Incoterms: A Complete Guide
Incoterms is the shorter version of International Commercial Terms. These specific terms are used throughout international commercial transactions. They are three-letter trade terms used to clearly communicate the risks, costs, and tasks associated with international transportation and the delivery of goods.
A basic understanding is just the start when it comes to Incoterms. If you plan to import and export goods internationally, it's a good idea to gain a strong understanding of what Incoterms are, why they are used and what they mean. For quick reference guides, infographics, and downloadable handouts click here.
The History of Incoterms
While Incoterms 2010 and Incoterms 2020 are the most recent versions, Incoterms actually dates back to 1923 when the first work published by the ICC was issued. The first known version of Incoterms wasn't published until 1936, however.
Since 1936, the Incoterms rules have been amended several times. They were amended for the first time in 1967, again in 1976, and starting in 1980, they were amended about every decade.
Just as differences in language and trade centuries ago caused the Phoenicians to come up with the standard alphabet we have today, the differences in trade and legal practices caused the set of rules called Incoterms to become industry standard.
The rules were put in place to help prevent misunderstandings and disputes. Litigation was rather common due to misunderstandings and Incoterms help to create an easier set of rules for all international importers and exporters to easily understand.
What Incoterms Do and Don't Do
Incoterms are the terms of sale defining many things, such as the arrangements for payment and handling of goods. They cover the entire transition from the second the goods leave the seller's door until they arrive at the buyer's final destination.
- Provide Instructions - Carriers, customs brokers, freight forwarders, and others involved in the shipping of the goods will be given instructions through Incoterms. In addition, banks and those involved in the financing also turn to Incoterms for instructions.
- Define Obligations - The obligations between the buyer and the seller are defined using Incoterms within the sales contract.
- Define the Costs - The different costs incurred during the transaction, along with the payment, will be defined using Incoterms within the sales contract.
- Define the Point of Passage of Risk - When it comes to the possibility of cargo damage or loss, Incoterms are used to define the passage of risk between the buyer and the seller.
- Cover the Payment - The terms of the actual payment for the goods will be negotiated separately.
- Cover Insurance - CIF (Cost, Insurance, and Freight) and CIP (Carriage and Insurance Paid) are the only Incoterms outlining insurance as the responsibility of the seller. No other terms outline responsibility for insurance.
- Cover Ownership or Passage of Title - The passage of title will be separately defined through the "retention of title" clause found within the sales contract.
It's important to understand what Incoterms do and don't do or you could think you're covered when you're not. A good freight forwarder or customs broker in Canada will ensure you are protected and will know how to properly use Incoterms, along with what they mean.
Moving From Incoterms 2010 to Incoterms 2020
The two main categories for Incoterms published in 2010 are currently used for international and domestic contracts. This set of Incoterms was the first to be used in this way and the new groups were created with the goal of simplifying the creation of contracts and making obligations to buyers and sellers clearer.
However, the 2010 Incoterms were replaced on January 1, 2020 with the new Incoterms 2020.
Incoterms 2020 Rules and Revisions
The most current revision consists of 11 Incoterms. The changes include:
- Renaming DAT (Delivered at Terminal) to DPU (Delivered at Place Unloaded)
- Changing the term FCA (Free Carrier) to allow the buyer to instruct the carriers to issue a bill of lading to the seller with an on-board notation to ensure the terms of a letter of credit are satisfied.
- CIP has been revised placing responsibility on the seller to purchase at least 110% of the value of goods in insurance coverage, which is detailed in Clause A of the Institute Cargo Clauses.
- Incoterms 2020 rules also call out the import and export security requirements. They identify if the buyer or the seller is responsible for meeting the requirements.
- Incoterms 2020 rules also recognize sellers may use their own transport to deliver goods. Sellers can now arrange for transportation or make a contract for carriage.
While previous versions of Incoterms can still be used, it's not preferred. Those not using Incoterms 2020 rules must define which version of Incoterms will be used before negotiating the sales contract. In addition, you will need to ensure documentation is correct all throughout the transaction.
The Incoterms 2020 Rules
Incoterms 2020 Rules are split into two groups; Incoterms for any mode of transport and Incoterms for sea and inland waterway transport only.
Group #1 - Any Mode of Transport
- EXW - Ex Works
- FCA - Free Carrier
- CPT - Carriage Paid To
- CIP - Carriage and Insurance Paid To
- DAP - Delivered at Place
- DDP - Delivered Duty Paid
- DPU - Delivered at Place Unloaded
Group #2 - Sea and Inland Waterway Transport
- FAS - Free Alongside Ship
- FOB - Free on Board
- CFR - Cost and Freight
- CIF - Cost, Insurance, and Freight
When do You Need Incoterms?
As a buyer, you want to consider Incoterms before the sales contract is negotiated. If you don't use Incoterms, you could be putting yourself at risk when it comes to the supplier. Without using Incoterms, you may run into shipment complications or the supplier may take advantage of you.
Differences For Specific Countries
While using Incoterms helps to make it easier to avoid misunderstandings and disputes, there are some exceptions to the typical Incoterms rules. Most countries and most circumstances will be about the same. However, the United States requires a Customs Bond, the UK requires a Deferment Account, and if you plan to export from India, you'll need to pay a withholding tax. Keep these differences in mind when importing from or exporting to these three countries.
What Won't Incoterms Cover
Incoterms make it easier to negotiate the sales contract, but they don't cover property rights, breach of contract, or possible force majeure situations. It's best to include these in the sales contract. Incoterms also does not assign any responsibility for arranging cargo insurance, except the C terms.
Most Common Incoterms Used
Some Incoterms are more commonly used than others. It's best to understand the most commonly used Incoterms to ensure you know what to expect when negotiating a sales contract. If you're hiring a freight forwarder or customs broker, it's a good idea to ensure they understand more than just the most commonly used Incoterms.
EXW (Ex Works)
This incoterm means the seller is responsible for creating the goods available at the premise of the seller. It also means the buyer will take on full responsibility, risk, and cost when the goods leave the seller's premises.
Two common misunderstandings of EXW terms are that the shipper is responsible for completion of the Export Declaration and that the shipper is responsible for loading the goods on to the collection vehicle. In both cases, this is the responsibility of the buyer. If the buyer wishes for the shipper to make these arrangements, then they should select FCA terms.
FOB (Free on Board)
Very commonly used, FOB means the seller is responsible for delivering the goods and loading them onto the ship at the port. FOB also means the seller is responsible for the costs, including terminal handling charges, and the risk is transferred to the buyer as soon as the goods pass the railing of the ship.
DDU (Delivered Duty Unpaid)
Delivered Duty Unpaid simply means the seller is responsible for the safe arrival of the goods to a specific destination. The buyer will be responsible for the import duties.
FCA (Free Carrier)
The buyer will name the carrier and the seller is responsible for delivering the goods to the carrier and the agreed delivery point. The seller will also be responsible for the costs associated with the delivery, along with the cost of loading the cargo and the risk associated with loading the cargo.
Why Incoterms 2020 is Important
Each revision to the Incoterms rules aims to make it easier and clearer when negotiating sales contracts between buyers and sellers. Understanding the responsibilities of both parties helps to ensure disputes are minimal and misunderstandings don't happen. The changes found in Incoterms 2020 rules helps to reduce the risk of legal complications.
Understanding the Incoterms revisions matters when you plan to import or export goods. Even if you plan to hire a customs broker or freight forwarder to handle your international shipping needs, it's best to have a basic understanding of what Incoterms are and how they work.
Make sure you take the time to learn the changes for the Incoterms 2020 rules and any other version you plan to use. If you have questions about Incoterms or you need a logistics partner to help you, Cole International is ready to become your international shipping partner. Contact us today and find out how we can help make importing and exporting goods easier.
Incoterms. it's what we do.
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