For commercial shippers, a working knowledge of the Incoterms® global system of terms—a system used by buyers and sellers in cross-border transactions—is invaluable in confidently navigating international trade.
But what exactly are Incoterms, and how do they help govern the commercial relationship between buyer and seller as laid down in a shipping contract? And with the International Chamber of Commerce (ICC) preparing to publish its latest revision to the terms, how may the rules be set to change?
Let’s start with a high-level overview of Incoterms. Then we’ll look at each of the terms as currently defined by the ICC, before reviewing some of the proposed changes to the framework.
Incoterms is an acronym for international commercial terms. According to Export.gov, Incoterms consist of “a set of rules which define the responsibilities for buyers and sellers for the delivery of goods under sales contracts.”
At a basic level, Incoterms clarify who is responsible for covering insurance, freight, and transportation costs in a shipping contract, and when the responsibility for costs and the assumption of risk shifts from the buyer to the seller. The terms are intended to facilitate international trade by providing common reference points.
There are 11 distinct Incoterms across four main categories—C terms, D terms, E terms, and F terms. Some terms apply to marine freight only, while the rest cover all modes of transportation. Once agreed upon, Incoterms are normally recorded in the sales contract and associated documentation, such as the commercial invoice and waybills.
Although the Incoterms themselves don’t address dispute resolution or payment, the ICC does offer arbitration for those buyers and sellers that include an ICC arbitration provision in their sales contract. “All of those areas of contractual concern have to be addressed in the sales contract, the invoice, or the purchase order,” explains Bill Flanagan, UPS Customs & Trade Compliance manager. “The ICC will provide arbitration if it is stipulated in the contract.”
The terms, which have been overseen by the International Chamber of Commerce since 1936, are updated every 10 years. The most recent update was in 2010, and the framework is set to be revised again in 2020.
C terms define the responsibility of the seller to provide carriage for the goods.
CPT (Carriage Paid To)
Under this term, the carriage is paid by the seller, who arranges the transportation of the goods to a designated place mutually agreed with the buyer. The buyer is responsible for insuring the goods.
CIP Incoterms (Carriage and Insurance Paid To)
The same as CPT except that the seller carries the cost of insurance.
CFR Incoterms (Cost and Freight)
The CFR Incoterm is used only for marine transport. With CFR, the seller assumes the cost of sea freight and delivers goods to the port of destination. The seller isn’t responsible for providing insurance to cover the risk of loss or damage to goods during transport.
CIF Incoterms (Cost Insurance and Freight)
The same as with CFR, but the seller is responsible for insuring goods through to the named port of destination. The seller must also carry the cost of obtaining any export licenses. As with CFR, the CIF Incoterm is only applied to marine transportation.
D terms capture the seller’s responsibility for delivering the goods to an agreed-upon location.
DDP (Delivered Duty Paid)
Under DDP, the seller assumes all the risk and costs associated with importing goods into the buyer’s country, including payment of custom duties, taxes, insurance, and export licenses if required. The seller delivers to a location that is mutually agreed upon with the buyer. The buyer’s only responsibility is for unloading the goods.
Of all the Incoterms, DDP carries the greatest risk to the seller, not least of all the potential for unexpected delays at customs and the incurring of additional duties and taxes, as well as costs related to storage. DDP is most commonly used in B2C transactions and by experienced B2B sellers dealing with known and stable trade routes where the risk of delay or disruption is low.
DDP is the only one of the Incoterms under which the buyer is not responsible for paying customs duties and import taxes.
DAT Incoterms (Delivered At Terminal)
Under DAT, the seller assumes all the risk and costs associated with importing goods to a mutually agreed-upon terminal, up to and including the point of unloading. Unlike DDP, the buyer is responsible for paying the import duties.
DAP Incoterms (Delivered At Place)
DAP is similar to DAT, except the buyer is responsible for unloading the goods at an agreed-upon location in the buyer’s home country.
There is just one E term, EXW (Ex-Works), under which the seller passes the goods to the buyer’s representative at the seller’s facility, such as a warehouse or factory. When the buyer’s rep signs off, all risk and cost is transferred to the buyer.
EXW is often used for “routed export transactions” in the United States, where the buyer is responsible for arranging the transportation and the seller turns over all relevant shipping documents to the buyer’s freight forwarder or carrier. The buyer is then responsible for preparing the goods for export. As with routed export transactions, EXW is the only Incoterm where the buyer is primarily responsible for clearing the shipment for export.
With F terms, the buyer names the carrier, and the seller’s responsibility ends once the goods have been delivered to that carrier.
FCA (Free Carrier)
Under FCA, carriage is organized and paid for by the buyer. FCA applies to any mode of transportation and captures any sales contract where the buyer is responsible for the shipping. Approximately 40% of all Incoterms transactions internationally operate under FCA.
FOB Incoterms (Free On Board)
FOB is one of the four Incoterms that applies to ocean freight only. Under FOB, the seller is responsible for making sure the freight is loaded on the ship. Once it is over the rail of the ship, the buyer assumes responsibility for the goods.
FAS Incoterms (Free Alongside Ship)
As with FOB, FAS covers ocean freight only. Under FAS, the seller is responsible for getting the freight alongside the vessel. As an Incoterm, FAS is generally applied when dealing with bulk commodities such as coal or grain. It is not often used nowadays, as most freight is containerized.
Although Incoterms are widely used and recognized across Asia-Pacific, Europe, and the rest of the world, they are less well known in the United States. Most U.S. shippers use Uniform Commercial Code (UCC) designations instead of Incoterms. This can lead to confusion in international shipping as some of the UCC terms use the same initials as Incoterms but have a different meaning, such as in the case of FOB, which means Freight On Board under the UCC. That said, awareness of Incoterms is becoming more common among U.S. shippers.
“Incoterms are complicated, and in the United States they are often conflated with the UCC designations,” Flanagan explains. “It’s important to let our U.S. customers know what Incoterms are and how risk and responsibility are segmented by these terms to make sure they feel more comfortable using them.”
Amid speculation that FAS will disappear and that DDP and EXW may change, experts expect the ICC to revise the terms to reflect the increasingly prominent role of e-commerce in international trade.
In addition, there are calls for the terms to align more closely with the European Union’s new customs code. “Responsibilities exist in the EU customs code that don’t necessarily match with the Incoterms. This needs to be addressed by the ICC,” Flanagan remarks.
And the ICC is reportedly looking to address changes in sales contracts associated with the rise of blockchain technology. According to Flanagan, the use of multipurpose Incoterms to cover various modes of transport and the growth of services in international trade have also attracted the ICC’s attention.
Whatever the ICC decides, “It’s important for shippers to get ahead of the 2020 revision and understand that changes are coming and that some of the terms they are familiar with using may go away,” he says.
Commercial shipping can be complex, and Incoterms are prone to misunderstanding and misinterpretation. Fortunately, UPS’s deep expertise and worldwide network of resources are here to help you navigate international trade with confidence.
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