California Cannabis Retailers Overpaying Tax On Items Not Legally Subject To It, New Lawsuit Claims

A marijuana company recently filed a lawsuit against the California Department of Tax and Fee Administration (CDTFA) and the state's Office of Administrative Law (OAL) alleging "massive overcollection of cannabis excise tax on items that legally are not subject to excise taxation."

In the third quarter of 2023, California cannabis taxes yielded $269.3 million, out of which excise tax generated $156.9 million, and the remaining $112.4 million came from sales tax. Since 2018, the state's cannabis taxes brought almost $3 billion in state revenue.

Now, HNHPC Inc., which operates one of Catalyst Cannabis Co.'s 26 dispensaries in California is challenging the legality of imposing an excise tax on "cannabis accessories." The case will be heard in the Superior Court of California, Orange County, reported Cannabis Business Times.

The lawsuit can be summarized with the following example: if a vape pen is sold for $40 but only contains $5 worth of marijuana oil, should the 15% state excise tax apply to the whole purchase?

"That's really what the argument's going to be about," Anthony Almaz, counsel for Catalyst, told the outlet. "What's really taxable in California?"

Emergency Regulatory Action

Is this excise tax new in the state?

The issue is somewhat complex, as last November the CDTFA approved an emergency regulatory action that requires dispensaries to collect excise tax not only on marijuana flower and products like concentrates, edibles and topicals, already included in the law, but also on what is called "optional" tangible personal property (TPP). OAL adopted the action in December and it is expected to last for two years.

Almaz argues that the optional TPP is a way for the CDFTA to impose excise taxes on marijuana accessories that have been otherwise excluded, until now.

How does this apply to the above example? For a $40 vape pen with just $5 of cannabis oil, the difference is $6 in excise taxes on the entire purchase and 75 cents in excise taxes on just the oil.

Catalyst has been explaining its retail charges on sales receipts for marijuana and non-marijuana items to enable customers to pay excise tax only on actual marijuana products, or the hypothetical 75 cents in the above example.

The Tax Law Is The Same

"Nothing really changed in terms of the language of the tax law," Almaz said. "So, the way we looked at it was, ‘OK, so long as now we separately stated on the invoice to the customer instead of the retailer, it should be the same result." According to him, Catalyst was not using a loophole in the law, it was just the way the company interpreted it for a year.

"We want to make that part clear," Almaz continued, "because the tax authorities back in 2019 came out with the regulation that says, ‘Listen, cannabis accessories are not subject to the excise tax so long as they're separately stated on the receipt and given to the purchaser.' … The tax law didn't change."

Now, the company is arguing that the CDFTA had no authority to enact this regulation and even if it did have the authority, it was not allowed to because it violates the APA.

"When the CDTFA learned HNHPC and the other Catalyst-branded dispensaries had found a way to separately state cannabis accessories, thereby exempting them from excise taxation, Respondents engaged in a ‘mad scramble' to do anything and everything possible to prevent them from continuing to do so and to dissuade other retailers from even thinking of also doing so," the suit claims. "In short, this action was made necessary by the CDTFA's legally improper ‘money grab' in violation of (cannabis tax laws) and its own regulations."

CDTFA spokesperson Tully Lehman commented on the emergency rulemaking process saying it "was used to expedite the clarification of RTC section 34011.2 and intended to help retailers better understand the tax issues as soon as possible. The emergency regulation will become permanent if CDTFA adopts the emergency regulation through the normal rulemaking process.”

Racing Against Time

According to Almaz, CDTFA was in a rush because its emergency regulation rulemaking power was nearing an end.

"When the OAL told them that the regulation did not satisfy the APA, what you're supposed to do is withdraw it, amend the language, resubmit it to the public, and then resubmit it to the OAL," he said. "But they would've run out of time. … They blew the clock essentially."

The case is scheduled for a hearing on April 4.

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