The International Chamber of Commerce (ICC) has released the new 2020 version of the Incoterms. Incoterms are important business shorthand and understanding their express meaning and intended usage is incredibly important in minimizing business risk and ensuring compliant VAT reporting. The following information provides some basic guidance for tax compliance professionals looking to refresh their knowledge and understand the extent of the recent changes.
What are Incoterms?
Incoterms are used to outline the allocations of risks, costs, and other obligations between buyers and sellers of goods. They define which party is responsible for carriage and insurance, obtaining and paying for shipping documents and import/export licenses, and paying for logistical costs. The terms also determine the point of “delivery,” meaning the point at which the risk of loss transfers from the seller to the buyer. Of course, the point of delivery may differ to their ultimate point of destination.
Incoterms are expressed as three letter abbreviations; for example, EXW for the term Ex Works. Both the 2010 and 2020 versions of the Incoterms split them into two categories.
- Category 1: Can be used with any mode of transport,
- Category 2: Requires the transport of goods by sea or inland waterway.
Within each category the ICC organizes terms based on the point of delivery.
Incoterms have no legal effect. They should be used to supplement and clarify a contract and not to replace one. To avoid confusion, contract provisions intentionally diverging from the selected Incoterm should be explicit and clear.
What is changing?
Whilst not radical, the 2020 Incoterms make some important changes and clarifications.
The most noticeable change is the replacement of the term DAT (Delivery at Terminal) with DPU (Delivered at Place Unloaded). This is intended to clarify that delivery (passage of risk) occurs at any appointed destination once the goods have been unloaded from the means of transport, and that such point is not limited to “terminals.” As the definition of terminal under the 2010 terms was relatively broad this change should have little effect on the use of this rebranded term.
Many of the changes to the Incoterms focus on the presentation of terms, with the goal of enabling businesses to select more easily the appropriate term for their needs and understand the costs associated with the use of each term. Some of the more substantive changes include:
- Under the Incoterm FCA, a new option has been added allowing for buyer and seller to contract that the buyer will instruct its carrier to provide a bill of landing to the seller.
- Under the CIP term, the minimum level of insurance that the seller must procure has been increased. This has the effect of differentiating the minimum insurance requirements under the CIP and CIF terms.
- Under the 2010 versions of incoterms FCA, DAP, DAT/DPU and DDP, the seller was required to contract for carriage of the goods, implying the need to hire a third party to transport the goods. The 2020 versions of these terms require that the seller contract OR arrange carriage, explicitly allowing the seller to transport goods using its own vehicles instead of a third party.
- Increased information on the allocation of security related costs have been added to the explanations of the incoterms to reflect the growing importance of such arrangements.
The updated list of 11 Incoterms is:
Rules for Any Mode of Transport
- EXW – Ex Works
- FCA – Free Carrier
- CPT – Carriage Paid To
- CIP – Carriage and Insurance Paid To
- DAP – Delivered at Place
- DPU – Delivered at Place Unloaded
- DDP – Delivered Duty Paid
Rules for Sea and Inland Waterway Transport
- FAS – Free Alongside Ship
- FOB – Free On Board
- CFR – Cost and Freight
- CIF – Cost Insurance and Freight
It’s important for businesses to familiarize themselves with the updated terms as contracts drafted after January 2020 will assume the use of the 2020 version of the terms unless explicitly stated otherwise. Businesses using a standardised template or set of terms when drafting new contracts should check if these templates or terms need to be adjusted to account for the Incoterm changes.
Implications for Indirect Tax Compliance
Incoterms are a shorthand describing how goods are transported between parties and who bears the risk and costs of delivery. Delivery represents the transfer of risk, and not the transfer of ownership/title. As a result, businesses should be wary of relying on Incoterms as a definitive basis to determine where a transaction has occurred for indirect tax purposes in jurisdictions, such as Canada and many US states, which consider the transfer of title when determining the place of supply as this can represent a compliance risk. Most contracts should separately outline when and where title/ownership is transferred.
Incoterms do, however, explicitly define which party would be responsible for import duties. In particular, the use of the Incoterm DDP (Delivered Duty Paid) explicitly assumes that the seller is responsible to clear goods for import, pay any import duty, and complete any customs formalities. The obligation to pay import duties would imply, in most cases, that import VAT (or its local equivalent) will likely be the seller’s responsibility. All other Incoterms assume the buyer is responsible for import duties, clearance, and other formalities. To reduce the likelihood of conflict and misunderstanding between the parties or tax jurisdiction, responsibility for Import VAT and similar taxes should still be explicitly laid out in the contract
Focusing on Europe, the party identified as bearing responsibility for the transport of the goods has added significance in cases of cross-border, Intra EU flows, as it drives which party in a chain transaction is able to exempt that particular stage as an intra-Community supply. This impacts the place of supply, taxability, and liability to VAT register across the whole supply chain. The introduction of the “EU Quick Fixes” package of VAT changes (which also enters into force in January 2020) compels business with a European footprint to review their cross-border flows, evaluate the impact, and consider what changes need to be made to their VAT determination processes.
Implications for Tax Determination
It is common for multinational companies with complex supply chains to incorporate Incoterms within their tax determination logic. Incoterms fields captured at transactional-level within ERP and logistics sub-systems are then passed as parameters through native ERP tax determination conditions or to external tax determination engines. This is seen as a vital mechanism to assess taxability and jurisdictional ‘place of supply’ in a dynamic and automated way, especially in cases of complex cross-border, chain transactions. The essential caveat here is the requirement for clear alignment between the use and interpretation of Incoterm fields captured within an ERP’s transactional data, and the legal tax position of the underlying transactions. While businesses which use Incoterms in their determination logic can breathe a sigh of relief at the limited scope of the 2020 changes, businesses still need to verify that their VAT determination processes, whether conducted internally or preformed by an external partner, have accounted for the upcoming changes.