Guide to Dropshipping and Sales Tax: Who collects, who pays?

Dropshipping sales tax is tricky territory in an e-commerce industry that’s already complicated and always changing!

We have over 10 years of experience helping online businesses sell remotely to customers, and many of our e-commerce clients are dropshippers. Their questions about whether dropshipping is legal and how to comply with sales tax – those are our business!

So in this post, we’ve compiled all of our experience to explain the lay of the land: the general rules around sales tax for drop shipments, plus how to comply with tax rules in major world markets.

Let's dive in!

What is dropshipping?

Dropshipping is an e-commerce technique that allows online entrepreneurs to sell products from their business, without ever owning or storing the product themselves.

Instead, once a customer buys the product, the business owner orders it from a third-party supplier, usually either a wholesaler or a manufacturer. The third-party supplier then fills the order and ships it straight to the customer. The third party is the dropshipper.

The allure of the dropshipping model is that entrepreneurs can start an online business without investing much money up front (e.g. buying all their inventory) and without a ton of overhead costs (e.g. renting storage space).

Is dropshipping legal in 2024?

Yes, dropshipping is legal! As long as you follow the local, national, and international laws that apply to any online retailer, your business is sound and you have low personal liability. You may want to ask a lawyer to draft up contracts with your dropshipping suppliers, to clarify who bears legal liability at different stages of the transaction, such as sale, shipping and customer use.

In general there are four legal areas you should consider when setting up your dropshipping business:

1. Copyright laws: Make sure you aren’t buying any counterfeit goods. That way your business can avoid any copyright infringements and potential lawsuits. More on this in the next section, “Legal liability issues with dropshipping.”
2. Consumer protection laws: Despite not manufacturing the product, your online business must adhere to consumer protection laws, ensuring the quality and safety of shipped goods. Any personal injury to your customer could lead to a lawsuit. If applicable, you could consider product liability insurance for your business.
3. Truth in advertising laws: Your marketing has to accurately and honestly represent the products you sell, regardless of whether you make them. Misleading customers can lead to legal issues, and at the very least, it could ruin your reputation as a seller!
4. Tax and licensing laws: Like any business, you must collect and remit sales tax and pay income tax. Some states will require you to register for a seller’s permit or sales tax permit, depending on where you’re located.

Legal liability issues with dropshipping

1. Untrustworthy suppliers. We haven’t seen this to be a common problem for retailers, in our experience, but it’s worth mentioning. Some suppliers sell fraudulent products or use a trademarked logo without legal permission. This type of deception can spell trouble for your business, if you purchase and then resell these products. Choose supplies wisely, and use a Dropshipping Agreement Contract if necessary.
2. Sales tax non-compliance. There can be major complications if your business does not comply with sales tax rules. There are two purchases at play for one product: the customer buys from the retailer, then the retailer from the supplier. So when is sales tax charged and collected, and by whom?

First, a quick debrief about sales tax.

What is sales tax, VAT, and GST?

Sales tax, VAT, and GST are forms of consumption tax. Consumption taxes are applied to the purchase of goods and services, and each country chooses which kind to use. It can be a flat rate applied to every transaction, or a percentage of the total value. Each type requires something different from you, the owner of an online business.

But one element always stays the same. The end customer pays the tax, because they are who’s actually consuming the end product. And it’s a tax on consumption. On buying and spending for one’s own personal use.

With dropshipping, the main question is a matter of who collects the consumption tax from the end customer. Is it you, the retailer, or the dropshipper who delivers the order?

Do you have to pay sales tax on dropshipping?

Dropshipping in the United States

Surprise! There’s no clear answer… But we’ll lay out the general scenarios you encounter, when purchasing from a dropshipper and when selling to a customer. We’ll also advise you on how to double-check your particular tax status.

Do you need to pay sales tax to your suppliers?

This is a tricky step. Usually you do not need to pay sales tax on the orders you make from your suppliers. That’s because there’s usually a sales tax exemption for purchases intended for resale. BUT to take advantage of this exemption, your business needs an official exemption certificate.

Sales Tax Exemption Certificates

Also referred to as resale certificates. The rules for these certificates vary by state. Some states only accept in-state issued certificates, while others accept multi state certificates.

• Multistate Tax Commission: One blanket sales tax exemption certificate accepted by 38 states.
• Streamlined Sales and Use Tax Agreement: If you’re registered for tax via the SSUTA, then that single Streamlined exemption certificate is accepted in every Streamlined member state.

When you make your purchase from the supplier, you need to provide them your complete exemption certificate. Then the supplier won’t charge you sales tax. But not all suppliers accept resale certificates, because they want to discourage resellers from buying their stock! So be sure to check.

Do you need to charge sales tax from your customers?

This B2C part is a bit more straightforward.

• If you have sales tax nexus in a state… Then you must register for sales there. Then you must collect and remit sales tax in all states where you’re registered. It gets confusing with dropshipping. Some states tax the full retail price of the transaction, and other states only require taxing the wholesale price.
• If you don’t have nexus in a state… That usually means you’re exempt for charging and remitting sales tax. But — there’s always a but! — if the dropshipper who delivers the order is located in the same state as the customer, then you might be on the hook for sales tax. Some states consider an in-state supplier to qualify as a nexus for that sale. California, New York, Texas, and Florida have particular clauses about this scenario.

Always check each state’s tax policy to make sure you’re staying within the rules. Here’s a list of each state’s revenue department website.

Side note: This doesn’t apply to you as the retailer, but there are special clauses for dropshippers, too. If the supplier has nexus in the state, but you don’t, then _they _might be responsible for collecting sales tax. These states include California, Connecticut, Florida, Hawaii, and others.

For a full explanation of how to comply with US sales tax, check out what you need to know about sales tax in the US

Dropshipping in the US: explanation 101

In our experience, it’s helpful to take all of those sales tax rules and reframe them in a “real life” scenario that you can relate to as a business owner. So now we’ll explain the sales tax dropshipping stuff in an example scenario between a buyer, a retailer (you!), and a supplier. There are three parts to this… let’s get started!

Imagine that Rebecca Retailer sells a hat to Bella Buyer. Rebecca doesn’t have the hat in stock, so she orders the hat from Dan Dropshipper, and has Dan send the hat to Bella directly.

In this case, Rebecca Retailer pays Dan Dropshipper for the hat, and Bella Buyer pays Rebecca.

Two sales, but who charges tax? Well, it can work out in a few different ways.

Scenario 1: Rebecca Retailer collects the sales tax from Bella Buyer.

Bella Buyer is located in a state where Rebecca Retailer has sales tax nexus. In this case, Rebecca is required to collect sales tax from Bella. If Rebecca _doesn’t _have sales tax nexus in Bella’s ship-to state, then she doesn’t have to collect sales tax from her.

Scenario 2: Dan Dropshipper collects the sales tax from Rebecca Retailer.

However, Dan Dropshipper may have sales tax nexus in the state where Bella is located. Since Dan is dropshipping the hat to Bella at her ship-to address, Dan is required to charge sales tax from the middleman, Rebecca Retailer.

Scenario 3: Rebecca Retailer provides Dan Dropshipper with a Resale Certificate.

Here, Rebecca shows Dan that she’s also a retailer who plans to resell the hat, and so Dan doesn’t need to charge sales tax to her. In this scenario, Dan does not collect sales tax from Rebecca, even if Dan has sales tax nexus in the state where Bella Buyer is located.

Note: In some cases, both Dan Dropshipper and Rebecca Retailer will be responsible for collecting sales tax!

Dropshipping in the European Union

Do you need to pay VAT to your suppliers?

If you are an EU VAT-registered business, and your supplier is also in the EU, then VAT on these B2B purchases is managed through the reverse-charge mechanism. If your business is located outside of the EU, but your supplier is inside the EU, then you probably don’t have to pay VAT.

Do you need to charge sales tax when dropshipping from your customers?

• If your business is located in the EU… Then you must charge VAT on each EU sale. But the tax rate depends on how much you sell annually. There are “distance selling thresholds,” which dictate whether you charge the tax rate of your home country or the customer’s country.
• If your business is located outside the EU… Then you must register for EU VAT and begin charging tax once you surpass the thresholds mentioned above.

If you remain _below _the thresholds and _never _register for VAT, then you run the risk of unhappy customers. If your goods are being imported from outside the EU, then upon delivery, the customer might end up paying some surprise VAT and import duties. Such unexpected costs make for poor reviews!

For the best customer experience and a consistent sales tax process across all EU member states, follow the rules for distance selling in the EU. Here you’ll also learn everything you need to know about the distance selling thresholds.

Managing dropshipping taxes in Shopify

Dropshipping taxes in Shopify are incomplete. The platform covers some parts of compliance for you, such as calculating and collecting the sales tax, but other essential parts of compliance are missing.

Shopify will collect sales tax for you, but you must configure your store to do so. Thankfully, Shopify has easy steps for enabling all of EU VAT and all of US sales tax, so you can knock out 28 countries and 50 states with one setting.

However, the platform does not:

• Send compliant tax receipts
• Alert you when your store becomes liable for sales tax in a new location (i.e. it’s time to register for business in a new place!)
• Provide tax reports with an overview of your tax data for easy return filing.

The best way to manage dropshipping taxes in Shopify is to use an all-in-one tax plugin. The Quaderno plug-in will cover the issues that Shopify cannot. In fact, we’ll close the gap and solve all your tax compliance needs, even beyond Shopify.

More than likely, you also use other channels for online selling, right? So you would have to combine the Shopify data with everything you’ve culled from Amazon, PayPal, and others.

The beauty of Quaderno is that once you’re using it with Shopify, you can easily integrate it with these other channels — so that all of your tax information in one place! And all of it can be delivered in an easy tax report, with the click of a button.

How to comply with dropshipping tax regulations

The best way to comply with dropshipping tax regulations is to use a cloud-based tool that automates the entire process, from charging the correct tax rate to collecting payment to issuing the proper invoice. All of your records are kept safely online for you, even if your computer crashes.

Quaderno is a tax compliance software that’s built to keep your dropshipping business tax-compliant as you grow — no matter where you sell. We built a tax database that serves sales tax, VAT and GST in countries all over the world.

In fact, Quaderno does all of the following:

• Notify you when you’re about to exceed a sales threshold in any state or country.
• Calculate the right amount of tax to charge each customer, right on your checkout page.
• Create and send invoices in multiple languages and currencies.
• Send tax invoices automatically.
• Provide easy-to-read tax reports for easy filing.
• Store secure records of all your transactions.
• Alert you when tax policies or tax rates change so that you’re always in the loop.

Start a risk-free trial today. No credit card, no obligation. Just a quick setup, and you’ll see how Quaderno can give hours back to your week.