California Prop 56 Sales Tax Explained

[Christopher]

Hi Folks, 

Here is a complete breakdown of the Prop 56 Tax in California. (Something that affects Vapor Talk directly as we have an office and soon wharehouse in California). Credit goes to Blue Dot Vapers. 

You asked us to clarify apply how the new Proposition 56 tax will apply to your various business functions. As you well know, Proposition 56, also known as the Tobacco Tax Increase Initiative (or “Prop 56”), was adopted into law by California voters on November 8, 2016. Prop 56 amended the existing California cigarette and tobacco product laws to: (1) define e-cigarettes as tobacco products under the tax code (note that e-cigarettes are already defined as tobacco products in section 22950.5 of CA’s Business and Professional Code (Cal. Bus. & Prof § 22950.5), (2) increase the tax on distributors of cigarettes by $2.00 a pack, and (3) impose an “equivalent” increase of the tax on distributors of “tobacco products”, which include “e-cigarettes”. Importantly, many of the details related to how this law will be applied to e-cigarettes will be worked out in the coming months, as the CA State Board of Equalization has been tasked with developing regulations to determine how to implement an “equivalent tax” for products like e-cigarettes.

We note that we interpret the “e-cigarette” definition below to mean that for purposes of the Prop 56 tax, closed-system (cigalikes) and open-system e-liqiuds are “electronic cigarettes,” but open-system devices (and related accessories sold separately) that are sold without e-liquid are not electronic cigarettes under this definition.

The Prop 56 tax (the amount of which, as noted above, has not yet been determined for e-cigarettes or e-liquid) applies to the distribution and distributors of e-cigarettes in California. Cal Rev. & Tax. § 30130.51(b). Manufacturers (or original importers) who sell e-cigarettes directly to licensed distributors are exempt from the tax. Cal Rev. & Tax. §§ 30103 and 30105. Rather, the tax is triggered the first time the (previously untaxed) e-cigarette is sold by a distributor to another distributor, wholesaler, retailer, or consumer in the state. (Please note we define these key terms (e.g., distributor, importer, manufacturer, etc. below). For example, a California-based manufacturer of a nicotine-containing e-liquid is not required to pay the tax for selling the product to a CA distributor. However, when the distributor then sells the e-liquid to a retailer or a consumer in California, the distributor is obligated to collect the appropriate tax for the state.

Distributors who sell e-cigarettes directly to CA consumers via the internet (i.e., are participating in delivery sales) must also pay the tax, regardless of their physical location, provided the tax has not already been paid by some entity upstream in the supply chain. Cal Rev. & Tax. §§ 30101-30111. See also Cal. Code Regs. ***. 18 § 4011. If the tax already has been paid, the distributor is classified as a wholesaler, and no tax is due. Distributors who sell to CA wholesalers (i.e., CA retailers and retail stores) via the internet also are required to pay the tax, even if they are located outside of the state.

Sales made to out-of-state consumers or distributors (who are not reselling into California) are not taxed. Also, in-state sales of e-cigarettes which are shipped to a point outside the state are not subject to the tax. Cal. Code Regs. ***. 18 § 4080. Importantly, if an e-cigarette for which the tax has not been paid is sold to a consumer, the obligation to pay the tax then falls onto the consumer. Cal Rev. & Tax. § 30107. See also Cal. Code Regs. ***. 18 § 4091.

The tax becomes effective on the first day of the first calendar quarter commencing more than 90 days after the effective date of Prop 56 (i.e., April 1, 2017).

You are correct that the tax will be due on the wholesale cost of the purchase price for the tobacco product.Cal Rev. & Tax. § 30123. California recently promulgated new regulations which determine how to interpret the term “wholesale cost”. Cal. Code Regs. ***. 18 § 4076; see also https://www.boe.ca.gov/regs/pdf/Reg4076_OAL_Approval_2016.pdf. In “arms-length transactions,” the wholesale cost is the amount paid for the e-cigarette, including any relevant federal excise taxes, but excludes transportation charges for a shipment originating in the U.S.

The wholesale cost for transactions of tobacco products where the manufacturer or importer is also the distributor are computed as specified in Cal. Code Regs. ***. 18 § 4076(b)(2). Specifically, these regulatory provisions provide that:

“If a manufacturer or an importer is also the distributor, the wholesale cost of tobacco includes all manufacturing costs, the cost of raw materials (including waste materials not incorporated into the finished tobacco product) prior to any discounts or trade allowances, the cost of labor, any direct (including freight-in) and indirect overhead costs, and any federal excise and/or U.S. Customs taxes paid. Wholesale cost includes all freight or transportation charges for shipment of materials and/or unfinished product from the supplier to the manufacturer concurrently licensed as a distributor, but excludes domestic freight or transportation charges for shipment of finished tobacco products.”

Cal. Code Regs. ***. 18 § 4076(b)(2). Thus, you cannot act as a manufacturer and sell a product to yourself for a deep discount, as doing so would not comply with the spirit or requirements of Cal. Code Regs. ***. 18 § 4076(b)(2). There is a relatively complex scheme in place to determine the wholesale cost of these non-arms-length transactions, and we advise you to carefully review the provisions in Cal. Code Regs. ***. 18 § 4076. You may find it necessary to obtain the assistance of a tax attorney or CPA to properly compute the cost of the tax due in these scenarios (if so, let us know).

Below is a short summary of the other key provisions of Prop 56.

I. California Proposition 56

A. Key Definitions

• 1 Arm’s-length Transaction – An “arm’s-length” transaction means a sale entered into in good faith and for valuable consideration that reflects the fair market value in the open market between two informed and willing parties, neither under any compulsion to participate in the transaction.
• 2 Consumer – A person who purchases tobacco products.
• 3 Dealer – Includes every person, other than one holding a distributor's or wholesaler's license, who engages in the sale of cigarettes or tobacco products.
• 4 Delivery Sale – Means the sale of tobacco products into and in CA in either of the following cases: “(a) The consumer submits the order for the sale by means of a telephone or other method of voice transmission, the mail, or the Internet or other online service, or the seller is otherwise not in the physical presence of the consumer when the request for purchase or order is made; (b)the cigarettes or tobacco products are delivered to the consumer by common carrier, private delivery service, or other method of remote delivery, or the seller is not in the physical presence of the consumer when the consumer obtains possession of the cigarettes or tobacco products.”
• 5 Delivery seller – A person who makes a delivery sale.
• 6 Distribution – Includes the sale or use of untaxed tobacco products in CA. Distribution also includes the placing of an untaxed tobacco product in a vending machine or in retail stock for purposes of selling the product to consumers.
• 7 Distributor – A person who distributes, as the term is defined above, tobacco products. The distributor is the person or entity that makes the first tobacco product distribution (i.e., sale of a previously untaxed tobacco product) in CA. See https://www.boe.ca.gov/sptaxprog/spctdistributor.htm.
• 8 Electronic cigarette – Defined as “any device or delivery system sold in combination with nicotine which can be used to deliver to a person nicotine in aerosolized or vaporized form, including, but not limited to, an e-cigarette, e-cigar, e-pipe, vape pen, or e-hookah.” The term includes any component, part, or accessory of a device that is used during the operation of the device when sold in combination with any liquid or substance containing nicotine. The term also includes include any liquid or substance containing nicotine, whether sold separately or sold in combination with any device that could be used to deliver to a person nicotine in aerosolized or vaporized form. Electronic cigarettes do not include any device not sold in combination with any liquid or substance containing nicotine, or any battery, battery charger, carrying case, or other accessory not used in the operation of the device, if sold separately.

As noted above, we interpret this to mean that for purposes of the Prop 56 tax, closed-system (cigalikes) and open-system e-liqiuds are “electronic cigarettes,” but open-system devices (and related accessories sold separately) that are sold without e-liquid are not electronic cigarettes under this definition.

• 9 Importer – Any purchaser for resale in the U.S. of tobacco products manufactured outside of the United States for the purpose of making a first sale or distribution within the United States.
• 10 Tobacco Product (Revenue and Taxation Code Definition) – A tobacco product is defined in the Revenue and Taxation Code as a “product containing, made, or derived from tobacco or nicotine that is intended for human consumption, whether smoked, heated, chewed, absorbed, dissolved, inhaled, snorted, sniffed, or ingested by any other means, including, but not limited to, cigars, little cigars, chewing tobacco, pipe tobacco, or snuff, but does not include cigarettes.” Electronic cigarettes are captured within this definition of tobacco product. See Cal Rev. & Tax. § 30121(b).
• 11 Wholesaler – A wholesaler is a person who engages in making sales of tobacco products intended for resale for which the tobacco product tax has been paid.

[Bebop]

Well, some good news in there.  No tax on most of the gear I buy.  That's good.  

[Christopher]

2 hours ago, Bebop said:

Well, some good news in there.  No tax on most of the gear I buy.  That's good.  

Yea, there's wiggle room in eliquids to sort of adjust for the tax increase but hardware...not so much. The law is still BS but it could be worse. 

[Bebop]

"Anything not sold in combination with e-liquid" is exempt! That is good. And better than I had hoped for.

Sent from my LG-D851 using The Vapor Talk mobile app

[Tam]

A $2.00 increase on a pack of cigarettes??? Holy cow. I wonder how much that will drive the black market on those... or send them to vaping instead.

[Christopher]

1 hour ago, Tam said:

A $2.00 increase on a pack of cigarettes??? Holy cow. I wonder how much that will drive the black market on those... or send them to vaping instead.

Hopefully it'll send them to vaping. I know if vendors switch over to larger bottles and ditch 10,30mls they could offset the increased tax. So not great, but not the end of the world either. 

[Bebop]

Yeah. In California that will make the cost of a pack if ciggys around $8.  Although, Im sure you can find those ciggys that I don't know where they come from for cheaper.  Like dollar store ciggys or whatever.  

 

Whatever it takes to keep sending them our way, I guess. 

[Christopher]

Who has awesome writing skills here? Vapor Talk - Let's make a religion called Vapor so we can talk about it. Boom tax exempt. 

Black Label will of course be our holy water.