The Importance of Proper Documentation in Drop Shipment Transactions

Drop shipment transactions are one of the most confusing areas of sales tax, and having the proper documentation to verify the transaction can mean the difference between the state assessing or not assessing sales tax.

By Tina Chunn, SALT senior manager

Of the many confusing and complex areas of sales tax, drop shipment transactions rank high on the list, mainly due to the fact that it involves two sales and three parties, but only one actual transfer of goods. A basic drop shipment transaction occurs when a retailer accepts an order from a customer, and the retailer in turn places an order with a supplier/manufacturer and directs the supplier/manufacturer to ship the goods directly to the customer. The first sale occurs between the retailer and the supplier/manufacturer, and the second sale occurs between the retailer and the customer.

How each party complies with its sales tax obligations depends on the state in which the goods are delivered to the customer and whether the retailer and/or supplier/manufacturer has nexus with that state. Recently, Florida, Arkansas and Massachusetts issued sales tax guidance pertaining to drop shipment transactions that highlight the importance of proper documentation and how it may vary among the states for similar transactions.

On Dec. 7, 2015, Florida issued Technical Assistance Advisement 15A – 020 regarding sales by a supplier with Florida nexus (due to a traveling sales force that visits Florida) to a retailer without nexus in Florida, whereby the supplier delivers the goods directly to the retailer’s customers in Florida by common carrier. The ruling states that the transaction between the supplier and retailer is not subject to Florida sales tax because neither party has a physical location in the state, and the goods, when purchased, are outside of Florida. However, the customer would be required to remit Florida use tax on the transaction (unless an exemption applies). Supporting documentation should be retained by the supplier to verify the transaction takes place outside Florida’s jurisdiction and the delivery is made by common carrier. Specifically, the invoices should include the non-Florida retailer’s physical location and that the common carrier destination point is the non-Florida retailer’s customer.

Arkansas, in Legal Opinion 20160104 issued on Feb. 9, 2016, addressed a similar drop shipment transaction to a customer in Arkansas, where the retailer does not have nexus in Arkansas but the supplier does. In this scenario, the Department was asked if Arkansas will recognize the retailer’s resale certificate from another state to exempt the sale from Arkansas sales tax (since that is where the good is delivered). [1] Similar to Florida, Arkansas ruled that the transaction between the supplier and retailer is not subject to Arkansas sales or use tax since the retailer is not located in Arkansas. Therefore, Arkansas does not require the seller to charge sales tax or collect any Arkansas exemption documentation from the retailer. Since the retailer does not have nexus within Arkansas, the consumer use tax would be imposed on the customer on the sale between the retailer and the customer.

Conversely, on April 4. 2016, the Massachusetts Appellate Tax Board issued a decision in which it ruled that the Department of Revenue properly assessed sales tax on a supplier with nexus in Massachusetts making sales to a retailer without nexus where delivery was made directly to the retailer’s customer in Massachusetts. [2] In this case, the supplier did not have a resale certificate from the retailer and could not prove the transaction was not subject to Massachusetts sales tax. Specifically, the Board noted that under Massachusetts laws, the supplier is considered the vendor of property delivered directly to a Massachusetts customer of a retailer when the retailer is not engaged in business in the state. The Board further clarified that the burden to prove the transaction is not a sale at retail is on the supplier and is subject to tax without any supporting documentation to the contrary. Therefore, the supplier is responsible for collecting and remitting Massachusetts sales tax or obtaining a Massachusetts resale certificate from the retailer.

These three rulings reiterate the importance of identifying what documentation is required in your specific drop shipment transactions in order to support that the transaction is not subject to sales tax. Without the proper documentation, the state may assess tax on the supplier since the taxable property is delivered to the customer in the state where the supplier has nexus.

The SALT Services team at Aprio is experienced with sales and use tax on drop shipment transactions and the varying documentation requirements in each state. We are here to assist you in reviewing your transactions to make determinations regarding these requirements for your sales transactions. We continue to keep our clients advised of important issues and developments in state and local taxes in order to help them address their specific tax situations. We will monitor these and other significant sales tax developments and include any updates in future issues of the Aprio SALT Newsletter.

Contact Tina Chunn, SALT senior manager, at or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at for more information.

This article was featured in the June 2016 SALT Newsletter. To view the newsletter, click here.

[1] The retailer is unable to give an Arkansas resale certificate since the retailer is not registered – and is not required to be registered – for Arkansas sales tax.

[2] D & H Dist. Co. v. Comm’r of Revenue, Docket No. C314566, (Mass. App. Tax Bd., April 4, 2016).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.