Drop-shipping Business: Income Tax Implications

1. Introduction

Drop-shipping has influenced many people to become an entrepreneur as it offers freedom to the entrepreneurs to check new product ideas and concepts taking a lower risk and while not owning or paying for the new product idea or product plan or business line. 

This is a retail method of business where the drop shipper doesn’t need to keep the stock of the product to sell. Unlike retail businesses, in drop-shipping, sellers are not ought to keep a stock of inventory, and still, the enterprise can fulfill every demand of the customers for any product.  

Like every other business head, dropshipping is also taxable. 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 (Section 28 of the Income tax Act, 1961).

2. What is Drop-shipping Business

Drop-shipping is a business in which the seller sells the goods which he does not own at the time of selling goods but passes the order to a third party after receiving the order. Such a third party then delivers the order to the purchaser. As a result, the seller does not need to handle the goods directly. Within the drop-shipping business, the drop shipper purchases the item from a third party and ships it on to the client. Dropshipping solves a lot of retail problems e.g., Sellers do not need to maintain large warehouses and manufacturers don’t have to manage the retail outlets.  The main distinction between standard retailing and drop-shipping is that the selling merchant does not stock the inventory, instead he purchases the goods from the third party (wholesaler or manufacturer) to fulfill the orders.

International drop-shipping is where the customers and the suppliers are both based outside of India. For example, the target customers are based in the USA, and goods are supplied by suppliers based in China.

So, a person in India takes orders from the customers who are based outside of India and then passes those orders to suppliers who are also based outside of India. These suppliers fulfill the order and get paid by the person in India.

3. Process of drop shipping
4. Customer

Customers browse a catalog or site, choose the product they wish to buy, and pay the seller, including all the applicable taxes. Then they receive their shipment, within the specified delivery period.

2. Seller

When the seller receives an order request and payment from a customer for any item, if the order is not in stock, then the seller places an order with the supplier. Along with payment, the seller provides the supplier with the customer’s shipping information.

3. Supplier

When the supplier receives an order and payment from the seller, he locates the items ordered, packs them up, and ships the order directly to the customer.  The supplier fulfills the order but does not maintain or have a relationship with the end customer.

As a result of which the seller doesn’t have to handle the stock of the products. 

4. Advantages of drop shipping business

• The owner does not have to find, manage, and pay for a warehouse to store the products, no need to pack and ship the orders, maintain stock levels, and handle returns or track inventory. Thus saving time and money.
• In dropshipping, the owner can sell as many different items as they want without any extra cost. Thus,  a benefit of lower storage costs and logistics costs.
• One of the biggest advantages of drop shipping to launch a store without having to invest thousands of amounts in inventory in advance. 

5. Taxation in drop-shipping business

Tax is imposed through different modes, including the locations of all three parties, the taxability of the goods, and where the seller or supplier has an obligation to collect sales tax. Usually, the customer pays sales tax to the seller then the seller remits the tax to the state and provides a resale exemption certificate to the supplier, and then the supplier maintains the certificate as proof of sales tax exemption. GST is also imposed on drop-shipping businesses.

6. Income Tax on drop-shipping business

Income tax is a type of tax that the central government charges on the income earned during a financial year by individuals and businesses. 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 (Section 28 of the Income Tax Act, 1961). 

1. Section 28

Section 28 of the Income Tax Act, provides that the income is chargeable to tax under the head “Profits and gains of business or profession” are:

1. profits and gains of any business or profession;
2. any compensation or other payments due to or received by any person specified in section 28(ii);
3. income derived by a trade, professional or similar association from specific services performed for its members;
4. the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession;
5. any profit on transfer of the Duty Entitlement Pass Book Scheme;
6. any profit on the transfer of the duty-free replenishment certificate;
7. export incentive available to exporters;
8. any interest, salary, bonus, commission, or remuneration received by a partner from the firm ;
9. any sum received for not carrying out any activity with any business or profession or not to share any know-how, patent, copyright, trademark, etc.;
10. The fair market value of inventory as on the date on which it is converted into, or treated as, a capital asset determined in the prescribed manner;
11. any sum received under a Keyman insurance policy including bonus;
12. any sum received (or receivable) in cash or kind, on account of any capital asset (other than land or goodwill or financial instrument) being demolished, destroyed, discarded, or transferred, if the whole of the expenditure on such capital asset has been allowed as a deduction under section 35AD; and
13. income from the speculative transactions.

1. Conditions on determining the income tax

According to Section 28, the following are the main conditions that require an income to be charged under profits and gains of business or profession:

1. There should be a business or profession.
2. The business or profession should have been carried on by the assessee.
3. The business or profession should be carried on for some time during the financial year.
4. The charge is in respect of the profits and gains of the financial year of the business or profession.
5. The charge extends to any business or profession carried on by the assessee whether under the taxpayer’s name or otherwise.

Under Section 28, one of the main aspects of determining if an income must be classified under profits and gains of business or profession is that if a business was carried on by the assessee at any time during the financial year. It is, however, not necessary that the business is carried out throughout the financial year or till the end of the financial year.

• If one is doing drop-shipping business only from overseas, there shall be no tax payable in India unless they have an office or a permanent residence in India because this is a business income of a foreign company which is taxed only if the said company has an office or a permanent establishment with employees in India.
• If the office or permanent residence is in India then since the income will be received in India, it will be taxable. Even if it is not received directly, as one is resident and as per income tax, will be taxed for the same. If the person involved in the drop-shipping business is resident and ordinarily resident, no matter what, all the income will be subject to Indian income tax. 

Thus, residential status is the main criteria for taxability in India, if one is a resident of India then one is liable to pay the tax of the global income, irrespective of the taxability of the income earned overseas in the country of Income. But can claim exemption of tax paid overseas in India based on the Double Taxation Avoidance Treaty entered into with that country. Double taxation avoidance treaty is a tax treaty between two or more countries to avoid taxing the same income twice. This means that there are agreed rates of tax and jurisdiction on specified types of income arising in a country.

2. Income Tax Return

The assessee has to file an ITR for reporting the income earned from the drop-shipping business. If any Drop-shipping 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. In e Commerce transactions, the “point of sale” is considered to be the buyer’s “ship to” address. It doesn’t matter where the buyer is located, the only matter is where the buyer takes possession of the item after it is shipped.