A significant volume of the trade worldwide comprises of the transactions between different ent...
Transfer pricing can be defined as the price paid for the goods or services provided from one unit of an organisation to the other unit situated in different countries. To calculate the transfer pricing, various methodologies have been devised out which Comparable Uncontrolled Price (CUP) method is one such method. This piece of writing discusses the meaning, methodology, usage, regulatory framework, advantages and disadvantages of CUP method.
The CUP method is used where the nature of the product dealt by an organisation is same and where similarity can also be observed in terms of geographical markets, credit terms and risk involved. There are two types of Comparable Uncontrolled Price methods:
Internal CUP method: In this case, the buyer is the subsidiary of the selling entity and the seller also sells the same product to some other external entity within the same geographical market where the subsidiary also operates.
External CUP method: When two unrelated entities are doing sale and purchase, it is called as external Comparable Uncontrolled Price method.
It has been observed that in external Comparable Uncontrolled Price method the parameters are not satisfied. However, in internal Comparable Uncontrolled Price method, the chances of success are very high. The ITAT has often said that internal Comparable Uncontrolled Price method should be preferred over External Comparable Uncontrolled Price method.
Some of the factors that are generally used for the purpose of Comparable Uncontrolled Price method are nature of service, time period, geographical market, contractual terms etc.
The first step to use CUP method is to first identify a comparable uncontrolled transaction which took place under comparable circumstances to the controlled transactions one intends to assess. Both internal as well as external comparables can be used for this purpose. Internal comparables can be those transactions that took place between one’s organisation and an independent party and external comparables can be transactions that took place between independent enterprises in comparable conditions to the controlled transaction.
Once the above mentioned identification process has been completed, the next thing to be done is to compare the price and conditions of the controlled transaction between associated enterprises with the conditions and price of the comparable uncontrolled transaction between the independent enterprises that one has located. If the two prices come out to be the same, then these controlled transactions are said to be at arm’s length. In case the two prices are found to be different, then the transactions cannot be said to be at arm’s length price.
In order to identify whether an uncontrolled transactions is comparable or not, a person must find out answer to the following two questions:
The CUP method is most useful for the commodity transactions where the same products are sold in the controlled and uncontrolled transactions. Here, an important thing to note is that products must be of similar quality, quantity and type in both the transactions and transactions ought to happen roughly at the same time in similar conditions, at the same stage in production or in distribution chain. This method can also be used where there is slight difference in the product so long as the difference does not bring a material effect on the price. If there exists a material effect on the price and one fails to make adjustments to eliminate this material effect, then a need for different method arises.
The Comparable Uncontrolled Price method is also very useful for organisations who wish to set arm’s length payments for intercompany loans or conduct transactions which involve royalty payments.
The regulations related to Comparable Uncontrolled Price method are found in Rule 10B(1)(a) of the Income Tax Rules, 1962. The regulations state that:
Among other methods, CUP method is the most effective transfer pricing method. However, it can be time consuming and may get complicated at times. Therefore, it is suggested for the organisations to take care of it and avail the services of professionals in getting it done.
Read our Article:An introduction to the 5 Transfer Pricing Methods