January 2020 will see the introduction of Incoterms® 2020. These are a set of globally-applied standard trading terms which help facilitate global trade between contracting parties – the seller and buyer.
The terms are administered by the International Chamber of Commerce (ICC): they were first codified in 1936 and have been updated periodically ever since (the last time was in 2010). Incoterms play an intrinsic role in the global movement of goods, but are often not applied correctly. This can lead to disagreements and expensive litigation between the seller and buyer as to their obligations, risks and costs.
With the prospect of Brexit in the near future, and the envisaged introduction of customs formalities for goods traded between the EU and UK, it is now even more important that companies understand and apply these trade terms correctly in their contractual arrangements.
What do the Incoterms cover?
There are 11 Incoterms rules, which are designed to reflect common business practices when moving goods between sellers and buyers, and they cover a number of key points, namely:
- Obligation of the parties relating to the carriage and insurance of the goods which are being sold by the seller to the buyer
- Risk between parties i.e. the point of delivery
- Costs to be borne by the parties: which party is responsible for the costs associated with moving the goods from the seller to the buyer, i.e. freight, insurance, packing, unloading and documentation preparation.
However, Incoterms are not contracts of sale and, therefore, they do not cover when ownership of the goods passes from the seller to the buyer.
Historically, for ease of reference, Incoterms have been put into 4 groups: E, F C and D. From the seller’s perspective the ‘E’ group was the most beneficial and least onerous, with the ‘D’ group being the least beneficial and most onerous.
There are a further 3 ‘F’ rules and 4 ‘C’ rules, which vary the obligations between the seller and buyer.
Changes brought about by Incoterms® 2020 rules
For comparison purposes, please see below a diagrammatic comparison between the 2010 and 2020 Incoterms. These show how obligation, risk and cost is allocated between the seller and buyer under each rule under both Incoterms® 2010 and Incoterms® 2020.
While Incoterms® 2020 does not introduce major changes, and the number of Incoterms remains the same, it does introduce some important changes in the detail to reflect the ever-changing nature of global trade. For example, the ICC has reordered the obligations, risks and costs within each rule of Incoterms® 2020 to give more prominence to delivery and risk. Further important changes are summarised below.
Change from DAT to DPU
The Incoterms® 2010 rule DAT (Delivered At Terminal) is replaced by DPU (Delivered at Place Unloaded). This is designed to reflect the commercial reality that goods can be delivered to any place - not just a terminal - and to re-emphasise that it is the seller’s responsibility to unload the goods under this Incoterm.
Bills of Lading and the FCA (Free Carriage Alongside) rule
Under the 2010 version of the FCA rule, the seller’s delivery obligation ends before the goods are loaded onto the vessel. The seller may not be able to obtain an ‘on board bill of lading’ from the carrier, (which it may need for payment and contractual purposes). Incoterms® 2020 allows for the carrier to provide this evidence to the seller.
Option to have different insurance cover under ‘C’ terms
Under Incoterms® 2010, CIF (Cost Insurance Freight) and CIP (Carriage and Insurance Paid) to, the seller has to obtain cargo insurance which meets the minimum insurance cover as provided by the Institute Cargo Clause ‘C’. Under Incoterms® 2020, under CIF the minimum requirement has been maintained, but under CIP, the seller must now adhere to the higher Clause A standards.
Introduction of security related elements in carriage obligations and costs
Reflecting the global concern on security in the global supply chain, Incoterms® 2020 introduces security-related obligations for each Incoterm and also sets out the costs incurred more clearly. Parties should verify whether their arrangements meet the new obligations.
Incoterms challenges now and going forward
Lack of specificity in the use of Incoterms often causes confusion in practice. Incoterms are intended to provide structure around the roles of buyers and sellers across all global transactions and supply chains so, in reality, they cannot cover all eventualities. Parties should, therefore, introduce additional detail where it is prudent to do so, for example, naming ports or places for delivery.
In many instances, where the seller is obliged to deliver the goods, (at which point risk passes), and where the seller is obliged to arrange carriage to, will be different locations. Therefore, the use of named locations in the Incoterms will help to clarify the position.
In some instances, the use of specific Incoterms hinders good commercial practice, for example the incoterm “Ex Works (EXW)”: under this rule, the seller merely has to put the goods at the buyer’s disposal. However, in practical terms, this raises questions as to who has the obligation and bears the risk of certain activities such as loading the goods. Technically it is not the seller who bears this risk but, if this activity is done on the seller’s premises, in reality it may well be the seller who loads the goods. If it loads the goods and something goes wrong, which party bears the risk and obligation for any damage?
One of the potential challenges raised by Brexit, is the inclusion in UK-EU purchase and supply contracts of Incoterms which may not reflect the reality of an existing commercial arrangement post-Brexit.
With the arrival of Brexit we will see the introduction of customs reporting requirements and declarations on goods moving between the EU and UK and vice versa. In addition, the UK will no longer be a member of the EU and, therefore, UK companies may no longer be able to (or want to) meet certain EU establishment requirements to act in certain roles within the supply chain.
A good example of this will be the use of the incoterm ‘Delivered Duty Paid’ (DDP), where the seller is based in the UK and the buyer is in the EU. Under these terms, the seller will need to complete both the UK export customs declaration and the EU import declaration. However, in order to do the latter, it will be required as a minimum to hold either an EU VAT registration, EU EORI number or appoint a fiscal representative in the EU. This may not be commercially practicable.
As part of their Brexit preparations, traders should look at their standard contracts and the Incoterms the normally agreed with customers to establish which party is taking responsibility for VAT, customs duty, or submitting the customs declarations in the country of destination.
For help and advice on any cross-border trade issue, please get in touch with your usual BDO contact or [email protected] or [email protected].
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