This article is written by Sanjay Sawlani, pursuing a Certificate Course in Advanced Corporate Taxation from LawSikho.com.
Table of Contents
Introduction
Drop Shipping is a business model that allows entrepreneurs to start an online business with zero inventory in hand and still sell products to their buyers. In the dropshipping business, the drop shipper purchases the item from a third party and ships it directly to the customer. Dropshipping gives freedom to the entrepreneurs that they can test new product ideas (or product lines) taking a lower risk and without owning or paying for the new product idea or product line. Drop-Shipping influences many people to become an entrepreneur.
What is a drop shipping business?
Drop Shipping is a retail method of business where the drop shipper doesn’t have to keep the stock of the products it sells. When a store sells using the drop-shipping model of business, the store purchases the products from the third party and delivers the products directly to the end consumer. As a result of which the seller doesn’t have to handle the stock of the products. Usually, entrepreneurs feel restricted because they have to spend a significant amount of money on inventory before they start selling their products. In dropshipping, there is no need to keep a stock of inventory and still, the enterprise can fulfill every demand of the customers for any product.
The difference between dropshipping and a standard retail business is that in the dropshipping business, there is no need to keep the stock of inventory instead of this the merchant purchases inventory directly from the third party and sells it directly to the customer to complete the orders.
How are they different from standard retailing businesses?
As compared to the Drop Shipping Business, the standard retailing businessman has to control everything like hold the inventory, shipping procedure, orders should be immediately filled in their warehouse, etc. The Standard Retailing businessman requires initial investment which may be too high especially in new product lines. These types of retailers have high capital risks from an excess inventory which requires storage cost, utilities, and employees to manage and organize it, shipping and handling costs as products move in and out of storage, and cost of maintaining the facility. There are many general risks associated with holding inventory like items may depreciate the longer they store in the warehouse, Inventory could expire like perishable items, Inventory could be damaged while stored or in between shipping processes.
So there is no best way to choose between dropshipping and standard retailing business. The owners have to decide which type of business will reduce their shipping costs and enjoy the high-profit margins in the current market.
Advantages of drop shipping
Low startup cost: One of the biggest advantages of drop shipping to launch a store without having to invest thousands of amounts in inventory in advance. The owner has to invest such a low amount as compared to a physical warehouse which needs large amounts of money before opening their store to purchase inventory, however with this method the owner does not buy the product until a customer has made an order.
Saving time, money, and flexibility: The owner does not have to find, manage, and pay for a warehouse to store the products and no need to pack and ship the orders. The owner did not need to monitor, maintain stock levels, and handle returns or track inventory. These things will save time and money.
Diversity of the products: When the owner purchases inventory, the owner will buy a small number of items in larger quantities at cheaper rates, however with drop shipping the owner can ultimately sell as many different items as they want without any extra cost. From this, there will be a benefit of lower storage cost and logistics cost.
Role of GST in drop shipping
In the 21st century, the world has guided the era of globalization and transformed all industries through an e-commerce platform. One term which is often used these days in the e-commerce trade is of High Drop Shipments.
Dropshipping is the concept that is relevant in the GST regime and it is worth knowing about the importance of the Dropshipping concept in GST rules in India.
The case of Drop shipment and its impact about GST tax can be understood with the help of a case study:
Let us say that, Sanjay Co. from India who had received the order from Pranshu Co. who lived in the USA to send the finished goods. For the said shipments, Sanjay Co. ordered the said goods from Deepak Co. who lives in the UK, and instructed them to ship the order goods directly to Pranshu Co., and for that, Sanjay issued the invoice to Deepak Co.
The above case study questions whether GST is applicable concerning the above transaction i.e. between Sanjay and Pranshu Co. on the direct consignment of the goods from Deepak Co. Here, Sanjay Co. did not take any physical possession of the ordered goods into its territory but they are directly supplying UK goods to the USA.
As per Section 7 of the IGST Act: If the supplier is located in India and the destination is outside India, the supply of goods shall be considered an interstate supply. So the transaction between Sanjay Co. and Pranshu Co. is interstate supply.
In the case of imports, the supply shall be treated as ‘supply in the course of Interstate trade or commerce’, if the goods have entered into the customs barrier of India. As per the GST Law, the transaction between Sanjay Co. and Deepak Co. will neither be treated as interstate or intrastate supply.
From this case, how the transaction between Sanjay Co. and Pranshu Co. be treated as per the IGST Act. The supply of goods from the UK Co. to the USA Co. is interstate supply, so IGST would be applicable. The supplier was located in India and the destination of supply is outside India, i.e. USA and this will be treated as export.
Additionally, the transaction between India and UK shall neither be treated as Interstate or Intrastate supply. So, there wouldn’t be IGST applicable.
Impact on income tax
Income from Drop Shipping Business is taxable under Income Tax as any other normal business income. The head under which the Income from Drop Shipping Business is taxable is Profit & Gains from Business & Profession. The assessee has to file an ITR for reporting the income earned from the dropshipping business. If any Dropshipping business is carried on by an assessee during the previous year then the Income of the previous year of the assessee from drop shipping business is taxable as per Income Tax Act in the following assessment year.
Cases/examples
In the United States, all sellers whether they are retailers or drop shippers are required to collect sales tax if they are selling the products in any state.
For example, Sanjay runs the tobacco store from Maryland (MD) State, which means he has a nexus in MD and is required to collect sales tax from MD buyers, however, Sanjay sells some products to a Maneet (buyer) who lives in Alabama, Sanjay did not require to collect any sales tax because he did not have any sales tax nexus in Alabama.
As per the above example, It’s important to note that in eCommerce transactions the “point of sale” is considered to be the buyer’s “ship to” address. It doesn’t matter where the buyer is located, only where the buyer takes possession of the item after it is shipped.
Let’s take more examples: suppose that Pranshu collects the sales tax from Sanjay (Buyer). Sanjay (Buyer) is located in a state where Pranshu has sales tax nexus. In this case, Pranshu would be required to collect sales tax from Sanjay. If Pranshu doesn’t have sales tax nexus in Sanjay’s ship-to state, then he isn’t required to collect sales tax from him.
Suppose in this case, Deepak is a drop Shipper collects the sales tax from Pranshu. Deepak (Shipper) may have sales tax nexus in the state where Sanjay is living. Since Deepak is drop shipping the product to Sanjay at his ship-to address, Deepak would be required to charge sales tax from the buyer, Pranshu, if Sanjay is located in a state where Deepak has nexus.
COVID-19 impact on drop shipping business
As per the current coronavirus (COVID-19) situation, various prospects are being implemented to keep local and international populations safe and it also includes steps such as countries going into lockdown, factory closures, travel restrictions, manufacturers, suppliers, and logistics companies have implications around the globe including dropshipping stores. The economic effects have been dramatic, and e-commerce has seen its fair share of problems. Entrepreneurs in e-commerce have seen their fair share of problems. Entrepreneurs in the e-commerce space have had to struggle with supply chain issues and regulatory changes on various platforms. Some of the biggest challenges we have seen include logistical delays and changes in consumer habits. While the crisis has presented the drop shippers with new challenges and opportunities, it is time to start thinking about life post-COVID-19, too.
At this time, the drop shipper can build social channels which takes time but it will be fantastic for building the brand and social proof. They can analyze the marketing activities and their results to reduce marketing costs which can save their money and increase the profitable business. They can search for alternative providers because china is an important source for supply, there are several other countries that you could consider sourcing from. Perhaps an Indian supplier may be expensive, but there are other advantages like the delivery routes are shorter. So look around for new delivery channels in good times, even if it comes with a hit on margins. It is important to communicate honestly in these difficult times. If it is foreseeable that delivery problems may arise in the future, inform your customers in a good time. Use all the channels available to you, i.e. your website, emails, and your social media presence. Whether you are new to dropshipping or you have been in the game for a while, there is unlimited information about what you can do to improve your business online.
Conclusion
As per the current market situation, Dropshipping is one of the most complicated tax laws in the whole world. Every businessman has to keep track of everything if they are selling their products worldwide and they have to follow the compliances as per country law. Sometimes businessmen and their accounting fees, however, they lose thousands of extra taxes and penalties as per country law. I think these types of businessmen should consult an accountant and tax practitioner with experience who can manage their financials as per the E-commerce business model and reduce their sales tax and income tax return as per country law so that they can grow their business in the worldwide competition and can earn high profits from their business.
References
- https://blog.taxjar.com/drop-shipping-sales-tax/
- https://blog.taxjar.com/drop-shipping-scenarios-sales-tax/
- https://retailbound.com/choosing-a-distribution-model-drop-shipping-vs-traditional-inventory/
- https://blog.payoneer.com/e-sellers/industry-tips-sellers/dropshipping-during-covid-19/
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