AUTHORED BY: JORDAN ZOOT
Accounting, Attest, Tax, Regulatory Compliance and Technology
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We have been receiving feedback from small cultivators that should be cause for concern when they sell product to some of the larger vertically integrated operators in California.
Specifically, the devil lurks in the details of the information contained on the receipts and other documents that a distributor or manufacturer provides to a cultivator. If the cultivator isn’t alert to what to look for, they can get screwed in a number of ways.
We have seen receipts where the only detail provided to the Cultivator is “we purchased X pounds of trim at $80/pound”. The concern starts with the Cannabis Cultivation Tax [“CCT”1].
The California Dept. of Tax and Fee Administration’s publication Tax Guide for Cannabis Businesses tells us:
“The cultivation tax applies to all harvested cannabis, medicinal or adult-use, that enters the commercial market. Cannabis ‘enters the commercial market’ when the cannabis or cannabis products, except for immature cannabis plants, clones and seeds, have completed and comply with both the quality assurance review and testing as required in the Medicinal and Adult-Use Cannabis Regulation and Safety Act. The cultivation tax also applies to cannabis transferred or sold to a distributor if the licensing agency allows cannabis or cannabis products to enter the commercial market without being tested. If the cannabis or cannabis product does not pass testing, cannot be remediated, and does not enter the commercial market, you are entitled to the return of the cultivation tax collected from you. The Distributor is responsible for returning to you the cultivation tax collected from you.”
Distributors are required to collect the cultivation tax from you, as the Cultivator, on all harvested cannabis based on weight and category of the cannabis that enters the commercial market.
If the first transfer or sale of unprocessed cannabis is to a manufacturer, and not a distributor, the manufacturer is required to collect the cultivation tax from you at the time of the first sale or transfer of the unprocessed cannabis based on the weight and category of the cannabis sold or transferred. The cultivation tax you pay to a manufacturer will be passed on to a distributor for payment to the CDTFA.
The cultivation tax is imposed on the cultivator. As a cannabis cultivator, you are responsible for the payment of the cultivation tax to your distributor or manufacturer. The tax is due on all harvested cannabis based on the weight and category of the cannabis that enters the commercial market.
No cannabis may be sold unless the cultivation tax has been paid.
You should obtain an invoice, receipt, or other similar document from the distributor or manufacturer that you pay the cultivation tax to. The invoice should identify:
The distributor or manufacturer’s name, as the licensee receiving the product.
Your name, as the cultivator.
The associated unique identifier for the cannabis.
The amount of cultivation tax.
- The date of sale or transfer.
“You are liable for the cultivation tax until it has been paid to the state or you are provided documentation that indicates that cultivation tax was paid, such as an invoice or receipt from a distributor or manufacturer.”
There is the trap…if the receipt that you receive from the Distributor or Manufacturer does not EXPRESSLY state an amount of CCT that you as the Cultivator are deemed to have paid, or the Distributor or Manufacturer doesn’t EXPRESSLY state that they assume the liability for the CCT, then CDTFA may seek to collect the CCT directly from the Cultivator.
Let’s take a moment to understand the financial consequences of the liability staying with the Cultivator. Let’s use our example of $80/lb. and assume that the Cultivator sells 15,000 lbs. of cannabis leaves for a total price of $1,200,000. The CCT for leaves is $44/lb.2 which means that the Cultivator owes CDTFA $660,000 for CCT plus the interest and penalties they add for failure to pay the tax.
In general, the law imposes a 10 percent penalty on taxpayers and feepayers for failure to timely pay the tax or fee due, or for filing a late return. In addition to these 10 percent penalties, the cannabis tax law imposes a mandatory 50 percent penalty for failure to pay the cultivation tax or cannabis excise tax due. Therefore, it is very important that you report and pay the cannabis taxes on or before the due date for each reporting period.
You may be relieved of the penalties assessed, including the 50 percent penalty, if the CDTFA finds that your failure to timely pay the tax was due to reasonable cause and circumstances beyond your control, and occurred notwithstanding the exercise of ordinary care and the absence of willful neglect.
Just to follow up on our example, if CDTFA were to assess the failure to pay penalty on the Cultivator in our example, the penalty would be fifty percent of the CCT or $330,000. The result being that out of the $1,200,000 proceeds of sale, the Cultivator’s taxes and penalties are $990,000 leaving them with $210,000 or 17.5% of the proceeds before consideration of any of the Cultivator’s costs of production
…which means IT IS IMPOSSIBLE TO EARN A PROFIT UNDER THE SCENARIO.
It is important to be mindful of CDTFA’s recordkeeping requirements which you can review here.
We can’t be any more emphatic about the need for cultivators, particularly small cultivators to carefully review the receipts and other documentation they receive when they sell to a distributor or manufacturer.
1 Effective January 1, 2018, a tax on cultivation of cannabis (including medicinal cannabis and adult-use cannabis) is imposed on cultivators at a rate of:
$9.25 per dry-weight ounce of cannabis flowers,
$2.75 per dry-weight ounce of cannabis leaves, and
$1.29 per ounce of fresh cannabis plant*.
The flower category includes all dried flowers of the cannabis plant, whether trimmed or untrimmed. The leaves category includes all other parts of the dried cannabis plant other than flowers that are consumed or sold. The fresh category includes flowers, leaves, or a combination of adjoined flowers, leaves, stems, and stalks of the unprocessed fresh cannabis plant that is invoiced as such.
*To qualify for the “fresh” plant category, the unprocessed cannabis must be weighed within two hours of harvesting.
Beginning January 1, 2020, the CDTFA is required to annually adjust the cultivation tax rates to account for inflation. A special notice will be mailed to cannabis businesses informing them of the rates. The cultivation tax rates will also be posted on the Special Taxes and Fees Rate Page, under Cannabis Taxes.
2 $2.75/ounce x 16 ounces/pound = $44/pound