Massachusetts Appellate Tax Board Decision Highlights the Drop Shipment Sales Tax Rule

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Insights  <  Massachusetts Appellate Tax Board Decision Highlights the Drop Shipment Sales Tax Rule

The Massachusetts Appellate Tax Board recently agreed with the Department of Revenue’s $525,024.17 sales tax assessment (for approximately a 3-year period) on an out-of-state wholesale distributor who shipped products to out-of-state third party retailers’ Massachusetts customers.  (D&H Distributing Company v. Massachusetts Commissioner of Revenue, Docket No. C314566 (4/4/2016)).

During the relevant period, D&H Distributing Company (D&H) was a wholesale distributor headquartered in Pennsylvania with warehouse distribution centers located throughout the United States, none of which were in Massachusetts. D&H employed a Massachusetts sales representative to solicit orders for the sale of its products (e.g., computer products, educational products, home electronics, outdoor goods and sporting goods). Due to this activity, D&H was considered to have nexus within Massachusetts.

D&H sold its products to non-Massachusetts retailers who in turn sold those products to their Massachusetts customers (end consumers). As a wholesaler, D&H’s sales were typically sales for resale and were usually exempt from sales tax when sold to retailers (when a properly executed Resale Certificate was received). Upon a sale by the retailers, the retailers instructed D&H to directly ship the products to their Massachusetts customers (i.e., “drop ship”), rather than ship them to the retailers.

The transactions were generally structured as follows:

  • First, a Massachusetts consumer purchased a product from an out-of-state retailer (the retailer invoiced the consumer, without Massachusetts sales tax);
  • Second, the out-of-state retailer would purchase the product from D&H (D&H invoiced the retailer, without Massachusetts sales tax); and
  • Third, the out-of-state retailer would direct that D&H package, label, and ship the products directly to the Massachusetts consumers.

As the out-of-state retailers did not have a physical presence (nexus) in Massachusetts, they were not obligated to register to charge, collect and remit Massachusetts sales and use taxes on the sales to their Massachusetts consumers. (See Quill Corp. v. North Dakota,U.S. Supreme Court).  However, according to the Massachusetts Tax Board, D&H as the drop shipper was obligated under Massachusetts’ drop shipment sales tax rule to remit the tax. Under thedefinition of “sales at retail” or “retail sale” as provided in G.L. c. 64H, § 1:

[w]hen tangible personal property is physically delivered by . . . a former owner . . . to the ultimate purchaser residing in . . . the commonwealth, . . . pursuant to a retail sale made by a vendor not engaged in business in the commonwealth, the person making or effectuating the delivery shall be considered the vendor of that property, the transaction shall be a retail sale in the commonwealth . . . and that person, if engaged in business in the commonwealth, shall include the retail selling price in its gross receipts, regardless of any contrary statutory or contractual terms concerning the passage of title. . . . (emphasis added)

Pursuant to the so called “drop shipment rule,” when a retailer doesn’t have the obligation to collect the Massachusetts sales tax from its Massachusetts customers, the drop shipper, if it has nexus in the state, is deemed to be the retailer and is required to remit the applicable sales tax on the products that are shipped to the Massachusetts consumers (unless the retailer properly and timely provides the drop shipper with a Massachusetts Resale Certificate).  In this case, the tax was assessed based on the wholesale price paid by the retailers to D&H, not the retail selling price paid by the Massachusetts’ consumers to the retailers.

This decision brings to light a sales tax law that many manufacturers and distributors may not be aware of.  Manufacturers and distributors that drop ship products (whether using common carrier or their own trucks) to their retailer customers’ customers may not realize that they may be liable to remit sales tax to the tax authorities of the drop-to-states. A company may have significant tax exposure and not know it.

Manufacturers and distributors need to take notice of this decision.  Similar decisions occur from time to time throughout the United States whereby state tax auditors find drop shipper manufacturers and distributors violating their drop shipment sales tax rule. Where a sales tax return hasn’t been filed, no statute of limitations exists to limit the audit period to the prior 3 years; often assessments are made on 6 to 10 years of sales activity (as a “practical” look-back period).

Manufacturers and distributors that are shipping products to their retailer customers’ customers should determine the following:

  1. Where does the company have nexus?
  2. Of those states, which states impose a drop shipment sales tax rule?
  3. Is the retailer collecting sales tax on its sales to the consumers in the drop-to-states?
  4. Can a proper and valid drop-to-state resale certificate be obtained from the retailer?
  5. If the company is required to remit tax, based on what sales price and from whom can it be collected from?

View the Massachusetts Appellate Tax Board’s decision here.

Should you have any questions or need assistance with the drop-shipment sales tax rule, please contact Tony Switajewski, State Tax Partner, at (860) 561-6810 or

Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.


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