BuzzFeed recently reported on Target’s short-lived effort at selling cannabis-based products online. By the end of the day on which the story ran, the major retailer had already removed the product from its website. The Phoenix New Times quoted Target spokesperson Kate Decker as saying, “We started carrying Charlotte’s Web hemp extract items last week on Target.com. After further review, we have decided to remove it from our assortment.” However, the Phoenix New Times reported earlier in September that Target was selling CBD products online. Decker could not confirm exactly when Target started selling CBD. The only certainty is that it ended the same day as BuzzFeed’s article.

The thing is that many online retailers (WalMart, Groupon, and Amazon) sell or have sold CBD online. This is in part likely because of the complex legal status of CBD. The Drug Enforcement Agency’s (“DEA”) stance is that CBD, and other cannabinoids derived from cannabis, are Schedule I substance under the Controlled Substances Act (“CSA”), regardless of their source. Last year the DEA created a rule defining “marihuana extract” as an extract “containing one or more cannabinoids derived from any plant of the genus Cannabis,” as marijuana, a Schedule I controlled substance. Use of “any” means it applies to any derivative of the cannabis plant including, CBD and other cannabinoids found in cannabis. This far-reaching definition, on its face, purports to make parts of the cannabis plant that were seemingly legal illegal.

Setting aside the Rule, there are three scenarios in which cannabis extracts are arguably legal under federal law. The first being when extracts are derived from the “mature stalk” of the cannabis plant because the CSA’s definition of marijuana “does not include the mature stalks of such plant, fiber produced from such stalks, oil or cake made from the seeds of such plant, any other compound, manufacture, salt, derivative, mixture, or preparation of such mature stalks (except the resin extracted therefrom), fiber, oil, or cake, or the sterilized seed of such plant which is incapable of germination.” 21 USC § 802(16). The DEA has clarified that the Rule does not include portions of the plant specifically exempt from the CSA’s definition of marijuana but also maintains that products that contain any meaningful amount of CBD can be derived from the mature stalks.

The second scenario is when extracts are derived from an industrial hemp plant lawfully grown in compliance with section 7606 of the 2014 US Farm Bill (“the Farm Bill”). The Farm Bill allows states to enact pilot programs for hemp research making hemp legal in the state’s borders. Hemp cultivated in compliance with a State’s program is expressly legal under the Farm Bill. Extracts from compliant hemp are legal in the State in which they were derived though the sale of these products in other states is not explicitly allowed.

The final scenario is when products are derived from imported hemp. In the early 2000s, two cases out of the Ninth Circuit, Hemp Indus. Ass’n v. DEA, 357 F.3d 1012 (9th Cir. Cal. 2004) and Hemp Indus. Ass’n v. DEA, 333 F.3d 1082 (9th Cir. 2003) determined that the DEA cannot regulate hemp products simply because they contain trace amounts of THC. This is because some portions of the cannabis plant are explicitly outside the scope of the CSA and the DEA was not permitted to expand its scope to encompass all parts the plant. At the time of the ruling, it was illegal to grow hemp so it only applied to hemp imported from outside the USA. However, its holding could also apply to hemp grown pursuant to the Farm Bill. In other words, marijuana extracts from non-psychoactive (industrial) hemp with only trace amounts (or less) of naturally occurring THC are permitted under the Ninth Circuit’s ruling.

The Hemp Industries Association has sued the DEA over the “marijuana extract” rule and that case is still pending and until it is decided, uncertainty remains as to the legality of CBD products. The DEA may very well lose because the Rule appears to conflict with the Farm Bill and the Hemp Industry cases from the early 2000s.  Nonetheless, despite potential legal flaws, the Rule is currently in place and anyone who distributes “marijuana extracts” is a potential target of the DEA. This is likely why online retailers like Target have flirted with selling CBD products online but often end up pulling products.

 

Cannabis trademarksThe Gorilla Glue Company and GG Strains LLC, a Nevada-based cannabis company, entered a recent settlement agreement in the trademark infringement case brought by Gorilla Glue back in March. This case provided a perfect illustration of what NOT to do when developing your cannabis brand, and it now illustrates the possible consequences of infringing the trademarks of a well-established company.

In its complaint, Gorilla Glue, the manufacturer of a variety of adhesives sold under the “Gorilla” brand and distinctive logo, alleged trademark infringement, dilution, unfair competition, and cybersquatting. The allegation was that by marketing their strains under “confusingly similar” names, GG Strains was trading off the goodwill and reputation established by Gorilla Glue over the course of 23 years.

The trademark infringement in this case appears to have been flagrant – GG Strains utilized a logo for its “Gorilla Glue #4” strain that incorporated a gorilla, and certainly conjured an association in the minds of consumers with the famous adhesive brand. But though this case involved a pretty flagrant example of trademark infringement – after all, the infringing word mark was exactly the same as the registered Gorilla Glue mark – the standard for infringement is actually significantly lower. Not only can you not use a mark that is the same as a registered trademark, you cannot use a mark that is confusingly similar to a registered trademark.

We’ve written before about the standard for assessing likelihood of confusion, but it warrants repeating. The Ninth Circuit (which sets the law on this for Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, and Washington) in AMF Inc. v. Sleekcraft Boats, developed an eight-factor test for determining whether one mark is confusingly similar to another. Here are those eight factors:

  1. Strength of the mark;
  2. Proximity of the goods;
  3. Similarity of the marks;
  4. Evidence of actual confusion;
  5. Marketing channels used;
  6. Type of goods and the degree of care likely to be exercised by the purchaser;
  7. Defendant’s intent in selecting the mark; and
  8. Likelihood of expansion of the product lines.

Some of these factors are clear-cut, and some are highly subjective. The Ninth Circuit has repeatedly reaffirmed that this is a flexible test, but it is useful to consider these factors when choosing a name for your brand that may be similar to another registered mark. For example, if the other, similar mark is a well-known brand, or a household name, your risk of infringement goes up. If the goods you are selling are similar to the goods provided by the other brand, your risk goes up. Likewise, if the marks are very similar, if similar marketing channels are used, or if either company intends to expand into the market of the other, your risk of infringement goes up. You’ll notice that the court also considers the intent of the defendant. This means that if you knew from the outset that your mark was similar to a registered mark, the court is less likely to look favorably on your case.

In the Gorilla Glue case, the intent of the defendant would likely have been a factor weighing heavily in favor of the plaintiff. It would have been tough for GG Strains to make a case that they weren’t intentionally referencing and playing off of the brand of the well-known adhesive company.

And the consequences for GG Strains’ branding choices were serious. The settlement agreement gives GG Strains twelve months to cease using the word “Gorilla,” an image of a gorilla, or any of the “Gorilla” trademarks. After December 18th of this year, GG Strains can only use their current “Gorilla” marks preceded by a new name, together with the phrase “formerly known as.” Affiliated companies, dispensaries, cultivators and other partners must stop using the word “gorilla,” or any Gorilla Glue trademarks or imagery, and licensees of the strain have ninety days from September 19, 2017 to cease use of the gorilla word, images or trademarks.

The founder of GG Strains estimates that the dispute and rebranding costs have totaled around $250,000. And the costs would have been astronomically higher had the case proceeded to litigation. This should serve as a lesson to cannabis business owners that your brands will be treated no differently than those in any other industry. Big brand owners are taking note of what cannabis businesses are doing, and they are not hesitating to enforce their trademark rights against cannabis brands in court.

California cannabis farmsWith California’s cannabis real estate market red hot right now, many cannabis businesses are looking at buying rural farms with family farmhouses as sites for their marijuana business. This though can be a risky approach. Businesses hoping to become legitimate licensed operators under California’s Medicinal and Adult Use Cannabis Regulation and Safety Act (MAUCRSA) should consider the following before signing on the dotted line on this sort of real estate deal:

  1. Government approval contingencies. One of the most important differences between a residential and a commercial Purchase and Sale Agreement is that well-crafted commercial agreements (especially in the cannabis industry) usually contain business-specific contingencies, including a contingency for local and state government approval that the buyer will be able to confirm that it can legally use the property for its intended use. Residential real estate Purchase and Sale Agreements (even those with an agricultural addendum) rarely include these specific contingencies, leaving the buyer to investigate and bear the risk. Because local law is king under MAUCRSA, you need a contingency in your real estate Purchase and Sale Agreement that will allow you to stop the deal if your local government is not going to let you conduct cannabis business on the property.
  2. Zoning. If a seller is using a residential Purchase and Sale Agreement because a house is included with the land purchase, chances are good that the property being bought is zoned residential. This sort of zoning increases the likelihood commercial uses will be disallowed altogether or restricted by local ordinance — many of which will roll out in the months and years to come as MAUCRSA licensing tees up. Even rural properties that look suitable for farming must be closely scrutinized for land use restrictions of all kinds, including zoning. A buyer cannot simply rely on the appearance of the property or on general knowledge about a past use.
  3. Nuisance. California’s Right-to-Farm laws generally work against neighbors seeking to bring nuisance claims against farming uses abutting a residential development. But those laws do not (at least as of yet) make cannabis an explicit agricultural product that landowners have a right to farm. Add that to probably the most common complaint about cannabis — odor — and you can see why that family farm could end up creating a NIMBY problem that would not be there with your typical cornfield. See California Cannabis NIMBYs and Land Use Disputes.
  4. Civil asset forfeiture. Even state-legal cannabis businesses are at risk of federal civil asset forfeiture actions and that sort of action could be even harsher for cannabis operators living in a house on their cannabis farm — the federal government could take their house as well as their land.
  5. Conservation Easements. California’s Williamson Act allows localities to enter contracts with landowners that restrict the use of their property to only agricultural purposes and not build any improvements on the land in return for local tax breaks. Some California localities (even those with medical cannabis licensing ordinances) will often decline to waive prohibitions on federal illegality in agricultural conservation easements to allow cannabis operations on those parcels, because federal funding is directly tied to these conservation programs, and it is much easier for the federal government to turn off a locality’s funding spigot than to pursue a civil asset forfeiture against individuals and their land. This means you should carefully examine all land use restrictions on any parcel you are considering buying.
  6. Water rights. California’s water rights laws are complex and contentious (see, e.g., Chinatown). A California landowner’s right to use a nearby water source can flow from a number of different legal sources, such as riparian rights (land is adjacent to water source), appropriative rights (first in time, first in right), prescriptive rights (akin to adverse possession), overlaying groundwater rights, adjudicated rights, contractual rights, statutory rights, etc., etc., etc. What’s more, these various rights frequently compete with each other in priority for finite water sources, particularly during droughts. A potential buyer of a residential farm will need to look closely not only at the existing water rights associated with the property, but also at the potential for those rights to be augmented, especially if the intended use is cannabis cultivation, which is water-intensive. Commercial properties, especially those with past manufacturing or large scale agricultural uses, usually have greater established water rights than a small family farm. Furthermore, though the California Department of Food and Agriculture has not yet issued its final cannabis cultivation rules (those will come in November), MAUCRSA will require government approval of any water diversion for cultivation purposes (and water board approval by certain fast-approaching dates for some water sources), which is something that can be included in a government approval contingency but that would not typically be included in a residential Purchase and Sale Agreement, so amend accordingly.

The above list highlights just some of the key land use issues you should consider before you do any residential land deal involving cannabis.

Republican Senator Gardner makes a good point. The small amount of research the federal government has permitted has shown many ways cannabis is medically useful, yet barriers to research continue. Gardner is one of several senators who support the Marijuana Effective Drug Studies (MEDS) Act to remove barriers to cannabis research.

It would be helpful for everyone. It’s simple and it’s necessary. Knowledge is power, especially when it comes to medicine and health.

Cannabis edibles and the FDA
The FDA is the 800 pound gorilla of cannabis edibles.

The Food & Drug Administration (FDA) has only the jurisdiction Congress gave it in the Food, Drug and Cosmetic Act (FDCA). Under this act, the FDA has broad regulatory powers over legal drugs, with more limited powers over food.

Under the FDCA, the FDA categorizes a substance as either a food or a drug depending on how it is labeled or advertised. 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 (except as noted below).

Cannabis edibles should stay out of the drug category if possible because drugs are subject to a comprehensive regulatory scheme that controls every part of the process, including formulation, testing for safety and efficacy, pre-clearance, manufacturing, labeling, sales, and recalls. For drug firms, the FDA is the 800-pound gorilla in the room.

The FDA categorizes food as anything people ingest that is not a drug. The FDA’s role in food is essentially hands-off. Though the FDA has promulgated hundreds of pages of food regulations, it mostly relies on food makers to self-enforce these regulations. However, when the FDA learns of regulatory violations it can and will take action.

The food/drug distinction is not always clear. In the Dietary Supplement Health & Education Act (DSHEA), Congress permitted some labeling claims for food (including dietary supplements) formerly limited to drugs. Under DSHEA, the FDA has issued regulations allowing certain specific health claims to be made on foods, e.g., “Three grams of soluble fiber from oatmeal daily in a diet low in saturated fat and cholesterol may reduce the risk of heart disease.” Food makers can also ask the FDA to permit other health claims if supported by scientific evidence. Other claims may be made, e.g., the role of an ingredient intended to affect a structure or function of the human body, under certain limited circumstances.

What does all of this mean for makers of cannabis edibles? If your cannabis label or your advertising does not make claims that bring your product within the FDA’s drug definition, the FDA will not treat your edible as a drug under the FDCA Act. This does not make it federally legal of course; it just means you won’t have to spend time having to deal with the FDA.

What if your edibles are marked with health claims or structure/function claims under DSHEA for cannabis or cannabis components, e.g., THC or CBDs? The FDA has in the past sent warning letters to firms making claims like these:

  • Studies have found CBD to possess the following medical properties: … Antipsychotic – combats psychosis disorders…combats neurodegenerative disorders … Anti-tumoral – combats tumor and cancer cells …combats…depression disorders
  • CBD helps with cancer, multiple sclerosis …diabetes, arthritis, dystonia, Crohn’s disease
  • Treats rheumatoid arthritis

The FDA has said that: “It is important to note that these products are not approved by FDA for the diagnosis, cure, mitigation, treatment, or prevention of any disease. Consumers should beware purchasing and using any such products.” If you make any health claims regulated by FDA for cannabis edibles, you risk federal administrative enforcement action.

For more on what the FDA has done with marijuana, check out the following:

There may though be change on the horizon. FDA Commissioner Scott Gottlieb recently said that “It’s high time [pun intended?] to start looking at rules around the [cannabis] plant, which some states have legalized for medicinal or recreational use.” Gottlieb also predicted that “We’ll have some answers to this question very soon because I think we do bear some responsibility to start to address these questions.”

 

Stay tuned.

 

 

California cannabis rules for deliveryLast week, California’s Bureau of Cannabis Control (“BCC“) finally announced the withdrawal of the MCRSA retailer, transporter, and distributor rules in light of the passage of the Medicinal and Adult Use Cannabis Regulation and Safety Act (“MAUCRSA” a/k/a SB 94) this past June. With that announcement also came some insight from the BCC on what we can expect in the emergency MAUCRSA rules that will drop this November. Specifically, the BCC posted on the California Cannabis Portal website that:

The three cannabis licensing authorities are in the process of drafting emergency regulations based on the new law for the commercial medicinal and adult-use cannabis industries. The licensing authorities will consider the public comments received on the draft medical cannabis regulations and use the feedback to inform the draft emergency regulations. The emergency regulations are expected to be published in November 2017.

And with that website post, the BCC also included a “high level” stakeholder-focused summary telling the public what it learned from the public comments to the MCRSA rules and how it will address those comments in the forthcoming retailer, microbusiness and distributor MAUCRSA rules.

Ultimately, it appears that the majority of public comments will be squared away automatically by MAUCRSA. For example, one summarized public comment was that specialty licenses for “delivery only” or “special events” should be created under the MCRSA (Medical Cannabis and Recreation Act). MAUCRSA takes care of both of these by allowing delivery for only retail and by providing “a state temporary event license at a county fair or district agricultural association event in local jurisdictions that authorize such events.”

There were though some summarized public comments where the BCC’s responses tell us what to expect in the future:

  1. One summarized public comment was that “The regulations should specify which party in the supply chain of transactions (manufacturer, transporter, or dispensary) bears the risk of loss and how much liability should attach.” And the BCC’s response was that liability pretty much has to be negotiated between licensees, which is 100% the right answer. We’ve blogged multiple times about the dangers of product liability (and Prop. 65 violations) in the industry and how to prepare for and shift that risk in your goods and services contracts.
  2. There were several comments about changing the definition of “owner,” lowering the 600-foot buffer requirement, and removing the mandatory labor peace agreement if you have 20 or more employees, dropping the minimum bond requirement, and other MAUCRSA-mandated operational standards, but the BCC made clear that its hands are tied because they must follow SB 94 as written.
  3. The public requested the BCC convene a hotline for assistance with applications, and the BCC replied that “The Bureau will have a call center available to help answer applicant’s questions, as well as materials on its website with information to assist applicants, licensees, and the public.”
  4. Another comment was that “The regulations should provide applicants a streamlined process for converting a business from a not-for-profit business to a for-profit business,” and the BCC punted in its response by stating that MAUCRSA doesn’t require any particular business structure for operation (again, the old collective model is not mandatory for compliance with MAUCRSA, so, if your local jurisdiction permits it, you should begin to think about corporate conversion as application time ramps up).
  5. Colocation of multiple licenses at the same “premises” is still up in the air and the BCC will address it in the emergency rules. Helpfully, AB 133 removed the “separate and distinct” requirement for multiple licenses and licenses of different types.
  6. Regarding comments about continued operations to ensure no disruption of services and goods to qualified patients, the BCC’s response is that temporary licensing should serve to prevent that disconnect.
  7. The public commented that licenses should themselves be transferable and the BCC responded that “By law, each owner must meet certain requirements to hold a license, therefore, a new application is needed. The Bureau is evaluating if a notification, rather than a new application, is appropriate when changes in persons with a financial interest in the business do not include a new owner, who is required to submit fingerprints.” Given that the withdrawn MCRSA rules rendered licenses non-transferable, we’re likely to see that again in the MAUCRSA rules, which means business purchases will likely be the only way to get a hold of a license — as long as you notify the BCC beforehand and the BCC approves that ownership change request. In any event, you should be aware of California’s M & A red flags.
  8. Summarized public comment wanted the distributor license eliminated or small businesses be able to self-distribute. The BCC responded it can’t get rid of the distributor license because it’s required under MAUCRSA, but that it is considering creating another distributor license for transportation only. Not to worry folks, you can self-distribute and you don’t need to contract with a distributor anymore to make a sale to a retailer.
  9. The BCC is reviewing whether cannabis licensees will be able to engage in “other [non-cannabis] activities.” This review came from a summarized public comment that distributors should be able to store and distribute non-cannabis related products. In all other states, licensees are restricted to only commercial cannabis activity for their license type so it would be groundbreaking if California were to go against that norm by allowing California cannabis licensees to take on other lines of business.
  10. The BCC isn’t going to allow for delivery or transport of cannabis other than by enclosed motor vehicle with sufficient GPS tracking despite summarized comments that the BCC should relax restrictions to allow for bike couriers and other modes for transporting cannabis product.
  11. On delivery, public comments asked that the BCC allow delivery by third party contractors or couriers. The BCC batted back, citing to MAUCRSA, which only allows delivery by “an employee of a licensed retailer, microbusiness, or non-profit.”
  12. Summarized public comments also leaned towards asking BCC fees for licenses be set according to a sliding scale of total net revenue. In response, the BCC stated that “Business and Professions Code section 26180 requires that fees are set on a scaled basis based on the size of the business. The Bureau is examining what method is most appropriate to determine the scaled fee, including total net revenue.”

All in all, the BCC has its work cut out for it as it goes back to the drawing board on the MAUCRSA regulations. Many issues will be out of the BCC’s control because MAUCRSA requires certain unchangeable operational standards and restrictions. November will fill in many of the outstanding “don’t knows” that still remain for California cannabis rule-making, so stay tuned.

Oregon Cannabis Laws
New Oregon recreational cannabis businesses are waiting over five months to get licensed.

It is a daily frustration for our clients in the licensing pipeline in Oregon. Some applicants have been waiting for over five months to have an inspector assigned by the Oregon Liquor Control Commission (“OLCC”). These delays mean lost time and lost profits. Some form of the following conversation can be overheard at our Portland office on an almost daily basis:

Client: How long will the OLCC application process take?

Lawyer: About five to six months, if your first application is perfect.

Client: What can we do to speed that up?

Lawyer: Nothing, really.

Client: Why?

Though the process can be incredibly frustrating, it is important to keep in mind that the fault rarely lies with the employees at the OLCC. The OLCC has simply been overwhelmed by the number of cannabis license applications. At a speech earlier this year, the OLCC’s Administrative Policy & Process Director, Jesse Sweet, said the OLCC has received twice the number of applications as budgeted for. The OLCC is short staffed and no matter how frustrated you might become, it will never hurt to be kind to your overworked OLCC contact.

The OLCC maintains up to date records of cannabis applications granted and received in Oregon, and the statistics are alarming. As of this week, the OLCC has 1,536 active cannabis licenses and 1,390 pending applications. In other words, the OLCC is currently processing nearly as many applications as the number of licenses it has issued since the beginning of Oregon’s recreational cannabis program! In fact, there are more producers currently waiting for their licenses than there are existing licensed cannabis growers.

There is a bit of good news/bad news in all of this though. Yes, things are taking a long time, but a large reason for the massive number of cannabis license applications is because Oregon is a very good state in which to start up and operate a cannabis business. The applications are relatively cheap and easy and Oregon remains one of the few states that are open to licensing out-of-state individuals and companies, including individuals and companies located outside the United States. It was no accident that after analyzing all 50 states last year (and the beginning of this year) we chose Oregon as the best for cannabis.

There isn’t much that can be done, except to be patient. However, if you really want to get involved, the OLCC recently announced it is looking to fill a management position to oversee licensee activities in the Portland Metropolitan area. The OLCC is accepting applications through October 10, so there is still time.

Leaving on a jet plane

Tom Price, Secretary of Health and Human Services (HHS), resigned his post last week amid public health and personal travel debacles. Mr. Price’s resignation drew very little coverage from cannabis reporters, however, which was sort of strange because the HHS Secretary wields more influence over cannabis law and policy than any other public official besides Attorney General Jeff Sessions, and whomever the new DEA Administrator turns out to be. If marijuana is ever to be re- or descheduled administratively, it will have to go through HHS.

The federal Controlled Substances Act (CSA), at 21 USC §811, provides that the Attorney General may remove substances from the CSA: (1) on “his” own motion; (2) at the request of the HHS Secretary; or (3) on the petition of any interested party. Number 1 will never happen and number 3 has often failed, but if a reasonable HHS Secretary were appointed, number 2 could get people talking. CSA §811 further provides that prior to the Attorney General moving drugs around, he must consult with HHS for scientific and medical findings. HHS recommendations to the Attorney General are binding, including any “do not control” recommendation.

HHS is also senior on its organizational chart to the Food and Drug Administration (FDA), a well-known agency with the power to conduct independent research on marijuana and to approve cannabis-based pharmaceuticals. The FDA is the agency that works with HHS whenever “any interested party” makes a petition to remove a substance from the CSA, as referenced above. In fact, the FDA made one such recommendation to HHS and DEA last year on marijuana. Unfortunately, it chose the status quo.

Tom Price is an old-school, War on Drugs hardliner, whose judgment as to cannabis is nearly as bad as his judgment on government travel. Cannabis advocates should be glad to see him go. Given the composition of President Trump’s cabinet, however, it seems unlikely we will have a fair-minded HHS Secretary anytime soon. Most of the candidates being floated as replacements have poor or unascertainable records on marijuana policy.

Ultimately, it seems more likely that marijuana will be re- or descheduled through Congressional action than administrative channels. And as it stands today, two of the three most critical cabinet posts on cannabis—the HHS Secretary and the DEA Chief—are oddly vacant. For cannabis professionals and consumers alike, it seems better to have these posts remain vacant, than occupied by the Chuck Rosenbergs and Tom Prices of the world.

Let’s enjoy it while it lasts.

California Cannabis hearings
Attend your local california cannabis hearings

One of the first questions clients usually ask our California cannabis lawyers is “where can I operate or expand my cannabis business?” That is because even though Californians voted for the Adult Use of Marijuana Act (a/k/a AUMA or Prop 64) California counties and cities are free to enact their own restrictions on cannabis businesses operating within their jurisdiction.

If you’ve been reading our California Cannabis Countdown series you know that to get a California State cannabis license you first need a license from your local city or county. Further complicating things is that prior to enactment of the Medical Cannabis Regulation and Safety Act of 2015 (MCRSA), many cannabis businesses were operating in an unregulated gray market or with tacit approval from their local government because few jurisdictions had their own medical cannabis ordinances and permitting processes in place. When the MCRSA and AUMA passed, most local jurisdictions created their own licensing processes so as to be able to receive a portion of California’s cannabis licensing fees and taxes.

Last week I spoke to the Marin County Bar Association on cannabis ordinances in Marin County and its municipalities. Except for Fairfax, the rest of Marin is generally not friendly towards medical cannabis. If you’re asking why I’m not talking about adult-use cannabis it’s because you’ve got to crawl before you can walk and Marin’s still figuring out how to crawl when it comes to cannabis. Both Marin County and its cities are still contemplating whether to allow medical cannabis; adult use cannabis is most likely quite some time away.

When a California city or county is trying to decide whether to allow cannabis businesses within their jurisdiction, the first thing they do is hold public hearings, with notice of the hearing made online or in the local paper. If your local government has a relevant listserv, I recommend you sign up as that’s the easiest way to stay informed. Our California cannabis attorneys regularly attend public hearings to advocate for our clients and for the cannabis industry and here is our top five list of what you should do if you would like to see your jurisdiction adopt reasonable/favorable cannabis regulations:

  1. Show up. You know the old saying about how 80% of life is showing up? Well, if you want your local jurisdiction to adopt reasonable cannabis regulations you need to show up to these hearings and voice your support – in large numbers.
  2. Be reasonable. Talk to your neighbors and local businesses. Maybe you’ll find out that a dispensary will be heavily opposed but the community is open to manufacturing, testing, and deliveries.
  3. Know your facts. Your local councilman or supervisor probably has a full-time job; most are volunteers with family obligations and work deadlines. They don’t have time to delve into the weeds (pun intended) of the cannabis industry. They want to be informed so let them know what they can expect in tax revenue. How about crime statistics in similar localities? What percentage of local residents voted for Prop 64? They probably don’t have this information so provide it to them. Help them so they can help you.
  4. Parking and traffic. Besides parking garage owners, no one likes a shortage of public parking. If you’re hoping your jurisdiction adopts a dispensary ordinance make sure you address parking and traffic.
  5. SHOW UP! I mention it twice because it’s that important. Time and time again, we’ve seen local legislators get cold feet because naysayers show up to public hearings in full force while proponents stay at home. You need to be there to balance the scales.

The California state agencies that will issue licenses (Bureau of Cannabis Control, Department of Food and Agriculture, and Department of Public Health) can only do so if your local jurisdiction allows it. Don’t take for granted that your local legislators will allow cannabis businesses in your town. Activism has been a hallmark of the cannabis industry for a long time and if you want to see cannabis businesses (either medical or adult-use) in your jurisdiction of choice, it could very well be up to you to help achieve that.

Cannabis TaxesI regularly speak with clients regarding the tax issues that impact their buying, selling or operating a cannabis business. There are certain things I hear again and again regarding their taxes and their tax planning that are simply not true. The below are the five most common.

1. Calculating the Odds of Getting Audited Constitutes Tax Planning. It does not. This is a dangerous myth as it causes businesses to focus on the wrong question. This handicapping is called “audit lottery” and it will always lead you astray. The IRS only audits a small portion of small business and individual returns, but as Mark Twain once said, there are “lies, damn lies and statistics.”  Stating the obvious, a cannabis business is just not comparable to any other legal business and its odds of being audited by both the federal government and the state where it operates are much higher than for other types of businesses.

Other factors auger against playing the audit lottery. To increase efficiency, the IRS selects issues or industries it believes are rife with noncompliance or abuse. Based on a history of noncompliance by cannabis businesses, the IRS is active in auditing cannabis businesses. A recent law change has made it easier for the IRS to audit partnerships and LLC’s and beginning in 2018, the partnership/LLC is responsible for remitting tax due on any IRS adjustment on audit.

The energy spent guessing the odds of an audit are better spent understanding how to comply with federal tax law and how to document transactions in the most efficient manner.

2. Drafting Legal Documents Are Sufficient To Support My Tax Return.  We have written on the importance of corporate governance and compliance here, here and here.  The same concepts apply to taxes.  You should have legal documentation to support the fundamental financial events of your business. Is this transaction a loan from an owner or a contribution to equity? What are the management rights and responsibilities of a new partner? The answer to these and other questions should be supported by your legal documentation.

But having contracts in place is merely the starting point when it comes to your taxes. An important tax law maxim is that the “tax follows economics.” This means the proper tax treatment reflects what happens in your business, not what contracts are drafted and placed in a file.

In evaluating the tax consequences of a transaction, the IRS will always start with the documents, but it will then analyze how the business really operates (i.e., its economics) and compare that to the documents. Unsigned documents are ignored. Documentation that does not support the economics of the business are ignored. Contracts and legal documents not reflected in your books and records are ignored. Your contracts and corporate documentation must reflect how your business operates. Then, and only then, are they useful in determining the correct tax treatment.

3. Compliance with State Law is not Relevant for Federal Income Tax Purposes. Our cannabis clients often wrongly believe state law operates independently from federal law. In administering federal tax law, the IRS often restructures or ignores transactions with no business purpose or that were structured solely for tax avoidance purposes. Most often, the starting point in that evaluation is state law and a transaction that comports with state law has a greater chance of being viewed favorably by the IRS. Conversely, a transaction or structure that does not comport with state law, will most likely be rejected by the IRS on its face.

4. Having a Tax Professional Prepare My Return Limits My Responsibility.  Wrong. You the taxpayer have the ultimate responsibility for the information presented on your return. By signing your tax return, you are declaring, under penalty of perjury, that to the best of your knowledge, the information presented is, true, correct and complete. This includes information presented on schedules and statements. It is therefore crucial you have a clear understanding of the facts presented on the return and the reasons behind any tax treatment of a transaction.

5. Tax Law Applies to My Cannabis Business Differently Than Other Businesses. This is true to the extent that cannabis businesses are forced to reckon with IRC §280E. But generally, the principles of federal income tax law apply to a cannabis business the same as they do for a non-cannabis business. The tax law allows for a degree of flexibility in evaluating how a legal entity and its owners are subject to tax. A business may choose to operate as a limited liability corporation, and as such, be treated for tax purposes as a disregarded entity (i.e., the sole member is subject to tax) a partnership (i.e. each partner is subject to tax) or as a “C” corporation (i.e. the corporation is subject to tax). The tax law governing these options are no different for a cannabis business.

The cornerstone of the cannabis industry is strict state regulation, reporting, and compliance. Understanding and avoiding the tax myths discussed above will assist you in evaluating how to properly and effectively comply with both state cannabis law and federal income tax law.