Harborside Redux Redux Redux
Harborside Redux Redux Redux – It is our impression Wendel Rosen is the most influential law firm in Oakland, California. Like so many other law firms, Wendel Rosen established a cannabis practice group when it became evident to a successful, conservative law firm that cannabis law was rapidly becoming a potentially lucrative practice area. Financial rewards quickly put the stigma and risk associated with providing legal services for criminal enterprises in the rearview mirror.
Therefore, it is perhaps unfair that we used a January 30, 2019, article “Legalized Cannabis 2019 – What Lies Ahead?” by Wendel Rosen as the take off for discussing an aspect of the application of the Harborside opinion to California’s cannabis industry that this article like so many other articles has missed.
The most significant aspect of the opinion in the Harborside case is that it is a reviewed opinion. As a reviewed opinion, Harborside is binding on all of the judges of the Tax Court unless and until some substantive issue addressed in this opinion is reversed or modified by a higher court. The substantive decisions addressed in the Harborside opinion largely confirmed and clarified earlier, and in many instances memorandum, opinions issued by other Tax Court judges. Judge Mark V. Holmes’ opinion in Harborside is comprehensive, thoughtful and well-written as is invariably true of opinions written by Judge Holmes.
The most significant aspect of the Harborside opinion for California’s cannabis industry lies not in the opinion but in the interplay between this opinion and California’s regulation of its cannabis industry. The Harborside opinion rejected the use of IRC Sec. 263A and approved the use of IRC Sec. 471 in the determination of COGS. The Harborside opinion allows a well-advised California dispensary to increase COGS for indirect costs pursuant to IRC Sec. 471 in a proper instance.
Harborside Redux Redux Redux
Unfortunately for California dispensaries, the Harborside case involved the tax years of 2007-2012. For almost all California dispensaries, the tax years before 2015 are closed. Neither the IRS nor a taxpayer can change the federal income tax reporting for closed years. However, a dispensary that followed the approach described in Harborside opinion has the option to file amended income tax returns to claim additional Cost of Goods Sold using IRC Sec. 471 for indirect costs for any open tax year based on Judge Holmes’ opinion if the facts support the changes in the amended returns.
Unfortunately, the benefit the Harborside opinion gave to California dispensaries under IRC Sec. 280E has a limited useful life. The Bureau of Cannabis Control [“BCC”] promulgated Regulations that restrict the processing, packaging. labeling and testing of cannabis to Distributors.
The standard practice for California dispensaries had been to purchase flower in bulk and process and package, label, and possibly test the flower in-house. With proper substantiation, the opinion in Harborside permits a dispensary to utilize IRC Sec. 471 to increase COGS for both the direct and indirect costs properly allocable to the handling, processing, packaging, and security for the conversion of bulk purchases of cannabis inventory into a retail product.
The Harborside opinion approves the use of IRC Sec. 471. California’s regulation of its cannabis industry, however, now prohibits a dispensary from processing products for retail sale. A California dispensary must acquire cannabis products from a distributor in a consumer-ready form. Commercial cannabis products must be acquired by a California dispensary fully packaged and labeled. As a consequence of this regulatory requirement, effective January 1, 2019, a California dispensary is effectively subject to income tax on Gross Income (Gross Revenue less Cost of Goods Sold [“COGS”] ) for federal income tax purposes.
Well-advised California dispensaries received a tool to minimize the impact of IRC §280E in the Harborside opinion. The California legislature, however, took away this tool with its regulatory scheme even before the Harborside opinion was filed by the Tax Court. The aspect of the Harborside opinion that most commentators have missed is that the Harborside opinion permitted substantial mitigation of the impact of IRC Sec. 280E on California dispensaries, but California’s regulatory structure eliminated this mitigation.