Massachusetts Drop Shipping: Prove It

Determining how sales tax applies to drop shipments is usually complicated, particularly since multiple states are typically involved in any one transaction. Who is liable for the tax is not always immediately apparent. As a result, errors often occur.

Consider the following real-life drop-shipping scenario:

• Massachusetts consumer purchases a product from an out-of-state retailer without nexus (an obligation to collect sales tax) in Massachusetts.
• The retailer purchases the product from a wholesaler that is located in Pennsylvania but has nexus in Massachusetts.
• The retailer directs the Pennsylvania-based wholesaler to package, label and ship the product directly to the Massachusetts consumer.

Who must collect sales tax: the retailer or the wholesaler? Or is it the consumer’s responsibility to remit use tax?

The audit

An audit revealed that the wholesaler did not charge any tax on transactions with a Massachusetts ship-to address but a bill-to address in another state—the classic drop-shipment transaction. Unfortunately, the wholesaler has nexus in Massachusetts and the retailer does not.

Under the Massachusetts Drop Shipment Rule (G.L. c 64H, § 1):

“When tangible personal property is physically delivered by . . . a former owner . . . to the ultimate purchaser residing in . . . the commonwealth, . . . pursuant to a retail sale made by a vendor not engaged in business in the commonwealth, the person making or effectuating the delivery shall be considered the vendor of that property, the transaction shall be a retail sale in the commonwealth . . . and that person, if engaged in business in the commonwealth, shall include the retail selling price in its gross receipts, regardless of any contrary statutory or contractual terms concerning the passage of title . . . ” (emphasis added).

The wholesaler in this case has nexus because it employs a sales representative who works from a home office located in Massachusetts. Because of this, the wholesaler is obligated to collect and remit sales tax on drop shipments to Massachusetts customers when the retailer does not.

The Massachusetts Commissioner of Revenue therefore assessed the wholesaler more than $500,000 in additional taxes, interest and penalties for the tax periods at issue, which the wholesaler appealed.

Prove it

The wholesaler does not deny that it has nexus in Massachusetts. It argues instead that the state must prove that the retailer does not have nexus, and that the state failed to do so.

You prove it

In D & H Distributing Company v. Commissioner of Revenue, the Massachusetts Appellate Tax Board found the burden of proof that the retailer does not have nexus in Massachusetts to rest with the wholesaler, not the state. This is in keeping with G.L. C 64H § 8(a):

“It shall be presumed that all gross receipts of a vendor from the sale of services or tangible personal property are from sales subject to tax until the contrary is established. The burden of proving that a sale of services or tangible personal property by any vendor is not a sale at retail shall be upon such vendor unless he takes from the purchaser a certificate to the effect that the service or property is purchased for resale, and such certificate is received and made available to the commissioner not later than sixty days from the date of notice from the commissioner to produce such certificate” (emphasis added).

Pay up

This is an expensive mistake. Had the wholesaler collected tax from customers in the first place, the customers would have paid the tax. Now the wholesaler must pay it.

Learn more about the sales tax implications of drop shipping.

photo credit: Taxable via photopin (license)