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For the past couple of years, the cannabis industry has faced significant challenges, with a bear market persisting. Plummeting flower prices, burdensome debt payments, and plateauing sales in mature markets have contributed to this situation.
There was hope that the industry’s fortunes would improve with the passage of banking legislation like the SAFE Act or significant developments such as TerrAscend’s approval to move to the Toronto Stock Exchange. Surprisingly, a potential solution could lie in something seemingly straightforward like 280e. As our friends at Green Market Report first pointed out, it is all about taxes, second place goes to banking and stock market listings!
However, in the complex world of cannabis, even addressing the issue of 280e is far from simple.
A Potential $700 Million Boost
Recent calculations by Viridian Capital Advisors have shed light on the significant impact that eliminating Section 280e could have on the cannabis industry. This impact could potentially outweigh the effects of the SAFE Act and a TSX uplisting. Section 280e, a provision in the Internal Revenue Code, restricts businesses from deducting ordinary expenses associated with the “trafficking” of Schedule I or II substances, as defined by the Controlled Substances Act.
Unlike most businesses that can benefit from tax deductions on various expenses, cannabis businesses face the burden of being excluded from these deductions. Viridian’s analysis focused on 13 major multi-state operators (MSOs), revealing that eliminating 280e would lead to positive free cash flow (FCF) for three companies that currently experience negative FCF. Additionally, the adjustment would more than double the FCF for the five companies on the graph’s right side.
In terms of financial impact, eliminating 280e could inject approximately $700 million into the 2023 FCF of the reviewed companies. These findings highlight the profound influence that addressing 280e could have on the financial landscape of the cannabis industry. By removing this hindrance, businesses would have more favourable conditions to thrive and allocate resources towards growth, innovation, and further market development. As stakeholders continue to advocate for change, the discussion around 280e amplifies, underscoring its potential significance in shaping the future trajectory of the cannabis industry.
Analysing the Numbers And Assessing the Impact
To evaluate the potential impact of eliminating Section 280e, Viridian Capital Advisors collected consensus estimates of 2023 cash flow from operations and CAPEX for the 13 companies under review. These figures were utilised to calculate free cash flow (FCF) after factoring in the impact of paying 280e taxes before considering any debt maturities. The analysis revealed that six of the 13 companies were projected to have negative FCF in 2023.
Subsequently, Viridian calculated an adjustment to eliminate the burden of 280e taxes. This adjustment involved determining the federal taxes imposed on each company based on the 2023 consensus gross profit while considering the taxes resulting from a tax imposed solely based on pretax profit.
The graph above illustrates the results of this analysis, with the orange bars indicating the adjustment made to eliminate the impact of 280e. In contrast, the green bars represent the FCF of each company after removing the burden of Section 280e.
These calculations visually represent the significant difference that eliminating 280e taxes can make for cannabis businesses. The adjustment holds the potential to transform negative FCF into positive figures and amplifies the FCF for companies already positioned favourably. These insights further emphasise the critical importance of addressing the issue of 280e and its potential to reshape the financial landscape of the cannabis industry.
Political Hurdles and Alternative Solutions
Eliminating a tax code provision like 280e should be straightforward. Congress could change the Internal Revenue Service (IRS) to rectify the issue.
While one potential solution to address the tax issue would be to reschedule cannabis to Schedule III of the Controlled Substances Act (CSA), thereby removing the burden of 280e taxes, this approach comes with its complexities. As highlighted in Viridian’s report, rescheduling to Schedule III or below introduces challenges such as the introduction of FDA oversight on a limited range of products and the continuation of state-level control over others. Drafting and approving the necessary regulations and achieving coordination among federal agencies in this regard could be time-consuming, potentially spanning several years.
In reflecting upon the current situation, Viridian aptly observed that unlike the rallying cry to eliminate “taxation without representation” during America’s independence in 1776, there is presently no such united call to address the issue of 280e. This further underscores the challenges faced in effecting change and underscores the need for continued advocacy and effort to navigate the complexities surrounding taxation and representation in the cannabis industry.
The Path to Resolving 280e
Addressing the complex issue of Section 280e in the cannabis industry requires careful navigation through various challenges and considerations. This provision, which prohibits businesses from deducting ordinary expenses associated with the “trafficking” of Schedule I or II substances, poses significant hurdles that must be overcome.
While eliminating or amending 280e may seem like a straightforward solution, the reality is that it involves intricate political and regulatory dynamics. Congress can enact changes to the Internal Revenue Code, but there is currently limited political motivation to pursue this route. The issue lacks the urgency and electoral impact that typically drives legislative action.
Alternatively, one potential resolution could be rescheduling cannabis to Schedule III or below within the Controlled Substances Act (CSA). This would effectively remove the tax burden imposed by 280e. However, such a rescheduling process is not without its challenges. It would necessitate careful consideration of issues like FDA oversight on specific cannabis products and the ongoing role of state-level regulations. Drafting and approving the necessary regulations and achieving coordination among federal agencies would be complex and time-consuming endeavours.
As stakeholders navigate these complexities, it becomes evident that a unified rallying cry, similar to the call for “taxation without representation” during America’s fight for independence, is currently absent. However, continued advocacy, education, and collaboration within the industry will be crucial in building momentum for change and finding viable solutions to address the burdensome impact of Section 280e.
Bottom Line
The potential impact of eliminating Section 280E in the cannabis industry cannot be underestimated. A recent analysis by Viridian Capital Advisors reveals that this step could have a more significant effect than other key developments such as the SAFE Act or TSX uplisting. With the potential to inject approximately $700 million into the 2023 free cash flow of reviewed companies, ending 280E holds the key to financial stability and growth for cannabis businesses. However, navigating the complex challenges and limited political motivation to address this issue requires continued advocacy and collaboration within the industry. By coming together and working towards change, there is a real opportunity to reshape the financial landscape of the cannabis industry, fostering a more equitable and prosperous future.
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