can’t avoid penalties by using this kind of language and claiming your product is a dietary supplement or food, either. According to the FDA, products that contain THC or CBD cannot be sold as dietary supplements. Their reasoning for this decision is that THC and CBD are active ingredients in FDA-approved drugs, such as Epidiolex and Dronabinol. Active ingredients in approved drugs may not be introduced into the food supply as dietary supplements or otherwise.

The language rules surrounding food can be equally complex. Foods approved by the FDA can make nutritional claims about how a nutrient impacts the structure/function of the body, such as “Calcium builds strong bones.” The problem for cannabis products is that these statements need to be authorized or qualified by the FDA and have significant scientific evidence and consensus. However, this consensus doesn’t exist for THC and CBD, meaning that you’re barred from making these kinds of claims.

Note that these rules don’t just apply to human supplements. They also apply to ones for pets. Many people don’t realize that a supplement for a pet is considered an “illegal drug of low regulatory concern.” But if you add in THC or CBD, a supplement becomes an illegal drug of—you guessed it—higher regulatory concern.

At a Loss for Words?

By now, you may be wondering what you can actually say to market your product; it may feel as though there are more restrictions than guidelines. Fortunately, the FDA hasn’t left us completely out at sea.

Just because we’re in a strange place under federal law operating our businesses every day doesn’t mean that we should disregard fundamental rules and regulations that all businesses must follow. The FDA published a final rule in the Federal Register in 2000 defining strict rules that govern the types of statements that may be used on a label without prior review of the agency. These are called structure/function claims. According to the FDA, “Structure/function claims may describe the role of a nutrient or dietary ingredient intended to affect the normal structure or function of the human body.” In contrast, statements that claim to diagnose, cure, mitigate, treat or prevent disease require prior approval by the FDA and are only for products that are approved drugs. Don’t use any of those words. Ever.

You can use the following words in your cannabis product names, advertising or marketing, as long as you’re not connecting them to a disease state: restore, support, maintain, raise, lower, promote, regulate, stimulate. You must specifically state that the claim relates to a non-disease condition; otherwise, you’ll be in trouble with the FDA. To go back to an earlier example, you cannot say that your product “prevents memory loss due to Alzheimer’s.” However, stating that your product “helps maintain a healthy brain” is fine.

Just because we’re in a strange place under federal law operating our businesses every day doesn’t mean that we should disregard fundamental rules and regulations that all businesses must follow. Following these rules does more than keep our enterprises out of trouble. It reinforces the idea that our industry is responsible, legitimate, and—perhaps most importantly—here to stay.

german flag

How Germany Gets Its Cannabis

By Marguerite Arnold
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german flag

The German cannabis cultivation bid may be mostly done and dusted (although the last four lots are now up for legal challenge) but the drama is only intensifying on the ground in Germany. Namely, where is the cannabis being consumed on the ground now actually coming from?

For the past several years (in fact since 2016 when a Frankfurt-based start-up called Medcann imported the first Canadian medical cannabis into the German market in partnership with Canopy Growth), the conventional wisdom has been that Holland and Canada were the only two countries allowed to import medical cannabis into the country.

Canopy_Growth_Corporation_logoAs is usually the case in the cannabis industry, when it comes to such things, there were also multiple and highly creative explanations about this strange state of affairs that sounded oddly exotic enough to be plausible. This is after all, the international cannabis business.

These explanations also usually referenced conventional industry “lore” including such tall tales as these two countries were not signatories to an international drug treaty (not true), to being European (nope) or even a member of the EU (also completely false).

Yet there was always something strange with such urban legends – perpetuated by insiders across the German industry. Starting with a deliberate vagueness about details. Especially as in the summer of 2017 when Tilray announced grow facilities in Portugal, and by the end of it, Canopy was moving into Spain, and later by early 2018 Denmark and more. Italybegan to appear on the radar of multiple big Canadian companies. Clearly all these big companies seemed to know something that those outside did not. See Greece. Not to mention the teeth-gnashing of the Israelis– repeatedly shut out of the German market by not being allowed to export by their own government until Christmas Day, 2018.

The mystery deepened in March in fact, as a furore rocked the German-based cannabis industry over the last weeks. Farmako, a new, Frankfurt-based distributor, not only announced that it was importing 50 tonnes of cannabis into the country– and from Poland (where production of such bulk has not even been seeded) – but then gave additional details on a Bloomberg appearance that appeared to indicate that in fact the medical cannabis they were already selling (sourced from other places) had come from Macedonia. 

Certification, and most certainly paperwork are the name of the gameIn fact, no such transfer of cannabis had occurred from the Macedonian side (yet), although the firm in question at the other end of the deal was subjected to considerable harassment in the German canna-specialty press in the meantime.

The news, that occurred right at a time when Tilray is clearly training pharmacists for the German market, the first bid is concluding, Greece issues even more cultivation licenses, Canadian companies are clearing still stepping up their production game, and South Africa is also getting into the formal licensing act, with all sorts of interesting things afoot in Uruguay, also set off what appears to be an official investigation of the firms involved at the governmental level.

Insiders are tight lipped and nobody is willing to talk on record. However, the distribution firm, Farmako, has subsequently reported that in the month of March, they became the top selling cannabis specialty distributor in Germany. And since they are not out of business, it is also clear that while their PR may have been a little premature if not easily misunderstood, the broader message is very obvious.

What is also very clear at this point, in other words, is that the German door for cannabis and the international industry appears to be opening to product sourced from many places. Further by extension, the German government is in the process of recognizing foreign GMP certification processes from multiple countries all over the world as being equal to its own – at least on the cannabis front.

In fact, this has been going on relatively quietly for the past six months or so.

What Are The Standards, Certifications, and Qualifications?

A press release from January of this year, issued from an Australian firm called MCA, announced they had accepted the first letter of intent to ship to a German firm (in 2020). The company is currently accepting pre-orders as it finishes construction and achieves EU GMP certification. The same (female founded) firm was also present at the ICBC in Berlin this year in March, reporting that German demand from a universe of local distributors was already greater than they could fill. The news that their first sale went to German firm Lexamed, the controversial German wheelchair distributor who helped bring down the first German bid, was also largely unremarked upon at the time by most of the industry press and in fact, ever since.

GMPIn truth, it appears that the countries and companies that have the right to import to Germany must first have their own national GMP certification recognized as being equal to German standards – or a so-called Mutual Recognition Agreement (or MRA) must exist between the importer and exporter nations. It still means that to be really EU-GMP compliant, inspectors have to walk your cultivation floors. But first your country has to have the MRA. And that is a matter for lawyers and regulators to decide.

In the Australian case, the GMP equivalence for cannabis production apparently became reality within the last six months although no one is giving exact dates. In the case of Macedonia, this is pending, with German inspectors now apparently scheduled to begin inspecting domestic cultivation facilities within the next month to six weeks.

The biggest news, of course, which makes even more sense on the heels of Canopy’s latest “record breaking” U.S. acquisition, is that the EU and the U.S. will enter into an MRA in July that was finally agreed to in February of this year. This will also mean that cannabis “medicines” potentially even beyond CBD, produced via U.S. GMP processes, will be allowed to enter Europe if not Germany in the near future – and from the U.S. for the first time. Ahead of federal legalization in the U.S.

It also means that Israeli and American firms will be allowed to enter the European and thus German market for the first time (on the ground with product) by at latest, the third quarter of this year.

Caused By The Bid….and Likely Shorter Term Outcomes

What the events of the last several weeks make clear is that the bid is not only insufficient for demand, but the authorities are officially, if quietly recognizing the same. There are already rumours about the next cultivation tenders in Germany, and there is a high likelihood that other countries (see Poland in particular) may also follow suit shortly.

Further, the difficulties in making sure that not only countries but the companies based in the same remain compliant with EU and further German sanctified EU- GMP processes (for one) is likely to be an issue that continues to bubble. Why? It is a problem already in the broader pharmaceutical market here.

The Plusses and Minuses of The News

The first thing that is also obvious is that even Wayland cannot source the entire German market with the product it has begun to grow here no matter who ends up with the last four cultivation licenses this time around. Further, that the other winning bid firms (Aphria and Aurora as known at this point) without cultivation on the ground, are sourcing from somewhere that is also probably at this point, not even Canada. No matter how much expansion is going on in Canada, in other words, what is now entering the German market may bear a Canadian brand but could just have easily been sourced from almost anywhere in the world.

That also means that enterprising firms (see Australian MCA) can skip the Canadian introduction to the German market and sell directly to local producers before they even have crops on the ground, as well as the burgeoning German cannabis distributors across the country.

For such firms now wanting to enter the market, however, it is not all clear sailing. The events of the last few weeks clearly show that the government is watching, including reading English language industry press, and willing to pursue any firms it deems are breaking the rules on both sides of national borders.

Certification, and most certainly paperwork are the name of the game, as well as greater accuracy in company intentions (even if in the near term).

Disclaimer: Nysk, the Macedonian firm referred to in this story, is a sponsor of the MedPayRx pilot to market program

Federal Funding Is Flowing To Canada’s Cannabis Production

By Marguerite Arnold
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The Canadian federal government is going where the U.S. (for now) is not: namely allowing provinces to channel federal agricultural funds into commercial cannabis production on the provincial level. The program is called the Canadian Agricultural Partnership (or CAP), which is a $2.2 billion annual initiative designed to support agricultural businesses across the country.

So far, not every province has opened this funding to cannabis production, although British Columbia already has, and Alberta is currently considering it.

Even more intriguing of course, are other programs that tie into such agricultural subsidies (including government support for exporting product). See Europe for one.

These programs are of course nothing new, including in the United States.

What is new, different and intriguing, is that unlike the United States, for the first time such government funds are being used to support not only the domestic cultivation of cannabis, but its global export. If there ever was the beginning of a “green new deal” then this might be it.

Canadian companies are certainly seeming to benefit from this federal largesse at the production point. For example, in the first weeks of April, CannTrust Holdings Inc. announced that its entire 450,000 square foot, perpetual harvest facility in Pelham, Ontario is fully licensed and will be online by summer 2019. THC BioMed just announced that it received Health Canada’s permission to begin additional production at its flagship location in Kelowna, B.C. And Beleave has just commenced sales of cannabis oil products at licensed facilities in Hamilton, Ontario.

The Rise of Government Funding In a “Publicly Owned” Company Environment

One of the more intriguing impacts of the rise of government funding for the industry comes at a time when the industry itself, certainly coming out of Canada, is facing a bit of a zeitgeist moment.

Sure, the industry has gained legitimacy, and there might be nascent cannabis funds in the UK, Switzerland and Germany, but the entire “public cannabis company” discussion is hitting a bit of a reset at the moment.

It was after all, ostensibly “public” Wayland that just dusted much higher fliers from the stock price perspective on winning the German cultivation bid. In fact, some insiders on the ground have commented that it is precisely because Wayland is not a stock market favorite, rather focused on fundamentals that they got chosen in the first place. Starting with the old-fashioned idea of committing resources and elbow grease to create production on the ground, locally.

There are also firms who are benefitting from the first tax funds that have flowed to promote the hemp industry (those are available from state governments here).

However, it is not just Germany where this discussion is going on in Europe right now. In Spain, there is political discussion about ensuring that the nascent and valuable cannabis industry does not end up in the control of “outsiders.” Namely international firms who have more of an eye on profit than community building. The idea of the cannabis industry as an economic development tool has certainly caught on in Europe (see Greece and Macedonia). And core in that idea is that the euros generated by this still remarkably price-resilient plant, and the products produced from it, should stay local.

Cannabis Socialism?

For now, and certainly in Canada, federal public funding looks pretty much like a fancy agricultural grant. But in the future as prices drop and the wars over strains and “medical” vs. “recreational” really begin to rage in Europe, the idea of government-funded cannabis cultivation may be an idea whose time has come.

The German automobile industry, for example, did not come from nowhere – and even today receives massive government funding. For now, certainly in Deutschland, that is not the case with cannabis, but things may be changing with the resolution of the first tender bid.

In the future, in other words, as countries across Europe begin to think about posting their own production bids and Germany contemplates additional ones, government funding of the industry and certainly incentives to help its growth will become much more widespread.

Water Policy in California: Six Key Takeaways from the State Water Board’s New Cannabis Cultivation Policy

By Amy Steinfeld
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Cannabis is the most highly regulated crop in California, and the state just added another layer of regulation. This article breaks down the State Water Resources Control Board’s (SWRCB) recently updated Cannabis Cultivation Policy – Principles and Guidelines for Cannabis Cultivation (“Policy”) into six key takeaways.1 These guidelines impose new rules on cannabis cultivation activities that have the potential to impact a watercourse (stream, creek, river or lake). Most of these rules apply to cultivation of sun-grown cannabis, which is currently allowed in some form in 12 counties. Compliance with these new requirements will be implemented through the CalCannabis Cultivation Licensing Program.

  1. When developing farmland, hillsides should be avoided and erosion must be controlled.

The Policy provides specific rules for growing pot on undisturbed land. To prevent erosion, numerous limitations are placed on earthmoving and activities in sensitive areas, and cultivators are not allowed to grade hillsides that exceed a 50% slope.2

Cultivation prepping activities must minimize grading, dust, soil disturbance, erosion, and impacts on habitat, especially during the winter season.3 No vehicles or heavy equipment may be used within a riparian setback4 or watercourse,5 and cultivators must avoid damaging native riparian vegetation6 and oak woodlands.7 All farm equipment, fuel, and hazardous materials must be carefully stored away from creeks and sensitive habitat.8 The Policy also governs road construction.9

  1. Cultivators should avoid work in or near a surface waterbody.10

If a cultivator’s activities impact a river, stream, or lake, they must consult with the California Department of Fish and Wildlife (CDFW).11 Cultivators must maintain minimum riparian setbacks for all cannabis activities, including grading and ancillary farm facilities. Before grading land, a biologist must identify any sensitive flora or fauna, and if any is located, consult with CDFW and provide a report to the Regional Board.12 No irrigation runoff, tailwater, chemicals or plant waste can be discharged to a waterbody.13 Diversion facilities for the irrigation of cannabis may not block fish passage, upstream or downstream, and must be fitted with a CDFW-approved fish screen; new facilities are subject to all applicable permits and approvals.

  1. During the dry season, cultivators may not use surface water.

The use of surface water supplies in California requires a valid water right and the use of water for cannabis cultivation is no different.14 Anyone seeking to appropriate “water flowing in a known and defined channel” or from a watercourse must apply to the SWRCB and obtain a permit or license.15 Alternatively, a landowner whose property is adjacent to a watercourse may have a riparian right to divert the water for use on her land. Riparian users do not need permission from the SWRCB to divert water, but they must report water use annually.16

The biggest obstacle that growers face under this Policy is that they cannot divert anysurface water during the dry season—the growing season (April 1 through Oct. 31). It should be noted:

  • The seasonal prohibition of surface water diversion applies regardless of the nature of the water right or what has been historically used to irrigate other crops.
  • During the dry period, cultivators may only irrigate using stored water (see no. 5 below) or groundwater.
  • It remains to be seen whether a legal challenge will be brought against the state for their draconian prohibitions on irrigating cannabis during the six-month growing season. Because this prohibition applies to all watersheds in California, singles out one low-water use crop, and ignores established water rights, it is overly broad and may constitute a constitutional “taking” of property rights.
  1. During the wet season, surface water diversions must be monitored closely.

Cannabis-specific restrictions also apply during the wet season. From Nov. 1 to March 31, cultivators must comply with instream flow requirements and check in with the state daily. All surface water diversions for cannabis are subject to “Numeric and Narrative Instream Flow Requirements,” to protect flows needed for fish migration and spawning. To ensure diversions do not adversely impact fish flows, cultivators must also “maintain a minimum bypass of at least 50% of the streamflow.”17,18

While valid appropriative right holders may divert more than 10 gal./min. for cannabis irrigation during the wet season, riparian right holders are not allowed to exceed that diversion rate.19 All cultivators (including small diverters <10 acre-feet (“AF”)/yr) are required to employ water-saving irrigation methods, install measuring devices to track diversions daily, and maintain records on-site for at least five years.20 Cultivators must inspect and repair their water delivery system for leaks monthly,21 and inspect sprinklers and mainlines weekly to prevent runoff.22

  1. Cannabis cultivators may obtain a new water storage right for use during the dry season.

To address dry season irrigation limitations, cultivators are urged to store water offstream during the wet season, including rainwater, for dry season use. Growers may not rely on onstreamstorage reservoirs, except if they have an existing permitted reservoir in place prior to Oct. 31, 2017.23 Alternatively, small growers (storage is capped at 6.6 AF/yr) may benefit from the new Cannabis SIUR Program, an expedited process for cultivators who divert from a surface water source to develop and install storage offstream. Only diverters with a valid water right that allows for diversion to storage between Nov. 1 and March 31 qualify.

  1. Groundwater is less regulated, but cultivators should avoid drilling or using wells near waterbodies.

Groundwater is generally the recommended water supply for cannabis because, unlike surface water, it may be used during the dry season and is not subject to many of the restrictions listed above. It should be noted however:

  • Many groundwater basins are now governed by California’s Sustainable Groundwater Management Act (“SGMA”), which requires water agencies to halt overdraft and restore balanced levels of groundwater pumping from certain basins. Thus, SGMA may result in future pumping cutbacks or pumping assessments.
  • In some counties, moratoriums and restrictions on drilling new wells are on the rise.
  • Under this Policy, the state may step in to restrict groundwater pumping in the dry season in watersheds where there are large numbers of cannabis groundwater, wells located close to streams, and areas of high surface water-groundwater connectivity.24

In short, groundwater pumpers are at risk of cutback if the state deems it necessary to maintain nearby creek flows.Noncompliance can bring lofty fines, revocation of a grower’s cultivation license, or prosecution

Final Takeaways

This cannabis policy presents one of California’s most complex regulatory schemes to date. Before investing in a property, one must understand this Policy and have a robust understanding of the water rights and hydrology associated with the cultivation site. Growers looking to reduce permitting time and costs should invest in relatively flat, historically cultivated land with existing wells and ample groundwater supplies, or alternatively, grow indoors.

This article attempts to synthesize the maze of water supply and water quality regulations that make compliance exceedingly difficult; more detailed information can be found here. Noncompliance can bring lofty fines, revocation of a grower’s cultivation license, or prosecution. Growers are encouraged to contact a hydrologist and water lawyer before making major investments and to designate a water compliance officer to monitor and track all water diversions and water used for irrigation. Growers should also consult with their local jurisdiction regarding water use restrictions and stream setbacks before moving any dirt or planting cannabis.

References

  1. The Policy is available at: https://www.waterboards.ca.gov/water_issues/programs/cannabis/cannabis_policy.html (will go into effect on or before April 16, 2019.)
  2. Policy, Appendix A, Section 2, Term 4. The Policy defines “Qualified Professional” as a: California-Licensed Professional Geologist, including Certified Hydrogeologist and Certified Engineering Geologist, California-Licensed Geotechnical Engineer, and Professional Hydrologist. (Policy, Definition 72, p. 11.)
  3. Policy, Appendix A, Section 2, Terms 4 and 10.
  4. Policy, Appendix A, Section 2, Term 3.
  5. Policy, Appendix A, Section 2, Term 40.
  6. Policy, Appendix A, Section 2, Term 33.
  7. Policy, Appendix A, Section 2, Term 34.
  8. Policy, Appendix A, Section 2, Term 7.
  9. Policy, Appendix A, Section 2, Terms 15 to 29.
  10. Policy, Appendix A, Section 1, Term No. 41.
  11. Policy, Appendix A, Section 1, Term No. 3; see also 1602.
  12. Policy, Appendix A, Section 1, Term No. 10.
  13. Policy, Appendix A, Section 1, Term No. 326.
  14. Policy, Appendix A, Section 2, Term 69.
  15. Wat. Code §1225; See alsoWat. Code §1201 [providing that the state shall have jurisdiction over, “[a]ll water flowing in any natural channel” except water that is appropriated or being used for beneficial purpose upon land riparian to the channel.”]
  16. Wat. Code §§ 5100–02.
  17. Policy, p. 12.
  18. Policy, Attachment A, pp. 60, 63.
  19. Policy, Section 2, Term 78.
  20. Policy, Section 2, Term 82.
  21. Policy, Section 2, Term 95.
  22. Policy, Section 2, Term 99.
  23. Policy, Section 2, Term 79.
  24. Policy, p. 11.

Taxes & Cannabis: 280E, R&D Credits, 199A & Qualified Opportunity Funds: Part 2

By Zachary Gordon, Jason Hoffman
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Editor’s Note: This is the second piece in a two-part series delving into tax issues. Part one discussed tax code 280E as it pertains to cannabis businesses. Part two will go into research and development credits, 199A and a discussion of risk as it relates to Qualified Opportunity Zones. 

While 280E is the most influential code section for the cannabis industry, structuring never happens in a vacuum. There are many open questions that each business must answer for themselves without court adjudication. We believe that among the riskiest of questions is whether a cannabis business can claim research and development credits.

There is no clear legal authority that either allows these credits or disallows them but certainly utilizing such credits comes at great risk. At the beginning of this article we talked about Congress and the purpose of 280E. Congress’s intention was to make sure that only the minimum required tax deductions were available to Schedule 1 and 2 sellers. A cannabis business receiving a research and development credit would not be with the intension of Congress. While the credits would be computed based on COGS expenditures, at this time we do not believe that a cannabis business should take this credit. Disallowance of COGS would create a constitutional challenge which is why Congress allowed the COGS deduction. Disallowance of Research and Development Credits does not open up the same constitutional issue since the credit is not part of COGS although calculated based on COGS expenditures. 280E states very clearly that credits arising from other code sections are disallowed in the entirety.

More recently the Tax Cut and Jobs Act (TCJA) opened up new issues for cannabis companies that are still unfolding. Two of the most publicized are Qualified Opportunity Funds and Section 199A, the 20% deduction (Qualified Business Deduction).

The 199A deduction allows eligible pass-through entities to claim an additional deduction of 20% of the income (subject to certain limitations) at the individual level potentially lowering the tax rate from 37% to 29.6%. While the American Institute of Certified Public Accountants (AICPA) and others have asked the IRS to clarify if 280E would make a cannabis business ineligible, the final regulations on the subject did not address this issue. There are other significant limitations and hurdles in 199A regulations that any business would have to first pass to be considered for the rate deduction. If a cannabis business meets all other eligibility and limitation criteria, should the pass-through income to their investors be qualified income under 199A? The answer will depend on whether the courts will treat this “deduction” as falling under the general prohibition of 280E.

We believe that there is a reasonable chance that the courts will allow the 199A deduction for cannabis companies. That does not mean, however, that we advise cannabis companies to claim this on their pass-through returns as Qualified Business Income. Much like everything else, it depends on the particular business and the risk profile that management is willing to tolerate. This is one area of tax law that is sure to be challenged in court. The more risk-averse business should pass on claiming this deduction on their returns, but monitor development with an eye to amending at a later date if favorable precedent emerges. If the amounts are large enough, consideration should be given to applying for a Private Letter Ruling, but that also has its own tax risks.

Another new tax incentive that was in the TCJA was Section 1400Z or Qualified Opportunity Zones (QOZ). The incentive allows for the deferral of capital gains until December of 2026. The use of 1400Z also results in up to a 15% decrease in capital gains tax- and tax-free appreciation if all requirements are met. While the IRS has only released proposed regulations and we anticipate significant changes to them when they are released as final, there was nothing in the proposed regulations limiting cannabis businesses from using Qualified Opportunity Funds (QOF) in their structure. It is interesting to note that the TCJA and proposed regulations did list other types of businesses that could not make investments under 1400Z along with all its benefits. Liquor stores, golf courses and sun tan parlors were among those listed but cannabis growers and dispensaries were not.

As the industry continues to mature, new issues and precedents will require CPAs and attorneys to find new solutions to best serve the industry.Using Opportunity Zones to entice investors sounds like a great opportunity, but there are significant risks. The first risk is that the proposed regulations, while currently proposed, may not be final. There is always a chance that the IRS will take a different position when the final regulations are released and add cannabis to the type of businesses that do not qualify. Another risk, and one that was previously mentioned as part of 199A and other areas of structuring, is that the IRS and the courts can always disagree with the taxpayer’s position. This is a new area of tax law and will eventually be litigated. The loss of the Opportunity Zone benefits can significantly change the return to the investors and lead to other issues.

All of these issues come into play when structuring businesses in this industry. These issues must be evaluated as they pertain to the business needs. This can be very complex and requires a great deal of research for each business opportunity. We have found that professionals operating in this industry like to know about all of their options. The most important thing we can do for the industry is to continue to educate the professionals working in it.

Accountants should be available to assist their clients and their clients’ attorneys with structuring techniques aimed at asset protection and minimizing 280E disallowances. Accountants should also be ready to speak to the questions outlined above and be prepared to explain the risks associated with each choice. As the industry continues to mature, new issues and precedents will require CPAs and attorneys to find new solutions to best serve the industry.

Introducing the Cannabis Quality Conference & Expo

By Aaron G. Biros
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An educational and networking event for cannabis safety and quality solutions: Innovative Publishing and Cannabis Industry Journal are pleased to present the first annual Cannabis Quality Conference & Expo (CQC). The conference will take place October 1-3, 2019, hosted at the Renaissance Schaumburg Convention Center in Schaumburg, Illinois.

The inaugural CQC will consist of two separate tracks: The Cannabis Labs track, focused on all things cannabis lab testing, and the Cannabis Quality track, focusing on quality in cannabis product manufacturing.

Sharing an exhibit hall and meeting spaces right alongside the Food Safety Consortium Conference & Expo, the CQC allows cannabis professionals to interact with senior level food quality and safety professionals, as well as regulators. Visit with exhibitors to learn about cutting-edge solutions, explore two high-level educational tracks for learning valuable industry trends, and network with industry executives to find solutions to improve quality, efficiency and cost effectiveness in a quickly evolving cannabis marketplace.

The CQC will be hosted at the Renaissance Schaumburg Convention Center in Illinois (just outside of Chicago)

With the cannabis industry in the Midwest growing at a rapid pace, the CQC offers attendees, exhibitors and sponsors unparalleled access to explore these emerging markets, their regulations, opportunities for business growth and best practices from the more established food industry.

For information on speaking opportunities and to submit an abstract, click here to view the Call for Proposals. The CQC will be accepting abstracts for consideration until June 3, 2019. For information on exhibiting, as well as additional sponsorship opportunities, contact RJ Palermo, Sales Director, rj@innovativepublishing.net, (203) 667-2212.

Take advantage of this chance to connect with cannabis industry and food safety professionals in the Greater Chicago Area. Don’t miss this opportunity to network with hundreds of industry stakeholders, get the latest on regulatory developments and see the newest technology disrupting the cannabis space.

Taxes & Cannabis: 280E, R&D Credits, 199A & Qualified Opportunity Funds: Part 1

By Zachary Gordon, Jason Hoffman
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Editor’s Note: This is the first piece in a two-part series delving into tax issues. Part one discusses tax code 280E as it pertains to cannabis businesses. Part two will go into research and development credits, 199A and a discussion of risk as it relates to Qualified Opportunity Zones. Stay tuned for Part two coming next week!

When building a knowledge base in the cannabis industry as a CPA, one’s tax research typically starts with Internal Revenue Code (IRC) Section 280E. For those that are unfamiliar, 280E is only three lines long. With this in mind, we at Janover realized that we needed to understand the context for this highly influential tax section.

The genesis of 280E dates back to 1981 with a Tax Court case: Jeffrey Edmonson v. Commissioner. The decision in this case was that a seller of cocaine, amphetamines and cannabis could deduct most business expenses, cost of goods sold, packaging, home, phone and automobile expenses relating to the seller’s illegal business.

In 1982, 280E was enacted to reverse the Edmonson decision and deny sellers of Schedule 1 or 2 controlled substances the right to deduct business expenses. Under the Controlled Substances Act, the federal government defined Schedule 1 drugs as drugs that have no currently acceptable medical use and a high potential for abuse. Since cannabis is classified as a Schedule 1 drug, cannabis businesses were unable to deduct most business expenses.

To get a better understanding of what the legislators were trying to accomplish, House and Senate reports provided insight into what their goals might have been. Under the Explanation of Provision, the Senate Report reads:

All deductions and credits for amounts paid or incurred in the illegal trafficking in drugs listed in the Controlled Substances Act are disallowed. To preclude possible challenges on constitutional grounds, the adjustment to gross receipts with respect to effective costs of goods sold is not affected by this provision of the bill.

As the Senate Report explanation provides, 280E specifically excluded cost of goods sold (COGS) from the disallowance of deductions. This treatment was affirmed by the Tax Court in 2012 in Olive v. Commissioner (139 T.C. 19 2012).

To date, there are not many cases that have dealt with the tax issues of 280E. In a 2007 decision involving Californians Helping to Alleviate Medical Problems (CHAMP), the Tax Court ruled that a taxpayer may deduct expenses allocable to an affiliated business that was separate from the entity “trafficking in a controlled substance.” In CHAMP, the legal caregiving business, which was a separate business, was able to deduct the allocated portion of shared expenses. This set a legal precedent that allowed a taxpayer engaged in the selling of a Schedule 1 or 2 controlled substance to distinguish expenses incurred on behalf of other non-prohibited business lines and deduct these expenses.

In addition to these court cases, tax professionals can rely on IRS Chief Counsel Memorandum CCA 201504011. The IRS Chief Counsel released this memorandum in January 2015 in order to respond to questions the IRS was receiving from practitioners.

Although Chief Counsel Memoranda, in general, may not be cited by taxpayers as precedent, this memorandum is the current and best authority outlining the IRS’s position with respect to the extent to which a cannabis business may deduct business expenses. The memorandum also refers to IRC Section 162, ordinary and necessary business expenses that would be disallowed, as well as separately identifying certain direct and indirect business expenses that would be allowed. Citing methods in Treas. Reg. 1.471, the memorandum states that a cannabis producer may allocate to inventory and COGS direct production costs, including direct material costs (Cannabis seeds or plants), direct labor costs (e.g., planting, cultivating, harvesting, sorting, etc.), and transportation or other costs to acquire of the cannabis. It also indicates certain indirect costs that may be taken as COGS.

As the industry continues to mature, more cases are finding their way to the Tax Court. On June 13, 2018, the Tax Court issued a ruling in Alterman v. Commissioner that specifically disallowed the use of 263A under 280E and applied only Section 471 to determine COGS. While we need to follow the facts and circumstances of each case, the broad language used might very well disallow capitalizing of inventoriable costs for companies subject to 280E.

IRC Section 471 is the general rule for inventory accounting for tax. IRC Section 263A is the uniform capitalization rules for tax. Most businesses need to utilize both 471 and 263A when accounting for inventory and to properly capitalize costs into COGS.This opinion may have lasting effects on the part of the industry trying to create brands associated with their cannabis products.

Many resellers and retailers of cannabis thought they could use 263A to capitalize more costs into inventory decreasing their tax burden. The Chief Counsel Memorandum disagreed and more recently the Tax Court in Patients Mutual Assistance Collective Corp v Commissioner sided with the IRS and upheld some of the precedents set in Alterman v. Commissioner. In siding with the IRS, the judge concluded that a taxpayer who is subject to 280E can only deduct costs of goods sold under 471 as the IRC existed when 280E was enacted (in 1982). The taxpayer in the case used two arguments that were not new to the cannabis industry, but to no avail. The first argument was that the business was not trafficking in a controlled substance because the government had abandoned a civil forfeiture action. The second argument that was rejected was that a portion of the business involved branding, marketing and the sales of other non-illegal products. The claimant tried to convince the court that deductions related to these operations should not be subject to the same disallowance of deduction as outlined in 280E.

This second argument is very important for structuring purposes. The court used a significant portion of its opinion to address why the entire business is integrated and completely subjected to 280E. This opinion may have lasting effects on the part of the industry trying to create brands associated with their cannabis products.

This case has even more implications given part of the ruling in which the courts stated that being state licensed in no way effected the Schedule 1 determination at the federal level and, therefore, subjected them to 280E. The judge went so far as to separate the Department of Justice, which enforces the Schedule 1 status of cannabis, and the Department of the Treasury, which has full authority and enforcement rights to treat cannabis as a Schedule 1 drug subject to 280E for income tax purposes. This ruling made it clear that even if the Department of Justice is not pursing criminal charges against state-licensed cannabis businesses the IRS is not precluded from fully enforcing the Internal Revenue Code.

A2LA Accredits GoodCat Analytical to ISO/IEC 17025

By Aaron G. Biros
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According to a press release published last week, the American Association of Laboratory Accreditation (A2LA) announced the accreditation of GoodCat Analytical, LLC, a cannabis testing laboratory based in Naples, Florida. This marks the first time that A2LA has accredited a cannabis testing lab in the state.

Adam Gouker, A2LA General Manager, says this is a momentous achievement for GoodCat Analytical. “A2LA is excited to expand our cannabis accreditation program into yet another state, promoting the value of independent third-party accreditation to support quality products in the industry,” says Gouker. “We congratulate GCA Laboratories in achieving this milestone for their organization and wish them all the best as they move forward with this new endeavor.”

According to Jimmy Dodsworth, chief science officer at GoodCat Analytical, they had to develop a lot of methods on their own. “I can’t say enough about each of our staff members efforts to develop and validate each analytical method,” says Dodsworth. “The level of quality for these internally developed tests is amazing considering we started from scratch.”

Raymond Keller, owner and president of GoodCat Analytical, says A2LA’s support was an incredibly valuable resource for them. “We also need to acknowledge the tremendous guidance and support from the A2LA staff,” says Keller. “There is no doubt that they had a hand in making our lab the impressive operation it is today and know they will continue to do so moving forward.”

Child-Resistant Packaging Designed for Adults

By Pate Gustafson
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As the cannabis industry grows so does the crucial need for child-resistant (CR) packaging solutions. There’s a long list of federal regulations that are required for any cannabis product to ensure that the package is both difficult for children to open, yet easily accessible for adults. This formula can often be difficult; add design into the mix and your packaging solution just got extremely complex.

However, brand image and appeal does not need to be sacrificed over packaging requirements. With the use of print effects, interactive elements, and captivating colors and designs, companies can create the ideal paperboard packaging for cannabis products while staying within federal regulations.

Let’s start with the packaging requirements first.

Child-resistant packaging can look aesthetically pleasing with the right design

CR Packaging Requirements for Cannabis Products

Depending on the state you do business in, your cannabis product is subject to a variety of child-resistant regulations that will keep children safe from potentially harmful materials. These regulations create packaging that is unappealing and inaccessible to children. Key elements of CR packaging for cannabis include:

  • Packaging must have resealable features
  • Packaging must exhibit a clear and detailed information label
  • Packaging must have an opaque appearance
  • Packaging must make product unappealing and unattractive to children

CR compliance requires that packaging undergo rigorous tests. The general concept is for the packaging to be difficult for children under 5 to open, while simultaneously being easy for adults to open and close.

These regulations create an immensely safer product for children. However, these same regulations limit the creative opportunities that normal packaging can provide, making most packaging for cannabis unattractive for adults.

CR Regulations & Packaging Challenges

Although CR regulations for cannabis products are vital to keeping children safe, these regulations cause a lot of roadblocks in the creative department.

Follow these tips to create a high-quality, CR-compliant cannabis carton packaging that the market will love.One of the most significant impacts these regulations have made on cannabis companies is the difficulty to align a brand image with these regulations. Every company has a brand image with which they need to align their entire marketing plan, including packaging designs. Add in strict CR regulations, and it becomes extremely difficult to balance the two.

Another key challenge in this process is structural design limitations. Businesses use inventive and innovative structural designs to help differentiate their products in a growing and crowded market. Cannabis products experience a significant disadvantage here. Cannabis companies must incorporate an opaque appearance and resealable features while also attempting to design a packaging structure that is attractive and eye-catching to consumers.

Designing CR-Compliant Cannabis Packaging that is Appealing to Adults

Although CR requirements make it challenging for companies to inject creativity into packaging designs, innovative solutions in the market do exist. These offer the best of both worlds by meeting the necessary CR guidelines, while maximizing branding, structural elements and print effects.

Incorporate Captivating Colors

Since there are no color restrictions for CR packaging, one of the best ways for a brand to express itself is through color. Companies are free to express themselves to tell a brand story utilizing unique colors in their packaging.

Before choosing a color palette, brands should ensure that packaging designs meet overall branding requirements. Consistency across branding, marketing and other avenues, will make any brand more recognizable and memorable. Colors can also set cannabis products apart from the hundreds of other products.

Smart packaging design can be simple with some good printing effects

Get Creative with Structural Design

Although CR regulations seem extremely restricting structurally, there are plenty of ways to still have a structurally appealing cannabis carton packaging while still in compliance with CR regulations. Just remember that cannabis packaging must be resealable and opaque.

In order to capitalize on your structural design process, experiment with different carton structures. Generally, carton packaging is rectangular or square but there’s ample opportunity for a variety of forms. Experimenting with designs, whether a straight carton or cartons with built-in trays, is an important step in finding the best packaging design that protects, promotes and differentiates the product it holds.

Never Overlook Print Effects & Finishes

Print effects and finishes are often an afterthought for cannabis carton packaging. Print effects and specialty finishes can make all the difference when looking for ways to set any cannabis product apart. The perfect finishing can take an average cannabis carton to the next level. Popular print effects include:

EmbossingJust because you have to stay aligned with CR regulations doesn’t mean that packaging should be plain and unattractive. 

Embossing is the art of incorporating a raised image, design, or pretty much any textural component in a packaging’s design. The process of embossing allows for artwork and specific elements to stand out against the background of the paperboard material.

Debossing

Debossing, as its name implies, is the opposite of embossing. Instead of creating a raised pattern, debossing creates a pressed imprint. It’s a great way to create a tactile experience and bring something extra to a packaging design while staying compliant with CR regulations.

Embossing and debossing can be used in conjunction with a variety of foil effects and other print finishing processes.

Making Interactive Experiences

The packaging is only as memorable as the process of opening it. Making packaging memorable requires focusing on creating an experience. Elements such as reveal flaps, tear-aways, doors and more are unique ways to add interactivity to a package design. This is great for increasing engagement and brand loyalty within your target market. Who says adults can’t have fun too?

Just because you have to stay aligned with CR regulations doesn’t mean that packaging should be plain and unattractive. Follow these tips to create a high-quality, CR-compliant cannabis carton packaging that the market will love.

Marguerite Arnold

Farmako Inks Deal To Import 50 Tonnes of Polish Cannabis Into Germany

By Marguerite Arnold
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Marguerite Arnold

The ex-im cannabis map of Europe has been promising to get interesting for some time. And in March, it’s long promised potential just bloomed a little more as Frankfurt-based Farmako announced a first-of-its kind import deal of 50 tonnes of medical cannabis (and from Poland no less) over the next four years.

Farmako was just founded in September 2018. They began distribution to German pharmacies this month. They also have an office in London and cross-European aspirations.

While Farmako is the first to announce such a unique cross-border production and distribution agreement, however, they are far from the only ones planning the same. In fact at least Tilray is expected to announce that their newly-minted Portuguese crop is being processed into oil bound for German pharmacies any day now. It is also not unrealistic to expect that (at least) Canopy Growth, of the big Canadian producers at least, will soon announce the same situation for their crops in countries across the continent, starting with Spain.

Outside Germany of course, this kind of entrepreneurial endeavour is already underway. In the UK, a new import group just announced the first bulk shipment of Dutch medical cannabis into the country, distributed directly to over 1,000 pharmacies nationwide.

There still are a couple of jaw-dropping things to consider about this new German development. Namely, that the amount of just this deal over the next four years between two (relatively new, non-Canadian) companies is approximately five times the amount currently called for in the still pending domestic cultivation bid in Germany.

The second, of course, is that the Polish company on the other side of the border and this ex-im deal, PharmaCann Polska, is a uniquely positioned conglomeration of individuals with apparently Canadian and Israeli market experience. This means that they are already positioned to access the biggest two production markets in the world and are certain to be looking to exploit other Eastern European connections (at minimum). If not ones further afield than that.

One thing is absolutely certain far beyond the particulars of this one deal. The current import limitations from Canada and the Netherlands into the German market appear to be a thing of the past. And the cross-border trade for medical cannabis is now clearly entering a new phase.

Implications

Farmako clearly intends to go after the existing Canadians in the market on price, which means both Canopy Growth and Tilray. But it also means Wayland, at this point is the largest domestic certified producer (albeit with Canadian roots and partners) and an entire licensed facility in eastern Germany ready to go. That is not an insignificant threat and sets up another looming question: Which will actually be cheaper in the long run? Domestically grown German cannabis, or that imported from adjacent countries with lower paying labor markets?

This announcement also means that the “cannabis shortage” in the country is officially over as of this spring. And that won’t just come from Farmako but others already in the market and those angling now to get in via other creative means.

Regardless, what that will do to overall sales, patient numbers and overall speed is another matter.

Other Looming Problems

There are two big issues that this development does not solve of course. The first is the ability of patients to find doctors willing to prescribe the drug, and further to make sure they spend the time filling out the paperwork and negotiating with the patient’s insurer, to make sure that patients can actually get it. Starting with affording medical cannabis in the first place. Most patients on what is known as “statutory” health insurance (90% of the country) cannot afford the out of pocket cost at pharmacies without insurance approvals. Once they get them, they pay up to $12 for a month’s supply (in the case of flower, about an ounce).

german flag
Photo: Ian McWilliams, Flickr

The second issue is that it is currently unclear, mostly due to the lack of granularity provided by the country’s statutory health insurers, what is actually being prescribed for which kind of condition and to whom. Earlier this month, new information was made available about the overall growth of coverage of medical cannabis in Germany. While the total spending, and rough breakdown of flowers vs. product was provided, it is unclear beyond that, where this is going. There were also apparently just over 46,000 patients in Germany as of December 2018. And this is a growth trend that while clearly on an upward trajectory for the last three quarters is slow and steady as she goes. The sudden uptick in the market seen in the second quarter of last year appears to be an anomaly.

Further, understanding market price points is also hard. Flos and prepared pharmaceuticals such as Sativex are highly expensive right now. In the case of the Canadian firms, their medical exports are being sold at about twice the price of their domestic recreational sales points. Look for this to change dramatically as real competition heats up across Europe (and from more distributors than just this Frankfurt upstart).

What the news in other words about Farmako really signifies is that the price barriers in the medical market are about to come down at the point of sale- and hopefully in the short term, patients will not have to rely on the approval of their insurance companies to be able to access the drug because they will be able to afford it themselves. No matter what happens with the bid. Although this too will also serve to lower prices.

The great medical normalization race for medical cannabis in Europe is now officially “on.” And that is good news not only for patients, but of course, the industry.