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California ends cannabis cultivation tax, partly blamed for strangling the legal industry

Gov. Gavin Newsom’s signing of the $308 billion state budget Thursday evening handed California’s struggling cannabis industry long-sought tax relief.

The state eliminated the cultivation tax on growers and capped the excise tax at point of sale at 15% for three years, moves hailed by industry advocates as a victory after a prolonged push in Sacramento to lighten the tax burden on the legal trade.

Growers have felt the pinch over the last two years as they watched the wholesale price plummet amid a glut of product. All the while, state taxes have gone up and the illicit market has remained intact.

“I’m celebrating,” said Amy O’Gorman Jenkins, the California Cannabis Industry Association lobbyist who has worked on reform for four years. ”The Legislature seems to have grasped a lot of what’s affecting the cannabis industry. More work needs to be done, but I see this as a big win. To critics, I say this is a significant first step.”

Much of the language of the trailer bill that enacted the tax relief came from state Sen. Mike McGuire, D-Healdsburg, who introduced legislation early this year that sought to shift the state tax growers pay to the excise tax paid on point-of-sale transactions. Senate Bill 1074 was blended into the state budget legislation as part of a reform package lawmakers passed Wednesday night.

McGuire’s involvement earlier this year came as more than 400 cannabis industry advocates signed a letter to the Legislature demanding tax relief.

That push, however, imperiled funding for youth organizations and services that draw revenue from the cultivation tax. The reform package preserves that funding by other means.

“We appreciate the governor and Legislature to take into account the funding for kids and childcare and to look to protect these funding streams,” said Jim Keddy, executive director of Youth Forward, a Sacramento-based youth advocacy entity.

“The bottom line is this, cultivation taxes have been crushing small farmers throughout the North Coast and impeding the state’s efforts to transition family cannabis growers from the unregulated market to the legal market,” McGuire said Friday in a statement to the Business Journal.

He said “basing taxes off of a cannabis flower’s weight” was flawed, while the state faced a potential market collapse.

“That’s why we’re thrilled our legislation has been included in the state budget. This action will give family farmers a fighting chance,” he said. “This is a lifeline for generations of families who built California’s storied cannabis industry.”

The tax relief comes as California first-quarter cannabis tax revenues were down 7% to $293 million, from $316.5 million in the fourth quarter of last year, the California Department of Tax and Fee Administration reported.

The state cultivation also rose this year from $9.65 to $10.08 per dry weighted ounce.

Many insiders have attributed the decline to the rising cost of business

Sonoma County, the most prominent North Bay local government allowing cannabis cultivation, has taxed growers from $1.12 to $12.65 per square foot, depending on which of the dozen types of licenses is held. The Board of Supervisors agreed in March to slash by almost half the tax paid by local cannabis cultivators.

The state tax system was established through the passage of Proposition 64, which in 2016 legalized adult, recreational cannabis use statewide. The state subsequently set up a license and tax program that imposes obligations at every level of the supply chain, from cultivation to sales, and rolled out excise taxes over a year later.

But the green rush anticipated at that time has not unfolded, at least not in way that’s benefited a wide cross-section of the industry. Only about a third of California’s local jurisdictions have permitted new businesses under the state law, while black-market growers, wholesalers and retailers continue to operate statewide.

An estimated half of California’s growers have opted in the past year or two to wait out the sour market conditions by fallowing their land

To acclaimed cannabis grower Mike Benziger of Glentucky Farms in Glen Ellen, the tax relief is necessary considering the plummeting price his crops are gaining in the market.

“I was getting $3,000 a pound. I turn around, and I’m getting $500,” he said. “Every penny (of relief) counts.”

A National Cannabis Industry Association survey released a few months ago indicated that only 26% of cannabis business respondents in California were making a profit. Over half said they were not, and 17% were simply breaking even.

But the recovery may not come quick enough for some.

“It’s going to take us at least two years before we see an impact from this,” said Sam Rodriguez, a policy director with Good Farmers, Good Neighbors, a growers advocacy group. “If anything, it’s a warning shot to local municipalities not to place extra taxes on the industry. We need to set them at a rate they can afford. They should be less than 10% for retailers.”

Retailers also collect local and sales taxes, along with the excise rates.

Even though Rodriguez represents farmers, the Northern California cannabis advocate believes any tax relief helps the industry as a whole. His phone has rung off the hook in the last few days because the issue has interested many in the industry.

“The variable here is local government. They can either accelerate this train or be an impediment,” Rodriguez said.

Eric Sklar, CEO of Napa Valley trailblazer Fumé Brands, said any relief is welcome.

“The taxation is too much. We need all of (the relief). But this is a step in the right direction. We’re grateful for the governor and the director for hearing us,” Sklar said of Newsom and Nicole Elliott of the California Department of Cannabis Control.

The agency has unveiled a few programs in recent months to help ease the burden of doing business in the state. One such program allows operators to apply for drought relief, which amounts to a temporary reprieve from paying license fees for those who qualify. Another is a sales mapping tool that connects buyers with sellers in their area, thus providing help for growers to get their product to market.

Elliott deems the state cannabis tax reform as a way “stabilize the cannabis market” with relief.

“California just moved forward with some of the most significant reforms to our cannabis policies in years,” Elliott said. “We will begin investing millions more into supporting equity operators and retailers and expanding retail access in areas of the state that currently lack it. These reforms are the result of strong collaboration with legislative and budget leadership and the advocacy and partnership of a broad range of stakeholders.

This latest reform package comes with tax credits of up to $250,000 starting in 2023 for cannabis employers that seek to diversify their workforces.

Eli Melrod, chief executive officer of Solful, a local cannabis retailer, said the tax relief for cultivators would help ease price and cash strains across the market.

Customers have often experienced “sticker shock” at his dispensaries’ partly as a result of the taxes charged, he said. They can amount to a third of the sales receipts.

“Any tax reform is meaningful. This is great for the cultivators. It was a poorly designed system, and we’re glad it’s gone,” Melrod said, adding his support behind a provision in the legislation that allows the excise tax to be paid quarterly instead of monthly.

“That does help from a cash flow perspective,” he said.

From a distributor’s standpoint, Tiffany Devitt, government affairs chief at Santa Rosa-based CannaCraft, called the new tax structure “substantial progress.”

Still, more work needs to be done, especially in stomping out the illicit market, she said. The reform package calls for a task force that would share information on how to address illegal operations.

The legislation also authorizes stiffer penalties that may be imposed on the illegal operators as well as those who aid them. According to a 2019 Statista report, the illicit market was valued at $8.7 billion a year.

“The true impact remains to be seen. It might make it easier for more to stay in business. We have to see (what happens) when the dust settles,” Devitt said.

Susan Wood covers law, cannabis, production, tech, energy, transportation, agriculture as well as banking and finance. For 27 years, Susan has worked for a variety of publications including the North County Times, Tahoe Daily Tribune and Lake Tahoe News. Reach her at 530-545-8662 or susan.wood@busjrnl.com.

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