How government can lend a hand to Canada’s struggling cannabis industry

Authored by:
Rami El-Cheikh - Partner, EY Consumer Markets | Americas Cannabis Centre of Excellence
Darrell Bontes - EY Canada Partner, Tax
Fred O'Riordan - EY Canada National Leader, Tax Policy

New EY report shows that industry and government, working together, can help Canada lead from the front in legal cannabis sales and exports.

The EY report outlines a broad menu of possible policy options for governments to consider, including:

• Reducing and harmonizing provincial and federal excise duty rates
• Reducing or even eliminating regulatory cost recovery fees, revising packaging restrictions
• Launching awareness campaigns to educate the public on the health risks of unregulated products
• Cracking down on illegal sales by increasing enforcement resources

In the fall of 2018, when recreational cannabis was legalized in Canada, there was considerable optimism that the three primary objectives of legalization would be met: keeping cannabis out of the hands of youth, protecting public health by providing adults access to safe cannabis products and keeping profits out of the pockets of criminals.

Almost four years later, and despite a rapid expansion of the legal industry, that sense of optimism is fading amid growing evidence that the illicit market continues to thrive — and deprive the legal industry of revenues needed to survive and compete.

The cause is complex. Of course, no one could have predicted the onset of a global pandemic and the impact it would have on storefront retail outlets. But the main cause comes down to a playing field heavily tilted in favour of an illicit market. Legal producers and sellers must comply with a myriad of government regulations and pay taxes at both the federal and provincial levels — rules illicit players don’t play by.

The legal industry has adapted in a number of ways to remain competitive. Producers have rationalized operations to gain efficiencies and lowered their prices to attract consumers. But that’s left many struggling for profitability, with some pushed to the brink of bankruptcy.

Price compression hasn’t had nearly the same effect on government revenues since most taxes on cannabis are based on volume, not price. In Ontario, licensed producers have seen their share of sales revenue fall from 74.2% to 60.8% — an 18% drop — since 2019. Meanwhile, the share going to the federal and Ontario governments in the form of excise duties has risen by more than 57% in the same period, from 23.9% to 37.6%.

A new EY report commissioned by the Cannabis Council of Canada on the regulation and taxation of cannabis raises serious questions about the industry’s continued viability if the government doesn’t join forces with industry to work towards a solution.

“The legal cannabis industry has worked hard to establish itself, both in Canada and as a leader on the global stage,” says Rami El-Cheikh, partner with EY-Parthenon and EY Americas Cannabis Centre of Excellence. “But the regulatory environment has made it difficult for producers to remain competitive and help ensure the goals of legalization are met.”

Phase I of the report focuses on the Ontario market and shows how taxation is not only eroding producers’ profits but hampering legal cannabis’s ability to compete with contraband products as well. In terms of the overall supply chain for cannabis products, licensed producers and retailers each only retain about a quarter of the retail price that is ultimately paid by consumers, whereas government taxes and markups capture almost half this amount.

But where there is concern, Rami says, there is also a tremendous market opportunity.

“Change will be critical over the next few years if the industry is to meet the objectives set out in the Cannabis Act. But there are limits to what the industry can do on its own. It will be critical that the federal and provincial governments work with the industry to combat contraband if we are to build a vibrant and sustainable legal cannabis industry in Canada.”

The EY report outlines a broad menu of possible policy options for governments to consider, including reducing and harmonizing provincial and federal excise duty rates, reducing or even eliminating regulatory cost recovery fees, revising packaging restrictions, launching awareness campaigns to educate the public on the health risks of unregulated products and, of course, cracking down on illegal sales by increasing enforcement resources.

As the first G20 country to nationally legalize recreational cannabis, Canada has a significant head start over its competitors in this expanding industry. Capitalizing on that jump-start and using what we’ve learned to evolve and transform our legal industry will keep us in front as new players enter the market and build a robust and profitable global industry for the future.