Last month, the California Department of Tax and Fee Administration announced an increase in the cannabis excise tax. Starting January 1, 2020, the new markup rate will be 80%, an increase from the original markup of 60%.
This is a 33% increase that will hit most cannabis operators in the state hard. In an industry already burdened by high license fees and taxes, it’s not clear whether these high taxes will help or hurt the state.
One potential reason for the excise tax hike is that cannabis taxes haven’t generated as much revenue for California as expected. NPR reports that “California's cannabis excise tax generated only $74.2 million in the second quarter of 2019, the state says, announcing numbers that are short of projections that were set months ago.”
California’s cannabis market hasn’t seen the explosive success as recreational cannabis in other states. Nevertheless, industry experts project the state’s legal cannabis sales will grow to $7.2 billion in 2024.
There were a few other changes in the CDTFA policy announcement. Changes to Regulation 3700, Cannabis Excise and Cultivation Taxes, include:
- A definition of the California Cannabis Track-and-Trace system.
- Clarification on the definition of cannabis accessories, cannabis flowers, and fresh cannabis plant.
- Cultivation tax invoicing requirements and a clarification of the invoicing requirements when there are multiple licensees in a transaction.
- “The distributor that conducts the final quality assurance review on the cannabis or cannabis products is responsible for reporting and paying the cultivation tax to the CDTFA.”
- Clarification on what information cannabis retailers must include on their receipts to purchasers.
- Clarification on how a cannabis retailer or a distributor shall handle any excess cannabis excise tax collected from a purchaser.
- Clarification on when the cannabis excise tax shall be collected when there are multiple distributors involved in a transaction.
- “The distributor that supplies a retailer with cannabis or cannabis products is responsible for reporting and paying the cannabis excise tax to the CDTFA.”
Increasing excise tax by 30% will only cause more cash flow and tax issues for legal operators and allow the black market to flourish. Further, this tax increase will not stay only with the businesses, but many operators will try to offset the additional costs by passing it onto consumers in part or in whole, whether it’s legal to or not.
The increased mark up on the excise tax has many California cannabis operators wondering how to survive with such a heavy tax burden.
Many operators have messaged us asking:
“is it better to use a third-party distribution company to move product to our distribution company, then we move products to our retail outlets or use a third-party distribution company to take our products to our retailers directly?”
Let’s do a quick back of the envelope calculation to see how this all plays out.
Here’s an example of how this works in both instances:
In this first example, the CDTFA guidance reports that excise tax is now 15% of the retail price for a non-arm’s length transaction which will bring cannabis excise tax to $30.
In this instance, the CDTFA guidance reports that you must make an 80% mark up on the cost and then 15% tax on the marked-up cost which brings excise tax to $27.
From what you see above, the distribution to retail model offers a slightly lower tax rate than the distribution to our distribution to retail markup. Our cannabis tax experts recommend this supply chain model for tax purposes.
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