California-based cannabis company Harborside Inc.  (CSE: HBOR), (OTCQX: HBORF) has been fighting the IRS over tax payments related to IRC Section 280E, which
prohibits businesses engaged in the trafficking of controlled substances (including cannabis as specified in Schedule I of the FCSA) from deducting normal business expenses associated with the sale of cannabis.

The company announced that the United States Tax Court ruled in favor of the Commissioner of Internal Revenue with respect to Docket Nos. 12313-15,12353-15, and 15714-18 to disallow all of SJW’s deductions pursuant to I.R.C. sec. 280E for all the years at issue.  Harborside said in a statement that the accrued liabilities in connection with its SJW dispensary will now be less than the provision previously set aside. The SJW refers to San Jose Wellness which had two pending tax court cases.

“Since our new Board of Directors was seated on November 24 ^th, we have committed to resolving all 280e disputes with the IRS and more importantly, the end of federal prohibition,” said Matt Hawkins, Chairman of Harborside. “I’m encouraged to report that our provision more than accounts for the potential liability with respect to the Cases. Harborside has developed a strong reputation for providing high-quality products and retail experiences to the California market and will continue to support the legal cannabis industry.”

In a company filing, Harborside had noted that on September 30, 2020, the reserve for that tax payments totaled approximately $38.2 million (December 31, 2019 – $36.5 million), which was comprised of the tax liability of approximately $26.7 million, a sum which includes the separate tax proceedings described below, and accrued interest of approximately $11.5 million (December 31, 2019 – approximately $9.8 million).

San Jose Wellness

The first case involves the 2010, 2011, and 2012 tax years, and in this case, the IRS has asserted a tax deficiency of $2,120,215. The second case involves the 2014 and 2015 tax years. The IRS has asserted in the second case that SJW owes an additional $2,259,528 in tax and penalties. Both of these proceedings involve substantially the same issues as the PMACC cases. The first SJW case has been stayed before the U.S. Tax Court, pending the outcome of the above-described tax cases involving PMACC. The second SJW case is proceeding without trial and briefs are being submitted. The Company expects that ultimately the SJW cases will also be controlled by the outcome of the PMACC Ninth Circuit appeal proceedings.

“The Company, after consulting with outside counsel, believes that only its subsidiaries that are either cannabis license holders or are otherwise plant-touching are subject to IRC Section 280E. However, there is a general risk that the IRS could attempt to apply Section 280E to other subsidiaries of the Company, in which instance the tax liability of the Company could be greater. While the Company would contest such efforts, the outcome of any such litigation is unpredictable.”

280 E Issues

The problem with cannabis businesses being unable to claim typical business deductions is that it affects a company’s profits. Many of the central issues relating to the interpretation of Section 280E remain unsettled, and there are critical tax accounting issues regarding the allocation of expenses to the cost of goods sold (thus avoiding disallowance as deductions under Section 280E). IFRIC 23 – Uncertainty over Income Tax Treatments (“IFRIC 23”) provides guidance that adds to the requirements in IAS 12 – Income Taxes (“IAS 12”) by specifying how to reflect the effects of uncertainty in accounting for income taxes. The Company evaluated these uncertain tax treatments, using a probability-weighted approach to assess the range of possible outcomes as required in its adoption of IFRIC 23 and, although it strongly disagrees with the positions taken by the IRS and the findings of the Tax Court, the Company has determined that a reserve for an uncertain tax position should be recorded for all years subject to statutory review.