Drop shipping is big business these days. In fact, drop shipments may account for as many as one-third of e-commerce sales each year. However, many consumers remain unaware of this sales strategy, in which retailers use a third party to fulfill orders for merchandise, rather than keeping inventory and shipping that inventory to customers themselves. The tech company Shopify is looking to change all that by offering budding entrepreneurs the opportunity to start their own drop shipping businesses using its subsidiary Oberlo for order fulfillment. However, those embarking on drop shipping as a side gig may want to consider the sales tax implications first.
The issue that sets drop shipping apart from other online retailers is the determination of which party is responsible for collecting the sales tax. Does the third party fulfilling the orders (the “drop shipper”) qualify for the resale exemption, or must they collect and remit sales tax on these transactions? In the 23 states that are full members of the Streamlined Sales Tax Project, this determination is simple. Under the Streamlined Sales and Use Tax Agreement, these states are required to allow drop shippers to use the resale exemption, thus placing the obligation to collect and remit sales tax on the retailer.
This analysis becomes more complicated in other states, however. Connecticut, for example, considers the delivery of the property to be the taxable point in a transaction where the drop shipper has nexus with the state, but the retailer does not. In such a situation (subscription required), the customer would pay the out-of-state retailer only the sales price of the property and would turn over the applicable sales tax on the purchase to the in-state drop shipper. Massachusetts also considers an in-state drop shipper to be the party obligated to collect sales tax when fulfilling orders for an out-of-state retailer into the Commonwealth.
Florida applies similar rules to drop shipment transactions. If the retailer has nexus with Florida, they must collect sales tax at the point of sale. If the drop shipper is a manufacturer and has nexus with the state, but the retailer does not, the drop shipper must collect and remit sales tax on its “sale” of the merchandise to the retailer. In-state drop shippers that are not manufacturers must only collect sales tax from the customer under specified circumstances surrounding COD (cash on delivery) sales.
Regardless of how easy it now may be to set up an e-commerce site that uses drop shippers to fulfill orders, it is clear that sales tax on these transactions is not quite as straightforward in many parts of the country.
Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: How does your state treat drop shipment transactions?
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