A UK manufacturer sells equipment to a buyer in Germany on DDP. Price agreed, margin looks healthy. Then the German import VAT bill arrives, and they have no EU VAT registration to reclaim it. Nothing went wrong with the freight. The Incoterm did the damage.
Incoterms appear on every invoice and contract, yet most businesses agree to them without checking what they’ve signed up for. Here’s what each common term actually means, and where companies get caught out.
Table of Contents
- What are Incoterms?
- The most commonly used Incoterms
- Summary table
- Who is responsible for costs, risk, and customs?
- Common mistakes businesses make
- Check the Incoterm before you sign
What are Incoterms?
Incoterms, short for International Commercial Terms, are a set of standardised rules published by the International Chamber of Commerce. They define the responsibilities of buyers and sellers in international trade transactions, specifically covering who pays for what, who bears risk at each stage, and who handles customs clearance.
These terms exist because international trade involves many stages where goods change hands, cross borders, and face various risks. Without standardised definitions, buyers and sellers might interpret responsibilities differently, leading to disputes about who should pay for damaged goods, missed deadlines, or unexpected costs.
Incoterms get updated periodically to reflect changes in trade practices, with the current version being Incoterms 2020. Each term is represented by a three-letter code that gets included in sales contracts and shipping documentation, clearly establishing the agreed responsibilities between parties.
It’s worth noting that Incoterms address transport and risk responsibilities, not ownership transfer or payment terms. These separate aspects of a transaction need to be addressed independently in your contracts alongside the chosen Incoterm.
The most commonly used Incoterms
EXW (Ex Works)
EXW places minimum responsibility on the seller. The buyer collects goods from the seller’s premises and handles everything from that point, including loading, export clearance, main transport, import clearance, and final delivery. This term gives sellers the simplest arrangement but requires buyers to manage the complete logistics chain.
One practical problem for sellers: under EXW, the buyer handles export. If the seller is VAT-registered in the UK and wants to zero-rate the sale as an export, they need evidence the goods left the country. Since they’re not arranging the export themselves, obtaining that evidence can be difficult, creating a VAT risk the seller doesn’t always anticipate.
FCA (Free Carrier)
FCA requires the seller to deliver goods to a carrier or location specified by the buyer, with export clearance completed by the seller. Once goods reach the named carrier, responsibility transfers to the buyer. This term works well for various transport modes and provides clearer handover points than EXW.
FOB (Free on Board)
FOB applies specifically to sea freight and requires the seller to deliver goods onto the vessel at the port of shipment. Risk transfers once goods are loaded onboard. The buyer handles main carriage, insurance, import clearance, and delivery from that point.
FOB is designed for bulk or break-bulk cargo, not containerised freight. With containers, sellers typically hand over goods at the container terminal, not on the vessel itself. From that point they lose control, but under FOB they still bear risk until the goods are on board. For containerised shipments, FCA is the more appropriate term.
CIF (Cost, Insurance, and Freight)
CIF, also for sea freight, requires the seller to arrange and pay for transport to the destination port plus minimum insurance coverage. However, risk transfers to the buyer once goods are loaded onto the vessel at origin, even though the seller pays for the onward journey.
The insurance requirement under CIF is minimum cover only (Institute Cargo Clauses C), which excludes a wide range of risks. If broader protection is needed, CIP (Carriage and Insurance Paid To) works for any transport mode and, since Incoterms 2020, requires all-risk cover under Clauses A. CIF and CIP are not interchangeable, and the difference in insurance quality is significant.
As with FOB, CIF is not suited to containerised cargo for the same reasons. CPT or CIP are more appropriate for container shipments.
DAP (Delivered at Place)
DAP requires the seller to deliver goods to a named destination, ready for unloading, with the buyer responsible for import clearance and any import duties. The seller bears risk and costs until goods reach the agreed destination. This is a buyer-friendly term: the seller manages the full journey and hands over goods at the buyer’s door, leaving the buyer only to clear customs on arrival.
DDP (Delivered Duty Paid)
DDP places maximum responsibility on the seller, who handles everything including delivery to the buyer’s premises, import clearance, and payment of all duties and taxes. The buyer simply receives goods with nothing further to arrange. This term offers buyers the most convenience but requires sellers to navigate the complexities of the destination country’s import requirements.
A common problem: import VAT is included in the seller’s obligations under DDP. In most countries, import VAT can only be reclaimed by an entity that is VAT-registered in the destination country. Sellers without a local VAT registration absorb that cost with no way to recover it, which can make DDP significantly more expensive than the duty rate alone suggests.
Summary table
| Term | Freight paid by | Risk passes at | Export clearance | Import clearance |
|---|---|---|---|---|
| EXW | Buyer | Seller’s premises | Buyer | Buyer |
| FCA | Buyer | Named carrier / place | Seller | Buyer |
| FOB | Buyer | On board vessel at origin port | Seller | Buyer |
| CIF | Seller | On board vessel at origin port | Seller | Buyer |
| DAP | Seller | Named destination (ready for unloading) | Seller | Buyer |
| DDP | Seller | Named destination (delivered) | Seller | Seller |
Who is responsible for costs, risk, and customs?
Understanding the progression from EXW through to DDP helps clarify how responsibility shifts. EXW places almost everything on the buyer. DDP places almost everything on the seller. The terms in between (FCA, FOB, CIF, DAP) distribute responsibility at different points along the journey.
Cost responsibility and risk responsibility don’t always transfer at the same point, which causes confusion. With CIF, for example, the seller pays for transport to the destination port, but risk transfers much earlier when goods are loaded at origin. This means if goods are damaged during the sea voyage, the buyer bears that risk despite the seller having paid for the shipping.
Customs clearance responsibility also varies significantly. Under EXW, FCA, FOB, and CIF, the buyer typically handles import clearance and pays any duties. Under DAP, import clearance remains the buyer’s responsibility, though delivery happens to their door. Only under DDP does the seller handle import clearance and duty payment.
Understanding exactly where these responsibilities transfer prevents disputes when problems occur. If you know precisely when risk passes to you as a buyer, you can arrange appropriate insurance from that point. If you know your customs obligations as defined by the chosen Incoterm, you can prepare properly rather than discovering responsibilities you weren’t expecting.
Common mistakes businesses make
Many businesses default to whatever Incoterm they’ve always used without considering whether it’s actually appropriate for the specific transaction. EXW might work for one shipment but create complications for another, particularly if the buyer lacks experience handling export documentation in the seller’s country.
Confusing cost responsibility with risk responsibility causes significant problems, particularly with CIF terms. Businesses sometimes assume that because the seller is paying for transport, the seller also bears risk for the entire journey. This misunderstanding leads to disputes when goods are damaged in transit and the buyer discovers they’re responsible despite not having arranged the shipping.
Using DDP without understanding the complexity of import requirements in the destination country creates problems for inexperienced sellers. Import duties, taxes, and customs procedures vary significantly between countries, and sellers who agree to DDP without proper understanding can face unexpected costs and delays.
Failing to specify the named place clearly causes confusion. Incoterms require a specific location (FCA Hamburg, DAP customer warehouse, for example), and vague or missing location details create ambiguity about exactly where responsibility transfers.
Not updating contracts to reference the current Incoterms version can create legal ambiguity. Each version has subtle differences, and contracts should clearly state which version applies (Incoterms 2020) to avoid confusion about which specific rules govern the transaction.
Check the Incoterm before you sign
Most Incoterm problems don’t show up at the quotation stage. They show up at the port, at the border, or on the VAT return.
At Zenith, we look at the Incoterm before we look at the rate: who’s declaring, who’s insuring, where risk actually passes, and whether the term works for that lane and that cargo. Our customs team handles UK and EU clearances, so the advice comes from the people who deal with the consequences, not just the booking.
Agreeing terms with a new supplier or customer? Send us the proposed Incoterm before you sign. We’ll tell you where the risk really sits.
