By James Hunt
Washington’s legislative session saw a flurry of cannabis bills that grappled with regulating the medical marijuana market.
In April, Gov. Jay Inslee signed into law the Cannabis Patient Protection Act, which established the same comprehensive regulatory structure for medical marijuana that already existed for the state-licensed recreational sector. As a consequence of this legislation, businesses currently operating in the medical marijuana space must now be licensed by the Liquor and Cannabis Board, and will need to reexamine prior year state taxes. Also, all retailers must obtain a medical marijuana endorsement in order to sell marijuana to qualifying patients or designated providers, and producers must state an intention to produce marijuana for sale by marijuana retailers holding medical marijuana endorsements.
In June, the governor signed into law House Bill 2136, which significantly changed the tax structure for the medical and recreational cannabis markets. The 25% three-tier excise tax has effectively been replaced with a 37% trust fund tax levied on the consumer and remitted by the retailer. The excise tax is in addition to sales tax and must be separately itemized on the sales receipt provided to consumers, but medical patients can qualify for a tax exemption. Bundled transactions and conditional sales are prohibited.
Applying for a License under the CPPA
The Cannabis Patient Protection Act mandates a competitive, merit-based licensing system that will use three levels of preference to evaluate applicants. In order to qualify for the first and second preferences, applicants must “have a history of paying all applicable state taxes and fees.”
As of this writing, the Liquor and Cannabis Board is in the early stages of crafting regulations. However, it’s possible that the agency will adopt guidance similar to current regulations, requiring applicants for a marijuana license to be “current in any tax obligation to Washington State as an individual, or as part of any entity in which they have an ownership interest.” Collective gardens and dispensaries that historically have not filed state excise tax returns risk being assigned the lowest priority in this application process.
In addressing historic tax liabilities collective gardens and access points should be aware of three issues: Washington’s voluntary disclosure program, the Compassionate Kitchen case and successor tax liability.
Voluntary Disclosure
The state Department of Revenue offers a program that allows taxpayers to come forward and pay prior year taxes. Generally, the department will require taxes for the current tax year and the prior four tax years. Current participants will need to file tax returns from 2011 to 2015. For participants, the department will waive the imposition of penalties of up to 35%. Other benefits include a simplified compliance process, as well as a formal filing agreement. Taxpayers that have been previously contacted by the department do not qualify for the program, which may disqualify many collective gardens and access points.
However, the implementation of this new regulatory system for medical marijuana deserves a closer look. First, the clear intent of the Cannabis Patient Protection Act is to create a regulatory framework for medical marijuana and to ensure compliance with all state and local laws. Second, growers, dispensaries and patients have been exposed to several conflicting views on the taxability of medical marijuana. On one hand, the Department of Revenue has a longstanding opinion that the transfer of medical marijuana is subject to sales tax. Yet, the taxability has successfully been challenged by a dispensary in Washington Superior Court.
Given the historic uncertainty present in Washington’s medical marijuana laws, I advocate that every effort should be made to outline a fair process for medical marijuana applicants to address prior year tax liabilities and issues.
The Compassionate Kitchen
In March, the Washington Superior Court in Spokane County reversed a Board of Tax Appeal’s decision and held that sales of medical marijuana are exempt from retail sales tax.
In that case, Rhonda Duncan had been operating a medical marijuana dispensary called the Compassionate Kitchen. She originally did not collect sales tax from patients; however, at some point she paid the prior year’s sales tax. Subsequently, she filed a refund claim which was consistently denied by the Department of Revenue and the Board of Tax Appeals. Duncan appealed the board’s decision. She presented the court a highly technical statutory argument: the strict language of the relevant sales tax exemption statute encompasses the sale of medical marijuana as a prescription drug. As such, the sale of medical marijuana is not subject to sales tax. The Superior Court agreed. The case is now under appeal at the Washington Court of Appeals, Division III. My view is that the case may proceed to the state Supreme Court.
The Compassionate Kitchen puts collective gardens and dispensaries that pay prior year’s sales tax in the awkward position of possibly paying tax on a transaction may ultimately be determined exempt by the courts.
Successor Liability
Those who are considering purchasing or otherwise transforming an existing Washington non-profit corporation currently operating a dispensary must consider the application of Washington’s successor tax liability statute.
When a taxpayer quits a business, sells or “otherwise disposes of” more than 50% of the fair market value of either its tangible assets or intangible assets, all tax of the business is immediately due and payable. If tax is not paid within 10 days of the date of sale or disposal, the successor is liable for full payment of tax due. If the fair market value of the assets are less than $50,000, successor liability is limited to the fair market value of the assets.
A successor may avoid tax liability if notice is given to the Department of Revenue, and the Department of Revenue does not assess tax within six months of receipt of such notice.
Accordingly, any restructuring of a medical marijuana dispensary currently operating should consider the impact that the successor tax liability statute may have on the anticipated transaction.
A number of state tax considerations face those who wish to participate in the production or retail sale of medical marijuana under Washington’s newly-modified regulatory structure. Potential applicants should consider the impact prior taxes may have on their licensing process. Hopefully, these issues will be addressed by the Liquor and Cannabis Board and/or the Department of Revenue as new applications move through the system.
James Hunt is a Seattle-based tax attorney who advises clients operating in the cannabis industry. He is a regular speaker and blogger on federal and state tax issues regarding the industry, and can be reached at jim@jghuntlaw.com.