We previously identified a number of sales tax exemptions available to California cannabis cultivators. Fortunately, the state legislature is looking out for other businesses up and down the supply chain, such that cultivators are not the only class of licensee eligible for sales tax exemptions. This post will focus on a partial tax exemption available to manufacturers and other cannabis businesses engaged in certain research and development. It’s an important exemption to understand.
First, the tax exemption is not so much an exemption as a reduction of the state sales tax rate. For example, an Oakland manufacture’s purchase of $100,000 of qualified equipment ordinarily pays state and district sales tax at a rate of 9.25%. The 9.25% rate includes a state rate of 7.25% and a district rate of 2.0%. In this example, the sales tax due is $9,250. With the partial exemption, the state sales tax rate is reduced from 7.25% to 3.3125%. Accordingly, the sales tax due is $5,312 [$100,000*(3.3125%+2.00%)] resulting in a total tax savings of almost $4,000.
A manufacturer must satisfy three key requirements to qualify for the credit:
- The manufacturer must be a “qualified person”;
- The manufacturer must purchase “qualified equipment”; and
- The equipment must be used in a “qualified manner”.
Note that the partial exemption applies to qualified equipment that is leased as well as purchased. The requirements are very specific and somewhat technical. What follows are the key points to consider when purchasing equipment.
A qualified person is a business that engages more than 50% of the time in a business activity described in the North American Industry Classification System (NSICS) under manufacturing codes 3111-3399 or codes related to research and development, revised codes 541713 or 541715. The NSICS code is a standard used by the federal government to classify businesses. It is no surprise that NSICS codes have not been created for the cannabis industry. However, it appears that all cannabis manufactures should qualify for Miscellaneous Manufacturing, Code 339999. Accordingly, all cannabis manufactures and processors should be considered qualified persons for purposes of the credit.
Determining what research and development businesses qualify is more difficult. The research and development class is narrowly defined. However, the CDTFA website suggests (without providing much detail) that certain product development and process improvement activities may qualify for the partial exemption. It is fair to say that any cannabis company operating a testing or genetics lab should look at this credit closely.
A wide variety of tangible property (i.e., equipment) qualifies for the partial exemption. First, the manufacturing process is broadly defined and includes tangible personal property involved in:
“manufacturing, processing, refining, fabricating, or recycling of tangible personal property, beginning at the point any raw materials are received by the qualified person and introduced into the process and ending at the point at which the manufacturing, processing, refining, fabricating, or recycling has altered tangible personal property to its completed form, including packaging, if required.”
Qualified Equipment includes:
- Packaging equipment “necessary to prepare goods so that they are suitable for delivery to and placement in finished goods inventory, including repackaging to meet the needs of a specific customer.” This definition is expansive and should include equipment that trims, packs, and seals cannabis products for sale in compliance with MAUCRSA:
- Pollution control equipment;
- Quality control equipment;
- Component parts such as belts, shafts and moving parts;
- Equipment used to operate, control, regulate or maintain the machinery including:
- Repair and replacement parts (with a useful life of more than one year);
- Special purpose buildings used in manufacturing or that constitute a research facility;
The following equipment generally does not qualify for the partial exemption:
- Consumables with a useful life of less than one year;
- Equipment used to store finished products (e.g., shelving); and
- Equipment and property used in administration, management, or marketing.
To meet this requirement, the tangible property must be used more than 50% of the time in:
- Any stage of the manufacturing process;
- Research and Development;
- Maintenance, repair, or quality control activity related to qualified equipment.
Generally, a seller of manufacturing and research and development equipment is required to collect sales tax from the buyer at the time of sale. However, a seller is not required to collect the full amount of sales tax if they receive from the buyer a partial exemption certificate, Form CDTFA 230-M.
The exemption certificate is proof that the seller properly collected a reduced amount of sales tax and protects the seller. The CDTFA can not collect the full amount of sales tax from the seller on audit provided that the seller accepts the exemption certificate in good faith. The good faith standard is reasonable easy to satisfy. However, the seller should look out for buyers tendering certificates for purchases of products that obviously do not qualify, such as consumables or office equipment.
If California sales tax is not collected by the seller, a California purchaser of manufacturing equipment is required to pay use tax. For example, the Arizona manufacturer of a dryer may not be required to collect California sales tax if the equipment is shipped from Arizona to a California cannabis business. In this situation, the California cannabis business is required to self-assess use tax on its purchases. Provided that the equipment meets the qualifications discussed above, the purchaser may claim an exemption on their use tax return filed with CDTFA.
California cannabis businesses operate in a very challenging tax environment. All marijuana businesses should be aware of the type of tax exemption available; aggressively pursue all that they qualify for; and, properly document all exemptions they claim. For large capital expenditures, a cannabis business should consider requesting from the CDTFA written confirmation that the planned expenditure qualifies for exemption. A cannabis business that discloses its name and accurately describes the facts of the transaction, may rely on the CDTFA’s determination.