MORGANTOWN — are working on a fix to HB 2079, the medical cannabis company vertical integration bill vetoed by the governor last month, to have it ready for the special session expected sometime before the end of May.
Last week, The Dominion Post spoke with Michael Haid, a consultant and lobbyist who heads a medical cannabis investment group and has worked with legislators on the bill, to learn more about the legal and economic requirements that necessitate the bill, and how ignorance of the industry apparently prompted the veto.
Haid also provided an array of materials from industry sources and financial media that explains vertical integration and the tax issue.
Medical cannabis is legal in 29 states and Washington, D.C. An industry chart shows that all but two require or allow vertical integration: West Virginia and Washington.
As background, the chief goal of HB 2079 was to allow vertical integration of medical cannabis businesses. Current law prohibits cannabis growers or processors from operating dispensaries. The bill would have allowed one company to operate all three.
Gov. Jim Justice said in his veto message that the bill unfairly favors vertically integrated cannabis business over others. He based that on a provision the Senate Judiciary Committee added to the bill. Current law sets a 10 percent gross receipts tax on sales by grower/processors to dispensaries.
The Judiciary amendment set two rates. The first applied to growers who sell to unrelated processors, processors who sell to unrelated dispensaries, or grower-processors who sell to unrelated dispensaries. They would pay the 10 percent rate.
But integrated businesses would be charged a 5 percent tax based on gross customer receipts.
Justice said in his message that the Legislature may classify and tax businesses differently, but federal law requires the tax to be reasonable, based on real differences and be germane to the enabling legislation. “Applying this test, it is impossible to justify the classifications in the bill.”
Haid said Justice and his team don’t understand how the business works. Federal tax law makes it financially impossible for a dispensary to operate as a standalone business, so that class Justice seeks to protect will never exist.
The problem stems from U.S. Code Code 280E. This explanation is combined from a variety of sources, including Forbes and the National Cannabis Industry Association (NCIA).
Section 280E emerged from a federal court case allowing a convicted cocaine trafficker to deduct his business expenses from his taxes. 280E deals with the conundrum of taxing illegal business by barring anyone trafficking in Schedule I or II controlled substances – including state-legal medical cannabis – from deducting expenses.
The code allows certain deductions for “cost of goods sold,” meaning inventory costs, including the cost of the product, the cost to ship it in and any directly related expenses. However, the IRS interprets this very narrowly.
NCIA illustrates the problem by comparing a cannabis and non-cannabis business both earning a gross income of $350,000 after deducting cost of goods sold. The non-cannabis business deducts $200,000 of expenses and has a taxable income of $150,000; with a 30 percent tax, it pays $45,000. The cannabis business, with no deductions, pays on the full $350,000 and shells out $105,000.
That $105,000 equates to a 70 percent tax on the non-cannabis business’ taxable income of $150,000.
The fineries require the knowledge of an accountant — Haid is one by training — and the IRS takes eight pages to explain it, but Haid boils it down to a few broad points. A grower-processor has more latitude in what it can deduct than a standalone dispenser who only sells what it buys from the processor.
A dispensary is capital intensive, he said, and a 70 percent effective tax rate doesn’t provide enough profit to stay afloat. The dispensary needs the tax padding — a 15 to 20 percent total difference — afforded by the other two aspects of the business in order to minimize the tax impact.
Haid cited a standalone dispensary in another state that earned $1 million in receipts one year and cleared only $45,000 after taxes.
Capitol regulars know that bills presented a committee meetings are frequently crafted behind the scenes with stakeholder input and lengthy negotiation (careful eavesdroppers will often see last-minute talks with legislators before a meeting).
This was no exception. Haid said senators and members of a medical cannabis wholesalers group negotiated the 5 percent tax for vertically integrated businesses, knowing no other kind would ever exist. Expenses get passed on and this two-tier tax was an effort to keep consumer costs as low as possible.
“Medical marijuana shouldn’t be about making money, but getting people help, getting them off of opioids,” he said. But a business also needs to be self-sufficient on order to provide its product.
Haid said that the veto was not only uninformed, but premature. The program launces on July 1, but the process of getting permits, setting up operations and planting the first crop means no cannabis will hit the market until the first quarter of 2021. No one is going to invest in facilities until they get a license.
If the program doesn’t get fixed and the Department of Health and Human Resources issues permits to standalone dispensaries, Haid said, “It’s going to fall on its face.”
Haid and others are working to get the message to legislators and the governor’s office, he said. “I feel like the education getting out there,” he said. When it gets rolling, along with helping patients who need the medicine, it could provide $10 million in investments and 2,000 jobs. “This is a jobs and investment bill.”
Tweet David Beard @dbeardtdp Email dbeard@dominionpost.com
