When concluding a sales contract with a foreign supplier, in addition to the selling price of the goods, it is necessary to take into account the associated costs: transport, customs, etc. Contractors working in different jurisdictions and not knowing the nuances of the legislation of another country are trying to indicate in the contract that in case of disputes the issues are resolved according to the legislation of their country. The other party, as a rule, does not agree with such a clause, considering this an unacceptable advantage.
An attempt to foresee all possible complications makes the contract unreadable, it is difficult to coordinate with the bank and customs. Omissions in the contract can lead to negative consequences and legal costs.
What is Incoterms and where is it used
The International Chamber of Commerce made life easier for merchants participating in foreign economic activity (FEA), having published in 1936 the first set of international commercial rules, called Incoterms. This document has become universal, allowing to resolve disagreements between sellers, buyers, forwarding companies and other participants in foreign economic activity.
Since 2011, Incoterms rules have been approved for use in domestic trade. The current edition is Incoterms 2010.
Despite recognition by all countries, the requirement to use international Incoterms rules is not enshrined in national laws. The contracting parties themselves decide how to regulate the deal. For the application of Incoterms, it is necessary to include in the contract a reference to a specific rule with an indication of the edition, for example, “Delivery Basis - CIF Incoterms 2010”. It is important to consider that the provisions of the contract are dominant. If there is a clause in the contract that contradicts the contents of the Incoterms basic delivery conditions specified in the contract, in the event of a dispute, the court will make a decision based on the provisions of the contract and not the Incoterms rules.
Incoterms has the status of an international regulatory document and is a glossary of terms that is used by participants in the supply chain, determining the conditions of freight forwarding and the transfer of risks of cargo transportation from the exporter to the importer.
Incoterms 2010 contains eleven rules. The terms formulated in it cover the following areas of international trade:
- tasks related to the dispatch of goods;
- determination of the parties and the date of execution of the contract;
- distribution of responsibilities and risks;
- delivery of goods;
- payment of insurance fees;
- customs clearance;
- taxation.
Incoterms delivery terms do not affect pricing and payment methods, transfer of ownership of the goods and liability of the parties for violation of the conditions or terms of the contract.
These issues must be resolved within the framework of the contract, they are either indicated by separate clauses or regulated by applicable law.
Unification of basic conditions options Incoterms simplified the procedure for concluding contracts. Instead of listing the transportation obligations of the parties, the Incoterms rule is indicated. What it is? An abbreviation of three letters, each of which has specific obligations of the exporter and importer. The thirty-eight-page Incoterms glossary is displayed in the form of the diagram below:
Incoterms rules are grouped. The first letter in the name of the rule determines the moment of transfer of (ex) risks during the subsequent transportation from the exporter to the importer:
- E - at the point of shipment, at the warehouse or at the seller's factory;
- F - at the beginning of the main carriage, which is not paid by the seller;
- C - at the beginning of the main transportation, which is paid by the supplier;
- D - at the buyer's warehouse.
From the list it is clear that the most favorable delivery option for the supplier is category C, for the buyer - D.
In each row of the table below, one or more items moves from the duties of the importer to the duties of the exporter, and the last row becomes a mirror image of the first. In total, international Incoterms maintains a balance of interests of the parties to the transaction.
For a better understanding of the differences in the following description of terms, only changes to Incoterms rules regarding the previous set of rules are considered.
From the listed basic conditions of delivery, categories E, C and D are applicable for transporting by any means of transport. Category F applies if most of the delivery route (main transportation) is by water.
EXW - Pickup
The transaction scenario in which the exporter is only responsible for the production of the required quantity of goods and its packaging. This rule is nothing but a simple and understandable pick-up for everyone. The supplier fulfilled its obligations under the basic terms of delivery of EXW as soon as it provided the buyer access to the goods. This is Incoterms rule with minimum obligations of the exporter and maximum obligations of the importer.
In the case of domestic trade, EXW is preferred over others. In the domestic market, the buyer has the transport links and supply chains that he uses. These links may be cheaper than the option offered by the seller-exporter.
In the international market this is a risky contract for the buyer. When applying an EXW arrangement, the buyer must consider the following costs:
- loading and docking fees;
- transportation costs;
- customs duties;
- relevant taxes;
- insurance;
- warehouse storage.
The above items include many variables that are quite expensive for the business, and can lead to a significant increase in the cost of purchased goods. It should be remembered that the customs value of the goods is formed from the sum of all costs incurred by the buyer outside the country. If you choose the EXW Incoterms rule based on the lowest selling price of the supplier, then the customs value of the goods at the final delivery point may be significantly higher than the expected value.
Like all other international Incoterms rules, EXW has its advantages and disadvantages. When applying it, the importing buyer can choose the forwarding and insurance company, the amount of insurance coverage, and the delivery time.
At the same time, a non-resident importer may encounter difficulties in customs clearance if licenses or permits are required to export this product in accordance with the law of the country of origin. The preparation of such documents usually requires additional costs of money and time. Suppliers always have the necessary documents for the export of manufactured goods.
Choosing EXW as the basic delivery condition, you should make sure that such Incoterms do not contradict the national legislation of the country of the counterparty, since in the customs legislation of some jurisdictions there is a ban on the export clearance of goods by a non-resident company.
FCA - free carrier
The FCA Incoterms rule is often used. What is so attractive in this supply basis for importers? An agreement by which a supplier agrees to pack and deliver goods to a port ready for export is multimodal. It is applicable to transportation by any means of transport: road, air, rail and water. The obligations of the supplier are deemed to be fulfilled as soon as he transferred the goods to the carrier-forwarder.
The text of the contract should indicate the specific address of the point of delivery of the goods, it is here that the risks pass to the importer. Other procedures for organizing cargo delivery are also the buyer's responsibility. If sea freight is used, then the shift of responsibility and risks from the exporter to the importer takes place in a container warehouse.
Since the passage of goods through customs is the responsibility of the supplier, this is much less problematic than the terms of the EXW rule. Sellers have the appropriate licenses required for export outside the country, as well as the best relations with customs brokers.
FAS - Free alongside
The contract indicates the specific berth to which the vessel will be moored. FAS is a multimodal rule, it is used for delivery by several modes of transport, but most of the way should go along waterways.
FAS is ideal for delivering:
- oil and other liquid raw materials;
- grain and other bulk cargo;
- oversized cargo;
- ore, coal and other goods transported without packaging.
FAS is not used for containerized cargo, because this Incoterms rule implies delivery to the berth. Containers are processed in a warehouse or in a terminal, therefore, in the case of container transportation, the FCA rule is chosen. The remaining points of the FAS and FCA bases coincide for the duties of the seller-exporter and the buyer-importer.
FOB - Free On Board
The difference between FOB and FAS is that the supplier delivers the goods not to the ship, but to the ship specified in the text of the contract. The responsibilities and risks of the exporter and importer in applying this Incoterms are balanced.
The very name "free-board" eloquently speaks of what Incoterms are and where it is used: exclusively in the case of the main carriage by water.
CFR - cost and freight paid
The delivery scenario obliges the supplier to pay the cost of transporting the goods delivered by water to the port of destination indicated by the buyer in the contract. This is the main difference between CFR and FOB. The transfer of responsibility and risk to the buyer occurs upon arrival of the ship at the port of destination.
The word “freight” means in the title of this Incoterms delivery condition that such a condition is used exclusively only for carriage by sea international or river inland transport.
CIF - cost, freight, insurance paid
The condition under which the supplier pays insurance, freight customs duties and shipping costs to the port of destination. The rule requires the supplier to provide insurance coverage of at least 110%. If the buyer wants to insure the purchased goods for a large amount, this is a separate clause in the contract, and the amount of additional insurance is included in the seller’s invoice. Damage to the goods during unloading and port charges become the buyer's responsibility. Risks are transferred to the buyer as soon as the goods are loaded onto the ship. The seller is responsible for the safety of the goods only until they are loaded onto the ship.
CIF and FOB - the most common terms for the transport of goods by water.
CPT - transportation paid to the terminal
Unlike CIF, CPT does not require the exporter to insure the goods upon shipment. The risk passes to the importer when the goods are forwarded to the forwarder. Responsibility for everything else rests with the consignee. CPT is applicable for transportation by any means of transport.
Cip
Freight, shipping, and insurance paid to destination. In this case, the obligation of the supplier to insure the goods at least 110% of the cost is added to the requirements of the CPT rules.
DAT - delivery to the terminal
A terminal means any place, closed or not, such as a berth, warehouse, container yard or road, railway or cargo terminal. The supplier pays the shipping costs, export duty and insurance.
DAP - delivery to the point
The goods are provided to the buyer in the agreed place. He is ready for unloading.
DDP - delivery with payment of duties
DDP places the maximum responsibility on the exporter: delivery from the place of manufacture directly to the final destination with the implementation of import customs formalities and payment of taxes and duties.
Exporters are reluctant to agree to the application of this rule, because such an Incoterms condition is difficult to fulfill due to bureaucratic obstacles in import clearance. Usually it is used in the delivery of large quantities of goods, the price of which is not subject to sharp significant fluctuations.
It may seem to a novice in foreign economic activity that such Incoterms are the most beneficial for the buyer, and this is indeed so in certain jurisdictions. In the Russian Federation, the application of this rule may have consequences in the form of an increase in the tax burden on business and a rise in the cost of goods.
Tax consequences of using Incoterms
Including delivery conditions in accordance with international trade rules of Incoterms in the contract, they should be checked for compliance with the tax and customs laws of the country of residence. In the event that the norms of national legislation and the prevailing business and legal practice in the country, especially in terms of taxation, create an additional burden on the business, it is wiser to choose another.
The exporter, not understanding the complex and bureaucratic procedures for customs clearance in the country of destination, may make mistakes and miscalculations that delay the processing of the import customs declaration and the stay of goods at the TSW. This causes an increase in the cost of delivery.
Tax authorities pay the closest attention to any foreign trade contact. In the event that the contract prices accepted for calculating the tax base are deviated by more than 20% of the market price for identical goods, the tax liabilities of the importing company are calculated based on market value. In addition to paying the accrued tax, the company will have to pay fines and penalties. VAT paid by a non-resident exporter upon registration of import, in accordance with the tax legislation of the Russian Federation, is not refundable. The seller will include the customs fees and duties paid for the buyer by the seller in the invoice amount. From the invoice price determined by the invoice, customs duties and fees will be calculated.
It is necessary to take a very balanced approach to including DDP rules in the contract with Incoterms.
Existing business practice for processing export-import
An analysis of foreign economic contracts indicates that, according to the established practice in international transport, the seller company is responsible for the customs clearance of exported goods in the country of departure, and the buyer company is responsible for import formalities in the country of destination. This is due to the fact that companies are better oriented in customs law in the country of residence, often have a professional customs broker or well-established business relations with customs officers, who can always get comprehensive advice.
The prohibition by national customs laws of some countries on customs clearance of non-resident companies also prevents the widespread use of the basic terms of delivery of EXW and DDP.
Tax laws in some countries sometimes make it impossible to pay value added tax to a non-resident legal entity. Even if the non-resident supplier pays VAT for the importer, the latter loses the opportunity to present it for refund. To the above reasons, bureaucratic difficulties and numerous nuances of tax and customs legislation are added. Companies registered in this country have a much higher chance of understanding these intricacies.
This is the reason why counterparties are reluctant to include DDP in Incoterms.