As many have observed, there has been a paradigm shift in the way that states approach exemption certificates. Historically, many states and auditors may have given companies wide latitude in sales tax audits for situations where it was plainly obvious that a particular sale was for resale. However, over the last seven or eight years, we have seen a shift away from “substance over form” to “form over substance.” More and more state auditors seem to view exempt sales as low hanging fruit, or, in other words, easy revenue.
As a result, distributors and manufacturers (let’s call them the “Suppliers” from now on) who may not have been selected for audit previously, or those whose audits did not reveal issues with their certificates, are now finding out the hard way that they have problems when it comes to certificates. A lot of certificate problems relate to drop shipping and right after these Suppliers get hit with an audit and pay a state a big sum of money, they usually set out to correct the problem. This generally includes the Supplier contacting all of their wholesale customers (let’s call the Suppliers’ wholesale customers “Resellers”) inform them that they (the Resellers) will now have to provide a certificate for every state based on the “ship-to” address of the Reseller's customer (let’s call these the “Customers”). The Suppliers usually tell their Resellers that if a certificate cannot be provided, sales tax will be charged from now on.
The response from the Reseller can range from mild concern to anger to outright panic, as they try to grasp how this will impact their business. This is when we usually get the question from the Reseller about how this all works. It just doesn’t seem reasonable or even possible that a Reseller would be required to produce certificates for every state where they have customers. Suppliers often have the same concerns.
In the following paragraphs we will answer this question as well as why the Suppliers are asking for certificates in all “ship-to” states even if the Reseller does not have nexus in that state.
Why is the Supplier asking for a certificate in the “ship-to” state if the Reseller doesn’t have nexus in that state?
This is a frequently-asked question. Resellers (and Suppliers) are perplexed as to how a sale for resale can even be taxable. And they are correct -- sales for resale are generally not taxable, but the proper documents to support the exemption must be obtained and maintained by the Supplier. In addition, since the Reseller usually does not have nexus in the “ship-to” state, the Reseller is generally not registered in that state and therefore does not have the ability to collect tax from their customer. So the tax would have to come out of the Reseller’s pocket, which is a big hit to the profit margin.
Well, the answer to this question is really fairly simple once we peel away the confusion that drop shipping often creates. A drop shipment, or as it is sometimes called, a “third-party” sale, occurs when a Reseller of tangible personal property (TPP), requests its Supplier to ship the product directly to the Reseller’s Customer. There are really two separate transactions and three parties. The first transaction is when the Customer orders a product from the Reseller. If the Reseller does not carry the item ordered in current inventory, the Reseller places its own order for the same good with the Supplier and then directs the Supplier to drop ship it directly to the Customer. If we concentrate just on the second transaction, the one between the Supplier and the Reseller it may be easier to understand.
Tax is Due in the Ship-to State
Let’s back up a little and first understand some basic sales/use tax concepts. First of all, in almost every state, any item of TPP is subject to sales/use tax. A seller with nexus in a state must collect sales/use tax on sales of TPP into that state. They must collect the tax unless they collect an exemption certificate (like a Resale Certificate, for example) that is acceptable to the ship-to state.
So, if the Reseller directs the Supplier to ship product to a state where the Supplier already has nexus (by virtue of employees, a warehouse, sales reps, etc.), then the Supplier is required to either collect the use tax for the ship-to state or the Seller is required to obtain a certificate (from the Reseller) for the ship-to state.
Where the Reseller has nexus is irrelevant in this scenario. It matters only where the Supplier has an obligation to collect a sales or use tax. Obligations to collect tax are based on where the Supplier has nexus.
Since the Reseller is the Supplier’s customer, the Supplier must do one of two things. The Supplier must charge the Reseller sale/use tax based on the ship-to state’s rules and tax rates, or the Supplier can accept a certificate that is acceptable to the destination state in lieu of the sales tax. Which brings us to the next question.
Must Dropshippers (Resellers) Provide a Certificate for Every State Where They Have Customers?
The simple answer to this question is, yes, the Reseller must provide an acceptable certificate for every state to which items are shipped in order for the Reseller to avoid being charged tax by the Supplier. However that does not mean the Reseller is required to get registered in every state in order to issue an acceptable certificate. The Reseller need only to provide a certificate that is acceptable to ship-to the state in question. Many states will accept certificates from other states.
The good news is that while there are some states in which the Reseller may have to register in order to issue a certificate, which is acceptable to that state, most of the states do not require Resellers, without nexus in their state, to get registered. In these states, here is usually some other type of documentation which can be provided that will be acceptable without being required to register in the state in question. Here is a list of the types of documentation which may or may not be acceptable to a given state when you are not already registered in the Customer’s state:
1. Home state certificates
2. Consumer state certificates with no nexus statements.
3. Consumer state certificates with no home state number.
4. MTC multistate certificates with home state numbers.
5. SST multistate certificates with home state numbers.
6. Affidavits or statements of no nexus.
7. Pass through of a valid consumer certificate.
The key is to know which state will accept which documentation in your situation. There are roughly ten states where you may have to get registered, but in about 35 you will be able to use at least one of the seven documents above. I will cover some state specifics in my next post. In the meantime - if you have any specific questions please feel free to post a question or comment - or reach out to me directly.
Other recent “Exemption Certificate Mgmt.” posts by Michael J. Fleming:
- Drop Shipping Exemption Certificates For AL, AR, AZ, CO and GA.
- Drop Shipping Exemption Certificates For IL, NY, PA, & TX
- Drop Ship Exemption Certificates: Four More Restrictive States
- Minnesota Simplifies Exemption Process - and Gets It Right!
- Dropship Exemption Certificates: The 6 "Most Restrictive" States