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Managing a Cannabis Business Within a Heavily Regulated Industry

By Renata Serban .

U.S. cannabis companies are forced to deal with significant regulations. These regulations are fragmented and vary dramatically by state, which makes it hard for consumers and business owners to understand different state laws and how each state’s rules differ from federal laws.

Industries such as oil and gas, pharmaceutical, and banking have dealt with regulations for a long time. Other industries, like credit rating agencies, have seen increased regulations following the financial crisis in the early 2000s with the passage of the Sarbanes- Oxley Act in 2002.

Unlike those industries, the biggest challenge for cannabis companies is that cannabis business activities remain federally illegal. This results in onerous tax rules and a scarcity of traditional capital sources available to other industries.

Furthermore, cannabis businesses face regulatory scrutiny related to product packaging, lab testing, advertising, and insurance. All of these challenges lead to compliance difficulties and add to the cost of doing business, making it very difficult for start-up cannabis businesses to withstand competition from illicit markets and bigger competitors.

Federal Regulations

Drugs and other substances that are considered controlled substances are regulated by the federal government through a U.S. federal statute called the Controlled Substances Act (CSA). CSA places various substances in one of five schedules based on their medical use, potential for abuse, and safety or risk for dependence. Schedule I substances are considered the most dangerous and addictive and currently have no accepted medical use. The CSA classifies cannabis as a Schedule I drug, placing it in the same category as cocaine and heroin.

Because cannabis is considered a Schedule I drug, it is subject to section 280E of the IRS code, which states that businesses selling cannabis (or any other federally illegal controlled substance) cannot deduct any expenses incurred in the production, distribution, or sale of that product. This means that cannabis companies pay taxes based on gross profits and cannot deduct typical administrative expenses, such as bookkeeper or receptionist salaries.

Cannabis used to be a cash-only business, having no access to banking or other types of financial services. Fortunately, regional banks and credit unions are now filling the void left by large federally insured banks that are unwilling to provide banking services to cannabis operators. And more FDIC-insured banks are getting involved with legal cannabis and cannabis-related businesses, albeit very carefully.

There is hope for banking relief down the road with the proposed SAFE Banking Act (known as the Secure and Fair Enforcement Banking Act), which would allow U.S. depository banks and certain other financial institutions, such as federal and state credit unions, to service cannabis businesses in states that have legalized cannabis. Passed in the House of Representatives, the bill will also help alleviate lending obstacles to cannabis companies.

State Regulations

Because of its status as a Schedule I drug, cannabis is highly regulated even in states in which it is legal. But state-by-state regulations vary and can be confusing.

Packaging

Whether for recreational or medicinal use, each state has different packaging and labeling requirements. According to CannaCon, “the most restrictive states for cannabis packaging regulations are Alaska, California, Maryland, and Massachusetts. The least restrictive are Arizona, Delaware, Maine, New Jersey, Rhode Island, and Vermont.”

The basic requirement for cannabis products is to have child-resistant packaging, including having an unattractive appearance for children, a resealable feature, and informational label. Unlike alcohol or tobacco, cannabis products can be consumed in various forms, such as edibles, vaporizers, and beverages. These variations of cannabis products have their own unique packaging considerations. In many states, cannabis labels include specific strains of cannabis and cannabis symbols to let consumers know if the product contains THC and whether it is a medical or recreational product.

Lab Testing

Before any cannabis product can be packaged, it needs to be tested in a lab to make sure it is safe for consumption and to inform consumers of its potency.

Cannabis is a challenging product to analyze, with no standardized testing methods and varying rules in each state. For instance, California requires all cannabis products to be tested for cannabinoids, terpene contents, pesticides, and microbial impurities. On the other hand, pesticides are the only category of contaminant specified for testing in Delaware’s rules.

Furthermore, compounds vary in cannabis products. For instance, potency levels are different in flowers, edibles, and oils.

Advertising

State laws on cannabis advertising vary from ones that severely regulate cannabis marketing to ones that have no cannabis advertising restrictions. According to CannaMedia, Arizona, Maine, Minnesota, New Mexico, Rhode Island, and Vermont do not have regulations around cannabis advertising. The states with multiple regulations are Colorado, Connecticut, Massachusetts, New Jersey, New York, Oregon, and Washington. Common themes include bans on misleading information, specific parameters concerning building signage, marketing cannabis strains individually, and not appealing to minors (those who are under 21 years of age). Several states also require approval of all advertising by state officials before launch.

Insurance

Like any other business, cannabis companies need insurance. However, unlike other businesses, the federal illegality and emerging nature of the industry creates unique challenges for obtaining coverage. Deciding the insurance needed for a cannabis business is further complicated by the differences in the types of insurance mandated by states and local cannabis regulations.

For example, according to the National Cannabis Industry Association (NCIA), licensed commercial cannabis operators in Colorado are not required to obtain any cannabis specific insurance coverage, other than what is required for all types of businesses. This is in contrast to Massachusetts where licensed commercial cannabis operators must maintain general liability insurance coverage as well as product liability coverage, according to the NCIA.

For more information on how Citrin Cooperman’s Cannabis Advisory Services Practice can assist you with your cannabusiness, please reach out to Renata Serban at rserban@citrincooperman.com.

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