Thursday, December 23, 2010


Ever Reward - (Panama) and Charleston HarborWhen I started writing this, I thought I'd give you a link that would explain what FOB meant.  I was surprised that there are several different meanings for FOB, other than the one I was going for.  This Wikipedia article should be sufficient to help you understand this term as I plan to use it.

To oversimplify, FOB means where the legal title to the shipment transfers to the buyer.  If the terms are FOB Origin (or shipping point), then the legal ownership of the goods transfers when the seller ships them.  If the terms are FOB Destination, then the seller hasn't transferred the ownership to the buyer until they arrive at her receiving dock.

Legal ownership determines who is responsible for the freight, and who suffers the economic loss when the shipment is lost in transit.  If you're the seller, you want to transfer ownership immediately, which means you're going to want the terms to be FOB Origin.  If the item is lost, it's the buyer's problem.

On the other hand, if you're the buyer, you would prefer to have the terms be FOB Destination, which means that the seller still is responsible for the shipment, until it arrives at your dock.  Purchasing agents usually negotiate terms as FOB destination just for that reason, particularly on more expensive items.

The question of the effect of FOB comes up frequently in sales and use tax conversations because people think that the FOB point determines the state that has jurisdiction over the transaction.  It doesn't.

The state that has jurisdiction is, very simply, almost always the state where the physical delivery occurs, or where the buyer takes control over the goods - which is pretty much the same thing.  This is because the tax that is imposed, when we're talking about an interstate sale, is use tax.  And use tax is generally imposed when the buyer uses (or controls) the goods.  No matter what the terms are, the buyer doesn't control the goods until they arrive at her dock (if shipped by common carrier).

Conversely, if the buyer (or her agent) picks up the goods herself (not using a common carrier), then the physical delivery occurs at the shipper's dock.  This is so, even if the original terms of the sale were FOB Destination and the buyer changed her mind at the last minute.  What counts is where the physical transfer of control took place, not where the contract terms state the ownership transfer occurs.

Think about it.  If it was that easy to manipulate the state that had jurisdiction, then all would have to do is put their warehouse in Oregon (no sales tax in Oregon), and then ship everything FOB Origin.  Then there would simply be no tax at all.  But that's NOT how it works.  What determines the state with jurisdiction is where the physical, real transfer of possession or control takes place.  That's an event that can't be manipulated by contract language.   And so that's the event that really counts.

When FOB does matter

Having said all of that, there are two states that specifically say that the FOB point determines which state has jurisdiction - Tennessee and New Mexico.

Tennessee* isn't really a problem because they have a big loophole.  As long as the seller arranges for the shipment of the goods, and the buyer doesn't pick them up, or arrange for the pickup, Tennessee doesn't claim jurisdiction.  But if the buyer picks up the phone and calls the common carrier and arranges for them to pick up the goods at the dock in Tennessee, then Tennessee does claim that they have jurisdiction.  The easiest way to solve this problem, other than letting the vendor arrange shipment, is to make sure the terms are FOB Destination.  Then the loophole is moot.

New Mexico is different.  They have no loophole.  If you order something FOB Origin from Albuquerque, New Mexico says that the tax belongs to them.  Period.  This goes in the face of all of the things we talk about regarding interstate commerce.   But the reason NM can get away with it is because they don't really have a sales tax.  They have a gross receipts tax that is solely imposed on the seller.  Since the transaction itself isn't being taxed, New Mexico can simply say that they get all of the taxes on anything that is sold in New Mexico, even if it's shipped out of the state.  However, they are fair.  If the terms are FOB Destination, they don't claim jurisdiction.  So, as with Tennessee, the best solution when you're buying from NM is to make sure the terms are FOB Destination.

Please remember that there are some complications if you decide to make all of your purchases FOB Destination.

1.  The vendor may not be interested in doing this.  This is often an easy negotiating point, but sometimes the vendor stands firm. And you have to bring it up if you want the change.  All sales contracts, if they're written by the seller, will state the terms as FOB Origin.  That makes sense, since those terms are best for the vendor.

2.  You may wind up paying the freight if the terms are FOB Origin.  That could be a significant amount of money - even more than the sales tax.  So watch this one.

3.  In some states, the freight may be taxable if the sale is FOB Origin.


FOB points don't count in determining the state that has jurisdiction.  What matters is where the goods are physically delivered.  Well, that's except for two states: Tennessee and New Mexico.  In those two states, the FOB point should be Destination to make sure the tax is for the delivery state.  And since purchasing usually works to set this up anyway, it may not be a big problem.

*Tennessee Important Notice No. 10/01/2001, 10/01/2001

The Sales Tax Guy

See the disclaimer - this is for education only.  Research these issues thoroughly before making decisions.  Remember: there are details we haven't discussed, and every state is different.  Here's more information

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1 comment:

Anonymous said...

Well written, Thanks.