California Cannabis Excise Tax Burden Increases with Reg 3802: Catalyst Cannabis Company Leads the Fight Against!
On December 15, 2023, California’s Office of Administrative Law (OAL) approved the CDTFA’s Emergency Regulation 3802 significantly increasing the excise tax burden on the state’s cannabis industry. Catalyst Cannabis Company, one of California’s largest retailers and a leading advocate for fair treatment of cannabis by government, has filed suit challenging Reg. 3802. If Catalyst is not successful in overturning the regulation, Catalyst states, Californians will be locked into paying triple the amount of excise taxes that should be charged.
Catalyst’s Lawsuit Against the CDTFA and Office of Administrative Law
Filed on December 28, 2023 by Catalyst’s parent company HNHPC, Inc., the lawsuit contends that the CDTFA and the OAL rushed through Reg. 3802, bypassing legal procedures required for new regulations by California’s Administrative Procedures Act. The suit seeks the invalidation of Reg. 3802 and the CDTFA’s parallel amendment to original excise tax Reg. 3700. In addition, the suit seeks judicial declaration that, under cannabis tax laws implemented as part of Proposition 64, cannabis accessories are not subject to excise tax.
Catalyst CEO Elliot Lewis is optimistic stating recently, “We’re going to knock out 3802. Once we knock out 3802, I think this becomes hundreds of millions of dollars back in the coffers of the cannabis industry and, ultimately, the consumer.”
Reg. 3700: the Original Excise Tax Regulation
Before 2023, the collection of excise tax was the responsibility of distributors and was governed by state Regulation 3700 which stated, in part:
When cannabis or cannabis products are sold or transferred with cannabis accessories (e.g., vape cartridges) to a cannabis retailer, and a distributor separately states the price of the cannabis or cannabis products from the cannabis accessories, the cannabis excise tax applies to the average market price of the cannabis or cannabis products, and not to the separately stated charge for the cannabis accessories.
Following this directive, Catalyst’s distribution arm, like many other distributors, separately listed on their invoice cannabis accessories from the actual cannabis product itself and charged retailers excise tax only on the cannabis product. For example, when they’d sell a retailer a vape pen for $20 with only $5 of actual cannabis oil, Catalyst would separately state the pen and the oil and only charge the retailer the excise tax on the $5 oil. The CDTFA did not have any problem with this.
In 2023, the collection of excise tax shifted from distributors to retailers. Catalyst continued to separately state the cost of the cannabis and the accessory on its receipts to customers and only charged them excise tax on the cannabis.
For example, on a $40 vape pen with its $5 cannabis cartridge, Catalyst would charge customers 15% on only the $5 cartridge (i.e., they’d charge excise tax of $0.75 not $6.75).
As Catalyst’s excise tax filings differed significantly from many other retailers, the CDTFA responded with multiple audits of their books. Catalyst and other retailers following this same process believe that the CDTFA is misinterpreting the state’s instructions regarding excise tax, forcing a significantly higher excise tax burden on the state’s retailers and their customers.
Reg. 3802 Departs from Reg. 3700
To codify their new method of excise taxation on accessories, the CDTFA came out with Regulation 3802, which states, in part:
… if a purchaser is required to purchase a cartridge and vaping device as a condition of the retail sale of the cannabis product contained in the cartridge, the amount the purchaser is required to pay for the cartridge and vaping device is included in the gross receipts from the sale of the cannabis product.
Reg. 3802 goes on to state that gross receipts can exclude accessories (which it describes as “tangible personal property”), but only if:
- Accessories are Optional – the purchaser is not required to buy the accessory to purchase the cannabis product.
- Accessories are Reasonably Priced – the markup on the vape, for example, cannot be inflated thereby allowing the cost of the cannabis oil to be lower, thus reducing excise tax charged the customer.
- Retailer Keeps Thorough Records – the retailer must retain detailed records proving the price charged for the accessory was reasonable.
Reg. 3802 Rushed into Law
In October 2023, the CDTFA initiated emergency regulations on Reg. 3802 and submitted Reg. 3802 to the OAL, which reviews regulations to ensure they comply with the Administrative Procedures Act. The Administrative Procedures Act requires that the public be given a reasonable opportunity to participate in the discussion and possible adoption of the new regulation.
However, according to Catalyst General Council Anthony Almaz, the discussion period was cut short, and the OAL approved Reg. 3802 on the 15th day – the minimum time possible to rush a regulation into law. In addition, the OAL approved an amendment to Reg. 3700 changing the original definition of excise tax. The public hadn’t even been notified about or given a chance to comment on this second amendment. This was a direct violation of the APA. Says Almaz, “You can’t just submit a regulation for approval without ever getting public participation.”
Per Almaz, the public discussion on Reg. 3802 was never meaningful, because email correspondence shows both the CDTFA and the OAL were focused on getting Reg. 3802 into law in time before their emergency rule-making powers ended on December 31, 2023. By doing this, they were able to avoid the ordinary rule-making process which requires creating reports to determine industry impact. This end-run by the two agencies also meant Reg. 3802 would apply to all retail transactions starting January 1, 2024.
Catalyst’s History of Activism
Catalyst Cannabis Company, its CEO Lewis, its General Council Almaz, and outside counsel and cannabis litigation specialist Jeff Augustini have a history of supporting California cannabis by confronting government agencies with negligent or injurious policies. In 2021, Catalyst filed suit against the Department of Cannabis Control asserting the agency was turning a blind eye while millions of pounds of cannabis was being diverted to the illegal market through the use of “burner” distributor licenses (similar in purpose to burner cell phones, which are meant to be used for a short period of time and often for illegal activities, and then thrown away). An Orange Country trial judge dismissed the lawsuit, but HNHPC’s appeal was upheld in an Appellate District Court ruling on August 2, 2023. This lawsuit in ongoing.
California’s Cannabis Industry is Struggling
California’s cannabis industry is struggling under the twin weights of excessive taxation and competition from an illicit industry that is believed to be at least twice the size of the Golden State’s $5.2 billion per year legal industry. In a recent interview on the legal podcast Cannabis Law Now, Catalyst GC. Almaz commented on their recent lawsuit and issued a warning and a call to action for legislative change.
“Regulation 3802 completely stops a legal way to help reduce the cannabis excise tax. [However, no matter what happens with Reg. 3802] you’re going to have to hope that you have legislative action because the CDTFA has the authority to increase the excise tax beginning in 2025 up to 19%.”
And that’s less than a year away.
