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California Updates Drop Shipping Information


 Amazon fulfillment centers are often used in drop shipping.

The State Board of Equalization (BOE) has updated its publication on drop shipments. Drop shipping is the practice of using a third party to deliver to a consumer goods purchased from an out-of-state retailer. While drop shipping facilitates many aspects of business, it often complicates sales tax.

Drop shipping generally involves “two businesses, two sales, and one customer,” which sounds a bit like a movie from the mid-1990s. The cast of characters is:

  • The true retailer, an out-of-state business with or without nexus in California. (Nexus is essentially the connection between a business and a state that triggers a sales tax obligation.) In drop shipment transactions, the retailer does not actually own or possess the product sold.
  • The drop shipper, the guy with the product. The drop shipper sells the product to the retailer but ships the product directly to the customer on behalf of the retailer.
  • The consumer, who buys the product from the true retailer and receives it from the drop shipper.

Lots of businesses rely on drop shipping. For example, many retailers participate in Fulfillment by Amazon, a program whereby Amazon stores and ships their products for them. It’s practical.

If an out-of-state retailer has nexus in California, it is required to collect sales tax on the transaction--whether a drop shipper is used or not.

However, as explained by BOE Publication 121, drop shippers delivering to California consumers are required to collect, report and remit sales tax when the following two conditions are met:

  • The sale is on behalf of an out-of-state retailer; and
  • The out-of-state retailer does not have nexus in California, and therefore has no California seller’s permit or California Certification of Registration-Use Tax.

Add 10% to that invoice

Sales tax is calculated from the price of a sale. When purchases are made directly from a retailer (in a store, for example), tax is based on a percentage of the retail price (the California state sales tax rate plus any applicable local taxes). However, when drop shipping is part of the equation, tax may be based on the retail price or it may be based on the wholesale price.

In California, when the amount the out-of-state retailer charged the consumer is known, sales tax is based on that amount even when it is collected and remitted by the drop shipper. If the retail price is not known, sales tax is based on the wholesale price plus a mark-up of 10 percent. However, a drop shipper “may use a lower mark-up percentage if the drop shipper can document the lower mark-up accurately reflects the selling price charged by the true retailer to the California consumer.”

Sounds like paradise for a revenue-seeking auditor, doesn’t it?

Resale certificates

If the true retailer has nexus in California, it should issue a resale certificate to the drop shipper. A resale certificate relieves the drop shipper “of the responsibility to report and pay the tax.” If no resale certificate is issued, the drop shipper could be held liable for sales tax.

Consumer use tax

In certain situations, neither the true retailer nor the drop shipper is required to collect sales tax on a taxable transaction. This is not a tax-free transaction. Repeat: this is not a tax-free transaction. In such situations, the consumer is required to pay consumer use tax directly to the state. It is particularly important for businesses to be aware of consumer use tax liability, because auditors are aware of it.

Spinning head?

If this makes your head spin, check out this awesome video explaining who needs to collect drop shipping sales tax in California.

Or switch to an automated sales tax solution. Learn how it works.

photo credit: Scottish Government via photopin cc


Gail Cole
Avalara Author
Gail Cole
Gail Cole
Avalara Author Gail Cole
Gail began researching and writing about sales tax in 2012 and has been fascinated with it ever since. She has a penchant for uncovering unusual tax facts, and endeavors to make complex sales tax laws more digestible for both experts and laypeople.