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With so many of our daily goods coming from abroad, Incoterms play a much more significant role in our lives than most of us realise.
Some estimates indicate that International Commercial Terms (Incoterms) help to facilitate around 90% of all goods and transport transactions worldwide.
However, despite their widespread use and importance, these terms are often the source of a lot of confusion for importers and exporters alike.
To help clarify the subject, Trade Finance Global (TFG) spoke with Holly Jade O’Leary, co-founder and director of Alinea Customs.
A small overview of Incoterms
Incoterms are the international terms that determine business-to-business (B2B) practices in transporting and delivering goods.
The International Chamber of Commerce (ICC) published the first Incoterms in 1936, and have since played a vital role in global trade.
They set out the critical fundamental terms that importers and exporters can embed into their contracts when dealing with international trade transactions, outlining which party to the transaction will be responsible for which obligations.
These obligations include transporting and insuring the goods, obtaining shipping documents, clearing customs, and acquiring import or export licences if necessary.
The terms also outline vital aspects relating to risks, such as which party bears the risk of loss or damage, at any specific point in the journey, and at what point that risk is transferred.
While many variations exist, there are eleven main Incoterms rules, most commonly referred to by their three-letter acronyms, such as Cost Insurance and Freight (CIF) or Delivered at Placed (DAP).
It is important to remember that when including Incoterms in any international contracts, practitioners must add the year that the referred to Incoterms was published and, most importantly, the precise place of delivery.
Main challenges for getting goods across borders
Selling goods outside the domestic market can be intimidating for many businesses, especially first-time exporters. Many run into challenges trying to get their goods across borders.
O’Leary said, “The most common mistake I see is importers that do not fully understand the implications of prepaid Incoterms. For instance, many importers don’t understand that freight prepaid doesn’t necessarily include the terminal handling charges.”
Unless a transaction uses the Delivered at Place (DAP), Delivered at Place Unloaded (DPU), and Delivered Duty Paid (DDP) Incoterms, the importer will be responsible for paying any terminal handling charges. These can reach up to £2000, even for Less than Container Load (LCL) shipments.
Often they will only become aware of the charges when the ship has docked and the goods are released to the importer by the cargo broker––an unpleasant surprise that can decimate profit margins.
Another potentially costly example would be misunderstanding which party is responsible for certain aspects of the goods handling.
For example, suppose an importer is purchasing a significant amount of a product from a factory, and the factory insists on Free Alongside Ship (FAS) rather than Free On Board (FOB) incoterms. In that case, the importer will have to arrange to load ship themselves.
This could involve hiring a team to load the freight into containers and then onto the ship. Depending on the product type, this could add a high extra cost to the brake charges.
Many importers will seek for their supplier to handle as many of the responsibilities as possible in the exporting country. A clear understanding of Incoterms can help ensure a business is not left with any surprise invoices.
Another significant challenge new exporters often need help understanding is how and when freight charges apply and which party pays for each part of the journey.
For instance, while it may seem favourable to transact on an Incoterm where your counterparty bears all transport costs, risks, and responsibilities until the goods arrive at your warehouse, this term may turn out to be more expensive. It also leaves you relying on the counterpart for several other periphery activities.
O’Leary said, “While Ex Works (EXW) may present the lowest risk to the importer, they will have to rely on their client to prepare both the import and export documentation. This means that they may not have immediate access to the proof of export documents required for zero rate VAT in the event of an audit.”
On the other side, the DDP Incoterm may be the easiest option for some exporters. The cost to hire an indirect representative as the importer of record in the destination country––to receive the goods––may significantly lower the profit margins.
In the grand scheme of things, most of the other challenges revolve around a simple need for more understanding, especially regarding nuanced aspects such as tariff classification, customs valuation, rules of origin, restrictions, and labelling to comply with the importing territories.
How the Russia-Ukraine conflict has impacted imports and exports
Customs guidelines during a time of geopolitical unrest can be crucial to enable frictionless global trade.
For O’Leary, the Russia-Ukraine conflict has resulted in some extraordinary requests and even shifts in trade flows.
O’Leary added, “We’ve provided guidance to UK charities seeking to export relief goods to Ukraine.”
[Additonally] on October 1 2022, Ukraine was granted access to the Common Transit Convention and as they are not part of the EU, a T1 was required to transport goods to or from Ukraine when travelling to Europe by road.”
Ultimately, the effect of the sanctions means that significant tariffs are levied on many Russian-originating goods and industrial parts, even if they are entering the UK from another territory. The consequences are multi-layered, and we are yet to see how the long-term effects will play out in the trade ecosystem.
How to learn more about Incoterms
While they may seem confusing initially, Incoterms provide a clear international framework for understanding which party covers certain costs, has certain obligations, and bears certain risks.
Thanks to work from the World Customs Organization (WCO) and the World Trade Organization (WTO), international customs legislation is mostly harmonised, meaning that once firms dive in and become familiar with the rules, they can recycle this knowledge for nearly every other deal they will have to do.
Over the long term, this makes learning Incoterms simpler than it first appears. To help even more, TFG has put together a complete Incoterms guide.
But Incoterms are just one aspect of trading internationally.
“I would suggest it’s important for importers and exporters to take the time to understand how customs compliance works,” O’Leary said.
“If traders prepare their documentation accurately rather than relying on the freight forwarder, they can be confident about executing a seamless import on behalf of their clients.”
For those in the UK, the Department of International Trade (DIT) has a website called great.gov.uk/markets, which provides detailed information concerning opportunities for exporters, trade barriers, customs, and duties.
For firms exporting to the European Union, the TARIC Consultation database is an excellent resource for determining the import requirements of the recipient nation.
Many other governments worldwide have similar information available to help exporters reach international markets.