question markSmall and medium sized enterprises mistakenly accept costs and financial risk when they agree to Incoterms without considering the consequences. SMEs should care about Incoterms because mistakes can be costly – very costly.

What is an Incoterm? Answer:  Incoterms is an abbreviation of the phrase International Commercial Terms. The Incoterms rules are a series of commercial terms published by the International Chamber of Commerce (ICC).  The current version are the Incoterms 2010.  Incoterms are used by buyers and sellers in international and domestic commercial transactions to allocate costs, risks and obligations/responsibilities. The Incoterms rules are so common that they have become an essential part of the daily language of trade. The Incoterms rules have been incorporated in contracts for the sale of goods worldwide. However, many small and medium sized businesses remain unaware of what these important rules mean.

There are two groups of Incoterms rules.  Group I includes:

  • EXW (Ex Works),
  • FCA (Free Carrier)
  • CPT (Carriage Paid To)
  • CIP (Carriage and Insurance Paid to)
  • DAT (Delivered at Terminal)
  • DAP (Delivered at Place)
  • DDP (Delivered Duty Paid)

Group II includes:

  • FAS (Free Along Ship)
  • FOB (Freight on Board)
  • CFR (Cost and Freight)
  • CIF (Cost, Insurance Freight)

Group I Incoterms are rules that can be used for any mode of transport.  Group II Incoterms are rules for sea and inland waterway transport only.

The Incoterms rules set the obligations of the sellers and the buyers (which can be changed by specifically adjusting the Incoterm in a contract).  It is important for SMEs to understand, right at the beginning of contract negotiations, which of the above Incoterms should be selected, so that they know what type of costs, risks and liabilities they will be accepting in the international trade transactions under the contract.

For example, EXW (Ex Works) imposes the minimum obligations on the seller.  The seller delivers the goods to the buyer at the seller’s warehouse and all costs, risks and obligations are transferred to the buyer at that point. On the other hand, the seller takes on more costs, risks and obligations when the goods are delivered DDP (Delivered Duty Paid) because the seller takes on all shipping costs and financial obligations and risks relating to outbound and inbound customs laws.

The correct use of Incoterms can give buyers and sellers a competitive edge.  They can also be used to shift risk to an unsuspecting party who does not know anything about Incoterms.  For example, if goods are delivered Ex Works, then it could be more difficult for a buyer to reject the goods if they arrive damaged or spoiled.  The buyer would be responsible for the transport of the goods.  If the buyer did not have any marine insurance, the buyer could not expect a claim to be processed by the seller whose obligations ended when the goods were delivered to the buyer at the seller’s warehouse.  The damaged goods should have been rejected by the buyer at the seller’s warehouse.  Buyers should only use EXW when they have in-country inspections (quality assurance agents) prior to shipment.

Further, Incoterm rules may place customs obligations on sellers and buyers in unfamiliar jurisdictions.  For example, if an American seller sells goods to a Canadian buyer DDP, the American seller will be responsible for Canadian customs duties and border goods and services tax.  The seller may be a non-resident importer or may have a Canadian presence.  The seller would have the relationship with the Canada Border Services Agency (CBSA).  If the seller uses the incorrect H.S. Code in Canada (it is not always the same number as used to import into the United States), then the seller would be responsible for additional duties and Administrative Monetary Penalties (AMPS) penalties.  The seller may also be required to be registered for goods and services tax and charge, collect and remit GST/HST in Canada (since delivery would take place in Canada).  In other words, the seller may take on Canadian registration and tax obligations.

What if a Canadian buyer buys from a Chinese seller and agrees to FOB (ships edge).  The buyer would be the importer of record and would take all risks of reporting to the CBSA.  If the Canadian buyer does not know that the goods are subject to antidumping and countervailing duties (e.g., fasteners, aluminum extrusions, stainless steel sinks, copper pipe fittings, solar modules, certain steel products, etc.), the buyer could face significant duties. If the buyer had agreed to DDP terms, the antidumping duty/countervailing duty liability would be on the Chinese seller.

There are many other examples that highlight why knowing about Incoterms is important.  Please ensure that you are using the correct Incoterm in your contract.  Please review your ongoing contracts to ensure that the Incoterm used is consistent with the agreement between the parties.  When in doubt, call a professional.