The cannabis industry knows a thing or two about taxes, but there are different rules to follow with purchases not intended for resale. Retailers often buy samples from various ends of the supply chain for marketing and promotional purposes, and those products never leave the shelves.
For all retail purchases, the type of use, initial product price, and mark-up rate as established by the California Department of Tax and Fee Administration (CDTFA), determine which tax applies and who owes what. So which, if any, affect samples?
When: Excise taxes are applied to certain goods, such as wine, tobacco, and you guessed it, cannabis! Since January 1, 2018, a 15% Excise tax has been owed by retailers who purchase with the intent to sell again, and this tax is ultimately passed on to the consumer who reimburses the tax to the retailer. The product Excise tax should be collected by the distributor upon initial sale to the retailer, though a retailer and distributor may have an agreement to have the excise tax paid within up to 90 days of receipt of product.
The Excise tax is calculated based on the wholesale cost and an anticipated mark-up, as included in this chart provided by the CDTFA.
(Chart provided by the CDTFA)
An Arm’s length transaction is when two parties involved with a sale are acting independently of one another (such as a distributor and retailer that are two separate entities). In these situations, the tax amount is relative to the wholesale price plus mark-up. This applies regardless of any discounts that the seller might have placed.
If the overall value of the product is reduced, however, that cost is then considered the market price. No amount needs to be added back on when calculating the tax.
Does it affect samples?: If the product is only being purchased for marketing and promotional purposes, and will only be consumed by the retailer, then the retailer does not need to pay an Excise tax, and the distributor is not responsible for collecting Excise tax on these samples. Samples intended only for use by retailers must be labeled as “not for retail sale.” However, if a sample is sold to the retailer with the intent of resale to consumers, the distributor is required to collect the excise tax from the retailer based on the average market price of the cannabis or cannabis product - which is equivalent to 15% of the wholesale price (including distribution fees) plus a 60% markup (this markup is the current rate at the time of writing of this article and is subject to change every 6 months at the discretion of the CDTFA).
Sales and Use Tax
When: Unlike Excise taxes, a Sales and Use tax amount is based on gross receipts. It becomes the responsibility of the entity selling the sample, which could be the cultivator, distributor, manufacturer, or retailer, depending on the arrangement.
Does it affect samples?: Yes, if a product is sold to a retailer that is not reselling the product, whoever is selling the sampled product is responsible for collecting and/or paying the Sales tax. In the case of selling a sample to a retailer for the retailer’s use, the seller (be it a cultivator, manufacturer, or distributor) is responsible for collecting and remitting a Sales tax on products sold to a retailer. This is because, by not reselling the product, the dispensary becomes the final consumer. How much is owed depends on a few variables, such as product selling price and value. If a product is sold for over 50% of its cost, then a sales tax percentage is due on that amount, and is to be remitted to the state by the entity that made the sale to the retailer. But if the product is sold for less than half its initial cost, then the seller would instead owe a Use tax in relation to the price it at which it was sold. However, if the sample is resold by the retailer, then the retailer is responsible for collecting a sales tax based on the sales price, and must remit that sales tax to the state.
It’s enough to make your head spin; we know. But here are some tips for keeping compliant:
When selling samples for promotional purposes direct to a retailer only, items should be clearly labeled “not for resale.” No excise tax is due, but sales and use tax is to be either paid or collected by the distributor, manufacturer, or cultivator, and the selling business is responsible for filing and remitting sales and use tax.
When selling samples to a retailer for resale to a consumer, Excise tax must be charged based on “average market price” calculations and collected and remitted by the distributor to the state, and sales and use tax must be calculated based on sale price, collected, and remitted to the state by the retailer.
Commercial Cannabis Businesses are required by law to keep accurate records of sales and purchases of products, including products used for sample purposes only.
If an item is being sold as a wholesale item for resale, the selling distributor, manufacturer, or cultivator should obtain a certificate of resale from the retailer or distributor (depending on the sales arrangement) and keep it in their records.
Samples are NOT free product and cannot be given away. The Bureau of Cannabis Control (BCC) must approve any donations of flower and cannabis products. Any free offering of cannabis without direct approval is prohibited.
If you are a distributor or other operating commercial cannabis business currently selling samples or considering doing so, it is best to first talk to your retailer to clarify each other’s obligations. If they are responsible for paying you a tax, you are also responsible for its collection. Save the trouble and clarify your expectations so that they are prepared when the time comes.
Have more questions about cannabis taxation? Contact Golden State!
DISCLAIMER: Golden State GR, Inc, is not licensed to practice law and does not engage in the unauthorized practice of law. Be advised that content of this correspondence is simply the observations and conclusions of Golden State GR, Inc. and is not intended as legal advice. It is recommended that clients retain legal counsel if they have any questions or concerns about legal compliance.