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Ecommerce retailers feel increased pressure toBut engaging with a drop shipper can bring onoffer both an expanded product line and rapidnew issues with nexus — laws governing whetherhome delivery, driving many to increase theircompanies have a physical presence that requiresdrop shipping programs. According to the Retailthem to collect sales tax.Systems Research report Retail Insight: MovingBeyond Omnichannel, 40% of retail respondentsexpect an increase in drop ship vendors in 2017, atrend echoed by logistics service providers cateringto retail.With more than 11,000 tax jurisdictions in thethe maze of nexus rules is truly Byzantine —their nexus rules and stepping up enforcement.while driving increased sales. “Often merchantsWith significant penalties for non-compliance, it’swant to start, grow or fine-tune their productcritical that ecommerce retailers establish systemsoffering without the headaches of warehousingand processes to ensure they’re getting it right.a great way to tip-toe into new categories without11%Today?- Retail Systems Research11%In 3 Years?16%16%21%29%Less than 5%26-50%Don’t Know5-10%51-75%11-25%76-100%Source: RSR Research, January 2017How Will The Number Of Drop ShipVendors Change In 2017?40%taking on overhead.”40% of retailersexpect an increase indrop ship vendors in 2017.11%5%16%11%revenue from brick and mortar retail seek a shareof ecommerce sales. States are both modifying13%26%and growing more so, as states losing sales taxin lowering inventory and supply chain costsPresident, Digital Commerce at Logicbroker. “It’s8%8%U.S., each with its own rates and requirements,Drop shipping delivers significant benefitseverything,” said George Heudorfer, VicePercent of Logistics Service Provider (LSP)Sales From Drop Ship32%26%2%IncreaseStaythe sameDecreaseNotapplicableSource: RSR Research, December 2016“Retailers are increasingly interested in dropship as a low-risk way of expanding theirassortment as a hedge against uncertainconsumer demand.”- Retail Systems Research’s Retail Insight:Moving Beyond OmnichannelThe 5 W’s Of Drop Shipping Tax Rules / 2

The Lowdown On Sales TaxesMany retailers don’t initially realize that theshipper does not. The order is for a drop ship item,benefits of expanded drop shipping programsso it’s really going right from the drop shipper tobring added sales tax complexity.the end customer. Usually the retailer can shareHere are the 5 W’s (and1 H) on what they needto know:Why?its resale certificate with the drop shipper, thencharge the correct sales tax to the customer.“But if the drop shipper has nexus or is registeredin the state where the retailer does not have nexus,it gets complicated,” said Pete Bunio, Tax Researchand Support Lead at Vertex. Many states willaccept the retailer’s resale certificate from anotherMost retailers have a handle on tax rules wherestate — those that are members of the Streamlinedthey maintain stores, offices, or distributionSales and Use Tax Agreement, for example, useoperations. They register with state tax authorities,an SST-certified exemption certificate for thatreceive a resale certificate, and charge sales taxpurpose. However, “there are handful of statesaccording to state and local rules. If the retailerthat don’t accept an out-of-state certificate,”sells into a state where it does not have nexus, theBunio said. “They’re very rigid and will only acceptretailer doesn’t have to charge sales tax — instead,their own.” That forces the drop shipper to chargethe customer is expected to pay a use tax.sales tax to the end customer.But it gets more complicated when a drop shipperCalculating that tax is tricky. Sales tax is agets involved. In drop shipping, there are reallypercentage of the sale, but which sale — the saletwo transactions:between the retailer and end customer, or the Retailer to customer Retailer and the drop shipper (usuallya manufacturer or distributor)Case in point: A customer places an order in astate where the retailer has nexus but the dropSales tax is apercentage ofthe sale, but whichsale — the salebetween the retailerand end customer, orthe retailer and thedrop shipper (thewholesale price)?retailer and the drop shipper (the wholesaleprice)? Drop shippers usually don’t know the retailprice. States deal with that situation differently.In California, if the retail price is unknown, thedrop shipper is expected to base the tax on thewholesale price plus 10%.The 5 W’s Of Drop Shipping Tax Rules / 3

In addition, many drop shippers aren’t equipped tobill the customer separately for tax, and retailersfind going back to the customer to recoup a taxbalance unwieldy or unwise. “It’s a rabbit holethat you don’t want to go down,” Bunio said.Jurisdictions might even disagree with how thebasis — wholesale or retail price — is determined.Calculating the correct sales tax also meansthe retailer must know which drop ship facilitythe inventory will ship from, instantly. Ideally,Calculating thecorrect sales taxmeans the retailer mustknow which drop shipfacility the inventorywill ship from,instantly.“you calculate tax immediately in the cart andyou charge the appropriate tax immediately,”said Michael Sonier, Senior Director, ProductManagement, Magento Commerce. “That requiresa pretty complex orchestration of your ordermanagement system, one that knows where you’regoing to source that order from immediately at thetime you take that order, and a tax solution thatknows exactly where that’s going to come fromand tells you the right tax. That’s the best-casescenario.” Without that, retailers are forced toguess, and make up any difference from marginto avoid compliance penalties. “You want to havethe most accurate information up front so youlimit your liability and deliver the best consumerexperience,” Sonier said.Customers are unaware of all this, of course. Theysimply want the retailer to calculate and displaythe correct sales tax so they can hit the “submitorder” button.The 5 W’s Of Drop Shipping Tax Rules / 4

Who?The 11,000 U.S. tax jurisdictions include states,States are starting to declare that drop shipperscounties, cities, and districts, each with itscreate nexus for the retailer. They’re viewing theown continuously changing regulations anddrop shipper as an extension of the retailer, anddocumentation requirements. “Districts can besince the drop shipper has a physical presence inanything from an economic development zone to athe state, the retailer has to register and collecttransit, library, or police jurisdiction,” Bunio said.sales tax in that state.Retailers must be able to quickly verify which taxThat won’t just mean for drop ship customers.rules and rates apply to the customer’s location“The retailer would then have to charge everyand correctly calculate the state city county customer from that state sales tax, whetherdistrict tax.or not they received the item via drop ship,”PwC predicts an uptick in legislation to expandBunio explained.nexus standards, limit exemptions and loopholes,States also are becoming more restrictive inand impose taxes on products/services that wereaccepting out-of-state resale certificates. Thattraditionally exempt. “Moreover, federal and stateintroduces the problem of demanding drop shipperslegislation will impact how states treat out-of-collect taxes and determining whether those taxesstate taxpayers, specifically around expandedare based on the wholesale or retail price.nexus provisions and market-based sourcingimplementation,” according to the Tax Functionof the Future report.Federal and statelegislation willimpact how states treatout-of-statetaxpayers.- Price Waterhouse CooperThe 5 W’s Of Drop Shipping Tax Rules / 5

Where?Laws are transforming everywhere, but manywidely varying thresholds where transactionexperts cite California, New York, Texas, Florida,costs or types of items trigger collection of dutiesand Indiana as among the dozen or so states whereacross countries.sales tax is seeing the most legislative pressure.For example: Use of “cookies” now constitutes aphysical presence in Massachusetts.In April 2017, the state announcedthat Internet vendors with more than 500K in sales and 100 transactionsin the prior taxable year will berequired to collect sales tax.Retailers who use Fulfillment byAmazon to ship from a Californiawarehouse are required to collectsales tax there.States also differ on whether shipping charges aretaxable. Some states always exempt separatelystated shipping charges, and others alwaystax these charges. However, in most states thetaxability of separately stated shipping charges willfollow the taxability of the product.According to 2017 survey data by Temando, 80%of U.S. enterprise retailers struggle with gettingan accurate cost of shipping, including taxes andduties, when trying to ship internationally. And yet42% of U.S. consumers won’t shop with a retaileragain if they had to pay tax and duties to have80% of U.S.enterpriseretailers struggle withgetting an accuratecost of shipping whentrying to shipinternationally.- Temandotheir items released from Customs. In comparison,when consumers encountered a positive shippingexperience, 73% stated they’d shop with theretailer again. Accuracy is critical to avoid losingthe customer or taking a big, margin-eating hit onthe transaction.“There’s a fairly big piece of friction there thatneeds to be removed for the consumer to havea seamless experience,” said Carl Hartmann,Co-Founder and CEO at Temando. “Consumersunderstand that tax exists. It’s when theirexpectations aren’t managed that there’s apotential issue.”A growing number of retailers are expandingtheir drop shipping programs internationally— using a non-U.S. company to fulfill orders inthe U.S., or drop shipping items from the U.S.or other countries to international destinations.Those transactions add complexity, such as theThe 5 W’s Of Drop Shipping Tax Rules / 6

When?these events.SMBs and fastgrowing companiesare in a double bindregarding salestax nexus.Taxable items and exemption rules also vary.- Sales Tax InstituteSales tax rules also can be time-based.Governments periodically hold sales tax holidays,eliminating or reducing taxes for some period.Retailers must implement and document“Clothing may be tax exempt — except forsome items that are not,” Bunio said. “It’s onthe retailer to correctly identify those items.”And some customers are exempt because theyare non-profits or part of government, such asteachers purchasing school supplies. As withresale certificates, some states will accept otherstates’ tax exemption certificates, and otherswill not. These laws, too, vary widely and areunder pressure as jurisdictions seek to replacedeclining revenue.Small- to mid-sized and fast-growing companiesin particular are in a double bind regarding salestax nexus: they’re sizable and busy enough to findthemselves in the increasingly broad sights of localtax officials, but they typically lack the expertiseand means to minimize their tax liability and auditexposure, according to Diane Yetter and SalesTax Institute.The 5 W’s Of Drop Shipping Tax Rules / 7