What are INCO Terms?
The Incoterms is a series of pre-defined 3 digits alphabetical commercial rules developed by the International Chamber of Commerce (ICC) to facilitate the exporter and importer across the world in creating a sales contract for delivery of goods between buyer and seller.
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These terms establish the responsibilities of both buyers and sellers at each stage of shipment to avoid misunderstanding. The exporter must agree to a particular Incoterm with importer while generating the export invoice itself. The Incoterms also becomes a part of the agreement between the buyer and seller and is mentioned clearly on all documents involved in the transaction.
Therefore, Incoterms are a standard set of terms used by businesses across the world in international trade. The International Chamber of Commerce (ICC) first introduced Incoterms back in the year 1936, in order to provide a standard set of terminology to traders and eliminate misinterpretations in international trade.
The International Chamber of Commerce (ICC) launched the latest trade terms, known as Incoterms 2020 on 10 September, 2019 and is effective from 1st January 2020 and is part of an international sales contract between the buyer and seller
Before the launching of new terms on September 10, 2019, the Incoterms 2010 were used for making sales contract in international trade transactions between buyers and sellers across the world.
Each Incoterm clearly details the break-up of costs involved and buyers & sellers responsibilities. For example, if the Incoterm is EXW – Ex Works, the exporter only pays till packaging and delivery right outside the factory gate. The remaining responsibilities to pick it up and get it delivered to the place of choice rests with the buyer. Similarly, if the agreed Incoterm is FOB – Free on Board, the seller responsibility would involve transporting the goods from seller’s premises up to the departing ship or air.
What the Incoterms Rules Do?
The Incoterms rules explain a set of eleven of the most commonly used three-letter trade terms, e.g. CIF, DAP etc. reflecting business-to-business practice in contracts for sale and purchase of goods. The INCO terms rules describe:
- Obligations: Who does what as between buyer and seller. For example, who organizes carriage or insurance of goods or who obtains shipping documents and export or import licences;
- Risk: Where and when the seller “delivers” the goods i.e. where risk transfers from seller to buyer;
- Costs: Which party is responsible for which costs, such as transport, packaging, loading, unloading costs and checking or security-related costs.
The Incoterms rules cover these areas in a set of ten articles, numbered A1/B1 etc., the A articles represent the seller’s obligations and the B articles relate to the buyer’s obligations.
What the Incoterms Rules Do Not Do?
The Incotermsrules do not deal with the following matters:
- Whether there is a contract of sale at all;
- The specifications of the goods sold;
- The time, place, method, or currency of payment of the price;
- The remedies which can be sought for breach of the contract of sale;
- Most consequences of the delay and other breaches in the performance of contractual obligations.
- The effect of sanctions;
- The imposition of tariffs;
- Export or import prohibitions;
- Intellectual Property Rights;
- Transfer of property/title/ownership of the goods sold.
Purpose of Incoterms Rules
Incoterms are a set of rules that guide domestic and international trade, facilitating the conduct of imports and exports, defining the costs, risks, and obligations of buyers and sellers in international transactions. The core functions of Incoterms 2020 used in international trade are:
- Outline the obligations of the buyer and seller in a trade transaction.
- Clarify when risk passes from seller to buyer under each of these rules.
- Outline how costs are distributed between the buyer and seller.
The main purposes of Incoterms 2020 are:
- Clarity in interpretation of trade terms and rules.
- Minimization of trade disputes.
- Base of contract of sale.
- Documentary evidence.
- Solid base to contract.
- Clear allocation of cost between buyer and seller.
- Makes Security obligations more prominent.
Types of Incoterms
There are four categories of incoterms:
- E Terms (Departure)
- F Terms (Main Carriage Unpaid by the Seller)
- C Terms (Main Carriage Paid by the Seller)
- D Terms (Arrival)
E Terms (Departure)
The most popular is EXW (i.e. Ex Works). If the agreed Incoterm is EXW, the seller makes the goods available at his/her premises for the buyer to collect. This term carries the “minimum obligation” for the seller.
F Terms (Main Carriage Unpaid by the Seller)
The seller must deliver to the carrier (rail, air, or ship) of choice of the buyer. The seller would deliver the goods till the carrier and the buyer is responsible for carriage from that point onwards. The three types of F-Incoterms are:
- FOB – Free on Board (Applicable for sea & In-land waterway transport only)
- FCA – Free Carrier (Applicable for any mode of transport)
- FAS – Free Alongside Ship (Applicable for sea & In-land waterway transport only)
C Terms (Main Carriage Paid by the Seller)
The seller must also contract and pay for the carriage, that is, freight or carrying cost, of the choice of the buyer. However, the risk of damage or loss during transit on carriage rests with the seller. The four C-Incoterms are:
- CIF: Cost, Insurance and Freight (Applicable for sea mode of transport)
- CFR: Cost and Freight (Applicable for sea mode of transport)
- CPT: Carriage Paid To (Applicable for any mode of transport)
- CIP: Carriage and Insurance Paid To (Applicable for any mode of transport)
D Terms (Arrival)
Under D terms, the seller bears the risk till unloading and clearance at the destination terminal or place as per the specific term. The three D terms are:
- DPU – Delivered At Place Unloaded (Applicable for any mode of transport).
- DAP – Delivered At Place (Applicable for any mode of transport).
- DDP – Delivered Duty Paid (Applicable for any mode of transport)
International Price Quotations and Incoterms
The term “quotation” refers to an offer to sell goods at a stated price and under specified conditions. An “export offer” or “quotation” is the basis of any export transaction.
Whenever an exporter writes a formal letter to an importer with an offer of his export goods, the importer, if replies in positive, needs to have any one of the following methods for an export quotation or order.
Proforma Invoice
An exporter prepares this after he gets an order from an importer. It is a standardized proforma, which is applicable throughout the world. It is similar to a document known as ‘commercial invoice’. It shows the price as well as other charges as per terms of contract given in shipment. The proforma invoice is needed by the importer to get the import license or allotment of foreign exchange.
Global Price List
The offer may be made in response to a public global tender given by a buyer. Such offer consists of all conditions of the tender and listing out the price together with other charges e.g. freight, insurance, customs, tariffs etc.
Letter Showing the Price
An offer can be given in the form of a letter showing the price, terms of payment and delivery of goods.
Price List
An offer may be in the form of a printed price list where the goods have a standard export price
The price quotation describes a specific product, states the price for the product as well as a specified delivery location, sets the time of shipment and specifies payment terms. The responsibilities of the buyer and the seller should be mentioned as they relate to what is and what is not included in the price quotation and when ownership of goods passes from seller to buyer.
Incoterms are the internationally accepted standard definitions for terms of sale set by the International Chamber of Commerce. Published in September 2019, Incoterms 2020 may be used to define the responsibilities of buyer and seller in contracts effective from 1st January 2020
The 11 terms contained in Incoterms 2020 as described earlier e.g. EXW, FCA, CPT, CIP, DAP, DPU, DDP, FAS, FOB, CFR, and CIF. The other quotations terms traditionally used were local price, free or Franco price and in bond price.
The following precautions are to be taken when quoting international prices by the exporter:
- Increase in cost of goods to be exported.
- Change in quality specifications by importer.
- Variations in the rate of foreign exchange.
- Cost of packaging.
- Providing guarantees and warranties.
- Supply of spare parts free of cost with the machinery.
- Penalty on exporter due to failure of export obligation.
