CUP method: Fuelling precision in transfer pricing

This is typically the preferred approach for determining the arm’s length price

By Mahar Afzal/Compliance Corner

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To determine the appropriate arm’s length price, companies need to undertake benchmarking studies using specific methods. — KT file
To determine the appropriate arm’s length price, companies need to undertake benchmarking studies using specific methods. — KT file

Published: Sun 12 Nov 2023, 4:09 PM

Last updated: Sun 12 Nov 2023, 4:10 PM

The corporate tax law and the latest guidance (CTGTP1) published by the Federal Tax Authority on transfer pricing necessitate that any transactions involving related parties or connected individuals adhere to the arm’s length principle. This dictates that the outcomes of the transaction or agreement should align with what would have resulted if the parties involved were unrelated to each other.

To determine the appropriate arm’s length price, companies need to undertake benchmarking studies using specific methods. These are in two categories: traditional transaction methods, such as the comparable uncontrolled price (CUP) method, resale price method, and cost-plus method; and transactional profit methods, including the transactional net margin method and transactional profit split method.

The CUP method involves comparing the price of a controlled transaction to the price of a comparable uncontrolled transaction under similar circumstances. If there is a discrepancy, it is necessary to replace the price in the controlled transaction with the price observed in the uncontrolled transaction.

The CUP method requires identifying the (i) comparable uncontrolled transaction and (ii) comparable uncontrolled arrangement represented by the quoted price. This means to find two independent parties where the external supplier is in the same business-like an internal supplier and selling the same goods and services under the same terms and conditions to any third independent party. To avoid this, usually, the price charged by the internal supplier to independent parties (internal CUP) is compared with the price charged by the same supplier to the related parties and connected persons.

When applying the CUP method to service sales, it is crucial to consider various factors, including the agreed-upon terms and conditions between the parties, the timing and mode of service delivery, and the location of service provision. On the other hand, when dealing with goods, it is important not to overlook the physical attributes and quality of the product. Additionally, the contractual terms of the controlled transaction, such as trade volumes, duration of the arrangement, delivery timing and terms, transportation, insurance, and foreign currency terms, should be considered. It’s worth noting that certain economically significant characteristics of certain commodities, such as prompt delivery, may result in a premium or discount.

Mahar Afzal is a managing partner at Kress Cooper Management Consultants.
Mahar Afzal is a managing partner at Kress Cooper Management Consultants.

When conducting a price comparison, if there are no discrepancies in terms of general conditions and quantities between the transactions, then the price charged to the independent party is considered the transfer price for both related party transactions and transactions with connected individuals. However, if any of the terms mentioned in the previous paragraph exhibit variations, adjustments are necessary to determine the price for transactions involving related parties and connected individuals based on the price charged to the independent party.

The CUP method is typically the preferred approach for determining the arm’s length price in the transfer of commodities between related entities. When referring to “commodities,” we are referring to physical products for which quoted prices serve as a benchmark used by independent parties in the industry to establish prices in transactions that are not influenced by related party relationships.

The CUP method is a conventional and straightforward approach to establish the transfer price. However, it can be challenging to locate an external CUP, making it difficult to find an appropriate benchmark. In cases where adjustments to the internal CUP are necessary, determining the accurate transfer price can be a complex task.

To facilitate a thorough assessment of a taxpayer’s transfer pricing strategy, it is essential for taxpayers to furnish credible evidence and documentation that supports the determination of the transfer price and justifies any adjustments made by the taxable person. This should include details such as pricing formulae employed, agreements with end-customers unrelated to the taxpayer, any applied premiums or discounts, the date of pricing, information regarding the supply chain, and records prepared for non-tax purposes. Given these requirements, taxpayers are obligated to maintain comprehensive documentation to comply with the regulations.

Mahar Afzal is a managing partner at Kress Cooper Management Consultants. The above is not an official opinion of Khaleej Times but an opinion of the writer. For any queries/clarifications, please write to him at mahar@kresscooper.com.


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