Incoterms 2020 explained: which rule to pick and who ends up paying

Key points

• The Incoterms divide carriage, risk, costs and customs formalities between buyer and seller, and nothing beyond that.
• There are eleven rules: seven for any mode of transport and four that apply to sea freight only.
• Under the C rules the seller pays the freight while risk already passed at loading.
• EXW and DDP look like the easy options and cause the most trouble in practice.
• The Incoterm does not decide who is the declarant at customs, the authorisation does.

Three letters in a sales contract decide who pays the freight, who carries the risk if the load arrives damaged, and who has to arrange the customs declaration. Those three letters are usually copied across from the previous contract without anyone working out what they cost.

The Incoterms are published by the International Chamber of Commerce. The current version is Incoterms 2020 and it has applied since 1 January 2020. They are not law but contract terms: they only bind you once you agree them in the contract.

Below is what they do and do not govern, which eleven exist, and which choices cost an importer money.

What do the Incoterms actually govern?

They divide five things between buyer and seller: who arranges the main carriage, where risk passes, who bears which costs, who handles the export formalities and who handles the import formalities. Two of the rules add an insurance obligation on top.

What they do not govern, and what people read into them anyway:

• the transfer of ownership, which follows from the applicable law and not from the Incoterm
• the payment terms and the moment payment falls due
• the price itself, and what happens on a breach of contract
• whose name appears on the customs declaration as declarant

That last point causes the most confusion. An Incoterm says who organises the import formalities, but in whose name the declaration is filed follows from the authorisation you give your broker. Those are two separate arrangements and they regularly contradict each other.

Which eleven Incoterms are there?

Seven rules work for any mode of transport, including road, rail and air:

• EXW, the buyer collects at the seller’s premises and does everything else
• FCA, the seller delivers to the buyer’s carrier and clears the goods for export
• CPT, the seller pays carriage to the destination while risk passes earlier
• CIP, as CPT but with insurance at the highest level of cover
• DAP, the seller delivers at the destination, the buyer unloads and imports
• DPU, the only rule where the seller also unloads
• DDP, the seller also handles and pays the import and the duty

Four rules apply to sea and inland waterway transport only: FAS, FOB, CFR and CIF. With those four, risk passes on board the vessel, or alongside it under FAS. They were never meant for containers trucked to a terminal, and that is exactly what they get used for most.

What separates the E, F, C and D groups?

The first letter tells you how far the seller goes.

Under the E rule the seller does nothing beyond making the goods available. Under the F rules he delivers to a carrier the buyer appointed, so he does not pay the main carriage. Under the C rules he does pay the main carriage, but risk already passed earlier. Under the D rules he carries the risk all the way to the destination.

That C group is the best known trap. Under CFR and CIF the seller pays the ocean freight to Rotterdam while risk passed the moment the container was loaded on board. If the cargo is lost at sea, that is your loss, even though the freight sits on his invoice. Cost and risk split at two different points there, and that is deliberate.

What does the Incoterm mean for your customs value?

More than most importers expect, because the customs value has to include freight and insurance up to the place of entry into the EU.

Buy on CIF and that freight already sits in the invoice price, so the build-up is nearly right from the start. Buy on FOB or FCA and the freight arrives on a separate carrier invoice that you have to add yourself. That is precisely where it gets forgotten, and then the declaration runs years too low.

The reverse happens too. Under DAP and DDP the carriage inside the EU sits in the price, and that part can come off. Only where the amount is shown separately on the invoice. If it is not shown separately, you pay duty on transport you were allowed to deduct.

Which Incoterm should an importer pick?

Our advice is nearly always the same: FCA instead of EXW, and DAP instead of DDP.

EXW looks cheap because the seller does nothing. The problem is that you then have to file the export declaration in his country, and as a foreign party you often cannot. In practice the seller does it anyway and charges it on, only without an agreement in place. FCA solves that: he clears the export, you arrange the main carriage.

DDP is the mirror image. A seller outside the EU then has to arrange your import declaration and pay the duty. That requires an EORI number in the EU and, in practice, indirect representation, where a third party takes on your customs debt. With Chinese suppliers offering DDP this is where it nearly always breaks: the shipment gets stuck, or it is declared in a name that has no business being there. Under DAP he delivers to your door and you keep the import in your own hands.

Where do contracts go wrong?

Four things keep coming back.

• Only a code, with no named place. “CIF” says nothing, “CIF Rotterdam Incoterms 2020” does.
• A rule from an older version, such as DAT, which has been called DPU since 2020.
• A sea rule on a road shipment, for instance FOB on a trailer out of Turkey.
• The authorisation with the broker contradicts the Incoterm on who handles the import.

The first three only surface once something goes wrong and there is an argument about damage or costs. The fourth surfaces on an audit, and then it covers three years of declarations.

Frequently asked questions

Q: Which Incoterm is best for an importer?

Ans: There is no single best one, but FCA and DAP give an importer the most control without carrying risk for nothing. FCA where you have good freight rates of your own, DAP where you want the seller to arrange transport without pulling him into your import declaration.

Q: What is the difference between DAP and DDP?

Ans: Under DAP the seller delivers at the agreed place and the buyer handles the import and the duty. Under DDP the seller handles the import as well and pays the duty. DPU sits between them: as DAP, but the seller also unloads.

Q: Can you use CIF for road transport?

Ans: Formally no, CIF is meant for sea and inland waterway transport. Use it anyway and it becomes unclear where risk passes, because there is no ship’s rail to hang it on. Use CPT or CIP for road shipments.

Q: Does the Incoterm decide who files the customs declaration?

Ans: No. It decides who organises and pays for the formalities, not in whose name the declaration is filed. That follows from the authorisation you give your broker and from the form of representation recorded in it.

Q: Do you have to name Incoterms 2020 in the contract?

Ans: Always name the version, because older versions stay valid where you agree them. Without a version a counterparty can rely on Incoterms 2010, and under CIP the required level of insurance is different there.

Not sure which Incoterm suits your shipments, or if your customs value holds up under the terms you agree now? Run a shipment through our import duty calculator, or let us test the build-up per supplier. We file the customs declarations and record who declares for whom in the authorisation you sign once.