What are Incoterms®?
International commercial terms or Incoterms® are a set of pre-defined, generally accepted terms and related acronyms developed by the International Chamber of Commerce (“ICC”). These terms define the respective obligations, costs and risks of the buyer and seller involved in the delivery of goods. These terms generally indicate where the title of the goods changes from hands from the seller to the buyer. There are 11 Incoterms®, these – in simplified terms- include: Free on Board (FOB): The seller is responsible for the goods, including shipping cost and liability, until the goods are loaded on to an agreed upon vessel. At that point, all responsibility for shipping of the goods transfers to the buyer. FOB is further subdivided to FOB (shipping point) and FOB (destination). Shipping point refers to the port where the seller ships the goods from, and destination refers to the port where the buyer receives the goods. Delivered at Place (DAP): The seller is responsible for the goods and their transport until the goods reach a place agreed upon by the buyer and seller. The buyer is responsible for unloading the goods, as well as all costs and risks related to the goods after that point.
Because Incoterms® are generally accepted terms, they are commonly used in commercial contracts. A contract may, for example, indicate goods are Incoterms® 2020 FOB (destination) – Freight Prepaid and both parties, as well as adjudicators, will understand what those terms mean without requiring further definition in the contract. While the terms were developed for use in an international context, they may also be used for purely domestic transactions. The ICC updates the Incoterms® every few years. The latest updated Incoterms® came into effect in 2020. The year the new Incoterms® came into effect is used to clarify which Incoterms® apply to a particular contract. Correctly referring to the current version of Incoterms® would mean including “Incoterms® 2020” in the contract. Failing to identify which edition of the Incoterms® is relevant to your contract may result in the wrong interpretation of the Incoterms® in your contract.
How do Incoterms® impact on GST/HST?
Goods and Services Tax (“GST”) and Harmonized Sales Tax (“HST”) apply to the sale of goods made in Canada. A good is deemed to be sold in Canada where the goods are delivered to or made available to customer(s) in Canada. The Excise Tax Act, which governs GST/HST, does not define the terms “delivered” or “made available”. As such, the law related to the sale of goods, including Incoterms®, is used to interpret these terms by top Canadian tax lawyers and CRA. Delivery tends to refer to the physical delivery of goods. Made available refers to circumstances where the goods are both legally understood and understood by the parties to have been delivered, even though the actual physical transfer of the goods from seller to buyer has not occurred. Made available may apply in situations such as when a third party agrees to take the goods from the seller and hold them for the buyer. The Canada Revenue Agency (“CRA”) will use the terms of the contract between the buyer and the seller to help determine where the goods were “delivered” or “made available”. As Incoterms® described the delivery terms the parties agreed to, they also allow for identification of where the goods were “delivered” or “made available”. Consider the following example: Seller is located in Japan, Buyer is located in Canada. Buyer purchases Goods A and Goods B from Seller. Goods A is shipped FOB (shipping point) and Goods B is shipped FOB (destination).
For Goods A, the legal delivery and exchange of title of the goods occurs in Japan at the Seller’s shipping port per the Incoterms® listed in the contract. The delivery of the goods is deemed to have occurred outside of Canada and the Seller does not need to charge GST/HST.
For Goods B, the legal delivery and exchange of title of the goods occurs in Canada at the Buyer’s shipping port per the Incoterms® listed in the contract. The delivery of the goods is deemed to have occurred in Canada and the Seller needs to charge GST/HST Please note the above example simplifies and excludes facts such as the value of goods to explain the application of Incoterms® in the GST/HST context. One of our experienced Canadian tax lawyers should be consulted to understand the tax impact of Incoterms® in specific contexts.
Pro Tax Tips: CRA is Not Bound By Taxpayers’ Contracts
While contracts constitute vital and material evidence in a tax dispute, the application of tax is not strictly bound by terms of a contract if another viable interpretation of the circumstances is available. The Incoterms® used in a contract may suggest the goods were delivered in a foreign country, but the actions of the seller and buyer could lead to a determination the goods were actually delivered in Canada, or vice versa. As a result, taxpayers must understand the terms and obligations of their contracts, as well as the potential tax impacts, to avoid adverse interpretations and outcomes in the event of a tax dispute. Contact our experienced Canadian tax lawyers to review and advise on the tax impacts of your commercial sale of goods contracts.