In the past few years, states have made numerous changes in statutes and regulations regarding the treatment of third-party drop shipment transactions. The specific fact pattern of a drop shipment transaction generally determines whether the seller, the buyer or the buyer’s customer is held responsible for payment of sales and/or use tax.
A drop shipment is typically comprised of three parties: the seller (manufacturer or distributor), the buyer and the buyer’s customer. A drop shipment occurs when tangible personal property is shipped from a seller directly to the buyer’s customer, at the direction of the buyer.
So what happens when the seller has nexus with the destination state, but the out-of-state buyer does not?
• Can the buyer claim the resale exemption?
• What tax exemption certificate should be used?
• Can the destination state hold the seller liable for collection of sales tax from the buyer’s customer?
• Does the out-of-state seller avoid nexus with the destination state by using a common carrier to deliver the property?
Assuming the seller has sales tax nexus with the destination state but the out-of-state buyer does not, most states will allow the buyer to claim the resale exemption utilizing one of several documents:
• Buyer’s home state certificate;
• Destination state’s certificate;
• Streamlined Sales Tax certificate;
• Multistate Tax Commission certificate; or even in some instances,
• Statement or affidavit.
In the scenario described above, Pennsylvania recognizes the sale between the seller and the buyer as a nontaxable sale for resale as long as the buyer properly prepares a Pennsylvania sales and use tax exemption certificate. Ohio is the same – it will allow the seller to accept a properly completed Ohio exemption certificate from a buyer not registered with Ohio. However, Maryland has determined that it is the seller’s duty to collect tax on the sale of property to the buyer unless the buyer has a valid Maryland license number. California does not recognize the sale between the seller and the buyer as a nontaxable sale for resale, and requires the seller to charge sales tax to the buyer. Connecticut recognizes the retail sale as occurring between the seller and the buyer’s customer. In this instance, the seller is required to include the retail selling price of the property in its Connecticut gross receipts.
Minor changes in the structure of a drop shipment transaction may have a significant impact on how the state views the drop shipment tax liability. In an effort to help clarify the tax responsibilities associated with drop shipments, several states have issued tax bulletins and letter rulings.
Should you have any questions regarding a specific drop shipment transaction, please do not hesitate to contact your state and local tax practitioner.
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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter