The dropshipping model is popular because of the ease and flexibility with which entrepreneurs can start and run their online business. But the model can run into tricky territory regarding one ever-complicated facet of e-Commerce: sales taxes!
In this post, we’ll explain the general rules around sales tax for drop shipments, plus how to comply with tax rules in major world markets.
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).
There can be complications, though, and one of the big ones is tax. 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 business owner.
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?
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Who collects sales tax, you or the supplier?
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 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 will not charge you sales tax.
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
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 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.