WHAT ARE INCOTERMS AND THEIR IMPACT ON CUSTOMS CLEARANCES  

Conducting international trade in the absence of guidelines can be like running on a track without a finish line, which can be risky and unpredictable. This is where Incoterms come in, guidelines for international trade.  

Incoterms are important for Indian exporters in order to prevent any kind of discrepancy or inconsistency in costs and ensure compliance with every activity in customs procedures. Incoterms affect contract arrangement, risk transfer, and customs procedure arrangement in a certain manner. 

This blog aims to impart knowledge of Incoterms, their usage in international trade, and their impact on cost arrangement, contract arrangement, and customs procedure arrangement. 

What Are Incoterms? 

Incoterms or International Commercial Terms are an international code of rules for international trade, which was made famous by the International Chamber of Commerce (ICC). These rules provide buyers and sellers with one convenient definition of their obligations for international sales. 

Incoterms regulate that: 

•  Who pays for transport? 

•  Who pays when the risk passes from the seller to the buyer? 

•  Who is responsible for the insurance? 

•  Who handles customs clearance in exports and imports? 

Incoterms define the responsibilities and duties of both parties while exporting and importing, making the operation clear of all doubts. This result is saving a lot of time and reducing the possibility of delays and any unnecessary costly disputes. Therefore, the incoterm guidelines become an integral part of international trade. 

Commonly used Incoterms & their implications 

Various incoterms are used by both sellers and buyers, depending on their needs and ease. Below are some clearly defined, commonly used Incoterms that you should use: 

1. EXW – Ex Works: 

EXW means that the seller of the product arranges and prepares the goods for shipment at his own site, that is, at his factory or warehouse. Therefore, the buyer of the goods assumes responsibility and the cost of transporting the goods to their location. 

Seller’s Responsibilities: 

• Make the goods available at the agreed location 

• Minimum documentation support 

Buyer’s Responsibilities: 

• Export customs clearance 

• International transportation 

• Import customs clearance 

• Payment of duties, taxes, and insurance 

2.Free On Board (FOB):  

This term is common in sea or waterway shipments. FOB means that the seller delivers the goods once they cross the rail of the ship at the port of origin. The seller will handle the export formalities, and the buyer will bear all costs and risks once the goods are on board. This is very popular in common commodities. 

Seller’s Responsibilities: 

•  Export customs clearance 

•  Unloading goods from the vessel 

 Buyers’ Responsibilities: 

•  Ocean freight 

•  Import customs clearance  

3. DAP (Delivered At Place):    

Here, the seller takes the responsibility of transporting the goods to the desired location of the buyer, bearing all required costs from onboarding the goods to unloading them. The import charges are assumed by the buyer of the goods, including the customs duties and taxes.  

Seller’s Responsibilities: 

• Transportation to destination 

• Risk until arrival 

Buyer’s Responsibilities: 

• Import customs clearance 

• Duties and taxes 

4.Delivered Duty Paid (DDP):   

Here, the seller assumes all responsibilities in relation to the transportation of the goods. The seller clears the import customs, meets the documentation requirements and pays the taxes, eventually making the goods available to the desired location of the buyer. This is best when the buyer does not want to be involved in any of the operations regarding the goods transportation. 

Seller’s Responsibilities: 

• Export and import customs clearance 

• Payment of duties and taxes 

• End-to-end delivery 

Buyer’s Responsibilities: 

• Receive goods 

5. Other Incoterms: Although these are the most common forms of Incoterms, other Incoterms such as Free Carrier (FCA), Carriage Paid To (CPT), Carriage and Insurance Paid To (CIP), Cost and Freight (CFR), and Cost, Insurance and Freight (CIF) also have important applications in different shipping situations. These all have different meanings regarding the transfer of risks and costs.  

What are the Advantages of Incoterms in International Trade? 

Businesses can massively benefit from these incoterms by using them in their day-to-day international trade.  

• Defined responsibility: Incoterms specify the role and responsibility for both the seller and the buyer. This helps in reducing doubts and confusion, resulting in a seamless flow of goods without any disputes or delays. 

• Handling of the risk properly: When the incoterms between the parties are transparent, then the risk factor gets minimized at the time of transfer of the goods from the seller to the buyer. 

• Globally Acknowledged: The Incoterms are for all dealers and businesses across the globe, making it convenient for a smooth trade and understanding-based ecosystem. 

• Boosts efficiency: Properly defined responsibilities and specified customs clearance duties lessen the delays and mitigate the chance of disputes.  

• Enhanced Logistics: Incoterms determine who takes care of what like insurance, customs clearance, and taxes. This facilitates the business operations and makes logistics a seamless task. 

Types of incoterms used for all kinds of Transport 

● EXW (Ex Works): The seller only provides the product by making it available at its own premises.                                       
● FCA (Free Carrier): The seller transports the goods to the carrier mentioned by the buyer, and from there, the buyer is responsible for taking care of the product. 
● CPT (Carriage Paid To): The seller pays for the carrier and ensures that it reaches the ultimate destination as mentioned by the seller. 
● CIP (Carriage and Insurance Paid To): It is quite similar to that of CPT, but here including the carriage cost, the seller must pay for the insurance as well. 
● DAP (Delivered at Place): Here, the seller bears all the expenses from delivery to insurance at the place mentioned by the buyer, but it does not pay for the unloading. 
● DPU (Denot livered at Place Unloaded): It is quite similar to that of the DAP, except the seller here has to pay for the unloading of the goods at the desired location of the buyer. 
● DDP (Delivered Duty Paid): Here, the seller almost bears all the cost in the entire journey of a product reaching to its destination. It includes transportation cost, insurance, and, most importantly, it pays imports and taxes. 

Incoterms that are only used for sea and inland waterways 

● FAS (Free Alongside Ship): The seller delivers the goods alongside the vessel at the named port of shipment. When the goods are alongside, the buyer assumes the responsibility for loading, ocean freight, insurance, and all the risks from that point onward. 
● FOB (Free on Board): The seller makes the goods reach the port and on-boards the products on the ship at the port of shipment. From there on, the buyer assumes the rest of the responsibility. 
● CFR (Cost and Freight): Here, the seller is supposed to transport the goods to the buyer’s country’s port and pays for the ocean freight. But the buyer assumes the charges for the insurance. 
● CIF (Cost, Insurance, and Freight): This is very similar to CFR, but here the seller pays for the insurance along with transportation and ocean freight. 

Limitations of Incoterms 

• Payment terms: Incoterms do not provide any clarity over the payments, meaning that, it does not specify any rules as to when and how the payment regarding the business operations must be made. 

• Ownership transfer: Incoterm does not mention anything about the transfer of ownership when the goods are handled to the buyer by the seller. It only talks about the transfer of risk. 

• Product quality and inspections: The product’s quality and quantity are not defined by Incoterms. Any major or minor defect in the delivered product is managed separately elsewhere. 

• Does not involve dispute resolution: Incoterms do not play any role in resolving any dispute between the dealers. Any issue related to business operations must be dealt with in a separate contract. 

• Works within boundaries: These terms do not override any local or national law. These are designed to comply with international laws, customs, and taxes. 

• Risk of misuse: There are some specified incoterms that only apply to road and rail transport. Lack of awareness of the correct incoterm can lead to delays and confusion of the responsibility. 

How do Incoterms determine the shipping cost? 

• Allocation of Transportation Costs: Incoterms define the responsibilities of either the buyer or seller to pay for freight at different points throughout the journey. For instance, if it’s EXW, then the buyer pays almost all freight charges. However, if it’s either a CIF or DDP shipment, then the seller pays for most or all freight charges. 

• Customs Duties and Taxes Responsibility: Under some Incoterms, the charges for importation, taxes, and customs are for the buyer (DAP). Under others, the charges are for the seller (DDP). This alone affects the land cost of the material substantially. 

• Insurance Costs: Incoterms like CIF or CIP include insurance, which is factored into the cost of shipping. In other Incoterm, the cost of logistics would include insurance that the buyer pays. 

• Risk Transfer and Cost Exposure: The transfer of risk identifies who pays if there is any loss, damage, or delays in movement. Early transfer of risk may result in extra costs for the buyers on account of damage claims, and storage charges, among others. 

• Port Charge-Terminal Charge and Handling Charge: Based on Incoterm, the cost of terminal handling charges, port charges, and unloading charges may be borne either by the selling or buying organization, thus impacting shipping expenses. 

How to choose the right Incoterm for your business? 

• Consider the experience: Either you or the other party must be confident at handling the insurance, custom clearance, and taxes. If you think , you can manage these operations, then opt for an incoterm that weighs most of the responsibility on you. 

• Expertise in regulations: If you don’t have knowledge of the import or export regulations of different countries, then you should choose an incoterm that lets the other party take care of this task. 

• Budget: Transferring responsibility and the handling of the operations of a trade shifts the cost between the buyer and the seller. Keeping your finances in mind, select the incoterm that suits your budget and aligns with your goal. 

• Choosing a suitable incoterm: Properly defining the incoterm that matches your trade needs. For example, use FOR and CIF only for sea freight, FCA and DAP for air, road, and multiple shipments. 

• Consider Customer Expectations: Some buyers prefer door-to-door delivery, while others want control over freight. Make sure that customer expectations support the aligned Incoterm to establish business relationships. 

Effective guidelines for using Incoterms 

• Know your duties and responsibilities: Make sure to define who takes care of what such as insurance, taxes, and custom clearance. This helps avoid confusion and prevent delays. 

• Clearly defining the location: Mention the place of delivery in detail, like warehouse in Delhi, strictly avoid wastage of time and avoid any disputes regarding the transfer of risk. 

• Be mindful of the incoterm: Select the incoterm that suits your mode of transport, like FOB and CIF for ocean freight and other incoterms, like FCA and DAP for road, rail, and multiple transport. 

• Know your expertise: If you have never handled any import or export related work, then you should not take responsibility for these operations. 

• Have things well documented: Remember that incoterms do not cover payments, ownership and any dispute resolution stuff. Therefore, have these areas covered and properly agree on these terms separately to avoid any confusion. 

Key Takeaways 

• Incoterm clearly states the role of both the partners involved in the business as to who will handle the cost, insurance, taxes and the customs clearances. 

• As Incoterms define the roles of each, this leads to clarifying the confusion to a great extent, resulting in a flawless journey of the shipments. 

• Import and export customs clearances can be a hassle as it involves documentation and adherence to the country’s trade rules. Incoterms decides who does all this in the trade. 

• Differnt mode of transport support different incoterms. . 

• Incoterms do not cover everything, such as transfer of ownership, payment terms, and dispute resolution. 

Conclusion 

Incoterms are extremely important in international business as they provide a clear understanding between buyers and suppliers about the responsibility, expenses, and risks involved in a business transaction. Incoterms can also ensure an effective and controlled flow of shipping spends and resolve discrepancies; however, they are not a comprehensive agreement and should be backed by proper agreements on payment terms, ownership, and legal rights. 

Choosing the correct Incoterm for your mode of transportation is very important, as there are different Incoterms specialized to cater to different transportation needs. Also, consider the incoterm that aligns with your budget, as incoterms can potentially shift the cost of shipment between the seller and the buyer.