Comparable Uncontrolled Price Method Transfer Pricing
The application of Arm’s Length Principle while implementing the provisions of Transfer Pricing, to arrive at the price of a transaction between unrelated parties is essential. However different situations call for application of different methods of the ALP principle, depending on the mitigating factors in every transaction. One such method is the Comparable Uncontrolled Price Method, also called, the CUP Method. Let’s take an in- depth look into this concept.
|Principle of International Taxation||Transfer Pricing|
|Transaction between||International Parties|
|Transfer Price||Price charged between two Associated Enterprises|
|Arm’s Length Price Principle||Price charged between two unrelated parties|
|Governing Provision||Section 92C, Income Tax Act, 1961|
|Type of Method||Traditional Transaction Method|
|Application in cases||When transaction is entered for similar goods or services|
|Application of method||Comparison of prices in the related party transaction, with that of the price of a transaction between unrelated parties|
|Types of transactions||
CUP Method Transfer Pricing or Comparable Uncontrolled Price Method Transfer Pricing
WHEN CAN CUP METHOD BE APPLIED – Comparable Uncontrolled Price, as the name suggests, compares the price in the related party transaction with the price charged /received between a transaction entered into between two unrelated parties for similar goods or services.
This can take place under two cases, i.e, where the transaction is between : –
- Internal CUP – Transaction between company and unrelated third party – Diagram 1.37
In such cases, the concerned company buys, or sells similar goods or services in comparable transactions with unrelated enterprises; or
- External CUP – Transaction between two unrelated enterprises – Diagram 1.38
In such cases, two unrelated enterprises buy or sell similar goods or services, as are being done in the related party transaction between the AE.
Note : – The fundamental principle of this method is identification of identical transaction : –
- Entered into by taxpayer with unrelated enterprise – This is termed as internal CUP; or
- Entered into between unrelated parties – This is termed as external CUP.
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, in which it owns 100% preference shares and 28% equity shares.
Identify whether which of the transaction is
Internal CUP or
Controlled transaction ?
- Transaction between ICO1 and FCO is a controlled transaction.
- Transaction between ICO 1 and ICO 2 is an internal CUP.
AE 1 sold unbranded Colombian coffee beans to AE 2. However,
it did not sell any unbranded Colombian beans to third party (Non-AE).
You are informed that there is a sale of unbranded Colombian coffee beans of similar type, quality and volume between non-AE 1 non-AE 2.
Identify the nature of transaction as External CUP and Controlled transaction ?
- 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 CUP Method Transfer Pricing
It has been assumed that we are examining Transactions for the purpose of TP compliance of X Ltd.
Step 1 : – Identify prices of Comparable uncontrolled transaction/s (between independent parties)
Identify prices charged on transfer of goods or services in comparable uncontrolled transaction/s by X Ltd. / paid for purchase of goods or services by X Ltd. Such transaction could be entered into by X Ltd. itself, or between two third parties (say Y and Z) , where Y and Z are unrelated to each other.
Note : – While comparable uncontrolled transaction can be an Internal CUP or External CUP, use of Internal CUP is preferred over External CUP
Step 2 : – Adjustments to Uncontrolled Price
The price arrived at Step 1 should be adjusted for the following : –
a) Functional Differences
If there are any functional differences between the international transaction or the Specified Domestic Transaction (SDT) under review, and the comparable uncontrolled transactions , adjustment should be made for such functional differences . Functional differences could be for the following : –
- Quality of product or service – Supply of different quality of coffee, supply of different type of mobiles etc ;
- Contractual terms ;
- Credit terms (one entity allows a credit of 1 month and other allows credit of 6 months),
- Transport terms – Free on Board or Cost, Insurance and Freight
- Market level – Wholesale purchase, retail purchase
b) Entity level Differences
If there are any differences between the companies entering into such transactions (X Ltd. and other entity which is being compared), such as size of the entity (if one entity is market leader and X is a small startup in same segment), operating environment (geographical differences), which could materially affect the price in the open market, the price should be adjusted for such differences.
Such adjusted price will be the arm’s length price.
Examples on Comparable Uncontrolled Price Method
Comparable Uncontrolled Price Method (CUP) Method Transfer Pricing – Example 1 : –
Arun Ltd . sold unbranded Colombian coffee beans to Varun Pte Singapore, a company under common ownership and control at Rs. 5,00,000. Arun Ltd . sold unbranded Colombian coffee beans of similar type, quality and quantity to third party Sunder Ltd. at Rs. 4,00,000. Analyse the impact of Transfer Pricing provisions and ascertain the ALP ?
Price charged by Arun Ltd . , for sale of coffee beans from Varun Pte Singapore is Rs. 5,00,000 and the price charged from Sunder Ltd is Rs. 4,00,000.
Since, the price charged from Varun Pte Singapore, Rs. 5,00,000 is more than the price charged from Sunder Ltd , a Non-AE of Rs. 4,00,000, we cannot consider Rs. 4,00,000 as ALP , as it will reduce the taxable income of Arun Ltd . . This is due to the reason that TP provision cannot be applied to result in reduction in taxable income(“Base Erosion Concept”).
Hence, the ALP for sale of coffee beans by Arun Ltd . to Varun Pte Singapore shall be Rs. 5,00,000.
Comparable Uncontrolled Price Method (CUP) Method Transfer Pricing – Example 2 : –
Arun Ltd . sold unbranded Colombian coffee beans to Varun Pte Singapore at Rs 5,00,000. Arun Ltd . sold unbranded Colombian coffee beans of similar type, quality and quantity to , Chandan Ltd. UK, wherein its parent owned 25% share capital but where it did not had any management or control at Rs 6,00,000. Analyse the impact of Transfer Pricing provisions and ascertain the ALP ?
- Price charged by Arun Ltd . for sale of coffee beans from Varun Pte Singapore is Rs. 5,00,000 and the price charged from Chandan Ltd. UK is Rs. 6,00,000.
- Since, the price charged by Arun Ltd . from Chandan Ltd. UK (an external third party) is Rs. 6,00,000, this would be an internal CUP . Since it is more than the price charged from Varun Pte Singapore under controlled transaction, i.e. Rs. 5,00,000, the ALP would be Rs. 6,00,000e the price charged from external third party.
- Accordingly, by applying the TP provisions, Rs. 1,00,000 ( 6,00,000 – Rs.5,00,000) would be added to the income of Arun Ltd . Thus revenue of Arun Ltd . for computing taxable income shall be increased by Rs. 1,00,000.
Comparable Uncontrolled Price Method (CUP) Method Transfer Pricing – Example 3 : –
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 third party (Non-AE) at Rs 5,50,000 (Internal CUP). Independent third party (i.e., Non-AE) sold unbranded Colombian coffee beans of similar type, quality and quantity to third party (Non-AE) at Rs 6,00,000. (External CUP). Analyse the impact of Transfer Pricing provisions and ascertain ALP ?
- 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 CUP should be preferred over External CUP for comparison of controlled transaction with 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).
Comparable Uncontrolled Price Method (CUP) Method Transfer Pricing – Example 4 : –
Arun Ltd sold unbranded Colombian coffee beans to Chandan Ltd. UK at Rs 5,00,000. Saloman Ltd., another Indian company, sold unbranded Colombian coffee beans of similar type, quality and quantity to its parent Coloman UK at Rs 5,50,000. A Ltd. an independent third party (i.e., Non-AE) sold unbranded Colombian coffee beans of similar type, quality and quantity to C Pte , an unrelated third party at Rs 6,00,000.
Analyse the impact of Transfer Pricing provisions on Arun Ltd and ascertain ALP ?
Transactions between two AE’s are controlled transactions and such transactions cannot be considered as a basis for determining ALP.
In the given case, transactions between Arun Ltd & Chandan Ltd. UK amounting Rs. 5,00,000 and Saloman Ltd., & Coloman UK 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 A Ltd. and C Pte , two Non-AE. Accordingly, the income of Arun Ltd would be increased by Rs 1,00,000 (6,00,000 – 5,00,000).
Comparable Uncontrolled Price Method (CUP) Method Transfer Pricing – Example 5 : –
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 order in large volumes, AE 1 offered quantity discount of Rs 200 per bicycle
Sales were made to Non-AE at credit facility of three months whereas the sales to AE 2 have always been on cash basis.
The cost of credit may be taken as 1% per month.
Analyse the impact of Transfer Pricing provisions and ascertain the ALP ?
|Price charged from Non-AE||Rs. 6,000 per unit|
|Quantity discount given to Non-AE||Rs. 200 per unit|
|Value of insurance/ freight paid by Non-AE||Rs. (500) per unit|
|Three months credit to Non-AE (Rs. 6,000 * 3%)||Rs. (180) per unit|
|Arm’s Length Price||Rs. 5,520 per unit|
|Increased income (5,520 – 3,000)||Rs. 2,520 per unit|
|Total increased income||Rs. 25,20,000|
Note – No deduction shall be allowed under Chapter VI – A on such enhanced income.
When can CUP Method be applied
- Cases where comparable uncontrolled transactions can be found – Internal comparable or external comparable ;
- Transactions for products where minor differences exist between various products – Columbian Coffee bean example discussed above;
- Sale of Product in different States of same country , where difference due to geographies is not material.
Example where CUP cannot be applied : –
- If a company owns a valuable trademark which it affixes to property sold in the controlled transactions , but does not affix in the uncontrolled transactions, as effect on price of the trademark is material and cannot be reliably estimated.
- Sale of Product in different countries , where difference due to geographies is material and cannot be reasonably estimated. For example sale of Mobiles in Africa vs Sale of Mobiles in USA.
Judicial Rulings on Comparable Uncontrolled Price Method Transfer Pricing
|Eli Lilly & Company vs. Commissioner –  70 taxmann.com 260 (Delhi – Trib.)||Where adjustments cannot be made on account of differences (credit terms, product quality and patent, etc.), CUP method cannot be considered as most appropriate method.|
|Bausch & Lomb Incorporated vs. Commissioner –  85 taxmann.com 163 (Delhi – Trib.)||CUP cannot be considered as most appropriate method where transactions are uncomparable due to difference in relationship.|
|Kailash Jewels Private Limited vs. ITO –  59 taxmann.com 473 (Delhi – Trib.)||Where nature of business of comparable companies were same, CUP method is most appropriate method.|
|Principal CIT vs. Toll Global Forwarding India (P) Ltd. –  66 taxmann.com 53 (Delhi)||When price determination for all business associates, whether associated enterprises or third party, was on same terms and profit sharing ratio, CUP method is most appropriate method.|
- Resale Price Method (‘RPM’)
- Cost Plus Method (‘CPM’)
- Profit Split Method (‘PSM’)
- Transactional Net Margin Method (‘TNMM’)
For any queries, please write them in the Comment Section or Talk to our tax expert