Importing or exporting is not so easy. You, as an individual, cannot understand the rules and regulations of all countries with whom you trade, likewise, it is difficult for other individuals or companies.
Therefore, the International Chamber of Commerce was established in 1921 to present the codified contractual standard to ensure that trading rules are the same across many countries thus easing international trade. They are known as Incoterms. Incoterms are short for international commercial terms.
In simple words we can say that they are trading terms used by the buyer and sellers in the international market; further imposed by the regulatory bodies. It involves the idea of who will bear the cost when goods are damaged or who will bear the carrier cost. It is important to know about the obligations of both parties otherwise disputes may arise.
Incoterms for different modes
There are different rules set for different modes of shipping, it is important to understand the difference between different incoterms for different modes, hence making it easier for an individual to follow specific rules and obligations when trading internationally.
It is sometimes difficult to understand or even misunderstood, as they are written from a legal point of view. You need to be careful when using any incoterm for your contract, as using the wrong incoterm can cause you a huge loss.
Incoterms for any transit mode
Following are the two incoterms that are used for any mode of transit:
EXM – Ex Works
Under this arrangement, the seller ensures that the traded products are available at a location for the buyer to pick up. What does that mean? Does that mean the seller has no other responsibility? Well, yes, the seller is all free, but the buyer must move the goods and pay for all the charges ranging from loading charges to custom clearance.
Seller is only responsible for the packaging and labeling of the product to ensure the safety of the products. In addition to this, the seller helps the buyer to get paperwork such as export licenses. If any cost is involved in the process, then the buyer is responsible to pay for it.
Why do people prefer this method? Most individuals or companies are trying to reduce their shipping cost imposed by the seller, for example, Company A is charging $200 to deliver a particular product, but you find some third party who can do it for you in $150. If you have experience in this field then definitely you will choose a third party to do this work for you, thus saving you $50.
But what if you are new to the international trading business?
FCA – Free Carrier
This ensures that the seller delivers the product to the required location by the buyer, it can be an airport, warehouse, or any other shipping terminal. Is it done for free? For sure, no, the seller includes the cost in the price of the product or the overall bill – considering all possible costs and risks involved.
Once, products are delivered to the desired location of the buyer, the responsibility of the goods is transferred to the buyer. Now buyer would have to move those goods across that location to its warehouse. However, the seller must ensure that all paperwork is completed to ensure that goods can be exported.
Following are the four incoterms that are completely related to business which transports their goods through seaways:
FAS – Free Alongside Ship
Through this contractual agreement, the seller is only liable to deliver the goods to an agreed port and next to the vessel of the buyer. At this point, the risk associated with the goods is transferred to the buyer. So, any damage to the products will not be bored by the seller. It is designed for bulk cargo.
Contacts usually include time and date of delivery, locations of the port, payment due, and which party would bear the cost of transport and insurance. This agreement may also include a date when the risk would be transferred between the parties.
FOB – Free On Board
This concept highlights who will be responsible when goods are lost or damaged, would it be seller or buyer, and under what would be the conditions. To answer this, it is further divided into FOB origin and FOB destination.
FOB origin means that the seller has transferred the risk to the buyer from the shipping out. Hence, if goods are damaged or lost then the buyer would have to bear the loss.
FOB destination means that the seller must ship the product to the buyer’s destination and once they are reached that area only then the ownership is transferred.
CFR – Cost and Freight
This term refers to the idea that the seller is required to arrange for the transport of the goods by sea to the port of the destination city or country. The seller is also responsible to provide all necessary documents to the buyer so that buyer can claim the goods from the shipping company.
This doesn’t mean that the seller would provide for the insurance, it is not required under this rule, however, the seller will be responsible till goods are loaded on the vessel. After that point, it will be buyers will be responsible for any loss or damage during the transportation.
CIF – Cost, Insurance, and Freight
Cost, Insurance, and Freight is an agreement under which the seller must pay for the cost of insurance and freight during the cargo is in transit. It means that the seller is responsible for any loss or damage that would occur during the transportation of the goods.
However, once the goods reach the buyer’s destination then the responsibility of the buyer to pay for the destination terminal charges, delivery to the buyer’s warehouse, and customs charges. It looks like the safest option available to the buyer as all risk is bored by the seller till it is delivered to the desired port. Hence, the seller charges higher for all these facilities and possible risks.
Any Transport Mode
Following are the five incoterms that are used for any mode of transport:
CPT – Carriage Paid To
Under this agreement, the seller delivers the goods to the carrier service provider, who can be individuals or entities, who further delivers the goods to the buyer. Here, all the risks are transferred by the seller to the buyer as soon as the products are delivered to the selected carrier.
The buyer doesn’t have to pay for any freight charges or any other charges that apply from the shipping point. However, the buyer is liable to pay all applicable costs from the destination point such as custom, delivery to destination, and terminal charges.
It is possible that the seller, as it is no longer responsible, may choose some cheap alternative to deliver the product which may damage the products during the transit. Thus, making a huge problem for the buyer.
CIP – Carriage and Insurance Paid To
Carriage and Insurance Paid To refers to the condition when the seller is responsible to deliver the goods at the first carrier or any individual that has been selected for this transaction. The seller pays for the freight and the insurance charges.
It needs to be noted that the risk of the goods is transferred to the buyer as soon as the products are delivered to the first carrier. However, they are required to be insured 110% during transit. Furthermore, the buyer is still for other expenses that are applicable when goods are delivered to the destination port such as customs, terminal charges, and other delivery costs.
DAP – Delivered at Place
This contract ensures that all the risks and costs are paid by the seller. Seller is responsible for delivering it to the agreed destination and must pay for the freight, handling charges, almost everything except custom. Along with this, the seller must ensure the documentation and packaging of the products.
The responsibility is shifted to the buyer as soon as goods are available for the buyer to collect. Hence, it is the buyer’s responsibility to unload goods and clear with the custom. Even buyers would have to pay for the storage cost if goods are not cleared in the suggested period.
DPU – Delivered at Place Unloaded
Under this incoterm rule, the seller is required to deliver the goods to the agreed destination and unload them for the buyer. Goods are under the seller’s responsibility till they are unloaded. The seller must pay for the costs related to the delivery and handling charges. However, the carriers are not required to load the goods to the buyer’s vehicle.
Once goods are unloaded then it is the buyer’s responsibility to clarify against the customs duties, inspection charges, and other taxes; even risk is transferred.
It is noticed that the seller doesn’t tend to contract under DPU terms when unloading involves complex products that involve great risk and uncertainty.
DDP – Delivered Duty Paid
Delivered Duty Paid exerts responsibility on the seller to pay for all the charges that are involved to ensure that the goods are delivered to the buyer. It involves packaging, documentation, loading charges, freight charges, export duty, origin terminal charges, destination terminal charges, delivery to destination, and import custom.
The risk is transferred to the buyer as soon as they are available at the agreed location for the delivery. It is widely used, especially for the new entrants as the risk lies with the sellers. Buyers do have to pay the extra amount to purchase those goods but this contract that goods are reached to the buyer safely.
It is noticed that this method is not so handy for the sellers, as it is very risky for them, as they must deal with different officials, and this also involves transactions with are affected by the changing exchange rate policies.
It is evident that several transactions are carried out through credit, thus trust is needed between both parties. What if you are doing it for the first time? Will the seller offer you credit? It is not possible. But to make things work for the buyer and seller, a letter of credit comes into play.
Letter of credit ensures that the buyer would pay for the products and would not refuse at the last minute when the seller has already paid for all the necessary costs involved to complete this shipment.
The less risk you bear, the higher it would cost you to import anything to your destination. Any contract which is favorable for a buyer is usually expensive, as the seller charges for all the costs involved and risk bared.
A Summary of Shipping Incoterms 2021
- EXM: Ex Works
- FCA: Free Carrier
- FAS: Free Alongside Ship
- FOB: Free On Board
- CFR: Cost and Freight
- CIF: Cost, Insurance, and Freight
- CPT: Carriage Paid To
- CIP: Carriage and Insurance Paid To
- DAP: Delivered at Place
- DPU: Delivered at Place Unloaded
- DDP: Delivered Duty Paid
To conclude, it is important to understand that these incoterms tend to make life easy for individuals who are involved in international trade. It ensures that the dispute between parties is minimized.
Most of the countries in the world tend to accept these contracts, but some countries do have certain other laws to consider. These laws may evolve around to the following, but not limited to these: withholding tax, deferment account, and customs bonds.
International Chamber of Commerce keeps revising the terms usually every year to ensure that they are updated and relevant to the international market.