INCOTERMS® 2020: WHAT IS IT ALL ABOUT?
By: Mark Anthony P. Tamayo on January 23,2020
Last of a series
In last week’s article, we completed the discussion on the 11 Incoterms® rules as they relate to cross-border commercial transactions.
In this last series, we shall focus on the possible effects and consequences of the chosen Incoterm® rule by the seller and the buyer.
The rules under Incoterms® 2020 are by themselves not legally binding since they are not, in essence, a contract of sale. They only become part of a contract when they are actually incorporated therein.
Thus, if the exporter (seller) and importer (buyer) want the Incoterms® 2020 rules to apply, both should ensure that the intention is clearly reflected and integrated in their contract by express reference to the specific Incoterm®. The parties must likewise insert the correct “named port, place or point,” which may refer to the place of delivery, the place of destination, or both, depending on the Incoterm chosen.
As suggested by the International Chamber of Commerce (ICC), the template for incorporation is as follows:
“[the chosen Incoterms rule] [named port, place or point, whichever is appropriate under the rules] Incoterms® 2020”
By way of an example, if the CIF (Cost, Insurance and Freight) Incoterm® is chosen, then the contract must state CIF Manila Incoterms® 2020. These words can immediately be interpreted that the 2020 version of the Incoterms® should apply.
The place named (i.e. Manila) after the chosen Incoterms rule (i.e. CIF) is vital as this indicates the destination to which the seller must organize and pay for the carriage of the goods. This is also particularly applicable for CIP (Carriage and Insurance Paid To), CPT (Carriage Paid To), and CFR (Cost and Freight) arrangements.
On the other hand, for DAP (Delivered at Place), DPU (Delivered at Place Unloaded) and DDP (Delivered Duty Paid), the named place is the place of delivery, as well as the place of destination. The seller must organize the carriage to that point.
For all other Incoterms®, the exact point which transfers the risk from the seller to the buyer is the named place that indicates where the goods are “delivered.”
On using Incoterms® 2020
In a cross-border transaction, the chosen Incoterm® has, among others, the following consequences:
First, the dutiable value (or duty base) upon which the appropriate duty rate is applied determines the amount of customs duty that would be payable. Dutiable value is composed basically of cost, insurance, freight and other dutiable charges.
On the other hand, the value-added tax (VAT) base (upon which the 12-percent import VAT rate is applied to determine the amount of VAT payable) includes, among others, the dutiable value, and customs duty as components.
Thus, in an arrangement where the buyer (importer) pays for the carriage and insurance, such as in the case of FOB (Free On Board), the importer must separately determine and add insurance and freight components to arrive at the dutiable value of the imported goods for customs purposes. The failure to add these components in the duty base would result to an under declaration of the customs duty, which results in an under declaration of the VAT base and the import VAT.
If the seller pays for the carriage and insurance (e.g. CIF and CIP), the costs relating thereto should be carved out (by the importer) from the total price reflected in the commercial invoice for goods declaration filing purposes.
Second, the chosen Incoterm® determines whether the seller or the buyer is responsible for the export and import formalities vis-à-vis the party who will bear the import duties and cost of transport, insurance and related charges.
Save for EXW and DDP, all the Incoterms® impose upon the seller the responsibility to complete all export formalities. The buyer, on the other hand, is tasked to complete all import formalities.
In contrast, the buyer, in an EXW arrangement, is responsible for both the export (if allowed in the country of export) and the import formalities. In a DDP, it is the seller that is required to complete both the export and import formalities (if allowed in the country of import).
Third, Incoterms® define the tasks, costs, risks and responsibilities associated with the transport and delivery of goods from the seller to the buyer. They do not address other key commercial considerations, such as, among others, (1) specifications of the goods sold; (2) time, place, method or currency of payment of the price; (3) remedies in case of breach of the contract; (4) method, venue, or law of dispute resolution in case of such breach; (5) sanctions; (6) dispute resolution; or (7) regulatory obligations. These are matters that need to be spelled out by the parties in the contract of sale.
Although the Incoterms® rules neither provide remedies nor solutions in case of a breach of contract, any violation thereof, may give rise to a cause of action against the other party.
Fourth, the Incoterms® rules do not define when title passes from seller to buyer. This matter has to be defined separately in the sales contract.
Fifth, it is essential to state the version of Incoterms® used. Otherwise a dispute could arise as to the correct version and may lead to a different tasks, costs, risks and responsibilities.
Sixth, incorporation of an Incoterm® into a sale contract will not bind any third party (e.g. banks, insurance companies, forwarders and carriers), nor govern any other contract. It is for the seller and/or the buyer to ensure that any contract of carriage, insurance contract or letter of credit entered, corresponds with the Incoterm® they have agreed.
With the dynamic growth of international trade, it is imperative that sellers and buyers have good understanding and awareness of the Incoterms® rules.
For the buyers, it is part of an effective procurement strategy; for sellers, correct pricing is determined. For both parties, the risks assumed are properly defined.
Although the updates introduced under Incoterms® 2020 further simplify and clarify the rules, an erroneous choice of a particular Incoterm® could expose a party to unnecessary risks.