Drop-shipping is an issue which impacts virtually any individual or company purchasing goods. While this scenario is very prevalent in e-commerce scenarios, it is becoming increasingly common in many other retail sales environments.
- What are Drop Shipments (aka Drop-Ship)?
- Why Drop-Ship Taxation Gets Complicated:
- Drop-Ship Exemption Documentation Requirements:
- Will Sales Tax Registration Trigger Other Tax Obligations in Ship-to States?
- Drop-Ship Assistance and Other Resources:
What are Drop Shipments (aka Drop-Ship)?
In a drop shipment transaction, the retailer does not hold the inventory that is delivered to the end consumer. Once the order is accepted, the retailer contacts the product supplier/shipper and asks them to ship the goods directly to the retailer's customer - the end consumer. The supplier/shipper will invoice the retailer - and the retailer will invoice the consumer.
Why Drop-Ship Taxation Gets Complicated:
Generally, if a seller has nexus in a state and has registered to collect sales tax, they are required to collect sales tax on all taxable sales delivered into that state. Drop ship transactions differ somewhat in that the purchase by the retailer (from the supplier/shipper) is in effect a purchase for resale - which is normally exempt from sales tax. However, quite often drop ship taxation becomes more complicated, as often the retailer is not registered in the ship-to state but the supplier/shipper is. In such cases, the supplier/shipper is obligated to collect tax from the retailer on the drop ship transaction unless the retailer can provide exemption documentation (deemed acceptable by the ship-to state). If a supplier/shipper is shipping product directly to a state in which they are not registered (and/or do not have nexus), then the supplier/shipper does not have an obligation to collect sales tax for that state. However, it is advisable for the supplier/shipper to still obtain appropriate resale documentation from the retailer for such ship-to states, in case it is later determined that the supplier/shipper did in fact have nexus. Additional complications may be present if the retailer's (end consumer) customer is claiming an exemption. In some cases such an exemption can be "passed through" to the supplier/shipper to claim the exemption.
Drop-Ship Exemption Documentation Requirements:
It is important to note that states vary in their rules regarding the exemption documentation that can be used in order to substantiate a sale for resale in drop shipment situations. Some states have developed alternate documentation rules. Depending on the jurisdiction, acceptable documentation can include home state registration or resale certificates, the MTC Multi-Jurisdictional Exemption Certificate, the Streamlined Sales Tax Exemption Certificate, the ship-to state resale certificate with the home state number or a no nexus statement or other alternative documentation that demonstrates that the transaction truly is a sale for resale. However there are other states (approximately 11) which require a reseller who is claiming a resale exemption to be registered to collect sales tax in their state. These states require a resale certificate with a registration number (from that state) to be issued in order to document the resale exemption. Once registered, retailers will be able to issue a resale certificate but they will also be required to collect sales/use tax on all taxable sales to customers in these states. Given the varying requirements, it is important that drop-ship retailers (as well as suppliers/shippers) consider the exemption requirements on a state by state basis.
Will Sales Tax Registration Trigger Other Tax Obligations in Ship-to States?
In order to obtain resale exemptions in all states, parties to drop shipment transactions may find it necessary to register in additional states. Some companies worry that this can bring about other tax obligations in those states. Generally, income tax liability is not a concern unless the company meets the nexus thresholds for income tax. If the company definitely does not have any nexus or presence then it is not likely they will be required to file income tax returns. (However, this should be reviewed with your income tax advisor.) That said, states are getting more aggressive in identifying any potential unregistered taxpayer. One method is to compare registrations between not only sales tax and income tax, but all other taxes and state licenses and registrations. For that reason it is imperative that a company does a comprehensive review of its activities prior to registering for any taxes. (This includes related entities.)
Drop-Ship Assistance and Other Resources:
If you require assistance regarding sales tax issues, YETTER is available to provide a broad range of services. Please call Diane Yetter at 312-701-1800 to discuss your requirements. The Sales Tax Institute also offers classes which review sales tax basics - through to advanced issues and best practices.
Don't forget about these additional DROP-SHIP resources:
Please visit the YETTER web page for more information on drop shipments and the tax consequences and to order the CCH book Drop Shipments Taxation, Compliance and Planning written by Diane Yetter.
If you subscribe to CCH IntelliConnect Tax Research, we have also written a publication that is available there. For more information, see Drop Shipments section in Sales Tax Research & Compliance Manager.
Are you a multi-state company with a DROP-SHIP question that we have not yet covered here - or in our Sales Tax Archives (below)? If so - Submit it here.
Sales Tax Questions - Drop Shipments
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