Are You Prepared for a CDTFA Audit?| October 12, 2017 2:53 pm
Lessons from the Field: Part 1
In the course of providing consulting and accounting services, our advisors encounter a multitude of issues affecting the day-to-day operations of our cannabis industry clients. This series shares the operational and accounting lessons we learn in the field to help develop and promote best practices benefiting the cannabis industry.
ELLO provided sales and income tax services to a cash-only Bay Area dispensary that provides medical cannabis to local patients. The dispensary was selected for a California Department of Tax and Fee Administration (“CDTFA” formerly BOE) audit and ELLO provided assistance throughout this process. The audit was not a result of an anomaly in tax filings or returns, and was likely a routine check … something for which all cannabis businesses should be prepared.
To perform the audit, the CDTFA requested copies of all financial documents for verification. This includes accounting records, copies of bills, general ledgers, and more. When ELLO requested this information from the client, acting as an intermediary between the CDTFA and the dispensary, we received a small collection of bills – but no receipts, sales invoices, record of purchase invoices, or bank statements.
The CDTFA’s audit is dependent on the auditor’s ability to reconcile the client’s tax returns with supporting financial documentation. When ELLO reached out to the client for more documentation, we were told there simply wasn’t any more. The client stated they did not keep sales records due to patient privacy concerns related to HIPAA (Health Insurance Portability and Accountability Act of 1996) and also had a small facility without the requisite space to store documents.
The ELLO team worked with the CDTFA auditor the best we could, helping supply information and reconcile documents, but our hands were tied. We tried to retrace information and create fact patterns based on interviews to provide to the CDTFA auditor. Ultimately the auditor was forced to use alternate methods to verify the documentation.
After performing the audit, additional taxes were assessed against the client. Because the client did not retain records, it was impossible to contest the assessment.
It is of the utmost importance that cannabis businesses retain essential financial records. We understand that many cannabis businesses still feel the need to destroy records to be HIPAA compliant or out of fear of litigation – should the federal stance toward cannabis shift – and many businesses face a similar storage issue. We work with our clients in many ways to ensure documentation is created and maintained safely and securely and there are simple technology solutions to address both concerns raised by our client.
There are several Point-of-Sale (“POS”) systems that are specific to the cannabis industry and take HIPAA and federal oversight issues into account. The consultants at ELLO have experience advising, installing, and helping manage systems that, for example, separate personal and financial information. This allows businesses to access accounting data without exposing patient details. These systems also help with storage issues as they collect financial data without taking up precious floor space. As an added perk, they can also output useful financial information a business can use to optimize operations, including data to help with compliance, loyalty systems that can boost return customers, and real-time reporting to optimize inventory control.
ELLO also serves a category of cannabis clients who cannot realistically operate a POS system, including cultivators and distributors. These companies are equally susceptible to CDTFA audits and must make a concerted effort to retain receipts and documentation for sales. Again, there are inventory management and document retention tools that operators can implement, and will be required to have moving forward.
This is especially important for resale transactions that are exempt from sales taxes. For every transaction to a distributor or dispensary, it is essential to retain a copy of the resale certificate, which lists the state, name, and CDTFA account number. In the event of a CDTFA audit, these documents demonstrate due diligence and confirm that no sales taxes are due. Without resale certificates, a business could face crippling sales tax assessments.
The advisors at ELLO have been serving cannabis businesses for over ten years and we understand the growing pains of an industry shifting from a black market to a regulated legal market. With legality comes increased regulation and scrutiny and cannabis businesses must strive for transparent, efficient, and legitimate business practices. Investing in solutions like Quickbooks and/or a POS system requires an initial investment, but is likely to provide significant value in the long run.Tags: accounting, advisory, audit, best practices, BOE, Cannabis, cannabis business, CDTFA, compliance, ELLO, HIPAA, Medical Marijuana, MMJ, Recordkeeping, regulation, tax