It may be a new year, but Catalyst CEO Elliot Lewis is still fighting California regulators. This time, Lewis is suing the state’s Department of Tax and Fee Administration (CDTFA) over emergency regulations that were approved last month, which Lewis says improperly squeezes more taxes out of cannabis operators.
“Respondents’ primary purpose in enacting such new/amended regulations was to improperly expand the cannabis excise tax base and to prevent HNHPC and other “Catalyst”-branded dispensaries from continuing to properly exclude ‘cannabis accessories’ from the cannabis excise tax,” argued attorney Jeff Augustini in the 41-page lawsuit he filed on behalf of HNHPC Inc., the parent company of Catalyst, on Dec. 28 in Orange County Superior Court.
While decrying the state’s new cannabis taxation rules, Catalyst’s lawsuit claimed that the most recent emergency regulation was improperly enacted without any opportunity for public input.
“The blatant money grab by the State, and the procedurally improper and downright shady way in which they went about it – declaring a non-existent emergency, promulgating emergency regulations on little notice, only to secretly change them or create entirely new regulations after the public notice period had ended, etc. –should be a wake-up call to everyone in the industry as well as to all consumers and California voters,” wrote Augustini in a social media post announcing the lawsuit he filed on behalf of Catalyst.
California changes excise tax calculation after tax revenue drops
California amended how cannabis was taxed when the state legislature passed AB 195 during the summer of 2022, which among other things, eliminated the state’s cultivation tax and shifted the obligation of collecting and paying excise taxes from distributors to retailers.
Following the shift, overall tax revenue from cannabis dropped, so the CDTFA further changed the rules for cannabis taxation by requiring that all retailers calculate their excise tax burden based on the total cost of products purchased from suppliers, regardless of whether or not they were actual cannabis products or just accessories.
The state’s Office of Administrative Law allows regulatory agencies to issue emergency rules if there is an immediate need for the change. The CDTFA submitted proposed emergency regulations clarifying its definition of “total sales receipts” on Nov. 27, 2023. The OAL approved the language change on Dec. 15, putting the new rules into immediate effect.
Prior to the rule change, Catalyst separated its pricing for cannabis and non-cannabis accessories, in order to minimize its excise tax burden, but that practice was scrutinized by the state when it initiated an audit of Catalyst in January 2023 for sales that occurred in the previous year. Eventually, the state would agree that Catalyst was properly accounting its taxes.
“Eventually, the CDTFA acknowledged in writing that the Catalyst Distributor’s interpretation of its excise tax obligations was correct, and that the ‘cannabis accessories’ which had been separately stated on invoices provided to the Catalyst-branded retailers were not subject to cannabis excise tax,” said the complaint.
Catalyst claims that by calculating excise taxes based on total retail receipts, store owners are being unfairly taxed for non-cannabis items, such as the battery and heating element in a vape pen that comes with a THC oil cartridge.
“Stated differently, to maintain or even expand excise tax revenues to the State, Respondents via regulatory coercion are attempting to force cannabis retailers and consumers to massively overpay excise tax and to prevent them from complying with the law, which clearly allows them to exclude cannabis accessories from cannabis excise taxation,” said the complaint.
In contrast, the state’s own emergency regulations clarify that while excise taxes are calculated based on total sales receipts, the operators are allowed to exclude “optional tangible personal property,” which is defined as any non-cannabis product that is not required when purchasing a separate cannabis product. For example, the cost of the jar that flower comes in is taxed, but the glass pipe that is also purchased to consume that flower is optional and does not incur an excise tax.
In terms of total dollars, the state collected more than $300 million every quarter from third quarter 2020 until second quarter 2022, but has not been able to break $300 million since then. During that same time, tax revenue averaged between 23% and 25% of total sales. That percentage dropped to about 19% when the state stopped collecting taxes directly from cultivators halfway through 2022. Since then, the percentage rebounded to 21.5% by the third quarter 2023 as the state started officially collecting excise taxes on “all retail sales,” which includes accessories.
A spokesperson from the CDTFA did not respond to an emailed request for comment.
Catalyst’s other pending lawsuits
Lewis previously sued the State of California over what it claims was the state’s failure to properly track legal cannabis through the METRC Track and Trace program. That case was dismissed until an appellate court revived the suit last August. A case management conference is scheduled for Feb. 26, 2024.
Catalyst also sued Glass House Brand last June alleging that the cultivation giant was diverting cannabis products through “burner distros” that took advantage of what Catalyst claims was the State of California’s failure to operate a functioning track and trace system.
At the time of his original filing Elliot Lewis repeatedly stated on social media that part of his intention with the lawsuit was to use discovery to unveil operators that were using “burner distros” to skirt the state’s track and trace requirements while diverting product to the illicit market.
Two weeks later, Glass House Brands struck back with a defamation countersuit.
Both cases remain in their pre-trial phase. Most recently, METRC got involved with the defamation suit in an attempt to block Catalyst’s motion for discovery. METRC and Catalyst are awaiting a Feb. 16 hearing to consider Catalyst’s motion to compel further discovery from the track and trace giant. Catalyst and Glass House will also return to the court Feb. 27 for another discovery hearing in their original case over alleged burner distros.
