Industrial Hemp Companies:
Tax Incentive Analysis & Opportunities
Agriculture Improvement Act of 2018 ("2018 Farm Bill")
The Agriculture Improvement Act of 2018, Pub. L. 115-334, (the "2018 Farm Bill") was signed into federal law on Dec. 20, 2018. The 2018 Farm Bill amended the Controlled Substance Act (21 U.S.C. § 802(16)) to exclude "industrial hemp" from the statutory definition of marijuana (cited as "marihuana" within the U.S. code) as a Schedule I controlled substance. The 2018 Farm Bill also expanded the definition for ''industrial hemp'' (amending the Agricultural Act of 2014, H.R. 2642; Pub.L. 113–79, also known as the 2014 U.S. Farm Bill, definition of industrial hemp) to further distinguish hemp and marijuana under U.S. law.
In the Comprehensive Drug Abuse Prevention and Control Act of 1970, 21 U.S.C. §801–971 ("Controlled Substances Act"), Congress created a regime to curtail the unlawful manufacture, distribution, and abuse of dangerous drugs (“controlled substances”), which includes marijuana as a Schedule I controlled substance. Congress assigned each controlled substance to one of five lists (Schedule I through Schedule V). See §812 of the Controlled Substances Act; see also Title 21 Code of Federal Regulations (C.F.R.) §§ 1308.11 through 1308.15 for assignment of specified controlled substances (Schedule I through Schedule V).
21 U.S.C. § 802(16)(A) states the term "marihuana" means all parts of the plant Cannabis sativa L., whether growing or not; the seeds thereof; the resin extracted from any part of such plant; and every compound, manufacture, salt, derivative, mixture, or preparation of such plant, its seeds or resin as a Schedule I controlled substance.
However, the 2018 Farm Bill amended 21 U.S.C. § 802(16)(B) to now define "marihuana" does NOT include
(i) hemp, as defined in section 1639o of title 7; or
7 U.S.C § 1639o defines the term "hemp" 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-9 tetrahydrocannabinol (THC) concentration of not more than 0.3 percent on a dry weight basis.
(ii) 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.
Note, the 2018 Farm Bill, still preserved the FDA’s authority to regulate products containing cannabis or cannabis-derived compounds under the Food, Drug, and Cosmetic Act (FDCA) and § 351 of the Public Health Service Act (PHS Act). FDA treats products containing cannabis or cannabis-derived compounds subject to the same authorities and requirements as FDA-regulated products containing any other substance. This is still true regardless of whether the cannabis or cannabis-derived compounds are classified as industrial hemp under the 2018 Farm Bill.
IRC § 280E: Non-Deductible Expenditures and/or derived Tax Credits
In general, the U.S. tax code allows a business to deduct all of its “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” See IRC § 162(a). But it also has exceptions, one of which is IRC § 280E.
Historically, IRC § 280E of the Internal Revenue Code has put cannabis companies at a disadvantage relative to non-cannabis businesses, which can deduct their ordinary and necessary business expenses, and use tax credits. However, starting in tax year 2019, taxpayers may now be allowed to legally grow industrial hemp throughout the United States through the passing of the U.S. Farm Bill in 2018, and be eligible to claim various U.S. tax incentives prohibited under IRC § 280E.
At the federal level, IRC § 280E of the Internal Revenue Code was passed in 1982 to specifically prohibit the tax deduction of otherwise ordinary and necessary business expenses from the gross income associated with the trafficking of Schedule I or II controlled substances within the meaning of the Controlled Substances Act.
IRC § 280E states “no deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.” This prohibition for any deduction or credit under the U.S. codes includes incentives such as the federal R&D tax credit pursuant to IRC § 174 and IRC § 41, and potentially state applicable R&D tax credits, derived from the same federal R&D tax credit statutes.
However, pursuant to the 2018 Farm Bill as stated above, 21 U.S.C. § 802(16)(B) provides that cannabis plants and derivatives that contain no more than 0.3 percent THC on a dry weight basis are no longer controlled substances under federal law, and removes industrial hemp from Schedule I under the Controlled Substances Act, making it an ordinary agricultural commodity.
As such, cannabis plants and derivative companies meeting the definition of industrial hemp under 7 U.S.C § 1639o and other applicable regulations may be eligible to claim federal (and potentially state applicable) tax deductions and credits (see R&D Tax Credits, Industrial Hemp & Derivatives Industry) previously prohibited. Passage of the 2018 Farm Bill results in qualified hemp cultivators’ or its derivatives (i.e. hemp CBD) manufacturers’ no longer being subject to IRC § 280E beginning with the 2019 tax year.