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Steps:
After a contract is concluded between buyer and seller, buyer's bank supplies a
letter of credit to seller.
Seller provides bill of lading to bank in exchange for payment. Seller's bank exchanges
bill of lading for payment from buyer's bank. Buyer's bank exchanges bill of lading for
payment from the buyer.
The letter of credit can also be source of payment for a transaction, meaning that
redeeming the letter of credit will pay an exporter. Letters of credit are used primarily in
international trade transactions of significant value, for deals between a supplier in one
country and a customer in another.
Properties:
Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without
prior agreement of the beneficiary, the issuing bank and the confirming bank, if any.
How it works
A business called the InCosmetika from time to time imports goods from a business
called ACME, which banks with the ABC Bank. InCosmetika holds an account at the
Commonwealth Bank. InCosmetika wants to buy $500,000 worth of merchandise from
ACME, who agrees to sell the goods and give InCosmetika 60 days to pay for them, on
the condition that they are provided with a 90-day letter of credit for the full amount. The
steps to get the letter of credit would be as follows:
Availability
A letter of credit being an irrevocable undertaking of the issuing bank makes available
the Proceeds, to the Beneficiary of the Credit provided, stipulated documents strictly
complying with the provisions of the letter of credit, UCP 600 and other international
standard banking practices, are presented to the issuing bank, then:
• i.if the Credit provides for sight payment – by payment at sight against compliant
presentation
• ii.if the Credit provides for deferred payment – by payment on the maturity
date(s) determinable in accordance with the stipulations of the Credit; and of
course undertaking to pay on due date and confirming maturity date at the time of
compliant presentation
• iii.a.if the Credit provides for acceptance by the Issuing Bank – by acceptance
of Draft(s) drawn by the Beneficiary on the Issuing Bank and payment at maturity
of such tenor draft, or
• iii.b. if the Credit provides for acceptance by another drawee bank – by
acceptance and payment at maturity Draft(s)drawn by the Beneficiary on the
Issuing Bank in the event the drawee bank stipulated in the Credit does not accept
Draft(s) drawn on it,
or by payment of Draft(s) accepted but not paid by such drawee bank at maturity;
• iv. if the Credit provides for negotiation by another bank – by payment without
recourse to drawers and/or bona fide holders, Draft(s) drawn by the Beneficiary
and/or document(s) presented under the Credit, (and so negotiated by the
nominated bank )
• Negotiation means the giving of value for Draft(s) and/or document(s) by the
bank authorized to negotiate, viz the nominated bank. Mere examination of the
documents and forwarding the same to the letter of credit issuing bank for
reimbursement, without giving of value / agreed to give, does not constitute a
negotiation.
• Commercial Documents
• Shipping Documents
• Official Documents
• Transport Documents
Bill of Lading (ocean or multi-modal or Charter party), Airway bill, Lorry/truck
receipt, railway receipt, CMC Other than Mate Receipt, Forwarder Cargo Receipt,
Deliver Challan...etc
• Insurance documents
1) Payment obligation is abstract and independent from the underlying contract of sale or
any other contract in the transaction. Thus the bank’s obligation is defined by the terms of
the credit alone, and the sale contract is irrelevant. The defences of the buyer arising out
of the sale contract do not concern the bank and in no way affect its liability.[1] Article
4(a) UCP states this principle clearly. Article 5 the UCP further states that banks deal
with documents only, they are not concerned with the goods (facts). Accordingly, if the
documents tendered by the beneficiary, or his or her agent, appear to be in order, then in
general the bank is obliged to pay without further qualifications.
If the responsibility for the validity of documents was thrown onto banks, they would be
burdened with investigating the underlying facts of each transaction and would thus be
less inclined to issue documentary credits as the transaction would involve great risk and
inconvenience.
Secondly, documents required under the credit could in certain circumstances be different
from those required under the sale transaction; banks would then be placed in a dilemma
in deciding which terms to follow if required to look behind the credit agreement.
Thirdly, the fact that the basic function of the credit is to provide the seller with the
certainty of receiving payment, as long as he performs his documentary duties, suggests
that banks should honour their obligation notwithstanding allegations of misfeasance by
the buyer. [2]
Finally, courts have emphasised that buyers always have a remedy for an action upon the
contract of sale, and that it would be a calamity for the business world if, for every breach
of contract between the seller and buyer, a bank were required to investigate said breach.
The “principle of strict compliance” also aims to make the bank’s duty of effecting
payment against documents easy, efficient and quick. Hence, if the documents tendered
under the credit deviate from the language of the credit the bank is entitled to withhold
payment even if the deviation is purely terminological.[3] The general legal maxim de
minimis non curat lex has no place in the field of documentary credits.
Legal writers have failed to satisfactorily reconcile the bank’s undertaking with any
contractual analysis. The theories include: the implied promise, assignment theory, the
novation theory, reliance theory, agency theories, estoppels and trust theories,
anticipatory theory, and the guarantee theory. [4] Davis, Treitel, Goode, Finkelstein and
Ellinger have all accepted the view that documentary credits should be analyzed outside
the legal framework of contractual principles, which require the presence of
consideration. Accordingly, whether the documentary credit is referred to as a promise,
an undertaking, a chose in action, an engagement or a contract, it is acceptable in English
jurisprudence to treat it as contractual in nature, despite the fact that it possesses
distinctive features, which make it sui generis.
A few countries including the US (see Article 5 of the Uniform Commercial Code) have
created statutes in relation to the operation of letters of credit. These statutes are designed
to work with the rules of practice including the UCP and the ISP98. These rules of
practice are incorporated into the transaction by agreement of the parties. The latest
version of the UCP is the UCP600 effective July 1, 2007[5]. The previous revision was the
UCP500 and became effective on 1 January 1994. Since the UCP are not laws, parties
have to include them into their arrangements as normal contractual provisions.
Where the buyer parts with money first and waits for the seller to forward the goods
Here the buyer can be confident that the goods he is expecting only will be received since
it will be evidenced in the form of certain documents called for meeting the specified
terms and conditions while the supplier can be confident that if he meets the stipulations
his payment for the shipment is guaranteed by bank, who is independent of the parties to
the contract.
• Documentary collection (more secure for buyer and to a certain extent to seller)
Also called "Cash Against Documents". Subject to ICC's URC 525, sight and usance, for
delivery of shipping documents against payment or acceptances of draft, where shipment
happens first, then the title documents are sent to the [collecting bank] buyer's bank by
seller's bank [remitting bank], for delivering documents against collection of
payment/acceptance
Where the supplier ships the goods and waits for the buyer to remit the bill proceeds, on
open account terms.
Legal Risks
• Non-delivery of Goods
• Short Shipment
• Inferior Quality
• Early /Late Shipment
• Damaged in transit
• Foreign exchange
• Failure of Bank viz Issuing bank / Collecting Bank
• Nominated Bank has made a payment to the Beneficiary against documents that
comply with the terms and conditions of the Credit and is unable to obtain
reimbursement from the Issuing Bank
• If Confirming Bank’s main risk is that, once having paid the Beneficiary, it may
not be able to obtain reimbursement from the Issuing Bank because of insolvency
of the Issuing Bank or refusal of the Issuing Bank to reimburse because of a
dispute as to whether or not payment should have been made under the Credit
Contents
[hide]
• 6 References
Unlo Unload
Landin Entr
ad Landi onto
Expor Transp Transp g Entry - y -
Loa from ng trucks Transp
t- ort to ort to charge Custo Duti
Incoter d to truck charg from ort to Insura
duty export import s at ms es
ms truc at the es at the destinat nce
paym er's er's import cleara and
k origi origin import ion
ent port port er's nce Taxe
n's 's port ers'
port s
port port
EXW No No No No No No No No No No No No
FCA Yes Yes Yes No No No No No No No No No
FAS Yes Yes Yes Yes No No No No No No No No
FOB Yes Yes Yes Yes Yes No No No No No No No
CFR Yes Yes Yes Yes Yes Yes Yes No No No No No
CIF Yes Yes Yes Yes Yes Yes No No No Yes No No
CPT Yes Yes Yes Yes Yes Yes No No No No No No
CIP Yes Yes Yes Yes Yes Yes No No No Yes No No
DAF Yes Yes Yes Yes Yes Yes No No No No No No
DES Yes Yes Yes Yes Yes Yes No No No No No No
DEQ Yes Yes Yes Yes Yes Yes Yes No No No No No
DDU Yes Yes Yes Yes Yes Yes Yes Yes Yes No No No
DDP Yes Yes Yes Yes Yes Yes Yes Yes Yes No Yes Yes
Taxation of inputs, like raw materials, components and other intermediaries had a number of
limitations. In production process, raw material passes through various processes stages till a final
product emerges. Thus, output of the first manufacturer becomes input for second manufacturer
and so on. When the inputs are used in the manufacture of product `A', the cost of the final product
increases not only on account of the cost of the inputs, but also on account of the duty paid on such
inputs. As the duty on the final product is on ad valorem basis and the final cost of product `A'
includes the cost of inputs, inclusive of the duty paid, duty charged on product `A' meant doubly
taxing raw materials. In other words, the tax burden goes on increasing as raw material and final
product passes from one stage to other because, each subsequent purchaser has to pay tax again
and again on the material which has already suffered tax. This is called cascading effect or double
taxation.
This very often distorted the production structure and did not allow the correct assessment of the
tax incidence. Therefore, the Government tried to remove these defects of the Central Excise
System by progressively relieving inputs from excise and countervailing duties. An ideal system to
realize this objective would have been to adopt value added taxation (VAT). However, on account of
some practical difficulties it was not possible to fully adopt the value added taxation.
Hence, Government evolved a new scheme, `MODVAT' (Modified Value Added Tax). MODVAT
Scheme which essentially follows VAT Scheme of taxation. i.e. if a manufacturer A purchases certain
components(raw materials) from another manufacturer B for use in its product. B would have paid
excise duty on components manufactured by it and would have recovered that excise duty in its
sales price from A. Now, A has to pay excise duty on product manufactured by it as well as bear the
excise duty paid by the supplier of raw material B. Under the MODVAT scheme, a manufacturer can
take credit of excise duty paid on raw materials and components used by him in his manufacture. It
amounts to excise duty only on additions in value by each manufacturer at each stage.
The modvat scheme is regulated by Rules 57A to 57U of the Central Excise Rules and the
notifications issued there under (The Central Excise Rules, 2002 (Section 143 of the Finance
Act, 2002).
Modvat Scheme ensures the revenue of the same order and at same time the price of the final
product could be lower. Apart from reducing the costs through elimination of cascade effect, and
bringing in greater rationalization in tax structure and also bringing in certainty in the amount of tax
leviable on the final product, this scheme will help the consumer to understand precisely the impact
of taxation on the cost of any product and will, therefore, enable consumer resistance to unethical
attempts on the part of manufacturers to raise prices of final products, attributing the same to
higher taxes.
Subsequently, MODVAT scheme was restructured into CENVAT( Central Value Added Tax) scheme.
A new set of rules 57AA to 57AK , under The Cenvat Credit Rules, 2004, were framed and
whatever restrictions restrictions were there in MODVAT Scheme were put to an end and
comparatively, a free hand was given to the assesses.
Under the Cenvat Scheme, a manufacturer of final product or provider of taxable service shall be
allowed to take credit of duty of excise as well as of service tax paid on any input received in the
factory or any input service received by manufacturer of final product.
1. All goods, except light diesel oil, high speed diesel oil and motor spirit, commonly known as
petrol, used in or in relation to the manufacture of final products whether directly or
indirectly and whether contained in the final product or not and includes lubricating oils,
greases, cutting oils, coolants, accessories of the final products cleared along with the final
product, goods used as paint, or as packing material, or as fuel, or for generation of
electricity or steam used in or in relation to manufacture of final products or for any other
purpose, within the factory of production
2. All goods, except light diesel oil, high speed diesel oil, motor spirit, commonly known as
petrol and motor vehicles, used for providing any output service;
Explanation 1 : The light diesel oil, high-speed diesel oil or motor spirit, commonly known as
petrol, shall not be treated as an input for any purpose whatsoever.
Explanation 2 : Inputs include goods used in the manufacture of capital goods which are further
used in the factory of the manufacturer;"
And includes services used in relation to setting up, modernization, renovation or repairs of a
factory, premises of provider of output service or an office relating to such factory or premises,
advertisement or sales promotion, market research, storage upto the place of removal,
procurement of inputs, activities relating to business, such as accounting, auditing, financing,
recruitment and quality control, coaching and training, computer networking, credit rating, share
registry and security, inward transportation of inputs or capital goods and outward transportation
upto the place of removal;"
Manufacturer and service providers can avail Cenvat credit of capital goods used by them. The plant
and machinery and allied items are purchased by a manufacturer. Such goods known as capital
goods may be duty paid. The capital goods shall be used in manufacture of final products or for
providing output service. The CENVAT credit in respect of duty paid on capital goods shall be taken
only for an amount not exceeding fifty percent of the duty paid in the same financial year and the
credit of balance amount can be take in any financial year subsequent to the financial year in which
the capital goods were received.
Duty Paying Documents against which CENVAT credit can be availed are:-
Invoice issued by
A supplementary invoice
A bill of entry.
A certificate issued by appraiser of customs
An invoice/bill/challan issued by providers of input service.
A challan evidencing payment of service tax.
Credit of duty is allowed only if all the conditions given below are met:-
The basic criteria for availment of credit of duty paid on inputs or capital goods is that the
goods shall be used in manufacture of final products.
The goods shall be accompanied with proper prescribed documents.
The final products shall not be exempt from whole of duty or chargeable to nil rate of duty.