When it comes to taking important decisions, we humans, knowingly or unknowingly, often tend to look into our neighbourhood for past examples of how people have handled similar situations before. It’s simple and straight forward – if someone else has already done similar work, let’s just refer the same to meet our purposes and save some precious time. The Comparable Uncontrolled Price Method is also from the same school of thought. While the name might sound too technical, the central idea is to determine the International Transfer Pricing by referring to other similar transactions which might have taken place in the past. However, it is important to account for all factors in detail, before concluding a transfer price.
Key Terms Used
Before we explain the method, let’s understand a few important terms used in our discussion ahead:
Controlled Transaction: A transaction between two associated enterprises is called a Controlled Transaction. It is the transaction for which the transfer price is being determined.
Uncontrolled Transaction: A transaction which has taken place between independent or unrelated enterprises is called an Uncontrolled Transaction. One of the entities involved in such transaction may be the entity under consideration, however, the counter party must not be an associated enterprise. In brief, the sole deciding factor is that the entities involved must not be related.
Internal Comparables: Data set pertaining to transactions taken place between any of the entity under consideration and other independent entities.
External Comparables: Data set pertaining to transactions which have taken place between two or more entities other than those under consideration.
What is the Comparable Uncontrolled Price Method?
The Comparable Uncontrolled Price Method (often referred to as CUP method) advocates determination of transfer price by identifying an uncontrolled transaction which is comparable to the transaction under consideration. Here, the comparability of the uncontrolled transaction is to be decided on the basis of terms and conditions of the transactions.
Thus, Comparable Price +/- Adjustments= Transfer Price. The adjustments are to account for the impact of differences between the transactions.
One must take into account the product or services being transacted, the contractual terms, the economic circumstances under which such transaction has occurred and the business strategies surrounding the transaction. After considering results of such comparison, an uncontrolled transaction will be considered comparable if –
- There are no materially price-altering differences in the transactions being compared, or
- If there are any material differences between the transactions, they can be adjusted with reasonable accuracy.
Based on the types of transactions used as comparables, there can be two variants of this method:
- Internal Comparable Uncontrolled Price – When the price is determined using internal comparables e.g. transaction between Alpha Inc and Beta Ltd in the illustration
- External Comparable Uncontrolled Price – When the price is determined using external comparables e.g. transaction between Omega Inc and Theta Ltd in the illustration
Computation of Arm’s Length Price under CUP Method
Step 1 – Find comparable products or services in the market and then find uncontrolled transactions and data set for the same.
Step 2 – Perform comparability analysis on the transactions being considered, and select the most appropriate transactions as comparables. Comparability analysis must consider the following points:
- Product Comparability – characteristics, quality, end-use, novelties, features, addon products, after-sales services, etc.
- Contractual Terms –the credit period offered, allied transactions, term period of the contract, the quantity contracted, the place of delivery, etc.
- Risk Incurred – In a transaction between Associated Enterprises, the associated enterprise may not be selling directly to end consumers. However, in an open market transaction, an independent entity is exposed to inventory risk and consumer default risk. These risks undertaken by the other associated enterprise must be quantified and adjusted to the price. There may be similar risks which may require adjustments.
- Geographical Factors – the location where the product is sold or produced, the Government regulations, the applicable taxes, the sources of raw materials, etc.
Step 3 – Analyse the differences between the controlled transactions and the uncontrolled transactions considered as comparable. Quantify the differences in terms of impact on the pricing and make adjustments to the price of an uncontrolled transaction to arrive at transfer price.
Advantages and Disadvantages of the CUP Method
- The Comparable Uncontrolled Price method is the most direct method of calculating transfer price. It establishes direct connections with market price through the comparable transactions and thus, presents enough evidence for tax assessments.
- The method is flexible and can be easily combined with other methods of computing the transfer price.
- Comparable data have to be from a reliable source and must be available in detail, to allow analysis of the transaction. However, such information may not be available at all or may involve a significant cost to procure or maintain, for many industries and product categories.
- Finding comparable transactions may sometimes prove to be a difficult task, as the uncontrolled transaction must strictly match the transaction being priced.
- Establishing a basis for adjustments to the price of the uncontrolled transaction and the impact of the same on the price with reasonable accuracy is difficult and can be long process as it requires a detailed analysis of both the transactions, the underlying products and the economic conditions.
When to use the Comparable Uncontrolled Price Method?
The CUP method works only under specific circumstances and therefore, one must firstly brainstorm on the following points, before proceeding with this method, to ensure the viability of its results:
- Comparable Product – Do the products or services being priced have an existing market? Are they comparable to the ones in the market? If the products or services are entirely a new introduction to the market or far-flung innovative, it may render them incomparable.
- Comparable Transactions – Are there any comparable transactions? The transactions being considered as comparable must be of same quality products and of approximately same quantities, at the same stage of production or distribution chain and in the same economy. If there are differences, can the differences be reasonable measured and adjusted?
- Access to Reliable Data –Is comparable data available? Is the same accessible and whether the source is reliable? Is the cost involved in procuring or maintaining the data reasonable?