Dropshipping and Taxes: Do You Have to Pay Taxes for Dropshipping?

Dropshipping and Taxes: Do You Have to Pay Taxes for Dropshipping?

Here comes the answer: Yes, you do have to pay taxes for dropshipping. It does seem a bit depressing since dropshipping itself is a way to increase profits. Unfortunately, you do have to pay taxes for dropshipping. It can be a huge risk to your business if you don't.

When you start a dropshipping business, it all boils down to two taxes. These are income taxes and sales taxes.

What Is Income Tax

💡 Note: An income tax is a tax imposed on individuals or entities (taxpayers) in respect of the income or profits earned by them (commonly called taxable income).

Income tax means you pay tax on a year's profits from a shop. Profit is basically the "revenue" of your business. Of course, if you don't make a profit, you don't have to pay any income tax. In fact, you can often claim your loss as a tax credit.

But all in all, the most important question here is: Where do I pay income tax? The answer is the country you live in.

For example, you pay income tax to the local government. Therefore, if you live in Australia, you will always pay income tax to the Australian government. It doesn't matter if your client is in the US: you don't pay income tax to the US government, you do pay income tax to the Australian government.

There's a rare situation, like in the United States, where you have to pay income taxes to both the federal government and your state. However, if you live outside the US, it's probably none of your business, as most countries have no states.

Fortunately, income tax is not a big burden, and it's pretty simple if you know how it works. But now, there's an even trickier problem: sales taxes.

What Is Sales Tax for Dropshipping

💡 Note: A sales tax is a tax paid to a governing body for the sales of certain goods and services. Usually laws allow the seller to collect funds for the tax from the consumer at the point of purchase.

From a simple point of view, the sales tax is not too complicated. This is simply the taxes you pay to your state or city for the sale of goods and services within its jurisdiction. Now sales taxes actually vary from state to state in the US. Each state has its own sales tax regulations and you should consider the best and the worst states for business taxes to find out which one is more tax-friendly

In some states, the tax can be reduced to less than 2%, and in others, it can rise to 5%. The sales tax is a consumption tax applied to the purchase of goods and services. The end customer pays the tax because they are the ones who actually consume the end product.

If you're a new dropshipper, you don't have to pay anything until you get a lot of sales and set up. But keeping track of all the amounts needed to pay taxes does get tedious. The best solution is Shopify dropshipping.

Shopify automatically charges a modest sales tax on orders. This is handy because, in some states, the amount of sales tax you'll have to pay varies depending on the city your customer lives in. Besides that, its over 3,000 apps - the most outstanding feature - can also help with your dropshipping business, and DSers is the top-ranked dropshipping app in the Shopify app store.

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Sales Tax and VAT

What's the difference between sales tax and value-added tax (VAT)? Both sales tax and value-added tax are types of indirect taxes - a tax collected from the buyer by the seller at the time of purchase and then paid or remitted to the government on behalf of the buyer. Sales tax and VAT are common sources of confusion in the corporate-tax world.

When an end sale in the supply chain is reached, the retailer collects a sales tax. In other words, the final consumer pays a sales tax on the purchase of goods or services. When buying supplies or materials to be resold, a business can issue a resale certificate to the seller and pay no sales tax. No sales tax is levied until the sale is made to the final consumer, and no tax is levied by the tax jurisdiction.

💡 Note: VAT, known in some countries as a goods and services tax (GST), is a type of tax that is assessed incrementally.

Compared with sales tax, VAT, on the other hand, is levied on all sellers at each stage of the supply chain. Suppliers, manufacturers, distributors, and retailers all charge VAT on taxable sales. Similarly, they all pay VAT on their purchases.

Businesses must track and record the VAT they pay at the time of purchase in order to get a VAT credit on their tax returns. Under a VAT system, tax jurisdictions receive tax revenue throughout the supply chain, not just at the point of sale to the end consumer.

Since 1st July 2021, some major changes to the rules governing VAT and tariff treatment of goods sold and shipped to customers in the European Union happened. The changes, which focus on personal and e-commerce transactions, will affect businesses and online shoppers. They could also affect Business to Business (B2B) imports and businesses that operate travel agency margin schemes and flat rate schemes.

Who Collects Sales Tax

For dropshipping, the main issue is who charges the sales tax to the end customer. Is it you, the retailer, or the supplier?

In the US

If you are registered through Streamlined Sales Tax Project Agreement (SSUTA) and you have a sales tax Nexus in a state, you must collect and pay sales tax in the state where you are registered.

However, if you run a dropshipping store, you may want to check your state's laws regarding sales tax and exemption certificates. On the other hand, if you have no Nexus in a state, this usually means you are exempt from collecting and filing sales taxes.

But again, if your supplier is in the same state as the end consumer, you may be subject to a tax. While some states consider in-state suppliers to be eligible as a link for the sale, some U.S. states have different legal provisions for this particular situation.

Make sure you always check each state's policies to confirm that you and your business are in compliance with the law.

In the EU

If you operate a VAT-certified business in the EU and your supplier is also in the EU, a reverse charging mechanism will be implemented for B2B transactions. On the other hand, if you do business outside the EU and your supplier is in the EU, you do not have to pay VAT.

If you are located outside the EU, you must register your direct selling business for EU VAT. Once the threshold is exceeded, you can start collecting taxes immediately. It is important to charge the customer a tax at the time of purchase. If you do not register your direct sales store for VAT, you risk providing poor customer service.

If your product is ordered from outside the EU, customers may have to pay additional charges and VAT. Such unexpected fees make up for a negative customer experience. If you wish to provide the best customer service to your buyers across the board, we recommend that you follow EU remote selling laws.

Do you remember that Shopify automatically charges a forwarding tax on each order? You may need to look at the guidance on other platforms to see how this collection process works on their platform. Keep in mind that the guide you'll find on each platform focuses on the process of collecting sales tax on each of its platforms. They do not promise to provide any legal advice.

Things to Ensure before Starting Your Dropshipping Business

First and most importantly, you must ensure that your business is registered. This step is so important that we recommend that you seek professional advice from the professional. And remember to contact your local municipality to find out if you need a local business license to operate a dropshipping store.

If you're a dropshipper who handles indirect taxes like sales tax and VAT, find out how an online e-commerce assistant like Osome can help you collect the right taxes every time.

Osome is an online e-commerce assistant that offers company formation, corporate secretary, accounting, and taxation services in Singapore, Hong Kong, and the United Kingdom. It combines personal care and experience with artificial intelligence's efficiency. The company's business model uses automation to significantly increase efficiency and customer satisfaction, resulting in a high potential for growth and profitability.

Osome provides international services as well as a team of dedicated accountants. The company also assists with business formation and provides corporate secretary services, adding to its distinctiveness.

Are you unsure about your company's sales tax obligations? If so, we encourage you to check out Osome for more indirect tax insights.

Final Word

From this article, we can conclude that, yes, you must pay two kinds of taxes when conducting dropshipping, depending entirely on your income and the size of your business (in associated states).

To make it easier for you to pay your taxes, you can always use Shopify to ship on behalf of you and make an immediate profit. With its handy apps like DSers, your dropshipping business is believed to be smooth and promising!

💡 Note: The definations of income tax, sales tax and VAT are from Wikipedia.

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