The United States has a long history with hemp, legally distinguished from marijuana, but genetically identical as the plant cannabis sativa (L.) — now, hemp is set to reemerge in U.S. agriculture as an important crop following passage of the 2018 Farm Bill expected sometime this week. There had been a lot of speculation, and disappointment, regarding the Bill’s hang up to date — in fact, many had resigned hope of the Bill passing this year at all and already started referring to it as the 2019 Farm Bill. Most people in the agriculture industry are very pleased that the Bill is finally moving forward.

Specific to hemp, people familiar with it as an industrial crop anticipate that the hemp will quickly grow into an important mainstream commodity. Widespread interest in hemp’s chemical derivatives, such as the non-psychoactive substance CBD, is one of the driving factors. Agriculture businesses that have already invested heavily in the industry are thrilled. Although hemp was previously considered an essential crop in the United States dating back to the original 13 colonies and grown by many founding fathers, it has been mostly illegal, except in limited circumstances, since well before the current generation of farmers took over from their own fathers.

Importantly however, it should be noted that although CBD is already big business in the U.S., broader allowances for the production of hemp under the new Farm Bill will not blanket legalize either human or animal consumption of CBD unless any such CBD containing products have specifically obtained approval from the Food and Drug Administration (FDA) under the Food, Drug, and Cosmetics Act (FDCA). Currently only a single substance, Epidiolex, has obtained such approval.

But there’s a lot more to hemp than CBD, such as its more traditional, well-known use as a natural fiber in ropes and textiles. Less well-known, however, may be hemp’s increasing popularity as a composite substrate (fiberglass) or for reinforcing concrete. Increased access and availability of hemp for such purposes will greatly improve research opportunities for other potentially useful applications. Hemp’s inclusion in this year’s Farm Bill signals its widespread shift back to mainstream acceptance over the last decade.

So, ready or not — here comes hemp — or perhaps more accurately, the return of hemp.

Earlier this week the U.S. Tax Court issued its long-awaited opinion for the Harborside case, which addresses several issues that impact cannabis tax planning strategies.  Those issues include:

  • Definition of “consists of” as used in section 280E;
  • A Narrow view of CHAMP and when a business engages in two or more trades or businesses;
  • Hints that separate taxpayers may be aggregated as engaging in separate trades or businesses;
  • Holds that section 263A does not apply to a trafficking business subject to section 280E and must rely on section 471 COGS methodologies; and
  • Interprets the meaning of “produce” for purposes of the COGS method found in Reg. 1.471-11.

The opinion does not discuss whether Harborside is liable for accuracy-related penalties under section 6662(a).  Also, the Tax Court did not adopt the IRS position previously asserted in an IRS Chief Counsel Advice memorandum — that taxpayers must use the section 471 methodologies that existed when Congress enacted section 280E.  We previously questioned that IRS position.

 

We try not to blog about developments outside the scope of our expertise. However, because many of our clients are very involved in Canada (or want to be), we want to share with you this article (authored by a very reputable Canadian law firm) about Ontario’s recently enacted Cannabis License Act and related regulations. Enacted last month, this legislation provides a mechanism for privately-owned business to become licensed retailers in Ontario, though the government-run Ontario Cannabis Retail Corporation remains the exclusive wholesaler and online retailer.  The window for license applications is expected to open December 17.

Headspace v. Podworks: Good News (With Warnings) for Marijuana Trademark Licensors

In January 2017, Headspace International, LLC, a California-based cannabis company, sued Podworks Corp., a Washington-state-based cannabis company, for trademark infringement. Headspace sells a product called “The Clear” and claimed Podworks’ “Top Shelf Clear” product infringed on its trademark. Podworks defended itself by claiming that Headspace did not have valid trademark rights in Washington and that the only use of Headspace’s trademark in the state had been by its in-state licensee, X-Tracted. The trial court in Headspace International LLC v. Podworks Corp., dismissed Headspace’s claim, finding that it had not established trademark rights in Washington. Headspace appealed and on October 29, 2018, the Washington Court of Appeals reversed the trial court’s decision and sided with Headspace.

What Does This Mean for Cannabis Businesses? First, the Good News

  • Lawful use of a trademark in Washington only by a licensee and not by the mark’s owner can support the owner’s state trademark rights, even for cannabis products.
  • A trademark licensor can lawfully exert sufficient quality control to maintain valid trademark rights without violating Washington’s Controlled Substances Act (the “CSA”).
  • A trademark licensor is not necessarily a “true party of interest” under the Washington Administrative Code (WAC).

Digging a Little Deeper

The court cited federal precedent in holding that:

. . . indirect use of a protected mark by a licensee inures to the benefit of the owner of the mark when the owner has sufficient control over the quality of the goods or services provided to customers under the licensed mark” and also that such “use” must be “lawful placement of a mark in the ordinary course of trade.”

The court then had to decide if an out-of-state trademark owner can exert “sufficient control” over the quality of its Washington licensee’s marijuana products without making that licensee’s use of the trademark unlawful under the CSA.

What is necessary to have “sufficient control” over quality? Three factors are assessed, any one of which may support a finding of sufficient control:

  • Contract language authorizing control over the licensee by the licensor,
  • Whether the licensor exercised actual control over the licensee, or
  • Whether the product quality over time was sufficient for the licensor to rely on the licensee to ensure quality control.

Under the CSA (as codified at RCW 69.50.331(1)(b)), licenses to legally produce, process or sell marijuana products may only be issued to in-state entities. Further, license holders may not permit any other entity to use the license (RCW 69.50.325), which the court says bars participation “in the production, processing, or sale” of marijuana products. How can an out-of-state trademark licensor exercise quality control without violating these requirements of the CSA?

Podworks claimed that in order to exercise sufficient quality control over its trademark, Headspace had to unlawfully participate in its licensee’s production or processing of the branded products. If true, this would create a “damned if you do, damned if you don’t” dilemma for Headspace — either it had no enforceable trademark rights because it didn’t exert sufficient control over X-Tracted, or it did exert sufficient control but still had no trademark rights because then X-Tracted’s use of the mark was unlawful. Nevertheless, the court held that sufficient quality control could be exerted “through contractual means” or by relying on the licensee’s own quality control measures, neither of which would violate the CSA, as neither would constitute participation in the production, processing or sale of the branded products.

Podworks then argued that the May 17, 2017 addition to the CSA (RCW 69.50.395), which requires marijuana businesses to disclose all licensing agreements to the WSLCB, should be applied retroactively and thus Headspace’s license to X-Tracted was unlawful, as X-Tracted did not disclose it to the WSLCB when it was entered into in 2014. The court held that X-Tracted’s failure to disclose the Headspace license in 2014 did not make it unlawful, but did note that the WSLCB must now require X-Tracted to disclose the license.

Along With the Good News, Consider These Warnings[1]

  • All current licenses must be disclosed to the Washington State Liquor and Cannabis Board (WSLCB), even those entered into before the disclosure obligation was created in 2017.
  • If a trademark licensor is paid a royalty based on a percentage of its licensee’s profits, said licensor will qualify as a “true party of interest” under the WAC and so must:
    • Be named on the licensee’s marijuana business license,
    • Disclose to the WSLCB the source of funds it invests in the licensee’s business, and
    • Have those funds pre-approved by the WSLCB.

This decision makes clear that licensing agreements will continue to be an effective way for Washington cannabis businesses and out-of-state IP owners to work together to their mutual benefit, but also highlights the significant dangers that can arise from poorly drafted or inappropriately implemented licenses. Creative approaches are required to appropriately compensate licensors without turning them into true parties of interest.  Lane Powell has structured such deals for both licensors and licensees in Washington and other states.

[1] (See WAC 314-55-035, which requires that marijuana licenses “must be issued in the name(s) of the true party(ies) of interest” and then goes on in subsection (1) to define “true parties of interest” as any party that “…has the right to receive, a percentage of the gross or net profit from the licensed business”, and in subsection (5) requires that after licensure true parties of interest “…must continue to disclose the source of funds for all moneys invested in the licensed business. The WSLCB must approve these funds prior to investing them into the business.”)

South Korea is currently garnering a lot of attention in the cannabis industry following its legalization of some cannabis derivatives for medical purposes. The legalization comes as a surprise for many in the international community, particularly because South Korea has aggressively opposed cannabis — most notably by criminalizing the consumption of cannabis by South Koreans traveling abroad to nations where cannabis is legal, such as Canada. Most of Asia, particularly Southeast Asia, has generally lagged behind other regions of the world in cannabis law reform. South Korea’s change of heart is prompting a lot of speculation regarding possible widespread reform across Asia much sooner than previously anticipated.

The revised law adopted November 23, 2018 is limited to CBD concentrates with THC levels too low to cause intoxication. Although somewhat unexpected internationally, it was less surprising for those in South Korea during last year’s media coverage of law enforcement action resulting in the incarceration of an ailing child’s mother for attempting to import CBD derived medication for her 4-year-old son who was suffering from brain cancer — public opinion clearly opposed such punishment. Not long after this event, Shin Chang-Hyun  introduced a legislative amendment to South Korea’s national drug policy — pointing to CBD’s acceptance as an effective treatment related to cancer, autism, dementia and epilepsy in other countries from Europe to North America.

The new rules impose highly restrictive conditions that will apply to the new regime governing the use of medical cannabis. Nevertheless, proponents of legal form for cannabis laws believe the change signals a major shift in attitudes not only by the public generally but more importantly among lawmakers. Additional details regarding implementation of those rules will be available by the end of the year with importation of CBD products anticipated by the middle of 2019.

A public records request by the Salem, OR-based Statesman Journal bore interesting fruit recently in the form of a report by the Oregon Cannabis Commission (OCC) recommending that a single agency regulate cannabis in Oregon. Currently, at least three Oregon regulatory agencies have some degree of oversight affecting the cannabis industry. The Oregon Liquor Control Commission oversees the recreational cannabis market. The Oregon Health Authority regulates the medical marijuana program. The Oregon Department of Agriculture administers the agricultural industry generally and certain food safety programs (as well as the industrial hemp program), which brings it into contact with many producers and processors of cannabis. The OCC, created in 2017 by statutory mandate to make recommendations about the future oversight of cannabis in Oregon, is considering whether Oregon is in need of “a unified and consistent vision on cannabis regulation.”

Some degree of regulatory overlap is likely unavoidable when it comes to cannabis. Cannabis sits in an unusual position in Oregon in that it is either a regulated recreational substance, a quasi-prescription drug, or a statutorily-protected agricultural crop, depending on the context. Indeed, among the states with both medical and adult-use cannabis, Oregon isn’t an outlier. Alaska, California, Colorado, Massachusetts, Nevada and Maine use separate agencies to regulate medical and recreational cannabis, in addition to whichever agencies’ mandates oversee agriculture and food safety (Vermont and Michigan have not yet finalized adult-use regulations).

Washington is the only state with established medical and adult use marijuana programs that has fully consolidated regulation under a single agency, the Washington State Liquor and Cannabis Board (formerly the Washington State Liquor Control Board – Washington has found efficiencies in both regulating marijuana and not reordering stationary). This approach has not been without controversy. Oregon itself has seen similar disputes, some quite recently, as the state’s crowded field of cannabis regulators attempts to rein in the black market trade in Oregon-made marijuana. Striking a balance between patients’ access to medicine, a well-regulated adult use market, and increasing federal scrutiny will likely be an active experiment for years to come.

If the OCC’s draft recommendations are finalized, there’s no certainty as to what form a single Oregon cannabis regulatory agency would take. Extensive statutory changes would be necessary, followed by rule making and transition periods, so it is unlikely that Oregon will see anything more than incremental changes for some years. Even then, cannabis businesses will continue to be overseen by a whole alphabet’s worth of acronyms depending on their activities as employers, taxpayers, farmers, manufacturers, etc. The OCC was supposed to meet on November 27 to discuss and vote on recommendations, but that meeting has been pushed out until at least mid-December. We will post updates as new information becomes available.

Thank you MJBizCon for another great hit last week in Las Vegas!  Previous conferences have consistently provided both valuable and relevant content for attendees. This year was no exception — high quality speakers covering a timely array of topics that ranged from recent developments in production and packaging to strategic considerations for potential partnerships with mainstream companies preparing to enter the cannabis industry. It was a seriously good conference and we encourage all industry participants to attend in the future.

We were happy to send four team members to the event, including three MJBizCon veterans who recently joined our Cannabis Team roster — Josh Ashby, Ben Pirie and Sativa Rasmussen. All four of us welcomed the opportunity to meet with our many clients and industry friends. Apologies to the many other clients (and potential clients) with whom we could not meet for lack of time. We simply had to jump ship in Vegas to head for the 6th Annual Northwest Marijuana Law Conference, hosted by Seattle University School of Law. Sativa and Josh co-chaired the seminar, Lane Powell served as a sponsor, and Justin Hobson and Ben were both speakers. So our absence at the Seattle conference would have been problematic. We have been assured that overlap of the two conferences will be avoided next year. Again, our apologies to the many people whom we wanted to accommodate but could not for lack of time. Of course our phone lines are always open . . . Our goal next year is not only to catch up with our friends and clients but also to facilitate introductions between participants in the industry.

Wishing you all a Happy Thanksgiving,

Josh, Justin, Ben & Sativa

The federal tax reform law that passed in December 2017 included a new incentive, the qualified opportunity zone (QOZ) regime.  The purpose of this tax incentive is to unlock and redirect trillions (yes, trillions) of capital gains into investments into new businesses, and substantial improvements to existing businesses, so long as those businesses are located in a QOZ (generally, designated  low income census tracts from the 2010 census).  The tax world has been abuzz about this enormous opportunity since the IRS issued taxpayer-friendly proposed regulations in late October.  Our summary of the QOZ regime is here, but the basic mechanics are simple: when taxpayers sell appreciated property (e.g., stocks or real estate) they can “roll” the gain into a new investment, with tax benefits for both the original “rolled” gain (deferral and up to 15 percent gain elimination) and the new investment (no tax on future gain).

In our summary, we highlighted the ability to secure QOZ benefits in urban areas, some of which are already attracting investments. QOZ benefits also are available for cannabis-business investments.  There are many QOZs in rural areas that are perfect for grow and processing operations; many urban and suburban QOZs may be good locations for retail outlets and dispensaries.

There are limitations on the types of business that can qualify for QOZ benefits, so no liquor stores, golf courses or sun tan parlors.  But Congress incorporated its “bad business” list from a Code section that has not been changed since 1986.  Accordingly, the “bad business” list does not include cannabis-related activities. (Please don’t ask us to explain why the cannabis industry is punished under one provision of the Tax Code but allowed to take advantage of another provision of the Tax Code; the best we can say is “it’s Congress.”)

So check the map before buying or building. You may find that some locations are more desirable than others, either because it will be easier to raise money from others, save taxes for yourselves, or simply turn out to be a neighborhood in which gentrification occurs more rapidly than normal.

It comes as no surprise that several Canadian cannabis company employees and investors will be traveling to the United States this week to attend the largest cannabis industry conference in the world, MJBizCon, in Las Vegas. The conference lists several Canadian companies among its speakers and will cover a variety of topics including investment, branding and an assessment of Canada’s first month of legalization, but for those wishing to cross the border into the U.S. for the conference, there are additional considerations that must be taken into account.

On October 9, 2018, United States Customs and Border Protection (CBP) revised its Policy Statement on Canada’s Legalization of Cannabis and Crossing the Border (the “Revised Statement”). Prior to this date, CBP had taken the position that merely being an employee (or an investor) of a legal cannabis business in Canada could result in inadmissibility under Section 212 of The Immigration and Nationality Act. See INA §212(a)(2)(C).

INA §212(a)(2)(C) permanently bars an individual if a CBP officer has reason to believe that he or she is an illicit trafficker in a controlled substance, or a knowing assister, abettor, conspirator or colluder in illicit trafficking. Prior to the Revised Statement, there were already a number of reported cases of employees and investors of Canadian cannabis businesses receiving lifetime bans under INA §212(a)(2)(C). Although these cases appeared to be limited to ports of entry on the West Coast, they demonstrated that employees and investors of Canadian cannabis companies were being banned as illicit traffickers.

The Revised Statement was welcome news for employees and investors of Canadian cannabis companies as it opened up the possibility of travel to the U.S. once more, but with a very import caveat. The current position taken by CBP is as follows:

A Canadian citizen working in or facilitating the proliferation of the legal cannabis industry in Canada, coming to the U.S. for reasons unrelated to the cannabis industry will generally be admissible to the U.S. However, if a traveler is found to be coming to the U.S. for reason related to the cannabis industry, they may be deemed inadmissible.

The Revised Statement confirms that employees of Canadian cannabis companies should be admissible if their reasons for coming to the United States are “unrelated to the cannabis industry.” This clearly includes traveling purely for vacation (for example, visiting with family) and even business visitor activities that were completely unrelated to the cannabis industry.

However, although the Revised Statement was a step in the right direction, CBP’s current stance means that someone can be barred merely for visiting a U.S. investor in his or her Canadian cannabis company or, you guessed it, attending a cannabis conference in the United States such as MJBizCon.

On October 25, 2018, the Canadian Press reported that they had received an email from Stephanie Malin, CBP Branch Chief for Northern/Coastal Regions, which stated the following:

If the purpose of travel is unrelated to the cannabis industry such as a vacation, shopping trip, visit to relatives, they will generally be admissible to the U.S. However, if they are coming for reasons related to the industry, such as the conference… they may be found inadmissible.

This statement by Ms. Malin in an ominous reminder that for Canadians wishing to come to the U.S. for conferences such as MJBizCon, there is a risk that you may be denied entry.

If you want to hear more about this issues, Lane Powell’s own Dustin O’Quinn and Sativa Rasmussen will present a Continuing Legal Education Society of British Columbia webinar on Tuesday, November 20, titled “The U.S. Border After Cannabis Legalization in Canada.” The presentation will start at noon PST and cover:

  • U.S. immigration law and how it’s impacted by some states’ legalization of cannabis,
  • Cross-border transactions to the U.S.,
  • Overview of U.S. policies that affect Canadians, and
  • Potential forms of relief.

The event is intended for lawyers who represent clients involved in the cannabis industry or clients who conduct business with cannabis-related industries.

For more information or to register for the conference, please visit the event website.

The cannabis industry is celebrating a lot of good news this week — support for legalization continues to grow while opposition dwindles steadily. Voters in three more states passed marijuana measures to increase the legal availability of cannabis both medically and recreationally. Two highly visible cannabis opponents, House Representative Pete Sessions and Attorney General Jeff Sessions, have departed from their respective federal positions.

Reports are estimating that the passage of recreational cannabis in Michigan, along with the medicinal cannabis measures approved in Missouri and Utah could generate upwards of $2 billion in medical and recreational sales. This additional round of state legalization is a clear indicator of our country’s continued march toward the ultimate objective for an end to federal prohibition. The new tally brings the total number to 33 states and the District of Columbia having adopted some form of legal access to cannabis.

This, coupled with the Democrat’s win in the House of Representatives and Pete Sessions failed re-election bid in Texas cannot be overstated. Sessions had been one of Congress’ most powerful and vocal marijuana prohibitionists and he used his position as Chairman of the House Rules Committee to further his agenda. While serving in his role as Chairman, Sessions’ panel consistently blocked cannabis proposals from advancing to the floor for a vote, including several bipartisan proposals over the past few years. In fact, due to Pete Sessions, no cannabis amendments have been voted on by the House of Representatives in two years. This blockage has now been removed and cannabis advocates will gain a new friend in Democrat Colin Allred. The Congressman-elect is a civil rights attorney who campaigned on healthcare and has been vocal in his support for medical cannabis.

The cannabis community was already having a good week following the results of the midterm elections when the industry lost one of its biggest opponents in Washington on Wednesday afternoon when Attorney General Jeff Sessions resigned at the request of President Trump. Sessions, who once famously said “good people don’t smoke marijuana,” has pushed for greater enforcement of the federal ban on marijuana throughout his tenure as Attorney General. Last January, Sessions rescinded the prior federal guidance to U.S. Attorneys, which mandated a mostly hands-off stance for enforcement of federal cannabis law against people complying with state cannabis law.

As Attorney General, Jeff Sessions ultimately had little effect on states’ autonomy for allowing cannabis — his greatest impact was to discourage private investment into the industry and sustain barriers to financial services, such as banking and commercial lending. Jeff Sessions’ exit is credited for the boost in prices of most marijuana stocks and investments shortly after his resignation was announced. Canada-based Tilray closed up 30 percent while Canopy Growth and Aurora Cannabis rose 8.1 percent and 9 percent respectively. Cronos Group added 8.4 percent.

Although we can only speculate at this point regarding the speed and manner in which legalization will occur moving forward, the direction cannabis laws are headed leaves little doubt that cannabis prohibition is coming to an end.