CUP method: Fuelling precision in transfer pricing

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. 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.