Splitting the Pot: The Federal Government’s Cannabis Taxation Framework

Background

After almost two decades of debate about whether to maintain the status quo, or decriminalize minor cannabis possession laws, current Prime Minister Justin Trudeau dropped a bombshell. Rather than proposing to implement either of the previously suggested options, during the 2015 federal election, the Liberal Party of Canada included the legalization of recreational marijuana, or cannabis, as a means of controlling and regulating the popular drug in its campaign platform.¹ Soon after winning a majority government, there was speculation that legalization would include special taxation rules for recreational cannabis, mainly because it will undoubtedly be a significant boon for the federal government. 

On November 30, 2016, the government released “A Framework for the Legalization and Regulation of Cannabis in Canada” (the “Initial Framework”), which outlined a general proposal for the taxation of cannabis.² On February 27, 2018, after ongoing consultations with the provincial and territorial governments, the federal government finalized its taxation framework for recreational and medicinal cannabis with the introduction of an excise duty on cannabis products.³ 

With passage of the Cannabis Act, the recreational use of cannabis became legal in Canada on October 17, 2018. And while the excise duty on cannabis has addressed most taxation issues surrounding the use of cannabis products, a few areas of concern remain.

Initial Framework

The Initial Framework was developed to provide general guidance on the regulation of recreational and medicinal cannabis in Canada.  One major area of concern is increasing levels of delta-9-tetrahydrocannabinol, or “THC”, found in certain cannabis strains. THC is the compound “chiefly responsible for the psychoactive effects of cannabis”.⁴ As THC consumption rises, the risk of adverse side-effects, such as depression or anxiety disorders, may also increase,⁵ and there are also added social dangers associated with its consumption, such as impaired driving. As a result, the Initial Framework proposed using taxation as a method of regulating THC, alongside maximum THC limits and THC quantity disclosure requirements for packaging to identify when a product may be harmful. 

Specifically, the Initial Framework suggested that any proposed legislation should implement a tax scheme under which cannabis products with a higher THC content per unit are taxed more than products with a lower THC content.⁶  Other tax proposals included: taxing medicinal and recreational cannabis in an identical manner; charging tax on a per unit basis, such as through an excise tax; and subjecting cannabis to both federal and provincial sales taxes.⁷ The Initial Framework also suggested that tax rates should be kept low, initially, so that product selling prices would not be markedly higher than prices in the existing illicit market.⁸ 

The Initial Framework also recommended that the wholesale distribution of cannabis, retail sales and enforcement should all be regulated by provincial and territorial governments.⁹ Indeed, the Cannabis Act charges the provinces and territories with this responsibility, while the federal government regulates the licensing and cultivation of cannabis, as well as the production, packaging and excise stamping of cannabis products. As a result, the proposals advised that any plan should distribute the tax revenues derived from cannabis sales in a manner that allows the provinces and territories to adequately oversee the distribution process and enforce provincial legislation.

Excise Duty Framework

In November 2017, the Government of Canada released a “Proposed Excise Duty Framework for Cannabis Products” (the “Excise Duty Framework” ), as well as legislative proposals and explanatory notes, related to the taxation of cannabis.¹⁰ Under the implementation of this framework, cannabis is subject to an excise duty through amendments to the Excise Act, 2001 (which also imposes excise duties on tobacco and alcohol products). As part of this tax regime, the government has introduced the following combined federal and provincial or territorial excise duty rates on recreational cannabis, which became effective upon legalization:

• $1.00 per gram of cannabis plant flower (which is “the whole or any part, other than viable seeds, of an inflorescence of a cannabis plant at any stage of development… but generally refers to the hairy, sticky, or crystal-covered parts of mature cannabis plants harvested for their high-potency content”)¹¹;
• $0.30 per gram of cannabis plant trim (which is plant material, other than the flower, used in a cannabis product)¹²; and
• $1.00 per seed or seedling for home cultivation.¹³

In addition, if a 10 percent ad valorem rate, calculated on the dutiable amount (i.e., the selling price), is higher than the flat duty rate for a cannabis product (as noted above), then the 10 percent rate will be used to determine the amount of duty imposed on that product. When first proposed, the rates presupposed coordination with provincial and territorial governments at similar taxation rates, and these were affirmed in various 2018 provincial and territorial budgets. At the time of writing, the federal and most provincial/territorial governments (all except Manitoba) had negotiated an agreement for the first two years after legalization, under which 75 percent of cannabis excise duty revenues will be shared with participating jurisdictions. The remaining federal portion (i.e., 25 percent) of cannabis excise duty revenues will also be capped at $100 million annually, with any excess being distributed to the participating provinces and territories.¹⁴ 

In addition, each province or territory can adjust the provincial or territorial component of the excise duty to be applied to cannabis products. At the time of writing, the provinces and territories listed below had put the following duty adjustments (i.e., additions to duty payable) in place:

• Alberta – 16.8%
• Nunavut – 19.3%
• Ontario – 3.9%; and
• Saskatchewan – 6.45%.¹⁵

The Canada Revenue Agency (“CRA”) is responsible for the administration of the cannabis duty regime, and cannabis duty is payable by the cannabis licensee that packaged the cannabis products for final retail sale at the time of delivery to the purchaser. Licensees are required to file a detailed Cannabis Duty and Information Return (Form B300) monthly.

Excise duty generally applies to any cannabis product that contains THC. However, a packaged product that contains a concentration of 0.3 percent or less THC is not subject to excise duty. Similarly, prescription drugs derived from cannabis are not be subject to duty. Note that this does not include medicinal cannabis; rather, this applies to prescription drugs that may contain cannabinoids (i.e., therapeutic compounds found in cannabis).

Transitional rules have also been introduced to account for timing differences in the production and distribution of cannabis products.

GST/HST on Cannabis Products

The Excise Duty Framework also affirmed that GST/HST applies to the sale of cannabis products. As quickly reported by the mainstream media, GST/HST is calculated on the selling price of such products after the inclusion of the applicable excise duty. Amendments to the Excise Tax Act (“ETA”) have been made to prevent cannabis product sales from benefitting from the zero-rating provisions for basic groceries and agricultural seeds and grains, as well as the exemption for certain sales by volunteers during fundraising activities for public service bodies. In addition, various changes have been made to preserve the tax relief afforded to grains, seeds and straw qualifying as industrial hemp.    

Provincial Rules and PST

Further complicating matters, at the time of writing, individual provinces had planned on regulating the recreational cannabis industry quite differently. For example, Quebec will open provincially owned retail shops throughout the province, in a similar structure to the current SAQ stores, with the government being the only legal seller of cannabis in the province. Initially, Ontario will only allow legal purchases of recreational cannabis through a government run online store. British Columbia and Manitoba, on the other hand, will use recreational cannabis license systems to enable the establishment of private cannabis stores. One wonders if some jurisdictions will sell cannabis through their stores at a high enough price to trigger the ad valorem duty rate and maximize their revenue. 

The Quebec Ministry of Finance has indicated that it will enact changes to the Quebec Sales Tax (“QST”) system so that the rules for cannabis are the same as those in place for GST/HST purposes, which means that both recreational and medicinal cannabis are generally subject to QST.

British Columbia and Saskatchewan both consider recreational cannabis to be tangible personal property and, as a result, in the absence of an applicable exemption (e.g., goods for resale), such products are subject to provincial sales tax (“PST”). British Columbia has announced that, effective October 17, 2018, PST also applies to medicinal (or medical) cannabis, regardless of how hazy the tax status of such supplies might have been in the past.¹⁶ Saskatchewan has adopted a similar position, recently stating that all cannabis sales, including medical cannabis, are generally subject to PST.¹⁷

Manitoba has announced that non-medical (i.e., recreational) cannabis will not be subject to PST. However, somewhat ironically, the province will continue to tax medical cannabis sales. Manitoba will also add a mark-up to all sales of non-medical cannabis (similar to the approach used for alcohol sales) and, effective January 1, 2019, introduce a “Social Responsibility Fee” to be collected from provincially-licensed retailers of non-medical cannabis.     

Alberta, which has no general PST, has indicated its intention to adjust the provincial component of the excise duty on cannabis sales in the province, as necessary.   

Commentary

It is evident that the federal government moved full-speed ahead with its recreational cannabis legislation. It is also clear that the provinces and territories will benefit greatly from the expected revenue stream to be provided by the excise duty on cannabis. And while it appears that the government took precautions to get things right, there are some potential issues.

First, the ad valorem rate duty amount could be substantial, as there are currently some strains available in the illicit market costing upwards of $20 per gram.¹⁸ In a legal marketplace, the price of higher quality strains could include an excise duty of $2 per gram, plus federal and provincial sales taxes. As a result, a strain costing $20 per gram in the illegal market would ultimately cost close to $25 per gram when purchased legally. This may have an adverse impact on one of the goals of the Initial Framework – to curb the illicit sale of cannabis products – if the total amount of tax and duty on cannabis products creates a significant price difference between legal and illicit sales. 

Another potential issue with the ad valorem rate duty is that it may not necessarily target and tax cannabis products with a higher THC potency effectively. For example, there are often premium strains that do not have high THC levels, but they command a higher price because the effects of consumption are less troublesome (i.e., less risk of anxiety or paranoia) or the psychoactive response (i.e., the “high”) has desirable attributes. Similarly, some lesser priced strains may still have a high THC potency, along with less desirable effects.¹⁹ Thus, while the ad valorem duty will increase the cost of higher priced strains, it will not necessarily meet the Initial Framework’s recommendation of limiting the potentially adverse effects of high THC quantities. 

In addition, the current excise duty rules do not provide much clarity on the taxation rates for other cannabis products.  Many cannabis dispensaries sell various forms of concentrated cannabis products, such as oils, hash, kief, shatter and distillates, which are meant to be smoked or vaporized in a similar manner to cannabis flower and are substantially more potent.²⁰ On a weighted basis, these products contain significantly more THC than traditional cannabis, and are priced accordingly. However, it is possible that, given the intent of the ad valorem rate duty to increase the amount of tax paid on higher potency products, a 10 percent rate may not be adequate. For example, a BHO oil pen can be sold on the illicit market for $60 and contains a THC concentration of 50%.²¹ Under the current rules, the excise duty for this product would be $6. Is it possible that the concentration and potency levels of THC in such products warrant a higher duty? Would a duty rate of 15 or 20 percent on these products be a more effective deterrent to excessive use?  These are questions that may need to be addressed soon.

Another issue is the emergence of what is expected to be a very large edible and topical market. Currently, illicit dispensaries sell a variety of edible products, ranging from chocolate bars, to gummy bears, to teas and other beverages. A recent CBC article suggests that several companies intend to sell additional edibles and beverages, such as beer and cocktails, now that recreational cannabis is legal.²² These products might pose considerable problems for the calculation of the excise duty, as currently constructed. Excise taxes are used as a deterrent for tobacco and alcohol, but consumption of these products tends to be uniform. For example, alcohol is generally consumed as a beverage, and tobacco is generally smoked. This makes the excise tax or duty easy to monitor and regulate. Recreational cannabis, on the other hand, can be smoked, vaporized, eaten, or consumed in a beverage. When it is edible or drinkable, it is often an additive in another product, which can lead to further complexities. 

Consider the following comparison: a one-time use lollipop with 100 mg of THC can be purchased for $10, whereas a chocolate bar which contains 5 separate pieces totaling 150 mg of THC can be purchased for $20.²³ Under the current rules, the chocolate bar would likely be subject to a higher excise duty than the lollipop, given its higher price.  However, the potency of the lollipop is much higher on a per unit basis. To meet its objectives in using excise duty to help regulate the recreational use of cannabis, the federal government should consider adjusting its tax policy to calculate the excise duty for edibles based on a THC content per unit basis, in addition to providing for some type of standardization in the edibles market. There is time, however, to consider such changes, as edibles have yet to be regulated under the current framework. 

Prescription cannabis products might pose another area for concern. Currently, only cannabis derived pharmaceutical products with a drug identification number (“DIN”) that can only be acquired under a prescription are eligible for GST/HST zero-rating.²⁴ However, one wonders if zero-rating should extend to any natural cannabis flower, or any derivatives that are not necessarily regulated by the DIN system. Otherwise, other than for possible insurance coverage, why would an individual go through the process of obtaining a prescription for a cannabis-based product, rather than simply purchasing it in the recreational market? Medicinal cannabis also remains subject to GST/HST, even when acquired under an authorization to possess, on the basis that it may be acquired without a prescription. While nothing has been proven conclusively, there are instances where medicinal cannabis may be a more effective treatment, especially when compared to opioids in pain management.²⁵ Given this possibility, the federal government may want to consider a taxation system that is fair to those who have legitimate medicinal cannabis needs.

George Tadross
Manager, Sales Tax Recovery
george.tadross@ryan.com