ADVANTAGE CCA! – We decided to write a primer on the advantages of Cannabis Cooperative Associations (“CCAs”) because many of our readers have asked us why we keep talking about them.
A CCA is an entirely new form of California corporation which was expressly created for the benefit of small California cannabis growers. A CCA can do everything a business corporation can do. A CCA is an incorporated agricultural cooperative owned by cannabis growers. CCAs were created by the Medical and Adult-Use Cannabis Regulation and Safety Act (“MAUCRSA”). [Chapter 22 (§§26220-26231.2) of Title 10 of the California Business and Professions Code (“B&P”)] Chapter 22 imposes substantial restrictions on the ownership, governance, and operation of a CCA. These restrictions limit the benefits of the use of a CCA to cannabis cultivators.
The express reason for the CCA legislation was to provide small cannabis cultivators with the benefits of agricultural cooperatives. Agricultural cooperatives were created decades ago to give small farmers the ability to compete with large corporations. [See Positioning California’s Agricultural Cooperatives for the Future, Exploring Farmer Cooperatives and Agricultural Co-ops | California Center for Cooperative Development.]
One reason the enabling legislation for CCAs was required was because growing cannabis was not treated as agricultural production for many years under California law. The law has changed. [See Cannabis now Considered Agriculture and California Cannabis Cultivation – Qualification as Farming] Treating cannabis cultivation as agriculture solved one problem, but cannabis remained a very special agricultural product. A special form of agricultural cooperative was required because of the special regulatory controls imposed on cannabis in comparison to other agricultural products.
A CCA is a financially more efficient structure than any conventional business structure for the conduct of business in California’s cannabis industry because it is an agricultural cooperative. Individuals, especially cultivators, who are interested in making money in California’s cannabis industry should think of Chapter 22 as the very fine, and very important, print in a critical insurance policy that they need. Small cannabis cultivators should look at Chapter 22 as providing an opportunity for livelihood insurance protection that they will never read or fully understand but almost certainly need.
Why does the operation of a cannabis business through a CCA have financial advantages over a conventional business structure? The economic benefits of operating a cannabis business through a CCA flow from the fact a CCA is an agricultural cooperative under California law. As an agricultural cooperative, a CCA has an advantageous income tax filing status. As an agricultural cooperative, a CCA also benefits from two important principles of tax planning that flow from its filing status.
A CCA files a Form 1120-C U.S. Income Tax Return for Cooperative Associations for federal income tax purposes. A CCA is treated as a non-exempt agricultural cooperative under Subchapter T of the Internal Revenue Code [“IRC”] for federal income tax purposes.
The California Department of Tax and Fee Administration [“CDTFA”], through the Franchise Tax Board [“FTB”], taxes CCAs as integrated business entities for California franchise tax purposes. A CCA files:
(1) a Form 100 if it is a non-exempt organization and has business income;
(2) a Form 109 if it is an otherwise exempt organization but has business income; or
(3) a Form 199N Annual Electronic Filing Requirement for Small Exempt Organizations.
The income tax filing for a CCA also explains why the operation of a cannabis business in an agricultural cooperative has a financial advantage over the use of a conventional business structure. The business activities of a CCA are deemed to be conducted within a single legally recognized economic entity for federal income tax purposes as well as for California franchise tax purposes.
The treatment of all business activities of a CCA as occurring within a single, consolidated entity for Federal Income and California franchise tax purposes establishes the foundation both for the deferral of the payment of tax as long as possible, and for the minimization of applicable taxes in almost all situations.
These two principles of tax planning apply to a CCA because this special form of corporation is an agricultural cooperative established pursuant to California law. All agricultural cooperatives have these advantages. The financial benefits that flow from the application of these principles are best illustrated through an example
Some of our readers will recall earlier articles [ Key To Success for California Cannabis Businesses – Managing Tax Liabilities, Allocation – Costs – Gross Profit – Taxes and It’s the Math] in which we described the impact of taxes on the conduct of business in California’s cannabis industry. In one of the examples, we illustrated the division of revenue, expenses, taxes, and profit as oil extracted from cannabis moved from Cultivator to Manufacturer, to Distributor, to a sale to a consumer through a Dispensary. The examples referenced above were designed to illustrate the sharing of an approximately 45% total tax load between Cultivator, Manufacturer, Distributor, and Dispensary.
We will utilize the same movement of oil extracted from cannabis using different and arbitrary amounts to illustrate the financial advantages of the use of a CCA.
Assume a Cultivator sells cannabis material with a production cost of $312 to a Manufacturer for $412 plus the Manufacturer’s assumption of the associated Cannabis Cultivation Tax (“CCT”) of $88. The Cultivator has a profit of $100. The Manufacturer pays $88 to the California Department of Tax and Fee Administration (“CDTFA”), adds $400 of costs extracting oil, and sells the oil to a Distributor for $1,100 plus the Distributor’s assumption of the liability for the Cannabis Excise Tax (“CET”) of $264 that is now associated with the oil. The Manufacturer has a profit of $200.
The Distributor adds costs of $500 and sells the packaged oil to a Dispensary for $1,800 plus the Dispensary’s payment to the Distributor of the associated CET of $432. The Distributor pays the $432 to CDTFA and has a profit of $200. The Dispensary sells the cannabis material to consumers for $2,880 (60% mark-up) plus CET, Sales Tax and any local taxes, but not CCT which is buried in the Cost of Goods Sold. If the Dispensary has $780 of costs, the Dispensary will have a profit of $300.
CDTFA received a total of $520 for CCT and CET. The total profit for the four profit centers is $800. This profit will be subject to taxation as income. The total profit of $800 is allocated among four profit-centers as follows: Cultivator, $100; Manufacturer, $200; Distributor, $200; and Dispensary, $300. If the same individual owns the four profit- centers as horizontally integrated businesses, or through a vertically integrated business structure, the tax consequences will be essentially the same. A vertically integrated ownership structure for the four profit-centers is likely to have some tax advantages.
Each of the four profit-centers will separately report and pay for cannabis tax purposes and income tax purposes based on their separate transactions and fiscal periods as well as for any other tax purposes.
A CCA completely changes the reporting and timing of the imposition and payment of cannabis taxes and income taxes. If the same individual owns the four profit-centers through a CCA, the payment of both CET and CCT can is deferred until the Dispensary remits these taxes to the Distributor. In addition, the entire $800 of profit will be income to a single profit-center. This profit-center is an agricultural cooperative for income tax filing purposes. The total net revenue of $800 for the entire cannabis business operation will receive the maximum deferral of reporting and payment. Reporting income for tax purposes as an agricultural cooperative is critically significant for the financial advantages of a CCA over other business structures.
The preceding is a simplified illustration of the use of a CCA for adult-use cannabis businesses. Proposition 64 preserved medical cannabis in California although some additional effort is required in order to keep the promises in Proposition 215. CCAs can be a vehicle for the movement of medical cannabis from a cultivator to a patient with even more spectacular financial results in comparison to conventional business structures. We will discuss this use of CCAs for medical cannabis businesses in another article.