That the City Council APPROVE THE FIRST READING OF ORDINANCE NO. ______ ENTITLED:  AN ORDINANCE OF THE CITY COUNCIL OF THE CITY OF LA HABRA, CALIFORNIA, ADDING CHAPTER 5.58 ("CANNABIS BUSINESS TAX") TO TITLE 5 OF THE LA HABRA MUNICIPAL CODE.

History
On August 3, 2020, the City Council considered a ballot measure to authorize the City Council to impose a gross receipts tax on cannabis businesses and authorizing the City Council to permit up to four licenses for cannabis non-storefront (delivery-only) retail facilities.  After receiving testimony from the public and staff responding to Council questions, it was the consensus of the City Council to allow the public to decide the issue of cannabis use within the community.  The City Council, by a 4-1 vote, placed the proposed City of La Habra Cannabis Business Tax and Regulation Ordinance of 2020 on the November 3, 2020 General Municipal Election ballot as Measure W (Attachment 1). At the election, Measure W received 67.46% (17,726) votes in favor of the measure while 32.54% (8,550) voted in opposition to the measure. Therefore, Measure W was approved by the La Habra voters.

Section 3 of Measure W provided that:

“The City Council is authorized to impose, by ordinance, a cannabis business tax. Such tax shall be imposed upon and payable by persons engaged in cannabis businesses in the City. The rate of such tax shall be up to, but not exceed 2.5% of the gross receipts of all cannabis distribution businesses, up to, but not exceed 2.5% of the gross receipts of all cannabis testing businesses, and up to, but not exceed 6% of the gross receipts of all other cannabis businesses.”
 
Ordinance
The ordinance before the Council tonight would adopt the cannabis business tax rate for the three types of cannabis business operations currently permitted to operate in La Habra.  City staff recently surveyed communities in California that allow for cannabis distribution (warehouse) facilities, testing laboratories, and non-storefront (delivery only) retail operations (Attachment 6).  Communities that have an established fixed percentage tax rate are identified in the survey, noting the rate for the specific type of commercial cannabis business activity.  In addition, staff identified communities that have been issued State licenses for each type of cannabis operation that is currently permitted in La Habra so as to understand areas of competition for these types of businesses.  Based on information provided by the Bureau of Cannabis Control as of January 13, 2021 within Southern California (Los Angeles, Imperial, Orange, Riverside, San Bernardino, San Diego, and Ventura counties), there are a total of 583 cannabis distribution (warehouse) licenses, 19 cannabis laboratory testing licenses, and 63 cannabis non-storefront (delivery only) retail licenses that have been issued by the State (Attachment 2).  The City's cannabis tax would be administered in the same manner as its current business license tax; however, would be collected quarterly.  Each type of cannabis business operation and how the specific proposed tax rate was determined is discussed in more detail below.

Cannabis Distribution (warehouse) Facilities
The Cannabis Business Tax survey determined communities are assessing a tax of between 2% to 15%.  The three cities with the largest number of warehouse distribution facilities is the City of Los Angeles with 256 licenses (Los Angeles and the neighborhood communities that make up the City of Los Angeles) with a tax rate of 2%, the City of Long Beach with 59 licenses with a tax rate of 6% and the City of Adelanto with 35 licenses and a tax rate of 5%.

A total of up to four cannabis distribution facility licenses are currently authorized by the City of La Habra municipal code.  A total of three licenses have already been issued by the City (River Distribution, Canna America, and Pinnacle Wellness Group).  Each cannabis distribution facility operates under a Development Agreement that requires the business to make contractual payments to the City until such time as the City adopts a cannabis business tax.  The largest and longest operating distribution facility in the City is River Distribution.  In the first five quarters of operation, River has made contractual payments totaling $594,863 to the City. 

River Distribution’s contractual payment obligations call for the first $12.5 million increment of gross receipts to be assessed at 2.5%. For the next $12.5 million increment of gross receipts, the contractual payment will be 2.0%. For the next $12.5 million increment of gross receipts the contractual payment will be 1.5%. For the next $12.5 million increment of gross receipts, the contractual payment will be 1.0%. For the next $50,000,000 increment of gross receipts, the contractual payment will be 0.5%. Upon reaching a cumulative total of $100,000,000 of gross receipts, the percentages and increments shall reset to the beginning of this paragraph. The blending of these percentages into a set tax rate results in a 1.125% fixed rate.  Under either approach, $100 million in gross revenue would yield $1.125 million in tax payments or contractual payments. The sliding scale approach in the Development Agreement was established to encourage River Distribution to utilize their La Habra facility at a higher rate versus their other locations.  A fixed gross receipts tax rate set at 1.125% keeps that incentive in place and is supported by River Distribution (Attachment 3). 

The other two approved distribution operators have yet to begin business operations and may operate on a much smaller market scale.  It was anticipated Canna America would pay the City $15,000 the first year, $50,000 the second year, $75,000 the third year and $100,000 during the fourth and fifth years, after which, the contractual payment obligations structure could then be renegotiated.  Canna America opposes the proposed tax rate of 1.125%.  Canna America argues that if they buy product at $2,000 and mark it up by 5% to $2,100 as they sell it to retailers, their gross profit is $100.  In this example, since the tax is based on gross sales, a cannabis tax of approximately $24 would be due to the City at the 1.125% tax rate, which Canna America argues is almost a quarter of their gross profit in this example (Attachment 4).  Canna America believes they should be permitted to operate under the conditions of the current development agreement for the first five-years and then later be subject to the cannabis business tax.  They argue this would allow the start-up business to establish itself before being subject to the new tax.  Furthermore, should a tax rate be set, they believe it should be at 0.25% or no more than 0.50%.  It should be noted that the purchase price of product and its sale price to retailers is a business decision of the operator and outside the control of the City.  Any modification in the sale and/or resale price of product will affect the overall gross profit to the operator i.e., if product is purchased at a lesser price and sold at a higher price, then the tax effect on gross profit becomes less than the figure presented by Canna America.  Based on the owner’s projected gross revenues over the first five years of operation (submitted during Development Agreement negotiations), the proposed Cannabis Business Tax rate of 1.125% would result in 6.52% of Canna America's gross profits paid to the City.  Under the existing terms of the Development Agreement, Canna America is currently obligated to pay the City 4.41% of their gross profits. If the staff recommended 1.125% fixed rate tax is approved by Council, and based on Canna America's projected gross revenues, they will be taxed $502,933 in their first five years of operations, compared to the fixed amount of $340,000 during that same time period as currently contemplated in the Development Agreement.  This represents an estimated increase in tax revenue of $162,933 to the City.    

The Pinnacle Wellness Group is the final licensee and has also not yet begun operations.  In their Development Agreement with the City Pinnacle agreed to a contractual payment amount of 3.75% of gross receipts to the City for their first five years of operation.  The projected amount to the City based on the contractual rate is $467,315.  A tax rate of 1.125% will generate revenues to the City of approximately $140,193, which will be approximately $327,122 less than what the Development Agreement contemplated for the same time period.  Pinnacle Wellness Group is in support of the proposed Cannabis Business Tax rate and believes it will assist in combating illegal cannabis operations (Attachment 5).

Laboratory Testing Facilities
The Cannabis Business Tax survey determined communities are assessing a tax of between 1% to 15%.  The three cities with the largest number of cannabis testing laboratories are the cities of Los Angeles with 7 licenses (Los Angeles and the neighborhood communities that make up the City of Los Angeles) with a tax rate of 1%, San Diego with 3 licenses and a tax rate of 8%, and Irvine with 3 licenses with a tax rate of 0%. 

A total of four cannabis laboratory testing facility licenses are available in La Habra.  Based on the survey of Southern California cities that have established tax rates for cannabis laboratory testing facilities, staff recommends a tax rate of 1% be set in order to be competitive with these communities (Attachment 6). To date, no operators have approached the City with interest to secure a cannabis testing facility license.

Non-storefront (deliver only) retail facilities
The Cannabis Business Tax survey determined communities are assessing a tax of between 2% to 15%.  The cities with the largest number of cannabis non-storefront (delivery only) retail facilities include the cities of Hesperia with 19 licenses with a tax rate of 4%, Commerce with 9 licenses with a tax rate of 5%, and Montebello with 8 licenses with a tax rate of 2%.  Staff is recommending that a gross receipts tax rate of 3% be established which places the City in a competitive position with surrounding communities (Attachment 6).  The City has four non-storefront (delivery only) retail cannabis licenses available to be issued and, although the guidelines for this business type have not yet been finalized, staff is aware of a large number of operators may be interested in locating in La Habra and will likely be applying for licenses.

Summary
The proposed ordinance does not itself authorize or permit any cannabis businesses to operate in the City.  Such businesses and permits for such businesses, are governed by Chapter 18.22 of the Municipal Code, and are subject to City Council approval. The subject ordinance established the business tax rate for each type of operation permitted within the City.  HdL, the City’s sales tax consultant that provides sales tax services to 345 California cities, has recommended a cannabis business gross receipts tax rate for warehouse/distribution facilities of not more than 2%, testing laboratories of not more than 1.5%, and for non-storefront retail facilities between 4% to 6%.  The tax rates recommended by staff are generally in line with HdL's recommendation with the exception of non-storefront retail facilities.  Given the tax rates in other jurisdictions in the local region, a 3% gross receipts rate strategically places the City in a position to compete with other jurisdictions which also allow these types of businesses to operate.  It is recommended that the City Council approve an Ordinance adding Chapter 5.58 (Cannabis Business Tax) to Title 5 of the La Habra Municipal Code with a cannabis gross receipts business tax rate of 1.125% for warehouse distribution facilities, 1% for testing laboratories, 3% for non-storefront retail facilities, and 6% for all other types of authorized and permitted cannabis businesses (Attachment 7).

NPDES:
The proposal has been reviewed pursuant to the requirements of the City’s National Pollutant Discharge Elimination System (NPDES) Municipal Permit, the Local Implementation Plan (LIP), and the Model Water Quality Management Plan (WQMP), Section 7.2.  Since the Cannabis Business Tax does not disturb any soil, it is exempt by the Water Quality Ordinance from the preparation of a WQMP.
 
CEQA:
The proposed action is exempt from the California Environmental Quality Act by the California Environmental Quality Guidelines Section 15378, (b), (4), “The creation of governmental funding mechanisms or other governmental fiscal activities which do not involve any commitment to any specific project which may result in a potentially significant physical impact on the environment.”  No land use improvements result from the proposed ordinance and therefore the proposed ordinance is exempt from CEQA.

Public Notice:

Government Code 54954.6 requires special noticing for the consideration of this tax ordinance. Specifically, subsection (b)(1) requires the tax to be considered at a public meeting and then again, a public hearing after publication is made in the newspaper. The public meeting must be at least 10 days after the first publication and the public hearing must be at least 7 days after the public meeting and at least 45 days after the first publication.

The voters of the City of La Habra approved Measure W to establish a Cannabis Business Tax.  Measure W indicated the tax would fund municipal services including fire protection, 911/emergency medical response, public safety/senior programs/preserve open space/address homelessness/retain small businesses/other general services.  The proposed tax rates allow the City to be competitive in attracting cannabis distribution, laboratory testing and non-storefront retail operators in Southern California thereby generating tax revenues to assist in providing needed services to the community.  At this time, it is unknown how much these recommended cannabis tax rates will generate in revenue for the City's General Fund, however, if all licenses are issued and full operations are reached, the amount would likely be in excess of $1 million per year.
 

Action on the Commercial Cannabis Ordinance implements the following General Plan Policies:

ED 9.1 Balanced Fiscal Practices
ED 9.2 Long-Term Infrastructure Viability
ED 9.3 Reciprocal Fiscal Benefit