In today’s business environment, where transactions between related parties are common, transfer pricing rules play a key role in reducing risk in a potential tax audit. For this purpose, taxpayers can use a number of transfer pricing verification methods. In a new series on our blog, we will try to provide an insight into the transfer pricing verification methods. In the following article, we will focus on the comparable uncontrolled price method (hereafter: CUP).

Basic assumptions of the CUP

The comparable uncontrolled price method is used to compare the price of the subject of a controlled transaction with the price applied in comparable transactions by unrelated parties. It is worth remembering that more than just monetary consideration should be considered as a price. The definition of price in this case also includes, for example, commission remuneration and the value of interest on financial transactions. The described method is the most direct method of transfer pricing verification, due to the fact that it directly refers to the price of a given item. In view of the above, a very important element is the high degree of comparability of the transactions, which we use to compare and verify the market range of the transfer price. The comparison may take the form of an internal or external comparison. If the taxpayer carries out transactions comparable to the controlled transaction with unrelated parties and thus has data relating to these transactions, it is possible to determine the transfer price on the basis of the prices applied in these transactions (internal comparison). On the other hand, if there are no such transactions, the only possibility is to perform an external comparison using external sources, e.g. databases.

The CUP method can be applied in particular to:

• transactions whose subject matter is listed on an exchange (e.g. electricity, metals),
• financial transactions, e.g. granting/receiving a loan,
• property rental transactions, 
• transactions the object of which is, for example, the granting of licences to intangible assets.

What is the verification process using the CUP?

The transfer price verification process using the CUP method involves identifying transactions between related parties and determining their key parameters. It is then necessary to determine whether internal data comparable to the analysed transaction exists. If such data exists and can be considered comparable it is possible to make an internal variant comparison. If, however, internal data cannot be considered comparable or are missing, one should proceed to a search for comparable transactions between unrelated parties and compare them to the terms of transactions performed by related parties.

In verifying the comparability of transactions under this methodology, factors such as the following should be taken into account:

1. The characteristics of the goods, services or other performances that are the subject of the transaction (extent of services provided, type of goods, etc.),
2. The impact of additional services on the price,
3. The quantity of goods, commodities sold,
4. Availability of goods, services,
5. Rights of third parties to the goods, commodities,
6. The geographical market and its size and nature,
7. The functional profile of the parties to the transaction, although in some transactions the functional profile is not so important for the comparability of the transaction.

The factors indicated above are only an illustrative list. The criteria for comparability depend on the type of transaction.

The next step after the verification and adoption of the comparability criteria is the preparation of a comparability analysis to assess whether the transaction prices between related parties are in line with the uncontrolled market prices. When done correctly, this process is crucial to ensure that the market price level is consistent and that the transfer pricing rules.

Issues and challenges in the CUP method

The CUP method, despite its universal nature, may not be usable in certain situations.. For example, it may be too problematic or impracticable to obtain reliable comparables or to verify relevant comparability criteria. In addition, it is important to be wary of errors that can be made when applying this method. Among the most common of these are the omission of factors affecting comparability and the comparison of prices in transactions in the core business with prices in transactions that are incidental.

Nevertheless, it is worth verifying the applicability of this method. CUP is characterised by simplicity and relatively low costs. In contrast, it is worth remembering that the choice of the appropriate method depends on the specific circumstances of each transaction. The decision as to which method is appropriate should be based on risk analysis, data availability and regulatory requirements.