PKF O’Connor Davies builds cannabis practice
PKF O’Connor Davies, a Top 100 Firm based in New York, recently set up a practice niche focusing on the burgeoning cannabis industry as more states around the country legalize medical, and in some cases, recreational marijuana.
Noam Hirschberger, a Chartered Financial Analyst and Certified Valuation Analyst, is leading the practice area, which includes between 20 and 30 people at the firm who work at least part-time in that area. “My background is in valuation, so one of the first clients that I had referred to me was by a private equity group that specialized in the cannabis space,” he said. “This was a couple of years ago when I wasn’t sure if our accounting firm could even take on the client. But I learned a lot from them about some of the basics of the industry. It was exciting to see the progress year after year because I do valuations of these portfolio companies every year. These portfolio companies include cultivators and lifestyle brands, a lot of very diverse operations. From the first year to the second year, we just saw so much progress in the cannabis industry. It really was moving much quicker than anybody — even my clients — could have imagined, so I knew that we were onto a once in a lifetime opportunity.”
There are some challenges in the cannabis accounting area, especially the fact that marijuana remains illegal at the federal level, though it has been making inroads in many states, “Certainly, there are a lot of states where it’s legal in some form,” said Hirschberger. ”There are over 30 states where some form of cannabis use is legal. We were certainly cautious to make sure that all our clients are respecting their state laws. But I will say that it's not challenging for us to do work with firms in Chicago or California or Colorado.”
Many banks are also reluctant to deal with cannabis money, so businesses are often forced to deal in cash only. But Hirschberger said he hasn’t found that to be much of a problem because he is mostly working with private equity-backed clients who have plenty of funds on their own. “They have a lot of investors so they have funds,” he said. “Because our clients have tended to be more private equity backed or have a lot of capital, we have not had any issues with getting paid or getting paid in cash. We're dealing with very large multi-state operators, which are publicly traded in Canada. It's another source of capital, so they're really not having trouble paying for us.”
So far, he has roughly a dozen clients in the cannabis practice, but he anticipates that will increase soon. “Things build quickly,” said Hirschberger. “We officially launched this about four months ago, but we've been doing a lot of work in this space for the last two years. When we formalized our practice, I did a search. The first thing I wanted to do as the practice leader was to see how much work we are doing in this space, so I started reaching out to our tax people. I found that we were doing some tax planning and tax structuring there as well. And I found out that we are auditing some ancillary companies, as well as ancillary product companies, so we actually did have a practice from even before we went official.”
One of the problems for clients remains the IRS’s prohibition on taking tax deductions for business expenses related to marijuana, since it remains on the federal Drug Enforcement Administration’s Schedule I list of controlled substances. Section 280E of the tax code says that no tax deduction or credit is allowed for any amount paid or incurred if the trade or business consists of trafficking in controlled substances prohibited by federal or state law.
“We have a lot of clients that are looking to us for tax structuring, and there are ways to get around 280E or at least minimize the exposure,” said Hirschberger. “Because cannabis is considered a Schedule 1 substance by the DEA, that means it's subject to section 280E, which says that if you're a cannabis company or dealing in some kind of Schedule I substance, you cannot deduct your operating expenses. You can only deduct your costs of goods sold. So in theory, it is possible for a cannabis company to be paying more in taxes than they are actually making in profit.”
One way to help clients is with the accounting for cost of goods sold. “What's really beneficial for cannabis companies is they want to be able to justify putting as much as possible into their cost of goods sold so they can actually deduct it,” said Hirschberger. “The issue is the IRS hasn't really provided a lot of guidance, so we have to help our clients with arguments as to why certain items might get into cost of goods sold.”
However, the IRS hasn’t been providing much guidance on how to do that, leaving accountants and tax professionals who service cannabis clients on shaky ground. “It's a big mystery,” said Hirschberger. “I think everybody's concerned that because the IRS has really held their cards to their chest, we don't really know. For example, we have a client that does testing on cannabis products. They have machine equipment that will tell you how much THC is in it, and does it have a lot of pesticide. Are they considered a ‘plant-touching entity’ or are they subject to 280E? We don't really know. The IRS has not addressed something like that.”
Even though the IRS hasn’t been particularly helpful with guidance for cannabis businesses, he sees opportunities in Canada and other countries where the PKF accounting firm network operates. “One of the things that makes us different is that we have a strong network,” said Hirschberger. “A lot of these cannabis companies are going public in Canada, and you need an accounting firm that can sign off on compliance with the Canadian exchanges. We have a network that we work with — our Calgary member network — and we collaborate with them on those clients. I think that makes us different, with some of the publicly traded multi-state operators, and we have the ability and the capacity to be able to do that work.”
Overall he sees plenty of opportunity for accounting firms like PKF O’Connor Davies that work with cannabis industry clients. “I've never seen an industry like this,” said Hirschberger. “Every few weeks there's a big piece of news, and it's really critical for anybody who's working with an accountant or a lawyer that they make sure that they have somebody who is really following the industry and understanding the many nuances to this industry.”