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Up in smoke: A primer on cannabis taxation in Canada

Wednesday, October 17, 2018 @ 9:04 AM | By Beverly Gilbert and Bhuvana Sankaranarayanan

Beverly Gilbert and Bhuvana Sankaranarayanan %>
Beverly Gilbert and Bhuvana Sankaranarayanan
As of Oct. 17, the production, sale and recreational use of cannabis will be legal, if heavily regulated. Legalization begets taxation; consequently, a new regulatory regime in respect of the taxation of cannabis also applies to sales of the product. This article provides a short overview of the general tax, duty and mark-up regimes that will apply to the sale of cannabis products as of the legalization date.

Federal cannabis duty and licensing regime

Generally, all cannabis products entering the consumer market for purchase will be subject to a federal excise stamp and duty framework implemented through amendments to the Excise Tax Act, 2001, which currently governs excise duties applicable to tobacco products and alcoholic beverages. The new Part 4.1 of that Act is intended to apply to tax cannabis “without undermining the government’s goals of keeping cannabis away from children and keeping profits out of the hands of criminals” (i.e., pricing cannabis at a rate competitive with the black market).

What is taxable?

The Excise Act, 2001 imposes duties on “cannabis products,” and implements the tax through an excise stamp regime. Only packaged products with the appropriate duty-paid stamps can be sold to consumers in Canada.

“Cannabis Product” means any “product that is cannabis” which is not industrial hemp, an industrial hemp byproduct, or a prescribed substance. The draft Excise Duties on Cannabis Regulations prescribe two exclusions from the definition of “cannabis product”: a cannabis “test kit” as defined under the Narcotic Control Regulations and a “reference standard.” A cannabis test kit is used to test for the presence of cannabis, where a reference standard is a sample of cannabis, used as measurement standard in the course of scientific or research purposes.

 “Cannabis” is defined as “a cannabis plant and anything referred to in Schedule 1 (of the Cannabis Act) but does not include anything referred to in Schedule 2 (of the Cannabis Act).” “Cannabis” for duty purposes thus includes all processed and unprocessed cannabis plants, any substances or mixtures containing cannabis plants, and any cannabinoid compounds or identical substances found in cannabis plants, but excludes cannabis stalks and stalk fibers, cannabis roots, and non-viable cannabis seeds.”

What is exempt?

The cannabis duty is not payable on several classes of cannabis products, such as low-THC cannabis products (containing less than 0.3 per cent THC), prescription cannabis drugs (cannabis products with a Drug Identification Number and only available via prescription) and cannabis products meant to be exported.

Additionally, cannabis grown for personal use, whether for recreational or medical purposes, is generally not subject to the cannabis duty if grown by an individual in compliance with cannabis laws.

Co-ordinated cannabis taxation agreements

The federal and provincial authorities are co-ordinating the implementation of a cannabis duty through so-called Coordinated Cannabis Taxation Agreements (CCTA), which have been ratified by all provinces other than Manitoba. Under each CCTA, the federal government is solely responsible for administering and enforcing duties on cannabis, with revenues split 25/75 in favour of the participating provinces. The CCTAs further cap the federal government’s share of cannabis duty revenue at $100 million annually for the first two years after legalization, with additional revenue flowing back to the provinces.

In exchange for this favourable revenue structure, the signatory provinces have agreed to restrict their own duties and taxes to those permitted under the CCTAs. In particular, this means agreeing to impose only “reasonable” margins and mark-ups on the wholesale distribution of cannabis (to account for operating and capital expenses, and a rate of return comparable to the private sector’s) and imposing further mark-ups and taxes at a rate that does not, in aggregate with the particular province’s general sales tax rate, exceed the highest provincially imposed retail sales tax.

Provinces have two options with respect to imposing these limited additional sales taxes. First, some provinces have subscribed to a mechanism provided for within the Excise Tax Act, 2001 framework itself, called the “Sales Tax Adjustment.” This Sales Tax Adjustment bumps up the provincial portion of the cannabis duty rate applicable to the sale of products in each province. The second option, chosen by provinces such as British Columbia, is to forgo the Sales Tax Adjustment for the right to impose a mark-up greater than what is “reasonable” under the CCTA, in order to increase the total revenue to match the highest provincially imposed retail sales tax.

The provinces will also generate additional revenue through acting as cannabis wholesalers and distributors, and in many provinces, through acting as retailers as well. Manitoba, which has not signed a CCTA, will impose its own unique taxation framework, although cannabis products sold in Manitoba will still be subject to the federal portion of the cannabis duty.

In total, cannabis products sold in Canada (except Manitoba) will be subject to the following government duties:

  • Federal portion of the cannabis duty;
  • Provincial portion of the cannabis duty;
  • Provincial sales tax adjustment or comparable provincial wholesale mark-up; and
  • Federal GST/HST (which should be payable except in the case of certain prescription cannabis products).

Looking forward

Although the exact intricacies of some aspects of the taxation of cannabis remain ambiguous as of Oct. 17, what is crystal clear is that commercial cannabis products are intended to — and likely will — raise substantial federal and provincial government revenue. Whether the taxes imposed on regulated and legalized cannabis will allow it to remain competitive with the underground market remains to be seen.

Beverly Gilbert is the national leader of the commodity tax group at Borden Ladner Gervais LLP. Bhuvana Sankaranarayanan is an associate in the firm’s tax group. The authors wish to thank Braek Urquhart, an associate in the firm’s commodity tax group, for his substantial contribution to this article.

Photo credit / mrhighsky ISTOCKPHOTO.COM

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