The cannabis industry has been mired in a bear market for at least two years now. Challenges range from plunging prices for flower to excessive debt payments, and sales in mature markets have begun to plateau.
Many believed that the catalyst to turn things around would be the passing of banking legislation like the SAFE Act or even TerrAscend’s approved move to the Toronto Stock Exchange. However, it could be something as simple as 280e.
But as with most things in cannabis, even 280e isn’t simple.
Viridian Capital Advisors recently calculated that eliminating 280e would make a bigger difference than either the SAFE Act or a TSX uplisting.
As a refresher, Section 280e in the Internal Revenue Code forbids businesses from deducting otherwise ordinary business expenses from gross income associated with the “trafficking” of Schedule I or II substances, as defined by the Controlled Substances Act.
Most businesses can take tax deductions on various expenses which helps the company’s profitability, but not cannabis.
After analyzing 13 large MSOs, Viridian found that three companies with negative free cash flow (FCF) would have positive FCF without 280e. The adjustment also would more than double FCF for the five companies on the right side of the graph.
The adjustment would add approximately $700 million to the 2023 FCF of the companies reviewed.
The company collected consensus estimates of 2023 cash flow from operations and CAPEX for these companies to calculate FCF after the impact of paying 280e taxes but before any debt maturities. Six of the 13 companies have expected negative 2023 free cash flow.
Next Viridian calculated an adjustment to eliminate 280 taxes by calculating the amount of federal taxes levied on each company based on the 2023 consensus gross profit minus the taxes (if any) that would result from a tax imposed based on pretax profit.
The orange bars in the graph above show the adjustment. The green bars depict the FCF of each company after eliminating the impact of 280e.
Challenge of Ending 280e
Killing a tax code should be pretty simple, right? Congress could just make a change to the IRS.
Unfortunately, there doesn’t seem to be much political desire to go this route. The issue doesn’t drive voters to the polls and taking a stand on 280e won’t affect reelection.
Of course rescheduling to Schedule III of the CSA would immediately remove the tax issue, but as Viridian pointed out in its report, “Rescheduling to level 3 or below has its own issues, including introducing FDA oversight on a limited set of products and continuing state control over others. It will likely take years to draft and approve the necessary regulations and achieve coordination among the federal agencies involved.”
Since the country just celebrated Independence Day, Viridian felt it fitting to state, “Unlike in 1776, there is currently no rallying cry to eliminate ‘taxation without representation.’”