See how one craft distiller is taking on the government. It’s Constitutional Rights Vs. Legalese Semantics.
Toronto Distillery Co. launched their Constitutional Fight back in July of 2015. Their concern? A mark-up imposed by the LCBO on their products. With no “spirits tax” in Ontario at the moment, the LCBO apply this mark-up in order to collect funds to cover their administrative and warehouse costs, and help fill the province’s coffers.
This mark-up is not applied to wines and beers; these industries both have their own tax, applied on a per litre bases and with lee-way in place to insure the industry can develop new, innovative products. Instead, distilleries must pay the LCBO a nearly 140% markup on every bottle sold both in the LCBO outlets and at the distilleries’ retail store. Designed to cover the LCBO’s overhead – storage facilities, administration costs and all of those other business-y things – this markup makes it difficult for craft distilleries, like Toronto Distillery Co., to cover their operating costs.
“Clearly, a greater than 100% markup really discourages distillers from investing in ingredients, packaging – things that drive up their COGS (Cost of Goods Sold),” says Charles Benoit, co-owner of Toronto Distillery Co. “Compare that to how Ontario taxes craft beer, which is flat per liter: if an Ontario brewer wants to invest her time, resources, and money into making a truly artisan beer (think of a bourbon-barrel aged barleywine), they pay no more tax on that beer than if it’d been a simple lager, which is much cheaper to make. This example drives home how the ‘ad valorem’ tax really discriminates against nice things!”
Benoit decided that enough was enough. He represented Toronto Distillery Co.’s cause in a lawsuit against the LCBO. “The ‘markup’ is like an excise tax, a tax on production that is hidden from the consumer,” says Benoit. “Unlike a traditional excise tax, which is ‘flat’ based on just the liters of alcohol, it also operates like a sales tax, in that it is ‘ad valorem’.”
(Ad Valorem, according to my quick googling, means levying or taxing “in proportion to the estimated value of the goods or transaction concerned.”)
This mandatory markup means that every bottle – EVERY bottle – no matter where it is sold, has a sales revenue of about 50%. This would hurt any business, even one that didn’t have to jump through hoops just to make it on the shelves of local retail stores. The hoops, in this case, being the LCBO strict screening requirements for new products (which, incidentally, the distillery may have to pay for out of pocket). Even if the product passes the LCBO’s tests, the company does not guarantee that the spirits will make it to the shelves – distilleries have to wait six months to a year to before they’ll know if their products will even be sold. This makes it very difficult to get new, innovative spirits on the shelves for provincial consumption and means that selling on-site is usually a better bet for new spirits.
“A tax lawyer friend explained that what the province was doing – taxing without any basis in legislation – was unconstitutional, so then we filed our challenge,” says Benoit. Section 53 of the Constitution Act, 1982 clearly states that any new taxes applied to alcoholic beverages must go through the House of Commons and be legally legislated through vote.
Their case went to court in January of 2016 and the judgement, given on April 1, 2016, was in the favour of the LCBO. “The central question in this case is whether the Mark-up is a tax (as argued by the applicant) or a proprietary charge (as claimed by the respondents),” reads the reason for judgement document Toronto Distillery Company Ltd. v. Ontario (Alcohol and Gaming Commission of Ontario, 2016 ONSC 2202). While the judgement does state that the mark-up checks all the boxes to be considered a tax, there are situations in which fees and levies “would not be characterized as a tax if they were, in pith and substance, a regulatory or proprietary charge.” In the end, the residing judge ruled that the mark-up is a proprietary charge and not a tax.
Judges ruling: “Here the applicant entered into a contract with the LCBO for a commercial advantage: the ability to sell its own products through its stores. Although it argues that it was ‘under a practical compulsion to obtain a licence to sell’ its spirits, it is clear that the applicant was not compelled to sell its products through its own store.”
This is where things get really murky. Distillery’s have limited sales location options. They can either sell through LCBO retail outlets or through their own retail store on-site. They cannot sell directly to bars or restaurants, as wine and beer producers can. Benoit and his team had no other venue, really, for selling their unique spirits – like their Organic Beet Gin, which doesn’t fall into any set category that is recognized by the LCBO – in Ontario, except to open a retail store on-site. “Of course you can always export,” says Benoit. “But customers abroad generally expect to see strength at home before bringing a product to a new market.”
While part of the judge’s ruling may be valid, the whole process is rather confusing. Why are spirits taxed, fined and charged differently (per bottle) than other developing alcohol industries in Ontario? Why do the wine and beer industries get to be taxed at a rate that will allow them to grow and develop innovative processes and products, while distilleries in the province are forced to count pennies before even attempting something new?
The answer may lie in the fact that the LCBO tried to tax these industries without legislative process and got burned. So they may have found a way to hide the fees quote-legally-unquote.
“In 2010, after being warned by the auditor general, Ontario replaced its old wine and beer ‘fee’ system with true wine and beer taxes (which means they were voted for by the Ontario legislature),” explains Benoit. “We would love to have a flat per liter tax system like Ontario craft beer has.”
Without similar provisions, craft distillers in Ontario may have to sacrifice local and organic for affordable and profitable if they’re going to be able to survive. I’m certain that many in the province would rather this didn’t happen. And for Benoit, there is a deceptively simple solution: “A graduated markup, similar to what British Columbia has done for several years now. In BC, there’s no provincial tax on the first 50,000 L of grain-to-glass distilled spirits by a craft distillery, and then the tax phases in between 50,000-100,000 L.”
This is why Toronto Distillery Co. will be appealing the decision. And also why there’s a light at the end of this slightly confusing tunnel of tax law. In February 2016, the ministry of finance added a line to their Tax and Benefit Measures memorandum for the 2016 Ontario Budget: “The government also proposes to introduce legislation to replace the current mark-up and commission structure at on-site distillery retail stores with a tax on purchasers of spirits.”
This light may be the end of the tunnel and an indication that freedom and relief is almost here; or it may be a train heading toward us… but at least it’s legislative change that, one hopes, serves to help our local craft distilleries and spirits producers thrive in this complicated and expensive industry.
If you’d like to learn more about the lawsuit, visit the Toronto Distillery Co site.