What Are Incoterms?
A Complete Guide to Incoterms 2020 and Their Use in International Trade
In international trade, buyers and sellers need to determine which party is responsible for transportation costs, responsibilities, customs formalities, and the transfer of risk. To define these matters, they use a set of rules known as Incoterms (International Commercial Terms). These standardized trade rules are developed by the International Chamber of Commerce (ICC) and are used in contracts for the sale of goods in both domestic and international trade. The current version is Incoterms 2020, which came into effect on January 1, 2020, and includes 11 trade rules.
What Are Incoterms?
Incoterms stands for International Commercial Terms. These rules define the responsibilities of the buyer and seller in a transaction, determine which party is responsible for various costs, and specify when the risk associated with the goods transfers from the seller to the buyer.
Simply put, when a contract states “FOB Shanghai – Incoterms 2020,” both parties understand that the transaction is governed by the FOB rule under the 2020 version of Incoterms, and the relevant responsibilities and costs must be determined accordingly.
Incoterms help reduce disputes and misunderstandings in international transactions. However, they do not determine the sales contract itself, the price of the goods, the payment method, or ownership of the goods.
How Many Rules Are Included in Incoterms 2020?
Incoterms 2020 includes 11 trade rules, divided into two groups:
Rules applicable to all modes of transport: EXW, FCA, CPT, CIP, DAP, DPU, and DDP. These rules can be used for road, sea, air, rail, or multimodal transportation.
Rules specifically for sea and inland waterway transport: FAS, FOB, CFR, and CIF. These four rules are designed for transactions involving sea and inland waterway transportation.
Key Incoterms Rules Explained
EXW – Ex Works: The seller makes the goods available to the buyer at the specified location, such as a factory or warehouse. The seller's responsibilities are relatively limited. In export transactions, using EXW may create challenges regarding export formalities and loading. For this reason, the ICC recommends considering alternatives such as FCA in certain circumstances.
FCA – Free Carrier: The seller delivers the goods to the carrier or another party designated by the buyer at the agreed location. This rule is suitable for many international shipments, particularly multimodal and containerized transportation.
CPT – Carriage Paid To: The seller pays the transportation costs to the named destination. However, the risk does not necessarily remain with the seller until the goods reach the destination. The point at which risk transfers is connected to the delivery of the goods to the carrier. Transportation costs should not be confused with the risk associated with the goods.
CIP – Carriage and Insurance Paid To: Similar to CPT, except that the seller must also arrange and pay for cargo insurance in accordance with the requirements of the CIP rule. Under Incoterms 2020, the required level of insurance coverage under CIP differs from that of CIF.
DAP – Delivered at Place: The seller delivers the goods to the named destination, ready for unloading, and makes them available to the buyer. The transportation costs and responsibilities up to the named place are borne by the seller, while import formalities and related costs are generally the buyer's responsibility.
DPU – Delivered at Place Unloaded: In addition to transporting the goods to the named destination, the seller is responsible for unloading them. DPU replaced the DAT rule in Incoterms 2020.
DDP – Delivered Duty Paid: The seller assumes the highest level of responsibility among the Incoterms rules and transports the goods to the named destination. Responsibility for import formalities, duties, and taxes is also assigned to the seller under this rule. DDP is appropriate when the seller is genuinely able to meet the legal and customs requirements of the destination country. The ICC cautions that fulfilling certain DDP obligations in the buyer's country may be difficult.
Incoterms Rules for Sea Transport
FAS – Free Alongside Ship: The seller places the goods alongside the vessel at the port of shipment. From that point, the responsibilities associated with the goods transfer to the buyer according to the rule.
FOB – Free On Board: The seller is responsible for delivering the goods and placing them on board the vessel designated by the buyer at the port of shipment. It is one of the most widely recognized trade terms in sea transportation.
CFR – Cost and Freight: The seller pays the transportation costs to the destination port. However, the risk transfers to the buyer at the specified point in the port of origin when the goods are placed on board the vessel.
CIF – Cost, Insurance and Freight: Similar to CFR, except that the seller must also arrange cargo insurance in accordance with the requirements of the CIF rule.
The Difference Between Cost and Risk Under Incoterms
One of the most important points to understand when using Incoterms is the difference between cost and risk. For example, the seller may pay the transportation costs to the destination, while the risk associated with the goods may transfer to the buyer before the goods arrive at the destination.
Therefore, simply determining who pays for transportation does not establish who is responsible if the goods are damaged or lost. When selecting an Incoterms rule, the delivery point and the point of risk transfer must be carefully examined.
Key Changes in Incoterms 2020 Compared with the 2010 Version
Those familiar with the previous version of Incoterms should be aware of several important changes in the 2020 version that can directly affect the cost or risk associated with a contract.
Higher insurance coverage under CIP: Under the 2010 version, the seller under CIP was only required to obtain insurance with minimum coverage (Institute Cargo Clauses C). Under the 2020 version, this requirement was increased to the highest level of insurance coverage (Institute Cargo Clauses A). By contrast, under CIF, minimum coverage (Clause C) remains sufficient unless the parties expressly agree on broader coverage. This means that, by default, a CIP contract under Incoterms 2020 provides significantly broader insurance coverage than CIF, which should be taken into account during price negotiations.
DAT renamed DPU: The term Delivered at Terminal (DAT) was changed to Delivered at Place Unloaded (DPU) in the new version because delivery is no longer limited to transport terminals and can take place at any agreed location, including the buyer's warehouse.
Option to request an On Board Bill of Lading under FCA: In transactions conducted under a Letter of Credit (L/C), banks commonly require a Bill of Lading marked “On Board.” However, under FCA, delivery takes place before the goods are loaded onto the vessel. Incoterms 2020 introduced an option allowing the seller to request the carrier to issue such a Bill of Lading, helping resolve the potential conflict between the FCA rule and documentary requirements under a Letter of Credit.
Clearer allocation of costs (A9/B9): Under Incoterms 2020, in addition to specifying individual costs within each rule, a complete list of the seller's costs under A9 and the buyer's costs under B9 is also provided in one place, making it easier to compare the costs of both parties at a glance.
Common Mistakes When Selecting and Using Incoterms
Using FOB or CIF for containerized shipments: One of the most common mistakes in international trade is using FOB or CIF for goods transported in containers. These two rules are based on delivery of the goods on board the vessel, whereas containers are normally handed over to the shipping line at a terminal or container yard before being loaded onto the vessel. This means the actual point of risk transfer may not correspond to the point specified in the contract.
For containerized shipments, the ICC recommends using FCA instead of FOB and CIP instead of CIF, because these rules are based on delivery to the carrier and are more consistent with the operational reality of container transportation.
Confusing Incoterms with the payment method or transfer of ownership: Incoterms determine transportation costs, responsibilities, and risks. They have no connection with the payment method—such as cash payment, Letter of Credit, or bank transfer—or with the moment when legal ownership of the goods is transferred. These matters must be specified separately in the sales contract.
Failing to specify the exact place of delivery: Stating only the name of the rule, such as “FCA,” without specifying the exact location, such as the warehouse or terminal address, can create ambiguity. Under many Incoterms rules, the precise delivery point is also the point at which risk transfers.
What Do Incoterms Specify?
Incoterms primarily help define the following:
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The place of delivery
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The division of responsibilities between the seller and buyer
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Responsibility for arranging transportation
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The allocation of certain transportation costs
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Responsibility for export and import formalities
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The transfer of risk from the seller to the buyer
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Insurance requirements under rules where the seller is responsible for obtaining insurance
Which Incoterms Rule Is Suitable for Road Transportation?
For international road transportation, rules such as EXW, FCA, CPT, CIP, DAP, DPU, and DDP can be used. The best option depends on the terms of the transaction, delivery location, responsibilities of the parties, payment method, transportation route, and the ability of the seller or buyer to handle customs formalities.
For example, when goods are transported by road from Iran to another country, the choice between FCA, CPT, CIP, DAP, or other rules should be based on the actual structure of the transaction. There is no single Incoterms rule that is the best option for every shipment.
How Should Incoterms Be Written in a Contract?
To avoid ambiguity, it is recommended to specify the Incoterms rule, the version, and the exact named place in the contract. For example:
“CIP Frankfurt, Germany – Incoterms® 2020”or“FCA Tehran Warehouse – Incoterms® 2020”
Specifying the exact location is particularly important because the place of delivery and risk transfer plays a fundamental role in many Incoterms rules.
Difference Between Incoterms, Transport Contracts, and Insurance
A common mistake is assuming that Incoterms alone determine all the details of transporting goods. Incoterms are part of the structure of the sales contract and should be considered alongside other contracts and documents, including the transportation contract, insurance policy, sales contract, and commercial documents.
For this reason, the choice of Incoterms should be consistent with the actual structure of the transaction.
Practical Tips Before Including Incoterms in a Contract
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For containerized shipments, consider using FCA and CIP instead of FOB and CIF with the other party.
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Always specify the Incoterms version, such as Incoterms® 2020, alongside the rule in the contract so that the applicable interpretation standard is clear in the event of a dispute.
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Specify the exact delivery location, including the full address, rather than only the city name.
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If the transaction is conducted under a Letter of Credit and FCA is used, coordinate in advance with the bank and carrier regarding the possibility of issuing a Bill of Lading marked “On Board.”
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Specify Incoterms, the payment method, and the timing of ownership transfer as three separate and independent provisions in the sales contract.
Frequently Asked Questions About Incoterms
Does Incoterms Determine When Ownership of the Goods Is Transferred?
No. Incoterms only determine transportation costs, responsibilities, and risk. The timing of ownership transfer must be specified separately in the sales contract.
Why Should FOB or CIF Not Be Used for Containerized Shipments?
Because these two rules are based on delivery of the goods on board the vessel, whereas containers are normally handed over at a terminal or container yard before being loaded onto the vessel. The ICC recommends using FCA and CIP for such shipments.
What Is the Main Difference Between CIP and CIF Under Incoterms 2020?
Under CIP, the seller must obtain the highest level of insurance coverage (Institute Cargo Clauses A), while under CIF, minimum insurance coverage (Institute Cargo Clauses C) remains sufficient unless the parties agree otherwise.
Incoterms is one of the most important tools in international trade. By defining the responsibilities, costs, and risks associated with the delivery of goods, it helps buyers and sellers conduct transactions more transparently. Incoterms 2020 includes 11 trade rules, and the appropriate rule should be selected based on the type of goods, mode of transportation, origin and destination, contractual terms, and each party's ability to fulfill its obligations.
For companies involved in import, export, and international transportation, having a clear understanding of Incoterms and the changes introduced in each version is highly important. Proper use of these rules can play a significant role in managing costs, defining responsibilities, and reducing commercial disputes.
For advice on selecting the right Incoterms rule for your shipment, you can contact the Shahan Kalaban experts.