Category: Hemp

Cannabis Taxation: Does IRC Section 280E Apply to Industrial Hemp?

Not always taxed like marijuana, in theory.

Short answer: It depends.

As we discussed last week, the US Court of Appeals for the 9th Circuit in Hemp Industries Assn. et.al., vs. U.S. Drug Enforcement Admin., upheld the Drug Enforcement Administration’s (DEA) broad rule creating a separate classification for “Marijuana Extracts.” Marijuana Extracts are broadly defined as “any extract containing one or more cannabinoids that has been derived from any plant of the genus Cannabis”. The ruling received an extraordinary amount of press, but lost in all of this breathless reportage was a very important point for a certain class of hemp businesses: The Court explicitly stated that the 2014 Farm Bill (“Farm Bill”) preempts the federal Controlled Substances Act (CSA). Accordingly, expenses incurred through an activity conducted strictly within the parameters of the Farm Bill arguably are not subject to IRC §280E.

Businesses that are operating outside the narrow parameters of Section 7606 of the Farm Bill, however, whether trading in hemp or any derivative product, will have to deal with IRC §280E. As a refresher, the Farm Bill allows a state to grow “Industrial Hemp” if it has implemented an official agricultural pilot program. These pilot programs, generally administered through state Departments of Agriculture, issue licenses or permits to businesses and individuals, allowing the cultivation of “Industrial Hemp.” That cultivar is defined as any part of the cannabis sativa plant with less than 0.3% THC on a dry weight basis. If a plant contains 0.3% or more THC on a dry weight basis, or is not cultivated by a pilot program licensee, the cultivator is operating outside of federal law and hence subject to IRC §280E.

So why is this such a big deal? As we explained previously, IRC §280E prohibits a deduction for any amount paid or incurred in carrying on any trade or business that consists of trafficking in a Schedule I or II controlled substance under the CSA. Accordingly, any industrial hemp business conducting the following activities is possibly subject to the horror of IRC §280E including:

  • Food and Body Care;
  • Textiles;
  • Building Material; and
  • Cannabinoids.

If IRC § 280E applies to a hemp business, that business will lose deductions otherwise available to almost every other US business. Clearly, IRC §280E puts these businesses at a competitive disadvantage. The disadvantage can be so severe as to be fatal in certain cases.

It’s important to note that although IRC 280E disallows expenses and credits paid for trade or businesses engaged in trafficking of marijuana listed as a Schedule I drug, this onerous code section does not apply to cost of goods sold. As such, a grower, farmer, cultivator, processor, or a manufacturer of hemp products may deduct any costs that are properly included in cost of goods sold. This rule is noncontroversial: In 2015, the IRS Chief Counsel issued a memorandum that clarified that a cannabis business may deduct these costs under IRC §471 and related regulations. Specifically, under IRC §471, costs included in cost of goods sold are those costs incident and necessary to production including:

  • Direct material costs;
  • Direct labor costs;
  • Utilities;
  • Maintenance;
  • Rent (real estate and equipment); and
  • Quality control.

Depending on your treatment for financial statement purposes, the following indirect costs may be included in cost of goods sold including:

  • Taxes necessary for production;
  • Depreciation;
  • Employee Benefits;
  • Factory administrative costs; and
  • Insurance.

On the other hand, a non-Farm Bill compliant hemp producer will lose under IRC §280E deductions related to sales, marketing and non-production related management costs.

In addition to creating headaches for non-Farm Bill compliant growers, the application of IRC §280E will have a detrimental impact on wholesalers and retailers of CBD products who also are not operating in full compliance with the Farm Bill. For these businesses, IRC §280E would operate to disallow a deduction for most overhead costs. This could have an especially severe impact on mixed retail businesses that sell CBD products in conjunction with other products.

Example: A pharmacy that sells products containing non-Farm Bill CBD as well as more traditional health products (e.g., shaving cream) may now be subject to IRC §280E. Unless the sale of non-CBD products can be considered a separate trade or business, it is possible that IRC §280E would operate to disallow the deduction of all operating expenses.

Finally, it is unclear if the IRS will apply IRC §280E retroactively to non-Farm Bill hemp businesses. The IRS could apply IRC §280E retroactively on audit or to years otherwise open. For example, the IRS could go back to tax year 2014 and adjust the income tax returns of certain taxpayers engaged in hemp manufacturing and sales of hemp products.

Under the new tax law effective January 1, 2018, Congress gave U.S. business several targeted tax benefits. For many businesses in the developing industrial hemp sector, the impact of IRC §280E reverses many of the benefits of the new tax law. Perhaps Congress can address some of these issues by passing the expansive Hemp Farming Act of 2018 which, as currently written, would explicitly remove Industrial Hemp and derivatives of that cannabis cultivar from the Controlled Substances Act. Better yet: repeal IRC §280E.

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Federal Court Denies Review of DEA’s Marijuana Extract Rule

The law on CBD is still a maze.

If you were hoping for some clarity as to the legality of industrial hemp and cannabidiol (CBD) derived from industrial hemp, I have some (mostly) bad news.

On Monday, the US Court of Appeals for the Ninth Circuit denied a lawsuit challenging the Drug Enforcement Administration’s (DEA) controversial Marihuana Extracts Rule. In Hemp Industries Assoc. v. DEA, the petitioners and other industry groups challenged the DEA’s rule creating a new drug code number for “”Marihuana Extracts” which is defined to include any extract “containing one or more cannabinoids that has been derived from any plant of the genus Cannabis.” This rule is so broadly drafted that it seems to prohibit extracts from parts of the cannabis plant that are legal or at least unregulated under federal law. Petitioners requested the Court clarify or strike down the DEA’s land-grab rule.

The Court denied both requests. Rather than diving into the substance of the petitioners’ complaint, the Court dismissed the action on largely procedural grounds, as we recently predicted it would. First, the court pointed to the fact that the petitioners failed to make an argument to the DEA while it was accepting comments on the Marihuana Extract Rule and are therefore barred from raising those issues before the Court. The petitioners claimed that another commenter raised their concerns by submitting a question as to whether the rule would cover “100% pure Cannabidiol by itself with nothing else?” But the Court determined the DEA considered this comment and altered the rule to clarify that it covered all cannabinoids. The Court also determined that several of the petitioners’ other arguments were waived for failure to raise the issue during the DEA’s notice and comment period.

The Court did determine that the petitioners’ argument that the Marihuana Extract Rule conflicted with 7606 of the 2014 US Farm Bill (the “Farm Bill”) was not waived, because Congress passed that law after the notice and comment period ended. The Farm Bill allows states to grow “Industrial Hemp” defined as having less than 0.3% THC on a dry weight basis in states that have implement agricultural pilot hemp programs. However, the Court determined that the argument failed on the merits. The Court found that the Farm Bill “contemplates potential conflict between the Controlled Substances Act [CSA] and preempts it. The Final Rule therefore, does not violate the [Farm Bill].” To the positive, the Court is stating that when the Industrial Hemp portions of the Farm Bill conflict with the CSA, the Farm Bill prevails.

This decision makes it clear that the Marihuana Extract Rule is unfortunately still valid, meaning that any products extracted from marijuana is still illegal under federal law, which has long been the case according to the DEA. The great unknown is how this ruling will be interpreted. It’s possible that the ruling could have a chilling effect on the growing CBD industry, by emboldening the DEA to actively pursue products that contain CBD. On this point, it’s important to note that Congress has limited the DEA’s ability to use federal funds “to prohibit the transportation, processing, sale, or use of industrial hemp” grown in accordance with the 2014 Farm Bill. However, it can be difficult to prove where a product containing CBD was derived and the DEA may try to push its boundaries in light of the decision. Therefore, it’s important that companies who are distributing CBD verify that it was derived from a legal source and are prepared to prove it.

State law enforcement agencies could also interpret this decision to crack down on CBD, especially in states that have not implemented Farm Bill hemp programs. These agencies are not limited by the budget provision that restricts the DEA enforcement activities. Although we have not heard any instances of state law enforcement cracking down on these sales, it is certainly possible that some will do so.

The Ninth Circuit could have used this as an opportunity to state explicitly that CBD derived from a legal source is also legal. Unfortunately, it did not. Because the Court did explicitly state that the Farm Bill preempts the CSA, though, the silver lining here is that Industrial Hemp, grown pursuant to the Farm Bill, is not illegal under the CSA according to the Ninth Circuit. In addition, shortly after the HIA filed its petition, the DEA made the following helpful clarifications:

  • The “marihuana extract” definition does not include materials or products excluded from the definition of marijuana set forth in the CSA.
  • The rule includes only those extracts that fall within the CSA definition of marijuana.
  • If a product consists solely of parts of the cannabis plant excluded from the CSA definition of marijuana, such product is not considered “marihuana” or a “marihuana extract.”

Consistent with the Court’s ruling, this appears to exempt extracts that are derived from lawfully grown Industrial Hemp. It also exempts extracts derived from portions of the cannabis plant that are not included in the CSA’s definition of “marihuana”, which include the mature stalks and seeds incapable of germination.

All in all, this convoluted mess of marijuana, hemp, and CBD law could soon become much clearer if Mitch McConnell’s Hemp Farming Act of 2018 is passed. Stay tuned for more information on the ongoing saga of legal hemp and its derivatives.

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Legal Hemp: Coming Soon Nationwide?

Are the glory days of hemp returning?

Senator Mitch McConnel (R-KY) recently introduced S.2667, a bill which would allow states and tribes to regulate hemp production. The proposed law is appropriately titled the “Hemp Farming Act of 2018” (the “Act”). As the Senate Majority Leader, McConnell is one of the most powerful politicians in Washington, so it goes without saying that this is a big deal. In addition, the Act is being fast-tracked through the Senate, bypassing the standard committee review process.

The Act is currently in draft form and the details are subject to change. As written, “hemp” would be defined as:

“the plant Cannabis sativa L. and any part of that plant, including the seeds thereof and all derivatives, extracts, cannabinoids, isomers, acids, salts, and salts of isomers, whether growing or not, with a delta-0 [THC] concentration of not more than 0.3 percent on a dry weight basis.”

This proposed definition is significant, because it specifically includes the term “extracts”, thereby undermining the DEA’s much-maligned “marihuana extract” rule, which broadly defines any extract from the cannabis plant as “marijuana” and not hemp. The proposed “hemp” definition also includes “cannabinoids” contained in hemp which could add much needed legal certainty to the already booming CBD market. The Act would also explicitly remove hemp from the Controlled Substances Act’s definition of marijuana.

The authority to regulate legal hemp would be placed in the U.S. Department of Agriculture. One major issue with the current federal “Industrial Hemp” program is that the 2014 Farm Bill, which established the program, does not name a federal agency to oversee it. Feel free to debate whether government regulations help or hurt an industry, but at least this bill provides some guidance as to who is responsible for the program.

Speaking of the 2014 Farm Bill, the Act would repeal and replace the “Industrial Hemp” section of that the 2014 Farm Bill one year after Act is passed into law. The 2014 Farm Bill allows states to enact pilot programs for hemp research making hemp legal within the state’s borders. Hemp cultivated in compliance with a State’s program is expressly legal under the Farm Bill. The Drug Enforcement Administration (DEA) and other federal agencies have issued a joint Statement of Principles claiming that the commercial sale and/or the interstate transfer of Industrial Hemp is outside the scope of the Farm Bill and therefore unlawful. However, Congress has limited the DEA’s ability to use federal funds “to prohibit the transportation, processing, sale, or use of industrial hemp” grown in accordance with the 2014 Farm Bill.

Ultimately, the Act would require that states and tribes submit a plan to the US Department of Agriculture in order to cultivate hemp. The plan must include details on how to track the land where hemp is produced, a procedure for testing the THC concentration in hemp, a procedure for disposing of products that are not in compliance, and procedures for enforcing the Act. The Act would also allow hemp researchers to apply for grants from the and make hemp farmers eligible for crop insurance.

McConnell introduced the Act in the Senate on April 12, 2018, and it was co-sponsored by Oregon senators Ron Wyden and Jeff Merkley. That same day saw Representatives James Comer of Kentucky introduce companion bill H.R. 5485 in the House of Representatives with and Rep. Jared Polis of Colorado co-sponsoring.

McConnell hails from Kentucky and it’s no surprise that lawmakers from Kentucky, Oregon, and Colorado would support hemp legalization. In 2014, we predicted Kentucky would lead the nation in industrial hemp as it was one of the first states to implement a hemp cultivation program under the 2014 Farm Bill. Kentucky was also one of the first states to legally obtain hemp seeds after it stepped up to fight the DEA in federal court in order to obtain those seeds. Since then, farmers in Kentucky have been happily producing hemp as a replacement for tobacco crops. McConnell and Kentucky Agriculture Commissioner Ryan Quarles highlighted Kentucky’s hemp program in announcing the Act:

McConnell: Hemp has played a foundational role in Kentucky’s agricultural heritage, and I believe that it can be an important part of our future. I am grateful to join our Agriculture Commissioner Ryan Quarles in this effort. He and his predecessor, Jamie Comer, have been real champions for the research and development of industrial hemp in the Commonwealth. The work of Commissioner Quarles here in Kentucky has become a nationwide example for the right way to cultivate hemp. I am proud to stand here with him today, because I believe that we are ready to take the next step and build upon the successes we’ve seen with Kentucky’s hemp pilot program.

Quarles: Here in Kentucky, we have built the best Industrial Hemp Research Pilot Program in the country and have established a model for how other states can do the same with buy-in from growers, processors, and law enforcement. I want to thank Leader McConnell for introducing this legislation which allows us to harness the economic viability of this crop and presents the best opportunity to put hemp on a path to commercialization.

In addition to Kentucky’s leadership on hemp, Oregon has reconfigured its hemp program and is a national bellwether in this space. Oregon hemp growers and handlers are able to sell their products to state-licensed marijuana businesses (as well as anyone else in the country). The merger of Oregon’s hemp and marijuana markets is unique and other states will likely follow suit, especially if the Act becomes law. Finally, Colorado has more acreage dedicated to hemp cultivation than any other state at present.

As mentioned above, it appears that McConnell is flexing his considerable political muscle to get this bill fast-tracked through Senate. McConnell is using procedural Rule 14 which allows a bill to skip over the committee process so that legislation may be brought up on the Senate floor. This doesn’t guarantee that the Hemp Farming Act will get a vote, but it does indicate that McConnell means business.

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Industrial Hemp: Oregon and Interstate Sales

So it goes with Oregon hemp.

In the past six to twelve months, we have seen an extraordinary increase in businesses and individuals interested in growing and processing industrial hemp. This is especially true in Oregon, where Department of Agriculture (ODA) grower and handler registrations are fast, cheap and easy to acquire. In many cases, these registrants are cultivating and processing hemp in order to create cannabidiol (CBD) based products. The products can be sold state-wide without limitation, including into the Oregon Liquor Control Commission (OLCC) adult use marijuana market via hemp-endorsed OLCC processors.

Other entrepreneurs, in Oregon and elsewhere, are extracting CBD for sale interstate. This is a legally nebulous area at the federal level, although interstate sales are not prohibited under Oregon law. With CBD isolate changing hands at upwards of $4,500 per kilo, however, and given the proliferation of CBD products making their way into big box retail, many businesses and individuals feel the risk is worth taking. Perhaps for this reason, we have been getting numerous weekly inquiries as to the viability of CBD sales interstate, especially as of late.

From a state rules perspective, Oregon has taken significant steps in the past several months in building out its industrial hemp regime. We wrote about the recent OLCC rules promulgated in December, which allowed for ODA hemp registrants to sell into the OLCC market; and more recently we wrote about House Bill 4089, which tied up a number of loose ends related to the tracking of those sales. The upshot of all of this is that we now have unprecedented interplay between the OLCC and ODA markets. And as the OLCC hustles to write rules implementing HB 4089, there is a fair bit of confusion about what is actually allowed.

One question that keeps coming up is whether an OLCC processor applicant may process ODA hemp (under both ODA and OLCC rules) while waiting to receive its license from OLCC. According to our reading of the rules, recently confirmed to us by OLCC, the answer is “yes.” Much in the way that marijuana growers used to attempt to “squeeze in” a medical marijuana crop pending their OLCC inspection and licensure, ODA hemp processors can float their operations by processing industrial hemp while in line with OLCC. Note that this is allowed even for ODA processors that are not seeking a hemp endorsement in their OLCC processor applications.

Of course, ODA, local fire marshals and other state or local actors may place limitations on hemp processing operations, or may require certain approvals. And just like with medical marijuana growers converting to OLCC production, OLCC may require that all hemp and hemp-derived items be removed from the processor’s premises as a condition of passing the necessary site inspection. If you think about it, this makes sense: Under OLCC rules, a licensed marijuana processor may not have hemp on its premises except if endorsed to receive that hemp via the OLCC Cannabis Tracking System (CTS) from an ODA grower or handler. Thus, pre-existing hemp items must be removed from the OLCC applicant’s premises prior to receiving the OLCC license.

Once licensed by OLCC with a hemp endorsement, the OLCC processor may receive hemp concentrates and extracts from ODA handlers, and the OLCC processor may receive raw hemp, hemp commodities and hemp products from ODA growers. Note that any form of hemp the OLCC processor receives from an ODA registrant must 1) come with clean ODA test results; and 2) be logged in CTS. Regarding the latter requirement, this means that no sale or transfer is allowed outside of OLCC channels, or to anyone other than OLCC wholesalers and retailers.

Finally, regarding ODA hemp processors–including those businesses waiting in the OLCC application queue–that’s another story. In keeping with the analysis above, those processors can sell their hemp products to anyone under Oregon law. When it comes to interstate sales and federal law, though, that’s a whole ‘nother question.

Happy 4/20.

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California Cannabis: Industrial Hemp Bill Moves Ahead

On Thursday, SB 1409, which proposes changes to California’s industrial hemp laws, was referred to committee. This piece of legislation proposes some much-needed updates to California’s industrial hemp laws. In our experience, states with adult use marijuana regulations, like California, tend to move more slowly building out their industrial hemp programs, which often come in as an afterthought. In that respect, SB 1409 is a welcome effort.

Currently, California law regulates the cultivation of industrial hemp, and specifies certain procedures and requirements on cultivators, not including an established agricultural research institution. Existing law defines “industrial hemp,” via the California Uniform Controlled Substances Act, as a fiber or oilseed crop, or both, that is limited to the non-psychoactive types of the plant Cannabis sativa L. and the seed produced from that plant.

Existing California law also requires that industrial hemp only be grown by those on the list of approved hemp seed cultivars. That list includes only hemp seed cultivars certified on or before January 1, 2013. Industrial hemp may only be grown as a densely planted fiber or oilseed crop, or both, in minimum acreages. Growers of industrial hemp and seed breeders must register with the county agricultural commissioner and pay a registration and/or renewal fee.

SB 1409 proposes to delete the exclusionary requirement that industrial hemp seed cultivars be certified on or before January 1, 2013. Additionally, “industrial hemp” would no longer be defined restrictively in the California Uniform Controlled Substances Act as a fiber or oilseed crop, and the bill would delete the requirement that industrial hemp be grown as a fiber or oilseed crop, or both. Presumably, this will allow cultivators to harvest hemp for CBD derivation, and related use.

SB 1409 would also authorize the state Department of Food and Agriculture to carry out, pursuant to the federal Agricultural Act of 2014, an agricultural pilot program for industrial hemp. Twinning a state-sanctioned pilot program with licensed, private cultivation is a model that has worked well in other states, like Colorado and Oregon. SB 1409 seems to have been well-researched in that sense.

To read more about the current state of industrial hemp under federal law, as well as what other states have done to regulate it, take a look at these posts:

We look forward to seeing whether California will take the lead, or at least take serious steps, toward regulating industrial hemp in a progressive way. SB 1409 was introduced only last month and seems to be moving along nicely. We will keep an eye on this bill, and keep you updated on any developments.

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Is CBD Legal? Hemp Industry Case Ruling Due Soon

As noted before in this blog, Hemp Industries Assoc. v. DEA, pending in the U.S. Court of Appeals for the Ninth Circuit, appeals the DEA’s final administrative rule creating a new drug code number for “marihuana [sic] extract,” defined as “containing one or more cannabinoids that has been derived from any plant of the genus Cannabis.” Petitioners, a cannabis industry trade group and other industry participants, argue that DEA’s rule effectively reschedules CBD as a Schedule 1 drug under the Controlled Substance Act (CSA), in violation of the Farm Act of 2014, which allows the states to set up pilot hemp programs. The DEA counters that this rule does not restrict substances that were not previously controlled, but simply adjusts DEA’s methods for tracking substances that Congress put in Schedule 1.

On February 15, 2018, a Ninth Circuit panel of three judges heard oral argument. You can watch the argument here. Because federal appellate courts never issue decisions at oral argument, we won’t know how the court decides for several months. But watching the argument gives some clues to how the judges are thinking about this case.

Before you watch, consider first that this case is a challenge to a rule made by the DEA, a federal administrative agency exercising rule-making power expressly delegated to it by Congress. Under established law, the court must defer to the DEA’s exercise of this power. The court may set aside DEA’s rule only if it is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law.” The court’s review is narrow: it must simply determine whether the DEA articulated a rational connection between the facts found and the choice made. As long as the DEA’s decision was “based on a consideration of relevant factors and there is no clear error of judgment,” the agency’s action is not arbitrary and capricious.

Second, consider that there are many administrative procedures that must be followed before a petitioner can even ask for review of an agency rule. All rulemaking is open to public comment by any interested party. If you fail to weigh in at the rulemaking procedure, you may not get to complain in court. Also, the petitioner has to show particular identified harm that it will suffer because of the rule.

Third, keep in mind that lower appellate courts such as the Ninth Circuit will often (though not always) try to decide a case on the narrowest grounds possible. This means that these judges may choose to decide on a technicality or procedural issue, rather than reaching the merits of the claim. That could very well happen here.

Keeping these points in mind, observe that the judges ask the lawyers: isn’t this rule just a change in the numbering system used by DEA made in order to facilitate record-keeping and reporting activities? Of course, the DEA lawyer agrees, while the cannabis industry lawyer strongly disagrees. Also notice that the judges continue to press the cannabis lawyer about whether evidence supporting harm claimed to be suffered is found “in the record.” This is an important point, because courts of appeal are not allowed to refer to facts that were not brought up in the original proceeding– in this case, the rulemaking process. Finally, there is no discussion about whether de-scheduling CBDs is a good or a bad policy. That is not an issue raised by this case, and the panel will almost certainly not address this in its opinion.

It is also worth reading a brief filed not by the parties to this case, but by several members of Congress who are appearing as amici, that is, friends of the court, Their brief supports the cannabis industry group, broadly arguing that DEA had no authority to issue its rule. The amicus brief also broadly urges that the Farm Act of 2014 allows states to effectively legalize CBD sales. Although many of the amici were among those who voted for the Farm Act, this brief is unlikely to sway the judges, who will likely say nothing about what the Farm Act does or doesn’t cover.

Check back in a few months, when we will discuss the opinion of the panel. My guess is that the opinion will narrowly decide the case, perhaps on procedural grounds, but that there will be no controlling ruling on scheduling of CBDs, keeping this area of law as confusing as ever. Stay tuned.

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Washington Marijuana: State May Allow CBD Additives

The Washington State House of Representatives is considering House Bill 2334, which would allow licensed marijuana producers and processors to use cannabidiol (CBD) from a source not licensed by the Washington State Liquor and Cannabis Board (LCB). The bill defines a “CBD product” as “any product containing or consisting of cannabidiol” and would permit the use of CBD products from unlicensed sources so long as the CBD product has a THC level of 0.3 percent or less on a dry weight basis and has been lab tested.

Washington’s regulated cannabis market is a closed loop that works on the principle that no marijuana comes in and none goes out. Everything sold in a licensed retail store is grown by licensed producer and processed into products like oils and edible by a licensed processor. If a licensee is caught bringing in marijuana from an outside source, the LCB will cancel the license.

HB 2234 would have the most impact on processors who could add CBD to products such as marijuana oils, candies, capsules, and other infused products. Though HB 2334 is still far from being law, processors in Washington have flirted with the idea of using unlicensed CBD to create products with higher CBD concentrations. Processors who choose to enrich products with unlicensed CBD do so at their own risk.

The legal basis for claiming that using CBD from cannabis outside of Washington’s regulated market is based on the idea that not all cannabis is in fact “marijuana” and that products containing CBD derived from “Industrial Hemp” or from portions of the cannabis plant that are excluded from the federal Controlled Substances Act’s (CSA) definition of “marijuana” are legal under federal law.

Section 7606 of the 2014 US Farm Bill (the Farm Bill) creates the framework for the legal the cultivation of “Industrial Hemp”, which is defined as cannabis with a THC concentration of less than 0.3% on a dry weight basis. The Farm Bill allows states to enact pilot programs for hemp research purposes. Washington has such a program, though it is underfunded. Hemp that is cultivated in compliance with a state’s pilot program is legal pursuant to the Farm Bill, although the sale of any products derived from this research is not explicitly allowed.

Last year, the state legislature required that the LCB study the viability of allowing processors to use hemp cultivated by licensed hemp farmers. See RCW 15.120.060. It’s also possible that a processor could use CBD derived from a hemp cultivator in another state that has implemented an Industrial Hemp program under the Farm Bill, but the Drug Enforcement Administration (DEA) has issued a Statement of Principle claiming that the interstate transfer of Industrial Hemp is outside the scope of the Farm Bill and therefore unlawful.

Processors may also claim that if CBD is derived from the mature stalks of the cannabis plant, it is not prohibited by the CSA. The CSA’s definition of marijuana “does not include the mature stalks of such plant, fiber produced from such stalks, oil or cake made from the seeds of such plant, any other compound, manufacture, salt, derivative, mixture, or preparation of such mature stalks (except the resin extracted therefrom), fiber, oil, or cake, or the sterilized seed of such plant which is incapable of germination.” 21 USC §802(16). In the early 2000’s, two cases out of the Ninth Circuit, Hemp Indus. Ass’n v. DEA, 357 F.3d 1012 (9th Cir. Cal. 2004) and Hemp Indus. Ass’n v. DEA, 333 F.3d 1082 (9th Cir. 2003) clarified that the DEA could not regulate hemp products merely because they contained trace amounts of THC. According to these rulings, some portions of the cannabis plant are explicitly outside the scope of the CSA. Thus, the court ruled that the DEA was not permitted to expand the scope of the CSA to encompass all parts the cannabis plant.

Because it was illegal to grow hemp in the United States until 2014, the Ninth Circuit decisions only applied to hemp imported from other countries. For CBD sourced from domestically grown hemp, today’s processors would need to know for certain from which part of the cannabis plant the CBD was derived to have a credible argument. If the CBD were sourced from any portion other than the mature stalks or seeds incapable of germination, then the product would be derived from marijuana and the processor could lose its license. There is also a question of whether a meaningful amount of CBD can even be extracted from mature stalks and seeds incapable of germination.

Processors who are using CBD additives do so at their own peril. Neither of the above legal theories provides much security as the licensee is counting on the fact that the LCB will accept this complex legal analysis and determine that the licensee is not using unlicensed cannabis. HB 2334 would provide some clarity and create a legitimate method to use unlicensed CBD. HB 2334 could also create an incentive for more farmers to participate in Washington’s fledgling hemp market. Finally, the bill would likely result in an increase in high-CBD products that some consumers–especially medical cannabis users–feel Washington’s market lacks.

For the bill to become law, it would have to pass the House, pass the Senate, and be signed by the Governor. It’s still too early to tell with HB 2334 will make it, but it’s worth keeping an eye on for now.

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Oregon Cannabis Laws: The 2018 Draft Bills Are Here

Just the facts on pending Oregon cannabis laws.

The Oregon legislative session began on Monday. Because 2018 is an even-numbered calendar year, this session is a short session, lasting just 35 days. That fact hasn’t stopped Oregon democrats from targeting ambitious policy objectives like cap-and-trade, along with a host of other items that will likely not get done. As to cannabis, there won’t be much movement, despite persistent rumors and calls for a limitation on license issuances, and the calls for an uptick in enforcement dollars.

Last year, Oregon kicked off the legislative session with 30 or so draft cannabis bills. This year, we have four. Two of them are likely to go nowhere and two may pass if things go well, but with significant modifications. The aptly named Joint Committee on Marijuana Regulation dissolved last session, which means that cannabis will get even less attention than before. Still, its former co-chair and Senate Majority Leader Ginny Burdick presides over the rules committee, and for that reason alone, we expect these bills get some play.

Below is the 2018 list, including links to each bill. As a reminder, text in bold typeface is proposed new language, and text in [italicized and bracketed] typeface is language that would be removed from existing statutes.

Senate Bill 1544

This bill would remove the 24-inch height limitation on immature plants produced for medical purposes. (Today, medical growers can theoretically have infinite starts.) It would also change the possession limit on immature marijuana plants for registered medical growers and for those responsible for medical grow sites. Finally, the bill proposes to exempt processors from testing requirements in the limited context of processing for a medical marijuana cardholder or that cardholder’s caregiver.

Will this bill pass? It’s possible, but if it does, it will probably look a lot different than it does today. SB 1544 is the “gut and stuff bill” we previously anticipated: it is rife for amending and may look different a few weeks from today. The changes related to medical starts are likely to stay, because this is something the feds are said to have noted as missing from the medical program. We may also see clean-up of language clarifying whether a person can be a designated grower for his or her own home grow under Oregon Health Authority (OHA) rules, and other minor issues. But the chance of consensus on multiple, high-impact issues is small.

Senate Bill 1555

This one has been moving along, with a few amendments already made. It will not impact Oregon cannabis industry players much, however, as it merely modifies the percentage allocation of marijuana tax revenues among various state beneficiaries. This one is an “emergency” bill, for what it’s worth, which means it would take effect immediately on passage.

House Bill 4110

This bill would allow the Oregon Liquor Control Commission (OLCC) to issue temporary “special events” licenses to qualified marijuana processors, producers, retailers and wholesalers. People have advocated for event licensing seemingly forever, but this is not an issue where consensus is easily gathered. For that reason, and because the session is so short, we give this bill a very low chance of going anywhere. If it surprises us, though, this one is also an emergency bill and would take effect immediately.

HB 4089

This is another emergency bill, but it relates to industrial hemp and not marijuana. It’s a big, multifaceted bill that was brought by the Oregon Industrial Hemp Farmers Association, and, like the recent OLCC rule amendments, it does a lot to shore up the state’s hemp program. As with SB 1544, we anticipated this bill a few weeks back. Here are the highlights:

  • Provides for OHA labs to test industrial hemp and related commodities;
  • Authorizes OLCC to enforce provisions of hemp laws that incorporate provisions of marijuana laws;
  • Changes the description of the limit on production and storage of homegrown cannabis plants;
  • Allows the Oregon Department of Agriculture (ODA) to adopt rules establishing higher average THC limits for industrial hemp if a higher average concentration limit is established by federal law;
  • Establishes a university pilot program to label and certify hemp seed; and
  • Establishes an Industrial Hemp Fund and appropriates money for administering hemp statutes.

For all it does, however, HB 4089 may be more notable for what it does not cover. Those items include:

  • A provision limiting the ability of hemp growers to sell high THC products;
  • A bill-of-lading, transport, or manifest requirement for ODA permittees similar to that for OLCC licensees; and
  • Tracking provisions related to the movement of hemp into OLCC channels.

We expect the legislature to look at these possible additions to HB 4089 and more, and we expect this bill to pass in some form. For now, though, it’s time to kick back and watch. We will report with a summary next month, at the end of the session.

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New Oregon Cannabis Rules: Part 4 – Industrial Hemp

In the three previous entires to this series (here, here, and here), we have discussed the major changes in the packet of rules amendments that the OLCC adopted at the end of 2017. Those changes cover promotional events, lender disclosures, and canopy size changes for marijuana grows. Today, we want to talk about the new rules for industrial hemp.

Industrial hemp regulation has been going through a series of rapid shifts since 2016, when the Oregon legislature adopted a two-tier system that allowed for the registration of industrial hemp growers (producers) and handlers (processors). At the time, only hemp handlers could sell industrial hemp products. This changed last year, when Governor Kate Brown signed into law SB 1015, which allows industrial hemp to enter into the recreational cannabis supply line.

Just before the new year, the OLCC adopted amendments to its administrative rules on cannabis that implemented SB 1015, providing much needed guidance on the new hemp regime. First and foremost, the term “industrial hemp” refers to any cannabis plants with a THC concentration below 0.3 percent, mirroring the definition under federal law. Hemp growers and handlers can apply to the OLCC for an industrial hemp certificate ($500 per year, plus a $250 application fee) to transfer hemp to recreational processors, and handlers can also receive a certificate to transfer their hemp concentrates and hemp extracts to recreational processors.

In turn, recreational processors can apply for a special “endorsement” that will allow them to accept hemp and hemp products from the handlers and growers, create hemp concentrates or extracts with a THC concentration below 5 percent, incorporate hemp concentrates or extracts into “marijuana items,” and sell those products to other OLCC processors, wholesalers, and retailers. OLCC retailers can then turn around and sell these hemp-based products to Oregon consumers.

None of this answers the question that we receive most often from industrial hemp producers: “Can I sell my industrial hemp products outside of Oregon?” It goes without saying that OLCC retailers must sell locally, so any hemp products transferred into the recreational supply chain can only be sold in Oregon. Hemp outside of the recreational chain is regulated by the Oregon Department of Agriculture (ODA). The ODA’s rules are surprisingly wide open when it comes to the sale of industrial hemp products. Under OAR 603-048-0100, a hemp handler can sell hemp products “to any person.” The ODA’s rules make no reference to whether that sale must occur in Oregon.

While interstate sales of hemp products may be legal in Oregon in certain circumstances, federal law on the issue is anything but clear. The DEA has taken the position that any concentrate or extract derived from the flower, leaves, or resin of any plant of the cannabis family, regardless of relative THC concentration, is a prohibited Schedule I drug. In contrast, the mature stalks of such a plant and fiber from such stalks, as well as oils or cake derived from hemp seeds or stalks are not included in the federal definition of marijuana, and are not subject to federal prohibition. There is currently a lawsuit pending before the Ninth Circuit Court of Appeals that challenges the DEA’s position, and we can hope that the court will provide a bit of guidance in this area. For now, we still advise our clients to keep their products in Oregon.

Note: Portions of this post were originally published in the Portland Mercury and are republished here with permission.

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CBD Beauty and Skincare Products in California’s Shifting Regulatory Landscape

CBD and skin care: it’s complicated.

As I read this week’s Forbes article titled, “Cannabis Could Be The Most Profitable Ingredient In Skincare, If The U.S. Government Allows It,” it felt like déjà vu. Legislators, law enforcement, lawyers, and cannabis business owners have been going in circles for years now trying to figure out how, exactly, CBD products fit within the current state and federal regulatory structure. But despite the potential legal ramifications of violating the Controlled Substances Act (CSA), CBD companies, particularly those manufacturing beauty and skincare products, are cropping up everywhere and expanding rapidly.

We wrote a few months ago about Target, which pulled a line of CBD products from its website after a BuzzFeed article calling out the sales. And even Forbes, which stated that “A Sephora executive who asked to remain anonymous confirmed the beauty giant has plans to launch at least one CBD-based skincare brand this year,” was unable to reach anyone at Sephora for comment. These large companies have legal counsel who are undoubtedly cautioning them against venturing into the realm of cannabis and CBD; such high-profile sales of CBD products would be an easy target for federal enforcement.

Because we’ve been getting so many inquiries on this topic in California and elsewhere from companies that are unsure whether or not they need a manufacturing license to make these products and a retail license to sell them, and because this is obviously still a hot topic in the media, we thought it would be a good time to revisit the Drug Enforcement Agency’s (“DEA”) stance on the subject, as well as the scenarios under which CBD products are arguably legal under federal law.

Currently, the DEA’s stance is that CBD as well as other cannabinoids derived from cannabis are Schedule I substances under the CSA, regardless of their source. In 2016, the DEA clarified that “marihuana extract,” which is an extract “containing one or more cannabinoids derived from any plant of the genus Cannabis,” is marijuana, and therefore a Schedule I controlled substance. The DEA’s use of the word “any” means that this interpretation applies to any derivative of the cannabis plant, including CBD and any of the other cannabinoids found in cannabis. This definition is extremely broad, and according to the DEA, makes derivatives of the cannabis plant that were formerly thought to be legal, illegal.

As we’ve discussed before, there are three scenarios in which cannabis extracts are arguably legal under federal law. The first scenario is when extracts are derived from the “mature stalk” of the cannabis plant, because the CSA’s definition of marijuana “does not include the mature stalks of such plant, fiber produced from such stalks, oil or cake made from the seeds of such plant, any other compound, manufacture, salt, derivative, mixture, or preparation of such mature stalks (except the resin extracted therefrom), fiber, oil, or cake, or the sterilized seed of such plant which is incapable of germination.” 21 USC §802(16). The DEA has clarified that the rule does not apply to portions of the plant specifically exempt from the CSA’s definition of marijuana, but there is debate as to whether products that contain any meaningful amount of CBD can be derived from the mature stalks.

Another scenario is when extracts are derived from an industrial hemp plant lawfully grown in compliance with Section 7606 of the 2014 US Farm Bill (“The Farm Bill”). The Farm Bill allows states to enact pilot programs for hemp research purposes. Hemp that is cultivated in compliance with a state’s pilot program is legal pursuant to the Farm Bill, although the sale of any products derived from this research is not explicitly allowed.

The third scenario is when products are derived from imported hemp. In the early 2000’s, two cases out of the Ninth Circuit, Hemp Indus. Ass’n v. DEA, 357 F.3d 1012 (9th Cir. Cal. 2004) and Hemp Indus. Ass’n v. DEA, 333 F.3d 1082 (9th Cir. 2003) clarified that the DEA could not regulate hemp products merely because they contained trace amounts of THC. This was because some portions of the cannabis plant are explicitly outside the scope of the CSA, and the DEA was not permitted to expand the scope of the CSA to encompass all parts the cannabis plant. At the time of the ruling, it was illegal to grow hemp so it only applied to hemp imported from outside the USA. Some now argue that the holding could apply to hemp grown pursuant to the Farm Bill although, as stated above, commercial sales of these products is not explicitly allowed.

The Hemp Industries Association has sued the DEA over the “marijuana extract” rule, and that case is still pending. Until it’s decided, we’re left with a legal quagmire of rules interpretations that leave businesses selling CBD products in a precarious legal position. And of course, if you’re hoping to sell to cannabis dispensaries in any regulated state, including California, you’ll have to be licensed by that state, and you’ll only be able to sell to other licensees. Given the recent shift in federal enforcement priorities, we wouldn’t be surprised to see an uptick in enforcement action against companies selling CBD skincare and beauty products, particularly in interstate commerce and outside the ambit of state regulatory systems. But that’s a legal and business risk that many are clearly still willing to take.

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New Oregon Cannabis Rules: Part One – Marijuana Promotional Events

Change is the only constant in cannabis regulation.

On December 22, the Oregon Liquor Control Commission (OLCC) adopted a large packet of rules amendments that incorporate the many cannabis bills signed by Oregon Governor Kate Brown this year, as well as “technical amendments [made] in response to market realities.” These changes, effective December 28, 2017, include:

  • implementation of mandatory seed-to-sale tracking for medical cannabis;
  • a new regulatory regime for hemp and hemp products that allows hemp products into Oregon’s recreational cannabis supply chain;
  • new rules governing Marijuana Promotional Events;
  • new canopy limits for growing immature plants outside of the standard canopy areas;
  • an exception to the retailers-must-be-1,000-ft-from-a-school rule if there is a physical or geographical barrier between the retail site and the school that prevents children from traveling to the retailer, such as a river;
  • new certifications for recreational wholesalers that can now trim cannabis, and can offer mobile for-hire trimming services;
  • some minor changes to transportation rules;
  • a small change to the definition of “financial interest” that will have a big impact on what investors must be pre-approved by the OLCC;
  • a new prohibition on sales through walk-up windows to complement the existing prohibition on drive-thru sales (Makes you wonder who came up with the work-around that led to this rule change); and
  • micro-tier producers can now do some processing of cannabis concentrates.

Because the changes cover quite a bit of ground, we’ll dig into several of these in more detail in future installments in this series. For now, we will focus on the new Marijuana Promotional Events, governed by OAR 845-025-1335. This new administrative rule allows recreational licensees to display their products at trade shows, which is something many of our clients have been eager to do for a while.

Under the new rules, trade shows or similar events will be organized by a single licensee or “Event Organizer”, that will be the primary contact with the OLCC. The Event Organizer must submit an application to the OLCC at least 28 days before the event that will include the names and signatures of any participating licensees, the amount and type of cannabis items that will be on display, and a control plan that explains how the participating licensees will prevent violations.

Assuming the OLCC approves an application, the participating licensees may bring and display marijuana and marijuana products from their inventory (sorry, no hemp). All of the marijuana must be returned to the licensee’s premises at the end of the event. Thus, these trade shows are not an opportunity to sell or otherwise distribute any cannabis products. Even samples are prohibited.

The ban on samples will probably dissuade some members of the public from attending, but that rule is no different than the ban on samples from licensed dispensaries generally. On the licensee side, trade shows may prove invaluable for smaller industry players hoping to distinguish themselves in a very competitive market. The other possibility, of course, is that licensees may find the regulations too strict, and decline to participate.

Check back soon for another dive into the new rules governing Oregon’s cannabis market. And Happy New Year!

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Oregon Cannabis: State of the State (Part Two)

Interesting times for Beaver State cannabis.

A little over a year ago, I put together a State of the State blog post on Oregon cannabis. At that time, the rules were rolling out in a business-friendly manner, many of our clients were proceeding toward licensure, and the market did not feel saturated. Today, the first two items remain true, but the Oregon market has become fuller and more competitive. Part of this has to do with the state’s lack of residency requirements, part has to do with how easy it is to acquire an Oregon marijuana license, and part is just standard free market dynamics. All of this has been a long time coming.

As of the Oregon Liquor Control Commission’s (OLCC) December 19 report, there were 877 licensed marijuana producers in Oregon, with nearly another 1,000 applications pending. Much of the massive Croptober harvest is drying out and finding its way to the market, and prices for outdoor cannabis seem to be falling fast: in some cases, flower is dropping below $400 per pound. It’s hard to know where bottom is. Program architects may not put the brakes on this anytime soon: the legislature won’t meet again until February (and may not take up the issue at all); and, in the interim, OLCC has no authority to cap the number of licenses awarded. Instead, the agency can only reduce canopy sizes (which it has no plans to do, according to our recent conversations).

Today’s market dynamics were somewhat predictable: given the state of the rules and Oregon’s unique accessibility, we predicted a lot of “triage, consolidation, litigation, guesswork, and general ups and downs” as far back as early 2016. Some of this was almost certainly by design: in the Cannabis Law & Policy class I teach we do a deep dive on markets, and we talk about the general desire for states to allow the price of state-sanctioned pot to stay low, so as to undercut the black market. The countervailing consideration, of course, is the state’s desire to create tax revenues. In an excise tax program like Oregon’s, those revenues are higher when prices hold up at retail.

All of this said, we still think Oregon is a great state for marijuana entrepreneurs, even as the market settles out. Here are three interesting trends we are seeing today:

Consolidation. The Oregon merger and acquisition market is in full swing for cannabis, and our well positioned clients are expanding by acquiring competitive and complementary businesses, up and down the supply chain. Other clients are selling, with the belief that prices are still reasonable, but may crater down the line. In the past week alone, we commenced five different purchase and sale transactions, and we don’t expect a lull in this type of activity any time soon. Interestingly, prices and valuation of these businesses are all over the board. For some basics on buying and selling Oregon pot businesses, see our series here:

Litigation. Unfortunately, when pot businesses fail, litigation sometimes follows. We have seen an uptick in Oregon pot litigation as of late, particularly partnership beefs and creditor actions. We do not expect the dispute dynamic to change anytime soon. For this reason, we have been staffing up with litigators in the Portland office, we and are even putting on a free litigation webinar next month to more fully discuss this topic. (Join us!)

Hemp? Lately, more and more of our clients have shown an interest in growing hemp under licensure by the Oregon Department of Agriculture. Some of these clients are pursuing hemp-derived cannabidiol (CBD) sales in interstate commerce, which the ODA program does not prohibit. Others are preparing to sell CBD into the OLCC stream of commerce, which is finally allowed under Senate Bill 1015 (new rules take effect next week). As to interstate CBD sales, federal law is a cluster, but that hasn’t stopped many big box retailers from trading in this area. Right now, a wave of Oregon cannabis growers are going there, too.

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