Exploring INCO Terms

Estimated duration: 2hrs

Introduction

This course introduces INCOterms® and explores their importance for business. The eleven INCOterms®, that were developed by the International Chamber of Commerce and are widely used in international and domestic contracts for the sale of goods, are discussed in detail throughout the course. These eleven terms specify how transaction costs and responsibilities are divided between buyer and seller.

Having completed this course, you will be better able to use the correct INCOterm® and, as a result, better understand the tasks, responsibilities and risks relating to an international shipment.

At this stage it might be useful to point out that the Incoterms® can be grouped using the first letter of each term.

Terms beginning with C

Four of them begin with the letter C (these are):    

CIP—Carriage and Insurance Paid;

CPT—Carriage Paid To;

CFR—Cost and Freight;

CIF—Cost Insurance and Freight (named destination port)

Terms beginning with the letter D

Three of the terms begin with the letter D (these are):  

DAP—Delivered At Place;

DAT—Delivered At Terminal;

DDP—Delivered Duty Paid

Terms beginning with the letters E & F

Only one begins with the letter E (that is):         

  • ExW—Ex Works

Finally, the three remaining terms begin with the letter F (these are): 

  • FCA—Free Carrier;
  • FAS—Free Alongside Ship;
  • FOB—Free on Board (naming loading port)

Let’s now discuss each of the eleven Incoterms® identifying the main issues that commonly arise for businesses using them.

EXW – Ex Works

Ex Works (EXW) is the term used to describe the delivery of goods to an available destination at their place of business, normally in their factory, offices or warehouse. The seller does not need to then load goods onto a truck or ship, and the remainder of the shipment is the responsibility of the buyer (e.g. overseas shipment and customs duty). EXW is therefore more favourable to the seller as they do not need to worry about the freight once it has left their premises.

Ex Works makes the seller (or shipper/supplier) of goods responsible for packaging and leaving the goods at their factory or place of manufacture. The buyer (or consignee) is then responsible for everything else (for example):

  • Loading goods onto transport
  • Transporting goods to a port or terminal
  • Shipping the goods
  • Unloading the goods at the buyer’s port or terminal
  • Transporting the goods to the end destination or warehouse

Ex Works can be complex and problematic for the buyer importing goods from overseas, given that they will still need the seller’s communication or authority to pass goods through customs or provide documentation to freight parties along the way. In Ex Works, the buyer is responsible for everything from the point of the goods being made available, so diligent and detailed planning is advised. Ex Works is preferable for domestic transportation of goods, and the buyer can use their preferred freight forwarders or logistics partners to arrange the transport, potentially being cheaper than the seller arranging the entire delivery process.

FCA – Free Carrier

Unlike EXW, Free Carrier pushes the responsibility of delivering the goods to the buyer’s nominated premises onto the seller, so they have to organise shipping and various export documents.

Free Carrier is a common agreement where a seller of goods is responsible for packaging and loading goods onto a truck at their transport hub or port, different to Ex Works, where the seller is just responsible for making the goods available at their own factory or place of manufacture.

The seller is also responsible for export clearance of the goods at the port or terminal. The buyer (or consignee) is then responsible for everything else (this can include):

  • Shipping the goods
  • Unloading the goods at the buyer’s port or terminal
  • Transporting the goods to the end destination or warehouse

An obvious question might be “When does FCA liability transfer from the seller to the buyer?” The agreed transportation point of the goods can be at a port, terminal or goods loading point, providing it’s within the home country of the seller.

Once the goods have been loaded and cleared customs (export clearance) and the shipment is accepted, responsibility shifts from the seller to the buyer to arrange shipment and delivery to the end warehouse or customer. The seller may charge for their services to arrange any contracts to the carrier (e.g. a cargo ship or airport authority). The buyer and seller might arrange for the goods to be shipped by ocean freight on a container. The liability might therefore shift to the buyer at the Container Freight Station or Container Yard – this needs to be clearly defined and agreed by both parties in advance.

CPT – Carriage Paid To

“Carriage Paid To”, or CPT, goes into a little more detail than FCA, specifying that the seller bears the costs for transporting the goods to the nominated place that the buyer requests.

CPT is common for large importers who have their own port agents that can manage the delivery of goods when they arrive in their country. However, the risk of the seller passes on to the buyer once the goods leave their country or port, despite the seller paying for the transportation of the goods. The buyer (or consignee) is then responsible for everything else:

  • Insuring the goods as they are being shipped (but not paying for this shipment)
  • Unloading the goods at the buyer’s port or terminal
  • Transporting the goods to the end destination or warehouse

When does the liability shift from the seller to the buyer under CPT?

As soon as the goods are delivered to the carrier (e.g. loaded onto the ship at the port of the seller’s country), the liability and risk of these goods is transferred over to the buyer. The agreed transportation point of the goods can be at a port, terminal or goods loading point, providing it’s within the home country of the seller.

CIP – Carriage and Insurance Paid To

“Carriage and Insurance Paid to”, or CIP, specifies that the seller needs to pay the costs of transport as well as the insurance cover for the goods in transit (by any transport mode) to the destination named by the buyer.

CIP sees the seller being responsible for the delivery of goods to an agreed destination in the buyers’ country and means the seller must pay for the cost of this carriage. The seller’s risk however, ends once they have placed the goods on the ship, at the origin destination. The buyer can pay for additional insurance during carriage of the goods. The risk is passed when the goods are received by the first carrier. Carriage and Insurance Paid to is eligible for any form of transportation.

How does CIP work?

Carriage and Insurance Paid requires the seller to pay for the cost of transporting the goods and also provide minimum insurance to transport them to the end destination. So with CIP, the seller pays for both the transportation and the insurance to the destination. The seller also needs to insure the goods during carriage, and it’s normally always at a minimum cover level as the liability lies with the buyer at this point. It’s worth noting that minimum insurance might not be adequate for manufactured goods or high-value / precious merchandise.

Given that the goods being shipped are at the buyer’s own risk, it’s advisable for the buyer to ensure adequate insurance protection is in place. The term ‘delivery’ means from the country of origin to the final destination. The seller also needs to arrange export clearance from the origin country of the goods, which can be for any mode of transport. In the case of CIP, damaged goods can be claimed against the insurance company through the buyer. When the goods arrive in the port of destination, the buyer needs to ensure the goods clear through customs.

Key aspects of CIP – Carriage and Insurance Paid To

1. Complying with contracts – Goods Delivery

The seller must prove the goods have been delivered and provide an invoice or equivalent, as well as shipping / delivery proof.

2. Licences and other formalities

The seller must provide a sufficient export license for the goods, or government authorisation to allow the goods to leave the country.

3. Insurance

The seller should provide a Contract of insurance at their own expense. The seller must obtain at his own expense cargo insurance as agreed in the contract, such that the buyer, or any other person having an insurable interest in the goods, shall be entitled to claim directly from the insurer and provide the buyer with the insurance policy or other evidence of insurance cover.

4. Delivery

The seller must deliver the goods to the first carrier as agreed at a named place and time.

5. Transfer of risks

The seller is responsible for any goods which are lost or damaged if this happens before the goods have been delivered.

How does DAT work?

The seller pays for all of the expenses incurred until the place of delivery and the buyer pays for customs clearance and taxes at destination. ‘Terminal’ means a quay, warehouse, container yard or any rail, air or road. As with all of the ‘D’ Incoterms®, the risks and responsibility of goods gets transferred from the seller to the buyer at the same point – the end destination. DAT was specifically designed to meet airport and port deliveries. For ocean cargo and shipping goods by sea, any discharged containers are then moved to a container yard (CY), which is where containers are stored before they are moved to their final destination. Sellers are responsible for any destination terminal handling charges and the buyer only pays for customs clearance, duties and taxes.

DAT – Delivered at Terminal

“Delivered at Terminal”, or DAT, means that all of the costs up until the point of delivery to a nominated terminal need to be covered. The buyer would need to arrange Duties and Taxes and clearing goods through customs. With DAT, the seller is also responsible for unloading the goods at the terminal. It’s advisable to ensure the terminal, hub or port is clearly specified, given the size of many terminals.

DAT, or, Delivered at Terminal, is where the seller clears goods for export and is fully responsible for the goods until they have arrived at a named terminal at the end destination. The goods must be unloaded at the terminal. DAT can be used with any transportation mode. It is recommended that the seller’s contract with their forwarding company mirrors the contract of sale. Delivered at Terminal is used when the seller’s responsibility includes the full delivery of goods up until the end terminal or port of destination, as well as the unloading of the goods.

Benefits of DAT

The key advantages of Delivery at Terminal are around convenience and reduced risk to the importer:

  1. The supplier delivers goods to the destination place (importer doesn’t need to cover these costs)
  2. The risk is transferred from the supplier to the importer once the goods have been dispatched and unloaded at a defined place at the destination
  3. The supplier bears the responsibility for most of the carriage/transport of the goods from the origin to the destination
  4. Less hassle and organisation for the buyer of goods.

DAP – Delivered at Place

“Delivered at Place”, or DAP, can also be used for any mode of transport. An extension of DAT, the seller delivers the goods at a named destination, specified by the buyer, although under the ICC rules, the unloading of the goods is the responsibility of the buyer. The buyer is also required to sort out duties and taxes, as well as clearing the goods through customs.

DAP, or, Delivery at Place is an incoterm defining the buyer and seller’s responsibilities when moving goods. In this case, the seller is responsible for moving the goods from the country of origin right through to the end destination, which includes responsibility for loading, transport and unloading.

With DAP, it is recommended that companies are very clear about the end destination place to avoid any confusion later on. DAP means that the seller bears the risk of any issues with the goods until the agreed delivery point. If there are any extra fees for unloading the goods, the seller must incur these. This term can be used for any mode of transportation.

How does DAP work?

DAP requires the seller to load, ship and unload the goods at an agreed destination place (normally after the port or terminal where the goods arrive at the country of destination). DAP can be used for any mode of transportation, and the seller needs to pay for:

  • import customs clearance
  • duties
  • taxes loading / unloading costs

DDP – Delivered Duty Paid

“Delivered Duty Paid”, or DPP, can be used for any mode of transport. In this case, the seller is responsible for delivering the goods at a place specified by the buyer, up to the point of unloading. Unlike DAP rules, the seller is also required to pay for all Duties and Taxes; clear the goods for import; and pay relevant taxes. DPP is often complex as shipment of goods into a market are often best left to local experts, so it’s a less commonly used Incoterm®.

So DDP is used to describe the delivery of goods where the seller takes most responsibility. Under DDP, the supplier is responsible for paying for all of the costs associated with the delivery of goods right up until they get to the named place of destination. The buyer is then responsible for unloading the goods at the end destination. DDP can be used to describe ocean, road or air transportation of goods, including multimodal transportation. It’s also expected that the seller clears the goods at export and import customs.

How does DDP work?

DDP requires the supplier to deliver goods from their factory/plant to an agreed point, known as the destination place. This could be the terminal, container yard, factory or warehouse of the buyer. The supplier is responsible for:

  • Clearing goods through export and import customs
  • VAT
  • Paying for duties and other taxes 

DDP is most risky for the seller of goods, so is normally used by advanced suppliers. DDP is used particularly when the cost of supply doesn’t vary too much and is easy to predict.

Benefits of DDP

The key advantages of Delivery Duty Paid are in favour of the buyer. The seller takes most responsibility and risk. DDP puts the maximum risk and responsibility on the seller. It is the only one of the Incoterms that requires the seller to take responsibility for import clearance and payment. The seller bears all the risks and costs involved in bringing the goods to the place of destination. The seller is obliged to clear the goods for both export and import, to pay duties for both export and import, and to execute all customs formalities. Sellers may not understand the complex and bureaucratic import clearance procedures that exist in some countries and make mistakes or miscalculations that affect their bottom line; therefore, it may be best left to the buyer who has local knowledge and understanding. Keep this in mind before choosing DDP.

  1. The supplier takes on the most risk and responsibility as opposed to the buyer. DDP is one of the only incoterms that requires the supplier to also take responsibility for import clearance and paying for various import taxes
  2. The supplier takes on all of the cost for transporting and getting the goods to the end destination
  3. The supplier needs to clear goods through customs at both the country of origin and place of destination, as well as clearing all customs formalities, duties and taxes

FAS – Free Alongside Ship

“Free Alongside Ship”, or FAS, is used in situations when the seller can place the goods alongside other non-containerised goods (e.g. on a vessel or barge). The seller might do this if they have access to sea or inland waterway routes and want to place the goods en-route to the buyer alongside other goods on the ship. It’s not recommended for goods that can be placed in a container. The risk of transporting the goods ‘alongside ship’ move from the seller to the buyer once the goods are delivered to a terminal or port and unloaded.

Under FAS, the exporter is responsible for clearing the goods at customs and delivering them to the vessel at the point of origin. Free Alongside Ship only applies to sea or inland waterway ports. As with most points of delivery, it’s recommended to highlight the exact location at which the goods are being delivered to, particularly in the case of large ports as the seller is responsible for the goods until the port of shipment.

FAS is ideal for the shipping of:

  • Hard commodities (e.g. oil)
  • Soft commodities (e.g. grain, soybean)
  • Liquids Chemicals (both pharmaceutical and non-pharmaceutical)
  • Bulk cargo
  • Break bulk cargo

FAS is generally not used for containerised goods as they would often be delivered to a container yard or terminal; in this case, FCA might be a more appropriate incoterm to go by.

In the case of FAS, the seller is responsible for delivering the buyer’s goods next to the shipping vessel. The seller is also responsible for completing export customs documentation. FAS is often used for cargo that doesn’t fit into containers – known as Out of Gauge (OOG) cargo – as these would typically be transported to a container yard under the FCA incoterm. FAS is applicable to goods being transported by inland waterway and sea transport, and the costs for loading these goods onto the vessel is the responsibility of the seller. With FAS, the buyer is then responsible for the cost of loading the goods onto the ship, and all costs thereafter.

Benefits of FAS

The key advantages of Free Alongside Ship:

  1. FAS is ideal for situations where the seller can easily access the vessel for loading the goods, for example, with bulk cargos or non-containerized goods.
  2. With FAS, the risk transfers to the buyer when the goods are alongside the ship, and the buyer bears the cost and responsibility thereafter.

FOB – Free On Board

“Free On Board”, or FOB, occurs when the seller delivers the goods to the port of shipment, at which point it becomes the responsibility of the buyer once unloaded onto a vessel. If the goods are damaged when on board the vessel, it’s the responsibility of the buyer.

To understand FOB pricing, one must really understand what FOB means. FOB is the short form term for Free On Board (or Freight on Board) and roughly translates to mean that the cost of product being delivered to the nearest port is included in the purchase price, but the purchaser is liable to pay the shipping costs from that port. This is along with all other fees for the outward journey to the port of the buyer’s destination. It is clearly understood when this shipping term is used, that the supplier will pay for the product cost and inland delivery costs from their factory to the port. This will not include costs in relation to onward shipping fees.

The price for FOB is best understood by contrasting it with other shipping terms. As discussed above, when purchasing FOB, the buyer will pay for the transport. In contrast to this many contracts are EXW (Ex-Works) or ExFactory cost. Therefore, it is just the cost of the product that is paid by the buyer; which includes no transportation or customs costs in the fee paid.

CFR – Cost and Freight

“Cost and Freight”, or CFR, places more risk and responsibility onto the seller. The seller delivers the goods and takes all responsibility and costs right up until the ship has docked at the end point and the goods have been unloaded. The seller will also cover the cost of insurance, at least at the minimum level.

This can be contrasted with a seller under an FOB shipping transaction; where the seller is merely responsible for delivering the goods to the port of destination.

In relation to a CFR trade, the exporter will pay for and arrange transportation to the port of destination that is specified by the receiving party. The exporting company will arrange and fund the transportation that is set out by the purchasing party. In relation to liability and ultimate responsibility, the purchaser will take on the responsibility when the ship has docked in the port of destination. The further costs that will include further transportation and the unloading of the vessel will be bourne by the buyer.

CIF Cost, Insurance and Freight

Cost, Insurance and Freight – CIF is a legal Incoterm®which is used in international shipping for the delivery of goods to a port. In this case, the seller must pay for the delivery of goods, and their export, including insurance, and has responsibility of the goods right up until they’re loaded on the ship. CIF and FOB (Free on Board) are the most common shipping terms.

The term CIF means that the seller has more responsibility; they will pay for and arrange transportation, freight duties and insurance.

CIF Tips

Watch outs for importers and tips for CIF:

  • Your supplier has control of the insurance coverage – this means that the supplier is likely to choose the cheapest / most basic insurance option for your product
  • Watch out for the beneficiary of the insurance policy – in the case of damages, if the seller is the beneficiary if your goods get damaged in transit, payment will go to them
  • CIF stops after the goods arrive at the port – if goods are damaged at the port or when unloaded, as well as if any additional port or storage fees are incurred, this will be your responsibility as the importer
  • CIF could be more expensive – given that the seller invoices CIF, the costs might be inflated above the actual cost of insuring your goods

Important things to remember when dealing with Incoterms®

In international trade, it would be best for exporters to refrain, wherever possible, from dealing in trade terms that would hold the seller responsible for the import customs clearance and/or payment of import customs duties and taxes and/or other costs and risks at the buyer’s end, for example, the trade terms DEQ (Delivered Ex Quay) and DDP (Delivered Duty Paid).

Quite often, the charges and expenses at the buyer’s end may cost more to the seller than anticipated. To overcome losses, hire a reliable customs broker or freight forwarder in the importing country to handle the import routines.

It would also be best for importers not to deal in EXW (Ex Works), which would hold the buyer responsible for the export customs clearance, payment of export customs charges and taxes, and other costs and risks at the seller’s end.

There are other things that all businesses should know about Incoterms®. To avoid making potentially costly mistakes it is important to gain a more detailed understanding of each of the Incoterms®.

Ten common mistakes in using the Incoterm® rules

1st Mistake

Use of a traditional “sea and inland waterway only” rule such as FOB or CIF for containerised goods, instead of the “all transport modes” rule e.g. FCA or CIP. This exposes the exporter to unnecessary risks.       

A dramatic recent example was the Japanese tsunami in March 2011, which wrecked the Sendai container terminal. Many hundreds of consignments awaiting dispatch were damaged. Exporters who were using the wrong rule found themselves responsible for losses that could have been avoided!

2nd Mistake

Making assumptions about passing of title to the goods, based on the Incoterm® rule in use. The Incoterm® rules are silent on when title passes from seller to buyer; this needs to be defined separately in the sales contract.

3rd Mistake

Failure to specify the port/place with sufficient precision, e.g. “FCA Chicago”, which could refer to many places within a wide area.

4th Mistake

Attempting to use DDP without thinking through whether the seller can undertake all the necessary formalities in the buyer’s country, e.g. paying GST or VAT.

5th Mistake

Attempting to use EXW without thinking through the implications of the buyer being required to complete export procedures – in many countries it will be necessary for the exporter to communicate with the authorities in a number of different ways.

6th Mistake

Use of CIP or CIF without checking whether the level of insurance in force matches the requirements of the commercial contract – these Incoterm® rules only require a minimal level of cover, which may be inadequate.

7th Mistake

Where there is more than one carrier, failure to think through the implications of the risk transferring on taking in charge by the first carrier – from the buyer’s perspective, this may turn out to be a small haulage company in another country, so redress may be difficult in the event of loss or damage

8th Mistake

Failure to establish how terminal handling charges (THC’s) 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, others do not.

9th Mistake

Where payment is with a letter of credit or a documentary collection, failure to align the Incoterm® rule with the security requirements or the requirements of the banks can lead to frustration and loss.

10th Mistake

When DAT or DAP is used with a “post-clearance” delivery point, failure to think through the liaison required between the carrier and the customs authorities can lead to delays and extra costs.

Exercise

The above section delved into 10 common mistakes made when using Incoterms®. Make an effort to identify an example from industry of each of the mistakes identified. The examples can either be from your workplace or from a search of secondary sources based around the areas.

This may take you longer than 60 minutes but it will be time well spent.

Summary

INternational COmmercial Terms (INCOterms®)

INCOterms® are three-letter trade terms developed by the International Chamber of Commerce and widely used in international and domestic contracts for the sale of goods. They’re widely accepted by governments and shippers worldwide, and are primarily used to prevent uncertainty or misunderstandings.

INCOterms® specify the rights and obligations of each of the parties that enter into a contract for the delivery of goods sold. First created in 1936 by the International Chamber of Commerce, revised INCOterms® took effect on January 1, 2011 with the number of terms reduced from thirteen to eleven.

INCOterms® are uniform, internationally recognised foreign trade terms that refer to the type of agreement for the purchase and shipping of goods internationally. These eleven terms specify how transaction costs and responsibilities are divided between buyer and seller.

The Incoterm® Rules

The eleven rules are divided into two main groups. There are seven in the “any transport mode” that are used where goods are containerised. The remaining four rules are used for bulk cargos  and non-containerised goods, where the exporter can load the goods directly onto the vessel. These fall under the “transport by sea or inland waterway only” rules.

A critical difference between the rules in these two groups is the point at which risk transfers from the seller to the buyer.