California Cannabis Oil Tax
California Cannabis Oil Tax – this article is the companion to our article relating to the impact of taxes on the sale of cannabis flower. Our earlier article provided a simple illustration of the impact of taxes on the movement of flower through California’s commercial cannabis market. This article provides a simple illustration of the impact of taxes on the movement of cannabis oil through this market.
The following is a simplified illustration of the impact of the taxes that are directly and indirectly imposed on the movement of cannabis in the form of oil from a cultivator to consumers. The Taxes imposed on the commercial movement of cannabis in California are Cannabis Cultivation Tax (“CCT”); Cannabis Excise Tax (“CET); Sales Tax; City and County Cannabis Taxes; and California and Federal Income Taxes.
We have again prepared three Pie Charts to illustrate the impact of taxes on the division of the dollars generated from the movement of cannabis from cultivator to consumers in California in the form of oil. The Pie Charts below are based on the sale of ten kilograms of cannabis material by a cultivator to a single manufacturer. The manufacturer extracts and refines the oil. The manufacturer sells the oil to a single distributor. The distributor puts the oil in cartridges and sells the oil packaged for retail sale to a single dispensary. The dispensary sells the packaged oil cartridges to consumers. As compared to our flower article, the dollars collected from the consumers are now divided into five shares instead of four.
The total taxes imposed on cannabis oil will always be in the range of 45% when all of the taxes are taken into account. As a consequence, the Dispensary, Distributor, Manufacturer, and Cultivator will usually be competing for slightly more than ½ of the total dollars collected from consumers. The relative share of the total dollars each of the four businesses will receive after taxes will vary widely. As a general rule, the Cultivator will receive the smallest fraction.
For the purpose of illustration in the Pie Chart on the left, we have divided total dollars collected from the consumers between Taxes, Dispensary, Distributor, Manufacturer and Cultivator into five segments as follows: 45%, 15%, 15%, 15%, and 10%. The Pie Chart in the center illustrates the movement of cannabis material from a cultivator to consumers through an extraction, refinement and packaging process with specific dollar amounts. The Pie Chart in the center reflects the impact of Taxes other than the Income Taxes that will be incurred by the Dispensary, Distributor, Manufacturer and Cultivator based on the assumptions in the example. The Pie Chart on the right takes into account all Taxes including an estimate of the Income Taxes each of these business segments may incur
In the Pie Chart in the center, the Cultivator sells ten kilograms (10,000 grams) of cannabis material to a Manufacturer for $2,904.00, which includes the $968.00 of CCT associated with material ($0.2904 per gram total cost, including $0.0968 CCT). The Cultivator receives a payment of $1,936.00. The Manufacturer expressly assumes the $968.00 CCT liability of the Manufacturer.
The Manufacturer expends a total of $7,096.00 extracting oil from the material and refining the oil. The Manufacturer produces 1,000 grams of refined bulk oil which carries a cost to the Manufacturer of $10,000.00 ($7,096.00 + $2,904.00) including CCT of $968.00. The Manufacturer sells the refined oil to the Distributor for $12,000.00 plus $2,880.00 of CET. The Distributor assumes the Manufacturer’s $968.00 liability for CCT, as well as the liability for the $2,880.00 of CET attributable to the bulk oil.. The Manufacturer, receives a total payment of $11,032.00.
The Distributor packages the 1,000 grams of refined oil for retail sale in 2,000 tips of 0.5 gram each at a cost to the Distributor of $8,000.00. The Distributor marks-up the tips by an additional $4,000.00 and sells the 2,000 tips to the Dispensary for $12.00 each, a total of $24,000.00. The $24,000.00 price at which the tips are transferred to the Dispensary includes the $968.00 of CCT. The Distributor also adds $5,760.00 of CET which is collected from the Dispensary. The Distributor receives $29,760.00 in payment from the Dispensary. The Distributor owes $6,728.00 to the California Department of Tax and Fee Administration (“CDTFA”) for CCT ($968.00) and CET ($5,760.00).
The Dispensary marks-up the tips by $14,400.00. This is the mark-up assumed in the computation of the CET that the Distributor collected from the Dispensary. The Dispensary sells the tips to Consumers for $38,400.00 ($24,000.00 + $14,400). The total amount of Taxes the Dispensary collects from Consumers for the 2,000 tips is $13,800.00. These Taxes consists of: CET, $5,760.00 (15.0% x $38,400); Local Taxes of $3,840.00 (10% x $38,400.00); and Sales Tax of $4,200.00 (8.75% x $$48,000.00). The Dispensary collects a total of $52,200.00 from the Consumers. This amount converts into a purchase price per tip of $19.20 plus $6.90 of taxes.
The total taxes due to CDTFA and local governments from the Dispensary’s sale of these tips is $14,768.00 ($13,800.00 + $968.00). This amount does not include the California and Federal Income Tax that will be incurred by the Dispensary, Distributor, Manufacturer, and Cultivator. The Pie Chart in the center reflects the division of the $52,200.00 among Taxes other than Income Taxes, and the Dispensary, Distributor, Manufacturer, and Cultivator.
The percentage breakdown of the $52,200.00 illustrated in the Pie Chart in the center is taxes, 28.3%, Dispensary, 27.8%, Distributor, 23.0%; Manufacturer, 17.2% and Cultivator, 3,7%. Each of these businesses, Dispensary, Distributor, Manufacturer and Cultivator, must recover costs and make any profit from these fractions of the total dollars paid by consumers.
If we take into account an estimate of the Income Taxes that will be incurred by the Dispensary, Distributor, Manufacturer and Cultivator, the percentage of the $52,200.00 that is lost to taxes changes dramatically.
If we assume the Dispensary will pay income tax at a 40% rate on the full amount of the Dispensary’s $14,400.00 mark-up because of Internal Revenue Code (“IRC”) §280E, the Dispensary will have an Income Tax liability of $5,760.00. If we assume the Dispensary has operating expenses of $5,760.00, the Dispensary will have an after-tax income of $2,880.00, which is a 20% after-tax profit.
For the purpose of illustrating the impact of Income Taxes on the Distributor, Manufacturer and Cultivator, we will assume each of these businesses is also subject to a 40% income tax rate. We will also assume IRC §280E has no application to the Distributor, Manufacturer or Cultivator.
The Distributor will have an income tax liability of $1,600.00 and an after-tax profit of $2,400.00 based on operating expenses of $8,000.00, a mark-up of $4,000.00 and an income tax rate of 40%.
The Manufacturer has a cost of $7,096.00 and profit of $2,000.00 on the sale of the tips to the Distributor. The Manufacturer will have an income tax liability of $800.00 and an after-tax profit of $1,200.00.
The Cultivator will have an after-tax profit of $750.00 and an income tax liability of $500.00 under the same set of assumptions if the Cultivator’s operating expenses for the production of the cannabis material are $686.00.
Based on the preceding assumptions, the total income taxes imposed on the Dispensary, Distributor, Manufacturer and Cultivator will be $8,660.00 ($5,760.00 + $800.00 + $1,600.00 + $500.00) = $8,660.00). These assumptions regarding income taxes increase the total amount of Taxes due to various governmental agencies out of the $52,200.00 paid by consumers to the Dispensary to $23,428.00 ($14,768 + $8,660.00). The total amount left to be divided among the Dispensary, Distributor, Manufacturer and Cultivator after-taxes is $28,272.00 ($52,200.00 – $23,428.00). As the reader will immediately see, various governmental agencies will collect almost 45% of the $52,200.00 paid by consumers for this cannabis oil in Taxes.
When Income Taxes are taken into account based on the preceding assumptions, the percentage of the $52,200.00 allocated to taxes is 44.9%. The percentage of the $52,200.00 retained by each of the cannabis businesses after all Taxes are taken into account will be: Dispensary, 16.6%, Distributor, 19.9%, Manufacturer, 15.8% and Cultivator, 2.8%. Each of these businesses must recover their respective costs and take any profit from these fractions of the total dollars collected from cannabis consumers when all of the direct and indirect Taxes are taken into account.
As we have stated on multiple occasions, managing tax liabilities may well be the most important factor in the success of a California cannabis business. As we also regularly remind our readers, tax liabilities cannot be managed without financial record-keeping and tax reporting systems specifically designed for California’s cannabis industry.