Harborside Archives - Green Market Report

Debra BorchardtDebra BorchardtNovember 22, 2019
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5min2560

California-based dispensary company Harborside Inc. (CSE: HBOR) reported that its third-quarter revenue increased 22.4% year-over-year to $14.1 million for the quarter ending September 30, 2019. The company said that the increase in revenue was attributed to a 13.5% growth in retail revenue and 57.1% growth in wholesale revenue.

Net losses for the third quarter were trimmed to $1.2 million versus last year’s net loss of $5.2 million for the same time period. This was attributed to decreases in fair value of biological assets, increases in operating expenses and a one-time write-down of investment which was offset by a non-cash gain on derivative liabilities of $9 million due to translation on exercise prices of options and warrants, and conversion prices of debentures, denominated in other foreign currencies.

“We are pleased with the continued strong results from our retail and wholesale operations, which have contributed to a robust third quarter. Our revenue growth remains solid and Q3 represents the 15th quarter in a row in which our revenue has tracked over $10 million,” said Harborside Interim CEO Peter Bilodeau.

“While we are pleased with our third-quarter results, there is still much work to be done. We are focused on executing on our goals, continuing to drive growth through our retail and wholesale divisions, and remaining laser-focused on our California-centric growth plan. In addition, we have worked with our executives, members of the Board of Directors and insiders to extend the terms of the company’s lockup agreements until June 1, 2020, and expect analyst coverage of our company to commence shortly.”

Expenses

Harborside reported that its total operating expenses for the quarter were $8.7 million, which rose over last year’s $6.7 million for the same time period. Total operating expenses in the third quarter of 2019 included general & administrative expenses of $5.4 million,  $2.1 million in expenses related to share-based incentive compensation, $2.3 million of share-based payments, an allowance for expected credit loss of $0.3 million, and $0.284 million of depreciation and amortization.

“In addition, in order to be a profitable business, we must address costs. To reach our goal of reducing our operating expenses, we have begun implementing the cost-cutting initiatives the Alvarez & Marsal team identified to recognize the efficiencies in our business and have focused on streamlining our operating costs at our Salinas facility.” Total assets totaled $53.0 million and included $16.6 million of cash on hand.

Looking Ahead

“We are updating our full-year 2019 revenue guidance from $5557M to $5052M to reflect the delayed timing of the openings of the Desert Hot Springs and San Leandro locations and the delayed closing of the LUX acquisition. Both stores are in the process of opening, and we now expect LUX to close by the end of December, such that they will be reflected in our run rate for 2020. The delay in the closing of the LUX acquisition is expected to result in an approximately $1.5 million decrease to 2019 annual revenue, and an additional $2 million decrease in revenue resulting from the delay in the opening of the two new locations. Additionally, a production issue at the Company’s farm disrupted three harvests which the Company expected to monetize in the fourth quarter of 2019 worth approximately $1.5 million of revenue.”

The company noted that 2019 guidance does not include the results of any pipeline acquisitions other than LUX.


Sean HockingSean HockingNovember 4, 2019
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16min2490
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The recent Tax Court decision in Northern California Small Business Assistants Inc. v. Commissioner [“Nor Cal”][1] made what is perhaps the most damning statement [2] yet regarding the application of IRC Sec. 280E to cannabis dispensaries. The Court stated:

“Our precedent is unambiguous. Congress, rather than this Court, is the proper body to redress the petitioner’s grievances. We are constrained by the law, and Congress has not carved out an exception in IRC Sec.280E for businesses that operate lawfully under State law.

Until then, the petitioner is not entitled to deduct expenses incurred in the operation of its drug-related business.”

In reaching our holding, we have considered all arguments made, and, to the extent not mentioned above, we conclude they are moot, irrelevant, or without merit.”

The Court in Nor Cal followed the Tax Court precedential analysis by Judge Mark V. Holmes in his opinion in the first Harborside case[3].

The first Harborside case rejected the manner in which the two dispensaries determined Cost of Goods Sold (“COGS”).  Judge Holmes agreed with the Chief Counsel Memorandum[4] that IRC Sec. 471 should be used by a cannabis dispensary to determine COGS.  The opinion in Harborside rejected the use of IRC Sec. 263A and approved the use of IRC Sec. 471 in the determination of COGS[5].

The situation becomes particularly grim for California dispensaries beginning after 2017.  California’s Bureau of Cannabis Control adopted regulations beginning in 2018 that require Retailers to purchase cannabis that has been tested, packaged, and labeled by a Distributor[6].  The adoption of these regulations renders virtually all adjustments to COGS by a dispensary improper[7].

A California cannabis dispensary can mitigate against a significant portion of the adverse impact of the Harborside and Nor Cal opinions. These opinions create an opportunity for a cannabis dispensary to exclude from gross revenue a substantial portion of the money collected from cannabis consumers. Through the adoption of proper record-keeping systems and procedures, a dispensary can treat all of the money it collects for taxes that are not included in COGS as taxes imposed on consumers, or as reimbursements for taxes paid or payable by the dispensary, that must be remitted to various governmental agencies.

A dispensary will collect state-level Cannabis Excise Tax [“CET”], California Sales Tax, and it may collect any of a variety of municipal and county sales taxes, excise taxes, and gross receipts taxes[8]. These funds are money that a dispensary is obligated to remit to various governmental agencies.

As a consequence of the Harborside and Nor Cal opinions, it is critical for a dispensary to not allow these funds [“Reimbursable Taxes”] to be included in gross revenue. If Reimbursable Taxes are properly identified and consistently segregated using an escrow account[9] [“Reimbursable Tax Escrow”], all taxing agencies should recognize these taxes are properly excluded from gross revenue.

The taxes included in the money a dispensary will collect from retail customers can be classified into five categories as follows:

(1) income taxes which will be paid by the dispensary out of income;

(2) CCT which will be paid to a distributor by the dispensary as part of COGS;

(3) local taxes on cannabis that may be comparable to the preceding classification (2) or comparable to either of the two classifications (4) and (5) that follow;

(4) CET which is an excise tax that a dispensary is required to collect from a cannabis consumer that has some aspects of being money held in trust by virtue of the requirement that collections of CET in excess of the amounts actually paid by a dispensary to distributors are owed to California under the language of the statute; and

(5) Sales Tax collections which are more specifically money that constitute a trust fund in the hands of the retail seller that is collected as an agent for California and for which there is personal liability for a failure to remit.

We believe that the taxes identified in (1) and (2) above cannot be excluded from gross revenue. However, the taxes identified in (3), (4), and (5) may be excluded from gross revenue by a dispensary if:

  • Each of the taxes is separately stated and identified on sales receipts that the dispensary provides to its retail customers; and
  • The dispensary creates and maintains separate Reimbursable Tax Escrow trust account as well as complete and accurate records of each type of tax collected, deposited into the account, and remitted from the account, and performs a reconciliation for the trust account and the various Reimbursable Taxes each time the dispensary prepares a tax return and remits tax to a governmental agency.

While this issue is not entirely free from doubt, a dispensary that carefully maintains and utilizes a separate trust account, and minimizes transfers into and out of such an account, has a high probability the segregation of these funds as well as the exclusion of these funds from gross revenue will be respected.

Sources / Footnotes

[1] 153 TC 4 (2019)

[2] The taxpayer also argued in this case that IRC Sec. 280E solely applies to IRC. Sec. 162 deductions.  The taxpayer argued that the text of IRC Sec. 280E “tracks” the language of IRC Sec. 162 which allows a deduction for all ordinary and necessary business expenses.  The taxpayer argued the use of the same language indicated the prohibition of IRC Sec.  280E should solely apply to IRC Sec. 162 deductions. Judge Goeke points out the taxpayer’s argument ignored the first line of IRC Sec.  280E which states, “No deduction or credit shall be allowed . . . .” (Emphasis added.)  The Court states the language of this section is clear and unequivocal.

Judge Goeke also points to a broader statutory scheme as support for the conclusion IRC Sec. 280E means what it says – no deductions under any section shall be allowed for businesses that traffic in a controlled substance.  As the Court points out, IRC Sec. 261 which is found in part IX of subchapter B of Chapter 1 of the Code, provides that “no deduction shall, in any case, be allowed in respect of the items specified in this part.”  IRC Sec. 280E is found in part IX[9]

[3] 151 TC 11(2018)

[4] CCM 201504011

[5] The tax year 2015 is significant for two reasons. The Tax Court’s decision in Olive v. Commissioner, 139 TC 19, 36-42 (2012) aff’d 792 f.3d 1146 [CA-9, 2015] was the first reviewed decision that discussed the phrase “consists of” in IRC Sec. 280E.  Olive was not affirmed by the 9th Circuit until 2015.  Chief Counsel Memorandum 201504011 was issued in 2015. This Memorandum provided the first guidance from the IRS relating to IRC Sec. 280E.  The IRS has never promulgated regulations relating to IRC Sec. 280E. A taxpayer that fails to utilize IRC Sec. 471 post-2015 is almost certainly subject to the “substantial understatement” penalty contained in IRC Secs. 6662, and potentially the civil fraud penalty in IRC Sec. 6663.

[6] See § 5412. Prohibition on Packaging and Labeling by a Retailer.

  • A licensed retailer shall not accept, possess, or sell cannabis goods that are not packaged as they will be sold at final sale, in compliance with this division.
  • A licensed retailer shall not package or label cannabis goods.
  • Notwithstanding subsection (b) of this section, a licensed retailer may place a barcode or similar sticker on the packaging of cannabis goods to be used in inventory tracking. A barcode or similar sticker placed on the packaging of a cannabis goods shall not obscure any labels required by the Act or this division.

Authority: Section 26013, Business and Professions Code. Reference: Section 26120, Business and Professions Code. and

  • 5303. Packaging, Labeling, and Rolling.
  • A licensed distributor may package, re-package, label, and re-label cannabis, including pre- rolls, for retail sale. All packages of cannabis, including pre-rolls, shall comply with the following:
  • Until January 1, 2020, all packages shall meet the following requirements:
  • The package shall protect the cannabis, including pre-rolls, from contamination and shall not expose the cannabis or pre-rolls to any harmful substance.
  • The package shall be tamper-evident.
  • If the package of cannabis or pre-rolls contains more than one serving, then the packaging shall be resealable.
  • The package shall not imitate any package used for goods that are typically marketed to children.
  • Beginning January 1, 2020, all packages shall meet the requirements of subsection (a)(1) of this section and shall also meet the following requirements:
  • The package shall be child-resistant until the package is first opened. For purposes of this division, the following packages are considered child-resistant:
  • Any package that has been certified as child-resistant under the requirements of the Poison Prevention Packaging Act of 1970 Regulations (16 C.F.R. §1700.15(b)(1)) (Rev. July 1995), which is hereby incorporated by reference.
  • Plastic packaging that is at least 4 mils thick and heat-sealed without an easy-open tab, dimple, corner, or flap.
  • The package shall be labeled with the statement “This package is not child-resistant after opening.”
  • Notwithstanding subsections (a)(1)-(a)(2) of this section, immature plants and seeds shall not be required to be packaged in child-resistant, tamper-evident, and resealable packaging.
  • A licensed distributor shall not process cannabis but may roll pre-rolls that consist exclusively of any combination of flower, shake, leaf, or kief. Pre-rolls shall be rolled prior to regulatory compliance testing.
  • Licensed distributors may label and re-label a package containing manufactured cannabis goods with the amount of cannabinoids and terpenoids based on regulatory compliance testing results.

Authority: Section 26013, Business and Professions Code. Reference: Sections 26013 and 26120, Business and Professions Code.

[7] The common practice for California dispensaries prior to the Harborside decision was to purchase flower in bulk, and then 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 regulatory requirements, 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.

[8] A similar set of principles applies to the portion of employment taxes which are withheld from employee paychecks and treated as “trust funds”. A discussion of employment taxes is beyond the scope of this article.

[9] An escrow account is an account where funds are held in trust for a particular purpose, for example a segregation of funds that were collected for a taxing agency. In formalized escrow arrangements third-party acting as a fiduciary will hold funds in a segregated trust account. Funds are subject to disbursement in accordance with the contractual arrangements for the escrow.

 


Sean HockingSean HockingOctober 27, 2019
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17min4280
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IRC Sec. 280E Insanity – We just completed writing what is perhaps our tenth article about IRC Sec. 280E and Harborside[1]. Harborside is a sophisticated taxpayer with well-designed financial and operational systems and expensive professional advisors. The two Harborside cases created an opportunity for analysis and a solid foundation for tax planning going forward for the cannabis industry.

Such planning is what tax professionals should be engaged with on a daily basis.

Northern California Small Business Assistants Inc. v. Commissioner[2], is an example of positions that should not be pursued in the Tax Court. The Tax Court is a prepayment forum in which taxpayers are permitted to contest tax liabilities without first paying the tax and claiming a refund. The Tax Court enforces federal tax laws. The Tax Court enforces federal tax laws. The Tax Court will only reluctantly consider policy. It will do so solely when it finds the statutory language ambiguous. Judge Mark V. Holmes had already addressed the language of IRC Sec. 280E. For the cannabis industry, the pursuit of the motion for partial summary judgment gave a number of Tax Court judges an opportunity to express in dicta opinions which were largely unfavorable to the cannabis industry. This case created an opportunity for judge to express opinions we anticipated that in several instances we would prefer not to have seen expressed. The dicta generated by this case will haunt taxpayers involved in t cannabis industry for the next ten years.

 

The summary of the case by the Tax Court is

“P is a California corporation that operates a medical marijuana dispensary legally under California law. R argues that P is subject to the limitations of I.R.C. sec. 280E, which disallows all deductions for a business that consists of trafficking in a controlled substance within the meaning of Schedule I or II of the Controlled Substances Act. P argues that I.R.C. sec. 280E imposes a gross receipts tax as a penalty in violation of U.S. Const. amend. VIII. Further, P argues, even if I.R.C. sec. 280E is constitutional, it only bars ordinary and necessary business deductions under I.R.C. sec. 162 and does not apply to other distinct sections of the I.R.C. Finally, P argues that it is not subject to I.R.C. sec. 280E because its business, legally operated under California law, does not consist of “trafficking” in a controlled substance.

 

Held: I.R.C. sec. 280E is not a penalty provision and therefore does not violate the prohibition on excessive fines in U.S. Const. amend. VIII.

Held, further, I.R.C. sec. 280E is not limited to deductions claimed under I.R.C. sec. 162 but applies to bar all deductions claimed by P.

Held, further, P has provided no compelling argument to overrule our precedent holding that I.R.C. sec. 280E applies to businesses operating legally under State law, notwithstanding its use of the word “trafficking.

 

The Tax Court was NOT pleased with the position taken by the taxpayer stating,

“On July 12, 2018, petitioner filed its motion for partial summary judgment pending before the Court in which it alleges that section 280E: 

(1) imposes a gross receipts tax as a penalty in violation of the Eighth Amendment to the Constitution;

(2) eliminates only ordinary and necessary business deductions under section 162 and does not apply to other distinct sections of the Code; and

(3) does not apply to marijuana businesses legally operated under State law.

 

We reject each of petitioner’s arguments and will deny its motion for partial summary judgment.”

 

It is our opinion the questions of whether IRC Sec. 280E is a penalty, whether the VIII Amendment applies, and whether IRC Sec. 280E is unconstitutional are well settled law. Judge Joseph Goeke affirmed these opinions. If taxpayers want to change or repeal IRC Sec. 280E[3], they should follow the lead of “the adults in the room” such as the Cannabis Trade Federation [“CTF”] and Marijuana Policy Project[4].

 

The Supreme Court has held that any deductions from gross income are a matter of legislative grace. Deductions can be reduced or expanded in accordance with Congress’ policy objectives[5]. Under the Sixteenth Amendment, “[t]he power of Congress to tax gross income is unquestionable[6].

 

Section 280E is directly tied to Congress’ policy objective to limit and deter trafficking in illegal controlled substances[7]. Section 280E is not an effort by Congress to punish violators of State law that has no legitimate Federal objective[8].

 

The argument that IRC Sec. 280E is a penalty cannot be reconciled with the authority of Congress to tax gross income. For that reason the Tax Court concluded IRC Sec. 280E is not a penalty provision. Consequently, the Eighth Amendment’s Excessive Fines Clause does not apply.

 

The taxpayer also argued that IRC Sec. 280E solely applies to IRC. Sec. 162 deductions. The taxpayer argued that the text of IRC Sec. 280E “tracks” the language of IRC Sec. 162 which allows a deduction for all ordinary and necessary business expenses. The taxpayer argued this indicated IRC Sec. 280E should apply solely to prohibit IRC Sec. 162 deductions. Judge Goeke pointed out the taxpayer’s argument ignored the first line of IRC Sec. 280E which states, “No deduction or credit shall be allowed . . . .” (Emphasis added.) The language of this section of the Code is clear and unequivocal.

 

Judge Goeke also points to broader statutory scheme as supports for the conclusion IRC Sec. 280E means what it says – that no deductions under any section shall be allowed for businesses that traffic in a controlled substance. As the Court points out, IRC Sec. 261 which is found in part IX of subchapter B of Chapter 1 of the Code, provides that “no deduction shall in any case be allowed in respect of the items specified in this part.” IRC Sec. 280E is found in part IX[9].

 

The taxpayer argued as its final argument that section 280E applies only to businesses that engage in illegal or disreputable sales of controlled substances. As support for the position the taxpayer pointed to the word “trafficking” in section 280E. The taxpayer argued the word suggested some unsavory or illicit purpose was required for IRC Sec. 280E to apply. The Court made short shrift of this argument[10] stating “[T]he sale of medical marijuana pursuant to California law constitutes trafficking within the meaning of section 280E.”

 

“Medical Marijuana” is a Schedule I controlled substance, and dispensing it pursuant to * * * [California law] is ‘trafficking’ within the meaning of IRC Sec. 280E.”). Thus, we hold that the use of the word “trafficking” in IRC Sec.280E encompasses petitioner’s medical marijuana dispensary legally operated under California State law.

 

The nasty bonus gift in the Tax Court’s opinion in this case includes an express denial of the taxpayer’s and an express statement by a majority of the Tax Court judges that IRC Sec. 280E denies as “trafficking expenses” all of the expenses associated with the operation of a dispensary. Solely items that are excluded from gross revenue such as reimbursed expenses before the deduction of Cost of Goods Sold [“COGS”] would be subject to IRC Sec. 280E[11]. Of course, the opinion in this case is a disaster for California dispensaries. The only saving grace is that the case is a denial of a motion for partial summary judgment. Most of the statements of the judges are dicta.

 

Upon reflection, this case might be viewed as a close cousin to “play stupid games, win stupid prizes”.

 

We must mention a couple of additional items. It is our impression many representatives of cannabis dispensaries failed to consider the opportunity to reconsider and amend returns based on CCM 201504011. We noted some time ago an argument could be made the failure to do so constituted malpractice. In light of Judge Mark V. Holmes opinion in Harborside[12] taxpayers and representatives of dispensaries should carefully evaluate the risks associated with IRC Secs. 6662-6664 as well as consider the inclusion of a Form 8275 – Disclosure Statement with returns. Practitioners should also consider the possible application of penalties on preparers pursuant to IRC Sec. 6694, including the consequences of an enhanced penalty for intentional disregard pursuant to IRC Sec. 6694(b)(2). An enhanced penalty constitutes grounds for a referral to the Office of Professional Responsibility.

 

FOOTNOTES

[1] 151 TC No. 3 (2018).

[2] 153 TC No. 4 (2019).

[3] Consistent with this designation, we have held that the limitations imposed by section 280E are applicable to the ever-increasing number of marijuana businesses operating legally under State law. Olive v. Commissioner, 139 T.C. 19, 38 (2012), aff’d, 792 F.3d 1146 (9th Cir. 2015); CHAMP, 128 T.C. at 182-183.

[4] See Killing Three Birds with One Bill: The STATES Act Simultaneously Harmonizes Federal Law with State Cannabis Laws and Addresses the Cannabis Industry’s Banking and Tax Issues and Marijuana Legalization

[5] INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934); see Keeler v. Commissioner, 70 T.C. 279, 284-285 (1978)

[6] .” Bagnall v. Commissioner, 96 F.2d 956, 957 (9th Cir. 1938), aff’g 35 B.T.A. 1 (1936).

[7] See CHAMP, 128 T.C. at 182 (“Section 280E and its legislative history express a congressional intent to disallow deductions attributable to a trade or business of trafficking in controlled substances.”); see also S. Rept. No. 97-494 (Vol. 1), at 309 (1982), 1982 U.S.C.C.A.N. 781, 1050 (“To allow drug dealers the benefit of business expense deductions * * * is not compelled by the fact that such deductions are allowed to other, legal, enterprises.”).

[8] Cf. Constantine, 296 U.S. at 295-296.

[9] See CHAMP, 128 T.C. at 180-181 (disallowing section 162 deductions under IRC Sec. 280E); Beck v. Commissioner, T.C. Memo. 2015-149, at *18 (disallowing a IRC Sec. 165 loss deduction under IRC Sec. 280E).

[10] See, e.g., Olive v. Commissioner, 139 T.C. at 38; CHAMP, 128 T.C. at 182-183;

Canna Care, Inc. v. Commissioner, T.C. Memo. 2015-206, at *9

[11] The Tax Court concludes,

“Our precedent is unambiguous. Congress, rather than this Court, is the proper body to redress petitioner’s grievances. We are constrained by the law, and Congress has not carved out an exception in IRC Sec.280E for businesses that operate lawfully under State law. Until then, petitioner is not entitled to deduct expenses incurred in the operation of its drug-related business.”

In reaching our holding, we have considered all arguments made, and, to the extent not mentioned above, we conclude they are moot, irrelevant, or without merit.

[12] 151 TC 11


Sean HockingSean HockingOctober 24, 2019
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We once again revisit the Tax Court’s decision in Harborside[1]and focus our attention on statements made to the public, in financial statement related disclosures, and just as importantly, on what has NOT been said. Let’s begin with the press release that was issued by Harborside which stated

“OAKLAND, CA and TORONTO, Oct. 21, 2019 /PRNewswire/ – Harborside Inc. (“Harborside” or the “Company”) (CSE: HBOR), today announced that the U.S. Tax Court has issued a final decision under Tax Court Rule 155 on the income tax deficiency for Patients Mutual Assistance Collective Corporation (“PMACC”), the Company’s 100% owned subsidiary and owner of the iconic Harborside Oakland cannabis dispensary. The U.S. Tax Court has ruled that PMACC owes an aggregate tax deficiency of approximately $11.0 million for the fiscal years 2007 through 2012. This amount is consistent with the Company’s one-time provision for its estimated tax obligation for PMACC expensed in its financial results for the three-month period ended June 30, 2019. All dollar amounts in this press release are expressed in U.S. dollars.

“The Tax Court’s final computation of our tax obligation in PMACC’s long-standing 280E case is a good outcome for Harborside shareholders. By challenging the IRS’s overly aggressive interpretation of the tax law as it applies to cannabis businesses operating legally under State law, we have succeeded in reducing Harborside’s liability from the $36 million originally sought by the IRS to approximately $11 million – a $25 million reduction. The reduction includes $6 million in penalties that the court previously ruled we did not need to pay because of the unclear state of the law, and because Harborside acted in good faith,” said Harborside CEO Andrew Berman. “This ruling is also an important one for the cannabis industry in that, through this litigation, the court recognized there are legitimate deductions that legal cannabis companies can take in cost of goods sold. Harborside still intends to appeal the Tax Court’s ruling with regard to aspects of the decision as it pertains to the calculation of cost of goods sold, and has already retained appellate tax counsel.” 

Steve DeAngelo, Harborside’s co-founder and Chairman Emeritus, also commented, “Harborside’s policy towards the federal government has always been to exhaust all reasonable available legal options to pursue justice. That policy has been validated by the Tax Court’s downward adjustment of PMACC’s liability. This outcome has strengthened our already strong resolve to continue pursuing justice by appealing the decision, with the goal of modifying or reducing 280E liability for Harborside, and in the future, eliminating it for every other state legal cannabis business in the United States. The issues at stake are of importance to the entire cannabis industry.”

 The Company has 90 days within which to file an appeal with the United States Court of Appeals for the Ninth Circuit.

The US Tax Court has not yet issued a final ruling on the tax deficiency for San Jose Wellness (“SJW”). The Company estimates that the deficiencies in tax and penalties asserted by the IRS, not including interest calculations, are approximately $4.4 million. As of June 30, 2019, the Company recorded a one-time provision of $4.4 million in relation to the tax rulings on SJW.”

 

We note that Harborside’s statement omits several significant items that will certainly factor into the ultimate outcome related to the tax litigation.

 

The press release fails to acknowledge that the $11 million deficiency is the amount of the tax due which does NOT include any provision for statutory interest. We estimate that the interest will increase the amount which will ultimately due by 75 – 100%.

 

The Management Discussion that accompanied Harborside’s financial statements for the quarter ended May 31, 2019 included the statement

“The primary reason for the 2019 net loss increase over the prior year is the inclusion in the second quarter of a one-time provision of $15.4 million relating to potential tax liabilities under Section 280E of the Internal Revenue Code. The Company contests in all aspects any and all such liabilities, and the recording of this one-time provision is not an indication of the Company’s position on this matter or an admission of any liability.”

The lack of detail provided in the financial statement disclosures required by the Canadian stock exchanges precludes us from delving into the depth that might have been available for a US issuer through  its ASR-149 disclosures.

In the first opinion Judge Holmes rejected the manner in which the dispensary in the Harborside cases determined Cost of Goods Sold (“COGS”).  Judge Holmes agreed with Chief Counsel Memorandum[2] that Internal Revenue Code (“IRC”) §471 should be used by a cannabis dispensary to determine COGS. 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.

 

There are significant lessons for other cannabis dispensaries in California to glean from the Tax Court’s decision.

 

  • A dispensary which filed its tax returns in a manner consistent with Harborside for “open” years subsequent to 2012 has the ability to amend those returns and make the change from utilizing IRC Sec. 263A rules to IRC Sec. 471 rules without the need to obtain consent for a method change from the IRS.

 

  • Harborside appears to have at least doubled its revenue in the six succeeding years.  Harborside may have a substantially larger federal income tax liability for the six succeeding years – 2013-2018.

 

  • The Tax Court was absolutely clear that for years beginning after 2015[3], taxpayers in the cannabis business are deemed to be on notice that they do not have protection from the assertion of IRC Sec. 6662 accuracy related penalties if they rely upon IRC Sec. 263A. They must use the provisions of IRC Sec. 471 and the regulations thereunder to calculate COGS.

 

  • 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 for years after 2018.

 

  • 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.

 

  • The combination of the Tax Court’s decision in Harborside combined with the BCC regulations that take effect after 2018 are going to make it just about impossible for a cannabis dispensary in California to earn a profit.

 

[1] 151 TC 11

[2] CCM 201504011

 

[3] The tax year 2015 is viewed as significant for two reasons, the more important being that the Tax Court issued its decision in Olive v. Commissioner, 139 TC 19, 36-42 (2012) aff’d 792 f.3d 1146 [CA-9, 2015] which was the first discussion of the phrase “consists of” in IRC Sec. 280E. Olive did not become final and unappealable until 2015. The seconod reason being the issuance of CCM 201504011, as the first guidance from the IRC under IRC Sec. 280E as the IRS had never promulgated regulations.


StaffStaffAugust 30, 2019
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4min7810

California-based cannabis dispensary company Harborside Inc.  (CSE: HBOR) delivered its results for the second quarter ending June 30, 2019, with revenues up 20% to $12.7 million. The results were driven by 6.5% growth in retail revenue and 208% growth in wholesale revenue.

Harborside reported a net loss for the second quarter of $15.6 million versus last year’s net loss of $4.8 million for the same time period. It was attributed primarily to a $15.4 million provision for potential tax penalties under 280E. The company had fought the 280e tax battle, which would have benefited the entire industry had they won. Unfortunately,  the issue remains tied up in the courts.

In addition to that, the company had $3.6 million of non-recurring expenses related to its reverse takeover transaction and other one-time items, offset by a non-cash gain on derivative liabilities of $7.2 million due to translation on exercise prices of options and warrants, and conversion prices of debentures, denominated in other foreign currencies.

“The second quarter was a milestone for Harborside. On June 10, we listed on the CSE after completing the RTO and raising capital. I am pleased that in our first quarter as a public company, we reported solid revenue growth and were profitable on an Adjusted EBITDA basis and that we now rank among the top 20 US-listed cannabis companies by revenue,” said Harborside CEO Andrew Berman.

He went on to say, “That said, the Board and our executive team are not at all satisfied with the significant loss of market capitalization in our first months as a public company. While the overall market is down, what upsets us is that Harborside is down even more despite our installed base of revenue and solid growth prospects. We think we are significantly undervalued, and to demonstrate that firm belief, today we also announced that we are implementing a normal course issuer bid under which we expect to buy up to 5% of our subordinate shares.”

Deals Called Off

As of August 29, Harborside decided that it would not move forward with the purchase among “FLRish Retail Management & Security Services LLC and Airfield Supply Co., Inc. and its owner, in light of the company’s current share price and the substantial cash component of the purchase price which management has determined are not in the best interests of shareholders.”

In addition to that, Harborside said it also will not move forward with “The Agris Acquisition as contemplated by the Agris Agreement, in light of the principal owner’s demand for an increase in the purchase price and other terms which in management’s judgment make the transaction not in furtherance of the Company’s goals or strategy or otherwise in the interests of the Company’s shareholders, and given the Company’s already substantial capacity to produce high-quality cannabis at its Salinas facility at significant scale.” The company went on to say that Menna Tesfatsion, the founder and principal owner of Agris Farms, would not be joining Harborside as Chief Operating Officer.

Berman did give a forecast for 2019, “We are targeting $55 to $57 million of revenue and to achieve positive Adjusted EBITDA. We believe that the combination of solid topline growth and margin expansion for a cannabis asset trading at 1.5x revenue makes for a highly attractive investment opportunity.” 


Debra BorchardtDebra BorchardtJuly 29, 2019
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4min5100

It’s time for your Daily Hit of cannabis financial news for July 29, 2019.

On The Site

Nextleaf Solutions
Extraction technology company Nextleaf Solutions Ltd. (CSE: OILS) (OTCQB: OILFF) said that its common shares will begin trading today on the OTCQB Market. Nextleaf will trade on the OTCQB under the symbol “OILFF” and the company’s common shares will continue to trade on the Canadian Securities Exchange under the symbol “OILS”. Nextleaf owns a portfolio of issued and pending patents pertaining to the company’s unique, industrial-scale process of extraction and purification of cannabinoids.

CannBioRx
Special Purpose Acquisition Company (SPAC) KBL Merger Corp. IV (NASDAQ: KBLM) signed a definitive agreement for the merger of a wholly-owned subsidiary of KBLM with CannBioRx Life Sciences Corp., a drug development company focused on treating inflammatory diseases. It began trading last Friday as a NASDAQ-listed cannabis biotech.

Fake CBD
Hundreds of people have been benefited from using Cannabidiol (CBD) – a substance scientifically proven to be safe for human consumption – even for children!
It not only has a wide range of therapeutic benefits but also has been useful for treating numerous serious ailments and disorders. However, not all products touted as “natural CBD oil” are actually as natural they claim to be.

In Other News

SOL Global Investments Corp. (SOL.CN) (SOLCF) has purchased an additional 16,766,250 common shares in the capital of HeavenlyRx Ltd. at a price of $0.40 for an aggregate subscription amount of CAD$23,909,000.
The subscription is part of a larger private offering by HeavenlyRx of Heavenly Shares. As a result of this subscription, SOL Global now holds 44.53% of the issued and outstanding Heavenly Shares and the other shareholders of Heavenly Rx collectively hold the remaining 55.47%. The Heavenly Shares are subject to an indefinite hold period under applicable Canadian securities laws.

Radient Technologies Inc. (TSX Venture: RTI)(OTCQX: RDDTF) has issued an aggregate of 93,151 common shares to a third-party consultant for services provided during the quarter ended June 30, 2019, pursuant to the shares for service agreement previously approved by the TSX Venture Exchange. The common shares were issued at the TSX Venture Exchange 15 day VWAP share price of CAD $0.87.

Iconic Northern California cannabis company Harborside Inc. (CSE: HBOR) has appointed Mattio Communications as its investor relations advisors. Mattio is a New York-based communications firm which provides public and private cannabis companies with an array of services designed to maximize shareholder value through customized strategic investor relations programs (see https://www.mattio.com/). Harborside has also engaged Mattio to provide media and public relations support in an effort to build awareness of the Harborside brand and to capitalize on the company’s heritage as one of the oldest, largest and most respected cannabis retailers in the world.


Video StaffVideo StaffJune 14, 2019

6min9450

Harborside Inc. (CSE: HBOR) Co-founder and Chairman Emeritus Steve DeAngelo sat down with the Green Market Report’s Editor-in-Chief Debra Borchardt to discuss Harborside becoming a publicly traded company.

GMR Debra Borchardt

The company just went public this week on the Canadian stock exchange and it must be just super exciting because you are a pioneer in the industry.

Steve DeAngelo, Co-Founder Harborside Inc.

Yeah, it’s incredibly exciting. Harborside was one of the first six licensed cannabis businesses in the United States, that’s back in 2006. Today we’re growing to be seven dispensary’s, 200,000 square feet of grow space, 250 employees, and we’ve launched two brands that we’re pushing out into the marketplace.

GMR

You have about a 3% market share in California. What are your plans to increase that?

Steve DeAngelo

So two ways basically. Number one, we’re going to continue to increase our retail footprint. And two, we have developed these two brands, the Key brand, and the Harborside brand and we offer vape pens, we offer flowers, we offer edibles, a line of products in both of those two brands. And so, we’re in a hundred dispensaries now. We’ll be in three or four hundred dispensaries within several months.

GMR

What makes Harborside so special because there are so many dispensaries competing for business right now. Why is a consumer going to go in your door versus another door?

Steve DeAngelo

Well, it’s a values-based proposition. Harborside has a well-earned reputation for not just being after our own financial gain but also representing values. And so, we’re very committed to the values of diversity and building a cannabis industry that is diverse. We were very committed to the values of fairness and economic justice and we’re very committed to the values of sustainability and you can see those values in everything we do

GMR

You really have a reputation as caring for the customer, caring for the patient, because that’s really was where you guys made your name was caring so much for the patients that were coming to you.

Steve DeAngelo

You know, Harborside was a medical cannabis dispensary for most of our life. And so, we had to be very, very careful to make sure that we gave not just customer service but also patient care. And that has developed an ethic in our culture of really engaging with everybody who comes through our door. We like to say that we want everybody to come out of Harborside feeling better than they came in.

GMR

So let’s talk about the elephant in the room, which is that 280E case. We know you guys have been fighting and really fighting it for the whole industry. If that judgment goes against you, what amount of money do you expect you would have to pay and is that money already set aside?

Steve DeAngelo

The maximum amount of money that we could be liable to the IRS has already been accounted for and is available as needed but this is a long ongoing struggle. We’ve been in this litigation for about 10 years now. It’s not going to end for at least several more years. We did have an adverse ruling on the underlying case at the trial court but we won on the penalties phase and we’re now appealing to the Ninth Circuit Court of Appeals, the most favorable court in the country on cannabis. There’s also legislation pending in the Congress, which is going to resolve the 280E situation. So, it’s far from over. Harborside will keep doing what we always do. We stand up for the industry, we stand up for what we think is right, and we’ll keep on doing that until we either win the case or have exhausted all legal avenues.

GMR

A lot of people may not know that you were part of the Yippies, that you have a storied history associated with this plant. Did you ever in your wildest imagination think that this was going to happen? Did you think it was going to happen sooner or what has been the biggest surprise to you with this?

Steve DeAngelo

There has never been any doubt in my mind that we would see a respected, honored place for cannabis in our society because of the inherent properties of the plant, its value and its safety just make it necessary over time. What has surprised me and still surprises me is how long that it’s taking us to get there.

GMR

You have been working on this for many years and I’m so thrilled that you took the time to talk to us at the Green Market Report.


Debra BorchardtDebra BorchardtJune 10, 2019
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4min11400

The much-anticipated Reverse Takeover for Harborside Health began trading on the Canadian Securities Exchange using the symbol HBOR on Monday. The plan to go public was originally announced back in August of 2018. At that time, Toronto-based Lineage Grow Co. said it would acquire Oakland-based FLRish – which manages Harborside’s retail and dispensary operations – in exchange for newly issued common shares of Lineage worth roughly 200 million Canadian dollars or $152.2 million.

Harborside was a pioneer in the medical marijuana world. It made the first legal cannabis sale in California and has been serving over 300,000 patients and generating over $400 million in sales since those early days. Harborside currently commands 3% of the entire CA retail market, which is by a landslide the biggest market in the country.

The company has previously completed a $26 million Series B funding round and a $14.6 million Series C. Founder Steve DeAngelo’s tireless, decades-long cannabis advocacy has made Harborside the most trusted and respected name in the game.

History

When Steve DeAngelo and Dress Wedding ( yes, his real name) founded Harborside in Oakland in 2006, they had the distinct purpose of providing patients with a safe, trusted source for high-quality medical cannabis products. The San Jose location is one of the first dispensaries in the city. In late 2016, the company acquired a cultivation facility in Salinas, allowing it to grow its own flower, which helped expand the product offerings and increase margins. The company currently employs 250 people in total and they are currently planning the expansion of Harborside locations throughout the Bay Area and eventually to San Leandro and more.

Tax Overhang

One issue clouding the IPO was the tax case that Harborside fought with the government over the 280e business deduction claim. DeAngelo said, “We did not seek this fight with the federal government, but don’t shrink from standing up for our rights and the rights of the cannabis industry when we think they are under threat. Our tax case began in 2009 when we challenged the right of the government to apply 280e to state-legal cannabis businesses. The case has wound through the courts since then, with wins and losses on both sides. Most recently, at the trial court level, the IRS won on the underlying judgment, while we won on the imposition of penalties.”

He went on to add, “We have appealed that ruling to the 9th Circuit Court of Appeals, historically one of the most favorable appeals courts for cannabis cases. We hope for a better ruling there. No matter what, our intention is to pursue this case until we either win or all legal avenues are exhausted. Unless the IRS decides to voluntarily dismiss its case, that process is expected to take several more years.”


William SumnerWilliam SumnerJune 6, 2019
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6min6480

It’s time for your Daily Hit of cannabis financial news for June 6, 2019.

On the Site

Cresco Capital Partners

Cresco Capital Partners (Cresco Capital) announced today that it has closed an oversubscribed fund of $60 million. Founded in 2014, Cresco Capital was one of the first and largest private equity firms to focus solely on the legal cannabis industry.

Italian court bans cannabis derivatives, in blow to popular sector

Italy’s top court has banned the sale of cannabis products, on the heels of threats by the country’s deputy prime minister to close shops who sell legal derivatives of the plant. Deputy Prime Minister and far-right League leader Matteo Salvini had declared war on so-called “cannabis light” shops in the run up to the European Parliament elections.

In Other News

Harborside

Harborside Inc. has announced that it has filed its listing statement with the Canadian Securities Exchange and that it will begin trading shares of the company on June 10, 2019 under the ticker symbol “HBOR.” “The start of trading represents a significant milestone for Harborside, and we’re grateful for the support that we’ve received from the CSE throughout the process,” said Harborside CEO Andrew Berman. “We’re excited to move forward as a public company, with a vehicle that attracts growth capital from new investors, and continue maintaining Harborside’s status as California’s premier cannabis operator.”

PharmaCielo Ltd.

PharmaCielo Ltd. (TSXV: PCLO) has entered into an implementation agreement to acquire all of the issued and outstanding shares and listed options of the global medical cannabis company Creso Pharma Ltd. for A$122 million. Under the agreement, PharmaCielo will pay A$0.63 per share, which is a premium of 50% over the closing trading price of the Creso Pharma shares on May 31, 2019. “PharmaCielo’s acquisition of Creso Pharma, harnessing the synergies between us, creates a combined company that is poised to become a global powerhouse in the medicinal cannabis industry,” said David Attard, CEO of PharmaCielo. “Upon closing of the transaction, the combined company will quadruple our global footprint with presence in more than a dozen countries spanning North and Latin America, Switzerland, Europe, the Middle East, Australia and New Zealand.”

Aleafia Health

Aleafia Health Inc. (TSX: ALEF) (OTC: ALEAF) (FRA: ARAH) reports that it is offering 35,000 convertible debenture units of the company, at a price of $1,000 per unit, for a total of $35 million. Leading the offering is Mackie Research Capital Corporation and BMO Capital Markets, which is acting on behalf of a syndicate of agents including Canaccord Genuity Corp.  The proceeds of the offering will be used for working capital requirement and other general corporate purposes.

Medicine Man Technologies

Medicine Man Technologies, Inc. (OTCQX: MDCL) has entered into a securities purchase agreement for the sale of up to $14 million of the company’s common stock from an affiliate of the private equity firm Dye Capital & Company. The company will use the proceeds to fund growth initiatives. The company also announced a series of pending acquisitions, including MedPharm Holdings, Colorado’s first licensed cannabis research & phytopharmaceutical company; Medicine Man Denver; Los Sueños Farms,  North America’s largest sustainable cannabis farm; and Mesa Organics, a cannabis products manufacturing company. “Dye Capital is the right partner for our Company with a unique set of skills and experience in merger and acquisition transactions, integration experience, and scaling operations.  Our entire team is excited about teaming with Dye Capital,” said Medicine Man Technologies Co-Founder and CEO Andy Williams.


William SumnerWilliam SumnerJune 6, 2019
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3min17200

Cresco Capital Partners (Cresco Capital) announced today that it has closed an oversubscribed fund of $60 million. Founded in 2014, Cresco Capital was one of the first and largest private equity firms to focus solely on the legal cannabis industry. Although the two names are similar, Cresco Capital is not connected to Cresco Labs (OTCMKTS: CRLBF), which is a vertically owned cannabis company operating in 11 U.S. states.

“Surpassing our original goal of raising $50 million for CCP Fund II by almost twenty-percent not only represents a significant milestone for Cresco Capital Partners, it serves to validate the leadership role we play in providing growth capital and advisory services to companies within the cannabis industry,” said Matthew Hawkins, Managing Principal of Cresco Capital Partners. “With the overwhelming success of CCP Fund II, we are preparing to begin marketing a third fund in which we hope to raise $200 million. This fund will continue to target investments in value-add opportunities in the legalized cannabis space both plant touching and non-plant touching.”

To date, the company has raised more than $85 million and has invested over $50 million in 32 cannabis companies through two funds, CCP I and CCP II, and co-investment vehicles.

The company’s portfolio includes a diverse set of cannabis companies, ranging from cultivation to ancillary services. Several of Cresco Capital’s most notable investments include MJ Freeway, PROHBTD, NorCal Cannabis Company, Sunderstorm, Phylos Biosciences, Sublime, Cellibre, and Harborside/FLRish Inc. Most recently, Harborside closed a C$19.5 million private placement of subscription receipts, with Cresco Capital as one of its investors.

So far, the company has achieved seven exits between its two funds; including Acreage Holdings (OTCMKTS: ACRGF) and Green Thumb Industries (CNSX: GTII); who recently closed the acquisition of Integral Associates, which holds multiple retail dispensary licenses in California and Nevada, as well as two cannabis cultivation and processing facilities.



About Us

The Green Market Report focuses on the financial news of the rapidly growing cannabis industry. Our target approach filters out the daily noise and does a deep dive into the financial, business and economic side of the cannabis industry. Our team is cultivating the industry’s critical news into one source and providing open source insights and data analysis


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