2018 was a big year for the commercial cannabis legalization and provided some clues for what’s to come. The year started with California’s recreational market kicking off just as now-former U.S. Attorney General Jeff Sessions rescinded the Cole Memo. By year’s end, the number of states allowing medical and recreational cannabis rose to forty-four and ten, respectively.

Some major milestones for 2018 included:

• The introduction of the STATES Act, which would give states the power to regulate commercial cannabis within their own borders.

• California’s first full year of legalization.

• Canada’s national legalization of commercial cannabis.

• High taxes on cannabis businesses and less than expected tax revenue for many states and localities.

These topics are discussed in greater detail in an article by Rob Selna and myself published in mg Magazine, which you can read here.

Court Ruling on 280E

Another major legal development came in late 2018: after a long battle, a US Tax Court ruled that the IRS can continue prohibiting cannabis companies from taking standard business deductions based on Internal Revenue Code Section 280E. 

As discussed in a previous post, Section 280E prevents any trade or business that consists of trafficking in controlled substances from taking deductions or credits for business expenses other than the cost of goods sold. 280E has been a thorn in the side of attorneys, CPAs, accountants and business owners working in the cannabis industry for as long as cannabis companies have been filing their taxes. It has greatly increased the cost of doing business and has prompted even small cannabis companies to adopt complex corporate structures, including management and holding companies. Another tact has been to undertake extremely careful, and sometimes creative, bookkeeping in order to minimize the overly heavy tax burden.

Fed up with what it perceived to be unfair treatment, Harborside Health Center, a major cannabis retailer headquartered in Oakland, decided to take a stand against Section 280E. Unfortunately, a Tax Court didn’t buy their argument. On December 20, 2018, the court ruled that Harborside would have to repay business deductions, estimated to be tens of millions of dollars, that it took on its taxes between 2007 and 2012.

Harborside argued that 280E did not apply to their dispensary earnings because about two percent of revenue came from the sale of non-cannabis related products like clothing and lighters. Harborside relied on the language in 280E, which states that its restrictions shall apply to any trade or business that “consists of trafficking in controlled substances” to mean consists “only of controlled substances.” The U.S. Tax Court disagreed with this interpretation and held that the sale of non-cannabis products was “neither economically separate nor substantially different” from Harborside’s primary business in selling cannabis products. Harborside has said it will appeal the ruling, but for now, 280E’s ban on standard business for cannabis operators stands.

Governor Jerry Brown recently signed a bill that allows thousands of cannabis operators surviving on expiring temporary licenses to stay open for an additional year without new approval from local authorities.

Brown signed Senate Bill 1459 amid a flurry of legislation on September 27. The bill addresses a problem faced by much of the California commercial cannabis industry: the state cannot issue licenses to operators who have completed state applications until the relevant city or county provides approval, but that local approval has been very slow to come.

In response to the slow local process, the state provided applicants with the option of operating on a 120-day temporary license (and three 90-day extensions) until they were issued a standard state license. The state required some form local authorization to issue the temporary license, but not a finalized local permit. However, the temporary license program was only meant to be a short-term fix and is scheduled to expire on December 31, 2018. After that, a cannabis business could only operate if it obtained a standard license. Yet, many local governments are still moving at a snail’s pace.

Making matters worse, some local jurisdictions announced that they would not provide applicants with local approval for their standard state license unless the applicant had obtained a finalized local permit. In one example, The City of Oakland sent applicants a letter in April refusing to provide local approval for a standard (non-temporary) state license until the applicant had obtained a city permit. Meanwhile, permit-seekers who had filed complete applications more than six months prior were still awaiting inspections from Oakland’s Building and Fire departments, placing applicants in a Catch-22.
Recognizing the protracted delays at the local level, AB 1459 wrests some control from the hands of city and county agencies and gives the state “sole discretion” to decide whether to issue the new a 12-month “provisional” license. The state does not plan to hand out provisional licenses casually however, and has included its own criteria that applicants must meet. In order to be eligible for the provisional license, applicants must have met the following list of conditions:

• Submitted a completed a standard (non-temp) state license application
• Filed and signed a provisional license application under penalty of perjury
• Held or currently holding a temporary license
• Provided evidence that compliance with the California Environmental Quality Act is underway

The bill represents a lifeline for the vast majority of cannabis permit applicants in counties and cities facing long permitting backlogs that have occurred by no fault of their own.

In Oakland, hundreds of applicants are awaiting sign-off from the City’s Building and Fire Departments before their final permits can be issued. The departments’ staffs have been overwhelmed by the volume of applications and the new complexities that cannabis infrastructure presents.

John Oram, CEO of Oakland-based Bloom Innovations, which owns the popular NUG brand said, “99.9 percent of Oakland cannabis businesses would have had to shut down” while waiting for their local permit to be issued had the Governor not signed SB 1459.

“If the bill had not passed The City of Oakland could have chosen to deny local authorization, which would have forced us to close,” Oram said.

[Special thank you to guest contributor Ana Orozco for this post.]

Three weeks have passed since the three agencies overseeing the implementation of California’s new cannabis laws introduced their Proposed Permanent Cannabis Regulations and kicked off a 45-day public comment period. This means that Californians have roughly three weeks left to submit comments in writing, or at public hearings held throughout the state, that could modify the draft permanent regulations. The public review and comment period invites input from the general public and cannabis operators, as well as local governments.

One new and notable draft regulation strongly opposed by local governments and their representatives in Sacramento is the proposed expansion of delivery services to all cities and counties. When voters approved Proposition 64, local jurisdictions understood that the regulations implementing the proposition would give them broad discretion to regulate recreational cannabis, including prohibiting it altogether. However, when state agencies adopted the initial “emergency” regulations they did not address whether local jurisdictions could restrict the delivery of cannabis in their jurisdiction. The Proposed Permanent Cannabis Regulations clarify this ambiguity by stating “A delivery employee may deliver to any jurisdiction within the State of California.”

Not surprisingly, a vocal opponent of the draft permanent regulations is the League of California Cities, which deems protecting local authority in the state’s new cannabis laws a priority under its 2018 Strategic Goals. On July 26, 2018, the League of California Cities submitted a letter to the Bureau of Cannabis Control stating its opposition to the draft and concerns about maintaining local control. Specifically, the letter emphasizes Proposition 64’s stated intent to give cities authority over all commercial cannabis activity, highlights the financial costs cities face in protecting public safety, and questions the Bureau of Cannabis Control’s regulatory power to alter the statutory provisions.

The League’s reasoning against the draft permanent regulations echoes its opposition to Senate Bill 1302 – which also would have allowed cannabis delivery in all jurisdictions – and likely previews the feedback cities and counties will provide during the public comment period. SB 1302 was ordered inactive by its author, Senator Ricardo Lara one month before the draft permanent regulations were introduced. However, the opposition to SB 1302 sheds light on the groups that would oppose the draft permanent regulations. To list a few, SB 1302 was opposed by the California Police Chiefs Association, Urban Counties of California, Rural County Representatives of California, and California State Association of Counties. In a joint letter to Senator Lara, these organizations expressed their concerns about losing local control and fears of “a race to the bottom” effect, in which cannabis sellers flock to jurisdictions with permissive cannabis regulations and low taxes, creating over-concentrated cannabis commerce and monopolies in those jurisdictions.

While no formal statements regarding the draft permanent regulations have been issued by local government organizations, it is expected that they will use the same reasoning as in SB 1302 to oppose the provisions in the draft permanent regulations allowing the delivery of cannabis in all jurisdictions. The contentious discussion will continue  at the upcoming public hearings.

There may be a significant tax break on the horizon for California’s growing legal cannabis market. A bi-partisan group of Assemblymembers introduced a bill (AB 3157) that will temporarily cut the state excise tax from 15% to 11% and eliminate the cultivation tax, which is currently $9.25 per ounce ($2.75 per ounce of cannabis leaf and $1.29 per ounce of fresh cannabis plant) until June 1, 2021. The bill is intended give the legal cannabis industry a chance for a strong start, encourage black and gray market cannabis operators to make the transition to the legal marketplace and prevent the black market from successfully competing with legally compliant tax-paying businesses.

AB 3157 will be welcome news to California’s cannabis entrepreneurs, many of whom are concerned about the ability of their businesses to survive under the heavy tax burden imposed by state and local governments, while simultaneously having to compete with a sophisticated and experienced black market. Assemblymember Rob Bonta (D-Oakland), a supporter of the bill, noted “California cannabis businesses are making significant investments as they embrace the regulated marketplace while, at the same time, being undercut by unregulated competitors.” Currently, California imposes an excise tax, cultivation tax, and sales tax, not to mention the license application fees, the general cost of complying with various state and local rules and regulations, and the usual corporate taxes. Local governments are also joining in and imposing significant cannabis taxes on local cannabis businesses, including sales taxes, cultivation taxes and other operation-specific taxes. On top of these state and local taxes, cannabis businesses are unable to deduct business expenses other than cost of goods sold (COGS) from their federal taxes due to 280E.

The Adult Use of Marijuana Act (AUMA) called for the regulation of cannabis to “reduce barriers to entry into the legal, regulated market,” and “tax the growth and sale of marijuana in a way that drives out the illicit market for marijuana and discourages use by minors and abuse.” The disproportionately high tax rate imposed on cannabis companies presents an incredibly high barrier to entry for a new or transitioning cannabis business. Additionally, the high prices that compliant cannabis businesses need to charge consumers in order to afford California rents and California taxes only encourage diversion, abuse and the growth of the black market. By temporarily relieving a portion of the heavy tax burden on cannabis companies while the industry gets its bearings, AB 3157’s supporters hope to reduce the disparity in price between the black market and the legal market for consumers and other operators along the supply chain.

Today, United States Attorney General Jeff Sessions has scuttled Obama-era federal law enforcement policy on marijuana. Effective immediately, the seminal Cole Memorandum and related guidance previously issued by the Justice Department have been rescinded. A copy of Sessions’ January 4, 2018, one-page memorandum announcing this policy shift can be found here.

Sessions, a strong critic of marijuana, has strongly hinted since his appointment that he would revisit federal enforcement policy regarding this Schedule I drug. Even so, the Attorney General’s announcement does not portend that federal enforcement in states where medical and recreational marijuana legislation has been passed is imminent. Sessions stated that future prosecutions are left to the discretion of individual U.S. Attorneys’ offices.

In deciding which marijuana activities to prosecute under these laws with the Department’s finite resources, prosecutors should follow the well-established principles that govern all federal prosecutions…. These principles require federal prosecutors deciding which cases to prosecute to weigh all relevant considerations, including federal law enforcement priorities set by the Attorney General, the seriousness of the crime, the deterrent effect of criminal prosecution, and the cumulative impact of particular crimes on the community.

Sessions’ about-face policy shift, however, has drawn sharp criticism from several members of Congress. Senator Cory Gardner (R-Colorado) tweeted his displeasure, threatening repercussions: “I am prepared to take all steps necessary, including holding [up] DOJ nominees….” Senator Lisa Murkowski (R-Alaska) also took to Twitter to decry the policy shift noting, “Over the past year I repeatedly discouraged Attorney General Sessions from taking this action and asked that he work with the states and Congress if he feels changes are necessary. Today’s announcement is disruptive to state regulatory regimes and regrettable.” Congressional Cannabis Caucus co-chair Representative Earl Blumenauer (D-Oregon) was even more blunt in his criticism, observing that Sessions’ edict is contrary to the opinion of a “majority of Americans – including a majority of Republican voters – who want the federal government to stay out of the way,” and that today’s policy change “is perhaps one of the stupidest decisions the Attorney General has made.”

Congressional outrage aside, if anything can be read from the tea leaves of Sessions’ announcement, consider today’s statement from U.S. Attorney Bob Troyer regarding marijuana prosecutions in Colorado:

Today the Attorney General rescinded the Cole Memo on marijuana prosecutions, and directed that federal marijuana prosecution decisions be governed by the same principles that have long governed all of our prosecution decisions. The United States Attorney’s Office in Colorado has already been guided by these principles in marijuana prosecutions — focusing in particular on identifying and prosecuting those who create the greatest safety threats to our communities around the state. We will, consistent with the Attorney General’s latest guidance, continue to take this approach in all of our work with our law enforcement partners throughout Colorado.

Placing U.S. Attorney Troyer’s statement in context, while Sessions’ announcement may be shocking to many, it should not be construed to suggest that enforcement actions have not been taking place despite the Obama-era policy of lesser enforcement. In November 2014, the U.S. Attorney’s Office for the District of Alaska secured a conviction against an Alaskan resident for establishing a significant marijuana cultivation operation in his home. In May 2015, the U.S. Attorney’s Office for the District of Colorado secured a guilty plea against a Colorado resident for sending marijuana through the U.S. Mail. In November 2017, a labor union organizer was successfully prosecuted by the U.S. Attorney’s Office for the Northern District of California for money laundering of allegedly illegal drug proceeds through the banking system.

Moreover, while Sessions is clearly signaling that there is a new sheriff in town, he must rely upon his deputies to instill law and order throughout the land. These attorneys’ past prosecutions suggest that the Cole Memorandum’s enforcement priorities may still hold considerable sway going forward. Therefore, prudent marijuana businesses should keep these priorities in mind:

• Prevent the distribution of marijuana to minors;
• Prevent revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels;
• Prevent the diversion of marijuana from states where it is legal to other states;
• Prevent state authorized marijuana activity from being used as a cover or pretext for the trafficking of other illegal drugs or other illegal activity;
• Prevent violence and the use of firearms in the cultivation and distribution of marijuana;
• Prevent drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use;
• Prevent the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands; and
• Prevent marijuana possession or use on federal property.

While not established policy anymore, conduct in compliance with these (former) enforcement priorities, as well as all applicable state and local laws and regulations, may be less likely to attract the attention of the “sheriff” in your town.

Beginning on January 1, 2018, numerous California cities will begin issuing licenses for recreational marijuana businesses.  To help you better understand the application process for the City of San Francisco, we set forth the following update from San Francisco’s Office of Cannabis.  If you have any questions, please do not hesitate to contact the experienced attorneys at Wendel Rosen who can help you navigate the application process.

Non-MCD cannabis businesses operating in San Francisco must register by November 30, 2017, to be able to apply for 2018 permits.

Medical cannabis dispensaries (MCDs) with an Article 33 permit do not need to register now. But any cultivators, distributors and manufacturers who work with permitted MCDs must register.

Most cannabis businesses who miss the November 30 deadline will have to stop operating and wait until 2019 to apply again.

We know many cannabis businesses are changing right now. In most cases, business registering with the Office of Cannabis will have a chance to update business name, management structure and address after this initial registration period.

If you have already registered, pass this email on to other cannabis businesses. 

Help us spread the word. Ask your contacts in the industry to register by November 30, 2017.

Last week three California Agencies issued a series of regulations governing recreational canna-business which is scheduled to launch January 1, 2018. The most controversial aspect of the regulations is what they don’t include. They don’t include limits on the number of cultivation licenses one person or entity can own or control.

For years, many in the cannabis industry have feared that big tobacco (R.J. Reynolds), big pharma (G.W. Pharmaceuticals) or big agriculture (Monsanto, Archer Daniels Midland) would swoop in and take over the cannabis industry once it was legalized and reached sufficient scale to make it profitable. Last November, California voters approved Proposition 64, the Adult Use of Marijuana Act., which required the California Department of Food and Agriculture to issue cultivation licenses for various size grows: Small (Type 2 up to 10,000 square feet), Medium (Type 3 up to one acre) and Large (Type 5 more than an acre). But Proposition 64 explicitly stated that “No Type 5 … cultivation licenses may be issued before January 1, 2023.”  Senate Bill 94, includes the same size descriptions and limitations, precluding large grows of more than an acre per premises until January 2023.

Many saw the five year waiting period for large grows as a barrier to entry that would allow the smaller local farmers to get a foothold in the legal recreational market, while discouraging and/or delaying big tobacco/pharma/agriculture since they wouldn’t be able to buy up, or convert their existing hundred-acre farms into pot plantations.

But the local cannabis industry was also hoping the recently proposed regulations would include a second barrier to entry; limits on the number of cultivation licenses any one person or entity could hold. The regulations issued last week don’t include such limitations.

Absent such limitations, local canna-businesses are concerned that big tobacco/pharma/agriculture will apply for unlimited cultivation licenses, effectively preempting the local cannabis industry just as it gets started.

Note: This post was updated August 21, 2017 to reflect amendments to the bill.

Earlier this year, California Assemblyman Jim Cooper, D-Elk Grove, introduced AB 1700 which seeks to amend the Business and Professions Code.  The original intent of the bill was to increase the cannabis worker’s knowledge on basic environmental and safety precautions, and sexual harassment and discrimination protections.  The July 2017 draft of the bill focuses more on safety than sexual harassment and discrimination prevention training.  The bill applies to an applicant for a state license under California’s cannabis regulations. Assuming there is no collective bargaining agreement, the applicant must provide a statement that the applicant employs, or will employ within one year of receiving a license, an employee who has successfully completed a federal Occupational Safety and Health Administration (“OSHA”) 10-hour general industry course.

Overview

The bill first proposed a 30-hour Cal-OSHA course to address sexual harassment and discrimination prevention training to improve industry concerns uncovered by the national media and local press that revealed widespread “instances of sexual abuse and human trafficking in every aspect of the marijuana economic supply chain.” Simply stated, the goal of AB 1700 is to increase cannabis worker safety knowledge and compliance which legislators believe can be accomplished through a 10-hour federal OSHA general industry course.

One concern pertaining to this bill is that this one “trained employee” would have no responsibility to train others within the company. In addition, this person would not necessarily benefit from the majority of the safety training offered in the 10-hour course, unless he or she happens to work in certain sectors of cannabis manufacturing or distribution.

One of the policy recommendations is to make the bill more narrowly tailored to require more appropriate training to the exact nature of the employee’s responsibilities. Another recommendation is to expand the scope to either require some percentage of all licensee’s employees to take such a course or to require a supervisor-level course be taken by supervisors who are responsible for enforcing workplace conditions.

Other Laws Aimed to Prevent Harassment in the Workplace

Note that the current version of AB 1700 does not include any requirements specific to sexual harassment and discrimination prevention.  However, California law already requires employers in all industries to take affirmative, reasonable steps to prevent and correct discriminatory and harassing conduct. For example, AB 1825 requires a supervisor to provide at least 2 hours of training regarding sexual harassment once every two years. For more information regarding your obligations as a California employer, visit the Fair Employment and Housing Act’s(FEHA) website and download the DFEH-185 brochure on sexual harassment.

[This is a guest post by Evelin Y. Bailey.]

Employers in the medical marijuana industry have a right, like all California employers, to maintain a drug-free workplace. For example, Prop 64, which made it legal for individuals to use and grow marijuana for personal use, contains clear and specific language allowing California employers to develop or maintain drug-free workplace policies. Prop 64’s workplace policy provision applies whether or not the employee is using marijuana for medical or non-medical reasons. There is no legal requirement that an employer, including one in the cannabis industry, accommodate the use or possession of marijuana in the workplace.

California Law Does Not Protect Employee Use of Marijuana

Employees should be aware that despite the increased acceptance of medical marijuana, no law (including California’s Compassionate Use Act or Medical Cannabis Regulation and Safety Act) protects an employee’s use of medical marijuana when such use impacts work performance or violates the employer’s drug-free policies. The California Supreme Court has found that employers have legitimate interests in not employing persons who use illegal drugs because such use results in increased absenteeism from work, diminished productivity, greater health costs, and increased problems with respect to safety in the workplace. Under California law, an employer may require pre-employment drug tests and take illegal drug use into consideration in making employment decisions.

Drug Testing Policies

California’s constitution guarantees an individual’s right to privacy, which makes it challenging for employers to adopt drug-testing policies. Generally, an employer has no legal right to perform a drug test unless there is evidence that an employee may be working below par or endangering the safety of others because of substance abuse (i.e., legal or illegal drug use). The law requires a balance of an employee’s expectation of privacy against the employer’s business-motivated reason for wanting to know information about an employee. In California, drug testing is possible during the pre-employment (application) screening, as part of a physical exam, under reasonable suspicion, following an on-the-job accident or as part of a random test. In the cannabis industry, an employer may want to test trimmers and growers, depending on the type of equipment used, to ensure people in these positions are able to operate their equipment in a safe manner.

Alternatives to Drug Testing

Employers can adopt a policy for no use, possession or sale of drugs or alcohol at work or on the premises and may enforce that policy through disciplinary action up to and including termination. An employer also has the right to judge an employee’s fitness for duty and work performance. Whether the employee is unfit to work due to fatigue, illness, being under the influence of drugs or alcohol or some other reason, the employer has the right to determine whether that employee should work. The employee’s appearance, behavior, judgment, motor skills and responses may present observable signs about whether the employee is fit to work. An employer may also discipline employees based on work performance alone, such as when employees miss work, arrive to work late, perform poorly or display erratic behavior.

Protected Time Off to Participate in a Rehab Program

Note that under California law, an employer who has more than 25 employees must provide time off work to an employee for the purpose of entering and participating in an alcohol or drug rehabilitation program. The employer must also protect the employee’s privacy when it accommodates an employee’s leave of absence for the purpose of participating in the rehab program. An employer does not need to provide this time off with pay, except that an employee may use accrued paid sick leave.

It is recommended that employers consult a human resources professional or employment attorney when developing drug testing programs and drug-free policies.