Arm’s length marijuana tax rule in California — superseded

Don’t read this whole post.

Instead, a corrected view of how California’s retail tax works is here (at https://newrevenue.org/2017/10/27/90-day-rule-for-californias-15-percent-retail-marijuana-tax/).  So go there.

The superseded and incorrect material below, for the record, reflects my thrashing around before I understood what California was even trying.  Why anyone would want to read about that thrashing, I can’t imaginge, but I don’t delete much.  Nobody’s perfect.

First analysis was wrong.  Proceed to UPDATEs at the end.  I still don’t get it.  Look somewhere else to figure this out (sorry).  To preserve the record, I’m not deleting the first analysis, which looks at the ordinary meaning of “arm’s length.”

A friend in California sends me tax news that has me surprised and confused.  I’d like to know what the government side is thinking. I’m thinking they have something backwards — that they provide a fix for arm’s length transactions that they instead need for non-arm’s length transactions.  This kind of thing is why taxing substance by price (as opposed to weight or stated THC) is problematic.Most retail transactions will be at arm’s length. Arm’s length means a deal between unrelated parties at market price. It’s the opposite of a sweetheart deal.

Exceptions I can think of are employee discounts, shareholder discounts, discounts for vendors, friends, family, and so on; and bundled transactions.

Here’s the proposed rule from the CDTFA, , the successor to the BOE: http://www.cdtfa.ca.gov/industry/cannabis.htm#Retailers

“Effective January 1, 2018, a 15 percent excise tax applies to the average market price of the retail sale. The average market price is determined by the type of transaction that occurred when the seller (cultivator, manufacturer or distributor) sold the product to you.

“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 means the average retail price determined by the wholesale cost of the cannabis or cannabis products sold or transferred to a cannabis retailer, plus a mark-up.  The mark-up will be determined by the CDTFA on a biannual basis in six month intervals.  A special notice will be mailed to cannabis businesses informing them of the mark-up rate when it is set.  The mark-up 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.”

I think the constructed price instead should be just the reverse — the actual gross receipts in an arm’s length transaction, and the wholesale plus mark-up in a non-arm’s length transaction.  So I think there’s a typo.  If I’m right, their approach is unobjectionable, designed to get at rare discount or bundling cases.  That will be a tiny fraction of retail sales.

The complication SHOULD arise only rarely, because there will be few sweetheart deals. But I think the CDTFA has it backwards.

I wonder if I’m missing something. The California tax folks (now at the CDTFA) I know are often a step ahead of me, and have studied this for a lot longer than I have (which is about 15 minutes). But I think they have it backwards.

Colorado and NV construct prices, but mainly for non-retail transactions that are not at non-arm’s length – vertically integrated or farm-to-market commerce. They construct artificial prices only for their producer tax (California solved that problem by basing the California producer tax only on weight).

Here’s some of what I have on CO and NV: https://newrevenue.org/2017/07/23/is-colorados-new-marijuana-tax-leaky/).

UPDATE:

I’ve heard back from California about that analysis:

I don’t think the concern is sweetheart deals.  This is how CDTFA explained the difference when we met with them a couple of months ago:
Arms length transaction is basically a ‘front’ from the distributor to the retail entity with terms that the retailer pay say … in 30 days, or when the product sells.
Non-arms length transaction is when the retailer pays the distributor for the product at the time of transfer.

I see.  I didn’t understand the transaction.  That’s completely different.

My quick first reaction is that the government is shooting itself in the foot.  Taxpayers who are free to arrange their payment date can choose whichever option produces (or is likely to produce) the lesser tax.  Buyers and sellers can cooperate to set a date to minimize tax – a win-win.

So if my product has a mark-up above average, I wait to get paid.  I want the formula, which produces a lower price for me.  I pay tomorrow.  If I think it has a mark-up below average, I want to get paid today and take the actual price.

I may have this confused – I certainly did the first time.

SECOND UPDATE:  Yes, I’m confused. “Non-arms length transaction is when the retailer pays the distributor for the product at the time of transfer.” But this is a retail tax. How can the retailer know the retail price when the retailer pays the distributor? That retail price will be paid later, and is uncertain.

THIRD UPDATE:  Here’s a more technical explanation from my friend and Washington tax lawyer Jim Hunt: https://www.bna.com/californias-new-marijuana-n73014463478/

Marijuana Excise Tax

MAUCRSA, imposes a 15 percent excise tax on “the average market price”(“AMP”) of any retail sale by a cannabis retailer. Cal. Rev. & Tax. §34011(a). Potentially, there are two AMP’s. The first AMP is arm’s-length and based on good faith negotiation in the open market, in which case the AMP is wholesale cost plus a mark-up determined every six months by the State Board of Equalization (“SBE”) or its “successor”. Cal. Rev.& Tax. §34010(b)(1).

The second AMP is based on a “non-arm’s length transaction,” in which case, the AMP is the gross receipt from the sale. Cal. Rev.& Tax. §34010(b)(2). Given the July 1, 2017 restructuring of the SBE, it is unclear if the AMP will be set by the current five-member Board of Equalization or the newly created California Department of Tax and Fee Administration (“CDTFA”).

The determination of the AMP is crucial in determining how the tax is collected and remitted. Though the cannabis consumer is ultimately subject to the Marijuana Excise Tax, it is the Distributor that must collect the Tax from the Retailer and, in turn, remit tax to the CDTFA.

On “non-arm’s length transactions”, the Distributor must collect the tax from the retailer when the retailer sells cannabis product to the consumer, but in no event more than 90 days after the Distributor’s sale to the Retailer. For “arms-length” transactions, the Distributor must collect the tax from the retailer “on or before 90 days after … the sale [from the distributor] to the retailer.” Cal. Rev. & Tax. §34011(b)(1).

++++

Here’s my reaction to Jim’s explanation:  “The first AMP is arm’s-length and based on good faith negotiation in the open market”: Negotiation between producer and retailer? Why do we care, for instance, whether producer and retailer are vertically integrated – in imposing a retail tax? Negotiation between customer and retailer? That occurs except in sweetheart deals.

I’m writing Jim to ask. I’m missing something and will post when I figure it out.

 

 

 

 

 

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Author: patoglesby

From 1982 to 1990, I worked in tax policy for Committees of the United States Congress. In recent years, I was Adjunct Lecturer at UNC-Chapel Hill's Business School and then Adjunct Professor at its Law School.

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