May 28, 2024
Rescheduling Reveals the Double Tax Advantage of Debt
The United States Department of Justice has formally moved to reclassify cannabis to a Schedule III substance,1 which would eliminate the punitive tax code 280E. This is expected to provide significant financial benefits for cannabis business operators by reducing the tax burden and allowing for debt cost deductions.
Currently, 280E imposes up to a ~65 percent tax on earnings before interest, taxes, depreciation, and amortization (EBITDA) as operating costs cannot be deducted. Once 280E is removed, the tax rate will drop to the standard corporate rate of 21 percent, and debt costs will become deductible.2
Elimination of 280E would stand to be a bellwether for investors and borrowers alike. For borrowers, it eases both the tax and interest cost burden, freeing up significant cash flow for potential growth. For investors, it is a win as the borrower is less burdened by a non-productive tax charge and a lowered (more productive) after tax interest charge, which essentially reduces overall risk to the company and provides more options for growth of the business.
USE CASE
We’ve put together a hypothetical company scenario to demonstrate the cost savings this move stands to deliver:
- Company Revenue: $100 million
- EBITDA: $25 million (25 percent margin)
- Debt: $75 million at 15 percent interest (three turns of EBITDA)
| Pre-280E | Post-280E | Difference | |
| EBITDA | $25 | $25 | |
| Taxes | $16.25 | $5.25 | |
| Interest | $11.25 | $8.36 | |
| EBDA | -$2.5 | $11.39 | $13.89 |
| Tax + Interest | $27.5 | $13.61 | $13.89 |
- True Cost of Debt: $8.36 million / $75 million = 11.15 percent
- Reduction of Cost of Capital: 11.15 / 15 = 74.3 percent
With 280E in place, starting with an EBITDA of $25 million and subtracting the tax bill of $16.25 million and the non-deductible interest cost of $11.25 million leaves a negative earnings before depreciation and amortization of -$2.5 million.
With 280E eliminated, the tax bill is smaller at $5.25 million, and the after-tax interest cost is $8.36 million, which allows for a positive $11.39 million in earnings before depreciation and amortization. The difference (savings) between pre- and post- 280E is $13.89 million. Pre-280E the tax and interest burden is 110 percent of EBITDA, and post-280E the effective interest and tax burden drops to 54 percent of EBITDA.
NEXT STEPS
There has been broad speculation that the cost of capital will decrease as a result of rescheduling. Many operators are missing the forest for the trees, thinking that result will come from an influx of capital available within the space. In reality, it is this demonstrated, substantial reduction in tax and true cost of debt that is much more likely to enhance cash flow and make debt more attractive to operators. As such, the reduced cost of capital would be much more immediate and direct. While the timing of this benefit is uncertain, its potential impact is clear.
“Who looks outside, dreams; who looks inside, awakes.” – Carl Jung
SOURCES
2 Congressional Research Service
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