5 Resolutions for Your California Cannabis Business

By Genevieve Meehan, Emily Hackman, Andrea Golan, Amanda Kilroe

Jan 14, 2022

2021 was yet another busy year for the California cannabis community. Following Gov. Newsom's signing of the 2021 Budget Trailer Bill in July, which consolidated the previous three commercial cannabis regulatory agencies into one Department of Cannabis Control (DCC) (within the state's Business, Consumer Services, and Housing Agency), the state issued updated regulations in late September. Though we all have become accustomed to rapid changes and evolving interpretations in this complex regulatory environment, these changes hit at a heavy time for cannabis operators—mid-pandemic, mid-harvest, amidst heightened security concerns, and just before news of the 2022 cultivation tax hike. What a whirlwind! 

As we settle into the new regulatory structure from fall 2021, we compiled a list of five resolutions to ensure your California cannabis business is focused on operational compliance for years to come. 

Resolution #1: Transition Focus from Licensing to Operational Compliance

In the coming months and years, California cannabis licensees must transition all provisional state licenses to annuals by completing any outstanding application requirements, including California’s Environmental Quality Act (CEQA) review. As operators achieve annual status, the focus is inherently shifting from licensing to day-to-day operational compliance. VS’s California Licensing and Compliance Teams are working to support you through this transition and to help your business develop and implement good practices to maintain operational compliance. For more information on CEQA and transitioning to annual licensure, read the VS insight, “The End of an Era: California Cannabis Provisional Licensing, a New State Regime, and CEQA.”

Resolution #2: Review and Reorganize Recordkeeping

While diligent record maintenance and organization does not address every potential regulatory violation, we know from experience that disorganized records are often a clear indicator to regulators that there may be underlying compliance concerns. Commit your business and operations to good organization of books and records in 2022 by taking the following steps: 

1. Implement Standard Operating Procedures (SOPs)

The DCC no longer requires applicants to upload detailed operational procedures in the initial submittal for new state license applications, though the DCC does have the authority to request them. The DCC clarified that detailed operational procedures and/or additional SOPs are required to be maintained onsite and are subject to inspection by the DCC. We expect that the DCC will review these SOPs to assess whether onsite conditions align. Well-considered SOPs are a key to compliant and efficient operations. 

2. Review Licensing Documentation On-File with the State

As the DCC works to transition provisional licenses to annual licenses, we have seen more scrutiny of application documents and related requests for clarification or additional information. Make sure to review the required licensing operational procedures and other documents that you submitted with your application. Ensure that all required information and documentation is up to date. 

3. Review Renewal Deadlines for Documents Other than State and Local Cannabis Licenses

Several local and state license application documents require renewal at various intervals. The list below contains just some of these items: 

  • Corporate Good Standing, including filing Statements of Information, as required – payment of minimum taxes annually

  • General Liability Insurance and Surety Bond, both of which may require annual fees

  • Water Board Notice of Applicability and Lake Streambed Alteration Agreement

  • DBA or Fictitious Business Name filing – typically requires renewal every 5 years

  • Local Business License – possible annual renewal, based on locality requirements

  • Seller's Permit – payment of sales use tax, if required, annually

4. Submit Notifications to State Agencies for Changes or Events/Issues

If, upon review of your state license application documentation, you discover that there are changes to your business or ownership information, you are required to notify and update the DCC with the new information. The following are some of the operational changes that require notification to the DCC:

  • Entering a Labor Peace Agreement (§ 15023(b))

  • Change in Ownership or Financial Interest Holders (§ 15023(c)) and (§ 15023(d))

  • Change in Contact Information (§ 15023(e)(1))

  • Change in Legal Name of Owner or Legal Business Name (§ 15023(e)(2))

  • Change in Business Trade Name / "Doing Business As" (DBA) or Fictitious Business Name (FBN) (§ 15023(e)(3))

  • Change in Bond (§ 15023(e)(4))

  • Physical Modification of Premises (§ 15027)

  • Discovery of Significant Discrepancy in Inventory (distributors and retailers) (§ 15036(a)(1))

  • Discovery of Diversion, Theft, Loss, or Any Other Criminal Activity Pertaining to Operation of a License (§ 15036(a)(2) & § 15036(a)(3))

  • Discovery of Breach of Security (§ 15036(a)(5))

5. Clean Up Sales Records & Metrc Reporting

Since the transition from temporary licenses to the Metrc system, it has become clear that staying compliant with state requirements for timely Metrc reporting is a critical part of day-to-day compliance. As a best practice, commit to quarterly cleanups of sales and Metrc records. 

Some tips for completing a Metrc cleanup:

  • Review sales records and transport manifests from the last year and ensure they are accurately documented

  • Keep transport manifests, invoices, and testing certificates of analysis clearly organized so that all relevant information for one transaction is easily obtainable

    • Pull records of sale or transfer and locate the details in Metrc and cross-verify for accuracy

  • Conduct a physical count of packages on site to confirm that the inventory reported in Metrc is accurate

    • If you discover discrepancies, create a Metrc Adjustment within the system and utilize a paper Adjustment Log to ensure redundancy in reporting. Complete corrective action plans and, if necessary, report significant discrepancies of inventory to the DCC

6. Maintain Records Evidencing Responsibility for Tax Payments

Although California’s cannabis regulators continued their somewhat laissez-faire enforcement practices in 2021, the California Department of Tax and Fee Administration (CDTFA) stepped up its industry audits, with a particular focus on distribution licensee tax remittance. As CDTFA regulators begin to understand the complexities of the California cannabis supply chain, it is imperative that licensees remit taxes in a timely manner. 

CDTFA has routinely waived the punitive 50% fee for late returns but warns licensees they cannot expect such leniency in the future. Further, licensees—particularly distributors—should document every instance in which they do not collect and remit cultivation or excise tax because another licensee is responsible for payment, preferably with written sign-off from the receiving party that will pay the tax. This will be discussed in more detail in Resolution #3. 

Remember, adequate records will save headaches and money later. 

Resolution #3: Be Prepared for Regulatory Inspections and Audits

DCC Inspections

If your business was not one of many to undergo inspection in 2021, we strongly recommend that you prepare for a likely increase in DCC inspections this year. 

Here are some tips to prepare for a regulatory inspection and audit: 

  • Conduct a third-party audit of your licensed premises to identify any deficiencies or observations. We recommend conducting a third-party audit at least once annually and completing internal audits quarterly utilizing the DCC's Inspection Checklist or a custom checklist prepared for you by VS

  • Prepare all managers for regulatory inspections or appoint an on-duty designated staff person to handle if a manager is not at the facility

  • Make sure all employees are prepared to cooperate with DCC personnel, law enforcement officers, and personnel from any other state or local regulatory body performing an inspection

  • On a quarterly basis, all onsite managers should review, at minimum, the following:

    • The location of all state and local business licenses, sales tax licenses, floor plans, fire safety permits, alarm system permits, equipment licenses, etc.

    • The location of all required books and records, including Visitor Access Logs, SOPs, and contracts

    • The process for utilizing the surveillance system, including playback of a specific date and time range, taking screenshots, locating all cameras throughout the facility, and printing a still image

    • The protocol for authorizing access to the facility for all visitors, including regulators or enforcement

    • The standards set for inventory management

California Department of Tax and Fee Administration (CDTFA) Audits

When preparing for an audit, take time to gather and organize supporting documents and identify discrepancies and gaps in information before meeting with the auditor. If you have been selected for a CDTFA cannabis audit, prepare with your CPA and keep the following in mind:

  • Make sure data matches. Ensure tax returns and supporting documentation, including Metrc, are aligned

  • Assemble all your primary sources of data (income tax returns, sales tax returns, and all other returns filed with the CDTFA, including the worksheets and supporting schedules used to prepare the electronic cannabis tax returns, books of account, and sales summaries from POS)

  • Additional records requested by the CDTFA include:

    • Original documents that support the entries to your books, including invoices, cannabis manifests, credit memos for returned product, bank statements, cash distribution records, copies of all cash payout receipts and merchant account statements

    • Records that support any transactions where the cultivation tax or the excise tax was not collected or remitted, preferably with affirmation from the remitting licensee

    • Worksheets used to calculate the average market price of the cannabis or cannabis product

    • Records that support the destruction of cannabis or cannabis products

    • Inventory records of all cannabis purchased and distributed (Metrc data is acceptable)

    • Copies of contracts that support agreements with other licensees

    • Copies of cannabis license(s) and the application(s) submitted to the DCC for licensure

  • Review invoices for mistakes prior to meeting with the auditor, so you are prepared to provide additional context if necessary

  • Auditors prefer electronic data because it is easy to work with and manipulate into their audit reports. Keep within the scope of the request, but if it is possible to provide electronic data, you will want to do so in most circumstances

  • CDTFA audit methods:

    • Examination of General Ledger Accounts

    • Examination of General Journal

    • Examination of Cash Receipts and Disbursements Records

    • Examination of Accounts Receivable Ledger

    • Examination of Purchase Journal

  • CDTFA will contact third parties for information. The agency has the authority to obtain information about taxpayers from various sources, including other state agencies, businesses, wholesalers, and data houses. Some of this information may include third-party proprietary data that cannot be shared with the taxpayer who is under audit

Resolution #4: Increase Industry Participation and Advocacy

In Fall 2021, the DCC adopted regulations through its emergency rulemaking process which provided only a brief public notice and comment period. We anticipate that the DCC will commence one or more regular rulemakings with a 45-day opportunity for public comment sometime in the second half of 2022. We strongly encourage participation and advocacy in the rulemaking process. Please reach out to the VS California Licensing and Regulatory team if there are topics of interest to your operations or business model. We will keep you apprised of relevant regulatory rulemaking developments and alert you of opportunities for public comment. 

Unfortunately, despite years of hard-fought campaigns, the state’s regulations and tax policies in 2022 are not optimized to support a robust and equitable cannabis industry. We must continue to advocate for equitable, business-friendly policies that safeguard public health and safety. While this remains an uphill battle, our voices are stronger when unified with a common purpose. 

Resolution #5: Develop a Coordinated Compliance Plan 

Compliance is essential for cannabis business success in the highly regulated California cannabis industry. Establishing a coordinated compliance plan and standard documentation will create efficiencies and consistency that will not only impact your bottom line by streamlining operations, but also by avoiding unnecessary crises and fines. As mentioned in Resolution # 3, we expect enforcement to increase now that the DCC regulations have been released. Are you prepared for a DCC inspection or CDTFA audit?

VS offers an efficient approach for cannabis compliance and license renewal needs, helping you to thrive in this highly complex regulatory environment. We'll provide you with understandable and actionable guidance on state and local cannabis laws and regulations to help you enact best practices in your facilities, empower you to work efficiently with regulators, and minimize enforcement actions, violations, inquiries, audits, and investigations. Our team will work with your investors, owners, key employees, and other stakeholders to answer complex compliance questions. We leverage our national scale and unparalleled industry experience to provide subject-matter expertise, insights into enforcement trends, and clarity on the intent and evolution of laws and regulations. As the California cannabis industry continues to evolve, so will VS’s approach to assisting your business. 

View our cannabis compliance services and please reach out with any questions.

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