The Role of INCOTERMS in Customs Clearance

Introduction

Globalization creates enormous opportunities for companies to reach out to new markets in different countries and regions. As more and more companies venture into international trade, conducting cross-border transactions can be a complex process that involves many factors for consideration, in particular, the responsibilities of seller and buyer:

• Who arranges for the transport?
• Who covers the insurance?
• Who handles export & import customs clearance?
• Who pays duties and taxes?

In order to ensure predictability and transparency in conducting international trade, the International Chamber of Commerce (ICC) and other stakeholders collectively launched a set of international commercial terms (INCOTERMS) in 1936 to help all parties understand their duties and responsibilities during cross-border transactions.

INCOTERMS are essential in international trade as they provide a standardized set of rules that help to prevent misunderstandings between buyers and sellers from different countries. INCOTERMS establish the responsibilities and obligations of each party and also help to identify where the risk transfers from seller to buyer and who is paying for what costs. However, INCOTERMS themselves are not legally binding. Rather, they constitute a set of guidelines that parties can choose to incorporate into their sales contracts covering various aspects of pre-carriage arrangements, such as packaging, import and export clearance, to onward delivery arrangements.

INCOTERMS are revised once every 10 years to keep in line with the developments in international trade. The latest version was updated in 2020 with 11 rules:

1. EXW (Ex Works)
2. FCA (Free Carrier)
3. CPT (Carriage Paid To) 
4. CIP (Carriage and Insurance Paid To)
5. DAP (Delivered at Place)
6. DPU (Delivered at Place Unloaded)
7. DDP (Delivered Duty Paid)
8. FAS (Free Alongside Ship)
9. FOB (Free on Board)
10. CFR (Cost and Freight)
11. CIF (Cost, Insurance, and Freight)

INCOTERMS and Customs Clearance Challenges

Under the customs procedures in all countries, the computation of customs value for duty & tax calculation is directly linked to INCOTERMS.  Hence, the correct use of INCOTERMS has a direct influence on the smooth clearance in exportation and importation.  In this article, a few possible customs challenges are discussed related to using different INCOTERMS in cross-border transactions:

Ex Works (EXW) 

This can be used for any mode of transport and can be used when there is more than one mode of transportation from the seller to the buyer.  Under EXW, it places minimum responsibility on the seller. The seller has to make the goods available, packaged for export, at the agreed place between the seller and the buyer, which is usually the seller’s factory or warehouse. 

One major requirement of this approach is that buyers are fully responsible for all export and import procedures which cover regulatory obligations.  Some possible cross-border issues which may arise under this particular Incoterm are:

• Export customs clearance could be problematic when the buyer has no local presence (legal entity) at the export origin.
• Usually, EXW is used when the seller is unable to export due to a lack of export rights (either in customs clearance or trading in foreign exchange). If so, the buyer will need to engage a 3rd party broker to facilitate export clearance, incurring additional costs in the overall transaction.
• For some restricted commodities, even if the buyer establishes a local entity in the origin country, the company may not be able to obtain the export permit successfully, and this will jeopardize the shipping of the cargo.
• For exporters located in a Free Trade Zone (FTZ) or Export Processing Zone (EPZ), they need to provide evidence of export when goods are exported out of the country.  Since the buyer is responsible for export clearance but is in no way obligated to hand over that proof, the exporter may be liable for any regulatory non-compliance with additional local tax payment.

Whenever possible, the seller (exporter) must support directly in the export customs clearance in order to avoid some of these challenges outlined, this will prevent delays of the shipment as well as to achieve customs and trade compliance for both the seller and buyer.

Delivered Duty Paid (DDP) 

Under the DDP Incoterm rules, the seller assumes all responsibilities and costs for the delivery of the goods to the named place of destination. The seller must pay for both export and import formalities, fees, duties and taxes.  This rule is commonly used in e-Commerce shipments since it offers some notable advantages. For one thing it provide seamless end-to-end online shopping experiences to the customers from the point of sale until ownership of the ordered goods is fulfilled. It is also an appropriate Incoterm for large wholesalers which may be more geared up for international trade and logistics with greater exposure in cross-border transactions, as compared to those less experienced e-Commerce retailers.

That said, the major challenge for using this rule in customs clearance is that DDP assigns maximum responsibility to the seller, including requirements for the application for any import permits and licenses, import declaration and the payment of any applicable duties and taxes in the destination country. It requires the seller to comply with legislation in countries where it may have no presence, and therefore possibly rely on 3rd party logistics providers for ensuring regulatory compliance.  Please also be aware that, if a 3rd party agent is used as Importer of Record (IOR) during importation, any duty drawback from local Customs office will be paid directly to the IOR, the seller may not be able to get back from the 3rd party agent.

In addition, during the online selling process, the seller has to estimate the amount of import duties and taxes to be applicable in the destination country, which may vary depending on the commodity, origin, value, and the regulations.  The estimation of the customs duties and taxes could be inaccurate making the sale less competitive or profitable.  Another problem is that the seller must deal with foreign exchange during import clearance, which means they are fully responsible for the foreign currency and any associated risks.

Similar to EXW, if the importer is located in customs bonded warehouse or specific customs zones such as Free Trade Zone (FTZ) or Special Economic Zone (SEZ), the shipment must be cleared under the name of the importer’s entity, the DDP term cannot be used for such transactions.

A better alternative to DDP is the use of DAP (Delivered-at-Place); the seller is responsible for all charges and risks in transit until the goods reach their destination (at a named place).  Under DAP, the buyer is responsible for all costs and risks associated with unloading the goods and clearing customs to import the goods into the destination country.

GEODIS: Your Trusted Partner in Customs & Foreign Trade Management

As the global leader in transport and logistics, GEODIS provides industry-leading customs brokerage services which cover a full range of professional customs & foreign trade management solutions to all our clients globally. We have more than 800 professional trade experts worldwide to support our customers in researching customs and trade regulations, as well as providing effective cross-border digital customs solutions to ensure efficient and cost-effective cargo shipping, duty & tax optimization with full customs compliance at all times.

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