How Incoterms impact customs duties and import VAT

Customs duties and import VAT are the most discussed topics in taxes at the moment. For a very long time these two taxes were nothing more than an afterthought for most businesses buying and selling cross border, but now they have become a significant cost and a potential issue if businesses do not get things right.

What are Incoterms?

Incoterms is an acronym for International Commercial Terms and is essentially a set of pre-defined commercial terms that businesses can use when buying and selling goods. They are meant to help buyers and sellers agree how risks and responsibilities are shared between the parties. While they can be used for any type of transactions involving goods, they are most useful for cross border supplies. This is because they cover how risk and responsibilities are split between buyer and seller when shipping goods that have been sold. They cover things such as:

• loading and unloading goods
• transport of the goods
• managing import and export formalities for the goods
• Insurance and other related goods

Whether the buyer or the seller should be responsible for these activities is important for two reasons:

1. It will show who arranges for and pays the costs for these services;
2. It will help manage the risk of having the goods damaged or lost e.g. whose loss is it if the goods are damaged while in transit or when they are loaded or unloaded onto a lorry?

Having clear terms is therefore a practical necessity and the Incoterms can be very helpful in most cases as they expressly focus on these aspects.

Some Incoterms are straightforward:

• EXW (ex-works) – If this Incoterm is agreed by the parties, then the buyer will be responsible for managing all the activities mentioned above. They will have to pick up the goods, load them, ship them, clear them for customs, insure them and bear all the other associated costs and risks;
• DDP (Duty Delivery Paid) – DDP is the opposite of EXW, whereby the seller will be responsible for managing all the activities related to the shipment of goods and bear all the risk in case anything goes wrong.

EXW and DDP are at opposite ends of how risk and responsibility can be divided. In practice, for international transactions the split in responsibility and risk is often aligned with geography, namely each party agrees to be responsible for things that happen in their country. A UK business selling to a US customer will typically be in charge with loading, unloading, transport and customs in the UK, while the client will be in responsible for these things in the US.

EXW or DDP cannot be applied in this case, therefore other Incoterms are needed.

There is of course the question of what happens while the goods are crossing the Atlantic. Or what happens if the seller is happy to do everything in the country of the buyer except for clearing the goods for customs. There are a number of other Incoterms designed to accommodate variations of these scenarios. You may see FCA, CPT, DAP or others referenced in contracts, correspondence, Purchase Orders or other documents related to these transactions.

Some of these Incoterms will also cover the customs side of things, although how they interact with the customs and VAT legislation can be quite complex.

How do Incoterms interact with duties and VAT?

Among the responsibilities that have to be shared between buyer and seller is of course, who will pay the duties and import VAT (if any are due). The issue is, in practice, buyers and sellers do not always explicitly discuss this requirement. While a lot of thought goes into discussions around cost related to shipping the goods, insurance etc, taxes are usually an afterthought. This is usually because, in the past few decades, duties have been low and if any VAT is due, it can usually be recovered. But with the recent tariff wars, duties (and sometimes VAT) have become a significant cost as well, which means discussing who will bear this cost is very important.

If we are to go back to the above examples:

• EXW – the buyer takes on all the risks and responsibilities related to the shipment of the goods. If there are any duties and import VAT to be paid, then it will be the buyer’s responsibility to pay them and they will bear the cost;
• DDP – the seller takes on all risks and responsibilities related to the shipment of the goods. If there are any duties and import VAT to be paid, then it will be the seller’s responsibility to pay them.

However, outside of EXW and DDP, the parties can agree to any arrangement they want. If the seller wants to offer a seamless customer experience, then they will typically pay the duties and import VAT and include any additional costs in the selling price. Otherwise, the buyer can manage this obligation in the country of import.

If your commercial terms are set using Incoterms you can check which party is responsible for clearing the goods for customs. Unless some bespoke terms were used, the party that manages the customs formalities will usually be the party that also pays any duties and import VAT.

Can you amend the Incoterms?

Incoterms are a set of “off the shelve” commercial terms that are meant to help businesses trade.

There is nothing stopping two businesses to agree bespoke terms that are based on Incoterms but amended to better suit their needs. You can also completely ignore Incoterms and agree very specific terms with your customer or supplier if both parties are happy with this approach. The important thing is, once these terms have been agreed (based on Incoterms or bespoke terms) both parties should apply them.

What if we’ve not followed the agreed terms?

Unfortunately, this is an issue we come across often, the parties have agreed certain terms but they were not followed.

For example a US business selling to UK customers may agree terms that require the buyer to pay the duties and import VAT in the UK. If the US seller mistakenly pays the duties and import VAT in the UK, it may struggle to correct this mistake. The customs and tax authorities do not check the Incoterms of each transaction to determine which party should pay the taxes. To them it does not matter if the wrong party paid the duties and the VAT as long as they have received full payment of these taxes.

It will however be an issue for the seller in our example as the duties are a non-recoverable cost to the business while VAT is recoverable only if certain conditions are met. As a side note, if the wrong party paid the import VAT usually the VAT is not recoverable either as it is likely they were not the owners of the goods at the point of import, which is a key requirement.

Can anything be done? In some cases yes, but this is usually contingent upon the other party cooperating as well. For example, amendments to the customs documentation may be required or perhaps a recharge of costs might be an easier solution. Either way the cooperation of the other party will be required. Otherwise, this may prove to be a very costly mistake.

Does this also apply to sales made to consumers?

Duties and import VAT, if they are due, will usually apply to both business to business (B2B) and business to consumer (B2C) sales (although B2C sales under IOSS in the EU are currently free of duty with a view to become taxable by March 2028)). Deciding who pays for these taxes will therefore be important for consumer sales as well. Incoterms are usually used in B2B transactions, however the logic behind them should be applied when a business decides to sell to consumers.

In other words, if you sell to consumer clients, do you want to pass on the requirement to pay these taxes to them? If yes, then it would be advisable to be clear about this in your terms and condition.

But will the client still want to buy the goods if they have to pay for the goods at checkout and then an additional amount in duties and VAT in order for customs to release the parcel?

Many foreign e-commerce companies have found that customers that are not in business do not want to pay anything in addition to what was listed as the price at checkout and may choose to buy locally instead. Therefore, they usually cannot afford to pass this responsibility to the customer and will need to deal with the customs requirements not just in their country but also in the country of the customer. If we are to look at the above Incoterms this is equivalent to using DDP on B2C sales if the seller wants to offer the buyer a seamless purchasing experience.

B2C sales where the seller deals with all customs formalities may also need to VAT register in order to account for VAT, although they might be able to use simplified registration schemes (IOSS and OSS in the EU, VOEC in Norway etc.).

Mistakes in this case can also be very costly, if the seller was not meant to pay the duties and the VAT on a B2C sale it will be very difficult (or simply impossible) to recover the additional costs from the consumer client or from the tax authorities.

Checklist

How can you avoid costly mistakes? Consider the following:

• Have you checked if your goods attract duties and import VAT? You will need information concerning the goods such as the HS or CN codes, the origin of the goods, any processing that has taken place, any trade agreements that might be in place and potentially other information. You may need specialised support on this matter as the rules can be quite complex. Feel free to reach out to us for help.
• If duties are due, have you discussed / agreed with the supplier or client who should pay them?
• Do you use Incoterms or bespoke commercial terms with your suppliers or customers?
• Have you already agreed the terms of the sale? If yes, you should check if they require you to pay the duties and VAT. (Online sellers should make sure their delivery terms are clearly stipulated for the consumer).
• If you have not agreed yet, do you need bespoke terms for your transactions or Incoterms? Have you had any preliminary discussions with your supplier or customer?
• Have you decided on the commercial implications around whether you should pay the duties or not?
• If you have paid duties and import VAT, have you checked if this is in line with the Incoterms or bespoke commercial terms you have with your partner?
• For import VAT in particular have you checked if you were the importer of record and owner of the goods?
• For sales where you are required to pay duties, VAT and clear the goods, have you checked if you also need a VAT (or similar) registration in that country?

Need any help?

Duties and VAT rules can be very complex and mistakes can be very costly if not managed properly. Feel free to reach out to us if you need support determining the amount of duty owed, managing errors, VAT registrations or other issues related to indirect tax and international trade.