Here, first, is the discussion paper published by the Tax Policy Bureau – Business Tax and Fee DivisionCalifornia Dept. of Tax and Fee Administration and re-published as a pdf
Below the paper follows a detailed commentary and thoughts by aBIZinaBOX Inc.
If you would like to contact aBIZinaBOX Inc please go to https://abizinabox.com/
RESPONSE & COMMENTARY BY aBIZinaBOX Inc
February 4, 2019
By Email – Trista.Gonzalez@cdtfa.ca.gov
Ms. Trista Gonzales, Chief
Tax Policy Bureau – Business Tax and Fee Division
California Dept. of Tax and Fee Administration
450 N Street
Sacramento, CA 95814
Re: Our Comments on the Second Discussion
Paper on Proposed Amendments to Reg. 3700
Dear Chief Gonzalez,
I am the Managing Director – CEO of aBIZinaBOX Inc. Both the firm and I are licensed California Certified Public Accountants [“CPAs”]. We have had extensive contact and discussions with a number of CDTFA attorneys and analysts in connection with Cannabis Cultivation Tax [“CCT”], Cannabis Excise Tax [“CET”], registration of Cannabis Cooperative Associations [“CCA’s], and other complex topics over the past year. While we understand and appreciate the need to address the topics addressed in the Second Discussion Paper, we feel compelled to take a step back and highlight what we view as much more important issues that CDTFA needs to address. We have written about many of the topics we are going to mention, so we ask that readers indulge the citation of our own writings.
We need to first acknowledge that we understand CDTFA was tasked with the implementation of the statutory language the California Legislature worked into SB 94. CDTFA has accomplished a great deal with the language it inherited. Unfortunately, there are some gaping holes in the statutory language, including some issues that CDTFA may not be able to remedy through the promulgation of regulations. Some issues may require a legislative fix.
The most glaring hole in our view is the lack of “responsible person” provisions for CCT and CET. We can easily envision a situation in which a distributor has a seven-digit liability to CDTFA for CCT or CET arising wholly from computational errors due to inadequate explanations from CDTFA with no individual personally responsible and the tax liabilities being uncollectable. Promulgation of a regulation requiring distributors and dispensaries to maintain “trust accounts” to segregate CCT and CET funds collected until their remittance to CDTFA would substantially improve both the secure internal accounting controls over trust fund taxes collected and make the administration process simpler for businesses and CDTFA, and reduce the problem created by the lack of responsible person provisions.
Our next area of concern is that even though CDTFA undertook a very well publicized effort to explain the proper procedure for the calculation of cannabis, state sales, and local taxes, this educational effort does not appear to have been successful. We have yet to see a receipt from a dispensary that contains all of the information that should be present as well as a proper calculation of all of the relevant taxes. Our concerns concerning the proper calculation of cannabis taxes are exacerbated by the emergence of cloud-based software that purports to calculate the taxes and file the returns for these taxes on behalf of the business owners.
The next issue which we need to point out is a potential trap for small cultivators. We have seen receipts where the only detail provided to the Cultivator is “we purchased X pounds of trim at $80/pound”. Our concern starts with the imposition of Cannabis Cultivation Tax [“CCT”]. Cultivators are initially responsible for the payment of CCT. Historically a cultivator has been paid a net price. The practice has carried over into the regulated market. Most cultivators are paid a net price. Frequently the net price is pursuant to a contract that provides the distributor will pay all taxes. The cultivators concern for CCT ends with receipt of payment for the cannabis. The regulations state
“You are liable for the cultivation tax until it has been paid to the state or you are provided documentation that indicates that cultivation tax was paid, such as an invoice or receipt from a distributor or manufacturer.”
This is a trap for the unsophisticated. If the receipt the cultivator receives from the distributor or manufacturer does not expressly state the amount of CCT that the cultivator is deemed to have paid, or the distributor or manufacturer does not explicitly state that they assume an express amount of CCT liability, then CDTFA could seek to collect the CCT directly from the cultivator. CDTFA could rectify this by adding more express requirements with regard to language in the receipts provided by distributors and manufacturers to cultivators. In order for this arrangement to be fully effective, the information required in the returns filed by distributors and manufacturers must be supplemented. This is an issue we will address in a separate communication.
Our second set of concerns relates to what we refer to the three “Black Holes” in the CCT and CET reporting and collection process. We wrote an article that describes three critical points of leakage in the cannabis tax collection process that demand tightening. Permit us to pull another small excerpt from the article.
The Black Holes are
- the collection, reporting and paying over of CET to Distributors by Dispensaries;
- the collection, reporting and remittance of CET by Distributors to CDTFA; and
- the collection, reporting, and payment of CCT to CDTFA by Manufacturers and Distributors.
We published a piece on collection best practices that highlight some of the steps that CDTFA might take to improve the collection process. An elaboration on best practices could form the basis for the second letter in itself.
Finally, we feel that there is a tremendous need for CPA’s and accountants to assist distributors and manufacturers in maintaining their records. Most distributors and manufacturers are required to maintain their books and records on an accrual basis of accounting for federal tax purposes reasons that are difficult to briefly explain. We note that while certain taxpayers may avail themselves of the cash basis method of accounting while sales are less than $25 million, the IRS’s powers to require methods of accounting to clearly reflect income, we believe that distributors and manufactures should use an accrual method by default. We further believe that CDTFA should consider adopting a regulation that expressly requires the use of an accrual method of accounting for CET calculations.
CCT is calculated on a cash basis. CET is inextricably linked to cannabis inventory which requires the application of accrual accounting principles. For these reasons professional assistance is critical in in connection with the preparation and maintenance of the financial records that are used by a California cannabis business to report cannabis taxes. Our 9,000-word discussion of Which Set of Books focused on the computation of CCT and CET.
We are going to submit a separate document which provides our recommendations for modifications to the information required on CCT and CET tax returns. Much can be done to streamline the process for both the taxpayers and the CDTFA and local tax agencies. Our experience is that tax returns which are logical and easy to understand result in far higher levels of taxpayer compliance than can ever be achieved with draconian provisions such as fifty-percent out of the box penalties.
Finally, thirty-eight years in practice as a CPA has provided a couple of cardinal rules that we would urge CDTFA to take to heart.
- While it is relatively easy to create internal accounting controls over cash, counting cash and “follow the money”, will NEVER provide an accurate picture of the activities of business with inventory.
- There compelling the businesses to maintain their books of account on an accrual method of accounting, which includes consideration of shipping terms [eg. FOB ] and reconciling the movement of the product dramatically simplifies the record keeping for CET which is expertly “baked into the inventory.” The maintenance of accrual-based books of account is substantially more complex than cash basis books of account. However, in the absence of an accrual method of accounting, accurate financial records are unlikely to be maintained and tax collections are unlikely to be accurate. California cannabis business will need to understand this and involve advisors with the necessary skills to accomplish the task.
We thank CDTFA and each of the other participants in the Second Discussion Paper commentary for this opportunity. If there are any questions, please feel free to contact the undersigned.
Very Truly Yours,
aBIZinaBOX Inc., CPA’s
California Accountancy Corporation License# 7995
By Jordan S. Zoot, CPA, Managing Director
 We have directly engaged with Mr. Robert Wilke, Mr. Jeff Vest, Ms. Monica Silva, Ms. Tracie West and Ms. Jennifer Hawkins.
 See Regulation 1702.5. – Responsible Person Liability
 The maintenance of “books of account” is a highly complex subject in and of itself. Tax practitioners often are accused of speaking a language that only they to understand…which may be an exaggeration, but in this case, the accusation is true. Let’s begin with an old joke how many sets of books does a business need to keep? The smartass answer is two…” one set for the tax collector and one set that is accurate”. We all know how that story ends. The new reality is that a California cannabis business needs to maintain FOUR sets of books to comply with the requirements of the agencies that regulate California’s cannabis industry.
Now that we have your attention [and we assume that you are reading this material from the perspective of having a financial interest in the success of a “touch the plant” cannabis business in California], we will explain why this old joke is no longer funny. We will start with the IRS requirements for maintaining books and records for any business.
“The U.S Dept. of the Treasury – Internal Revenue Service [the “IRS”] provides taxpayers with detailed guidance regarding the types of records business is required to keep.
The California Franchise Tax Board has promulgated rules which track the statutes enacted by the California Legislature for the conformity of California’s tax rules to those promulgated by the Federal Government and enforced by the IRS. Therefore, a taxpayer that is subject to the California income and franchise tax statutes is required to maintain a separate set of books for California income and franchise tax purposes. All California cannabis businesses are owned by individuals or entities and are therefore subject to California income tax or franchise tax.
The statute that imposes the Cannabis Cultivation Tax [“CCT”] and the Cannabis Excise Tax [“CET”] uses the same definition as Sales Tax for its definitions of “gross receipts” as well as for its definitions of “retail sale,” “purchase” and “transfer.”
The agencies within the State of California with primary responsibility for oversight of the cannabis industry for regulatory compliance are: the Bureau of Cannabis Control [“BCC”] for Retail [Dispensaries, Offsite Event and Distribution licensees; the California Department of Food and Agriculture’s [“CDFA”] CalCannabis Unit for Cultivation licensees; and the California Department of Public Health’s [“CDPH”] Manufactured Cannabis Safety Bureau [“MCSB”] for Manufacturing, Extraction and Testing Laboratories.
BCC has guided the retention of required accounting records in Sec. 5037, track-and-trace records, and track-and-trace reporting requirements for Retail Dispensaries. The recordkeeping requirements are augmented for Distributors.
The recordkeeping requirements are mandated by CalCannabis for Cultivators include records, sales receipt and invoice requirements, track-and-trace requirements, track-and-track unique identifier requirements.
Section 8404 Track-and-Trace User Requirements, Section 8405 Track-and-Trace System Reporting Requirements, Section 8406 Track-and-Trace System Inventory Requirements, Section 8407 Track-and-Trace Cannabis and Non-Manufactured Cannabis Products in Temporary Licensee Possession at the Time of Annual License Issuance, Section 8408 – Inventory Audits, and Section 8409 Notification of Diversion, Theft, Loss or Criminal Activity are outside the scope of this article.
CalCannabis has provided specific guidelines for inspections and audits of licensees.
CDPH-MCSB has added provisions which are substantially similar to the rules created by BCC and CalCannabis in Subchapter 6, Article 1, Section 40500 – Record Keeping Requirements, Section 40505 – Sales Invoices and Receipts, Section 40510 Track-and-Trace System General Requirements, Section 40512. Track-and-Trace System Reporting Requirements, Section 40513 Track-and-Trace – Loss of Access, Section 40515 Track-and–Trace Temporary Licenses, and Section 40517 Track-and-Trace System – UID Tag Order.
 See IRC Sec. 448(c)