If you drive down any commercial district, you will see several colorful signs for “CBD”.  What once was considered a fringe business, the hemp industry is now experiencing explosive growth given the passage of the Farm Bill in 2018 and getting attention from private equity investors.  Some studies are showing that the CBD market could reach $20 billion by 2024.  With numbers like that, it is easy to see why so many investors are entering this market. 

During 2018 in Tennessee, 226 Industrial Hemp Grower’s Licenses were issued.  So far, more than 2,900 hemp grower licenses have been issued in 2019.  Elsewhere in the supply chain, Bluhen Botanicals in Knoxville received a $30.6M equity placement from SOL Global to expand its processing and retail operations.  

Investors need to understand some key elements of the hemp industry, that may differ from other types of investments.

Key Elements of the Hemp Industry

1. Section 280E does not apply to hemp or hemp derived products.

Under Section 280E, an illegal business is barred from taking tax deductions or credits.  Under current law, marijuana businesses are considered “Illegal”, and they are subject to Section 280E (but not hemp businesses).

Thus, it is vital that hemp and marijuana operations are not comingled.

2. Private Equity is filling the gap left by the banks.

Banks and credit card companies are hesitant to work with hemp businesses, even basic checking accounts and credit card processing.  Equity financing is the primary way most hemp businesses are being started.  Thus, the capital structure of hemp businesses will be much different than in other industries.

3. State Taxes

Hemp businesses, specifically internet based and retail focused firms, should be mindful of sales tax.  Under the Wayfair ruling, companies crossing sales and/or transaction thresholds may inadvertently trigger sales tax collection and reporting requirements.  A nexus study should be completed to understand thresholds that trigger sales tax issues to avoid any expensive compliance issues.

4. Information is key

The hemp industry is still emerging, and there is little standardized information as to pricing and demand.  Companies that can capture and interpret information from its customers and the market will have a competitive advantage.  Data firms like LBMC Data Insights can help setup systems to capture and interpret information related to hemp businesses to provide decision makers with better tools.

5. Take advantage of federal and state incentives

Hemp businesses are investing heavily in research and development.  These companies should be looking at what expenses qualify and tracking accordingly.   Specifically, hemp business should take advantage of the R&D tax credit for startups that can be used to offset payroll taxes.

The criteria for being considered a qualified small business are two-fold: (1) The company must have less than $5 million in gross receipts in the year the credit is claimed; and, (2) they must not have any gross receipts five years prior to the year they are claiming a credit.

Some hemp companies are in Opportunity Zones.  Each company should evaluate its operations to see if this is an area that would allow the business to qualify for this tax break.

Likewise, state and local incentives may be available and should be investigated.

6.  Expect more regulation

With the passage of the Farm Bill, the hemp-derived CBD market is now looking to the FDA for guidance on CBD’s status under the new law. The FDA issued a letter to the industry hours after the Farm Bill passed, and the expansion of the hemp-derived CBD market will hinge largely on how the FDA’s regulatory plan unfolds.

Additionally, as global expansion continues, look for international standards to become key barriers to entry and differentiating factors – GMP (Good Manufacturing Practices), GACP (Good Agricultural and Collection Practices, and GSP (Good Storage Practices).  These standards are expensive to implement.  Investors should consider these standards to determine if capex budgets are reasonable given the fast-changing environment.

LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.