What tax rules apply if I sell both physical and digital products?

Introduction: why “both physical and digital” changes the tax conversation

When you sell physical products—say clothing, candles, or printed books—the tax rules you run into are often familiar: sales tax or VAT on goods, shipping rules, inventory accounting, and income tax on your profit. When you sell digital products—like downloadable templates, software, ebooks, online courses, or memberships—you can run into a different set of rules: where the customer is located matters more, platforms may be deemed the “seller,” and the definition of what you’re selling can shift the rate and the reporting.

If you sell both physical and digital products, you’re dealing with overlapping tax systems that don’t always line up neatly. You may have to register in different places sooner than you expect, handle different tax rates for different product categories, and keep records that can stand up to audits across multiple jurisdictions. The good news is that the core principles are manageable if you treat your business like a set of separate “tax lanes” that converge into one overall income picture: (1) indirect taxes collected from customers (sales tax/VAT/GST), (2) direct taxes on business profits (income/corporation tax), and (3) special compliance issues (platform rules, invoices, exemptions, digital-service rules, and cross-border thresholds).

This article explains the major tax rules and practical steps that typically apply when you sell both physical and digital products. Because tax laws vary by country, state, and even city—and because definitions of “digital goods” or “electronically supplied services” are not uniform—you should treat this as a structured guide to the issues you need to check, not a substitute for jurisdiction-specific advice. Still, if you follow the framework below, you’ll know what to track, what to configure in your checkout and accounting tools, and what to ask a tax professional when you need a definitive answer.

Two big buckets of tax: income taxes vs. consumption taxes

It helps to separate taxes into two categories that behave differently.

Income taxes (or corporation taxes) apply to your net profit. You generally pay income tax where your business is resident and possibly in other places if you have a taxable presence there. Whether you sell physical or digital goods doesn’t usually change the fundamental income-tax calculation, but it can affect deductions, inventory treatment, and how revenue is recognized.

Consumption taxes—sales tax, VAT, GST, and similar—are charged to the customer at the point of sale and then remitted to a tax authority. This is the area where the physical-versus-digital distinction often matters a lot. Physical goods may be taxed based on where the product is shipped, where you have a nexus/presence, and whether the product is exempt. Digital products may be taxed based on where the customer is located, sometimes regardless of where you are, with special rules for “electronically supplied services.”

If you sell both, you can end up collecting consumption tax in one way for physical goods and a completely different way for digital products, sometimes to the same customer in the same cart. That makes proper product classification, customer location evidence, and clear invoicing crucial.

How physical products are commonly taxed

Physical products tend to be taxed under long-established rules. While the specifics vary, most systems rely on some version of these concepts:

Place of supply / destination rules: For physical goods, the taxable location is often tied to where the goods are delivered. In sales-tax systems, tax is frequently based on the shipping destination (destination-based sourcing), though some places use origin-based rules. In VAT/GST systems, cross-border shipments can be treated as exports/imports, which may be zero-rated or exempt on one side and taxed on the other, sometimes with customs duties layered on top.

Inventory and cost of goods sold: If you hold stock, you often track inventory purchases and treat them differently than immediate expenses. The cost of goods sold reduces taxable profit, but the timing depends on inventory accounting rules in your jurisdiction.

Product exemptions and reduced rates: Some physical items are taxed differently (for example, food, children’s clothing, medical items, or books). The category determines whether you collect tax and at what rate.

Shipping and handling taxability: Some jurisdictions tax shipping charges if they are part of the sale; others do not, or they tax them only when the underlying goods are taxable.

Physical products also bring in practical compliance: returns, damaged goods, replacement shipments, and backorders can all change tax amounts and require credit notes or adjustments.

How digital products are commonly taxed

Digital products can be treated as goods, services, or something in between depending on the tax system. This classification affects whether you must charge tax, where, and at what rate.

Digital goods vs. digital services: A downloadable file might be treated as a “digital good” in one place, while an online course or software subscription might be treated as a service. Some jurisdictions tax one but not the other. Some tax both but with different place-of-supply rules.

Customer location often controls the tax: Many VAT/GST regimes tax electronically supplied services based on the customer’s location. That means you may have to charge the customer’s local VAT/GST even if you have no physical presence there, and even if your business is small.

Evidence and “two-point” rules: Because digital delivery doesn’t have a shipping address in the same way, rules often require you to collect evidence of the customer’s location (for example, billing address, IP address, bank location, SIM country code). Some regimes require two non-contradictory pieces of evidence.

Platform or marketplace rules: If you sell through app stores, marketplaces, or certain payment intermediaries, the platform may be treated as the “deemed supplier” and may handle VAT/GST or sales tax. That can reduce your obligations in some cases but can also complicate reporting and revenue recognition.

Special thresholds and registrations: Some places have low or even zero thresholds for non-resident digital sellers. This is one of the biggest “surprises” for businesses that start with domestic physical goods and then add global digital downloads.

When you sell both: mixed transactions, bundles, and carts with different tax outcomes

Selling both physical and digital products means you’ll encounter mixed transactions—single orders containing items that are taxed differently. Tax authorities generally expect you to apply the correct rule to each component.

Mixed carts: A customer buys a physical workbook and a downloadable companion PDF. The physical item might be taxed based on shipping destination rules; the digital item might be taxed based on customer location rules; shipping might be taxed differently again. Your checkout must handle this reliably.

Bundles: A bundle could be one price for a physical item plus a digital item (e.g., “starter kit + video course”). Tax outcomes depend on whether the bundle is treated as a single supply or multiple supplies. Some systems look at the “dominant” element; others require splitting the price across components at fair market value. How you describe and invoice the bundle matters.

Add-ons and upgrades: If the digital component is optional (e.g., “Add the digital version for $10”), you may have a clearer basis to tax each item separately.

Memberships with physical perks: A subscription that includes periodic physical shipments plus digital access can be especially tricky. You may need to tax the subscription differently depending on how the benefits are structured and where your customers are located.

The main lesson: as soon as you sell mixed baskets, you must be able to classify products correctly and itemize them in a way that matches tax logic. “One SKU to rule them all” often creates tax risk.

Consumption tax registration: where you must collect and remit

Whether you must register to collect sales tax/VAT/GST depends on where your customers are, what you sell, and sometimes how much you sell. Selling both physical and digital products increases the number of scenarios where registration becomes necessary.

Domestic sales: If you sell within your home country/state, you typically register once you pass a threshold or when you start trading, depending on local rules. Physical and digital may both count toward the threshold, but not always in the same way.

Out-of-state / out-of-province sales (sales tax systems): In some sales-tax jurisdictions, you may need to register when you have “nexus” (a sufficient connection). For physical goods, shipping into a jurisdiction can create obligations once you exceed economic thresholds. For digital products, rules may also impose obligations based on economic activity, even without physical presence.

Cross-border sales (VAT/GST systems): For physical goods, exports may be zero-rated by the seller and taxed at import by the customer, though there are many consumer-friendly regimes that shift collection to the seller at the point of sale. For digital products, many countries require non-resident sellers to register and charge local VAT/GST to consumers, often from the first sale.

Marketplace facilitation: If you sell through a marketplace that collects and remits, you may not need to register in the same way for those sales. But you may still need to register for direct sales through your own site. You also need to keep marketplace reports and reconcile them.

Because registration rules are jurisdiction-specific, the practical best practice is to map your sales by customer location, channel, and product type, then check each region’s rules for (1) physical goods and (2) digital products separately.

Defining “where the customer is” and why your records matter

Digital tax rules often hinge on customer location. Physical goods usually have a shipping address that can anchor the tax. Digital goods and services often require additional evidence.

What you may need to collect: Depending on the jurisdiction and product type, you may need some combination of billing address, shipping address (if any), IP address, country code of the payment card, bank location, or mobile SIM country code. Some rules require you to store at least two pieces of non-conflicting evidence for consumer transactions.

Why this matters for mixed carts: Suppose a customer enters a shipping address in one country for a physical product but uses a billing card issued in another country. Which country governs the digital tax? In many systems, you must resolve discrepancies using prescribed rules. If you don’t collect the right evidence, you may not be able to justify your treatment later.

Practical approach: Configure your checkout to capture billing address, and store IP-derived location (even if you only keep the country-level detail). Maintain logs or reports that can show what evidence was used. For privacy reasons, keep only what you need, secure it properly, and document your data-retention policy.

Product classification: the hidden lever that changes tax rates and rules

If you sell both physical and digital products, product classification becomes the backbone of accurate tax calculation. Getting it wrong can lead to under-collection (which you may have to pay out of pocket) or over-collection (which can cause customer complaints and regulatory issues).

Examples of classification differences: A physical book might be zero-rated or reduced-rated in some places, while an ebook could be standard-rated. A “downloadable software license” might be taxed differently than “access to hosted software” (SaaS). A digital video course might be treated differently if it includes live instruction versus prerecorded content.

What to do with ambiguous products: If your offering doesn’t fit neatly into a standard category, write a clear internal description of what the customer receives: downloadable file, streaming access, time-limited access, support included or not, updates included or not, and whether any human service is involved. This description helps you (or an advisor) match your product to the correct tax category.

Keep a product tax matrix: Create a simple matrix listing each SKU or product family, whether it’s physical/digital/service, and which tax category it falls under in each major market you sell to. You don’t have to cover the entire world at first; start with the places you actually have customers.

Invoicing and receipts: what should appear when you sell both types

Invoices and receipts aren’t just customer-facing—they’re compliance documents. If you sell both physical and digital products, your invoices should make it easy to see what was sold, how tax was calculated, and what jurisdiction’s rules were applied.

Itemization: List physical items, digital items, shipping, discounts, and taxes separately. Avoid vague line items like “bundle” unless you also break down the components or your jurisdiction explicitly allows single-supply treatment.

Tax labels: Where applicable, show the tax type (sales tax, VAT, GST) and rate. For VAT/GST regimes, invoices may require the seller’s VAT/GST registration number and other formal elements, especially for business customers.

Customer type (B2C vs. B2B): Many regimes treat business customers differently, especially for cross-border digital services. If you can validate a business tax ID, the transaction may be treated under a reverse-charge mechanism in some systems, changing whether you charge VAT/GST. Your invoicing and records must support whichever treatment you apply.

Currency and exchange rates: If you sell internationally, you might collect tax in the customer’s currency or your own. Some regimes require reporting tax in local currency using specific exchange-rate rules. Keep consistent records of the rate used on each transaction.

Income tax basics when you have both physical and digital revenue

For income tax, selling both physical and digital products usually means you have multiple revenue streams and potentially different cost structures. The key is accurate bookkeeping so your taxable profit is calculated correctly.

Revenue recognition: Physical product revenue is often recognized when control passes to the customer (commonly shipment or delivery, depending on terms). Digital downloads may be recognized when the customer gains access. Subscriptions and memberships may need to be recognized over time rather than upfront, especially under accrual accounting.

Cost of goods sold vs. operating expenses: Physical goods typically have direct costs (materials, manufacturing, purchase cost, inbound shipping). Digital products may have upfront creation costs (design, filming, programming) and ongoing platform costs (hosting, transaction fees). Depending on the rules, some creation costs may be expensed immediately or capitalized and amortized.

Returns and refunds: Track them separately by product type. Physical returns can involve restocking and damaged inventory; digital refunds may be governed by platform policies and consumer law, and they can create chargebacks and payment processor fees.

International income issues: If you have customers everywhere, that alone does not always create an income-tax filing obligation in each place. But if you have employees, offices, warehouses, or other forms of presence, you can trigger additional corporate-tax obligations. Fulfillment arrangements for physical goods (like storing inventory in third-party warehouses) can sometimes affect where you have a taxable presence.

Common platforms and “deemed supplier” rules

If you sell through platforms, taxes can be handled in ways that differ from direct sales. Understanding who is treated as the seller is essential.

Marketplaces for physical products: Many jurisdictions have marketplace facilitator rules where the marketplace collects and remits sales tax on behalf of sellers for marketplace transactions. You may still need to file returns reporting those sales, even if tax is collected by the platform, depending on local requirements.

Platforms for digital products: App stores and certain digital marketplaces are often treated as the supplier for VAT/GST purposes on B2C sales, meaning they charge the tax and remit it. In that case, your payout is typically net of tax, and you should record it correctly in your accounts.

Don’t assume this covers everything: If you also sell on your own website, those are usually your responsibility. Many sellers get caught because the platform handled taxes on marketplace sales, but direct site sales were never configured correctly.

Documentation: Keep platform tax reports and settlement statements. You need them for reconciliation, for proof of tax handling, and for accurate income reporting.

Shipping, fulfillment, and warehousing: why physical logistics can create tax obligations

Physical products come with logistics, and logistics can create tax presence.

Warehousing and inventory storage: Storing inventory in a location—especially through a third-party fulfillment center—can create a sufficient connection for sales tax obligations in some systems. It can also affect local business registration or other compliance duties.

Drop shipping: Drop shipping can create complicated chains of documentation. Some jurisdictions require resale certificates or specific forms to avoid tax being charged incorrectly on the wholesale leg. If you also sell digital products, you must keep the records clean so you don’t confuse resale/exemption documentation with digitally delivered items.

International shipping and customs: Cross-border physical shipments may involve customs declarations, duties, and import VAT/GST. Depending on the sales model, you or the customer may be the importer of record. The commercial invoice values, HS codes, and incoterms can affect the total tax and duty paid.

Discounts, coupons, and store credit across physical and digital products

Discounts aren’t just marketing; they change the taxable base in many regimes. When discounts apply across mixed carts, you need consistent rules for allocating the discount between items.

Cart-wide discounts: If a discount applies to the entire cart, some jurisdictions expect you to allocate it proportionally across taxable items, which changes the tax collected for each line. This matters when the cart includes items taxed at different rates or items that are exempt.

Coupons tied to specific products: It’s easier to handle tax accurately if discounts are item-specific rather than cart-wide, especially when mixing physical and digital products.

Store credit and gift cards: Tax treatment of gift cards can differ: in some systems, tax is applied when the gift card is redeemed rather than when it is sold. When redeemed for mixed items, your system must apply tax correctly at the item level.

Refunds, chargebacks, and “digital returns”

Refund handling becomes more complicated when you sell digital products, because “returns” often don’t exist in the same way as physical goods. Still, tax authorities generally expect that if you refund the customer, you adjust the tax accordingly—if you previously remitted it.

Physical returns: You typically issue a refund and a corresponding tax adjustment (credit note) according to your jurisdiction’s rules. Timing matters: you may need to adjust the return in the period the refund occurs.

Digital refunds: Some platforms handle refunds and tax reversals for you; for direct sales, you should issue a corrected receipt or credit note where required. Keep evidence of the refund transaction and any customer communications that support it.

Partial refunds in bundles: If a bundle includes both physical and digital components, you need a method to allocate the refund to the appropriate taxable components. Ideally, your original pricing strategy and invoice itemization already establish separate values for each component.

Cross-border digital rules: B2C vs. B2B and why customer status changes everything

One of the biggest distinctions in digital tax is whether you are selling to consumers or to businesses.

B2C digital sales: Many regimes require the seller to charge local VAT/GST based on the consumer’s location and remit it through a registration or simplified scheme. This can apply even to small sellers and can apply from the first sale in that country.

B2B digital sales: In some systems, cross-border B2B digital services may be subject to a reverse-charge mechanism where the business customer accounts for the VAT/GST. To apply this treatment, you often need to collect and validate the customer’s tax ID and maintain evidence of business status.

Mixed customers: If you sell a digital product to both individuals and businesses, your checkout may need logic to capture business details, validate IDs where possible, and issue invoices that meet business-invoice requirements.

Recordkeeping: what to track when you sell physical and digital products

Good records reduce stress and cost. When you sell both physical and digital products, your records should allow you to answer four questions for every sale:

What was sold? SKU, description, classification (physical/digital/service), and tax category.

Where was the customer? Shipping address for physical, and location evidence for digital.

What tax was charged and why? Rate, jurisdiction, exemption or reverse-charge details if applicable.

What happened after the sale? Refunds, returns, replacements, chargebacks, and any tax adjustments.

Also track channel (your site vs. marketplace), because tax responsibility and reporting can differ. Store copies of platform settlement statements, payment processor reports, and shipping documentation.

Practical setup: how to structure your store, checkout, and accounting

Here’s a practical approach that works for many businesses selling both physical and digital products:

1) Separate SKUs by tax behavior: Don’t lump physical and digital into the same SKU. Create distinct SKUs and categories so your tax engine can apply the correct rules.

2) Use a tax calculation tool or properly configured platform tax features: Manual rate tables break down quickly when you sell in multiple jurisdictions and offer both physical and digital products. If you can’t automate everything, automate the highest-risk areas first: cross-border digital rules, destination-based sales tax, and shipping taxability.

3) Configure customer type capture: If you sell B2B internationally, build in a way to collect business tax IDs, business names, and billing addresses. If your platform supports validation, use it; if not, maintain a process to review and document.

4) Build an internal “tax decision log”: For each product family, write down how you treat it and why. Include the evidence you rely on (product description, delivery method, customer type). This helps you stay consistent as you add new products.

5) Reconcile tax collected to tax reported: Each filing period, reconcile orders, refunds, and platform settlements to what your returns report. Mixed carts and multiple channels make this step essential.

Common mistakes when selling both physical and digital products

These are pitfalls that show up repeatedly:

Assuming digital is “tax-free” everywhere: Many places tax digital products and services, sometimes aggressively, and often based on the customer’s location.

Relying on shipping address alone for digital tax: Digital rules may require additional evidence, and discrepancies can create problems.

Bundling without itemization: Bundles can be taxed in unexpected ways. Without clear pricing allocation, you may struggle to justify your tax treatment.

Not tracking marketplace vs. direct sales: Platform-collected tax doesn’t automatically cover your direct sales obligations.

Ignoring thresholds and registration triggers: Economic thresholds can be easy to cross, especially with viral digital products. Physical inventory stored in new locations can also quietly create obligations.

A simple compliance checklist for mixed physical + digital sellers

Use this checklist to get organized:

Classify products: Identify which are physical goods, digital goods, and digital services/subscriptions. Note any reduced-rate or exempt categories.

Map customer locations: List where your customers are, by country/state/province. Separate B2C and B2B if possible.

Identify collection obligations: For each region, determine whether you must register and collect consumption taxes for physical goods and for digital products.

Configure checkout: Ensure tax is calculated correctly per line item, with correct shipping tax treatment, and with customer location evidence for digital sales.

Set invoicing rules: Ensure invoices/receipts show itemization, tax rates, and required registration numbers. Ensure B2B invoices meet local requirements.

Plan filing and remittance: Calendar deadlines, frequency, and required reports. Assign responsibility internally.

Keep records: Store order data, location evidence, invoices, refunds, platform statements, and shipping documentation.

When to get professional advice

If you sell both physical and digital products, it’s often worth getting targeted advice in these situations:

Rapid growth or international expansion: Especially when digital sales reach customers in many countries.

Complex bundles or subscriptions: When one price covers multiple tax treatments.

Warehousing in multiple locations: Including third-party fulfillment and cross-border storage.

B2B digital sales: Where reverse-charge rules and invoice requirements can be strict.

Unclear classification: If your product sits in a gray area between goods and services, or includes both automated and human-delivered elements.

A short consultation can help you confirm classification, registration triggers, and the best way to structure your offerings to reduce compliance burden without taking unnecessary risk.

Conclusion: treat physical and digital as separate tax lanes that you reconcile into one business

Selling both physical and digital products can be a powerful business model: physical items add tangible value and brand presence, while digital products scale efficiently and can reach customers globally. The tax side becomes manageable when you stop treating “tax” as one monolithic setting and instead build a system that respects the differences.

For physical goods, focus on destination rules, shipping taxability, inventory, and logistics-driven obligations. For digital products, focus on customer location evidence, platform rules, and cross-border VAT/GST or sales tax requirements that can apply even without physical presence. Then bring it all together with consistent product classification, itemized invoicing, reliable recordkeeping, and periodic reconciliation between your store, payment processor, and tax returns.

With the right setup, you can sell both types of products confidently, reduce unpleasant surprises, and spend more time on what matters: building products people want and running your business sustainably.