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Warning Signs For CBD Food & Drink Manufacturers

By Jonathan C. Sandler
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CBD-infused coffee? CBD-infused chewing gum? Many think cannabis and its derivatives are the next big wellness craze that will make the demand for flax, fish oil and turmeric combined seem meager. The food and drink industries are cautiously exploring the cannabis market, trying to determine the optimal timing to introduce their own product lines.

The structure of cannabidiol (CBD), one of 400 active compounds found in cannabis.

The cannabis plant produces chemicals known as cannabinoids, one of which is cannabidiol, or CBD.When the Agriculture Improvement Act of 2018 (also known as the Farm Bill) passed, the food and drink industries jumped into the hemp-derived CBD world with both feet because the Farm Bill lifted the federal ban on hemp production, which previously classified hemp as a controlled substance akin to heroin. Lifting the ban led to an explosion in the number of CBD products hitting the market around the country. However, repeated and recent actions by the U.S. Food and Drug Administration (FDA) provide clear warning signs that the legal pitfalls surrounding CBD in food and drinks are not yet resolved.

CBD is marketed as a featured ingredient for a wide variety of products ranging from pain relievers, to protein bars beverages and supplements. Both CVS and Walgreens have announced plans to carry CBD products in their stores. However, despite the money pouring into CBD products, federal agencies are not relinquishing their controls.

FDAlogoIn the Farm Bill, the FDA retained authority to regulate products containing cannabis or derivative products. The FDA has regulatory authority over foods (including dietary supplements and food additives), drugs (prescription and non-prescription), cosmetics, veterinary products and tobacco products, among other categories. Therefore, vendors of virtually all products containing CBD are regulated by the FDA.

It is important to note that the FDA does not view CBD derived from hemp differently than any other CBD despite the fact that it is non-psychoactive. CBD is an active ingredient in at least one FDA-approved prescription drug—Epidiolex. Therefore, under the logic of the Federal Food, Drug & Cosmetic Act (FDCA), CBD is a drug. If a substance has been “approved” by the FDA as an active ingredient in a drug product, it is per se excluded from being defined as a “dietary supplement” under sections 201(ff)(3)(B)(i) and (ii) of the FDCA and it cannot be included as an ingredient in food.

It is highly unusual that CBD has been able to proliferate in the marketplace given the FDA’s technical legal position on it. FDA regulations on drugs are much more stringent than for food or dietary supplements. Generally, the FDA’s position on CBD in food and beverages is that it is unlawful to engage in interstate commerce with products containing CBD. The given reason is that the Federal Food, Drug, and Cosmetic Act prohibits the introduction of a food product into interstate commerce that contains an active ingredient in an approved drug. While arguments against this position exist, they have not carried the day, yet.

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

In March 2019, FDA Commissioner Scott Gottlieb announced he would be resigning on April 5, 2019, but he sent clear warning signals to the CBD industry prior to his departure. In early April, the FDA cracked down on websites making “unfounded, egregious” claims about their CBD infused products. The FDA sent warning letters to three companies who made claims about their CBD products including that their CBD products stop cancer cell growth, slow Alzheimer’s progression, and treat heroin withdrawal symptoms. Commissioner Gottlieb issued a statement that he believed that these were egregious, over-the-line claims and deceptive marketing that the FDA would not tolerate.

The FDA also announced in early April that it will hold a public hearing on May 31, 2019, to obtain scientific data and information related to safety concerns, marketing and labeling cannabis and cannabis-derived compounds including CBD. The FDA expressed interest in hearing whether drug companies would still be motivated to develop drugs with CBD and other compounds if their use in food and beverages became more widespread. The FDA also announced plans for an internal working group to review potential pathways for legal marketing of CBD foods and dietary supplements. Of particular concern to the FDA is online retail products available nationwide such as oil drops, capsules, teas, topical lotions and creams.

Still, some states are trying to take matters into their own hands. For example, the California State Assembly recently passed bill A.B. 228 that permits the inclusion of CBD in food and beverages. Colorado has already passed a similar bill. Other states such as Ohio and cities such as New York City have gone the other way, prohibiting CBD from being added to food or beverages.

The May 31 FDA hearing is an opportunity for interested parties to give feedback and help focus where the FDA should be creating clear industry standards and guidance. In the meantime, the industry should continue to expect warning letters from the FDA as well as possible state-level scrutiny. Companies would be wise to proactively review their labels and promotional practices in order to mitigate the risk of forthcoming actions and engage in the FDA’s provided avenues for industry input. Companies must also look to the laws of the states and even to the counties where they are selling their products.

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.

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.

Cannabis Legalization in Massachusetts: An Interview with Steven Hoffman, Chairman of the Cannabis Control Commission

By Aaron G. Biros
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On February 13 at the upcoming Seed To Sale Show in Boston, MA, Steven Hoffman, Chairman of the Cannabis Control Commission of Massachusetts, will deliver a keynote discussion. Hoffman will sit down with National Cannabis Industry Association (NCIA) Executive Director Aaron Smith to discuss the first few months of recreational legalization, challenges and the path forward for the state. We caught up with Hoffman to hear about some of the biggest obstacles and successes when it came to standing up a regulated adult-use cannabis market.

On November 8, 2016, voters in Massachusetts ushered in a new era for the East Coast, when they passed a ballot initiative to legalize adult-use cannabis. Almost immediately after that, the Massachusetts Legislature put a hold on implementation in order to study the issues and revise the legislation, which was ultimately signed in July of 2017. That September, Steven Hoffman and his colleagues at the Cannabis Control Commission were appointed to figure out how the state should regulate the market, enforce its regulations and roll out the new adult-use program.

Steven Hoffman, Chairman of the Massachusetts Cannabis Control Commission

The Commission was tasked with creating something brand new, without a roadmap in place and developing rules around some very contentious issues. “I think the biggest obstacle was that we were doing something unprecedented,” says Hoffman. “Every state is different demographically and the laws differ state to state, and we got a lot of help from other states sharing their experiences with us, but we were still going down an uncharted path for Massachusetts.”

Hoffman told us the very first thing they needed to do in 2017 was conduct listening sessions in which the commissioners listened to citizens for recommendations and heard people’s thoughts on cannabis legalization. “We did that immediately. We needed to conduct a process that was transparent, thoughtful and inclusive,” says Hoffman. “We then, in public, debated policies around adult-use marijuana regarding licensing processes, criteria and enforcement.”

They debated policies in a public forum for four days and came back the following week to embed their decisions in draft regulations that were submitted to the Secretary of State in December 2017. Then, they had 10 more public hearings, made some modifications to the rules, and promulgated a final version of the adult-use regulations in March 2018, keeping everything as transparent and inclusive as possible. “I don’t think anyone has been critical of that process behind it,” says Hoffman.

Certain pieces of the regulations stand out as particularly inclusive and progressive for Massachusetts’ cannabis program. For example, certain mandates encourage diversity and support communities affected by the drug war. Hoffman says the Commission couldn’t take credit for those completely because their objectives are explicit in the legislation, however, the agency still made sure the state followed through. “The mandate said the industry should look like the state of Massachusetts in terms of our diversity,” says Hoffman. That includes creating a diverse industry with respect to ethnicity, gender, LGBTQ, veteran and disabled participation. Additionally, he added, “it was a very explicit set of requirements that those communities who were disproportionally harmed by the drug war are full participants in the new industry we set up. Those were both legislative mandates, so we take them very seriously and I wouldn’t have taken this appointment if I didn’t think it was absolutely essential.”

You can expect to hear more from Hoffman on this and other matters related to implementing cannabis regulations at the upcoming Seed To Sale Show in Boston, MA, February 12-13, 2019. On November 20, 2018, the first adult-use dispensaries in the state opened their doors for business and began selling cannabis. Hoffman says he is most proud of their rollout of the program as well as the transparency and inclusiveness through which they conducted the process. “I think this is a very controversial issue; the voters approved this issue by 53-47%,” says Hoffman. “No matter what we do, we won’t make everyone happy, but we’ve done everything possible to allow people to participate and feel like they’ve been listened to. We made our decisions publicly and transparently.”

Beyond that, the Commission wanted to take their time to make sure things were done the right way the first time. “From day one, we decided we were going to do this right rather than meet an arbitrary timeline,” says Hoffman. “It’s gradual, it’s maybe slower than some people would like, but our rollout has been well-received and relatively smooth. I think a gradual and thoughtful process, not focused on a deadline, went very well. Hopefully we have given other states a model when they plan their own rollout.”

Hoffman wouldn’t comment on whether or not he would encourage other states down a similar path, but he did say they could probably learn a thing or two from them. “I expect other states will do what we did,” says Hoffman. “They will talk to other states ahead of them like us and hopefully will benefit from learning from our experiences. I don’t know what the laws will look like but I expect other states need to make it work for them specifically.”

You can expect to hear more from Hoffman on this and other matters related to implementing cannabis regulations at the upcoming Seed To Sale Show in Boston, MA, February 12-13, 2019. Make sure to check out his keynote discussion with Aaron Smith on Wednesday, February 13 at 10:30am.

Richard Naiberg
Quality From Canada

Protecting Intellectual Property in Canada: A Practical Guide, Part 3

By Richard Naiberg
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Richard Naiberg

Editor’s Note: This is the third article in a series by Richard Naiberg where he discusses how cannabis businesses can protect their intellectual property in Canada. Part 1 introduced the topic and examined the use of trade secrets in business and Part 2 went into how business owners can protect new technologies and inventions through applying for patents. Part 3, below, delves into plant breeders’ rights and how breeders in Canada could protect new plant varieties.

Plant Breeders’ Rights: Protection For New Plant Varieties

Unlike the Patent Act, Canada’s Plant Breeders’ Rights Act does provide intellectual property protection for whole plants. Plant breeder’s rights are available for new cannabis plants, whether they are the product of genetic engineering or more traditional cross breeding.

The applicant must also propose a name (referred to as a “denomination”) for the new variety that is acceptable to the Commissioner.The Plant Breeders’ Rights Act focuses on the material used to propagate a new variety of plant, such as its seeds. The owner of a plant breeder’s right can stop others from selling, producing or reproducing the propagating material, conditioning the propagating material for use, exporting or importing the propagating material, repeatedly using the protected variety to commercially produce another variety, and stocking the propagating material for the purpose of doing any of the above acts. The owner can also assert these same rights to stop another’s activities as they relate to another plant variety that is essentially derived from the protected variety. The owner can also recover for the damages it suffers as a result of any infringement. For cannabis plants, the term of a plant breeder’s rights endures for 20 years from the date of its issuance.

To register a plant-breeder’s right, a breeder provides an application to the Commissioner of Plant Breeders’ Rights Office, which is part of Canadian Food Inspection Agency.

To be registrable, the plant variety must be new, meaning that the propagating material has not been sold in Canada more than 1 year prior to the application (or elsewhere more than 4 years prior to the application); it must be distinguishable from all varieties that are known to exist at date of filing of the application; it must be sufficiently homogeneous, meaning that its relevant characteristics are predictable and commercially acceptable; and it must be stable in its essential characteristics over successive generations. Registration under the Plant Breeders’ Rights Act provides plant breeders’ rights in Canada only. However, Canada is a signatory to a treaty (UPOV) that allows an application originally filed in Canada to provide priority for registration in other member countries, and vice versa.The Commissioner also has the power to require the performance of tests on a sample of the propagating material, such as to verify its stated characteristics.

The applicant must also propose a name (referred to as a “denomination”) for the new variety that is acceptable to the Commissioner. The Plant Breeder’s Rights Act puts limits on what may be chosen as the denomination. Among other things, the denomination cannot refer to characteristics the variety does not have, suggest that it is derived from another variety or bred by a particular breeder when this is not case, or comprise laudatory descriptives that could cause confusion. The denomination cannot be used or registered as a trademark and, once accepted by the Commissioner, must be used by all traders when selling the propagating material, even after the expiry of the plant breeder’s right. Indeed, the Plant Breeders’ Rights Act makes it an offence to misuse or misapply the name. The same denomination will be used for the same variety in all UPOV countries.

The application process can involve some back-and-forth with the Commissioner, as well as the opportunity for others to oppose the registration. The Commissioner also has the power to require the performance of tests on a sample of the propagating material, such as to verify its stated characteristics.

A unique feature of a plant breeder’s right is that it can be enforced even before the Commissioner finishes his or her review against infringers who are given notice of the applicant’s application.

As of this writing, there are three registered denominations of cannabis plants under the Plant Breeders’ Rights Act. Chris Griffin has registered “Big C” – cannabis sativa subsp. indica; and MedReleaf Corp. has registered MR2017001 and MR2017002, both being varieties of cannabis sativa. It is expected that further registrations will follow.

There are some important limitations to the plant breeder’s rights. Farmers who harvest the plant variety on their “holdings” are given a privilege: they can store, produce and reproduce (but cannot sell) the variety on such holdings. The Commissioner also has the power to issue compulsory licenses when a protected variety is not available to the public at reasonable rates. Further, the plant breeder’s right is not infringed when the protected variety is used for non-commercial or experimental purpose.


In Part 4 of the series, Naiberg will discuss trademarks and how cannabis businesses should go about protecting their brand identity in Canada. Stay tuned for more!