5.3 Incoterms® 2020 Rules, Customs & Global Trade Compliance

Global trade operations demand precise contractual clarity and strict regulatory compliance. Supply management professionals managing international procurement must master Incoterms® 2020 rules to allocate costs, risks, and transport responsibilities accurately. Furthermore, global trade compliance requires expert knowledge of customs entry procedures, Harmonized System (HS) code classification, valuation methodologies, and strategic tariff mitigation programs.

Structure & Scope of Incoterms® 2020 Rules

Published by the International Chamber of Commerce (ICC), Incoterms® (International Commercial Terms) are standardized 3-letter trade terms recognized globally. Incoterms define three critical elements of an international purchase contract:

1. Task & Cost Division: Which party pays for export clearance, main carriage, transit insurance, terminal handling, and import duties.
2. Risk Transfer Point: The exact physical location where the risk of cargo damage or loss shifts from seller to buyer.
3. Clearance Responsibilities: Which party handles customs entry procedures and regulatory documentation.

Critical Note: Incoterms® do NOT define when legal ownership (title) transfers, nor do they define payment terms, breach remedies, or jurisdiction law. Title transfer must be explicitly specified in the sales contract.

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Incoterms® 2020 Rules for Any Mode or Modes of Transport (7 Rules)

• EXW (Ex Works): Minimum seller obligation. Seller makes goods available at their premises. Buyer bears all transport costs, risk of loss, export clearance, and import duties.
• FCA (Free Carrier): Seller delivers goods cleared for export to a carrier specified by buyer at a named place. (Updated in 2020: allows buyer/carrier to issue an On-Board Bill of Lading to seller for bank L/C compliance).
• CPT (Carriage Paid To): Seller pays main carriage freight to destination. Risk transfers to buyer as soon as goods are delivered to the FIRST carrier at origin!
• CIP (Carriage and Insurance Paid To): Seller pays main freight + mandatory cargo insurance. 2020 Major Update: Seller MUST provide high-level Institute Cargo Clauses (A) All-Risk Insurance (110% contract value).
• DAP (Delivered at Place): Seller bears all costs and risks to bring goods ready for unloading at named destination. Buyer handles import clearance and duties.
• DPU (Delivered at Place Unloaded): Replaced DAT in 2020. Seller bears all risks and costs to deliver AND unload goods at named destination.
• DDP (Delivered Duty Paid): Maximum seller obligation. Seller handles export, main transit, import customs clearance, import taxes (VAT/GST), and delivery to buyer premises.

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Incoterms® 2020 Rules for Sea & Inland Waterway Transport (4 Rules)

• FAS (Free Alongside Ship): Seller places goods alongside vessel at named port of shipment. Risk transfers when goods are alongside ship.
• FOB (Free On Board): Seller loads goods on board the vessel at origin port. Risk and cost transfer when goods are safely loaded on board ship.
• CFR (Cost and Freight): Seller pays ocean freight to destination port. Risk transfers to buyer as soon as goods are loaded ON BOARD ship at origin port!
• CIF (Cost, Insurance and Freight): Seller pays ocean freight + cargo insurance. Default insurance requirement remains low-level Institute Cargo Clauses (C) Minimum Coverage.

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Comprehensive Incoterms® 2020 Matrix

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Customs Entry & Harmonized System (HS) Classification

Customs compliance is a strict legal obligation. Importers of record are subject to legal audit standards under Customs Informed Compliance laws.

1. Harmonized System (HS) Codes

Administered by the World Customs Organization (WCO), HS codes standardize commodity classification globally using a 6-digit international base, extended by nations up to 8–10 digits for statistical and tariff rates (e.g., HTSUS in the U.S.):

• Digits 1–2 (Chapter): Broad product category (e.g., Chapter 85: Electrical Machinery).
• Digits 3–4 (Heading): Specific product group (e.g., 85.42: Electronic Integrated Circuits).
• Digits 5–6 (Subheading): Detailed product classification (e.g., 8542.31: Processors and Controllers).
• Digits 7–10 (National Tariff Line): Country-specific statistical suffix and duty rate determination.

2. Customs Valuation (Transaction Value Method)

Customs duties are calculated as a percentage ad valorem against the declared Transaction Value—defined as the price actually paid or payable for imported goods, including packing costs, selling commissions, and assists, but excluding post-importation assembly and domestic freight.

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Landed Cost Optimization: Drawback, FTAs, and FTZs

Procurement leaders utilize strategic customs mechanisms to eliminate or recover tariff spend:

1. Duty Drawback (19 U.S.C. § 1313)

A provision permitting importers to claim up to a 99% refund of paid customs duties, taxes, and fees on imported raw materials or commercial goods that are subsequently exported or destroyed under customs supervision. Includes Direct Identification Drawback and Substitution Drawback (matching commercially interchangeable merchandise).

2. Free Trade Agreements (FTAs) & Rules of Origin

Agreements like the USMCA (United States-Mexico-Canada Agreement) eliminate tariffs on qualifying regional goods. Qualification requires satisfying specific Rules of Origin via Tariff Shift rules (change in HS classification during regional processing) or Regional Value Content (RVC) requirements:

$\text{RVC (Transaction Value Method)} = \frac{\text{Transaction Value} - \text{Value of Non-Originating Materials (VNM)}}{\text{Transaction Value}} \times 100$

3. Foreign Trade Zones (FTZs)

Designated duty-free geographic areas considered outside U.S. Customs territory. Benefits include Duty Deferral (duties paid only when goods enter domestic market), Duty Elimination (zero duty on goods re-exported), and Inverted Tariff Relief (paying lower duty rates on finished products assembled inside the FTZ rather than higher duty rates on imported raw component parts).