Do Incoterms® Really Matter?
While Incoterms® have been around since 1936 and have been updated every ten years since 1980, there are still many misconceptions and misunderstandings regarding the proper use.
Incoterms® are commercial terms or rules published by the International Chamber of Commerce. The rules establish which risks, obligations, and costs with a shipment are the responsibility of the Seller and which are the responsibility of the Buyer. The different Incoterms® rules cover such things as loading, delivery, transportation, and import and export obligations. While Incoterms® are generally used with international transportation, they may also be used with domestic shipments.
The Incoterms® rules range from the Buyer bearing all of the risks, obligations, and costs (i.e. “EXW”) to the Seller bearing all of the risks, obligations, and costs (i.e. “DDP”), with many terms or rules that divide the responsibilities between the two parties.
The misconception and misuse of a rule comes into play when you expect one thing, but, you use a rule that means something entirely different. Perfect examples are “EXW” or ExWorks and “DDP” or Delivered, Duty Paid.
Under the EXW rule, the Seller has minimal risks, obligations, or costs. The Seller is essentially only responsible for producing the product, packing the goods appropriately for the mode of transportation, contacting the Buyer when the goods are ready, and, opening their doors for the Buyer’s carrier.
The Seller doesn’t have to load the freight or even provide any equipment for the carrier to load the goods. Additionally, the Seller isn’t responsible for any export formalities that may be required by their country – this is the obligation of the Buyer.
People will often say “But we’re paying the freight from the vendor’s warehouse – isn’t that ExWorks?”
Incoterms® rules are more than just asking “who’s paying the freight.” Who’s responsible for loading the goods? Under ExWorks, the Buyer is responsible, so you better have your carrier bring a forklift. Who’s responsible for any documentation or export formalities with the foreign government? Under ExWorks, the Buyer is responsible so you better hope the Seller’s country allows a foreign entity to be filing documentation (here’s a little hint…most countries do not allow a foreign company to be the legal exporter).
DDP: Delivered, Duty Paid
At the opposite end of the Incoterms® spectrum is Delivered, Duty Paid or “DDP.” With this rule, the Seller is responsible for everything including the customs’ formalities involved with the importation into the Buyer’s country.
We see the improper use of DDP both with purchases and sales. A common occurrence is when a company in the U.S. purchases goods on a DDP term, only to be told by the Seller’s freight forwarder and customs broker that they’ll have to complete a Power of Attorney.
“Oh don’t worry” the Seller’s customs broker will say, “we’re billing all of the charges back to the shipper.” You want the freight so you complete the form. Unfortunately, now you’ve taken on the responsibility to be the legal importer or record with U.S. Customs and Border Protection when, under DDP terms, the Seller has that obligation. Even though you’re not paying any duties or fees, you’re legally responsible for the importation and you would be the one subject to any fines for penalties if there was an issue.
DDP “pitfalls” also exist when selling to your customer under DDP terms. The overwhelming majority of countries in the world require the local Buyer to be the importer and responsible for any customs’ declarations. While you, as the Seller, are paying for all of the costs, including any foreign duty, fees, and taxes (e.g. VAT tax), the foreign customer is the legal importer on paper and many Buyers actually use this to their advantage. Most countries allow an importer to reclaim, as an offset or refund, any VAT that they “paid” for raw materials, pass-through items, or production equipment. So, while you paid the forwarder for the VAT tax, your customer is the one that receives the money back from the government because they were the legal importer. Improper use of DDP terms is a good way for your customer to get a nice “discount” on the goods they buy from you when they recover the VAT you paid.
So what Incoterms® rule should be used?
The Incoterms® rule to use depends on what you want to have happen in the shipment. What risk, obligation, and cost are you expecting to be responsible for, and what should be the responsibility of the other party? Once you know the division of the responsibilities, you can find the Incoterms® rule that would apply to the shipment.
Please contact us to find out how we can assist with the proper use of Incoterms® with your purchases and your sales.