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How Cultivators and Manufacturers Can Protect Themselves When Distributors Refuse to Pay California Cannabis Taxes

by Omar Figueroa

December 6, 2021

Quote from Benjamin Franklin, showing a skull to the right of the words: "In this world, nothing can be said to be certain except Death and Taxes."

Recently, Michael “Mikey” Steinmetz, owner of numerous licensed cannabis companies as well as the Flow Kana trademarks, wrote a piece on Medium after the state announced both a $31 billion budget surplus and an increase in the three types of cultivation tax.

In California Cannabis Taken to Tax – We’re Not Going to Take It Any More, Mr. Steinmetz announced a proposal to withhold payment of the cultivation tax after July 1st, 2022 and to place the estimated tax in escrow:

We are 100% committed to working alongside Governor Newsom and the legislature; with that said, we are prepared for the unfortunate possibility of continued inaction. Thus, we are also making the recommendation to our board that we refrain from paying the cultivation tax after July 1st, 2022. Our recommendation will be to place our estimated tax in escrow in good faith, and to withhold payment until we see real, actionable change. We invite our fellow California operators to join us.

(Emphasis in the original.)  This proposal got significant attention and a headline in the Sacramento Bee entitled “California retail marijuana CEO calls for cannabis tax revolt.”

What are the potential consequences for “fellow California operators” who choose to withhold payment of the cultivation tax? Does it make a difference if the withheld tax is placed in escrow?  What steps can licensed cultivators or manufacturers take to protect themselves in the event that distributors refuse to pay the cultivation tax?

Background

In a recent blog post, Senior Associate Lauren Mendelsohn explained in detail the proposed increases to the cultivation tax rates.  To review, the California Department of Tax and Fee Administration (CDTFA) has announced that effective January 1, 2022 the cannabis cultivation tax rates in California will be increased. The adjustment is due to inflation and is required under the State’s Cannabis Tax Law. Below is a table comparing the current cultivation tax rates to the rates effective January 1:

Table of CA's current and new cultivation tax rates.

The cannabis cultivation tax is paid by licensed cultivators. Any sales or transfers made by a cultivator prior to January 1, 2022, will be taxed at the “current rate” above. However, any sales or transfers from a cultivator on or after January 1, 2022 will be taxed at the “new rate” above. Please refer to CDTFA’s Special Notice – Cannabis Rates Effective January 1, 2022 for more information.

A helpful guide for how to calculate and properly collect cannabis taxes can be found on CDTFA’s website.

Governing Law

Proposition 64, California’s cannabis regulation and taxation initative, added Section 34013 to the Revenue and Taxation Code in order to tax commercial cannabis activity.  This provision of law sets forth in relevant part that any licensed cannabis business which fails to pay cannabis taxes shall, in addition to owing the taxes not paid, be subject to a penalty of at least one-half the amount of the taxes not paid.  Additionally, the licensed cannabis busines faces revocation of its license if it fails to pay taxes:

Any person required to be licensed pursuant to Division 10 (commencing with Section 26000) of the Business and Professions Code who fails to pay the taxes imposed under this part shall, in addition to owing the taxes not paid, be subject to a penalty of at least one-half the amount of the taxes not paid, and shall be subject to having its license revoked pursuant to Section 26031 of the Business and Professions Code.

Revenue and Taxation Code § 34013(f).

For example, let’s assume hypothetically that a licensed California operator takes to heart the recommendation to refrain from paying the cultivation tax, and to place the estimated cultivation tax in an escrow account.  The most serious potential consequence is that, by failing to pay taxes imposed by California law, the licensed California operator is now facing revocation of its license, which is an existential threat.  Another serious potential consequence of failing to pay taxes is that there is no “escrow defense” in the applicable sections of the Revenue and Taxation Code, and the operator would end up owing not only the unpaid taxes, but also a penalty of at least half of the unpaid taxes.  Thus, a cannabis distributor which fails to pay taxes in the amount of say, $200,000 would face revocation of its license as well as a penalty of at least $100,000 on top of the unpaid taxes.

How Cultivators and Manufacturers Can Protect Themselves When Distributors Refuse to Pay California Cannabis

We reached out to the California Department of Tax and Fee Administration (CDTFA) seeking guidance on this issue and received the following response on December 6, 2021:

Thank you for submitting your inquiry to California Department of Tax and Fee Administration (CDTFA). In your inquiry, you request guidance on how cultivators protect themselves from tax liability when a distributor collects the cultivation tax and withholds cultivation tax payments to CDTFA.

The Cannabis Tax Law provides that the cultivation tax is imposed on cultivators for all harvested cannabis that enters the commercial market. The cultivation tax is based on the weight and category of the harvested cannabis that the cultivator sells or transfers to a distributor or manufacturer. The distributor or manufacturer is responsible for collecting the cultivation tax from the cultivator based on the weight and category of the cannabis and providing a receipt to the cultivator indicating, among other requirements, the amount of the cultivation tax collected from the cultivator. This receipt relieves the cultivator from its cultivation tax liability. The distributor that arranges for the required testing and conducts the required quality assurance review is the distributor responsible for reporting and paying the cultivation tax owed to CDTFA.

Additionally, in accordance with the Revenue and Taxation Code section 34012(k), CDTFA is required to adjust the cannabis cultivation tax rates annually for inflation beginning January 1, 2020. The cultivation tax rates administered under the Cannabis Tax Law are adjusted each year by the incremental change in the California Consumer Price Index (CCPI) published by the California Department of Industrial Relations. For the 12 month period June 2020 through June 2021, the percentage increase in the CCPI is 4.428%. We adjusted the 2021 cultivation tax rates by 4.428% to set the cultivation tax rates for the 2022 calendar year to be effective on January 1, 2022. See our rates page for the current and historical cultivation tax rates.

The answers given are intended to provide general information regarding the application of the tax and will not serve as a basis for relief of liability under Revenue and Taxation Code section 55045.

For additional information, please visit our Tax Guide for Cannabis Businesses located on our web page at http://www.cdtfa.ca.gov/industry/cannabis.htm. If you haven’t already done so, please subscribe to our email lists located at http://www.cdtfa.ca.gov/subscribe/. You will receive CDTFA special notices, notifications on any updates, and proposed regulatory changes.

Hopefully, this information is helpful.

Thank you,

Tracie West | Business Taxes Specialist

Tax Policy Bureau

In sum, the best way for cultivators to protect themselves is to get a detailed receipt indicating the amount of the cultivation tax collected from the cultivator.  This receipt relieves the cultivator from its cultivation tax liability.

Contents of Cultivation Tax Documentation

The CDTFA Tax Guide for Cannabis Businesses sets forth in detail the information that should be reduced to writing in order to relieve the cultivator of the liability for the cultivation tax:

The invoice or receipt you receive from the manufacturer or distributor showing the amount of cultivation tax paid relieves you of the liability for the cultivation tax. The invoice or receipt 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 weight and category of the cannabis. The weight and category on the invoice or receipt should be consistent to the weight and category recorded in the California Cannabis Track-and-Trace system.
  • The date of sale or transfer.

Similarly, the Tax Guide for Cannabis Businesses sets forth the tax-related responsibilities of manufacturers.  These responsibilities include:

  • Collecting the cannabis cultivation tax from cultivators (including processors) from which the manufacturer receives cannabis and providing the cultivator with a receipt.
  • Paying to the distributor the cultivation tax collected from cultivators.

Since manufacturers have to pay the cultivation tax collected from cultivators to distributors, manufacturers would be wise to make sure that they also document that the cultivation tax collected from cultivators has been paid to distributors.  The information for cultivators in the Tax Guide for Cannabis Businesses seems to be applicable to manufacturers, and can be adapted to read as follows:

The invoice or receipt the manufactuer receives from the distributor showing the amount of cultivation tax paid is intended to relieve the manufacturer of the liability for the cultivation tax. The invoice or receipt should identify:

  • The distributor’s name, as the licensee receiving the product.
  • The name of the manufacturer.
  • The associated unique identifier for the cannabis.
  • The amount of cultivation tax.
  • The weight and category of the cannabis. The weight and category on the invoice or receipt should be consistent to the weight and category recorded in the California Cannabis Track-and-Trace system.
  • The date of sale or transfer.

Conclusion

The potential consequences for licensed cannabis businesses who withhold payment of the cultivation tax are draconian: potential license revocation plus payment of unpaid taxes plus a penalty of at least one half of the amount of unpaid taxes.  Does it make a difference if the withheld tax is placed in escrow?  No, California law does not recognize an “escrow defense.”  What steps can licensed cultivators and manufacturers take to protect themselves in the event that distributors refuse to pay the cultivation tax? In order to be relieved of liability for payment of the cultivation tax, cultivators and manufacturers should be sure to get detailed proof of payment in writing.

This information is provided as a public educational service and is not intended as legal advice. For specific questions regarding cannabis laws and regulations in California, please contact the Law Offices of Omar Figueroa at 707-829-0215 or info@omarfigueroa.com to schedule a confidential legal consultation.

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