CUP Method Application

The Comparable Uncontrolled Price (CUP) method is a Transfer Pricing approach used to evaluate whether the prices or profit margins in transactions between related entities align with the arm’s length principle. It works by comparing the prices or margins of these related-party transactions (controlled transactions) to those of similar transactions conducted between independent, unrelated parties under comparable conditions. The OECD outlines this method as being “the most direct and reliable way to ensure compliance with the arm’s length principle,” if sufficient reliable comparable uncontrolled transactions can be identified.

When is CUP method used?

The CUP method is particularly well-suited for transactions involving commodities, where the same or very similar products are traded in both controlled and uncontrolled transactions. For this method to be applicable, the products in both transactions should be of comparable type, quality, and quantity. Additionally, the transactions should occur around the same time, under similar market conditions, and at the same stage in the production or distribution process.

The method can still be applied if there are minor differences in the product, provided those differences do not significantly impact the price. However, if the differences do have a substantial effect on the price and cannot be reliably adjusted for, it may be necessary to choose an alternative Transfer Pricing method.

Using the CUP method involves comparing the price and terms of the controlled transaction with those conducted between independent parties. If the prices match, it indicates that the controlled transaction is at arm’s length. However, if the prices differ, it may suggest that the controlled transaction does not meet arm’s length standards. In such cases, the price in the controlled transaction would need to be substituted with the price from the comparable uncontrolled transaction to determine what the conditions should look like to comply with the arm’s length principle.

How to apply the CUP method?

For application of the CUP method, you first need to identify a comparable uncontrolled transaction that occurred under similar circumstances to the analyzed one. These comparisons can be based on either internal or external comparables:

• Internal comparables involve transactions between your organization and independent third parties.
• External comparables involve transactions between two independent enterprises under conditions like the controlled transaction.

After you identify the uncontrolled transactions for comparison, the further step is to assess the transactions based on relevant characteristics, such as the type of goods or services, contractual terms, geographic markets, functions performed, risks assumed, and other significant economic factors.

The prices or profit margins of the controlled transactions are compared to those of the uncontrolled transactions.

• If the prices or margins of the controlled transactions fall within the arm’s length range, they are considered to be in compliance with Transfer Pricing standards.
• If significant differences between the controlled and uncontrolled transactions are identified that could affect the prices or margins, adjustments may be necessary to ensure comparability. These adjustments could account for differences in functions, risks, or other relevant factors.

In terms of comparability, as the number of potentially comparable data may be somewhat limited in certain industries, the OECD guidelines also allow to apply a broader approach by expanding the search to more general and parallel sectors. In particular, we can refer to the guidance of OECD on the availability of comparables suggested in OECD Transfer Pricing Guidelines, ‘Limitations in available comparables’ section Paragraph 3.38 stating that ‘The identification of potential comparables has to be made with the objective of finding the most reliable data, recognising that they will not always be perfect. For instance, independent transactions may be scarce in certain markets and industries. A pragmatic solution may need to be found such as broadening the search and using information on uncontrolled transactions <..> in other industries.’

Finally, it is crucial to maintain detailed documentation to support the use of the CUP method. This documentation should include a thorough comparability analysis and records of any adjustments made to the data, as tax authorities often require such evidence to validate the transfer pricing approach.

Why CUP?

The CUP method is considered the most reliable approach for Transfer Pricing when high-quality comparable data is available. A transaction is deemed comparable if any differences between the transactions or parties being analyzed do not significantly impact the price, or if adjustments can be made to account for and neutralize the effect of such differences. For the controlled transaction to meet the arm’s length standard, its price must match the price observed in the comparable uncontrolled transaction.

Read more about the challenges of CUP method here.

To effectively apply the CUP method, it is important to utilize reliable data from comparable uncontrolled transactions. Use a free trial or request a demo of our databases today.