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Cannabis Company Keeps Fighting IRS View of Drug-War Era Law (1)

Dec. 3, 2019, 5:00 PMUpdated: Dec. 3, 2019, 8:46 PM

A cannabis company has appealed its case against the IRS at the Ninth Circuit in an effort to soften the blow of a policy that can push state-legal marijuana businesses’ tax rates to upwards of 70%.

Harborside Inc., which is based in Oakland, Calif., is challenging the government’s view of tax code Section 280E, which bars those “trafficking” in Schedule I and II substances from taking ordinary deductions afforded to other businesses. The company on Dec. 3 filed its appeal of the U.S. Tax Court’s 2018 ruling in Patients Mutual Assistance Collective Corp. v. Commissioner.

At issue is the extent to which the ban applies to federally legal activities, and what exactly counts as the “cost of goods sold,” or the cost of inventory, the one thing state-legal cannabis businesses can use to reduce the amount of their income that is subject to tax. The latter question can often be a major area of uncertainty for accountants and a minefield for potential audits, industry tax professionals have said.

The 2018 Tax Court opinion, which combined three cases—held that Harborside was a reseller, not a producer. The classification can expand what goes into the “cost of goods sold” bucket, and therefore reduce a company’s effective tax rate. The court also said Harborside used the wrong tax code section to tabulate its inventory costs.

The court on Oct. 11 ordered Harborside to pay about $11 million in deficiencies for fiscal years 2007 through 2012, according to court documents.

James Mann, a partner at Greenspoon Marder LLP in New York, is representing Harborside in the appeal. He said he is considering using a legal argument against the constitutionality of Section 280E laid out in another Tax Court opinion, Northern California Small Business Assistants Inc. v. Commissioner.

While the court found the code section constitutional, some judges suggested that it may exceed Congress’ income taxing authority under the 16th Amendment and could violate the Eighth Amendment’s prohibition on “excessive fines.”

The case is Patients Mutual Assistance Collective Corp. v. Commissioner, 9th Cir., No. 29212-11, 12/3/19.

To contact the reporter on this story: Lydia O'Neal in Washington at loneal@bloombergtax.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Colleen Murphy at cmurphy@bloombergtax.com