Incoterms Explained
If you’re new to the world of international trade and importing, Incoterms might be a completely new and, excuse the pun, foreign concept to you.
Don’t worry… you are not alone! Many companies that have been importing for many years still do not have a thorough understanding and grasp of what Incoterms are in practice and how they can either benefit or put their businesses at risk, depending on which Incoterm is used when buying goods from an international supplier.
Incoterms are there to protect both the supplier and the buyer and clearly define the terms of business agreed between both parties.
We could simply tell you which Incoterm we believe you should specify when confirming quotations and your orders with a supplier, but we’d prefer to provide you with a not-so-short synopsis, so that you can make an informed decision after we’ve given you our professional recommendation (hint: go with our professional recommendation).
So here it is, in a rather large Incoterms nutshell:
The Incoterms or International Commercial Terms are a series of pre-defined commercial terms published by the International Chamber of Commerce (ICC) relating to international commercial law and are designed to assist traders when goods are sold and transported internationally. They are a series of three-letter trade terms related to common contractual sales practices and are primarily intended to clearly communicate the tasks, costs, and risks associated with the global transportation and delivery of goods.
They were devised to reduce, preferably remove, uncertainties arising from differing interpretation of the rules in different countries and any language barriers that might exist.
Each Incoterms rule specifies:
· the obligations of each party (e.g. who is responsible for services such as sea/air freight, import and export clearance, duties, delivery etc).
· the point in the journey where risk transfers from the supplier to the buyer.
By agreeing on an Incoterms rule and incorporating it into the sales contract/ documentation, the buyer and supplier can achieve a precise understanding of what each party is obliged to do and where responsibility lies in event of loss, damage or other accident.
The first edition known as Incoterms was published by the ICC in 1936. The Incoterms rules were amended in 1953, 1967, 1976, 1980, 1990, and 2000, with the latest version - Incoterms 2010 - having been published on January 1, 2011. The ICC has begun consultations on a new revision of Incoterms, to be called Incoterms 2020.
Incoterms 2010 is the eighth set of pre-defined international contract terms published by the ICC and defines 11 rules, down from the 13 rules previously defined by Incoterms 2000.
The 11 pre-defined terms of Incoterms 2010 are subdivided into two categories, based on method of delivery. The larger group of seven rules may be used regardless of the method of transport, with the smaller group of four being applicable only to sales that solely involve transportation by water, where the condition of the goods can be verified at the point of loading on board ship.
Rules for any mode of transport
EXW – Ex Works (named place of delivery):
This rule places minimum responsibility on the supplier, who merely has to make the goods available, suitably packaged, at the specified place, usually their factory or depot. This term places the maximum obligation on the buyer and minimum obligations on the supplier.
Please be aware that the EXW term is often used by sellers while making an initial quotation for the sale of goods without any costs included in order for it to look as competitive as possible.
EXW means that a buyer incurs the risks for bringing the goods to their final destination. Either the supplier does not load the goods on collecting vehicles and does not clear them for export or, if the supplier does load the goods, they do so at the buyer's risk and cost.
It is common practice that the buyer arranges the collection of the goods and freight from the designated location and is responsible for clearing the goods through Customs. The buyer is also responsible for completing all the export documentation, although the supplier does have an obligation to obtain information and documents at the buyer's request and cost.
FCA – Free Carrier (named place of delivery):
The supplier delivers the goods, cleared for export, at a named place. The goods can be delivered to a carrier nominated by the buyer, or to another party nominated by the buyer.
It should be noted that the chosen place of delivery affects the obligations of loading and unloading the goods at that place. If delivery occurs at the supplier’s premises, or at any other location that is under the supplier’s control, the supplier is responsible for loading the goods on to the buyer's carrier. However, if delivery occurs at any other place, the supplier is deemed to have delivered the goods once their transport has arrived at the named place; the buyer is responsible for both unloading the goods and loading them onto their own carrier.
In all cases, the supplier is responsible for export clearance; the buyer assumes all risks and costs after the goods have been delivered at the named place.
CPT – Carriage Paid To (named place of destination):
The supplier pays for the carriage of the goods up to the named place of destination. However, the goods are considered to be delivered when the goods have been handed over to the carrier, so that the risk transfers to buyer upon handing goods over to the carrier at the place of shipment in the country of export. In other words, the supplier is responsible for origin costs including export clearance and freight costs for carriage to the named place of destination, but not for insuring the goods.
The buyer should therefore arrange insurance cover for the main carriage, starting from the point where the goods are taken in charge by the carrier. If the buyer requires the supplier to obtain insurance, the Incoterm CIP should be considered instead.
Things to watch for:
Terminal Handling Charges (THC) are charges made by the terminal operator. These charges are generally not included by the carrier in their freight rates, so the buyer should obtain confirmation of the THC in advance, so as to avoid unwanted surprises.
CIP – Carriage and Insurance Paid to (named place of destination):
The supplier is responsible for arranging carriage to the named place, as per CPT above, and in addition to this is also liable for insuring the goods.
CIP requires the supplier to insure the goods for 110% of the contract value under at least the minimum cover of the Institute Cargo Clauses of the Institute of London Underwriters. The policy should be in the same currency as the contract, and should allow the buyer, the supplier, and anyone else with an insurable interest in the goods to be able to make a claim.
CIP can be used for all modes of transport, whereas the Incoterm CIF (see below) should only be used for sea freight.
Again, as with CPT, the buyer should obtain confirmation of the Terminal Handling Charges (THC) as these charges are generally not included by the carrier in their freight rates.
DAT – Delivered At Terminal (named terminal at port of destination):
The supplier delivers when the goods are placed at the disposal of the buyer on the arriving means of transport ready for unloading at the named place of destination. Under DAP terms, the risk passes from supplier to buyer at the point of destination mentioned in the contract of delivery.
All necessary legal and clearance formalities in the exporting country are completed by the supplier at their cost. The supplier is also responsible for arranging carriage and for delivering the goods, ready for unloading at the named place (an important difference from Delivered At Terminal DAT, where the supplier is responsible for unloading).
After arrival of the goods in the country of destination, the customs clearance in the importing country needs to be completed by the buyer, e.g. import permit, documents required by customs and etc., including all customs duties and taxes.
Under DAP terms, all carriage expenses with any terminal expenses are paid by supplier up to the agreed destination point. The unloading cost at final destination has to be borne by the buyer.
DDP – Delivered Duty Paid (named place of destination):
Supplier is responsible for delivering the goods to the named place in the country of the buyer and pays all costs in bringing the goods to the destination including import duties and taxes. The supplier is not responsible for unloading. This term places the maximum obligations on the seller and minimum obligations on the buyer. No risk or responsibility is transferred to the buyer until delivery of the goods at the named place of destination.
The most important consideration for DDP terms is that the supplier is responsible for clearing the goods through customs in the buyer's country, including both paying the duties, and obtaining the necessary authorizations and registrations/permits from the authorities in that country. This is the only rule that requires the supplier to take responsibility for import clearance and payment of taxes and/or import duty.
These last requirements can be highly problematical for the supplier as import clearance procedures can be complex and bureaucratic, making it a very big risk for both parties in terms of delays and unforeseen additional costs (e.g. demurrage).
Rules for sea and inland waterway transport
FAS – Free Alongside Ship (named port of shipment):
The supplier delivers goods, cleared for export, alongside buyer's vessel at the named port of shipment, at which point risk transfers to the buyer.
The buyer is responsible for loading the goods and all costs thereafter. This means that the buyer has to bear all costs and risks of loss of or damage to the goods from that moment. FAS requires the supplier to clear the goods for export.
FOB – Free on Board (named port of shipment):
Under FOB terms the supplier bears all costs and risks up to the point the goods are loaded on board the vessel at the designated port. Once goods have been loaded onto the vessel the buyer is responsible for any costs and risks involved in the onward shipment.
FOB are the most commonly used and universally accepted Incoterms when importing goods via sea freight as they are a fairly evenly split in terms of costs and risk between the supplier and the buyer.
CFR – Cost and Freight (named port of destination):
The supplier pays for the carriage of the goods up to the named port of destination. Risk transfers to buyer when the goods have been loaded on board the ship in the country of Export. This means that the supplier is therefore responsible for origin costs including export clearance and freight costs for carriage to named port, but is not responsible for delivery to the final destination from the port (generally the buyer's premises), or for the insurance.
If the buyer does require the seller to obtain insurance, the Incoterm CIF should be considered.
So, there you have it, the not-so-short synopsis of the latest Incoterms available when agreeing terms of an import order with an international supplier!
We generally recommend our clients order on an FOB basis for sea-freighted goods, as most global suppliers agree to and understand the fairness of these terms to both parties. It also puts the cost and management of shipping the goods under your control, which is of vital importance when monitoring landed costs vs budgets and ensuring your stock arrives in time for important sales seasons.
To be extra judicious, we’ve also listed some common mistakes in using the Incoterms rules by importers below - just to make sure you’ve got all of your bases covered:
Making assumptions about passing of ownership to the goods, based on the Incoterms rule in use. The Incoterms rules are silent on when ownership passes from seller to buyer; this needs to be defined separately in the sales contract (don’t worry, we’ve got that covered for you).
Failure to specify the port/destination with sufficient precision, e.g. “CIP London”, which could refer to many locations within a wide geographic area.
Attempting to use DDP without thinking through whether the supplier can undertake all the necessary formalities in the buyer’s country, e.g. paying import duties or VAT.
Attempting to use EXW without thinking through the implications of the buyer being required to complete export procedures.
Use of CIP or CIF without checking whether the level of insurance in force matches the requirements of the commercial contract – many suppliers try to obtain a minimal level of cover, which may be inadequate to cover the actual cost of the goods.
Failure to establish how Terminal Handling Charges (THC) are going to be treated at the point of arrival. Carriers’ practices vary a good deal here. Some carriers absorb THC’s and include them in their freight charges; however most do not.
Hopefully the information we’ve provided above proves both informative and useful to you; but if you’re still battling to get you head around it (and you are definitely not the only one out there that finds this a minefield), worry not – that’s exactly what we’re here for: We’ll take care of these terms when liaising and negotiating with international suppliers on your behalf, always in the best interests of your business.