Marijuana bond issuance clouded by federal status
The legal uncertainties surrounding the multibillion-dollar legal marijuana industry mean bonds backed by cannabis taxes are probably a long way off.
While 33 states have legalized marijuana, either for recreational or medical purposes, the federal government continues to classify it as an illegal Schedule 1 controlled substance on par with heroin.
Federally insured and regulated banks have refused to handle transactions from cannabis businesses, because the federal government still considers marijuana an illegal drug.
The legal conflicts between states and the federal government have left the industry without banking services, forcing marijuana businesses to operate on a cash system, making them targets for robberies and making it more difficult for governments to track taxable
No safe harbor
For a bond issue paid solely from marijuana taxes, Dee Wisor, National Association of Bond Lawyers president and attorney at Butler Snow in Denver, said a safe harbor banking bill might give more confidence to market participants.
He mentioned first-time farmer bonds and manufacturing facility bonds as two kinds of private activity bonds he could see as being backed by marijuana tax revenue. First-time farmer bonds, sometimes known as aggie bonds, are a type of public-private partnership used in some states to allow local lenders to earn tax-exempt interest while helping to finance a beginning farmer's purchase of land, equipment, and livestock.
“On the other hand, such a bond issue might be a tougher credit sell given the concentration risk,” Wisor said. “In Colorado, we have local governments selling bonds payable from the municipal sales tax, which inherently includes the sales tax on marijuana.”
Marijuana tax revenues are usually a small part of overall sales tax revenues. In 2017, Colorado’s government received about $247 million in revenues from marijuana taxes, licenses and fees, less than 1% of the state’s budget.
Tax practitioners will not be willing to do tax-exempt financing for marijuana businesses until it becomes legal on the federal level, Wisor said.
Wisor has yet to see a transaction that is exclusively reliant on marijuana tax revenues that would be used to pay back bondholders. However, in Colorado marijuana sales taxes are not isolated from other sales taxes and go into a general fund.
“The irony here is at some point, all of this money ends up in the banking system,” Wisor said. When the retail marijuana tax gets paid out, he said, it goes into the state’s general fund and eventually is deposited into a bank.
Tax revenues from marijuana dispensaries are embedded in revenues from sales, income and property taxes. Businesses that do business with marijuana cultivators or dispensaries such as utilities are also paying taxes to federal, state and local governments, Wisor said.
“So tax revenues at all levels of government include some amount that is derived directly or indirectly from marijuana businesses,” he said.
NAST weighs in
The disconnect between state and federal regulations is a “huge problem” because state legislatures are passing laws that conflict directly with federal law, said Utah State Treasurer David Damschen, who is president of the National Association of State Treasurers.
“It puts state treasurers into a horrible bind,” Damschen said.
NAST recently sent a letter to Congress encouraging lawmakers to pass some form of legislation that would create a safe harbor for banks to handle cannabis-related businesses where it’s legal under state law.
The group emphasized it was not necessarily taking a stance on the legalization of cannabis, but Damschen said the divergence between state and federal laws has now become a states' rights issue.
“We’re looking at a states’ rights as well as a public safety issue,” Damschen said. “It’s high time for Congress to act and create some form of safe harbor to allow the states to implement whatever they may have legalized into state law.”
Damschen doesn’t want the NAST resolution to infringe on states that have chosen not to legalize marijuana and said that the resolution doesn't endorse any specific legislation.
A couple of bills in Congress attempt to bridge the gap between federal and state law. But neither one has made it out of committee.
U.S. Senate Bill 2100 introduced by Oregon Democrat Sen. Jeff Merkley and Colorado Republican Cory Gardner would create a safe harbor for banks to work with the marijuana industry. U.S. Rep. Ed Perlmutter, D-Colo., introduced a companion bill in the House.
“We are expecting the legislation to arrive on the house floor in mid to late June,” said Dustin McDonald, vice president of government relations for Weedmaps, an online community for cannabis consumers and businesses. “We don’t expect any movement on the Senate side this year, where there is more opposition.”
The only way McDonald sees the banking issue being resolved is if Congress first works with President Trump and the Department of Justice to decriminalize marijuana.
He is more optimistic about legislation presidential hopeful Sen. Elizabeth Warren, D-Mass, and Sen. Cory Gardner, R-Colo., reintroduced in April called Strengthening the Tenth Amendment Through Entrusting States Act, or States Act. Reps. Earl Blumenauer, D-Ore., and David Joyce, R-Ohio, introduced it in the House. A similar bill was introduced in both chambers in 2018 but stalled.
States have also been trying to find their own solutions independent of the federal government.
Former treasurer John Chiang created a California task force that studied creating a state bank to serve the cannabis industry, but ended up advocating against such a move in January.
In Nevada, Gov. Steve Sisolak signed Assembly Bill 466 Thursday, legislation to create a closed-loop payment processing system similar to mobile payment systems like PayPal in a three-plus-year pilot program that would provide cannabis businesses with a safe place to store cash and pay state and local taxes.
Nevada’s first-year treasurer Zach Conine came up with the idea for the system while campaigning for treasurer. He then worked with Assemblywoman Daniele Monroe-Moreno on the legislation.
Conine’s office will now be in charge of meeting with vendors and crafting a request for proposal for a pilot program that would start in October.
“There is no cost to taxpayers,” Conine said. “The cost would be borne by the vendor and then going forward by the users of the system.”
The purpose of the system is to find a “solution to what we consider to be a serious threat to life and safety.”
He added that nothing would make him happier than seeing the problem solved at the federal level.
“We just can’t wait,” Conine said. “I have a responsibility to Nevada and Nevadans to solve this problem. It’s too dangerous of a situation to sit around and wait for the federal government. They have not got it done quickly and there is no reason to think they will get it done next week.”
Given there is no cost to taxpayers, if the federal government surprised everyone by adopting a safe harbor law quickly, the only thing that would be lost on the Nevada program is the time Conine and his staff put into working on the issue, he said.
If there were a safe banking harbor created at the federal level, it would enhance revenue collection certainty and transparency from states that legalized marijuana, Damschen said.
It could create more confidence for bonds backed by marijuana sales taxes where it’s legal for recreational use.
“Seeing a safe harbor created and seeing these transactions handled in the regulated financial system would be beneficial from a credit standpoint, from a revenue stabilization and a revenue transparency standpoint,” Damschen said.
It would also go a long way toward making cannabis a more stable revenue source, said Tim Schaefer, California deputy treasurer of finance.
“You can’t engage in normal commerce if you can’t pay employees with a check, and you can't borrow money to buy a Chevy pickup without a bank account,” Schaefer said. “If we want to bring people into the mainstream, we need to give them an alternative to walking around with a fistful of hundred dollar bills.”
The legal uncertainty means issuing bonds through a first-time farmer program or special tax-exempt financing could be a long way off, Schaefer said.
"Why would anyone loan money based on cannabis, when you don't even have a bank account to pay us on those dollars," Schaefer said. "The toothpick doesn't come out clean on that one."
If marijuana were legal on the federal level, two types of private activity bonds could be used, first-time farmer bonds and a manufacturing facility bond.
First Time Farmer Bonds are a special tax-exempt financing category for new farmers that provide an incentive to get into the agriculture business. The bonds can be used to buy farm equipment, land and other depreciable property.
Ryan Jardine and Matthias Edrich, both partners at law firm Kutak Rock in Denver, said that they have met prospective borrowers who are first-time farmers who want to grow hemp on agricultural land using tax-exempt bond financing, but issuers are reluctant to move forward.
“Hemp production may be a very big potential market here especially among young farmers,” Jardine said. “Uncertainty as to federal law relating to hemp production may be having a chilling effect on being able to help these farmers with tax-exempt financing.”
First-time farmer bonds also could be helpful for new farmers trying to get started in the marijuana farming business in Colorado under the right state and federal legislative framework, Jardine said.
Many banks are still hesitant to participate in transactions involving marijuana or hemp given the conflict between state and federal laws, and this hesitancy has caused practical problems such as finding financial institutions that are willing to hold bond deposits relating to marijuana or hemp production, Edrich said.
Farmers looking to grow marijuana products and use those first-time farmer bonds may just be out of luck.
The federal and political uncertainty have prevented use of the financing mechanism "even though maybe for state law purposes they might be valid issuances,” Edrich said.