CHAPTER TWO

Letter of Credit (L/C) / Documentary Credit

2.1 Meaning of Letter of Credit (L/C)

Letters of Credit (L/C) have been used for centuries to facilitate payment in international trade. Their use will continue
to increase as the global economy evolves. L/C used in international transactions is governed by the International
Chamber of Commerce Uniform Customs and Practice for Documentary Credits (ICC-UCP). The general provisions and
definitions of the International Chamber of Commerce are binding on all parties.

A L/C is a payment term generally used for international sales transactions. It is basically a mechanism, which allows
importers/buyers to offer secure terms of payment to exporters/sellers in which a bank (or more than one bank) gets
involved. The technical term for L/C is ‘Documentary Credit’. At the very outset one must understand is that L/C deal in
documents, not goods. The idea in an international trade transaction is to shift the risk from the actual buyer to a bank.
Thus, an L/C (as it is commonly referred to) is a payment undertaking given by a bank to the seller and is issued on behalf
of the Applicant i.e. the Buyer. The Buyer is the Applicant and the Seller is the Beneficiary. The Bank that issues the L/C is
referred to as the Issuing Bank which is generally in the country of the Buyer. The Bank that Advises the L/C to the Seller
is called the Advising Bank which is generally in the country of the Seller. The specified bank makes the payment upon the
successful presentation of the required documents by the seller within the specified time frame. Note that the Bank
scrutinizes the documents and not the ‘goods’ for making payment. Thus, the process works both in favor of buyer and
the seller. The Seller gets assured that if documents are presented on time and in the way that they have been requested
on the L/C the payment will be made and Buyer on the other hand is assured that the bank will thoroughly examine these
presented documents and, ensure that they meet the terms and conditions stipulated in the L/C.

To put in a nut shell, a L/C is a contractual agreement between banks, known as the Issuing bank, on behalf of one of
its customers/clients, authorizing another bank, known as the Advising/confirming bank, to make payment to the
beneficiary. In this regard, the elements of a L/C

 A payment undertaking given by a bank (Issuing Bank)

 On behalf of a Buyer (Applicant)
 To pay a Seller (Beneficiary) for a given amount of money
 On presentation of specified documents representing the supply of goods
 Within specified time limits
 Documents must conform to terms and conditions set out in the L/C
 Documents to be presented at a specified place
2.1.1 Parties Involved and their Respective Responsibilities under L/C

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 The Buyer, the Beneficiary, the Issuing Bank, the Confirming Bank/ Advising/Notifying/ Negotiating Bank are the
parties involved in a specific L/C term of payment. The following discussion presents you the brief description of each of
the parties involved and their respective responsibilities.

1. The Buyer

The buyer refers to a person who is the importer, applies to the bank for the opening of a L/C. The bank may or may
not require the buyer to secure the L/C by providing sufficient deposits to protect its own interests. It depends on the
confidence that the bank has over the buyer applying for the L/C.

The respective responsibilities include:

 Knowing the exporter or getting a status reports (truck records) on him/her.

 Making sure the terms of the L/C application form are consistent with, the underlying purchase contract.
 The terms of the L/C must be “Capable of Performance” by the exporter, if they are not, amendments will have to
be made, which could prove expensive.
 Ensuring that the instructions to the Issuing Bank are clear and brief especially the description of the goods.
 Recognize that Irrevocable L/C does not have options once entered into. They must be paid for, unless cancelled,
2. The Beneficiary

The beneficiary is entitled to payment as long as he/she can provide the documentary evidence required by an L/C.
The L/C is a distinct and separate transaction from the contract on which it is based. All parties deal in documents and not
in goods. The Issuing Bank is not liable for performance of the underlying contract between the buyer/importer and
beneficiary/exporter. The Issuing Banks obligation to the buyer is to examine all documents to insure that they meet all
the terms and conditions of the credit. Upon requesting demand for payment the beneficiary warrants that all conditions
of the agreement have been complied with. If the beneficiary (seller) conforms to the L/C, the seller must be paid by the
bank.

The responsibilities include:

 Making sure the terms and conditions on an L/C agrees with the underlying sales contract and is “Capable of
Performance”. If any provisions cannot be carried out, ask the importer to.’ arrange for an amendment.
 Dispatching the goods.
 Preparing the documents exactly as called for in the L/C and presenting them to the Advising Bank within the time
limit stipulated in the L/C.
3. Issuing Bank

The Issuing Bank refers to a bank which issues the L/C at the request of the Applicant. The Issuing Bank must be well
known and acceptable to the seller. The buyer gives instructions regarding the terms and conditions of the L/C. The
Issuing Bank’s liability to pay and to be reimbursed from its customer becomes absolute upon the completion of the
terms and conditions of the LIC. Under the provisions of the Uniform Customs and Practice (UCP) for Documentary
Credits, the Issuing Bank is given a reasonable amount of time after receipt of the documents to honor the draft.

The responsibilities include:

 Ensuring that importers are aware of their obligations; providing guidance on application completion, import
regulations and special documentation.

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  ‘Check the importer’s credit limit, if he/she is granted with L/C facility.
4. Advising Bank / confirming Bank

An Advising Bank, usually a foreign correspondent bank of the Issuing Bank will advise the beneficiary. Generally, the
beneficiary would want to use a local bank to insure that the L/C is valid. In addition, the Advising Bank would be
responsible for sending the documents to the Issuing Bank. The Advising Bank has no other obligation under the L/C. If
the Issuing Bank does not pay the beneficiary, the Advising Bank is not obligated to pay. The negotiating bank has to see
that the documents negotiated conform strictly to the terms and conditions of the L/C.

The responsibilities include:

 Checking the authenticity of the Letter of Credit. If there is any doubt, the Issuing Bank should be contacted by
tested telex.
 If requested to do so, confirming the Letter of Credit. This is normally done by adding a phrase such as “We confirm
this Letter of Credit” signed by an authorized officer of the bank. If the Nominated Bank is not prepared to confirm
(usually because of country risk), it must inform the Issuing Bank without delay. Unless the Issuing Bank has given
instruction to the contrary, the Nominated Bank may then advise the L/C, making it clear to the beneficiary that it does so
“Without engagement” on its part.
 The L/C is genuine and the signature of the officer signing the Letter on behalf of the Issuing Bank corresponds to
the specimen signature in the possession of the Negotiating Bank.
 The period of its validity has not expired. The L/C is issued for specified period.
 The amount of the draft to be negotiated is with the same as the balance of the amount given in the L/C,
 The terms of the L/C are satisfied. If the Negotiating Bank fails to satisfy him/herse1fn respect of the terms of the
L/C, he/she may have no claim against the bank which issued the L/C,
 The party whose bill the bank is asked to negotiate is the same as the one given in the L/C.

Note: It should be remembered that the Confirming Bank has no recourse to exporter where it will not be reimbursed
by the Issuing Bank.

2.1.2 Characteristics of Letter of Credit

Letter of credit possesses four basic features that somehow differentiate from other types of international trade
modes of payments. They are: negotiability; revocability; transfer and assignment; and it can be sight or time draft

a. Negotiability

Letter of credits are usually negotiable. The Issuing Bank is obligated to pay not only the beneficiary, but also any bank
nominated by the beneficiary. Negotiable instruments are passed freely from one party to another almost in the same
way as money. To be negotiable, the L/C must include an unconditional promise to pay, on demand or at a definite time.
The Advising Bank becomes a holder in due course. As a holder in due course, the holder takes the L/C for value, in good
faith, without notice of any claims against it. A holder in due course is treated favorably under the UCC,

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 The transaction is considered as a straight negotiation if the Issuing Bank’s payment obligation extends only to the
beneficiary of the credit. If a L/C is a straight negotiation it is referenced on its face by “we engage with you” or “available
with ourselves”. Under these conditions the promise does not pass to a purchaser of the draft as a holder in due course.

b. Revocability and Irrevocability

L/C may be either Revocable or Irrevocable. A revocable L/C may be revoked or modified for any reason, at any time
by the Issuing Bank without notification. A revocable L/C cannot be confirmed. If a Correspondent Bank is engaged in a
transaction that involves a revocable L/C, it serves as the Advising Bank.

Once the documents have been presented and meet the terms and conditions in the L/C, and draft is honored, the L/C
cannot be revoked. The revocable L/C is not a commonly used instrument. It is generally used to provide guidelines for
shipment. If a L/C is revocable it would be referenced on its face.

The irrevocable L/C may not be revoked or amended without the agreement of the Issuing bank, the Confirming bank,
and the Beneficiary. An irrevocable L/C from the Issuing Bank insures beneficiary that if the required documents are
presented and the terms and conditions are complied with, payment will be made. If a letter of credit is irrevocable it is
referenced a face.

c. Transferable and Assignable

The beneficiary has the right to transfer or assign the right to draw, under an L/C only when the credit states that it is
transferable or assignable. Credits governed by the Uniform Commercial Code (Domestic) maybe transferred for
unlimited number of times. Under the Uniform Custom and Practice for Documentary Credits (International) the credit
may be transferred only once. However, even if the L/C specifies that it is nontransferable or non-assignable, the
beneficiary may transfer their rights prior to performance of conditions of the credit.

d. Sight and Time Drafts

All L/C require the beneficiary to present a draft and specified documents in order to receive payment. A draft is a
written order by which the party creating it, orders another party to pay money to a third party. A draft is also called a bill
of exchange (B/Ex). There are two types of drafts: sight and time. A ‘sight draft’ is payable as soon as it is presented for
payment. The bank is allowed a reasonable time to review the documents before making payment.

A ‘time draft’ is not payable until the lapse of a particular time period stated on the draft. The bank is required to
accept the draft as soon as the documents comply with credit terms. The Issuing Bank has a reasonable time to examine
those documents. The Issuing Bank is obligated to accept drafts and pay them at maturity.

2.1.3 L/C Opening and Settling Procedure

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 1. Seller and Buyer conclude a sales and/or purchase contract, with method of payment usually by L/C (documentary
credit) as the seller wants to guarantee payment.
2. Buyer applies to his/her Issuing Bank, usually in Buyer’s country, for the opening L/C in favor of Seller (beneficiary).
3. Buyer’s bank approves the credit risk of the buyer, issues and forwards the L/C to its correspondent bank (Advising
or Confirming). The correspondent bank is usually located in the same geographical location as the seller (beneficiary).
The correspondent bank will advise, and usually to confirm, the credit.
4. Advising bank, usually in Seller’s country, will authenticate the L/C and forward the original L/C to the seller
(beneficiary) informing about the terms and conditions of L/C.
5. If credit terms and conditions conform to sales and/or purchase contract, Seller prepares goods and
documentation, and arranges delivery of goods to carrier.
6. Seller presents documents evidencing the shipment and draft (B/Ex) to paying/Accepting/Negotiating Bank named
in the L/C (the Advising Bank usually), or any bank willing to negotiate under the terms of credit.
7. The Advising Bank examines the documents and draft for compliance with credit terms. If complied with, bank will
pay, accept or negotiate. If the documents are correct, the Advising or Confirming Bank will claim the funds by:
 Debiting the account of the Issuing Bank.
 Waiting until the Issuing Bank remits, after receiving the documents
 Reimburse on another bank as required in the credit.
8. Advising Bank sends the documents and draft to the Issuing Bank.
9. Issuing Bank examines the documents and draft for compliance with credit terms. If complied with, Seller’s draft
is honored (paid).
10. Documents release to Buyer after payment or on other terms agreed between the Issuing Bank and Buyer
such as debiting the buyer’s account.
11. Buyer surrenders B/L to carrier (in case of ocean freight) in exchange for the goods or the delivery order.

L/C may be opened either by means of airmail or by means of full-text cable (i.e. in SWIFT format). SWIFT stands for
Society for Worldwide Interbank Financial Telecommunications.

2.1.4 Common Defects in Documentation under L/C

A discrepancy is an irregularity in the documents that causes them to be in Non-compliance to the L/C. Requirements
setforth in the L/C cannot be waived or altered by the Issuing Bank without the express consent of the customer. The
Beneficiary should prepare and examine all documents carefully before presentation to the Paying Bank to avoid any
delay in receipt of payment.

Commonly found discrepancies between the L/C and supporting documents include:

 L/C has expired before the presentation of draft (B/Ex).

 B/L evidences delivery prior to or after the date range stated in the credit.
 Charges included in the invoice which could be commercial and/or manufacturer not authorized in the credit.
 Inconsistent description of goods.
 Insurance document errors.
 Invoice amount not equal to draft amount.
 Ports of loading and destination not as specified in the L/C.
 Description of merchandise is not as stated in L/C.
 A document required by the L/C is not presented.
 Documents are inconsistent as to general information such as volume, quality, etc.

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  Names of documents not exact as described in the L/C. Beneficiary information must exact.
 Manufacturer and/or Commercial Invoice or statement is not signed as stipulated in the L/C.
When a discrepancy is detected by the Advising/Negotiating Bank, a correction to the document may be allowed if it
can be done quickly while remaining in the control of the bank. If time is not a factor, the exporter/beneficiary should
request that the Advising/Negotiating Bank to return the documents for corrections.

If there is no enough time to make corrections, the exporter should request that the Advising/Negotiating Bank send
the documents to the Issuing Bank on an approval basis or notify the Issuing Bank by wire, outline the discrepancies, and
request authority to pay. Payment cannot be made until all parties have agreed to jointly waive the discrepancy.

2.1.5 Overcoming Potential Risks under L/C: from the perspective of supplier

1. Understand the Rules - UCP 500 / UCP 600

To maximize the chance for payment under a L/C, a seller/beneficiary and the foreign buyer/importer must know the
rules of the game. The rules are codified in a publication sponsored by the International Chamber of Commerce (“ICC”),
known as the Uniform Customs and Practice for Documentary Credits (UCP). It is a set of rules on the issuance and use of
Letter of Credit.

Historically, the commercial parties, particularly banks, have developed the techniques and methods for international
trade finance. This practice has been standardized by the UCP. The UCP is promulgated by the International Chamber of
Commerce (ICC). The ICC has developed and molded the UCP by regular revisions. The result is the most successful
international attempt at unifying law ever, as the UCP has substantially universal effect.

A significant function of the ICC is the preparation and promotion of its uniform rules of practice. The ICC’s aim is to
provide a codification of international practice occasionally selecting the best practice after ample debate and
consideration. The ICC rules of practice are designed by bankers and merchants and not by legislatures with political and
local considerations. The rules accordingly demonstrate the needs, customs and practices of business. Because the rules
are incorporated voluntarily into contracts, the rules are flexible while providing a stable base for international review,
including judicial scrutiny. International revision is thus facilitated permitting the incorporation of the changing practices
of the commercial parties. ICC, which was established in 1919, had as its primary objective facilitating the flow of
international trade at a time when nationalism and protectionism threatened the easing of world trade. It was in that
spirit that the UCP were first introduced — to alleviate the confusion caused by individual countries’ promoting their own
national rules on L/C practice. The aim was to create a set of contractual rules that would establish uniformity in practice,
so that there would be less need to cope with often conflicting national regulations. The universal acceptance of the UCP
by practitioners in countries with widely divergent economic and judicial systems is a testament to the rules’ success.

The rules in the UCP 500 are drafted by and for the banking community. One of the major purposes is to protect the
banks from liability in Letter of Credit transactions. The banks are providing a service - the financing of the transaction -
and they expect to be protected from getting involved in disputes between the parties as to the terms of the contract of
sale. For this reason, “the independence principle” is a very important concept in L/C transactions. This means that the
L/C, and the documents required under the L/C for payment are completely independent from the underlying transaction
between buyer and seller i.e., Purchase and/or sales contract concluded between them.

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 The bank is not concerned with whether the contract between buyer and seller is being performed according to its
terms. The bank’s only concern is whether the documents presented by the seller conform to the documents required
under the L/C, and whether the documents are presented within the required time periods. The bank employees who
examine documents presented under the L/C are essentially clerks. Their job is not to make judgment calls, but simply to
see if the documents presented by the seller/beneficiary comply strictly with the documents required by the L/C. It is
therefore very important to assist clients in understanding the rules, because a lack of knowledge will only work to their
damage.

2. Choosing the reliable Issuing Bank

The exporter has to try to control the payment process from the outset. This means that when negotiating with the
buyer, the seller should try to get the buyer to use a bank of the seller’s choice to issue the L/C. the seller should find out
from its own bank, preferably a bank with a substantial international presence, what corresponding bank it uses in the
country of the buyer. If the buyer can have the L/C issued by that correspondent bank, the process can proceed more
expeditiously.

At the very least, the seller should insist that the buyer use a bank that is well-known and highly regarded by the
banking community. The seller’s own bank can provide information on the financial status and reputation of the foreign
bank. Since a major purposes served by a L/C is that the issuing bank assumes the risk of the buyers insolvency, if the
bank itself is financially weak, the L/C may not serve its purpose.

3. Confirming the L/C

If the seller does not have a confidence in the bank of the buyer’s choice, or if there is any question about the political
stability of the foreign country where the issuing bank is located, then the L/C should conformed by a local bank. When
the local bank conform a L/C issued by a foreign bank, it takes upon itself the payment obligation. Thus, if a local bank
confirmed an L/C, and subsequently, for political or economic reasons, the foreign bank could not reimburse the local
bank, the local bank is obligated to pay the beneficiary under the L/C.

There is a charge for confirmation, which becomes more expensive in proportion to risk the local bank believes it is
taking in confirming the L/C. There are some situations where the risk may appear so high that a local bank will not agree
to confirm at all. If the bank is refuses to confirm because of political instability, advice the client to try to have the L/C
issued outside the politically unstable area. The question of who pays the local, bank’s confirmation charge is negotiable,
but if not negotiated in advance, the bank will generally charge the beneficiary for this service.

4. Keeping Documents Simple

The seller should negotiate with the buyer prior to the issuance of the L/C exactly what documents must be presented
to the bank for payment under the L/C. The most important from the seller’s point of view is to have as few documents
as possible, to have as simple a description as possible, and to be sure that all documents called for by the L/C can in fact
be produced. Cases have occurred where one of the documents is a certificate supposed to be issued by the foreign
government, which was simply never produced. Another problem can be created if the L/C requires a document to be
signed by someone under the control of the buyer. The document may not be signed by the right person, or may not be
signed at all.

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 Almost all L/C’s require production of a Commercial Invoice and a transport Bill of lading With respect to the
commercial invoice, the L/C will typically state the description of the goods which must be found in the invoice. If the
goods are not described in exactly the same way, the seller may not be paid. In one case where payment was denied, the
L/C required for the commercial invoice to describe the goods as “100% Acrylic Yarn”. When the invoices were presented
to the bank, they described the goods as “Imported Acrylic Yarn.” Even though the packing list attached to the invoice
described the goods as 100% Acrylic Yarn, the court upheld the bank’s refusal to pay under the L/C because the
documents did not strictly comply with the requirements of the L/C.

In many cases, even if the documents do not comply exactly, the buyer will agree to waive any discrepancies in the
documents, and, if the bank agrees, the payment will occur. In the Acrylic Yarn case above, however, the buyer had gone
into bankruptcy, and the trustee in bankruptcy would not agree to waive discrepancies. In another case, buyer and seller
sought to amend the L/C to correct a discrepancy. The bank, however, was having never checked the financial status of
its customer, the buyer, prior to issuing the L/C, and having learned in the meantime that its customer might not be able
to reimburse the bank if it paid the L/C, refused to amend the L/C. The court held that the issuer bank had no duty to
amend a L/C upon the request of a customer and a beneficiary.

These cases teach three important lessons. First, documents must be accurate. Second, if there is a mistake or a
problem with the documents which the L/C requires to be presented, the seller/beneficiary should not ship goods until the
L/C has been amended. The UCP 500 makes clear that no amendment can take place unless the Issuing Bank, the
Confirming Bank, if any, and the seller, agree to it. UCP 500, Article 9(d). Unless the seller has written confirmation from
the bank that the amendment to the L/C has been issued, and the confirming bank has accepted the amendment, he/she
bears the risk that the L/C will not be paid.

Third, a prudent seller will not let the buyer take possession of the goods until he/she has been paid under the L/C. The
reason should be obvious. If there are discrepancies in the documents preventing payment of the L/C, a buyer in
possession of the goods has much less incentive to waive discrepancies so the seller can be paid. If the seller is not paid
by the bank, the buyer still has a contractual obligation to pay for goods, but the difficulty of collection can make the
price drop substantially, even assuming the buyer is solvent and can pay something. Particularly when the goods have
been shipped to a foreign country, the attempt to collect payment can be quite costly. The buyer, knowing this, will
undoubtedly attempt to negotiate a lower price, if he/she pays at all.

To keep goods out of the buyer’s possession, the seller should be sure to have the marine B/L consigned to order of
the bank. Since the marine B/L is a title document, a consignment to order of the bank gives the bank title to the goods
until they have been paid for by the buyer. Assuming proper payment, the bank transfers title to the buyer, who can then
take the B/L and go pick up the goods. If payment is not made, the bank has an obligation to hold the documents for the
seller, or return them to the seller if instructed to do so by the seller. The buyer should not be able to get the goods
without the title document.

A buyer may ask the seller to have the B/L made out to order and blank endorsed, and to send one or more sets to the
buyer within a few days of shipping the goods. This is like writing a blank check. It enables the buyer to pick up the goods,
and thereby provides him/her with a disincentive to waive any discrepancies in documents the seller presents to the
bank. Given the high failure rate of initial presentations of documents under an L/C, a seller needs to know he/she will

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have the buyer’s cooperation will be more forthcoming if he/she cannot get possession of the goods until any problems
with discrepancies have been resolved.

5. Meeting the deadlines

Every letter of credit has three important dates: (1) the date by which goods must be shipped, (2) the date by which
documents must be presented, and (3) the expiry date for the L/C. the seller should make sure that each of these dates
can be met, and should allow a large margin for error. After the L/C has been issued, if the seller learns that the date for
shipping goods can not be met , he/she should not ship any goods until he obtains an amendment to the L/C permitting
later shipment. If an L/C which calls for transport documents does not contain a date by which documents must be
presented, does this mean the seller can wait until the expiry date to present his/her documents? Not if he wants to be
paid. Article 43 of the UCP 500 provides that if no time period after shipment is given in the credit for presentation of
documents, banks will not accept documents presented to them later than 21 days after shipment. An exporter
unfamiliar with the 21 day rule of the UCP 500 could easily miss this deadline.

The exporter should make sure that the expiry date of the L/C permits sufficient time to permit correction, if possible,
of any mistakes in the documents. Under the UCP 500, once the documents are presented, the bank has a maximum of
seven days to let the beneficiary know if there are any discrepancies. If discrepancies can be corrected, they must be
corrected and sure that the expiry date allows enough time for errors to be rectified.

2.1.6 Benefits and Types of L/Cs

2.1.6.1 Benefits of L/Cs

L/C has multifaceted use for both the foreign purchaser/importer and exporter/supplier. The following section
discusses the benefits enjoyed by both party.

A. Benefits to the Importer

Purchases without Cash: an importer can by means of a Letter of Credit purchase goods from foreign merchants who
cannot know or rely upon his/her own standing; and such purchases can be made where the exporter demands cash on
payment. In fact, the Issuing

Banker lends to the importer the advantage of his/her own credit and goodwill.

Guaranteed Shipment: shipment of goods cannot be delayed once a L/C is issued. Therefore, the importer is assured
of the delivery of goods in time.

Payment after Satisfying Conditions: the exporter cannot obtain the cash under Letter of Credit without actually
shipped the merchandise. The system of documentary bills provides for the honoring of bills only when there are
according to certain conditions. Overdraft Facility: the importer may also get a L/C issued in favor of the exporter on the
basis of overdraft facility extended to him/her by the Issuing Bank. Thus, the importer gets possession of goods without
making actual payment.

Better terms of Trade: since in the case of a Letter of Credit, payment is assured, the importer is in a better position to
negotiate the terms of trade with foreign suppliers which otherwise is not possible.

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 B. Benefits to the Beneficiary/Exporter

An L/C facilitates trade transactions between importer and exporter who are not known to each other as to their
respective reputations and/or creditworthiness.

The major advantages derived by the exporter or beneficiary of a L/C are as follows:

 Prevents Blockage of Finance: the Letter of Credit received from the importer can be discounted with the
Confirming Bank and money can be realized immediately. This prevents blockage of funds. At the same time, after
fulfilling the required formalities the exporter gets immediate payment.
 Prevents Bad Debts, in the case of an L/C, the payment is guaranteed by the Issuing Bank and therefore, the risk of
bad debts is less. A Confirmed Letter of Credit is more secured due to double guarantees from the Issuing Bank and the
Confirming Bank.
 Fulfillment of Import and Exchange Control Regulations: the Letter of Credit is issued by the Issuing Bank after the
importer complies with the import regulations and exchange control regulations in his/her country. Thus, after getting
L/C unnecessary delays caused by import regulations can be avoided.
 Importer’s Obligation: the importer may refuse to accept goods in the case of other methods of payment. But in
the case of the L/C, the importer cannot do so because it is obligatory for him/her to accept goods and make payment
once he/she gets the documents negotiate in his/her favor.
 Helps to Procure Pre-shipment Finance: an exporter can obtain pre-shipment finance from commercial banks on
the strength of a Letter of Credit issued by the importer’s bank in his/her favor.

2.1.6.2 Types of L/C

There are different types of Letter of Credit. Common types of the L/Cs are briefly discussed as follows:

1. Revocable and Irrevocable L/C: Revocable Letter of Credit can be withdrawn, cancelled or modified by the Issuing
Bank at any time without the prior consent of the beneficiary. However, the Issuing Bank has to give a notice to the
exporter after revoking the Letter of Credit. Since, Revocable L/C is very risky; exporters do not accept such L/C. Where
as, Irrevocable L/C cannot be withdrawn, cancelled or modified without the prior consent of the beneficiary or the other
parties involved in the transaction such as Confirming Bank. Exporters, normally, prefer an irrecoverable L/C.

2. Confirmed and Unconfirmed L/C: in the case of a Confirmed L/C an exporter has an additional guarantee from a
local bank, in addition to the one given by the Issuing Bank.

Thus, the Confirmed L/C carries guarantee from two banks, i.e., the Issuing Bank and the Confirming Bank.
Unconfirmed L/C is one, which is not supplemented by additional guarantee from a bank in exporter’s country.

3. Transferable and Non-transferable L/C: a Transferable L/C is required when the beneficiary (first beneficiary) acts a
trader only and orders the respective goods from so called “sub-supplier’ (second beneficiary), who ships the goods
covered under the L/C directly to the applicant or the party specified in the L/C. However, the Issuing Bank must be
informed about such transfer. The first beneficiary of the L/C, in this case, assures his/her contractual payment obligation
to the second beneficiary by transferring the L/C in full or in part to the second beneficiary without investing his/her own
capital or using his/her own credit facility. There is no contractual relationship between the applicant and the second

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beneficiary, although the second beneficiary ships the goods directly to the applicant. This applicant must, therefore,
trust that the beneficiary will transfer the L/C to a reliable party only. A Non-transferable L/C, on the other hand, cannot
be transferred to a third party. Usually, all L/Cs are non transferable, unless and until so stated in them.

4. Clean and Restricted L/C: when the Issuing Bank does not put any condition regarding the negotiation of export
documents, the L/C is referred to as a Clean L/C. When the Issuing Bank puts a condition regarding the negotiation of
export documents through a specific bank, the L/C is referred to as a Restricted LIC.

5. Red-Clause and Green-Clause L/C: a ‘Red Clause’ L/C is one which authorizes the exporter to obtain pre-shipment
finance from his/her bank. Such finance is guaranteed by the Issuing Bank and is generally printed or typed in red ink.
Hence, such L/C is known as a ‘Red Clause’ L/C. A ‘Green Clause’ L/C, in addition to permitting pre-shipment finance,
provides the storage facilities to the exporter at the port of shipment. Such facilities are extended by the Issuing Bank and
is generally printed or typed in green ink. Hence, such Letter of Credit is known as a ‘Green Clauses’ L/C.

6. Revolving and non- revolving letter of credit: revolving letter of credit serves for more than transactions especially
when there is long term relation ship between buyer and seller. It is not subject to exhaustion. It renewed automatically
for the same amount and the same period once it is authorized. Non revolving letter of credit: when it impossible to use
letter of credit for more than one transaction, it is issued for a fixed amount and for a fixed period of time. In this case, an
exporter has a right to draw bill of specified amount with in stipulated time.

2.1.7 The circular flows /the relation ship between parties involved in letter of credit

There is contractual relation ship between buyer and seller and also the flow of goods from the seller to buyer.

2.2 Other Modes of Payments (Alternative to L/C)

Most sales/purchase agreements stipulate, in some manner, that certain collection of documents must be submitted
in advance by the exporter to the buyer or its bank in order to generate payment once the goods have been received. The

11
main documents, just to refresh your mind, include commercial invoices (the exporter’s bill of sale), consular invoices
(required by some foreign countries), certificates of origin (attesting to the origin of the exported goods), import licenses
(some countries require importers to obtain these for restricted items), inspection certificates (health or sanitary
certificates are required by many countries for animals, animal products, plants, and other agricultural products), and
dock and insurance receipts.

2.2.1 Documentary Collections / Bill of Exchange (B/Ex) / Draft

What do you understand by bill of exchange or draft?

A draft is a written order by an exporter instructing an importer/agent to pay a specified amount at a specified time.

The exporter issues a B/Ex which is an unconditional request for payment on demand or at a specified time and other
documents which transfer ownership to the foreign buyer. The exporter instructs the bank to transfer ownership upon
full payment. The banks, in this case, act as intermediaries. If payment is not made the document of title, usually the B/L
is held by the foreign buyer’s bank until instructions for payment by the buyer are provided. This is riskier than the Letter
of Credit b/c the bank will not guarantee a bill of exchange. Therefore, the exporter assumes responsibility for the
shipment and risks of non-payment. Documentary collection will be used as a method of payment if the buyer is not
willing to open documentary credit (L/C) or to provide a bank guarantee, and competition does not allow the seller to
insist on a documentary or a hank guarantee; import regulations of a certain country require it, and if the solvency of the
buyer no longer allows delivery against Open Account, thus the seller wishes to retain disposition over the goods until
payment is made.

2.2.1.1 Types of Documentary Collections

i. Documents against Acceptance (D/A)

If the draft is payable at later date (time draft) the instruction specify that the documents will be released to the
importer up on an acceptance of the draft. When a draft is drawn Documents against Acceptance (D/A), credit is
extended to the importer on the basis of his/her acceptance of the draft calling for payment within a specified time and
usually at a specified place. Acceptance means that, the importer formally agrees to pay the amount specified by the
draft on the due date. The specified time may be expressed as a certain number of days after sight (time draft), which
means after the day that the draft is first presented to the consignee. The specified time may be expressed as a certain
number of days after date (date draft), which means that the date on which the draft is drawn serves as the beginning
day of term (i.e., length of time before payments due) of the draft. Date drafts are preferred to time drafts because they
indicate the exact date of the maturity of the draft depending upon the arrangements made, the drawee of a draft may
be permitted to examine the merchandise before accepting the draft.

ii. Sight Draft/Documents against Payment (DAP)/Cash against Document (CAD)

If the draft is payable on sight then the instruction letter specifies that the documents will be released to the importer
up on payment of the draft. Here the importer must make payment for the face value of the draft before receiving the
documents conveying title to the merchandise. This occurs when the importer first sees the draft. Sometimes, with

12
instruction from the drawer, the importer may be given a certain limited period within which to make payment. In the
mean time the merchandise remains in the name of and in the hands of the collecting agency, which is usually a bank. It
should not be assumed, however, that the drawee must make immediate payment. It is the custom, in most foreign
countries for the drawee of the draft to make credit arrangements with his/her own bank, at point of destination, to
advance the funds with which to pay the full face of the draft or some part of the draft against delivery to the importer of
a proportionate amount of the merchandise.

iii. Clean Drafts versus Documentary Drafts in the Documentary Collections

Clean Draft: in a clean draft, no shipping documents are attached to the draft sent to the Remitting Bank. The
documents are sent together with the goods, directly to the buyer. Therefore, unless the credibility of the buyer is
unquestionable, using a clean draft in the shipment of goods is risky. The clean draft is more often drawn for the
collection of payment for the services, not goods.

Documentary Draft: in a documentary draft, the shipping documents are attached to the draft sent to the Remitting
Bank. The buyer will be able to receive the shipping documents from the Collecting Bank only after he/she has accepted
the draft for payment later or after he/she has paid the draft.

2.2.1.2 The Parties in the Documentary Collection

There are four parties involved in documentary collections. These are:

1. Drawer: the drawer is the party who issues the draft and to whom the payment is made. The drawer is the seller
(the exporter) and the payee of the draft. The payee could be another party rather than the exporter, or could be the
bona fide holder (the bearer) of the draft.

2. Drawee: the drawee is the party who owes the money or agrees to make the payment and to whom the draft is
addressed (made out). The drawee is the buyer (the importer), the acceptor and the payer of the draft in a documentary
collection. In a letter of credit the drawee most often is the Advising Bank or Confirming Bank or the Issuing Bank, which
are the acceptor and the payer of the draft.

3. Remitting Bank: is the exporter’s bank to whom the exporter sends the draft, shipping documents and
documentary collection instructions, and who subsequently relays them to the collecting bank in a documentary
collection is called the remitting bank. The term Remitting Bank as used under a L/C may refer to a nominated bank from
whom the issuing bank or the confirming bank, if any, receives the shipping documents.

4. Collecting Bank (Presenting Bank): the bank in the importer’s country (the importer’s bank usually) involved in
processing the collection---presents the draft to the importer for payment or acceptance, and thereafter releases the
shipping documents to the importer in accordance with the instructions of the exporter---is called the Collecting Bank or
the Presenting Bank.

2.2.2 Consignment

The goods are shipped to a foreign distributor who sells them on behalf of the exporter. The exporter retains title to
the goods until they are sold, at which point payment is sent to the exporter. The exporter has the greatest risk and least

13
control over the goods with this method. Additionally, receiving payment may take quite a while. When consignment
method is used, payment is usually made by means of a clean draft, which is a type of cheque drawn by the consignor (by
the exporter) to which no documents are attached. Payment typically occurs after the products have been resold by the
buyer (importer). This is a convenient way for the importer to make payment. Timing and procedures for payment will
depend on the prior arrangements made between the importer and exporter. The exporter may draw a clean draft (no
documents are attached) on the importer for the value of a particular shipment or shipments. Actual remittance
(payment) is made by cheque, bank draft, or wire transfer. It is wise to consider risk insurance with international
consignment sales. The contract should clarify who is responsible for property risk insurance that will cover the
merchandise until it is sold and payment is received. In addition, it may be necessary to conduct a credit check on the
foreign distributor.
2.2.3 Cash on Delivery (COD)
Cash on Delivery transactions are not frequently used in export trade except in connection with air transport.
Numerous airlines have facilities at their terminals for making delivery of merchandise against cash payments by the
consignee. Where these facilities are available, a convenient method is afforded shippers for collecting payment.

2.2.4 Cash with Order (Cash in Advance) - Telegraphic Transfer (TT)

The buyer bears the highest possible risk since he/she has no guarantee that he/she will receive the goods ordered.
Receiving payment by cash in advance of the shipment might seem ideal. In this situation, the exporter is relieved of
collection problems and has immediate use of the money. A wire transfer is commonly used and has the advantage of
being almost immediate. Payment by cheque may result in a collection delay of up to six weeks. Therefore, this method
may defeat the original intention of receiving payment before shipment.

2.2.5 Open Account

The exporter ships the goods as soon as the order is received and then invoices the purchaser for payment within a
certain amount of time say for instance 30 days. It allows the buyer receive goods without being obliged to pay or to
accept a draft immediately. It is at the buyer’s sole discretion to fix the payment date and to effect payment at a time
chosen by him/her. All risks including transfer and transportation risk goes to the seller. The seller’s risk of receiving
payment is further increased because no exact date of payment is stipulated.

This term of payment requires a high degree of confidence in the buyer’s ability to pay and willingness to fulfill
this/her obligations. At present, it is not application the Ethiopian banking system.

Sample Form For Requesting A Letter Of Credit

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 Dear International Buyer:

We are providing the following instructions as a guideline to be used when

opening a letter of credit to us. Because a letter of credit is a very critical document,
please verify that the information is accurate and complete, without any mistakes
which can create a discrepancy and lead to our subsequent request for an
amendment, and delay the shipment.

Regarding your purchase order number dated , please ask

your bank to open an irrevocable, at sight, commercial letter of credit according to
the following terms and conditions.

Beneficiary Name

Beneficiary Address

Requested Advising Bank Name

Requested Advising Bank Address

Telephone Fax Swift

In the amount of US$

name of bank
The letter of credit must be payable at the counters of or it must be
city near the seller
negotiable and payable at the counters of a bank in .

The letter of credit must be in the possession of the Advising Bank and

received by us days before the agreed upon shipment date.

Shipment will occur days after an acceptable letter of credit is in the

possession of the Advising Bank.

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 Shipment terms are: Incoterms 2000
destination

Partial shipments are permitted.

Latest shipment date is . Latest expiration date is .

Documentary requirements are:

1. Signed commercial invoice originals and copies

2. Packing list originals and copies

3.

4.

Documents are to be presented within days from the shipping date.

CHAPTER THREE

Ethiopian Import Bank and Customs Clearing Procedures and Practices

3.1 Definitions of Important Terminologies and Concepts

To have full understanding about the definition of customs clearance, it is better to define some of the jargons
associated with it. These are the following:

1. Customs clearance” means a process of fulfilling customs’ formalities for import and export cargo on
behalf of consignor or consignee with in customs station. Or it is a process of action done by the authorized
customs official in fulfilling customs’ formalities form import or export of goods/merchandise on behalf of
consignor or consignee within the office of customs. Customs formalities means any customs operations carried
out in connection with importation, exportation or transit of goods from the time of arrival at the customs port
until released from the customs control. It is also in the operations materials must be out by the person concerned
and by the customs in order to comply with the statutory or regulatory provisions which the customs are
responsible for enforcing in connection with the control of persons at the customs frontier and the clearance of
baggage, goods and means of transport at importation, exportation and in transit. These formalities may include
those relating to veterinary, immigration, currency and licensing regulations. Or in short we can define Cargo
clearance as the process of clearing cargo through customs at sea port or inland clearance depot.

16
 2. Port clearance-means a process of fulfilling port’s formalities for import and export cargo on behalf of
consignor or consignee within port area until the import cargo is brought out from the port or the export cargo is
loaded on to the ship. Port of registry- home port of a vessel at which place the vessel is registered
3. Cargo declaration- document on arrival and departure providing information required by public authorities
relating to the cargo.

4. ACYCUDA++ :- a computer system followed by Ethiopian customs authority to automate customs revenue
calculation and prepare different statistics.
5. customs Approved route: is any road, railway, waterway, and other route like pipeline, which in accordance
with the customs provisions of a state, must be used for the importation, exportations, customs transit, etc,. Of
the goods.
6. Discharge- the unloading of a vehicle, vessel, aircraft or barge/landing of cargo.
7. Shipper-person or firm with cargo to transport.
8. Dry-dock- dock in which ships may be repaired or built, the water being pumped out as required.
9. Bunker port- a port, which is available for bunkering ships (bunkers-the quantity of fuel on board vessel)
10. Stevedores- Dockers engaged on cargo/baggage transshipment.
11. Quay-the location in sea port at which cargo arrives or departs
12. Customs Transit: - is customs procedures by which goods are transported under the customs control
from one customs office to the other. The customs transit operation is the transport of goods from an office of
departure to an office of destination under customs transit. Goods carried under customs transit shall not be
subjected to the payment of duties and taxes provided the conditions laid down by the customs are complied with
and any security required has been furnished.
13. Customs Declaration Annex Form (CDAF) is a document that enables authorized exporter to export
products to other foreign countries or authorized importer to import products to Ethiopia. The permit has a
limited period of time that the exporter and or importer should be able to utilize before the expiry date. If not
utilized before the expiry date, the declaration will be returned immediately to the Exchange Controller National
Bank of Ethiopia, or to the authorized bank which issued.

Government of Ethiopia has started to pave the way towards modernizing the Ethiopian Customs Authority.
This allows choosing one of the customs clearance tools to be introduced in order to improve government
finance and to strengthen the economy of the country through increased efficiency in the foreign trade
environment. The Government of Ethiopia has selected ACYCUDA++ system for the computerization of their
customs revenue calculation and statistics, gathering their process and as the base tool to achieve the objectives.
Government has made dry ports (e.g. mojo dry port) with modern facility and implemented computerized
procedures at a major customs point to facilitate customs clearance.

Customs law, regulations and other government notifications made provisions and procedures to clear the
export and import cargo and to facilitate trade. It does not only simplify and promote international trade, but also
regulates unauthorized, illegal and movement of contraband items. This procedure can be considered as an
instrument for anti-dumping and unwanted import

3.2 Harmonized System (HS)

The Harmonized System Codes (HS Code) is a standard issued by the World Customs Organization (WCO)
to unify the classification of the goods. HS refers to an ideal system of internationally identifying goods for tariff

17
purposes. These are six digit codes for identifying different products across the world. The country using these
HS codes can suffix additional digits to the existing six digits according to their needs. One can use HS code to
search the tariff for imported goods at the customs website; or one can enter the key word of the goods (for
example steel for hot trolled steel sheets) and locate the correct tariff and HS Code. By using this link you can
get the tariffs rate assigned to each product and the correct HSC of the products
http://www.erca.gov.et/search.php All goods that we can see, feel, use, buy etc, are coded in customs. The
coding will differentiate one commodity from another which means each commodity or group of items will have
a separate code from another. This coding makes customs clearance easy. The coding of items also helps
customs officer to compile data of imports and exports. The arrangement of the codes and the goods in the
customs tariff is systematic and progressive and because of this, the tariff is sometimes called the nomenclature-
which means the systematic naming of goods in the tariff. It is nomenclature because goods are systematically
and progressively arranged from raw materials, semi-finished products, then finished products. The
internationally harmonized commodity description and coding system in short (HS) is a multipurpose six-digit
nomenclature.

3.3 L/C Opening and Settling Procedures: Ethiopian Commercial Banks' Practices

The following are typical Letter of Credit Transaction steps of a confirmed irrevocable letter of credit
practiced by commercial banks of Ethiopian.
1. Buyer and seller must conclude a purchase/sales contract by specifying L/C as a mode of payment
2. After the exporter and buyer agree on the terms of a sale, the buyer arranges for its bank to open a letter of
credit that specifies the documents needed for payment. The buyer determines which documents will be required.
3. The Buyer's Bank issues, or opens, its irrevocable letter of credit includes all instructions to the seller
relating to the shipment.
4. The Buyer's Bank sends its irrevocable letter of credit to an Exporter’s Bank and requests confirmation.
The Exporter may request that a particular local bank be the Confirming Bank, or the Foreign Bank may select a
correspondent bank in the Exporter’s country.
5. The Confirming Bank prepares a letter of confirmation to forward to the Exporter along with the
irrevocable letter of credit.
6. The Exporter reviews carefully all conditions in the letter of credit. The Exporter's freight forwarder is
contacted to make sure that the shipping date can be met. If the exporter cannot comply with one or more of the
conditions, the customer is alerted at once.
7. The Exporter arranges the goods for shipment and the forward/deliver the goods to the appropriate port or
airport.
8. When the goods are loaded, the exporter/Freight Forwarder completes the necessary documentation.
9. The Exporter (or the Freight Forwarder) presents the documents, evidencing full compliance with the letter
of credit terms, to the Confirming Bank.
10. The Confirming Bank reviews the documents. If they are in order, the documents are sent to the Buyer's
Bank for review and then transmitted to the Buyer.
11. The Buyer (or the Buyer's Agent) uses the documents to claim the goods.

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 12. A draft, which accompanies the letter of credit, is paid by the Buyer's Bank at the time specified or, if a
time draft, may be discounted to the Confirming Bank at an earlier date.

3.4 Import Customs Clearance Procedures: ECuA Practices

These procedures have been taken out of The Re-establishment and Modernization of Customs Authority
Proclamation No. 60/1997 or 60/1989 (according to the Ethiopian calendar - EC) and its amendment
Proclamation No. 368/2003 or 368/1995 EC

However, it’s advisable that a reader gets these documents for a comprehensive understanding of the existing
proclamations and regulations.
1st. Lodgment of Customs declaration
2nd. Supporting Documents of Customs Declaration
3rd. Verification of Documents and Examination of Goods
4th. Examination at the request of Importer
5th. Delivery of Goods
Lodgment of Customs Declaration
Except exempted by directives all goods entered in accordance with Article 17 of the proclamation shall
forthwith lodged for clearance in aspect copies of customs declaration. Goods exempted form clearance shall be
determined by directives issued by the Customs Board. Where customs clearing agent applies for hold function
and fulfils supporting documents pre lodgment of customs declaration may be allowed for and five days before
the arrival of the goods at customs port. However, if the goods do not arrive within the five days, a new
declaration shall be lodged at the time of arrival of the goods. The Authority may allow goods to be cleared
urgently due to their nature or the reason they are required for. The details and the reasons that justify this
procedure shall be prescribed in the directives issued by the authority. All information supplied in the customs
declaration shall be filled and signed by the customs clearing agent. Any imported goods registered for home
consumption shall be identified and declared in Customs declaration. Goods entered for an outright exports or
temporary export shall be declared in Customs declaration. Customs declaration accepted by the entry reception
shall immediately be registered for the accomplishment of customs formalities. Customs declaration may be
lodged orally, by bodily action or electronically. The ministry may issue directives as to the goods and
conditions of lodging Customs declaration orally, by bodily action or electronically.
Supporting Documents of Customs Declaration
On the lodgment of customs declaration and declaration of facts the following original documents in support
shall be supplied to customs in a number of copies fixed by the Authority: Transportation document, commercial
invoice, Bank permit, Packing list, Certificate of origin, and other necessary documents to be prescribed in the
directives issued by the Authority. Transportation document that is required in support of export goods shall be a
document that is used as evidence for the transpiration of goods up to the customs port of exit. The Authority
may require any document to be presented in an Amharic translation made by official translators. Customs
declaration shall be acceptable where the necessary documents which are prescribed under this Article are
presented and approved by the customs officer.
Verification of Documents and Examination of Goods

19
 The proper customs officer shall verify documents and examine goods to assure the accuracy of information
supplied in the document. The owner of the goods or his authorized agent shall attend during examination of the
goods. Where the owner or his agent fails to appear at the time of examination, the proper Customs Officer shall
open and examine the goods in the presence of relevant officials. Procedure of goods examination shall be
prescribed by directives issued by the Authority.
Examination at the request of Importer
If any importer or his agent believes that the goods have suffered damage, short or pilfered in route may
request for prior examination of the goods before the lodgment of goods declaration. Where the request made in
accordance and its reason are justified by the Authority; goods examination may be carried out upon payment of
service charge. Customs declaration shall, therefore, be filled in accordance with the examination report. Service
charges for prior examination of goods shall be prescribed by directives issued by the Authority
Delivery of Goods
All goods listed in customs declaration shall be removed from the warehouse by the owner or his agent
immediately upon the accomplishment of customs formalities. Goods which are not removed from the
warehouse with in the period specified in sub-Article (3) of Article 43 of the proclamation shall be sold or
disposed otherwise as deemed abandoned to the customs.
3.5 objectives, Duties & responsibility of Ethiopian custom Authority

As it is promulgated in Federal Negarit Gazeta Proclamation no.60/1997 issued on its 3 rd year No. 18
February 15th 1997, the Ethiopian Customs Authority (ECuA) is given judicial responsibility by the House of
Representative to fulfill the following three major objectives:

 Collect duties and taxes on goods imported or exported.

 Implement laws and international conventions related to its objectives.
 Control the importation or exportation of prohibited or restricted goods.
In order to achieve the aforementioned objectives, the Ethiopian Customs Authority (ECuA) has specific
duties and responsibilities. These are:

 To assess the duty paying values, collect duties and taxes, collect license and service charges.
 To examine documents of importers or exporters so as to enforce Customs law.
 To establish Customs Stations in any Customs port, frontier post and Transit routes.
 To approve the place for the deposit of import and export goods, establish warehouses, give license for
those who establish Customs warehouse, supervise the proper handling of deposited goods, suspend or revoke
warehouse license.
 To prevent and control the importation or exportation of goods in contraband.
 To search any goods and means of transport entered into or departing from Ethiopia through Customs
ports, Frontier posts and other customs stations.
 Under the authority given by and supervision of the authority of the attorney general, to investigate
customs offences, institute criminal proceeding, and follow up the case in court.
 To collect, organize and disseminate import and export data.
 To carry out studies as to the levying, assessment and collection of customs duties, devise ways of
combating and repression of contraband activity and implement same up on approval.
 To sell or dispose otherwise goods without owner, abandoned, or forfeited.
 To issue or revoke customs clearing license.
 To prepare forms and brochures necessary for customs activity.
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  To prepare and implement systems for the assessment, and collection of duties, financial accounting and
other related activities.
 To arrange for trainings and workshops to upgrade the efficiency of Customs officers.
 To own property, enter into contract, sue and be sued in its own name.

3.6 Control of ECuA over Imported/Exported Goods

1) For the implementation of the objectives of Customs the following goods shall be under the supervision
and control of Customs:
A. Imported goods from the time they get at customs port until the completion of customs formalities and
received by importer.
B. Goods under drawback procedure from the time of drawback claim until exportation. The term ‘drawback’,
here in, is used in the customs regulations in the sense of allowing a person or a business to drawback or to get a
refund of, subject to some conditions on import duties paid earlier. For instance if duty is paid on raw materials
used in the production of commodities while imported is refunded back upon exportation of the processed
commodity.
C. Goods, entered into customs warehouse until removed from the warehouse.
D. Goods of export from the time they entered into Customs port until the completion of customs formalities
and be exported.
E. Goods in transit, from the time their movement is allowed until the completion of transit procedure.
F. Goods found without owner, abandoned, forfeited or contraband goods until they are sold or disposed
otherwise.
2) Without prior authorization no one is allowed to enter into customs warehouse in which goods are
deposited or; open or do any acts on those goods controlled and supervised by Customs.
3) The Authority shall be responsible for the damage on goods under its control and supervision caused by its
employees while discharging their official duties.

3.6 Types of Customs Clearance Payments

Unless exempted by law, items imported into Ethiopia are subject to a number of taxes. Government levies
five kinds of taxes on import items. These taxes are assigned priority levels and are calculated in a sequential
order. These taxes, in their sequential order, are customs duty, excise tax, VAT, surtax and withholding tax.
Taxes on imported goods are collected by the Ethiopian Revenues and Customs Authority (ERCA). These taxes
provide considerable revenue to the government. According to the report issued July 2009 by Planning
Directorate of ERCA, these taxes provided revenue of 11.8 billion Birr.

1. Customs Duty and its Rates

The first of the five taxes levied on import items is customs duty. The term customs duty denotes taxes
imposed on goods entering or leaving the country. ERCA collects customs duty only on import items as no tax

21
on export is levied. The government waived taxes on export items on purpose- just to encourage export.
However, there is a 150 percent export tax particularly on certain hides and skins of animals.

Customs duty provides significant revenue to the government. ERCA collects Customs duty based on the
rules stipulated in the customs proclamation No. 622/2009 and other regulation and directives. Customs duty
has 6 bands or groups of rates which are applied to imported goods. These bands of rates are 0%, 5%, 10% 20%,
30% and 35%. From these bands of rates one can see that the minimum customs duty rate is 0(zero) while the
maximum is 35 percent of the CIF (Cost + Insurance + Freight) value of an imported item. According to the
Customs Tariff (Amendment volume 1, 1996 edition), the maximum customs duty rate used to be 60 % of the
CIF value of an imported item. However, since then the government has taken steps towards reducing customs
duty rate in order to support inward investment and the broad business community. Such steps were taken in
2000 and 2002 where the maximum customs duty rate was reduced to 40 and then 35 percent of the CIF. The
long run government's aim is to reduce this figure to near zero (0).
To calculate the customs duty, the CIF is multiplied by tariff rate applicable to each imported item. ERCA
collects customs duty on a great variety of goods which can be classified into two categories. The classification
is based on the primary purpose of the imported goods. Those import items used for productive purpose, items to
be re-exported and for public use are classified in category one while import items for all other (nonproductive)
purpose are classified in category two.
Category 1. Accordingly, raw materials, semi finished goods, producers goods, and import items for public
use such as minibuses, buses etc fall under category one. Raw materials can be processed or unprocessed
materials that would be used as industrial or agricultural input while producers’ goods are goods such as capital
goods and others imported by business organization for productive purposes. To encourage business
organizations involved in activities such as producing goods and services, special privileges are granted to them
including the exemption of customs duty and other taxes. As a result, raw material, and producers goods are
largely zero (0) rated although there is up to a 10 percent customs duty rate applied to some of them. For
example the importation of agricultural production inputs such as a tractor is charged with 10 percent customs
duty rate. The importation of raw material and producers goods are highly encouraged for they promote
domestically produced goods which replace imported goods and helps to save cash flow out of the country.
Generally speaking, the more the imported goods are to be used for productive purpose, the more would get the
customs duty rate near to zero. Semi finished goods are also classified under category one. These goods are
imported into the country for further processing and their importation is encouraged next to raw materials and
producers goods. ERCA charges semi finished goods at a 10 and 20 percent customs duty rate.
Category 2. Imported goods which are classified in category two are items such as consumer or finished
goods imported for personal use or for a nonproductive purpose. Consumer goods may also be sub classified into
durable and nondurable goods. Durable consumer goods are goods like automobiles, furniture that have an
expected useful life of three or more years. Nondurable goods such as foods, gasoline, articles of clothing etc
that are depleted or discarded relatively soon. The highest customs duty rates are usually applied to consumer
goods. For example, an automobile is heavily taxed at a 35 percent customs duty rate on the grounds that it is
imported for personal use while ambulances which are primarily used for public use is imported free of customs
duty and other taxes. The general principle in setting customs rate in Ethiopia is that the more the imported item
is to be used solely for personal use the higher the rate of customs duty and other taxes. Full information on rates
of customs duty on each item to be imported can be obtained from the Ethiopian Customs Tariff prepared based
on the harmonized commodity description and coding system (H-S).
Export Tax

22
 Customs duty and other taxes on export items are waived purposely to encourage export. However, the
government levies export tax on specific semi-prepared hides and skins of animals. This export tax includes
taxes on wet blue skin of an ox, wet blue hides of sheep and goat, and pickled hide of a sheep. The tax is 150
percent of the selling price of the hides and skins to be exported. This tax is introduced on January 1, 2010 by a
directive no. 25/2009 issued by Ministry of Finance and Economic Development. The government imposed
export tax on these items as a method to curb the exportation of the items, and to increase domestic leather
products such as shoes, purses, ready-made garments etc.
Preferential Tariffs
Ethiopia is a member of the Common Market for Eastern and Southern Africa (COMESA) and it administers
preferential tariffs that favor trade with member countries of COMESA: The table below describe the special
customs tariff rates applicable to goods produced in and imported from COMESA member countries as against
the regular customs tariff rate which is applicable to goods produced in and imported from non member
countries.
2. Excise Tax
Excise tax is the second of the five taxes levied on import items and it is one of the most well known forms of
tax in Ethiopia. It is a tax levied on selected goods such as luxury goods and basic goods which are demand
inelastic i.e. goods that shows no change at all in quantity demanded when price goes up or down. Moreover,
excise tax is also applied to goods which are considered as hazardous to health and that may cause social
problems. Additionally, the government uses excise tax as a revenue-producing device. In Ethiopia, both the
federal and regional governments collect excise tax. ERCA is responsible for collecting excise tax for the
Federal government and collects excise tax levied on locally produced and imported items into the country. The
minimum excise tax rate applied to excisable goods is 10% while the maximum is 100%. Excise tax has 10
bands or groups of rates at which excise can be charged. These band rates are 10%, 20%, 30%, 33%, 40%, 50%,
60%, 75%, 80% and 100%. These rates are used to calculate the payable excise tax.
Who must pay excise tax? Excise tax on when ever the goods which are subjective for excise taxes are
imported from a foreign countries the importer is responsible to pay excise tax or when such goods are locally
produced the manufactures/producer of such good is responsible to make effective payment to the custom
authority. Or the excise tax on goods locally produced is paid by the producer whereas excise tax on imported
items is paid by the importer. Each taxpayer is liable to compute his or her tax liability/the amount of money he
or she owes. The base of calculation for goods locally produced is the cost of production multiplied by its excise
tax rate. However, the cost of production means direct labor and raw material cost incurred in the production
process, cost of indirect inputs and overhead costs, but does not include depreciation costs of machineries.
In calculating excise tax payable on textile and textile products locally produced in a factory and vehicles
assembled locally, the tax paid on import of inputs that are used to produce such goods shall be deducted.
Likewise, cost + insurance + freight (CIF) + customs duty multiplied by excise tax rate is the base of
computation for goods imported into the country. Excise tax on imported items is paid at the time of clearing
those goods from customs area. According to sub article 2(a) of article 6 of the proclamation 307/2009, excise
tax on locally produced goods is to be paid, not later than 30 days from the date of production. However this
provision is amended by the directive No 18/2009, which allows for the excise tax to be paid within 30 days of
the next month following production.
3. Value Added Tax (VAT)
VAT is the third of the five taxes to be levied on import items. In Ethiopia, VAT is levied at a flat percentage
rate. To the exclusion of goods detailed in article 8 of the proclamation No. 285/2002 and goods exempted from
VAT by the directive issued by the Ministry of Finance and Economic Development, VAT is levied on every
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imported item. Importers are liable to pay 15 percent of the sum of cost, insurance, freight, customs duty and
excise tax.
4. Surtax
Surtax is the fourth of the five taxes imposed on import items. Surtax was introduced in the Ethiopian tax
system on April 9, 2007. The council of Ministers issued a regulation to levy 10 percent surtax on imported
goods. The imposition of surtax was necessitate to build the financial capacity of the government for
interventions to solve the rise in the cost of living which is affecting consumers with low and medium income
level. The government has been exerting effort to make grain available at a low price for urban dwellers with
medium and low income level until the market is stabilized. Hence, the government required additional budget to
pay for the subsidy and this is financed by surtax on import items. Necessary care has been taken so that the
imposition of surtax over the imported goods wouldn't result in a rise in the cost of living and in the cost of
goods for investment. Ten percent of the sum of cost, insurance, freight, customs duty, excise tax, and VAT is
the base of computation for surtax on all goods imported into the country.
However, the following items and services are exempted from payment of surtax. Fertilizer, Petroleum and
lubricants, Motor vehicles for freight and passenger and other special purpose motor vehicles, Air craft,
spacecraft and part thereof , capital (investment goods) and some medicines, raw materials and other goods
which are already decided by law to be tax free.
5. Withholding tax
Withholding tax is the last tax on import items and was introduced in Ethiopia on December 30, 2000.
Proclamation No 227/2001 introduced withholding tax. Later on, this proclamation was replaced by income tax
proclamation No 286/2002 and the Council of Ministers Income Tax Regulation No 78/2002. The latter
proclamation made effective a withholding tax of 3 percent on import items and a 2 percent on payments made
in return for the purchase of goods and services.
Withholding tax on imports
Income tax is collected on the import of goods for commercial use and the collected amount is treated as a tax
which is withheld and is creditable against the taxpayers’ income tax liability for the year. Therefore,
withholding tax is not a tax in the traditional sense. The amount collected on imported goods shall be three
percent of the sum of cost, insurance and freight (CIF value). If the amount of income tax collected on the
imported goods results in underpayment of business income tax due for the year, as determined at the time of
declaration of income tax, the tax payer is required to pay the difference with the declaration. If the amount
represents an overpayment of income tax due for the year, the tax authority shall, after ensuring the accuracy of
the books and records, refund the taxpayer the amount overpaid within three months. The tax authority does this
pursuant to article no. 76 of the proclamation no. 286/2002. According to this article, refund to the taxpayer is
made after compensating for other taxes he/she owes the tax authority.
Goods imported by the following individuals and firms are exempted from the 3 percent withholding tax
imposed on commercial import items. The individuals and firms that enjoy such privilege include:
 Nonprofit and nongovernmental organizations and associations, subject to the provision of registration
certificate issued by Ministry of Justice or an authorized body.
 Privileged individuals to import their personal effects free of duty pursuant to the directive issued by
ERCA
 Individuals and organizations allowed to import duty-free items pursuant to category two of the customs
tariff.

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  International organizations, foreign diplomat, consular missionaries, and their members who, in line with
diplomatic and other international agreements, are exempted from profit tax
 Individuals and organizations who are exempted from income tax by federal and regional investment
authority. However these Individuals and organizations are subject to provide evidence that authenticate
privileges of such a kind
 Raw materials and capital inputs like spare parts used by individuals and organizations licensed to engage
in the activities of production are exempted from a three percent withholding tax provided that the inputs are not
directly used for commercial purpose. However an industry owner, as read in the proclamation no.286/2002,
shall pay a two percent withholding tax when the item produced using the foregoing inputs is made available for
sale in the market.
 Capital goods imported into the country for the establishment or development of industry or power
generation or transportation facilities. However, the importer is subject to provide evidence, from the Ethiopian
Investment Authority or from concerned bodies, that authenticates the imported items are capital goods and are
not to be directly used for commercial purpose,
 Gift items, advertising items, sample of goods,
 Individuals and organization engaged in the activities of mining and petroleum for they are governed
pursuant to a special tax law.
Exemplary way to calculate customs duty and other taxes on an automobile imported for
personal use

Consider a typical example: an importer brought in an automobile with 1300 cc for personal use. So
the importer is liable to pay 35% custom duty rate and 30% excise tax rate. How do you think the total
customs duty and other taxes can be calculated? To determine customs duty and other taxes on the
automobile the importer may use the following seven key steps. The first step is to identify the duty
paying value of the automobile. The duty paying value of any import item is the actual total cost of the
goods i.e. cost + insurance + freight. Cost stands for the transaction value (purchase price of the good)
and other related costs. Insurance represents the money or premium that for insurance coverage. Freight
is money paid for the transportation of cargo (good) from port of shipment up to port of destination.

 Once the duty paying value of the imported item is calculated, the next step is to calculate customs
duty payable on the automobile. Suppose the duty paying value of the imported item is 60,000 birr, the
importer is liable to pay customs duty of 21000 birr. This figure is obtained by multiplying customs duty
rate with the duty paying value of the imported item i.e. 60,000 x 35% .
 Having calculated customs duty next is the third step used to reflect how excise tax is calculated.
In this step, the importer multiplies the sum of duty paying value and customs duty by excise tax rate
(60,000 + 21,000) x 30%. This gives the importer 24,300 birr which is the payable excise tax.

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  The fourth step shows the way value added tax is calculated. In this step, the importer multiplies
the sum of duty paying value, customs duty, excise tax by value added tax ( 60,000 + 21,000 + 24,300)
x 15%which is VAT rate. The result of this calculation is 15, 795 birr which is VAT to be paid on the
automobile.
 The fifth step, to calculate surtax, involves multiplying the sum of duty paying value, customs
duty, excise tax, VAT, by surtax rate (60,000 + 21,000 + 24,300 + 15,795) X 10% which is surtax rate.
Accordingly the payable surtax is 12,109.5 birr. 5%.
 The sixth step is to calculate withholding tax. In this step, the importer multiplies the duty paying
value by withholding tax rate i.e. 60,000 x 3%. The result is 1800 birr which is the withholding tax to be
paid. The last step involves adding the payable customs duty, excise tax, value added tax, surtax, and
withholding tax to arrive at the figure of the total payable customs duty and other taxes. Accordingly,
the calculation results in a sum of 75,000.5 birr i.e. 21,000 + 24300 + 15,795 +12,109.5 + 1800.
 The formula for calculating customs duty and other taxes:
 DPV =Cost + Insurance + Freight
 DPV x CUDU =A
 (DPV + A) x EXTA= B
 (DPV + A + B) x VAT=C
 (DPV + A + B + C) x SURTAX =D
 DPV x WHT = E
 Total payable = A + B + C + D + E
 ………………………………………………..
 Where DPV= Duty Paying Value
 CUDU= Customs Duty Rate
 EXTA = Excise Tax Rate
 SURTAX= Surtax
 WHT = Withholding Tax
7/04/2009 E.C

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