This publication is intended for California retailers and explains the application of tax to drop shipment transactions, including who is liable for the tax and why.
What is a drop shipment?
A drop shipment is the delivery of tangible personal property by a California retailer on behalf of an out-of-state retailer to a consumer in California. If you make a drop shipment to a California consumer, you are responsible for reporting and paying sales tax on the retail selling price if:
- The sale is on behalf of an out-of-state retailer, and
- The out-of-state retailer does not hold a California seller's permit or a California Certificate of Registration-Use Tax.
Typically, drop shipment transactions involve two businesses, two sales, and one consumer:
- The true retailer is an out-of-state business that is not registered to collect California tax. The true retailer sells the product to the California consumer.
- The drop shipper sells the product to the true retailer, but ships the product directly to the California consumer on behalf of the true retailer.
- The consumer in California buys and receives the product.
Please note: This publication summarizes the law and applicable regulations in effect when the publication was written, as noted above. However, changes in the law or in regulations may have occurred since that time. If there is a conflict between the text in this publication and the law, decisions will be based on the law and not on this publication.
Who is liable for the tax when a California retailer delivers a product on behalf of an out-of-state retailer?
When an out-of-state retailer holds a valid California seller’s permit or a California Certificate of Registration-Use Tax, the out-of-state retailer is liable for tax due on any sale made in California, even if the product is delivered by another California retailer. However, if the out-of-state retailer does not hold a seller’s permit or Certificate of Registration-Use Tax and the retail sale of the property is subject to California sales or use tax, the California retailer (drop shipper) is liable for the tax.
A California consumer orders and pays for a doghouse from ABC Supplies (ABC), an out-of-state retailer who is not registered to collect and pay California sales or use tax. ABC buys the doghouse from XYZ, a California retailer, and directs XYZ to deliver the doghouse to the California consumer. XYZ delivers the doghouse directly to the California consumer on behalf of ABC. XYZ is the drop shipper and is liable for the sales tax due on the transaction because ABC is not registered to collect tax in California.
Amount of tax due
How does the drop shipper calculate the amount of tax due?
The retail amount subject to tax of a drop-shipped item is one of the following:
- The amount the out-of-state retailer (true retailer) charged the California consumer, or
- The amount the California retailer (drop shipper) charged the out-of-state retailer plus a mark-up of 10 percent.
A drop shipper may calculate the amount subject to tax based on their retail selling price of the tangible personal property plus a mark-up of 10 percent. A drop shipper can use a lower mark-up percentage if they can document the lower mark-up accurately reflects the selling price charged by the true retailer to the California consumer.
If a drop shipper charges a true retailer $200, the drop shipper may collect, report, and pay tax on a retail selling price of $220 ($200 +10% markup of $20 = $220).
If the drop shipper knows the California consumer purchased the tangible personal property for $210, tax may be determined based on that amount. When the drop shipper charges the true retailer $200, a mark-up of 5 percent is established ($200 + 5% mark-up of $10 = 210). A mark-up of less than 10 percent is allowable in this case because the drop shipper can document the lower mark-up accurately reflects the selling price charged by the true retailer to the California consumer.
Which retailer is liable for sales tax
What if the drop shipment involves more than one California retailer?
It is not uncommon for drop shipments to involve more than one retailer. Generally, the first retailer engaged in business in California in the series of drop shipment transactions is liable for the sales tax. The first retailer is the in-state retailer that received the order from the out-of-state retailer. The first retailer knows the selling price to the true retailer and is required to collect, report, and pay the appropriate tax accordingly.
ABC Supplies (ABC), an out-of-state retailer who is not registered to collect and pay California use tax, sells a doghouse to a California consumer. ABC then buys the doghouse from XYZ, a California retailer, and directs XYZ to ship the doghouse to the California consumer. However, XYZ does not have a doghouse in stock and must buy one from 123, who is also a California retailer. XYZ directs 123 to deliver the item to the California consumer.
XYZ is the first retailer (drop shipper) and owes the sales tax even though 123 (second drop shipper) is engaged in business in California. XYZ is the first California retailer engaged in the series of drop shipment transactions beginning with the purchase by the true retailer (ABC).
Drop shippers and resale certificates
Who does the drop shipper charge for sales tax?
If the out-of-state retailer (true retailer) holds a permit, they should issue the drop shipper a resale certificate for the sale. Once the resale certificate is issued, the drop shipper is relieved of the responsibility to report and pay the tax.
However, if the true retailer does not hold a permit:
- The drop shipper is responsible for reporting and paying the tax.
- The drop shipper should charge the true retailer tax based on the retail amount and report and pay it to the California Department of Tax and Fee Administration (CDTFA).
- The true retailer may choose to seek reimbursement from the in-state consumer for the cost of sales tax charged to them by the drop shipper either by increasing the selling price of the product or adding an additional line on the invoice for reimbursement.
- The true retailer cannot issue an invoice with a line called “California tax” or “California sales tax.” However they may use a phrase such as “California tax paid to California drop shipper” or similar terminology on their sales invoice, indicating that California tax has been paid to a drop-shipper. This will also alert the in-state consumer that California tax has been paid on their purchase.
Please note: If you are a drop shipper that drop ships tangible personal property to a California customer who is buying the property for resale, tax may not be due. You must obtain a valid California resale certificate from the customer and keep it in your records. The resale certificate provided to the true retailer will be accepted as proof that the sale was for resale.
Sales made to the United States government are not subject to tax. As such, the sale by drop shipment of tangible personal property to the United States government is exempt from tax. In order to relieve the drop shipper from the sales tax liability, the true retailer should forward to the drop shipper, documentation that the ultimate purchaser of the materials is in fact the United States government. Supporting documentation for this transaction includes a copy of the purchase order from the United States government or other documents demonstrating direct payment by the United States government to the true retailer. For additional information on sales to the United States government, please see publication 102, Sales to the United States Government.
This publication does not apply to deliveries of vehicles, vessels, or aircraft. For information on those items, see Regulation 1610, Vehicles, Vessels, and Aircraft, Regulation 1620, Interstate and Foreign Commerce, and publication 34, Motor Vehicle Dealers.
Additional information is available from our website at www.cdtfa.ca.gov, or from our Customer Service Center at 1-800-400-7115 (CRS:711). Customer service representatives are available Monday through Friday from 8:00 a.m. to 5:00 p.m. (Pacific time), except state holidays.
1610 Vehicles, Vessels, and Aircraft
1620 Interstate and Foreign Commerce
1706 Drop Shipments
34 Motor Vehicle Dealers
Tax and Fee Guide
Tax Guide for Out-of-State Retailers
Tax Guide for Marketplace Facilitator Act
Use Tax Collection Requirements Based on Sales Into California Due to the Wayfair Decision