How Taxes Apply to Cannabis Inventory

How Taxes Apply to Cannabis Inventory 

CDTFA has issued a Special Cannabis Notice that explains how taxes apply to cannabis inventory as of January 1, 2018.

Effective January 1, 2018, a 15 percent cannabis excise tax applies to the average market price of the retail sale. The average market price is determined by the type of transaction (either “arm’s length” or “non-arm’s length”) that occurred when the seller (cultivator, manufacturer or distributor) sold the product to the retailer.

How Taxes Apply to Cannabis Inventory
How Taxes Apply to Cannabis Inventory

An “arm’s length transaction” is a sale that reflects the fair market price in the open market between two informed and willing parties.

In an arm’s length transaction, the average market price is the wholesale cost of the cannabis or cannabis products sold or transferred by a cultivator, manufacturer or distributor to a cannabis retailer, plus a markup determined by the CDTFA. The wholesale cost is the amount paid by the retailer for the cannabis or cannabis products, including transportation charges and adding back in any discounts or trade allowances.

The CDTFA will determine the markup rate every six months starting January 1, 2018. A special notice will be mailed to all cannabis businesses notifying them of the markup rate. The markup rate will also be posted on the Special Taxes and Fees Rate Page.

In a non-arm’s length transaction, the average market price means the cannabis retailer’s gross receipts from the retail sale of the cannabis or cannabis products. Gross receipts include all charges related to your sales, such as labor, service, and shipping and handling charges.

For more information on gross receipts, see Revenue and Taxation Code section 6012. How Taxes Apply to Cannabis Inventory

The example below provides a sample scenario and guidance on how to determine the average market price in an arm’s length transaction:

Example – You are a distributor and you sell one pound of cannabis flowers for $1,200 (which reflects the fair market price in the open market) to a retailer and charge a $300 transportation fee. The wholesale cost paid by the retailer to you is $1,500 ($1,200 + $300).

To determine the average market price, take the wholesale cost and add the markup. This example assumes a 60 percent markup on cannabis flowers.

Wholesale cost of cannabis flowers
$1,500
Markup ($1,500 × 60%)
$900
Average market price
$2,400

The cannabis excise tax due from the retailer to the distributor on this transaction is $360 (15% × $2,400). See Excise Tax Computation topic below for more information.

Non-Arm’s Length Transaction

The example below provides a sample scenario and guidance on how to determine the average market price in a non-arm’s length transaction:

Example – A microbusiness (which is licensed to be a cultivator, distributor, manufacturer, and retailer) grows one pound of cannabis flowers and sells the flowers at retail to their customer for $2,500. The average market price is determined by the type of transaction (either arm’s length or non-arm’s length) that occurred when the seller (cultivator, manufacturer or distributor) sold the product to the retailer.

Since a microbusiness is both the cultivator and the retailer, there is no sale between two parties that reflects the fair market price in the open market. As such, this is a non-arm’s length transaction and the average market price is the $2,500 representing the retailer’s gross receipts from the retail sale of the cannabis flowers.

The microbusiness is responsible for reporting and paying the cannabis excise tax of $375 ($2,500 × 15%) to the CDTFA on their cannabis tax return.

The cannabis excise tax is 15 percent of the average market price of the retail sale. To properly calculate the cannabis excise tax due, it is important to know whether the retailer’s purchase of the cannabis and/or cannabis product was at arm’s length or not. For more information, see the heading Average Market Price above. The examples below provide sample scenarios and guidance on how to compute the amount of cannabis excise tax due. How Taxes Apply to Cannabis Inventory

Example #1 – The retailer purchased five pounds of cannabis flowers for $7,500 and 50 cannabis candy bars for $300 in an arm’s length transaction. The average market price in the case of an arm’s length transaction is the wholesale cost of the cannabis plus a markup. This example assumes a 60 percent markup.

Wholesale cost of flowers
$7,500
Markup for flowers ($7,500 × 60%)
$4,500
Average market price of flowers
$12,000
Wholesale cost of candy bars
$300
Markup for candy bars ($300 × 60%
$180
Average market price of candy bars
$480
Total average market price ($12,000 + $480)
$12,480
Total cannabis excise tax due ($12,480 × 15%)
$1,872

The distributor is responsible for reporting and paying the $1,872 cannabis excise tax to the CDTFA on his/her cannabis tax return.

The key concept here is :

The distributor is not responsible for verifying the retail selling price of the cannabis. The cannabis excise tax is based on the average market price. In an arm’s length transaction, the average market price is not based on the retailer’s gross receipts from the retail sale.

Example #2 – The retailer, which is part of a microbusiness, sells four pounds of cannabis flowers for $9,600 and 25 cannabis candy bars for $500 to their customers (the consumer). This is considered a non-arm’s length transaction because the microbusiness is both the distributor and the retailer. The average market price in the case of a non-arm’s length transaction is the cannabis retailer’s gross receipts from the retail sale.

Gross receipts from sale of flowers
$9,600
Gross receipts from sale of candy bars
$500
Total average market price ($9,600 + $500)
$10,100
Total cannabis excise tax due ($10,100 × 15%)
$1,515

The microbusiness is responsible for reporting and paying the $1,515 cannabis excise tax to the CDTFA on their cannabis tax return.

Source: CDTFA Cannabis Special Notice 1/10/2018

Author: abizcannabis

Managing Director & CEO of integrated transactional financial advisory, tax, and technology consulting firm - aBIZinaBOX Inc New York, Chicago, and OaklandCPA.CITP.CISM.CGEIT.CGMAExpertise with: Alt. Investments/Private Equity, Real Estate, Professional Services, CA Cannabis, Tech Start-Ups and Distressed Assets/DebtTechnology Certifications including:Advanced & High Complexity Cloud Integrator AICPA PCPS, CAQ,, IMTA, CITP ISACA CGEIT, CISMState CPA Societies in California, Florida, Illinois, New York and TexasExpertise with Regulatory Compliance - US - HIPAA, FINRA, SEC Rule 17(a)(3)/(4), eDiscovery, FINCEN - EU- EBA, ESMA, EIOPA UK - BoE, PRA, FCA