Comparable Uncontrolled Price Method

The comparable uncontrolled price (CUP) method compares the charges of the property or services of transfers in a controlled transaction to the charges of the property or services of transfers in comparable uncontrolled transactions in comparable circumstances. It is one of the five major transfer pricing methods.

The method helps determine the arm's length pricing of cross-border transactions and the royalty of an intangible asset. It is most appropriate for commodity transactions where the same products or services are sold in both uncontrolled and controlled transactions. The products here are of the same type, quantity, and quality.

The comparable uncontrolled price method is a traditional transaction method. It ensures that the transactions between related companies are comparable to those conducted prices with unrelated organizations. The method helps determine arm's length pricing across companies. It is generally used in cases where the nature, credit terms, geographical markets, and risks of products match. 

In the United States, it is also known as the CUP method for tangible goods, the CUT method for intangible goods, and the CUSP method for services. CUT represents the comparable uncontrolled transaction method for pricing intangible goods, while CUSP represents the comparable uncontrolled services price method for pricing services. 

The CUP method can be used in cases of comparable uncontrolled transactions. These are transactions that have taken place in comparable circumstances with respect to the uncontrolled transactions to be assessed. The CUP method can be used using external or internal comparable. 

The next step would be comparing the conditions and price involved in the controlled transaction between one company and the conditions of the located independent companies' comparable uncontrolled transactions. The conditions of the controlled transactions are said to be at arm's length if the two prices turn out to be the same. Suppose they are different; it means the company's financial relations are not at arm's length. Prices have to be substituted to achieve arm's length. 

Below is a brief description of the types of CUP methods.

1. Internal CUP Method: Under the internal comparable uncontrolled price method, a company determines prices by finding comparable transactions it has executed with third parties. The conditions of transactions with related parties are the same as those with the third parties.
2. External CUP Method: For the determination of prices through the external CUP method, the company shall take into account comparable transaction prices between third parties. It shall be covered to an extent to whichever level they exist.

It can be applied in cases where there is high product comparability. The products involved shall be of the same type, nature, quantity, and quality. The transactions are required to happen at the same or similar conditions, stage of production, or distribution.

However, they can also be used in cases where there are slight product differences as long as there are no material effects on prices. If differences exist, then making adjustments to eliminate the effect would require using a different method.

Let us look at a few examples to have an understanding of the concept.

Example #1

Let's say there is a company X that sold car parts to company Y at $5,000. X sold parts of the same nature, quantity, and quality to an unrelated party, Z, at $6,000. The transaction between X and Y is called a controlled transaction as the price is available to X. There is a difference in the transfer price. 

Thus, to find the arm's length price, adjustments have to be made. In this case, the difference for adjustment is $1,000 ($5,000-6,000), which shall be added to X's income. 

Example #2

In 2021, Latin American tax authorities increased transfer pricing audits that are related to intercompany commodity transactions. They had challenged the use of the CUP method in certain cases. They argue that it is as complex as capturing economically relevant characteristics. The recommended OECD comparable uncontrolled price method is typically suitable for commodities. Also, there are suggestions to separate spot market and future market transactions as they could have different pricing structures. It is recommended that taxpayers keep records of transaction price commodity pricing policies and document complete information with commercial and operational areas. Thus, they are useful for audit purposes

The advantages and disadvantages of the CUP method are given as follows:

Advantages

• The most accurate and has low transfer pricing risk. 
• A highly recommended method of calculation of price. 
• A reflection of the price agreed by two unrelated parties in relation to the transaction and hence analyzed from both ways. 
• Eliminates the need and issue of involvement of related parties to be treated as the tested party with regard to pricing transfers. 
• It is a direct measure of arm's length price. 
• It is less sensitive to differences in non-transfer pricing factors, which include accounting treatment differences and costs between uncontrolled and controlled parties. It can be readily used in certain transactions, such as commodity products. 

Disadvantages

• It is challenging to find comparable uncontrolled transactions especially with intellectual property or services. Hence, perfect CUP is difficult to attain. 
• Highly sensitive to product's characteristic changes, which makes the application difficult. 
• It is challenging to make accurate, reasonable adjustments for comparability. Differences such as markets, geography and volume, profit potential, and contract terms must be comparable.  
• The adjusted differences may only sometimes have justifications or proof.  
• It is hard to achieve in real life.