Comparable Uncontrolled Price (CUP) Method

Meaning and Applicability

9th May 2012

Presented by: Sadaf Farooqi Trainee (Transfer Pricing)

Contents

Comparable Uncontrolled Price (CUP) method explanation in

Indian TP Regulations

OECD TP Guidelines
US TP Regulations

Important Judicial Precedents

2010 2012Grant GrantThornton ThorntonIndia. India.All rights reserved.

CUP Method Indian TP Regulations

2010 2012Grant GrantThornton ThorntonIndia. India.All rights reserved.

CUP Method Indian TP regulations

Applicability of CUP

As per Rule 10B(1)(a) of the Indian Transfer Pricing Regulations - Comparable uncontrolled price method is a method by which i. ii. The price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identified; Such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transactions (CUT) or between the enterprises entering into such transactions, which could materially affect the price in the open market.

iii.

The adjusted price arrived at under sub-clause (ii) is taken to be an arms length price (ALP) in respect of the property transferred or services provided in the international transaction

CUP method is considered as one of the traditional methods of determining the arms length price

2010 2012Grant GrantThornton ThorntonIndia. India.All rights reserved.

CUP Method Indian TP regulations

Applicability of CUP

No specific guidance is provided on when this method is reliable except rule 10C(2) However typical transactions in respect of which the comparable uncontrolled price method may be adopted are:

Transfer of goods Provision of services Intangibles Interest on Loans

Factors of Comparability to be considered while selecting CUT

Characteristics of property / services & FAR Contractual terms Conditions prevailing in the markets, location, laws in force etc.

2010 2012Grant GrantThornton ThorntonIndia. India.All rights reserved.

CUP Method Indian TP regulations

Internal CUP v/s External CUP

There are two types of CUP evidences, internal and external

Internal CUP

Internal CUP evidences are gathered from the assessees own transactions with independent third parties E.g. A Ltd sold x commodity to A Inc., its AE and it also sold to P Ltd (independent third party). In this case sales made to P Ltd is internal CUP evidence

External CUP

On the other hand external CUP evidences can be gathered from the sources outside the company which includes quotes from public exchanges, report of trade journal, data from Customs authorities etc.

Internal CUP is preferable over external, because the quality of data is more accurate in case of Internal CUP.

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CUP Method Indian TP regulations

How it is applied?

Identify the price charged or paid in CUT

Adjustment of the above price for transaction level differences on the basis of FAR analysis and enterprise level differences

Adjusted price is the arms length price

If two or more uncontrolled transactions are available, arithmetic mean would establish the arms length price

2010 2012Grant GrantThornton ThorntonIndia. India.All rights reserved.

CUP Method OECD Guidelines

2010 2012Grant GrantThornton ThorntonIndia. India.All rights reserved.

CUP Method OECD Guidelines

Applicability

Organization for Economic Co-operation and development (OECD) defines CUP as under: A transfer pricing method that compares the price for property or services transferred in a controlled transaction to the price charged for the property or services transferred in a comparable uncontrolled transaction in comparable circumstances

The CUP method is considered as the most direct and reliable way to apply arms length principle. When Comparable Uncontrolled price method and another transfer pricing method can be applied in equally reliable manner, the CUP method is to be preferred.

2010 2012Grant GrantThornton ThorntonIndia. India.All rights reserved.

CUP Method OECD Guidelines

Applicability

An uncontrolled transaction is comparable to a controlled transaction (i.e. it is a comparable uncontrolled transaction) for purposes of the CUP method if one of the two conditions is met:

None of the differences between the transactions could materially affect the price in the open market; Or Reasonably accurate adjustments can be made to eliminate the material effects of such differences

Where differences exist between the controlled and uncontrolled transactions, reasonably accurate adjustments should be made to eliminate the effect on price. The relative reliability of the CUP method is affected by the degree of accuracy with which adjustments can be made to achieve comparability.

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CUP Method OECD Guidelines

Examples of application of CUP method

Example 1 - Sale of Unbranded coffee beans

An independent enterprise sells unbranded Colombian coffee beans of similar type, quality and quantity as those sold between two associated enterprises and the controlled and uncontrolled transactions occur at the same stage in the production/ distribution chain and at approximately the same time then the price charged by the independent enterprise can be used as CUP. If the only available uncontrolled transaction involved unbranded Brazilian coffee beans, then it should be enquired whether the difference in the coffee beans has a material effect on the price of the coffee beans in the open market. If the difference leads to a difference in prices then

reasonable adjustments should be made in the price charged in the uncontrolled transaction. If reasonable adjustments are not possible then the reliability of CUP method vis--vis other methods is reduced and therefore some other method should be analyzed.

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CUP Method OECD Guidelines

Examples of application of CUP method

Example 2 - identical sales with difference in terms of sale

Circumstances surrounding controlled and uncontrolled sales are identical, except for the fact that the controlled sales price is a delivered price and uncontrolled sales are made FOB factory. The differences in terms of transportation and insurance generally have a definite and reasonably ascertainable affect on price. Therefore to determine the uncontrolled sales price adjustment should be made to the price for the difference in delivery terms.

Example 3 - difference in Volumes

A taxpayer sells 1000 tons of a product at Rs 80 per ton to its AE and 500 tons of the same product to an independent party at Rs 100 per ton. In this case it is to be analyzed, with regard to the market conditions and trends, whether the difference in volume should result for a difference in price.
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2010 2012Grant GrantThornton ThorntonIndia. India.All rights reserved.

CUP Method US TP Regulations

2010 2012Grant GrantThornton ThorntonIndia. India.All rights reserved.

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CUP Method US TP Regulations

Comparability and reliability considerations

As per the US TP regulations CUP method evaluates whether the amount charged in a controlled transaction is arms length by reference to the amount charged in a comparable uncontrolled transaction

Similarity of products generally will have the greatest effect on comparability under this method.
Contractual terms or economic conditions are also very important and comparability under this method depends on close similarity with respect to these factors, or adjustments to account for any differences.

The results derived from applying the comparable uncontrolled price method generally will be the most direct and reliable measure of an arms length price .

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CUP Method US TP Regulations

Factors relevant to CUP method

Quality of the product Contractual terms (e.g. scope and terms of warranties provided, sales or purchase volume, credit terms, transport terms);

Level of market (i.e., wholesale market, retail etc.,)

Geographic market in which the transaction takes place Date of transaction Intangible property associated with the sale; foreign currency risks

Alternatives realistically available to the buyer or seller

The reliability of the results derived from the comparable uncontrolled price method is affected by the completeness and accuracy of data used and the reliability of assumptions made

2010 2012Grant GrantThornton ThorntonIndia. India.All rights reserved.

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CUP Method US TP Regulations

Examples for application of CUP

Example 1 Effect of trademark

A Ltd sells the same product to controlled and uncontrolled distributors under substantially similar circumstances. The only difference is that A Ltd affixes its valuable trademark to the property sold in the controlled transaction.

Issue
Can the sale price of sales made to uncontrolled distributor be used as a CUP?

Example 2 - Effect of geographic differences

R Ltd manufactures radios and sells the same to a controlled and uncontrolled distributor. All the terms and conditions of sale are the same, but both the distributors are operating in different geographical regions namely Europe and US

Issue
What are the factors that need to be considered before deciding whether CUP method can be used or not?
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CUP Method US TP Regulations

Indirect Evidence of CUT

In general a comparable uncontrolled price may be derived from data from public exchanges or quotation media, but only if the following requirements are met

The data is widely and routinely used in the ordinary course of business in the industry to negotiate the prices for uncontrolled sales; The data is used to set prices in the controlled transaction in the same way it is used by uncontrolled taxpayers in the industry The amount charged in controlled transaction is adjusted to reflect the product and service variations

Limitation: Use of data from public exchanges or quotation media may not be appropriate under extraordinary market conditions

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CUP Method US TP Regulations

Examples for Indirect Evidence of CUT

Example1 Use of quotation medium

On June 1, X Ltd enters into contract with Y Ltd. its foreign subsidiary to purchase crude oil. They agree to base their sales price on the average of the prices published for that crude oil in quotation medium in the five days before Aug 1, the date set for delivery. Both the entities agree to adjust the price for the particular circumstances of their transactions The quotation medium used by the entities is widely used in ordinary course of business to establish prices for uncontrolled sales. Can the price derived from the quotation medium be considered as an evidence of CUP? Would the answer be different, if war breaks out in countries X and Y , major oil producing companies, causing significant instability in the price of oil in the world oil markets?

Issue

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Important Judicial Precedents

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Important Judicial Precedents

UCB India Private Limited v/s ACIT (Mumbai ITAT)

CUP method is the most direct method for determining arms length price.

Serdia Pharmaceuticals (India) Pvt. Ltd v/s ACIT

CUP method is a preferred method and it leads to more reliable results vis--vis the results obtained by applying transaction profit method.

Nimbus Communications Ltd v/s ACIT (Mumbai ITAT)

For computing notional interest external CUP can be used.

DCIT v/s 3 global services Pvt Ltd (Mumbai ITAT)

CUP method preferable over TNMM where price is determined on the basis of hourly rate and not as percentage costs .

Per hour billing rate published by NASSCOM for a specific business segment can be used as an external CUP in determining the ALP.
2010 2012Grant GrantThornton ThorntonIndia. India.All rights reserved.

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Important Judicial Precedents

Intel Asia Electronics Inc v/s ADIT (Bangalore ITAT)

For benchmarking slump sale, in the absence of identical / similar transaction(s), valuation report to be used, failing which IT WDV can be considered as a reasonable methodology

Coastal Energy Pvt. Ltd. v/s ACIT (Chennai ITAT)

Use of comparable prices obtained from customs authorities are appropriate in computing ALP of import transactions However, to the converse, in the case of Serdia Pharmaceuticals (India) Pvt Ltd vs ACIT (Mumbai ITAT) and Panasonic India Private Limited v/s ITO (Delhi ITAT), prices obtained from customs authorities were not considered as appropriate CUP.

Agility Logistics Private Limited v/s DCIT (Mumbai ITAT)

Application of CUP method based on comparable transactions of foreign AE with its unrelated customers upheld

2010 2012Grant GrantThornton ThorntonIndia. India.All rights reserved.

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Important Judicial Precedents

Liberty Agri Products Pvt Ltd V/s the Income tax Officer
Customs rate on the date of contract and not as on the date of actual receipt of consignment relevant for determining ALP

Drilbits International Pvt. Ltd v/s DCIT

Price charged by predecessor business from the AE, from whom business was acquired by the assessee can be used as CUP. Rates charged to third parties in the domestic market were not comparable with the rates charged to AE in the export market on account of differences between the two segments as to product liability risk, marketing risk, bad debts risk etc.

2010 2012Grant GrantThornton ThorntonIndia. India.All rights reserved.

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Thank You
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