I’m often asked questions about drop-ship transactions and sales tax. This isn’t surprising as the sales tax rules on drop-ship transactions and their sales tax implications, such as what type of documentation is accepted by the various states to exempt what is essentially a sale for resale, can be complex. The Massachusetts rules, in particular, are not just complex, but can create sales tax issues for an out-of-state retailer that is not registered for sales tax collection purposes in Massachusetts and who directs goods be drop-shipped to a Massachusetts customer. And so, in today’s post, I’ll explain the Massachusetts drop-ship rules, their application and how they can create a "catch-22."
What Exactly is a Drop-Ship Transaction?
Before launching into the Massachusetts rules, it’s important to have a basic understanding of a drop-ship transaction. These transactions, which generally involve at least three parties, are not only complex, but can be quite confusing in terms of which party does what and how each is impacted sales-tax wise. Part of the confusion comes from the fact that there can be a variety of business types involved in a drop-ship transaction, including manufacturers, suppliers, distributors, wholesalers, resellers, vendors, retailers, etc. To add to this confusion, the various states do not always use consistent terms to describe the various parties, or may use these terms interchangeably. Which is why focusing on the two key parties, what their role is, and the various terms that can be used to refer to these parties, is a good starting point.
Party A – Seller. A drop-ship transaction always includes a seller. This is the party that makes the sale to the final consumer – the retail sale. The seller, however, does not typically maintain inventory of the goods it sells. When the seller receives an order from its customer (generally the final consumer), the seller directs its supplier (Party B in the next bullet) to “drop-ship” the goods directly to the seller’s customer who may be located anywhere in the country or even overseas. States use a variety of terms when referring to Party A, including seller, retailer, vendor, distributor, and reseller. But to things simple and consistent, I’ll refer to this party as “the Retailer.”
Party B –Supplier/Shipper of Product. This is the party that holds the goods that are being sold by the Party A to the final consumer. Party B may be the manufacturer of the goods or may be a wholesaler who purchases inventory for distribution. Thus, while Party B is also a seller, in a typical drop-ship transaction Party B sells at the wholesale level – such as to Party A who will then sell the goods at retail. States use a variety of terms to refer to Party B, including manufacturer, wholesaler, and supplier. But to keep things simple and consistent, I’ll refer to this party as “the Manufacturer”.
As you can see, from a business perspective, a typical drop-ship transaction consists of two sales – a sale from the Manufacturer to the Retailer, and a second sale from the Retailer to the final consumer. From a sales tax perspective, the Manufacturer has made a sale for resale, and if the Manufacturer is registered for sales tax purposes in the final consumer’s “ship to” state, the Manufacturer must charge sales tax on the sale to his customer, the Retailer, unless the Retailer provides the Manufacturer a resale certificate that is accepted by the “ship to” state.
The Massachusetts Rules - Complex and Inflexible
What happens when a Manufacturer registered for Massachusetts sales tax purposes drop-ships goods to a Retailer’s Massachusetts based customer, but the Retailer is not a Massachusetts registered sales tax vendor? (Note in situations like this, states will often refer to the Retailer as the “unregistered vendor” or “unregistered retailer.”)
First of all, the Massachusetts sales tax law generally requires a Manufacturer with nexus to Massachusetts to collect tax when it ships goods into Massachusetts on behalf of a Retailer that is not required to collect the tax because the Retailer does not have nexus to Massachusetts. Although from a business perspective, there is no actual contract between the Manufacturer and the Retailer’s Massachusetts customer (remember, the contract is between the Manufacturer and the Retailer), from a Massachusetts sales tax perspective, the Manufacturer is deemed to have made a retail sale to the Massachusetts consumer. (For this reason, Massachusetts is sometimes referred to as a "deemer" drop-ship state.) Here's how the Massachusetts law addresses this in its definition of a "retail sale":
"When tangible personal property is physically delivered by an owner, a former owner thereof, a factor, or an agent or representative of the owner, former owner or factor, to the ultimate purchaser residing in or doing business in the commonwealth, or to any person for redelivery to the purchaser, 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 by the person….. "
In effect, because the Manufacturer is considered to have made a Massachusetts retail sale, if the Manufacturer is registered for Massachusetts sales tax purposes, it is required to either charge Massachusetts sales tax on the sale to the Retailer or collect a valid resale certificate. Since the Retailer is the Manufacturer’s customer, the Retailer must provide a resale certificate in accordance with the Massachusetts rules. Once again, from a business perspective, the Manufacturer’s legal contract is with the Retailer (not with the Retailer’s Massachusetts consumer).
The Massachusetts Sales Tax Resale Certificate "Catch-22"
Here is where things can get problematic for an unregistered Retailer. You see, in order for Manufacturer to “exempt” the sale from Massachusetts sales tax, the Retailer must be able to provide a Massachusetts Form ST-4, the Massachusetts Sales Tax Resale Certificate. However, issuing an ST-4 requires the Retailer to certify that the Retailer holds “a valid Massachusetts Vendor’s Registration Permit, issued by the Commissioner of Revenue, pursuant to Massachusetts General”. Thus, an unregistered Retailer is not legally permitted to provide a Massachusetts ST-4.
And here’s what even more problematic for an unregistered Retailer – Massachusetts is extremely inflexible when it comes accepting other forms of documentation that support a sale for resale exemption. For instance, states that are members of the Streamlined Sales and Use Tax Agreement (SST) are required to accept the SST Exemption Certificate. However, as I mentioned in my last Massachusetts post, Massachusetts is not a SST member state so the SST Exemption Certificate cannot be used to claim a resale exemption. (For more Massachusetts sales tax facts, see my last post, “Massachusetts Sales Tax: Five Things You Should Know”) Many other states, including states that are not SST members, are much more flexible than Massachusetts and will accept the MTC Multijurisdictional Exemption Certificate or even a certificate from the “ship to” state with a “no-nexus” statement or with the unregistered distributor’s home state sales tax permit number.
In a nutshell, an unregistered Retailer that directs a registered Manufacturer to drop-ship product to the Retailer’s Massachusetts customer is subject to Massachusetts sales tax on its purchase from the Manufacturer even if the goods are being purchased for resale. (Another complexity not touched on is that the Manufacturer is supposed to charge tax on the sales price that the Retailer charges its final customer – but the manufacturer may not know this amount.) The only documentation that Massachusetts will accept to support that the Retailer's purchase qualifies as a purchase for resale is Massachusetts Form ST-4. (For the Massachusetts rules on resale and exempt use certificates see Massachusetts regulation, 830 CMR 64H.8.1) Adding to the Retailer’s problems, since the Retailer is not a Massachusetts registered vendor, it cannot attempt to recoup the sales tax it paid by charging sales tax to its Massachusetts customer. Yes, a "catch-22" indeed!
Incidentally, drop-ship and exemption certificates are two topics that are consistently searched for here at SalesTaxSupport (as evidenced by the “Top Searches” box in the left side bar). As I’ve only focused on the Massachusetts rules, if you looking for information on other states, or have a specific drop-ship related question, check out the following sections on SalesTaxSupport: Drop Shipments Q & A - Third Party Shippers & Other Multi-Address Scenarios, Resale/Exemption Certificate Requirements - "By State" Lookup , and the Sales Tax Exemption Certificate Library.
If you have questions or comments on today’s post, or ideas for future “Massachusetts Sales Tax” posts, I invite you to post a comment below.
Other recent “Massachusetts (MA)” posts by Sylvia F. Dion, CPA:
- The Massachusetts DOR Website - A Great (Sales) Tax Resource
- MassTaxConnect - 5 Things Massachusetts Sales Tax Filers Should Know
- Massachusetts Sales Tax Holiday Is Consumer Perk – But Retailer Pain
- Massachusetts Exemption Certificates for Drop-Ship: A Catch-22
- Massachusetts Sales Tax: Five Things You Should Know