Back in September, we published a blog post titled “Where Can I Get a Distribution License in California.” Now that the ordinances for the majority of jurisdictions in California have been reviewed and somewhat solidified, Margolin and Lawrence presents an updated list on the viable locations for distribution licenses in California.
Update: This blog post does not apply to Los Angeles, as the distribution of free samples is non-compliant under the LA Ordinance 185344 Rules and Regulations for Cannabis Procedures, Regulation No. 10. Operational Requirements and Violations. Section D.
Since the pot-prohibition era has ended, there has been much ambiguity around the transition from an illegal market to one that is becoming strongly regulated. The cannabis tax rates for California were definitely met with much opposition, with both merchants and customers appalled by the exorbitant tariffs on California’s favorite vice (read more here).
California’s transition into a regulated market has many operators wondering what the universe of compliance looks like and where they fit into the process. In order to operate legally in California after January 1, 2018, you need both a local authorization and a state license. Temporary licenses from the state of California are sufficient to continue operating, though you will eventually need to obtain an Annual License. To date, 954 cannabis businesses in California have received Cease and Desist letters from the Bureau of Cannabis Control. While some were in error, others were operating without the required licenses for California.
It’s important to understand that licensure is not the end-all-be-all of compliance -- in fact, it is the minimum requirement for your business to operate legally. In addition to having a state license (which requires local authorization), you will need to begin thinking about how to set up your business with compliance processes that facilitate and enable adherence to state regulations for your activities: cannabis microbusiness, retail, manufacturing, cultivation or testing. The below infographic is an overview of the entire licensing/compliance process.
Where does your business fit in?
The City of San Francisco began its process of licensing retailers to sell adult-use cannabis on January 6, 2018. Any MCD (Medical Cannabis Dispensary) businesses that conducted delivery, cultivation, manufacturing, testing, or any other cannabis activity were required to register the activity with the Office of Cannabis between September 26, 2017 and November 30, 2017. Those that registered were then required to get their temporary permit(s) from the City. To continue each of these activities in 2018, temporary licensing must be obtained from the State. Any applicant who did not register as an existing business before November 30, 2017, must apply for a permit as a new cannabis business. The “Transition Provision” of City Ordinance 230-17 declares that existing MCD applicants temporarily permitted to sell cannabis starting January 1, 2018 cannot cultivate cannabis without new licensing as of April 1, 2018.
Beginning in 2018, all applicants must apply to the Equity Program (see eligibility requirements) either as individuals or incubators before applying for cannabis licensing. Since San Francisco was consistently targeted by the War on Drugs, the City is determined to make amends through this initiative, and compliance is mandatory for all cannabis businesses.
All new businesses require a license from the San Francisco Office of Cannabis and the State of California in order to sell cannabis in San Francisco. To be eligible for a temporary permit in the City of San Francisco, applicants must comply with the City’s zoning codes. These can be found on the SF City Planning website - check out the zoning for cannabis retail businesses. The Land Use Regulations for the City are have also been outlined in a table by the San Francisco Office of Cannabis, which provides useful zoning requirements for all retail and non-retail cannabis businesses (including cultivation, manufacturing and distribution). Mobile cannabis dispensaries will not be permitted in San Francisco.
At this time all cannabis licensing is temporary, subject to review by each municipal zone’s governing body and the State before permanent licensing can be applied for through the Office of Cannabis. According to Section 1605 of Article 16 in San Francisco City’s Ordinance 230-17 “Amending the Administrative, Business and Tax Regulations, Health, and Police Codes,” all cannabis businesses awarded a temporary license must apply for permanent licensing within 30 days of the date when the Office of Cannabis makes such permits available. Once permanent licensing becomes available, temporary licensing will no longer be offered to new businesses.
In summary, whether you are looking to start a business in cultivation, manufacturing, retail, distribution, a combination of the above (microbusiness), or testing, you will need to obtain temporary licensing from the City of San Francisco’s Office of Cannabis. The window for existing MCDs to register with the City has passed, but these businesses can still apply for new licensing along with all other new cannabis business applicants. The Office of Cannabis in San Francisco has not yet announced when permanent licensing will become available to businesses awarded temporary licenses by both the City and the State. More information about the application process and requirements can be found on the San Francisco Office of Cannabis website.
Last week, despite controversy, criticism from both sides of the aisle, and talk of a veto, President Trump agreed to sign the federal government’s omnibus spending bill for 2018. To the relief of many in the legal cannabis industry, the spending bill retains a provision known as the Rohrabacher-Blumenauer (or Rohrabacher-Farr) amendment, which provides limited protection from federal prosecution for state-level legal cannabis activity.
Given both Trump’s and Attorney General Jeff Sessions’ tough talk on drugs and threats to crack down on the cannabis industry, the continued presence of this amendment is a silver lining for those anxious about the future of legal cannabis. While this won’t mean a change in the federal treatment of marijuana – the amendment has been included in every spending bill since 2014 – it does indicate that the government intends to keep on its current course with regard to cannabis, as the provision has to be renewed every year to remain in effect.
Likewise, though the actual protections afforded by the Rohrabacher-Blumenauer amendment are limited, its being signed into law was, and remains, an important indication of the federal government’s shift in attitude regarding cannabis: as the LA Times reported following the provision’s first inclusion in the spending bill, “Congress for years had resisted calls to allow states to chart their own path on pot. The marijuana measure, which forbids the federal government from using any of its resources to impede state medical marijuana laws, was previously rejected half a dozen times.” In this light, the amendment was a notable pivot from a top-down to a state-level approach to cannabis regulation.
California cannabis consumers and business owners shouldn’t get too comfortable, though: not only does the amendment not change anything about the federal government’s cannabis policy in and of itself, its terms only apply to medical marijuana, not recreational cannabis. So far, the government has rejected proposed amendments that would grant recreational cannabis operations the same protection from federal intervention. For the time being, California cannabis business owners’ best bet is to stay in full compliance with state and local law as the federal situation develops.
Legalization has been a bumpy road for California cannabis operators, and since January 1, owners are learning that it also comes at a price. The state’s steep taxes on cannabis businesses – with effective tax rates as high as 57% for some cannabis activities – have many operators bracing, and calling for a reduction in these so-called sin taxes. Consumers are also encountering price increases -- prices are up about 15% compared to last year.
The state of California has officially begun to grant temporary licenses for cannabis distribution, pending applications and processing of full state licenses. Temporary licenses are “a conditional license that allows a business to engage in commercial cannabis activity for a period of 120 days.” They can only be granted to businesses which have already received their local licenses, and are intended to allow locally-licensed businesses to operate while waiting for their full state license to be reviewed.
When it comes to record-keeping, in particular, the requirements of temporarily-licensed cannabis distributors are different from those of annually-licensed ones. The reason for this difference is that the track-and-trace system which California will use to record the movements of cannabis products has yet to be fully implemented. While annual license holders will be required to use this system, based on the Franwell METRC software, to keep track of their inventory, CalCannabis states that temporary license holders must manually document their sales using “paper sales invoices or shipping manifests”.
For the temporary distribution licensee, then, keeping in compliance with state regulations is not only about following the operating requirements, but also about keeping track of a relatively complicated set of information for the sake of record-keeping. Distributors need:
- Local cannabis recordkeeping requirements (usually keeping business, inventory, & patient records for a several-year period)
- State cannabis record retention requirements (listed in California Code of Regulations, Title 16, Division 42, §5037) – financial, personnel, training, security, etc.
- The California Board of Equalization’s general record-keeping requirements for businesses (keeping track of the sales & use taxes, receipts, deductions, and purchase prices for 4 years).
- Paper sales invoices or shipping manifests for all sales
- A resale certificate for all sales intended for resale
If a distributor plans on reselling cannabis rather than just distributing it, they’ll need to make sure their seller’s permit is in order as well. For more information on resale certificates, check our recent post on the subject.
While all this paperwork may seem daunting at first, a licensed distribution operation should be more than qualified to handle it – and, once the California METRC system is implemented, keeping records of sales and inventory should be streamlined considerably.
As recreational “adult-use” cannabis is officially legalized across California, cannabis taxation is more important than ever for legal cannabis operators. Our Los Angeles Cannabis attorneys are often asked about the new state tax system and what is new since January 1, 2018. As of a few months ago, the BOE became the CDTFA. For California, there are three different state-level taxes on cannabis business: the Cultivation Tax, the Cannabis Excise Tax, and the Sales and Use Tax. The new state tax agency has released an educational series to explain the new tax regime. Cannabis manufacturers and distributors need to become familiar with the resale certificate. As its name implies, a resale certificate relates to the Sales and Use tax.
The Sales and Use Tax applies to sales of cannabis or cannabis products (flowers, plants, hash, bud, vape pens, edibles, oils, etc.) to consumers – in other words, the “final sale” of cannabis before the product is used/consumed. However, there are circumstances in the cannabis supply chain where these products are sold to a cannabis business for resale, rather than to a consumer. For instance, if a licensed distributor sells cannabis to a licensed retailer, they’re making a sale, but the purchaser doesn’t intend to use or consume the product themselves. In order to prevent the distributor from being liable for taxation on this type of sale, the retailer can give the distributor a resale certificate. If timely and valid, this certifies that the purchaser intends to resell the product and therefore exempts the distributor from the tax.
Without a resale certificate, both the seller and the purchaser are liable for Sales and Use Tax. In the example above, the distributor would need to pay it for their sale to the retailer, while the retailer would need to pay it for the sale they make to the final consumer. The same goes for other sales of cannabis between licensed cannabis businesses. For instance, when a cultivator sells cannabis flower to a manufacturer, the cultivator is liable for a Sales and Use Tax unless the manufacturer gives them a resale certificate for the purchase.
One important thing for distributors to keep in mind is the distinction between “transport” and “sale”. If one licensed cannabis business purchases cannabis products directly from another, e.g. a retailer buying flowers from a cultivator, the distributor who is contracted to transport the products from the cultivator’s operation to the retailer’s isn’t making a sale, and therefore doesn’t need to pay a Sales and Use Tax, regardless of whether they’re given a resale certificate.
Even if all their business’ sales are for resale and exempt from Sales and Use Tax, all cannabis operators are still responsible for filing a tax return and reporting their activities to the California Department of Tax and Fee Administration. Remember, a resale certificate only applies to the Sales and Use Tax, not the Cultivation or Excise taxes.
Many are excited about California’s new era of legalized marijuana. For the first time, state and local governments are allowing marijuana sales to all adults. There is also a new licensing system for all sectors of the industry. The new system creates many new opportunities for businesses and consumers. But is also comes with new taxes that have caused sticker shock for many California cannabis operators and customers visiting dispensaries this month. Governments are eager for the new tax revenues, although some predict that if taxes are too high, a black market will persist as people opt out of the licensed system. One of the questions our Los Angeles cannabis attorneys are most frequently asked is about the new cannabis taxes and how they will affect California cannabis businesses.
To sum it up, effective tax rates for marijuana operators are high. Not only do cannabis businesses have to pay corporate taxes like any other business (except that they can't take deductions on their federal taxes due to 280E), but there are also additional city and state taxes specifically for cannabis operators that need to be factored in as well. Just as Federal, State and Local law apply to cannabis operators, those governments all also apply their own taxes to cannabis.
Here is a chart that gives you an overview of the effective tax rates for different cannabis businesses, using Los Angeles as an example for factoring in local taxes as well:
NOTE that the Excise Tax (15%) and Sales Tax (8.5%) imposed on retailers is passed directly on to the consumer. So the effective tax rate is similar to the other activities when you factor that in, but overall the tax rates are very high for operators.
One of the reasons cannabis operators must pay so much in taxes is that cannabis is still a Schedule I controlled substance under Federal Law. Section 162 of the U.S. Tax Code allows for businesses to deduct Ordinary and Necessary expenses from their taxes. An exception to this section is 280E, which prevents deductions from Federal Taxes for businesses involved in selling Schedule I controlled substances. You can read the text of 280E here and check out a seminal 2007 Tax Court decision -- CHAMPS v. Commissioner (2007) which allowed an operating dispensary to separate out product-touching deductions and deductions for a separate ancillary business. A related 2015 ruling in U.S. Tax Court held that unlike CHAMPS, an operator running an activism business and selling cannabis could not separate the two businesses and take deductions under 280. These two cases apply to retailers. Other cases have found that cultivators and manufacturers can take certain deductions for costs of production. We will cover this in a future post.
Here are the individual maximum tax rates that apply:
|Federal Corporate Tax Rate***||California Cannabis Taxes||California Business Taxes 8.84%||Los Angeles Cannabis Taxes||Los Angeles Business Taxes (.425%)||Payroll Taxes (Estimated effective rate)||Estimated Effective Tax Rate|
|Retail||21%||23.5% -- 15% excise tax + 8.5% sales tax||8.84%||10% in LA for adult use; 5% in LA for medical||0.43%||3%****||57%|
|Cultivation*||21%||12% estimated ($9.25/ounce tax on flower = $148 per pound) + $0 sales tax||8.84%||2%||0.43%||3%||45%|
|Manufacturing||21%||Collect Cultivator Tax + $0 sales for resale||8.84%||2%||0.43%||3%||35%|
|Distribution||21%||Pay CDTFA Cultivator Tax + $0 sales for resale||8.84%||1%||0.43%||3%||35%|
|Testing||21% + Deductions = Estimated 15%||-||8.84%||1%||0.43%||3%||34%|
|Microbusiness||21%||per activity||8.84%||per activity||0.43%||3%||Varies per microbusiness activity|
|*(flower - different tax rates for stems and fresh plants; clones are not taxed by state)|
|**280E likely does not apply to testing labs|
|***280E prevents deductions for businesses trafficking cannabis|
|****Social Security, Medicare, Calif & Fed. Unemployment - this is a percentage of employees' salaries, for purposes of the chart it is converted to be tied to revenue consistent with the other percentages|
These are the required California state cannabis taxes by activity:
Cultivators must pay a $9.25/ounce tax on all dried cannabis flowers (and a lower rate per ounce for cannabis leaves or fresh cannabis plant).
Retailers must pay both a 15% excise tax on all their purchases of cannabis, as well as a sales tax on all their taxable retail sales, which varies by locality but can be close to 10%.
Manufacturers must collect cannabis cultivation taxes from cultivators from which they receive unprocessed cannabis, and pay these cultivation taxes to the distributors.
Distributors must collect cultivation taxes from cultivators and manufacturers from which they receive cannabis, and collect cannabis excise taxes from retailers they supply with cannabis.
In addition to these taxes, localities are free to impose their own cannabis business taxes, and many impose substantial taxes on both cultivation and all business proceeds.
It is important to note that the cannabis specific taxes are in addition to standard taxes like Federal and State corporate tax, and local business taxes for businesses operating in cities like Los Angeles.
While distributors, testing facilities and manufacturers appear to pay less taxes than cultivators or retailers, they will no doubt share the costs of taxation as cultivators increase their prices to account for the cultivation tax.
If these taxes are passed directly on to consumers, that could mean a retail outlet previously charging $60 per 1/8 of an ounce of marijuana would increase their price to $90. On the other hand, many have predicted that the pre-tax prices of cannabis will drop over time, as more large-scale cultivation, distribution, and retail operations reduce their overhead costs and margins, would could counteract some of the higher taxes.
For operators, these effective tax rates are extremely high and it is important to consult with a tax attorney and a qualified accountant who can help you with tax planning and preparation to set up your business for success. For more information and worksheets to calculate your California cannabis taxes, refer to the CDTFA’s website.