A top Department of Health and Human Services official just made one of the most consequential federal announcements ever concerning cannabis prohibition. The agency formally recommended cannabis be moved from Schedule I of the Controlled Substances Act, a classification for drugs that have a high potential for abuse and no recognized medicinal value, to the much less restrictive Schedule III.
First off, we should recognize this is a truly historic announcement, marking the first time that a major government agency has recognized cannabis’ misclassification as a dangerous substance of abuse. The Schedule III decision was the result of a nearly yearlong investigation — one of the most comprehensive reviews ever conducted by the federal government on the issue.
In the near term, this likely will not have a major impact on the cannabis industry because the Drug Enforcement Agency now will have to conduct its own review and decide whether to follow the HHS recommendation. It also does not legalize marijuana. State-licensed cannabis businesses will still be operating in violation of federal law. But given this HHS review was called for by President Biden himself, it seems probable that cannabis will be moved to Schedule III sometime in the next year, quite possibly before the 2024 presidential election.
So, what does this mean for the cannabis industry in the long term? Much is still unknown, but one major and immediate impact, assuming the DEA follows HHS’ recommendation, will be Section 280e of the IRS tax code will no longer apply to cannabis businesses. The 280e provision treats state-licensed cannabis businesses as if they are drug traffickers under federal law and prohibits these businesses from claiming standard business deductions available to every other business in America. It has become arguably the single biggest financial drain on the cannabis industry.
But Section 280e only applies to Schedule I and II substances. Moving cannabis to Schedule III would eliminate one of its businesses’ largest hindrances to profitability. At a time of major price compression and increased competition, squeezing margins to the point where turning a profit is virtually impossible for most businesses, eliminating 280e would be arguably the single most impactful federal reform for the cannabis industry.
While rescheduling would not explicitly open up access to institutional banking and lending in cannabis, something Congress has attempted but failed to do through the SAFE Banking Act, the elimination of 280e may well lead to new sources of capital entering the space, particularly new lenders. First, moving cannabis to the less restrictive Schedule III is a clear signal to cautious investors that the federal government is easing its stance and the risk for them has lowered. While this likely won’t lead to the addition of large institutions like Bank of America
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More importantly, simply eliminating 280e should stir up new lending in a market where access is so difficult to come by. Most cannabis loans currently come with a 20% – 40% cost of capital, rates considered predatory and usurious in any other industry. One of the lenders’ biggest challenges today is that 280e saps most of the free cash flow out of cannabis businesses that is needed to service debt. Eliminating 280e will provide massive cash flow relief, allowing companies to take in debt for new projects and expansion that is not currently available. And with more lenders willing to loan to the cannabis industry, interest rates on those loans will likely fall as well, allowing more companies to take on much needed operating and expansion capital.
Rescheduling could potentially have additional benefits for publicly traded cannabis companies and their shareholders, who have seen these companies’ stock values plunge to one tenth of their value from a couple of years ago. Nearly all U.S. cannabis companies trade on the Canadian Securities Exchange, and trading volume there has slowed to a molasses-like crawl. CSE investors poured capital into these businesses in advance of two stock plunges, making them wary of redeploying more resources into these same companies.
But moving cannabis to a less restrictive schedule could entice a higher volume exchange, like the Toronto Stock Exchange, to take on U.S.-based cannabis companies. TSX’s current stance against accepting American cannabis businesses is not based on any specific law or regulation, but rather the exchange’s risk tolerance and internal policy of not listing companies that are illegal under federal law. With marijuana’s status becoming more lenient under federal law, it could prompt the TSX (or much less likely U.S.-based exchanges like the NASDAQ
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It is also possible this recommendation prompts Congress to take further action on the issue. Armed with the federal government’s top health agency’s recommendation, Congress now has more political cover to pass bills like SAFE Banking and possibly further comprehensive reform. After all, these bills have passed the House of Representatives multiple times and fell just short in the Senate’s last session. Boosted by HHS’ new stance on cannabis’ medicinal value and relative harm, congressional champions for reform may make new pushes to further remove related restrictions and penalties, both for businesses and consumers.
While there will be much speculation over the next year or so about exactly what rescheduling will look like and its real-world implications for the cannabis industry, it is clear HHS’ announcement is being welcomed by industry participants and advocates alike and takes the United States one step closer to a post-prohibition reality. That is truly something to celebrate.
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