Everything You Need to Know About Taxes as A Dropshipper (Dropshipping Taxes Explained)

dropshipping taxes explained photo 1

Introduction

Dropshipping is usually a simple and profitable idea until you begin talking about legal formalities and taxes. Are you in the dropshipping business or planning to join in the future and would like to know more about the involved taxes? If so, then this detailed dropshipping tax guide should help you understand all you need to know as a dropshipper and the relevant taxes and VAT.

We’re going to discuss drop shipping taxes, factors to consider when starting up a dropshipping business, and the advantages and disadvantages of dropshipping.

What is Dropshipping and How Does it Work?

Dropshipping is a form of retail fulfillment that involves selling commodities without shipping, storing, or managing inventory. Instead, you engage the dropshipping suppliers and source their commodities to sell online. In this type of business, the consumers place orders and check them out on your website, then you forward their order information to the supplier, who in turn fulfills that order.

Unlike the traditional online retail business, dropshipping sets the merchant free from having to fulfill customer orders. Therefore, you can skip the costs and time involved in manufacturing commodities, or acquiring stock, storing it, and shipping it to the final customers.

The main advantage of dropshipping is that it makes the fulfillment process for vendors simpler and more convenient. It also reduces the initial outlays and overheads which is important for entrepreneurs who are starting up an eCommerce business, especially those who have a small budget.

What is the Dropshipping Business Model?

In recent years, dropshipping has been gaining immense fame and popularity across the world. With world-class e-commerce platforms like WooCommerce, Shopify, Weebly, and BigCommerce, it is now easier now than ever for people to start operating an online store, as long they have a sound business plan in mind, says E-commerce Expert, Joe Riviello of Zen Agency, a WooCommerce Development Agency.

However, this successful model could turn into a nightmare if your dropshipping business fails to adhere to the legal challenges. When you observe the dropshipping business model keenly, you will realize that there are two purchases at play for just a single commodity. First, the retailer purchases a commodity from the actual vendor. Second, the final buyer purchases the commodity from the retailer.

Taxes Associated with Dropshipping Business

If you’re in the dropshipping business, there are two major types of taxes that you will pay; Sales tax and income tax.

Income tax

Income tax is the tax that you pay as a percentage of the annual income from your business. It is equivalent to the tax levied on your wage when you’re doing a regular job. Income tax is paid to the local government.

The amount of income tax you’re required to pay will depend on the income earned by your business. If your business didn’t realize any profit, you will not be expected to pay this type of tax. Interestingly, you can claim a tax credit if your business had a loss in the last year.

Sales tax

Sales tax is a form of consumption tax that is levied when you buy goods and services. Since the end-users of a particular product or service are the actual consumers, they must pay this tax. In the traditional eCommerce retail sector, as long as your business has the sales tax nexus, you’re required to charge your customers the sales tax and remit it to the relevant government department. 

For instance, X operates a music store online in New York which means that he has a nexus in New York. X will be expected to collect the sales tax from New York customers and remit it to the government. If X sells a synthesizer to customer Y in New York, X will be expected to charge customer Y sales tax. If X sells another synthesizer to customer Z located in Texas, X is not required to charge customer Z sales tax since X won’t be having a sale nexus for Texas.

On the other hand, since the dropshipping business model varies significantly from the regular retail business model, it could be difficult for your online business to identify who is the actual consumer or buyer of a product or service. In the dropshipping business, the main point of concern is which party is supposed to collect sales taxes from the end-user. Is it you, the vendor or the retailer? In the US, every seller (whether dropshipper or retailer) is expected to collect sales tax if they have a sales tax nexus in the location where the item will be shipped.

Another thing to note in eCommerce is that the point of sale is viewed as the shipping address of the buyer. The location of the buyer doesn’t matter, only where the buyer receives the goods after shipping. This means that at some point you, as the dropshipping company, could be a buyer from a third-party supplier; hence, you’d be required to pay sales tax if your supplier has a sales tax nexus in your state.

What is an Exemption certificate?

Also referred to as a resale certificate, an exemption certificate is an official document issued to a business to grant it special permission not to pay sales taxes. An exemption certificate allows a buyer to make tax-free purchases that otherwise would be eligible for sales tax. The buyer fills the certificate out and gives it to the vendor. The vendor keeps that certificate and then can sell commodities to the buyer without charging them sales taxes.

Different states have different rules governing how the issuance of these certificates to retailers. Some states acknowledge multiparty resale certificates (certificates that are accepted in multiple states) whereas others only acknowledge the certificates provided by their state.

In addition, if your business is registered in the Streamlined Sales and Use Tax Agreement (SSUTA), your exemption certificate will be recognized in all member states. There are two main things you need to understand regarding resale certificates before you begin your journey as a dropshipper.

  • Resale certificates are considered to be legal only if they’re used to buy commodities with an intention to resell them. Although every state has different regulations regarding resale certificates, they can only be used to buy items that you truly intend to resell. You can also use a resale certificate if you want to buy a product and use it as a component of another product that you intend to resell. For instance, you can buy wood to create a piece of furniture with and then resell it.
  • Resalecertificates are not acknowledged by every supplier. The supplier reserves the right to either accept or reject your resale certificate. The reason behind this is the supplier will be charged for unpaid sales taxes if it turns out that your resale certificate is fake or fraudulent. Suppliers can also reject an exemption certificate to discourage resellers from purchasing their products. An example of such a supplier is Target which discourages the use of exemption certificates.

Should You Charge Your Customers Sales Tax?

dropshipping taxes explained photo 2

In The United States of America

If you’re a member of SSUTA and you have a sales tax nexus in a particular state, then you’re eligible to collect and remit the sales tax in the states that you’re registered. However, if you’re a dropshipping business, you must take a closer look at your state laws on tax and resale certificates.

On the other hand, if you don’t hold a sales tax nexus in a particular state, it means that you’re not eligible to collect and submit sale tax. You might also be forced to pay sales tax if your supplier is located in the same state as the final buyer.

Although some states, such as Texas, California, Florida, and New York, regard in-state suppliers as eligible to hold a sales tax nexus for sales, other states have varying legal clauses when it comes to this situation. Ensure that you thoroughly understand every state’s policy to confirm that your dropshipping business is compliant with the stipulated legal clauses.

In Canada

If your dropshipping company is Canadian or sells in Canada, you will have to apply for and collect a GST (Goods and Services Tax) instead of sales tax. This tax is usually charged at each production stage. Just like the sales tax in the US, the GST is typically charged as a flat-rate percentage of the transaction’s value.

Canada generally follows the place of supply rule. This rule determines the rate of tax that you ought to charge your consumers and remit to the relevant government agency. What determines the place of supply differs according to what you sell, your business location, and who you sell to.

If you’re an eCommerce company that sells tangible commodities such as electronics, clothes, and such, you must charge the goods and services tax (GST) across the board if Canada is the destination.

In European Union

If you’re an EU business that is VAT-registered and your vendor is also a member of the EU, then the VAT that will be applied on the B2B purchases will be handled via the reverse-charge technique. However, if your vendor is located in the EU but your dropshipping business is located outside the EU, then you will not be obliged to pay VAT.

If your business is located outside of the EU, you’re expected to register for the EU VAT and start charging sales tax as soon as you have surpassed the requirements. Besides, it is important to register for the EU VAT so that you can charge customers the sales tax at the time of purchase.

If your business is below the requirements and fails to register for EU VAT, then your business runs the risk of unsatisfied customers. The reason here is, if your products are imported from outside the EU, customers could end up paying hidden import and VAT duties upon delivery of their products. These unexpected costs will annoy your consumers and make for bad reviews.

What to Consider Before You Operate a Dropshipping Business

  1. Costs

These are the details that you need to consider when planning your business’ finances. They range from standard costs like income tax, customs duties, and VAT to hidden and advertisement costs. Are you prepared to pay for the photoshoots, cover the delivery fees for your customers or purchase a custom domain? These costs are crucial not only for elevating your business but also to ensure that your business’ budget accommodates them.

It is also a great idea to request product samples from your supplier. Why? To make sure that you’re selling quality products. These products will be associated with the name of your brand, so ensure that it’s not stained.

  1. Marketing

Affective marketing is how your business can reach new customers and drive more traffic to your commodities. From effective social media adverts and email marketing to regular advertisements and captivating blog posts, marketing can take several forms.

This era has seen digital marketing strategies grow and expand tremendously to even include social media influencers. If social media presence and strategy are effectively used in the dropshipping business, it can prove to be an effective marketing technique.

Blog posts and articles are also an effective way of drawing in traffic from audiences who are seeking a specific topic. There are advanced ways of marketing through blog posts. Effectively implementing SEO is one of those ways. Correctly implementing keywords can also help your blog posts to rank highly on Google. Appearing on Google’s first page is the ultimate goal and it can help to drive the desired traffic to your dropshipping website.

  1. Customer service

Outstanding customer service results in satisfied customers. Your dropshipping business to accord maximum priority when it comes to treating your customers right. The good thing about dropshipping is that the majority of your customer service is included as part of the supplier’s service.

Good customer service pleases customers and encourages them to return. It also creates a solid customer relationship that is based on mutual understanding and trust. You should ensure that all the contacts of your business are well displayed and the services are being efficiently operated.

Quick replies can play a significant role and can result in more orders from customers. You want to develop a seamless chain that will help your customers promptly. Therefore, make sure that your customers know how they can contact you should need be.

  1. Content

This refers to the “flesh” of your business website. This is where all the detailed information regarding your business and its products will be located. The best place to include the ethos of your brands and outline your unique selling points is the “About Section” on your website. It is the ideal place to encourage prospective customers to your products and brand a try.

FAQs are also a suitable place to provide plenty of information that customers could commonly have to avoid receiving myriads of messages and emails from customers that could be resolved here.

  1. Visuals/Images

Visuals and images make up a significant portion of your dropshipping website. Information alone without the appropriate images makes it difficult to align with your product descriptions. High-quality and detailed product shots will go a long way in selling your products to your audience.

It is also necessary to have a recognizable logo. It is crucial for promoting brand recognition and establishing the identity of your brand.

Advantages and Disadvantages of Dropshipping

dropshipping taxes explained photo 3

Advantages of Dropshipping

  • Dropshipping requires less capital to start. You can simplify your process of starting up an online store by opting to dropship. Typically, retailers have to first pre-purchase and stock their warehouses first. By dropshipping, your vendors will absorb this cost which means that you won’t have to tie up huge capital to begin your online business. All you have to do is set up your store online, choose your preferred payment provider, partner with a dropshipping supplier and start selling products.
  • Hassle-free warehousing. With dropshipping, you don’t have to fill your warehouse with stock. Your vendors will bear the responsibility of storing and shipping your products to the final customer. Not only will your business save resources on storage areas, but you also can increase your product offering. This is because you’re not limited to geographical boundaries or physical storage space. Also, you can concentrate on your core activities.
  • You can run your business from anywhere. Since your products are not tied to a physical location, you can carry out your dropshipping business anywhere as long as you have internet access. What you have to do here is ensure that you can get in touch with your customers and suppliers swiftly and easily. By doing so, you can be sure to handle any queries regarding orders.
  • Efficient scaling. In the traditional online retail model, if you’re business is receiving plenty of orders, you will have to carry out myriads of activities. These activities include sourcing, order management, handling, packing and shipping your products to the final buyer. Since these responsibilities are handled by the supplier in dropshipping, you can grow your business with fewer employees and few logistical challenges. However, you need to bear in mind that as your sales increase, more work will be required. Be it accounting, customer support or website updating and maintenance.
  • Dropshipping allows you to test your ground. Dropshipping allows you to adjust your inventory swiftly according to the most recent trends in the industry. You can be more agile when sourcing commodities from vendors with no upfront costs because nothing will force you into selling that commodity.

Disadvantages of Dropshipping

  • Absence of quality control. When dropshipping, you just have to trust your vendors that they’ll be delivering the right quality products to your customers. It can be difficult to control quality if you can’t inspect each delivery yourself. You also have little control over the delivery times. These two factors (delivery times and quality) are very sensitive and can result in customer dissatisfaction in your business. Fortunately, to minimize this risk, you must use reliable and vetted vendors such as Shopify and others.
  • Low profitability. The dropshipping niche is extremely competitive. The low barriers to entry such as quick setup and low overheads make it highly attractive to entrepreneurs. It is common for dropshippers to source commodities from the same suppliers. You’re very likely to find another business selling near-identical commodities as yours, even at a lower price. Even though this is great for customers, reducing your prices to cope with the competition can only lower your profitability. Before you start dropshipping, conduct thorough research to see if the business is viable.
  • Customization is limited. Dropshipping has limited opportunities for customizing your products. Picking products from a third-party vendor means that you will have less or no control of how the final product will look like, how it will be branded and how it will be presented to the customer. Without customization, you will find it challenging to set apart your product offering in a saturated marketplace. To mitigate this risk, often partner with dropshipping suppliers who provide white-labeling. This will help you to customize and ship your products to the customer with customized packaging and branding.

Conclusion

In the current global selling market, there is a high probability that you could use a dropshipper beyond your state. Therefore, it is important to understand dropshipping taxes to avoid finding yourself on the wrong side of the law. The main takeaways from this article are that just like in employment, you’re required to pay an income tax from your business’ profits. The income tax is paid to the government of the region your business is situated in and is usually paid once a year.

Another key takeaway from this article is that online sellers are expected to collect and remit sales tax to the state where their business is based. If you’re selling to an out-of-state customer and you don’t have a nexus of that area, you’re not required to charge or remit sales taxes.

Hopefully, this article has made dropshipping taxes easier to understand. Click here to learn more about how you can create a successful dropshipping business.