Dropshipping & Sales Tax: Who Collects, who Pays?
Dropshipping is a standard model because of the ease and flexibility with which entrepreneurs can start and run their online business. The model will have to deal with sales taxes, which is a complicated aspect of e-Commerce.
This article will provide information on how to comply with tax regulations in major global markets and the general sales tax rules applicable to drop shipment.
What’s dropshipping?
Dropshipping allows internet entrepreneurs the opportunity to sell their products without having to buy or store them.
The company owner instead purchases the product from a third party retailer. This is usually a wholesaler, or producer. The order is then completed by the third-party seller who delivers the product directly to the customer. Dropshipper is the third-party seller.
The appeal of the dropshipping method is that entrepreneurs can start an online business without having to spend a lot upfront (e.g. buying all their inventory) or incur operating costs (e.g. renting warehouse space).
There will be issues, and taxes is one of them. Two sales are involved in one product: The buyer buys from the vendor and then the retailer of the supplier. What is the tax payment and collection for this sale?
A short debrief on sales tax, first.
What are sales tax, VAT and GST?
The three forms of consumption tax are income tax, VAT and GST. Consumption taxes are applicable to the purchase of goods or services. Each country decides which tax to use. This could be a flat fee, or a percentage. Each form requires something from the owner of the company.
One aspect remains constant. Since they use the product directly, the final user is responsible for paying the fee. It’s a consumption tax. It applies to personal purchases, saving, and personal use.
Dropshipping has the greatest problem. It is not who gets the final customer’s consumption fees. Which is it? The retailer or the dropshipper who delivers the order?
You or the supplier collect sales tax?
In the United States
Surprise! Surprise! We will discuss the various situations that you might encounter when purchasing from a dropshipper or selling to buyers. We will also instruct you how to double-check the tax status of dropshippers.
Do your suppliers need to pay sales taxes?
This is a difficult move. You may not be required to pay sales tax for orders you place with vendors. This is because transactions intended for resale are exempt from sales tax. To take advantage of this exemption, the company must obtain an official certificate of exemption.
Sales Tax Exemption Certificates
These certificates are also known by the name “resale certificate”. These certificates have different regulations depending on the jurisdiction. Some jurisdictions only accept in-state certificates, while others will accept multistate certificates.
- Multistate Tax Commission One blanket certificate for sales tax exemption that 38 states have recognized
- Streamlined Use and Sales Tax Agreement: Every Streamlined Member States recognizes the one Streamlined exemption Certificate if you are enrolled in the SSUTA to tax.
Before placing an order with a retailer, you will need to provide them with your complete exemption certificate. If you do not supply this certificate, the supplier will not charge sales tax.
Should you charge sales tax to your customers?
This section of B2C is a bit more clear.
If your state has a sales tax nexus…
Then, you will have to pay the purchase. You must then pay the sales tax in all states you are enrolled. Dropshipping makes this even more complicated. Some jurisdictions charge the full retail price, while others consider wholesale prices to be subject to tax.
If there is no nexus between you and a state…
This usually means you are exempt from sales tax and remittances. However, there is a catch! You could be subject to sales tax if the dropshipper who is carrying the order resides in the same state that the buyer. Some states consider an instate retailer to be a nexus. This situation is different in California, New York and Texas.
Review the tax policies in each state often to ensure compliance with the law. The website for each state’s revenue agency has a complete list.
Side note: While this does not apply to you as the dealer or dropshippers, it does include specific provisions. If the state’s supplier has an nexus but you don’t, they will be responsible to collect sales tax. These states include California, Connecticut and Florida as well as Hawaii.
For a complete explanation on how to deal US sales tax, see What You Need to Do About It.
Dropshipping Sales Tax United States
Sales tax 101
All sellers, whether drop shippers or retailers, are required to collect sales taxes in the United States if they have sales nexus within the state where the item is shipped.
Adam, for example, runs an online music shop from Archer City in Texas. This means that he is required to collect Texas sales tax. Adam must charge the buyer sales tax if he sells a synthesizer in Denton, Texas.
However, if Adam sells the synth to Kenner, Louisiana to someone else, Adam doesn’t need to collect sales tax since he doesn’t have sales tax nexus to Louisiana.
Drop shipping can make things more complicated. It doesn’t matter where a buyer is located. The buyer only takes possession of the item once it has been shipped.
If your vendor has nexus within your state, this means you may have to pay sales tax as the buyer.
It’s like you were five.
Confused? That’s understandable. People can feel lost when they have to pay sales tax. Let’s look at some examples.
Imagine Ron Retailer selling a coffee cup to Bobby Buyer. Ron doesn’t own the coffee cup so he orders the cup from Debbie Drop Shipper and Debbie delivers the cup to Bobby.
In this instance, Ron Retailer pays Debbie Drop Shipper, his supplier, for the cup and Bobby Buyer pays Ron.
Who is responsible for sales tax? It can be done in many different ways.
Scenario 1 – Ron Retailer collects Bobby Buyer’s sales tax
Bobby Buyer lives in a state with Ron Retailer’s sales tax nexus. Ron would have to collect the sales tax from Bobby in this instance. Ron is not required to collect sales taxes from Bobby if he doesn’t have sales nexus in Bobby’s ship-to state.
Scenario 2 – Debbie Drop Shipper collects Ron Retailer’s sales tax
Debbie Drop Shipper might have sales tax nexus where Bobby is. Debbie drops shipping the product to Bobby from her ship-to address. If Bobby is in a state that Debbie has nexus, Debbie will need to collect sales tax from Ron Retailer.
Scenario 3 – Ron Retailer gives Debbie Drop Shipper a Resale Certificate
Ron provided proof to Debbie that he doesn’t have to collect sales taxes from her, as he is also an retailer. This scenario means that Debbie doesn’t collect sales tax from Ron even though Debbie has sales tax nexus within the state where Bobby Buyer lives. Continue reading to learn more about resale certificates.
Remember that someone collects sales tax. In some cases, both Debbie Drop Shipper or Ron Retailer may be responsible.
Drop shipping and Resale Certificates
A Resale Certificate allows retailers to purchase products for reselling without having to pay sales tax. To let your vendor know that you don’t require them to collect sales tax, as a retailer, they can present your resale certification to you.
Ron Retailer and Debbie Drop Shipper: If Ron presented his resale certification to Debbie, she would be able to see that he didn’t need to collect sales taxes from her, even if she dropped shipping to him to a customer in a state where she has sales tax.
These are some important facts that retailers need to know about resale certificate.
Only legal resale certificates can be used to purchase items for resale
Although every state in the United States has its own laws and regulations regarding resale certificates they cannot be used to buy items you intend to resell or use as part of an item for resale. You will not use wood for furniture manufacturing.
Some vendors may not accept resale certificate
Your vendor has the right to refuse to accept your resale certification. It’s the vendor that is responsible for any unpaid sales taxes if the resale certificates are found to be fraudulent. Vendors might not accept resale certificate because they don’t want resellers to purchase their products. Target is an example of a retailer that strongly discourages the use resale certificate.
Work with a drop shipper from outside your state
There is a good chance that you will use drop shippers outside of your state in today’s global selling environment.
36 of the states that have a sales tax will allow you to accept a state-issued resale certification. (Hint – In most cases, a resale permit is the same as a sales tax permit.
To enjoy the benefits of a resale certification, you must register in ten States for a sales permit.
Dropshipping Sales Tax European Union
Do you have to pay VAT to suppliers?
If your entity is registered in EU VAT and the provider is located within the EU, then the reverse charge system will be used to collect VAT on these B2B transactions. You don’t have to pay VAT if your organization is not located in the EU but your provider is.
Should you charge sales tax to your customers?
If your organization is located in the EU…
For each EU sale, you must charge VAT. The tax rate is determined based on the amount of EU sales you make each year. There are “thresholds” for distance transactions, which determine whether or not you bill your home country’s taxes rate or that of the consumer.
If you are outside of the EU…
You will then need to apply for EU VAT. If you have met the above thresholds, you can start charging tax.
If you do not file for VAT and sit below the caps, you run the risk that disgruntled customers will find another way to get their money. The products imported from the EU can be subject to import duties and surprise VAT. These unforeseen costs are not applicable to ratings below mediocre.
For the best consumer service and transparent sales tax system across EU member states, please follow the EU guidelines for distance selling. You can also find all the information you need about distance sales thresholds.
Dropshipping Sales Tax In The UK
First, do you have to pay tax on the UK dropshipping income? Unfortunately, yes. The UK tax system is complex and requires you to know many subsections. We’ll help you understand it.
Dropshipping taxes can be daunting. But, it’s possible to break it down into two sections: Income Tax and VAT/Customs duty. Let’s look at each individually.
Dropshipping Income Tax
Income tax is the first tax you should be aware of. The UK government collects this tax and it is calculated as a percentage from your income. This is where things get a bit confusing: the UK has a “banded” system. Each band has its specific tax percentage. These are the bands:
- 0% tax on income above PS12,500/year
- 20% tax for annual income between PS12,500 & PS50,000
- 40% tax for annual income between PS50,001 & PS150,000
- 45% Tax on an annual income of more than PS150,000
If your income falls below PS12,500 during the tax year (April to April), then you don’t have to pay income tax. Important to remember is that the PS12,500 does not include dropshipping income. Let’s say you have a part-time job and also run a dropshipping company. Your combined earnings from both of these businesses will be your income. Make sure to know what your income is and what you must pay.
What does the other band mean? If you earn between PS12,500 to PS50,000 per year, 20% of that income will be taxed. If you earn PS20,000 in the tax year, you will have to pay 20% tax on PS7500. PS12,500 is your ‘tax-free allowance’. Your tax for the year would be PS1500 or PS125 per monthly. You must file your personal tax return every year to pay the required taxes. This can be done by yourself or by hiring an accountant.
One final thing to remember is that the tax rates for those residing in Scotland differ from the rest of the UK. The system still works, but the percentages are and amounts slightly different. Below are the exact numbers:
- 0% for income up to PS12,500/year
- 19% for annual income between PS12,501 & PS14,549
- 20% for annual income between PS14.500 and PS24.944
- 21% for annual income between PS24.945 and PS43.430
- 41% for annual income between PS43.431 and PS150,000
- 46% for an income greater than PS150,000
Dropshipping and VAT
VAT is the second tax area to be aware. Dropshipping VAT is the UK’s tax on goods sold. This tax is also known as sales tax in the US or other countries. It’s basically the same thing.
The VAT rate is 20% of the product’s value. If you sell an item for PS20 you will have to pay PS4 VAT. Dropshipping is where most people will raise the product’s price to PS24 in order to absorb this tax. However, this can have an impact on conversion rates so be careful.
The rules regarding VAT have been changed by Brexit. You don’t have to worry about VAT if you earn less than PS85,000 annually. You must register for VAT in the UK if your income is higher than this threshold. It is easy to complete online and it is quick. You will receive a VAT number at the end. This allows you to claim VAT back on business expenses. For tax purposes, this VAT number must be entered on both your website and Contrado’s.
Importantly, VAT must be paid at the point-of-sale (POS) if you are required to. This means that you are responsible for collecting this VAT when you make a sale. You can do this through Shopify, PayPal or Klarna. Contrado’s dropshipping services include VAT when shipping to the UK.
Dropshipping Customs Duty
Another tax that must be paid when goods enter the UK is customs duty. Customs duty charges 2.5% of the item’s cost. However, items with a higher value than PS630 will be subject to special rates. This tax is not required to be paid for goods valued below PS135. This is the value of the package plus the contents. It’s best to separate more expensive items from the rest to get customs duty relief.
