On November 30, 2018, The California Department of Tax and Fee Administration (“CDTFA”) adopted Emergency Regulation 3700, Cannabis Excise and Cultivation Taxes. Shortly before issuing these emergency regulations, the CDTFA released a Formal Issue Paper with an analysis critical to understanding the regulations. This post provides a high-level overview of these emergency tax regulations and what you need to know now about California’s cannabis tax regime.
Cannabis Cultivation Tax. The cannabis cultivation tax applies to all cannabis that enters California’s commercial market as follows:
- $9.25 per dry-weight ounce of cannabis flower;
- $2.75 per dry-weight ounce of cannabis leaves; and
- $1.29 per ounce of fresh cannabis plant.
Fresh cannabis plant is defined as flowers, leaves, and whole plants, that have been weighed within two hours of harvest without further processing. The emergency regulations address measurement issues in computing the cultivation tax. The CDTFA rejected the current industry standard that an ounce equals to 28.00 grams and instead calculates an ounce at 28.35 grams.
Cannabis distributors are to collect the cultivation tax when the cannabis enters the commercial market, which is when all testing and quality assurance has been performed. Beginning on January 1, 2018, the California Bureau of Cannabis Control will allow the sale of untested cannabis or cannabis product for a limited time. During this transition, the emergency regulations clarify that the distributor collects the cultivation tax when the cultivator sells or transfers cannabis or cannabis product to the distributor. With but a few exceptions, cannabis removed from a cultivator’s site is presumed to have been sold and is taxable.
Plant waste is not subject to the cultivation tax. The emergency regulations define the term “Plant Waste” by referencing Sections 40141 and 40191 of the California Public Resource Code. In general, plant waste is unusable cannabis mixed with other ground material such that the total mixture is at least fifty percent non-cannabis material by volume.Cannabis Excise Tax
The Cannabis Excise Tax is imposed on the retail purchase of all cannabis and cannabis products at 15% of the Average Market Price, which price is determined by first identifying whether the transaction was at arm’s length or not. An arm’s length transaction is a sale that reflects a fair market price between two informed and willing parties. For arm’s length transactions, the Average Market Price is the wholesale cost plus a markup determined by the CDTFA. The emergency regulations define wholesale cost as the amount paid by a retailer for cannabis and cannabis products including transportation costs. Discounts and trade allowances do not reduce the amount included in the wholesale cost.
Every six months, the CDTFA must determine the markup. Recently, the CDFTA has determined that the markup from January 1, 2018, to June 30, 2018, is 60%. The computation of the cannabis excise tax is illustrated in the following example:
Assume a retailer purchases cannabis from a Distributor at $200.00 per ounce and incurs $20 of transportation costs. In this case, the Average Market Price of an ounce of cannabis is $352.00 ($220.00 x 1.60) and a consumer who purchases a 1/4 ounce of cannabis will pay $13.20 ($352.00 x 1.15 x 1/4) in cannabis excise tax. The Average Market Price is used to compute the cannabis excise tax and may not be the ultimate retail sales price.
California allows a single business to engage in multiple commercial cannabis activities and a business that engages two or more licensed cannabis activities (e.g., as a distributor and a retailer), will not be deemed to have transferred cannabis at an Average Market Price. Instead, these transfers will be considered not to have been at arm’s length and the Average Market Price will be the retail sales price at which the retailer sells the cannabis. For example, if the retail sales price of cannabis is $200 per ounce a consumer who purchases a quarter ounce of cannabis at $200 will pay $7.50 in cannabis excise taxes ($200.00 x 15% x 1/4).
The emergency regulations clarify that a distributor must report and remit its tax payments to the CDTFA during the quarterly period in which the cannabis was sold or transferred to a retailer, not during the quarterly period when the retailer pays its taxes to the distributor. This may lead to accounting and cash flow issues since distributors must pay their taxes to the CDTFA before they receive cash reimbursement from their retailer buyers.
The emergency regulations also clarify that the penalty for nonpayment of tax is 50%. Take note that this 50% penalty takes effect if the tax payment is only one day late. The emergency regulations allow for a waiver of this penalty for “reasonable cause,” but never define what constitutes reasonable cause. According to CDTFA commentary, examples of reasonable cause include late payment of tax due to a lack of banking services, a limited number of facilities to accept cash payments, evolving industry regulations and the remoteness of some commercial cannabis operators.
California is clearly very serious about collecting tax revenues from cannabis businesses and the complexity of California’s new cannabis tax laws is going to make tax compliance a challenge for every participant in the California cannabis market.