Friday, September 29, 2006

Why is my vendor charging me tax on drop shipments?

Drop Ships

Here’s the problem.

- Moe (in California) orders goods from Curly, the retailer.
- Curly (in Wyoming) orders goods from Larry, the manufacturer or distributor.
- Larry (in Georgia, but with nexus in California) ships the goods to Moe.
- Larry bills Curly.
- Curly marks it up and bills Moe.
- Curly is registered ONLY in Wyoming, has a WY resale certificate and does NOT have nexus in California. Which means he doesn’t charge Moe any tax.

In, what I like to call, the “nutty” drop ship states (California is one of them), they require that Larry must charge CA tax to Curly, even though Curly is buying for resale. They will let Larry off the hook for the tax if Curly provides Larry with a California resale certificate (and CA registration number, of course). Curly doesn’t have this because he doesn’t have nexus in CA. And he doesn’t want to register in CA and therefore collect tax because he’ll loose any competitive advantage he has in CA, aside from the other problems with letting CA know he’s out there.

So Larry must collect the tax from Curly and Curly obviously has his margins squeezed. And he can’t pass on the tax to Moe because he’s not registered to collect tax in CA.

Moe also loses here because, since he has an invoice from Curly with no tax shown, the auditor will assess him for use tax on the purchase that Larry has already paid the tax on!

Many vendors (Larry) have been caught on this issue by NDSS (nutty drop ship states), so many of them just automatically follow these rules, regardless of whether they’re shipping to a NDSS or not. This causes problems for the Curlys of the world because they’re being forced to pay tax that isn’t truly due.

If you find yourself in this situation, I recommend that you research the NDSS situation in the ship-to state, and then challenge the vendor. Make them show you where they’re required to charge tax and show them what you’ve come up with. And of course, depending on the relationship you have with the vendor, don’t pay the tax.

There's more on this here

Sales Tax Guy
Of course, the usual disclaimers

Picture note: the illustration above is hosted on Flickr. If you'd like to see a larger version, click here



Anonymous said...

What other states besides California enforces this rule? Do you know of states that do not recognize other state's resale/exemption certificates? Some insite would be great.

numbersguy said...

I have a question about sales tax nexus in state of CA. I am the controller for a non-profit 501c3 religious organization that does campus ministry in universites around the country. We have one employee in CA, our campus ministry director. He travels around the US as well as CA visiting and teaching. He has absolutely no connection to our bookstore operation. Does the fact that we hired him constitute nexus? I have applied for a sales tax license from CA to be on the safe side.

Thanks for your help.

Paul Schultz