In our last installment, we discussed the reasons why Oregon’s cannabis sales tax should not apply to cannabis seeds. So what do you do if you believe that a retailer wrongfully charged you sales tax on seeds or any other cannabis item? There’s a law for that!

Oregon Revised Statute (ORS) 475B.740 requires that cannabis retailers return taxes imposed on a sale that is not taxable upon written notice from the Oregon Department of Revenue (ODOR). The relevant ORS on the refund process is not clear or easy to follow. However, the Oregon Legislature granted ODOR broad authority to establish rules and procedures regarding the cannabis sales tax — and it did just that.

ODOR created Oregon Administrative Rule (OAR) 150-475-2060, which provides the relevant how-to of the specific process a consumer must follow for obtaining a refund of excess taxes paid, as follows:

  1. Within 30 days from date of sale, the consumer requests a refund in writing to the retailer by mail or hand delivery. The request must include the retailers (i) name, (ii) the nature of the excess tax paid, (iii) the remedy requested, and (iv) the receipt clearly identifying the date of purchase and proof of payment.
  2. If within 60 days of the request the retailer does not return the excess tax paid, then the consumer may appeal to ODOR within 120 days of the date of the original request for a refund.
  3. ODOR must refund excess cannabis sales taxes upon satisfactory proof that (a) the consumer paid an excess tax to the retailer, (b) the excess tax was not refunded, and (c) the consumer made a timely request for a refund.

One small problem: ODOR believes the sales tax equally applies to seeds and immature plants, (i.e., ODOR concluded the sales tax on seeds is legal). So don’t hold your breath waiting for ODOR to voluntarily send you a check.

Once you’ve exhausted these options, you are left with the Oregon Tax Court. The Tax Court is the sole, exclusive, and final judicial authority for questions of law and fact in Oregon. The Tax Court is broken into two separate divisions — the magistrate and the regular divisions. Cases typically start at the magistrate division and may later be appealed to the regular division. A taxpayer that is unhappy with a regular division decision may appeal to the Oregon Supreme Court.

A taxpayer appeals the failure of ODOR to issue a refund by filing a complaint against ODOR with the Tax Court no later than 90 days following the decision to deny the request for refund. With any luck, the Tax Court will agree with our position that the cannabis sales tax does not apply to seeds. As the saying goes, there are only two certainties in life — death and taxes.

One more thing. Even if you win, you’ve probably lost. ORS 305.490 requires that taxpayers pay a filing fee for each complaint or petition. The current filing fee is $265. The statute also provides for the recovery of costs and reasonable attorney’s fees in limited circumstances. However, those circumstances are generally limited to situations involving an individual’s request for a refund for a tax measured on net income and property tax matters. Costs and reasonable attorney’s fees are not recoverable in sales tax matters.

Takeaway for Consumers

ODOR probably got it wrong in concluding that the cannabis sales tax applies to cannabis seeds. Anticipating a challenge to their weak position, ODOR has created a number of onerous obstacles for anyone willing to challenge their authority.  Fighting ODOR on this issue is probably not worth the cost. A consumer spending $100 on seeds this spring will generally pay $20 in sales tax. Getting that sales tax refunded requires that you jump through the hoops noted above. If the retailer and ODOR refuse to make the refund, then you’re stuck paying $265 to recover $20 — creating a loss of at least $245, because the $265 cannot be recovered under current law. This doesn’t begin to account for the time and effort involved jumping through all of these hoops. The only way we’ll ever know if ODOR got it wrong is if someone is willing to take up the fight on principal. Even then, a win in Tax Court probably means the Oregon Legislature will “fix” the law in a future legislative session. If this happens, we can only hope that the Legislature will be kind enough to expand recovery of costs and reasonable attorney’s fees to sales tax matters.

Takeaway for Seed Retailers

Be wary of refunding any taxes to your customers because you can be held liable for not collecting and remitting the tax.

The Oregon Department of Revenue (ODOR) recently issued a permanent administrative rule relating to the retail sales tax imposed on certain marijuana items. OAR 150-475-2100. The rule itself provides guidance to retailers on how certain types of marijuana items should be classified and how such items should be subject to the retail sales tax imposed on them. However, the administrative rule reaches beyond the statutory language adopted by the Oregon Legislature to suggest that, somehow, cannabis seeds are subject to the retail sales tax. Prepare yourself for a bit of legal analysis and simple logic. Let’s take a look at how ODOR got it wrong.

The Law

The Oregon Revised Statutes (ORS) cannabis tax rules are codified in ORS 475B.700 through ORS 475B.760. ORS 475B.700 contains the relevant definitions for the cannabis tax. The provision includes definitions for the terms “cannabinoid product,” “immature marijuana plant” and “useable marijuana.” Each of these terms are defined by reference to their definition under ORS 475B.015.

ORS 475B.705 contains the enabling language and the tax rates. It states that a tax is imposed on “the retail sale of marijuana items” in Oregon. The tax is imposed on the consumer, but withheld and remitted by the retailer. ORS 475B.705(2) imposes a 17-percent tax on the retail sales price of several marijuana items, including “immature marijuana plants” and cannabinoid products other than those intended to be used by applying the product to the skin or hair.

ODOR’s Administrative Rule

ODOR adopted Oregon Administrative Rule (OAR) 150-475-2100 regarding the retail sales tax imposed on certain cannabis items. The rule states that the definitions found in ORS 475B.015 apply the terms used in the rule and that “seeds” are taxed at the rate in ORS 475B.705(2)(c).

Getting It Wrong The Legal Analysis

The Oregon statute covering the retail sales tax begins by creating defined terms. There is nothing inherently wrong with doing this. In fact, ORS 475B.700 creates defined terms not otherwise used by chapter 475B. However, it fails to do something important. It fails to incorporate the many defined terms found in ORS 475B.015. The defined terms found in ORS 475B.015 only apply to ORS 475B.010 through 475B.545. Among the terms incorporated are cannabinoid product, immature marijuana plant, marijuana items and usable marijuana.

Let’s jump to the low hanging fruit. ORS 475B.015(24)(a) defines the term “marijuana seeds” to mean “the seeds of the plant Cannabis family Cannabaceae.” The definition of “marijuana seeds” is not carried over to the tax section by virtue of ORS 475B.700. It’s glaringly omitted. OAR 150-475-2100 attempts to remedy this by rule and adopting all defined terms in ORS 475B.015.

Next, the term “marijuana” is defined by ORS 475B.015(17)(a). It means “the plant Cannabis family Cannabaceae, any part of the plant Cannabis family Cannabaceae and marijuana seeds.” The definition of “marijuana” is not carried over to the tax section by virtue of ORS 475B.700. It’s also glaringly omitted. Again, the administrative rule attempts to remedy this by adopting all defined terms in ORS 475B.015.

One important term that is carried over to the tax section is the term “marijuana item.” The enabling language found in ORS 475B.705(1) states “a tax is hereby imposed on the retail sale of marijuana items in this state.” Marijuana items are defined by ORS 475B.015(19) to mean “marijuana, cannabinoid products, cannabinoid concentrates and cannabinoid extracts.” Cannabis seeds do not fall within the definition of cannabinoid products, cannabinoid concentrates or cannabis extracts. That only leaves “marijuana” as the potential category for cannabis seeds. If we assume that the defined terms in ORS 475B.015 carried over to the tax section, then it is clear that cannabis seeds are “marijuana” as that term is defined, and therefore, would be a “marijuana item.” However, we cannot make this assumption because ORS 475B.700 fails to incorporate the defined term “marijuana” from ORS 475B.015.

But wait, there’s more. ORS 475B.705(1) simply states that taxes are imposed on the retail sale of marijuana items. ORS 475B.705(2) sets the applicable tax rates — and this is where the Oregon Legislature really swung and missed. Tax rates are set for the following items:

  • Marijuana leaves,
  • Marijuana flowers,
  • Immature marijuana plants,
  • Cannabinoid edibles,
  • Cannabinoid concentrates,
  • Cannabinoid extracts,
  • Cannabinoid products intended to be applied to the skin or hair, and
  • Cannabinoid products not intended to be applied to the skin or hair.

Cannabis seeds do not fit within any of these. The only reasonable possibility is that they are cannabinoid products not intended to be applied to the skin or hair. So let’s take a look at the defined term “cannabinoid products.”

ORS 475B.015(5)(a) defines cannabinoid products to mean “a cannabinoid edible and any other product intended for human consumption or use, including a product intended to be applied to the skin or hair, that contains cannabinoids or dried marijuana leaves or flowers.” Cannabis seeds are not edibles, and they are not intended for human consumption. They are also not used for any cannabinoids that they may contain. Cannabis seeds are intended to be germinated, grown and harvested. ODOR may argue that this intent constitutes “use” within the meaning of ORS 475B.015(5)(a), but this should be a losing argument.

ODOR did not look to the cannabinoid product argument when making their permanent administrative rule. OAR 150-475-2100(2)(c) states that seeds are subject to the rate set by ORS 475B.705(2)(c). That section imposes a 17-percent tax on “immature marijuana plants.” It doesn’t impose a tax on seeds. A plant is not a seed. Therefore, the tax imposed by ORS 475B.705(2)(c) cannot apply to cannabis seeds.

You may recall our prior blog post on making a difference. We provided written comments to ODOR suggesting that they lacked statutory authority to tax seeds. They disagreed with our position. In their written response (PDF), ODOR makes two arguments. First, they argue cannabis seeds are a “marijuana item.” Second, they argue that there was legislative intent to tax all marijuana items, including seeds. Lastly, they believe it is appropriate to tax seeds at the rate imposed on immature plants in an attempt to comply with the statutory language.

The first argument fails a law school admissions test (LSAT) logic problem.  ODOR’s argument relies on the defined term “marijuana” found in ORS 475B.015(17)(a). The defined term “marijuana” does not apply to the tax statutes. The defined terms relevant to the retail sales tax on cannabis items are found in ORS 475B.700. Those terms do not include a definition for “marijuana.” Reliance on the definition found in ORS 475B.015(17)(a) is misguided.

Legislative intent is a tool used to interpret statutes, contracts and other items when an item is ambiguous. Legislative intent is not used when a document or statute is facially clear — meaning there is no ambiguity in the drafting. There is only one potential term that might be ambiguous. That term is the word “use” in the definition of cannabinoid product. My view is the term “use” is intended to mean utilizing and consuming the THC, CBD or other cannabinoids the product contains. It should not mean germinating a seed to create a seedling, immature plant, mature plant and finally useable marijuana.

Even if we lost the cannabinoid product argument, ODOR’s permanent administrative rule states that seeds are subject to the tax rate imposed on immature plants. Seeds and immature plants are separately defined terms — a seed is not a plant. Therefore, the tax rate imposed on immature plants should not be imposed on seeds.

What’s Next?

So what do you do if you’ve purchased seeds in Oregon and paid the sales tax ODOR says you must pay? Stay tuned for our next post on the fun hoops ODOR set out for you to request a refund!

Sometimes the best place to hide something is in plain sight. That’s what Congress did in December when they passed the tax reform. In plain sight they (inadvertently?) muted the impact of 280E for corporate taxpayers.

How? Why? Because Congress lowered the corporate tax rate to 21%. IRC 280E denies deductions for costs associated with “trafficking in controlled substances,” which includes marijuana because it is still listed as a Schedule I substance under the Controlled Substances Act. Consequently, unless business expenses can be included in the cost of goods sold (COGS), expenses incurred in a cannabis-related business are not deductible when computing federal taxes. This rule presents a material tax problem for retailers, though other cannabis-related businesses can certainly be caught in this web.

By lowering the Federal corporate tax rate to 21% from 35%, the law now reduces the impact of the IRC 280E expense disallowance to about 60% of what it was prior to January 1 of this year. For example, a C corporate taxpayer who had $100X of net income after $30X of IRC 280E disallowance would pay tax of $35X last year. That same taxpayer with the identical income now pays tax of only $21X, muting the impact by 21% of the disallowed expense.

Taxpayers organized as C corporations don’t need to do anything except celebrate. Taxpayers organized as flow-through taxpayers, such as subchapter S corporations and LLCs taxed as partnerships, should look at their 280E exposure and consider whether restructuring might make sense.

Most government agencies rely on an informal rulemaking process when drafting and finalizing rules interpreting the law. This process generally requires the appropriate government agency to notify the public of the proposed new rule or proposed modifications to existing rules. The government agency generally must consider all comments received before finalizing a rule.

An exception to the public-comment period generally applies for “emergency” or “temporary” rules. Emergency and temporary rules are usually effective immediately, but are temporary in length. Unless the agency takes additional action, most temporary and emergency rules will expire.  A formal rulemaking and comment period generally applies before an emergency or temporary rule becomes permanent.

We encourage our clients and blog readers to participate in the rulemaking process.

The Oregon Department of Revenue (ODOR) issued a Notice of Proposed Rulemaking on October 19, 2017. ODOR scheduled a public hearing regarding these proposed rules on November 28, 2017 in Salem, Oregon.

ODOR proposes the adoption of two new rules – OAR 150-475-2030 and 150-475-2030. The stated need for the latter rule is to “codify the tax categorization of various products sold by marijuana retailers.” However, our review of the proposed rule includes a drafting error, inconsistent defined terms between the proposed rule and state statute, and an attempt to subject the sale of cannabis “seeds” to the state’s 17 percent retail sales tax. Our view of the applicable Oregon statute is that the retail sales tax does not apply to cannabis seeds as currently drafted and the proposed rule improperly classifies cannabis seeds as “immature plants.” Our Cannabis Team drafted and submitted the following public comments to ODOR and intends to attend the public hearing in Salem later this month.

A federal judge in Colorado recently upheld a summons issued by the IRS to the Marijuana Enforcement Division (MED) of the Colorado Department of Revenue. Rifle Remedies, LLC v. U.S., 120 AFTR 2d 2017-5447, (DC CO), 10/26/2017. The ruling contains very few facts but suggests that a taxpayer actively engaged in the cannabis industry objected to an IRS summons issued to MED for information related to such taxpayer.

The IRS may enforce a summons when the following conditions are met:

  1. The investigation will be conducted pursuant to a legitimate purpose,
  2. The information sought may be relevant to that purpose,
  3. The information sought is not already in the IRS’s possession, and
  4. The IRS follows the required administrative steps.

In this particular case, the IRS asserted that it sought records from MED pertaining to the taxpayer’s federal tax liabilities to 1) verify financial records and 2) determine if the IRS could substantiate information contained in the taxpayer’s returns.

The taxpayer’s arguments against the summons focused on whether or not the IRS had a legitimate purpose for obtaining MED records. The taxpayer argued the IRS summons was pretext for a criminal investigation. The fact that an IRS summons could have a criminal investigation impact is not relevant to determining its validity when the summons has an otherwise valid and non-criminal basis such as revenue recognition or section 280E compliance.

The taxpayer also asserts that the IRS summons includes MED “Transfer Reports” that could be used by the IRS as a fishing exercise for determining other taxpayers in the cannabis industry and subject to section 280E. According to the court, the taxpayer’s argument did not put “much meat on the bone” because the summons applied to a single taxpayer. So-called John Doe summons are subject to section 7609(f) when a summons does not identify the person with respect to the potential tax liability.

IRS examination of taxpayers in the cannabis industry may lead to John Doe summons in the future. See U.S. v. Coinbase, Inc. 120 AFTR 2d 2017-5239 (DC CA), 07/18/2017. In general, an IRS John Doe summons is valid when:

  1. The summons relates to the investigation of a particular person or ascertainable group or class of persons,
  2. There is a reasonable basis for believing that such persons or group or class of persons may fail or may have failed to comply with any provision of any internal revenue law, and
  3. The information sought to be obtained from the examination of the records (and the identity of the person or persons with respect to whose liability the summons is issued) is not readily available from other sources.

The first and third prong should not be much of an IRS obstacle. The validity of an IRS John Doe summons will likely depend on the second prong — whether or not the IRS can assert a reasonable basis for believing cannabis-industry taxpayers generally fail to report revenue includable under section 61 or comply with section 280E. A systemic failure of taxpayers to accurately report revenue or calculate taxable income may lead to widespread issuance of John Doe summons of MED (and other state’s) records.

The takeaway? Taxpayers subject to state seed-to-sale tracking requirements should expect and anticipate that the IRS (and state taxing authorities) have complete and full access to such records. Furthermore, taxpayers lucky enough to have access to bank accounts should expect their financial institution to perform due diligence including comparing seed-to-sale records to financial records and tax returns. See FinCEN memo — “BSA Expectations Regarding Marijuana-Related Businesses.” Any differences should be reconciled and explained.

Money backgroundIs your cannabis business ready for an IRS exam? IRS examinations are increasingly focused on IRS Form 8300 reporting requirements. These requirements are the result of USA PATRIOT Act provisions requiring all trades or businesses to report their receipt of more than $10,000 in currency in a single transaction or in two or more related transactions. 31 USC §5331 and 31 CFR §1010.320.

The required currency filing must be made in accordance with IRS Form 8300 instructions. The instructions provide that the form must be mailed to the IRS Detroit Computing Center or electronically filed within 15 days of receipt of the currency. Filers must also provide each person named on its filed Forms 8300 with a specified written statement by January 31 of the year following the calendar year in which the currency was received. The statement must show the name, telephone number, and address of the information contact for the business, the aggregate amount of the reportable cash received, and note that the information was furnished to the IRS.

Continue Reading Cashed Cannabis: Required Reports for Amounts Exceeding $10,000

The U.S. Drug Enforcement Agency (DEA) recently denied a petition to initiate proceedings to reschedule cannabis under the Controlled Substances Act (CSA). Thus, cannabis will remain a Schedule I substance under the CSA. Prior to the announcement, there was a good deal of speculation that the DEA was considering rescheduling cannabis to Schedule II.

Continue Reading DEA Just Said No to Rescheduling Cannabis: Why It Matters

I. The Conflict: The Long Arm of Federal Law

Recreational cannabis businesses operate in a world of conflicting state and federal laws. Several states have legalized recreational cannabis, yet, under federal law, cannabis remains an illegal Schedule I drug under the Controlled Substances Act (CSA). The CSA created five classifications of controlled substances. These classifications range from Schedule I to Schedule V, with varying qualifications for a substance to be included in each. The criteria for a Schedule I controlled substance includes a high potential for abuse, a lack of currently accepted medical use, and a lack of accepted safety for use under medical supervision. Controlled substances in Schedules II through V generally have a lower potential for abuse and/or some degree of currently accepted medical use. On April 4, 2016, the Department of Health and Human Services, the Drug Enforcement Administration (DEA), and the Office of National Drug Control Policy issued a letter indicating the DEA intends to reconsider the classification of cannabis in the first half of 2016. It is unclear if the DEA will continue to classify cannabis as a Schedule I drug, reclassify it to a different schedule, or remove it from the five schedules of controlled substances. Legalization at the state level does not protect recreational cannabis businesses from federal prosecution. The federal government continues its war on drugs and drug trafficking. This war currently includes cannabis. Cannabis businesses need cannabis to be removed from the schedules of controlled substances in order to eliminate the threat of federal prosecution.

State legalization rules are limited in scope to in-state purchase and consumption in an effort to “legitimize” the legislation and avoid federal intervention. For instance, state laws in Oregon and Washington do not permit a recreational cannabis consumer to acquire cannabis in Washington and later consume it in Oregon. States have carefully drafted their laws to prohibit importing or exporting cannabis. It is not so easy, however, to prevent federal intervention in all respects, and the long arm of federal law is felt most deeply in two areas: taxation and banking. This article addresses the tax challenges.

Continue Reading Recreational Cannabis — Section 280E and Tax Efficient Structuring