Transfer pricing refers to determining the arm’s length price at which tangible goods, services, intangible goods (intellectual property) or loans are exchanged between entities within a multi-national and/or multi-jurisdictional entity. This practice is critical in the cannabis industry due to the complex legal and regulatory landscape surrounding the cultivation, manufacturing and sale of cannabis products. Cannabis businesses often operate in multiple jurisdictions with varying tax laws and regulations.
One of the primary challenges facing cannabis businesses is the lack of federal legalization in the United States. This has led to a patchwork of state-level regulations that can vary widely regarding taxes and compliance requirements. Transfer pricing allows cannabis businesses to navigate these regulatory hurdles by accurately categorizing costs related to cultivation, manufacturing, sale and strategic leadership business and valuing intercompany transactions to ensure compliance with state and local tax laws. The characterization of costs between the cost of goods sold (COGS) and operating expenses for cannabis businesses is crucial due to the distinct tax treatment as a result of Internal Revenue Code Section 280E, which 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 which is prohibited by Federal law or the law of any State in which such trade or business is conducted.” Quantifying the value of strategic leadership of cannabis founders and executives poses an added challenge in terms of finding comparable benchmarks since their expertise is so unique and the depth of their knowledge in driving the success of the cannabis business is extensive.
A management company that provides services to its various licensed entities correctly and appropriately documented in legal contracts for which the agreement executes the services is critical to differentiating a fact pattern from that in Alternative Health Care Associates v. Commissioner, 151 T.C. No. 13 UTSC. In Alternative Health Care, the Tax Court held that a management company whereby the employees were directly involved in providing medical marijuana to customers of a related licensed entity was found to be engaged in the trafficking of a controlled substance. We believe that particular executive and administrative services that do not directly “touch the plant,” priced at arm’s length, would not be reflected by the courts in the same manner as that held in Alternative Health Care. Transfer pricing that reflects current market rates along with precise cost allocations and categorization allows cannabis operators to ensure that profits (or losses) are appropriately allocated among different entities while minimizing tax liabilities depending upon the company’s structure.
Additionally, cannabis businesses often rely on strategic partnerships and joint ventures to operate across multiple jurisdictions without crossing State lines with cannabis-infused products. Transfer pricing can help ensure that these relationships are structured in a mutually beneficial and transparent way and that transactions between them are independent. The importance of transfer pricing in the cannabis industry is often overlooked or misunderstood, as many cannabis businesses are unaware of the potential tax implications of intercompany transactions, which can lead to unexpected liabilities and compliance issues.
Ultimately, transfer pricing is essential for cannabis businesses operating in complex legal and regulatory environments. By adequately valuing intercompany transactions and ensuring compliance with state and local tax laws, cannabis businesses can minimize tax liabilities and navigate the challenges of operating in multiple jurisdictions. Failure to implement effective transfer pricing strategies can result in significant financial and legal risks, making it a necessity for any cannabis business operating in today’s landscape.