February 4, 2025
TO: City Council
REQUESTED BY: Erika Gomez, Finance Director
APPROVED BY: Robert A. Johnson, City Manager
SUBJECT: Cannabis Tax Rates Discussion
RECOMMENDATION:
Staff recommends that the City Council provide direction to staff regarding the Cannabis Business Tax.
BACKGROUND:
In November 2016, the citizens of San Jacinto overwhelmingly approved Measure AA, authorizing the City Council to impose taxes on commercial cannabis businesses of up to $50 per square foot for cultivation and manufacturing space and 15% of gross receipts (sales). Measure AA did not explicitly authorize or permit the cultivation or sale of cannabis, but rather posed this question:
In the event future State or local law permits marijuana [cannabis] activities to operate in the City of San Jacinto, shall the City enact a tax on marijuana activities of up to $50 per square foot of space utilized for marijuana cultivation or manufacturing, and up to 15% of the gross receipts from marijuana and related products, generating approximately $1,250,000 annually to pay for general City services, such as police, fire, and parks, until ended by voters? Measure AA was approved, with nearly 68% of voters in favor compared to 32% in opposition.
In addition to establishing the maximum tax rate for cannabis-related activities, Measure AA also included Ordinance 16-08, which established Chapter 3.32 – Cannabis/Marijuana Business Tax, added to Title 3 – Revenue and Finance, of the San Jacinto Municipal Code. Following the adoption of Measure AA, the City Council adopted Ordinance 16-16, establishing the following tax rates consistent with Measure AA and Ordinance 16-08:
1. Fifteen cents ($0.15) for each one dollar ($1.00) of gross receipts or fractional part thereof on any retail sale of marijuana, marijuana accessories, or marijuana products (as defined in Section 3.32.030(C)); and
2. Ten dollars ($10.00) per square foot of space utilized in connection with the distribution, transport, and any other commercial activity licensed under Division 10 of the Business and Professions Code, whether related to cannabis, cannabis-infused products, or other cannabis-related products (as defined in Section 3.32.030(E)), other than retail sale of said products.
3. Fifteen dollars ($15.00) per square foot of space utilized in connection with the outdoor cultivation of cannabis within the jurisdiction.
4. Fifteen dollars ($15.00) per square foot of space utilized in connection with the testing of any type of marijuana within the jurisdiction.
5. Twenty-five dollars ($25.00) per square foot of space utilized in connection with the indoor cultivation of cannabis within the jurisdiction.
6. Twenty-five dollars ($25.00) per square foot of space utilized in connection with the manufacturing of marijuana of any type within the jurisdiction.
For clarity, it's important to note that during the initial processing of cannabis-related applications and ballot measures, the term "Marijuana" was used. However, as the industry evolved and legal frameworks were refined, the terminology shifted to "Cannabis" to better align with its scientific nomenclature and to avoid the negative connotations historically associated with the term "Marijuana." This change reflects a broader effort to adopt more accurate and respectful language in legal and regulatory contexts. For the purposes of this report, Marijuana and Cannabis should be considered the same product, as the two are used interchangeably to reflect the terminology in effect at the time.
Also, on the November 2016 ballot was Proposition 64 (Adult Use of Marijuana Act [“AUMA”]), which, as approved by 57% of votes, legalized the adult recreational use of cannabis by persons 21 years or older.
In April 2017, the City Council approved Ordinance 17-02 authorizing and establishing development standards for the commercial cultivation of marijuana within the IL, Light Industrial Zones of the City. Ordinance 17-02 only permitted Commercial Marijuana Cultivation as defined as “cultivation, possession, manufacture, distribution, processing, storing, laboratory testing, labeling, transportation, distribution, delivery or wholesale sale of marijuana and marijuana products, including but not limited to medical, commercial and recreational marijuana and marijuana products” and did not allow for the commercial sale or distribution of marijuana.
Ordinance 17-02 allowed the City Council to limit the number of indoor and outdoor cultivation facilities and initially elected for three of each, for a total of six citywide. In September 2017, the City Council adopted Resolution No. 3680, increasing the number of facilities to eight each, for a total of 16 citywide as most of the licenses had been claimed, but none constructed.
In early 2018, the City Council requested an update on the status of the various licenses, as none had made progress to start operating and many were starting to use the licenses as a commodity, preventing other businesses that may have had the financial wherewithal to actually construct and operate a facility.
In January 2019, the City Council directed staff to evaluate and update the cannabis regulations to reduce or eliminate some of the extraneous regulations while identifying opportunities for streamlining as well as to better align the local regulations with state requirements.
On June 4, 2019, the City Council adopted Ordinances 19-10, 19-11, and 19-12 to provide a comprehensive update to the cannabis regulatory framework and Resolution 3755, establishing the new tax rates for non-retail cannabis uses and businesses. Ordinance 19-10 amended Title 17 of the Municipal Code (Development Code) to, among other things, authorize the establishment of Dispensaries and Microbusinesses, thereby allowing retail sales for the first time within the City.
Over the past few months, there have been requests from some dispensary owners and their employees to revisit and reduce the cannabis retail tax from 15% to a lower amount consistent with current rates in other Riverside County Cities. These comments have been received in both form letters (the same letter used multiple times by different operators) as well as a few public speakers.
At the August 20, 2024, City Council meeting, Councilmember Hawkins requested that an item be brought to the Council to discuss the tax rate to determine if the rates should be reduced.
At the October 1, 2024, meeting, City staff presented a report to the City Council that outlined the history of cannabis in the city, provided a comparison with the tax rates in other jurisdictions, and estimated the potential impacts on the City's budget if the rates were to be reduced. After reviewing the report, the Council voted 4-1 in favor of advancing a resolution to reduce the Cannabis Business Tax on dispensaries and microbusinesses to 8% of gross receipts. The Council also requested additional information, including a detailed analysis of budgetary impacts and quarterly data, to be presented concurrently with the resolution.
At the October 15, 2024, City Council meeting, City staff presented a report to the City Council that included the requested information. The City Council voted 3-2 to approve Resolution 4046, reducing the Cannabis Business Tax on dispensaries and microbusinesses to 10% of gross receipts. The resolution became effective on January 1, 2025.
At the December 17, 2024, City Council meeting, Councilmember Ruiz requested an item to reconsider cannabis tax rates.
DISCUSSION:
Limitations on the Number of Dispensaries
When the City initially permitted cultivation uses and imposed a limit on the number of licenses, these licenses were awarded on a first-come, first-served basis. This approach created several unforeseen challenges. Firstly, while early applicants secured their licenses, there was little to no incentive for them to commence operations promptly. As a result, the City did not benefit from the expected tax revenue, as many of these license holders delayed opening their businesses.
Furthermore, these licenses quickly became valuable commodities, with holders "selling" them to higher bidders rather than establishing their operations. This practice led to a secondary market for licenses, complicating the regulatory landscape. Some license holders would circumvent the system by temporarily adding a new owner to the license, only to later reduce their ownership stake to 1%, effectively transferring control of the business without jeopardizing the license.
Given these past experiences, imposing a limit on the number of dispensaries could lead to similar issues. Dispensaries currently operating within the City would gain an unfair advantage as they already hold licenses, potentially stifling competition and innovation. To avoid repeating these challenges, the City is proposing to let the market naturally determine the appropriate number of dispensaries. This approach promotes fair competition, ensures a more dynamic market, and better aligns with the City’s regulatory goals.
Taxation Structure for Retail Cannabis
The taxation of retail cannabis within the City is part of a broader system that includes both state and local taxes, each playing a crucial role in the regulation and revenue generation associated with the legal cannabis market. While state-level taxes establish a foundational structure, the City’s tax policies significantly impact how cannabis businesses operate locally.
At the state level, cannabis sales are subject to a 15% excise tax on the gross receipts of all cannabis products sold at retail. This excise tax is now required to be included as a separate line item on the receipt at the point of sale, ensuring transparency for consumers regarding the amount being paid toward this specific tax.
Locally, the City imposes a 15% business tax on the gross sales of cannabis businesses operating within the City. Unlike the state excise tax, the City's business tax is not added as a separate charge to consumers but is instead absorbed by the businesses themselves. This means that cannabis businesses must account for this tax within their overall pricing strategies, impacting profit margins and potentially influencing the final price of products available to consumers.
In addition to these cannabis-specific taxes, cannabis transactions in the City are also subject to California’s standard state sales tax, which currently stands at 8.75% for San Jacinto. This sales tax is applied uniformly across most goods and services sold within the state, including cannabis.
Of this 8.75%, the City directly receives 2%, which includes 1% from the Bradley-Burns uniform local sales tax and an additional 1% from the voter-approved Measure V. However, for the purposes of this discussion, sales tax revenue is not included in the analysis of City revenues, as it is not unique to cannabis and applies to all taxable goods sold within the City, but is included for clarification and background.
This taxation structure, while complex, is vital for supporting the local regulatory framework.
The revenue generated from these taxes is used to fund a variety of public programs and services at both the state and local levels, including public health initiatives, enforcement of cannabis regulations, and community development projects. Within the City, the revenue from the business tax contributes directly to local services and infrastructure, reinforcing the City’s commitment to responsibly managing the legal cannabis market.
SB 1059
At the October 1 meeting, a dispensary owner raised concerns about the legality of using a gross receipts-based tax model. The owner asserted that as of September 28, 2024, it is illegal for a city to charge a cannabis business tax based on gross receipts. Upon further analysis, it has been determined that gross receipts are a legal basis for taxation. The law simply seeks to clarify what can be included in the definition of gross receipts. The relevant code section states:
SECTION 1. Section 16005 is added to the Business and Professions Code to read:
16005. (a) A city shall not include in the definition of gross receipts, for purposes of any local tax or fee imposed by the city on a cannabis retailer licensed under Division 10 (commencing with Section 26000), the amount of any cannabis excise tax imposed under Section 34011.2 of, or any sales and use taxes imposed under Part 1 (commencing with Section 6001) of, Part 1.5 (commencing with Section 7200) of, or Part 1.6 (commencing with Section 7251) of, Division 2 of the Revenue and Taxation Code, or Section 35 of Article XIII of the California Constitution. (b) For purposes of this section, city includes a charter city and a city and county.
The City’s method for determining gross receipts has been compliant with applicable regulations since the commencement of dispensary operations in San Jacinto. In compliance with SB 1059 and previously established practice, the City does not include the State’s cannabis excise tax or sales and use taxes when determining gross receipts to calculate the local business tax.
State Excise Tax
1. Cannabis Excise Tax (Effective January 1, 2018):
a. The cannabis excise tax of 15%, became effective on January 1, 2018. This tax has been in place for several years and applies to the purchase of cannabis or cannabis products. It is important to note that this tax itself has not changed.
2. Before January 1, 2023:
a. Cannabis retailers paid the excise tax to distributors for the cannabis they purchased. Distributors were responsible for calculating and collecting this tax based on the average market price.
b. When retailers sold cannabis to their customers, they were required to collect the excise tax from the customer, but this tax was already included in the price. The tax didn’t need to be itemized on the receipt. Instead, the receipt included a statement saying, "The cannabis excise taxes are included in the total amount of this invoice."
3. After January 1, 2023:
a. The way the tax is collected changed. Retailers now collect the excise tax directly from customers at the point of sale. The distributor is no longer responsible for collecting this tax from the retailer.
So, while some are under the impression that a new tax took effect on January 1, 2023, this is incorrect. The tax itself didn’t change; only the method of collection did. Retailers now handle remittance to the CDTFA directly, rather than the distributor.
This change streamlines the process but doesn’t introduce a new tax. It was effected through the passage of AB 195, a tax reform bill intended to provide tax relief to the industry. In addition to the changes discussed, AB 195 also eliminated the 15% state cultivation tax. AB-195’s changes, therefore, not only reduced taxes for the industry overall but also alleviated some of the compliance inefficiencies created by California’s former cannabis tax regime.
Retail Cannabis Tax Gross Receipts in the City
The financial data below highlights the strong performance of cannabis dispensaries in the City, with revenue reaching an all-time quarterly high in the fourth quarter of fiscal year 2024. As demonstrated in the accompanying table, the cannabis sector continues to experience ongoing consumer demand and market stability.
FY Quarter Gross Receipts
2020/2021 3 491,140.00
4 2,716,020.00
2021/2022 1 4,662,333.33
2 4,831,440.07
3 4,919,426.13
4 4,746,055.00
2022/2023 1 4,232,658.93
2 3,939,840.00
3 3,553,940.47
4 3,628,845.13
2023/2024 1 4,086,407.13
2 4,989,887.00
3 4,653,600.00
4 5,166,438.00
Grand Total 56,618,031.20
It is important to note that declining sales are typically the first sign of a business in distress. A downward trend in revenue often points to underlying issues such as decreased consumer interest, rising competition, or operational inefficiencies. These challenges can eventually lead to more severe financial problems, including cash flow shortages and potential business closures.
However, the data shows no such decline in San Jacinto. Instead, the revenue figures presented indicate a resilient market.
Use of Cannabis Retail Business Taxes
The Cannabis Business Tax is a General Tax and is not earmarked or set aside for specific uses.
Instead, it is General Fund Revenue, which is used to pay for general city services. The adopted FY24/25 budget included $39,495,823 of projected recurring revenue, including $3,879,134 from the Cannabis Business Tax. This projected revenue is comprised of retail and non-retail taxes, with retail accounting for $2,779,444 and non-retail accounting for the remaining $1,099,690. Cannabis Business Tax Revenue generated by retail sales makes up 7.04% of the General Fund’s recurring revenue budget.
At the City Council’s request, the preceding information has been provided for evaluation in conjunction with the matter of reducing the tax. Some of the options for reduction and their impacts are presented below:
Option 1 – Maintain the 10% Tax Rate
Option 1 would retain the existing 10% Retail Cannabis Business Tax. However, because revenue estimates for FY 24/25 assumed a 15% tax rate, it is anticipated that this option will result in a revenue shortfall for FY 24/25. If this option is chosen, the effective tax rate for FY 24/25 would be 12.5%, demonstrated in the table below.
Q1 July - September 15.00%
Q2 October - December 15.00%
Q3 January - March 10.00%
Q4 April - June 10.00%
FY 24/25 Effective Tax Rate 12.50%
Tax revenue from dispensaries and microbusinesses was originally estimated at $2,779,444. If Option 1 is chosen, the revenue estimate decreases by $463,241 to $2,316,203. In other words, budgeted revenues will fall short of the original estimate by approximately 16.66%.
Thereafter, tax revenue from dispensaries and microbusinesses is anticipated to fall short of base year revenues (FY 23/24) by 33.33% indefinitely.
Option 2 – Reinstate a 15% Tax Rate
Option 2 would reinstate the 15% tax rate. This option would have the smallest impact on the City’s budget. If this option is chosen, the effective tax rate for FY 24/25 would be 13.75%, demonstrated in the table below.
Q1 July - September 15.00%
Q2 October - December 15.00%
Q3 January - March 10.00%
Q4 April - June 15.00%
FY 24/25 Effective Tax Rate 13.75%
Tax revenue from dispensaries and microbusinesses was originally estimated at $2,779,444. If Option 2 is chosen, the revenue estimate decreases by $231,620 to $2,547,824. In other words, budgeted revenues will fall short of the original estimate by a more manageable 8.33%.
Thereafter, tax revenue from dispensaries and microbusinesses is anticipated to stabilize and remain consistent with base year (FY 23/24) revenues.
Option 3 – Adopt a Tax Rate below 15%
Option 3 would reduce the retail tax rate to some other rate below 15% determined by the City Council. This change would reduce tax revenues proportionate to the percentage change in the tax rate when compared to the base year tax rate of 15%.
Staff has drafted a resolution that would adjust the Cannabis Business Tax on microbusinesses and dispensaries pending direction from the City Council. The resolution includes an effective date of April 1, 2025.
Staff recommends that the City Council consider the information and provide direction regarding the Cannabis Business Tax.
FISCAL IMPACT:
• If the City Council maintains the 10% tax rate, it is anticipated that the City will receive
33.33% less than base year tax revenues. This is equal to a reduction in revenue of $944,817 annually.
• If the City Council increases the tax rate to 15%, the City’s tax revenue from dispensaries and microbusinesses will remain consistent with base year tax revenues. • If the City Council adopts a different tax rate below 15%, the City’s tax revenue from dispensaries and microbusinesses will be reduced proportionately to the percentage change in the tax rate as compared to the base year tax rate of 15%.
ATTACHMENTS:
San Jacinto - Resolution Setting Cannabis Tax Rate