Comparable Uncontrolled Price Method

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Comparable Uncontrolled Price (“CUP”) Method

WHEN CAN COMPARABLE UNCONTROLLED PRICE METHOD BE APPLIED?

Comparable uncontrolled price method (also known as “CUP method transfer pricing”) is one of the transfer pricing methods, which, as the name suggests, compares

  • the price in the transaction which is being evaluated for arm’s length,
  • with the price charged /received between two unrelated parties for similar goods or services.

 

This can take place under two cases, i.e, where the transaction is between : –

  • the company and unrelated third party (Internal comparable uncontrolled price). In such cases, the concerned company buys, or sells similar goods or services in comparable transactions with unrelated enterprises; or
  • Two unrelated parties (External comparable uncontrolled price). In such cases, two Unrelated enterprises buy or sell similar goods or services, as is being done between the AE.

comparable uncontrolled price ("CUP") Method

 

comparable uncontrolled price ("CUP") Method

 

Facts : – Problem  1 on CUP method transfer pricing

  • ICO 1 sold unbranded Colombian coffee beans to ICO 2 (non AE).
  • ICO1 also sold unbranded Colombian coffee beans of similar type, quality, and quantity to FCO.

Issue:

  • Identify the nature of transaction as
    1. Internal CUP; and
    2. Controlled transaction.

Solution:

    • The transaction between ICO1 and FCO is a controlled transaction.
    • The transaction between ICO 1 and ICO 2 is an internal CUP.

comparable uncontrolled price ("CUP") Method

Facts: – Problem  2 on CUP method transfer pricing

  • AE 1 sold unbranded Colombian coffee beans to AE 2.
  • AE 1 did not sell any unbranded Colombian beans to a third party (Non-AE).
  • There is a sale of unbranded Colombian coffee beans of a similar type, quality and volume between non-AE 1 non-AE 2.

Issue:

  • Identify the nature of the transaction as External CUP and Controlled transactions?

Solution:

  • Transaction between AE 1 and AE 2 is a controlled transaction.
  • Transaction between Non – AE 1 and Non AE 2  is termed as external CUP, since it’s a transaction between two external parties.

 

STEPS INVOLVED IN COMPARABLE UNCONTROLLED PRICE METHOD  (“CUP method transfer pricing”)

STEP 1: – IDENTIFYING PRICES OF  COMPARABLE UNCONTROLLED TRANSACTION/S

Identify prices charged from or paid to, on the transfer of goods or services in comparable uncontrolled transaction/s by X Ltd. Such transaction could be entered into by X Ltd. itself or between two unrelated enterprises.

CUP Method

STEP 2: – ADJUSTMENTS TO UNCONTROLLED PRICE

The price arrived at Step 1 should be adjusted for the following : –

1. If there are any functional differences between the international transaction or the Specified Domestic Transaction (SDT) under review, and the comparable uncontrolled transactions, the adjustment should be made for such functional differences. Functional differences could be for the following : –

  • Quality of product or service,
  • Contractual terms,
  • Credit terms (one entity allows a credit of 1 month and other allows a credit of 6 months),
  • Transport terms – Free on Board, Cost, Insurance and Freight
  • Market level (wholesale, retail, etc.));

2. If there are any differences between the enterprises entering into such transactions, such as the size of the entity (if one entity is market leader and other is a small startup in the same segment), operating environment, which could materially affect the price in the open market, the price should be adjusted for such differences.

Such an adjusted price will be the arm’s length price.

 

EXAMPLES ON CUP METHOD TRANSFER PRICING

EXAMPLE 1 ON CUP METHOD TRANSFER PRICING : –

  • AE 1 sold unbranded Colombian coffee beans to AE 2 at Rs 5,00,000.  AE 1 sold unbranded Colombian coffee beans of similar type, quality, and quantity to a third party (Non-AE) at Rs 4,00,000.
  • Analyze the impact of transfer pricing provisions and ascertain the ALP?

SOLUTION: –

  • The price charged by AE 1 for sale of coffee beans from AE 2 is Rs. 5,00,000 and the price charged from Non-AE is Rs. 4,00,000.
  • Since, the price charged from AE 2,  Rs. 5,00,000 is more than the price charged from Non-AE Rs. 4,00,000, we cannot consider Rs 4,00,000 as ALP as it will reduce the taxable income of AE 1. This is due to the reason that TP provision cannot be applied to result in a reduction in taxable income.

Hence, the ALP for sale of coffee beans by AE 1 to AE 2 shall be Rs. 5,00,000.

EXAMPLE 2 ON CUP METHOD TRANSFER PRICING: –

  • AE 1 sold unbranded Colombian coffee beans to AE 2 at Rs 5,00,000.  AE 1 sold unbranded Colombian coffee beans of similar type, quality, and quantity to a third party (Non-AE) at Rs 6,00,000.
  • Analyse the impact of transfer pricing provisions and ascertain the ALP?

SOLUTION : –

  • The price charged by AE 1 for sale of coffee beans from AE 2 is Rs. 5,00,000 and the price charged from Non-AE is Rs. 6,00,000.
  • Since, the price charged from Non-AE is Rs. 6,00,000, this would be an internal CUP. Since it is more than the price charged from AE 2 under the controlled transaction, i.e. Rs. 5,00,000, the ALP would be Rs. 6,00,000.
  • Accordingly, by applying the TP provisions, Rs. 1,00,000 (6,00,000 – 5,00,000) would be added to the income of AE 1.

 

EXAMPLE 3 ON CUP METHOD TRANSFER PRICING : –

  • AE 1 sold unbranded Colombian coffee beans to AE 2 at Rs 5,00,000.  AE 1 sold unbranded Colombian coffee beans of similar type, quality, and quantity to a third party (Non-AE) at Rs 5,50,000 (Internal comparable uncontrolled price). Independent third party (i.e., Non-AE) sold unbranded Colombian coffee beans of similar type, quality, and quantity to a third party (Non-AE) at Rs 6,00,000. (External comparable uncontrolled price).
  • Analyze the impact of transfer pricing provisions and ascertain ALP?

SOLUTION : –

  • In the present case, ALP can be as under : –
    • Applying internal CUP, the price would be Rs 5,50,000
    • Applying external CUP, the price would be Rs 6,00,000
  • Where both internal and external CUP are available, Internal Comparable uncontrolled price method should be preferred over ExternalComparable uncontrolled price method for comparison of the controlled transaction with the uncontrolled transaction.
  • In this case, the ALP would be Rs 5,50,000, i.e., the price at which coffee beans were sold by AE 1 to Non-AE.
  • Hence, the income of AE 1 would be increased by Rs 50,000 (5,50,000 – 5,00,000).

EXAMPLE 4 ON CUP METHOD TRANSFER PRICING: – 

  • AE 1 sold unbranded Colombian coffee beans to AE 2 at Rs 5,00,000.  AE 3 sold unbranded Colombian coffee beans of a similar type, quality and quantity to AE 4 at Rs 5,50,000. Independent third party (i.e., Non-AE) sold unbranded Colombian coffee beans of a similar type, quality, and quantity to a third party (Non-AE) at Rs 6,00,000. (External CUP).
  • Analyze the impact of transfer pricing provisions on AE 1 and ascertain ALP?

SOLUTION: –

  • Transactions between two AE’s are controlled transactions and such transactions cannot be considered as the base for determining ALP.
  • In the given case, transactions between AE 1 & AE 2 amounting Rs. 5,00,000 and AE 3 & AE 4 amounting Rs. 5,50,000 are controlled transactions and hence should not be considered as comparables for the purpose of determining ALP.
  • Therefore, ALP would be Rs 6,00,000 in the case, i.e., the price at which coffee beans were sold between two Non-AE.
  • Hence, the income of AE 1 would be increased by Rs 1,00,000 (6,00,000 – 5,00,000).
  • AE1 sold 1,000 bicycles to AE 2 at FOB price (Free on Board) of Rs 3,000 per bicycle
  • AE 1 sold 10,000 bicycles to Non-AE at CIF price (Cost, Insurance and Freight) of Rs 6,000 per bicycle.
  • AE2 would bear the cost of insurance and freight of Rs 500 per bicycle.
  • As Non-AE placed an order in large volumes, AE 1 offered a quantity discount of Rs 200 per bicycle.
  • Sales were made to Non-AE at a credit facility of three months whereas the sales to AE 2 have always been on a cash basis.
  • The cost of credit may be taken as 1% per month.
  • Analyze the impact of transfer pricing provisions and ascertain the ALP?

Solution: –

CUP Method

 

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