By Rachel Gillette and James Mann
The Tax Court’s decision yesterday in Harborside Health v. Commissioner, 151 TC No. 11 (2018) [opinion here] is another loss for a cannabis sector taxpayer. The opinion eviscerates every single argument made by the taxpayer’s counsel, leaving open for a subsequent opinion only the question of whether the taxpayer owes accuracy-related penalties. In the decision, Judge Holmes endorses the reasoning in IRS Chief Counsel Advice Memorandum 201504011 (2015) regarding the interaction of Section 263A and Section 471 with respect to cannabis-related cost of goods sold (COGS) calculations. Simply put, Harborside reads Section 263A out of the Internal Revenue Code with respect to cannabis-touching businesses, holding that the Section 280E disallowance of deductions prevents any additions to the cost of goods sold under the uniform capitalization rules of more-recently enacted Section 263A.
Further, the opinion is entirely dismissive of taxpayer’s Sixteenth Amendment claims, pointing out that “Section 471 wasn’t found unconstitutional during the many decades when it was the only means of calculating COGS, and it wouldn’t be unconstitutional now if Congress repealed Section 263A.”
It is also worth noting that the Tax Court held that Harborside was a reseller, not a producer, and that producers are subject to a different set of regulations under Section 471 that allow additional expenses to be included in COGS.
In reviewing the briefs presented to the Tax Court in Harborside, it seems unfortunate that the taxpayer relied so heavily on constitutional claims that were summarily dismissed. The IRS was not forced to go beyond its position as set forth in Chief Counsel Advice Memorandum 201504011. Harborside is clearly an adverse precedent, but may not be the final word on the Section 263A question.