As companies directly or indirectly involved in international trade and cross-border supply chains navigate the complexities of tariffs and their expected retaliatory impacts, one effective strategy to mitigate their impact is choosing the right Incoterms.
Incoterms® 2020 Rules are standardized trade terms used in international contracts that define the responsibilities of buyers and sellers for the delivery of goods, allocating:
- the responsibility for arranging carriage;
- cost of carriage;
- transfer of risk of loss or damage to the goods;
- insurance responsibilities; and
- the name of place/location/port of shipment where delivery takes place.
In the absence of a stand-alone contract agreement, the Incoterm can be incorporated into other commercial documents such as purchase orders and acknowledgment of orders, among others.
By selecting the appropriate Incoterms 2020 Rules, businesses can shift responsibility for duties, tariffs, taxes, and shipping costs to suppliers or customers, thereby managing the financial and logistical burden of tariffs. For instance:
- DDP (Delivered Duty Paid): The seller assumes full responsibility for shipping, duties, taxes, and delivery to the buyer’s location, mitigating the buyer's tariff exposure.
- EXW (Ex Works): The buyer assumes responsibility for all costs, including tariffs, once the goods are made available for pickup by the seller. This puts the burden of tariffs on the buyer.
- CIF (Cost, Insurance, and Freight): The seller is responsible for transportation costs and insurance to the destination port, but the buyer bears responsibility for tariffs once the goods reach the port.
- FOB (Free on Board): The seller delivers the goods to the port, and the buyer assumes responsibility for tariffs and further shipping costs once the goods are loaded onto the ship.
Although designed primarily for use in international contracts of sale, Incoterms can also be (and are frequently) used for U.S. domestic contracts, in which both parties are located in the U.S.
The Uniform Commercial Code (UCC) also includes standardized shipping terms that aim to allocate responsibility and risk between the buyer and the seller for transporting the goods. Several UCC shipping terms share the same names as individual Incoterms, for example, FOB, FAS, and CIF but have different meanings. Therefore, in a domestic sale of goods contract the parties should specify which terms (Incoterms versus UCC) they are referring to (and not just say, for example, FOB).
It is common practice for the parties in a domestic transaction to select an individual term that was not specifically designed for domestic transactions. If that occurs, the parties should understand the rights and requirements of the selected term that do not apply to the transaction (for example, customs clearance requirements, and so on).
The Incoterms address the following:
- Transfer of risk
- Location of delivery
- Packaging and marking
- Responsibility for loading and unloading
- Arrangement of contract of carriage
- Allocation of costs of carriage
- Responsibility for arranging insurance cover (to a limited extent)
- Responsibility for export and import clearance
- Responsibility for supply chain security measures
- Notices and assistance with information
The Incoterms DO NOT ADDRESS the following:
- Transfer of title (optional)
- Price
- Payment
- Exclusive distribution arrangements
- Minimum purchase obligations
- Product liability, including responsibility for product recalls
- Governing law and jurisdiction
Incoterms in Commercial Contracts
When indicating the selected Incoterms in a contract, the parties must specify:
- The three-letter term, denoting the applicable individual term, for example, EXW
- The named place/delivery location
- The applicable version of the Incoterms Rules (for example, the 2020 version)
The parties should write the term, the designated place, and the applicable version of the Incoterms, for example, EXW [NAME AND ADDRESS OF SELLER'S FACILITY] (Incoterms® 2020 Rules). The parties must specify the named place with sufficient precision. Use a specific address where possible. For example, "CIP London" would be too vague. Failing to specify the precise port or place of destination may leave a party bearing an enhanced cost. For example, in the case of the D term rules, this would be a cost borne by the seller.
The parties must ensure that the rights and obligations of the parties set out in the selected shipping terms are consistent with the rights and obligations set out in the sales contract's other provisions, including the contract's transfer of title provision, price provisions, risk of loss provisions, and insurance covenants. Many contracts include separate risk of loss provisions, and if the parties incorporate Incoterms, the risk of loss provision should be deleted and drafted consistently with the selected Incoterms; or drafted intentionally to expressly supersede the selected Incoterms regarding risk of loss.
Classification of Incoterms 2020 Rules
Incoterms is a registered trademark of the International Chamber of Commerce. The International Chamber of Commerce publishes a chart that includes the allocation of buyer and seller responsibilities, transfer of risk, obligations, and charges, applicable to each mode of carriage. Click here to access the Incoterms chart.
Practical Application
The implications of how, when, and how much anticipated tariffs will impact a company are moving targets that change based on new announcements, deals with specific countries or industries, and individual exemptions. Creating a broad-stroke solution won’t work in this particular tariff climate. Tariff impacts will vary depending on the countries involved, the type of goods, a company’s location in the supply chain, and the actions of other companies. However, by reviewing contracts, terms, governing jurisdiction, and other items, companies can try and get ahead of the potential price increases by determining who pays for what and where. While the threat of tariffs can seem overwhelming on a broad scale, focusing on one small action, like identifying the correct Incoterms, can help companies regain some control in risk mitigation.
Conclusion
Choosing the right Incoterms 2020 Rule helps businesses optimize cost structures and reduces unexpected tariff-related expenses, especially in today’s shifting trade environment.
