Bloomberg Tax
Aug. 5, 2021, 7:00 AM

Cannabis Tax and Transfer Pricing—Part 2—Methods

James Mann
James Mann
Law Office of James B. Mann
David Merrick
David Merrick
Riverbank Consulting LLC

Following on from those basic definitional provisions in Part 1 is the list of acceptable methods. Practice in the area consists to a great extent of choosing the method that yields the optimal result (which in the present case is the one that optimizes capitalized costs) and defending why it is the right choice, in the case of preferred methods, or why it is the wrong choice, in the case of the not-preferred. The list of possibilities is as follows:

"(1) The services cost method, described in paragraph (b) of this section [Treas. Reg. 1.482-9];

(2) The comparable uncontrolled services price method, described in paragraph (c) of this section;

(3) The gross services margin method, described in paragraph (d) of this section;

(4) The cost of services plus method, described in paragraph (e) of this section;

(5) The comparable profits method, described in Section 1.482-5 and in paragraph (f) of this section;

(6) The profit split method, described in Section 1.482-6 and in paragraph (g) of this section; and

(7) Unspecified methods, described in paragraph (h) of this section.”

Services Cost Method

From a “280E optimization” perspective, the recovery of costs of the service provider is directionally positive to the extent that it converts potentially disallowed deductions into capitalized costs that are beyond the scope of disallowance. But given the focus on knowledge and advantageous circumstances, it would be better to see that the capitalization was capturing the premium value of the services rendered. In this regard, the services cost method does not capture any premium value.

Fortunately, Treas. Reg. 1.482-9(b) limits the availability of services cost method to “covered services.” The rule of paragraph (b)(5) makes it clear that a service cannot constitute a “covered service” if it involves “key competitive advantages, core capabilities, or fundamental risks of success or failure in one of more trades or business of the controlled group.”

The notion that serviceco management possesses special knowledge about an industry runs squarely into this rule of exclusion, so it follows that this method is not a correct method.

Comparable Uncontrolled Services Price Method

Because the cannabis industry is not widely served by established management consulting firms, there is not a great deal to draw on in terms of comparable uncontrolled transactions. This may evolve as time goes by, but at present the lack of data seems to present an insurmountable challenge to the application of this method.

In terms of tax code Section 280E optimization, comparable market transactions covering the same services are obviously the best indicator of value. But until the market value is more clearly established, this method is theoretically sound, but not really administrable in practice.

Gross Services Margin Method

As the drafters note at Treas. Reg. 1.482-9(d), “this method ordinarily is used in cases where a controlled taxpayer performs services or functions in connection with an uncontrolled transaction between a member of the controlled group and an uncontrolled taxpayer.” For a vertically integrated cannabis corporation, the only uncontrolled sales are typically at the consumer level. In the world of Section 280E, one would want to create as much space as possible between the management consultant and a specific retail sale as possible. As the examples reveal, this method fits particularly well in a commission agent context.

The serviceco in our fact pattern is emphatically not involved in selling the products.

Cost of Services Plus Method

From a practical perspective, the cost-plus method rules the world. Adding a 10% to 20% premium to the cost of service is as simple a solution as one could hope for. In many cases, a 10% to 20% mark-up on the cost of services does capture significant value. But the key question remains as to whether a greater rate of return is warranted based on the value of the particular services in question.

Treas. Reg. 1.482-9(e)(1) provides that the method “is ordinarily used in cases where the controlled service renderer provides the same or similar services to both controlled and uncontrolled parties.” This leads to the question of which servicecos in the industry provide services to any uncontrolled party, and in cannabis, they are not great in number.

The regulations continue to note that the method “is ordinarily not used in cases where the controlled services transaction involves a contingent-payment arrangement.” For those who think that cost-plus is not capturing the true premium value of the services rendered by the serviceco, having some contingent consideration for the services would seem like a prudent choice.

Comparable Profits Method

This is the first item on the list that takes the reader out of the services regulations, back to the generally applicable methods (Treas. Reg. 1.482-5). This is probably where the cannabis industry wants to be because the method is looking to “objective measures of profitability (profit level indicators) derived from uncontrolled taxpayers that engage in similar business activities under similar circumstances.” Although there are bound to be a number of points to debate, high-end consulting firms generate high rates of return, and choosing which high-end consulting firm one is most like is the kind of conversation that is likely to yield the optimal result.

Profit Split Method

Here again we are taken back to other generally applicable methods, in this case Treas. Reg. 1.482-6. This method involves the allocation of income to “routine contributions” of the controlled parties and then allocates the residual profits based on their respective “nonroutine contributions.” While we do not rule out the possibility that this method could apply in the cannabis industry, it depends on the value of the intangible property provided, for example, brand licensing and proprietary production methods. It therefore may be that analogizing the serviceco to various high-end consulting firms seems like a more productive path.

Unspecified Methods

These are not regularly encountered in practice. Given the relative novelty of the cannabis industry in the economy, it would probably not be wise to pursue relatively novel methods of transfer pricing. Thus, we think that the better choice would be stick to an analogy that is readily understood, like high-end consulting, and seek to breathe life into the analogy.


We believe that there is a strong case to be made that the services rendered by the serviceco in the typical cannabis firm are analogous to the services rendered by high-end consulting firms. Moreover, we believe that, in certain circumstances, a strong case can be made that the cost of consulting services should be a capitalized cost to the person bearing the expense. If both of these things are true, there is a significant opportunity for controlled groups to mitigate the adverse impact of 280E disallowance through a careful analysis of the way in which intercompany services are transfer priced.

This column doesn’t necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.

Author Information

David Merrick is Tax Advisor at Riverbank Consulting LLC. He has worked extensively with transfer pricing issues pertaining to services in the financial services and technology industries. In addition, he has represented clients in tax controversies involving intercompany transactions.

James B. Mann is the owner of the Law Office of James B. Mann. His current areas of focus are the taxation of cannabis enterprises and general tax accounting issues.

Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at

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