CCT CET – Responsible Persons – we see a constant barrage of complaints about how oppressive the cannabis regulatory structure in California has been. Well, we work with that structure every day, and that includes regular contact with analysts and attorneys who are involved in both writing the regulations and attempting to implement them. We will pause for a moment to commend their efforts; most of them are working quite hard to make the system work.

 

Author – aBIZinaBOX Inc: Jordan S. Zoot, CPA

https://abizinaboxcannabis.com

 

Today we turn our focus to what we believe is a weak spot in the regulatory process. The weakness relates to the collection and remittance of Cannabis Excise Tax [“CET”] and Cannabis Cultivation Tax [“CCT”]. Before we dive into the problem, a bit of background is required.

When the Distributor role was created, the California Legislature decided to place the majority of the collection and remittance responsibility on it[1]. The Bureau of Cannabis Control [“BCC”] has further refined the Distributor[2] role.

The Distributor is the “choke” point in the supply chain. The California Dept. of Tax and Fee Administration [“CDTFA”] defines a Distributor as

“A cannabis distributor is a person who procures, sells, and/or transports cannabis between licensed cannabis businesses, such as a cultivator, manufacturer, or retailer. A microbusiness licensed to act as a distributor must comply with all the same requirements as a distributor”

CDTFA has defined the responsibilities for the Distributor role[3]. CDTFA has provided detailed guidance with respect to the collection of CCT which follows:

“As a cannabis distributor, excluding a transport-only distributor, you are responsible for collecting the cultivation tax from cultivators and manufacturers from whom you receive cannabis and/or cannabis products.

You must collect the cultivation tax from cultivators when the cannabis enters the commercial market based on weight and category of the cannabis. The flower category includes all dried flowers of the cannabis plant, whether trimmed or untrimmed. The leaves category includes all other parts of the cannabis plant other than flowers that are consumed or sold. The fresh cannabis plant category includes flowers, leaves, or a combination of adjoined flowers, leaves, stems, and stalk of the fresh cannabis plant that is weighed within two hours of being harvested, and the cannabis is invoiced as such. 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.

You must also collect the cultivation tax from manufacturers when cannabis product is sold or transferred to you for quality assurance review and testing. You will need to know information on the category and weight of the cannabis that was used to manufacture cannabis product to properly complete the cannabis tax return. The manufacturer will need to calculate the amount of cultivation tax associated to each individual product item or batch that is transferred or sold to you based on weight and category of the cannabis that was used to produce the cannabis product.

If the cannabis or cannabis product is sold or transferred to one or more manufacturer(s) prior to being sold or transferred to the distributor who arranges for testing and performs the quality assurance review, the cultivation tax must be collected based on the category and weight of the cannabis used to make cannabis product and passed to the next manufacturer who takes possession of the cannabis or cannabis product until the tax is remitted to the distributor who is responsible for remitting the tax to the CDTFA.

The distributor who performs the quality assurance review after the cannabis or cannabis product passes the required testing is the distributor who is responsible for remitting the cultivation tax to the CDTFA.

When collecting the cultivation tax, you must provide an invoice, receipt, or other similar document to the cultivator or manufacturer that includes and identifies the following:

  • Your name, as the licensee receiving the product.
  • The cultivator from which the product originates.
  • The associated unique identifier for the cannabis or cannabis product.
  • The amount of cultivation tax.
  • The date of sale or transfer.”

CDTFA then continues by describing CET and states

  • “As a cannabis distributor, you are responsible for collecting the cannabis excise tax from the cannabis retailers that you supply (sell and/or transport) with cannabis and/or cannabis products.
  • You must provide an invoice, receipt, or other similar document to the cannabis retailer that identifies:
  • The retailer’s name, as the licensee receiving the product.
  • Your name.
  • The associated unique identifier for the cannabis or cannabis product.
  • The amount of cannabis excise tax.
  • The date of sale or transfer.”

CDTFA continues with an explanation of the mechanics of reporting and paying cannabis taxes.

  • “As a distributor (or microbusiness operating as a distributor), you must report the cultivation tax and cannabis excise tax on your cannabis tax return and pay the amount due.
  • You must report the cultivation tax due for any cannabis or cannabis product that entered the commercial market during your reporting period and pay the amount due. You must separately report the total weight in ounces of medicinal and adult-use harvested cannabis that entered the commercial market by category (i.e. flowers, leaves, or fresh cannabis plant) on your cannabis tax return.
  • Additionally, you must report the cannabis excise tax due for any cannabis or cannabis products sold or transferred to a cannabis retailer during your reporting period and pay the amount due. This is required whether or not the retailer has already sold the cannabis or cannabis products, or whether or not you have collected full payment from the retailer. You must separately report the total average market price of medicinal and adult-use sales or transfers of cannabis to a retailer on your cannabis tax return.
  • The cannabis excise tax that you collected from retailers for the inventory the retailers purchased prior to January 1, 2018, and sold at retail on or after January 1, 2018, should be reported on your electronic cannabis tax return in the box available to report any excess excise tax collected and the amount due paid to the CDTFA. For these types of transactions, retailers will collect the excise tax from their customers based on the average market price. The average market price will not be available to you and it is not required to be stated on the invoice you provide to the retailer. For the specific invoice requirements related to these types of transactions.”

The preceding unequivocally imposes on Distributors responsibility for collecting CCT and CET from Retailers, Manufacturers, and Cultivators. A cannabis Distributor will quickly accumulate a substantial amount of money because CCT and CET will usually be 24%-30% of the amount at which a Distributor transfers a cannabis product to a Dispensary. This money is not the Distributor’s money. This money is money that is owed to the State of California that the Distributor collected from third-parties. The Distributor, as the holder of these funds, is a fiduciary for CDTFA. It is easy to see that CDTFA is vitally interested in being certain all CCT and CET collected by Distributors is timely remitted to CDTFA.

Employment Tax provisions as well as California Sales Tax statute recognize such critical points in tax collection. These other tax regimes address this issue by defining and imposing ultimate responsibility for tax collection and remission on “responsible persons.”[4] The adoption of a responsible person regulation relating to CET and CCT under the broad powers of CDTFA will create personal liability and establish the authority of CDTFA to pursue those individuals who failed to see that the funds were duly paid over. Pursuant to duly adopted regulations, CDTFA will have the ability to collect any funds wrongfully diverted by the individuals responsible for remitting funds owed to the State of California. Generally, such regulations include broad and draconian powers to pierce any legal entities and reach the personal assets of the responsible person[5].

Responsible person penalties and procedures will provide a very effective tool for encouraging the proper collection, reporting and remittance of CCT and CET. We were, shall we say ‘SHOCKED,” to learn that the statute which enacted CCT and CET did not provide for a similar provision. We are not certain CDTFA has sufficient authority to adopt “responsible officer” regulations without legislative action. However, we have a temporary solution that we will suggest before discussing the long-term solution that we believe requires legislative action. Given the potential magnitude of the CCT and CET that is not being remitted to CDTFA, we suggest Governor Gavin Newsom borrow from POTUS’ playbook and declare a California emergency in its cannabis industry and instruct CDTFA to publish “responsible person” emergency regulations comparable to those existing in California’s Sales tax regime pending the adoption of legislation. There are a number of reasons California’s revenue 2018 projections from its cannabis industry did not meet expectation. Slippage at the Distributor is one reason why.

As a long-term solution CDTFA should pursue the following course of action in order to protect both the agency and the individuals and business entities that are paying over CCT and CET to Distributors:

CDTFA needs to persuade the California Legislature to enact legislation that creates “responsible person” mechanism in the statute the governs CCT and CET. There is no reason for CDTFA not to have this powerful tool available to enforce the collection, reporting and remittance of CCT and CET by a Distributor [or any other cannabis business that collects the tax on behalf of CDTFA]. Such a tool should have been included in the legislation.

CDTFA should enact a regulation that creates a reporting mechanism which requires that:

  • The receipts issued by a Distributor that collects CCT or CET should be required to include a unique receipt number, the name, employer identification number, cannabis permit number from CDTFA, and license number of the Distributor as well as the description of cannabis product transferred, its unique identifier, and a specific separate statement of the amount of CCT or CET attributable to the cannabis product transferred in addition to all other information included in the invoice or receipt. In instances in which a Distributor fails to have secured from a cultivator a signed and dated acknowledgement by the cultivator that CCT has been paid by the cultivator, the distributor shall be deemed to have expressly assumed the CCT liability from the cultivator and the obligation to pay-over the CCT to CDTFA.
  • The quarterly Cannabis Tax Return should be modified to require that any taxpayer that claims to have paid CCT or CET declare under penalty of perjury that it has prepared and maintains a detailed schedule that identifies each unique receipt issued for CCT or CET tax paid, together with the name and Cannabis License Identification and cannabis agency license number for every payment for which filer claims credit. The taxpayer further must expressly represent that the detailed schedule has been reconciled to the total amount of credit for CCT and CET paid on the quarterly return.
  • The payors of CCT and CET should be required at the end of each year to complete a reporting form similar to the Federal Form 1098 that indicates the total amount of CCT and CET paid to each distributor during the year. The completed form should be provided both to the payees and CDTFA.

We have no doubt that someone is going to “bitch” about a tax professional that would make a suggestion that would increase the reporting burden and create personal liability for taxpayer in the cannabis industry. As to the reporting burden, a legalized and regulated cannabis industry was sold to the public based in part on the tax revenue such an industry would generate. Verifiable record-keeping and reporting is required in order to be certain these tax revenues are collected. With respect to personal liability for trust fund taxes exists in most tax regimes, employment taxes, Sales Tax, and other taxes, where taxes that are the property of a taxing agency are collected by a third-party as a trustee for the tax agency. Both the federal government and the State of California have “responsible person” laws that create personal liability for failure to collect and pay-over. Of significance, it is only those who have not properly collected, reported and paid-over who need be concerned.

In the case of the Distributors operating in California’s cannabis industry, the issue is acute because of the amount of CCT and CET a Distributor will collect in a short period of time.   This rapid accumulation of money, of course occurs because CCT and CET are a substantial portion of the value of the cannabis product that passes through the hands of a Distributor.

The procedures which we have suggested will go a long way towards protecting both CDTFA as well as the businesses that remit CCT and CET to distributors. We welcome comments for our readers.

 

[1] Division 10, Chapter 7, Section 26070(a)(2) states ““Distributor,” for the distribution of cannabis and cannabis products. A distributor licensee shall be bonded and insured at a minimum level established by the licensing authority”.

[2] § 5300. Distribution Activities A licensed distributor shall distribute only cannabis goods, cannabis accessories, and licensees’ branded merchandise or promotional materials.

 

  • 5301. Storage-Only Services
  • A distributor may provide storage services, including cannabis goods storage-only services that are unrelated to the quality assurance and laboratory testing processes, to a licensed Bureau of Cannabis Control to a cultivator, licensed manufacturer, licensed microbusiness, licensed retailer non-profit, or another licensed distributor.
  • A licensed distributor may provide storage services to other licensees for only cannabis goods packaged as they will be sold at retail, cannabis accessories, and licensees’ branded merchandise or promotional materials.
  • A licensed distributor shall ensure that each batch of cannabis goods that are stored for another licensee are stored in accordance with section 5302 of this division.
  • Notwithstanding subsection (b) of this section, a licensed distributor shall not store live plants, except for seeds, on the licensed premises.
  • 5303. Packaging, and Labeling, and Rolling

 

(a) A licensed distributor may package, re-package, label, and re-label cannabis, including pre-rolls, for retail sale. All packages of cannabis, including pre-rolls, shall comply with the following:

 

(1) Until January 1, 2020 all packages shall meet the following requirements:

 

  • The package shall protect the cannabis, including pre-rolls, from contamination and shall not expose the cannabis or pre-rolls to any harmful substance.
  • The package shall be tamper-evident.
  • If the package of cannabis or pre-rolls contains more than one serving, then the packaging shall be resealable.
  • The package shall not imitate any package used for goods that are typically marketed to children.

 

(2) Beginning January 1, 2020 all packages shall meet the requirements of subsection (a)(1) of this section and shall also meet the following requirements:

 

  • The package shall be child-resistant until the package is first opened. For purposes of this division, the following packages are considered child-resistant:
  • Any package that has been certified as child-resistant under the requirements of the Poison Prevention Packaging Act of 1970 Regulations (16 C.F.R. §1700.15(b)(1)) (Rev. July 1995), which is hereby incorporated by reference.
  • Plastic packaging that is at least 4 mils thick and heat-sealed without an easy-open tab, dimple, corner, or flap. (B) The package shall be labeled with the statement “This package is not child-resistant after opening.”

 

(3) Notwithstanding subsection (a)(1)-(a)(2) of this section, immature plants and seeds shall not be required to be packaged in child-resistant, tamper-evident, and resealable packaging.

 

(b) A licensed distributor shall not process cannabis, but may roll pre-rolls that consist exclusively of any combination of flower, shake, leaf, or kief. Pre-rolls shall be rolled prior to regulatory compliance testing.

 

(c) Licensed distributors may, label or re-label a package containing manufactured cannabis goods with the amount of cannabinoids and terpenoids based on regulatory compliance testing results.

 

  • 5307.2. Licensed Distributor to Licensed Distributor Transfers Cannabis goods, packaged as they will be sold at retail, that have undergone and passed regulatory compliance testing and have an accompanying certificate of analysis may be transferred to one or more licensed distributors. However, cannabis goods that have not been transported to retail within 12 months of the date on the certificate of analysis must be destroyed or retested by the licensed distributor in possession of the cannabis goods.
  • 5310. Records

 

In addition to the records required by section 5037 of this division, a licensed distributor shall maintain the following records:

  • Records relating to branding, packaging and labeling;
  • Inventory logs and records;
  • Transportation bills of lading and shipping manifests for completed transports and for cannabis goods in transit;
  • Vehicle and trailer ownership records;

 

(e) Quality-assurance records;

  • Records relating to destruction and disposal of cannabis goods;

(g) Laboratory-testing records

(h) Warehouse receipts; and

(i) Records relating to tax payments collected and paid under Sections 34011 and 34012 of the Revenue and Taxation Code sections 34011 and 34012.

 

[3]The responsibilities of a Distributor include

  • Registerwith the CDTFA for a seller’s permit, if you make sales of cannabis, cannabis products, or tangible personal property in California.
  • Register with the CDTFA for a cannabis tax permit (this is separate from your seller’s permit).
  • Collect the cannabis cultivation tax from cultivators and manufacturers from which you receive cannabis and/or cannabis products.
  • Collect the cannabis excise tax from cannabis retailers you supply (sell and/or transport) with cannabis and/or cannabis products.
  • Provide an invoice or receipt to the businesses from which you collect the cultivation tax and the cannabis excise tax.
  • Electronically file bothyour sales and use tax and cannabis tax returns and pay the amounts due to the CDTFA.

 

In addition, you must also:

  • Obtain a distributor license issued by the Bureau of Cannabis Controlwithin the California Department of Consumer Affairs.
  • Contact your city and/or county government office for information on local licenses you may be required to obtain.

 

[4] Regulation 1702.5. RESPONSIBLE PERSON LIABILITY.

Reference: Section 6829, Revenue and Taxation Code.

(a) GENERAL. Any responsible person who willfully fails to pay or to cause to be paid, under circumstances set forth below, any taxes due from a corporation, partnership, limited partnership, limited liability partnership, or limited liability company pursuant to Part 1, Division 2, of the Revenue and Taxation Code shall be personally liable for any unpaid taxes and interest and penalties on those taxes not so paid upon termination, dissolution, or abandonment of the business of the corporation, partnership, limited partnership, limited liability partnership, or limited liability company.

Personal liability shall only apply if the Board establishes that while the person was a responsible person, as defined in subdivision (b)(1), the corporation, partnership, limited partnership, limited liability partnership, or limited liability company:

  1. sold tangible personal property in the conduct of its business and collected sales tax reimbursement on the selling price (whether separately itemized or included in the selling price) and failed to remit such tax when due; or
  2. consumed tangible personal property and failed to pay the applicable tax to the seller or the Board; or
  3. issued a receipt for use tax and failed to report and pay the tax.

(b) DEFINITION OF TERMS.

(1) RESPONSIBLE PERSON. As used herein, the term “responsible person” means any officer, member, manager, employee, director, shareholder, partner, or other person having control or supervision of, or who is charged with the responsibility for, the filing of returns or the payment of tax or who has a duty to act for the corporation, partnership, limited partnership, limited liability partnership, or limited liability company in complying with any provision of the Sales and Use Tax Law. The fact that a person possesses any of the aforementioned titles, in and of itself, is not sufficient to establish that the person is a “responsible person.” The term “responsible person” does not include any person who would otherwise qualify but is serving in that capacity as an unpaid volunteer for a non-profit organization.

(2) WILLFULLY FAILS TO PAY OR TO CAUSE TO BE PAID. As used herein, the term “willfully fails to pay or to cause to be paid” means that the failure was the result of a voluntary, conscious and intentional course of action. A failure to pay or to cause to be paid may be willful even though such failure was not done with a bad purpose or motive. A person has willfully failed to pay the taxes, or to cause them to be paid, only when the Board establishes all of the following:

(A) On or after the date that the taxes came due, the responsible person had actual knowledge that the taxes were due, but not being paid.

(B) The responsible person had the authority to pay the taxes or to cause them to be paid (i) on the date that the taxes came due and (ii) when the responsible person had actual knowledge as defined in (A). A responsible person who was required to obtain approval from another person prior to paying the taxes at issue and was unable to act on his or her own in making the decision to pay the taxes does not have the authority to pay the taxes or to cause them to be paid.

(C) When the responsible person had actual knowledge as defined in (A), the responsible person had the ability to pay the taxes but chose not to do so.

(3) TERMINATION. As used herein, “termination” of the business of a corporation, partnership, limited partnership, limited liability partnership, or limited liability company includes discontinuance or cessation of all business activities for which the corporation, partnership, limited partnership, limited liability partnership, or limited liability company was required to hold a seller’s permit or certificate of registration for the collection of use tax.

(c) COLLECTION.

(1) Once the Board has established the requirements of personal liability in subdivision (a), and further defined in subdivision (b), the Board may issue a Notice of Determination, in the manner provided in Chapter 5 of the Sales and Use Tax Law, for the amount of the personal liability of the responsible person, and penalties and interest shall be added to the amount due as applicable. The Board may collect the amounts due from the responsible person in the manner provided by Chapter 6 of the Sales and Use Tax Law for the collection of sales and use taxes.

(2) On or after January 1, 2009, a Notice of Determination shall be mailed within whichever of the following periods expires earlier:

(A) Three years after the last day of the calendar month following the quarterly period in which the Board obtains actual knowledge, through its audit or compliance activities, or by written communication by the business or its representative, of the termination, dissolution, or abandonment of the business of the corporation, partnership, limited partnership, limited liability partnership, or limited liability company; or

(B) Eight years after the last day of the calendar month following the quarterly period in which the business of the corporation, partnership, limited partnership, limited liability partnership, or limited liability company was terminated, dissolved, or abandoned.

(3) If a business or its representative files a notice of termination, dissolution, or abandonment of its business with a state or local agency other than the Board, this filing shall not constitute actual knowledge by the Board under this regulation.

(d) BURDEN OF PROOF AND STANDARD OF PROOF. In order for a person to be personally liable, the Board has the burden to prove that the requirements of personal liability in subdivision (a), and further defined in subdivision (b), have been satisfied under the preponderance of the evidence standard of proof.

(e) PRESUMPTION. If the person is not an officer or a member or a partner or a manager with an ownership interest in the entity, the person is presumed to not be personally liable under subdivision (a), unless the Board rebuts this presumption with clear and convincing evidence.

History: Adopted February 22, 1996, effective February 8, 1997.

Amended September 17, 2008, effective January 2, 2009. Amendments in subdivision (a) and (b) clarify that a partner in a partnership, limited partnership, or limited liability partnership may have liability as a responsible person. Amendments in subdivision (c) incorporate a specific statute of limitations for issuing deficiency determinations to corporate officers or other responsible persons.

 

Amended August 30, 2016, effective April 1, 2017. Amended the first sentence of the second paragraph of subdivision (a) to add “only” after “shall” and added “as defined in subdivision (b)(1),” after “responsible person”. In subdivision (b)(1) added “The fact that a person possesses any of the aforementioned titles, in and of itself, is not sufficient to establish that the person is a ‘responsible person.’”. In subdivision (b)(2) replaced “Willful” with “Willfully Fails to Pay or to Cause to be Paid” in the heading; replaced “‘willful’” with “‘willfully fails to pay or to cause to be paid’” in the first sentence; added “that the failure was the result of a” after “means” and added “course of action” after “intentional” to the first sentence, and deleted “evil” from before “motive” in the second sentence; also added “A person has willfully failed to pay the taxes, or to cause them to be paid, only when the Board establishes all of the following:” to subdivision (b)(2). Added new subdivisions (b)(2)(A), (B), and (C); added “all” after “cessation of” and added “for which the corporation, partnership, limited partnership, limited liability partnership, or limited liability company was required to hold a seller’s permit or certificate of registration for the collection of use tax” after “activities” to subdivision (b)(3); added “Once the Board has established the requirements of personal liability in subdivision (a), and further defined in subdivision (b),” to the beginning of the first sentence of subdivision (c)(1); and added new subdivisions (d) and (e).

 

[5] There were a number of clarifications made to the responsible person regulation in 2017 which included

The definition of “responsible person” has been clarified. The definition now provides that simply because someone was an officer, member, manager, employee, director, shareholder or partner of a defunct business is not in and of itself proof that such a titleholder is responsible for the taxes.

The definition of “willfully fails to pay or to cause to be paid” has been clarified. The new law provides that this phrase is defined as a failure that was “the result of a voluntary, conscious and intentional course of action.” The amendment provides that the BOE must prove that the person being held responsible had “actual knowledge” that the taxes were due and had the responsibility to pay on the day the taxes became due. This person must also have the authority within the business to pay the taxes.

The BOE’s burden of proof has been clarified. The BOE must prove the elements set forth in the regulation by a preponderance of the evidence.

A rebuttable presumption of no personal liability will now apply if the person being held responsible is not an officer, member, partner or manager.