Comparable Uncontrolled Price

(‘CUP’) Method

Himanshu Tanna

7 February 2015

Page 2 CUP Method

► Computation of Arm‟s Length Price

► What is CUP Method

► Types of CUP

► Application of CUP Method

► Case Studies

► Key Indian Judicial Precedents

Contents

Page 3 CUP Method

► Determination of ALP using one of the Prescribed methods. A method which is:

► Best suited to the facts and circumstances of each particular international transaction and

► Provides the most reliable measure of an arm‟s length price in relation to the international

transaction shall be “Most Appropriate Method”

► Where more than one ALP is determined, the arithmetic mean of such prices is taken to be the ALP

Computation of Arm’s Length Price (ALP)

No hierarchy or preference of methods prescribed under the Act

Prescribed Methods

Traditional Transaction

MethodTransactional Profit

Method

TNMM

Method

Other

prescribed

Method

PSM

MethodCPM

Method

RPM

Method

CUP

Method

Page 4 CUP Method

► Compares the price charged in a controlled transaction with the price in

an uncontrolled transaction

► Organization for Economic Co-operation and Development („OECD‟)

defines CUP as under:

“A transfer pricing method that compares the price charged for property or

services transferred in a controlled transaction to the price charged for

property or services transferred in a comparable uncontrolled transaction

in comparable circumstances”.

What is CUP Method?

B Ltd

A Ltd

AEs Independent enterprises

Y Ltd

X Ltd

Controlled transaction Uncontrolled transaction

Page 5 CUP Method

Manufacturer A

Related party - Manufacturer B

Non-related party

Non-related party B

► External CUP

Non-related party A

► Internal CUP

Types of CUP

Page 6 CUP Method

Methodology under CUP

► Identification of price charged or paid in comparable uncontrolled situations

► Such price adjusted to account for differences if any between international

transaction and uncontrolled transactions

► Adjusted price arrived above taken to be arm‟s length price

Application of CUP Method

Page 7 CUP Method

► Most direct and reliable method

► However, requires strict comparability in products, contractual terms,

economic terms, etc - Accordingly, difficult to practically apply

Key comparability factors that have a material impact

► Product characteristics, quality and volume

► Contractual terms (credit period, shipment terms, currency, after sales

service, warranties)

► Timing of transaction

► Geographical location and size of market (place of origin & market of sale)

► Level of market (wholesale or retail)

► Intangible property associated with sale (eg brand, know-how)

Application of CUP Method

Page 8 CUP Method

Case Studies

Page 9 CUP Method

Case Study # 1

ABC Inc.

USA

ABC GmbH

Germany

ABC Limited

India

Sale of 100 Kg

@ Rs. 10

Whether price charged to ABC

GmbH can be considered as CUP ?

Page 10 CUP Method

Case Study # 2

XYZ Netherlands

(Licensing of

Technology)

Third party in India

XYZ India

Licensing of formulations and

technicals - 3% of gross domestic

sales and 5% of gross export sales

of Product A

Licensing of technicals

5% of net domestic sales and 8% of

net export sales of Product A

Whether royalty rate charged to

third party can be considered as

CUP ?

Page 11 CUP Method

Case Study # 3 – Application of CUP MethodFacts

► Ind Co, an Indian Company is engaged in

the refining and sale of copper metal.

► Ind Co purchases crude metal from both

related and unrelated parties

► Critical factors that affect the crude copper

price are:

► Volume,

► Tenure of supply contract (long terms,

short term)

► Product mix (with or without small

quantities of other metal alloys like gold

and silver)

► Other terms of contracts (FOB vs CIF,

port of shipment etc)

Unrelated

Party A

(Japan)

Unrelated

Party B

(Russia)

Related Party

ForCo (AUS)

Ind Co

Page 12 CUP Method

Case Study # 3 – Application of CUP Method Comparison of various CUPs

Criteria Related Party ForCo

(Australia)

Controlled

Unrelated Party A

(Japan)

Uncontrolled

Unrelated Party B (Russia)

Uncontrolled

Tenure of Contract Long Term (10 yrs) Long Term (8 yrs) Short Term (2 yrs)

Volume during year

under consideration

2200 MT 3000 MT 9000 MT

Alloy Mix 0.5% Gold, 1% silver 1% Gold, 1% silver None

Port of shipment Australia Japan Russia

Price (per MT) INR 29,500 (applicable

for entire year)

INR 32,000 (applicable

for entire year)

INR 28,500 (applicable for

entire year)

Other Terms FOB basis CIF basis FOB basis

Page 13 CUP Method

Case Study # 3 – Application of CUP MethodApplicability of CUP – Unrelated supplier A

► The controlled and uncontrolled

arrangements are comparable except in

following areas

► Different alloy mix: Supplier A‟s crude

copper contains a higher mix of gold,

making the product more expensive

► Difference in terms of supply:

Supplier A sells on CIF basis, whereas

ForCo sells on FOB basis.

► Other differences, including the difference

in volume and the term of contracts (10 yrs

vs 8 yrs) is not expected to influence the

prices.

Unrelated

party A

(Japan)

Related party

ForCo (AUS)

IndCo (India)

Page 14 CUP Method

Case Study # 3 – Application of CUP MethodApplicability of CUP – Unrelated supplier B

► The controlled and uncontrolled arrangements

have following differences

►Difference in volume: the difference in

volume purchased from ForCo and from

Supplier B is significant (2200 MT and 9000

MT)

►Difference in tenure of contract: 2 years vs.

10 years

►Different alloy mix: Supplier B‟s copper crude

does not contain any gold or silver

►Different port of shipments: Russia vs.

Australia

Related

Supplier

ForCo (AUS)

IndCo (India)

Unrelated

party B

(Russia)

Page 15 CUP Method

Case Study # 3 – Application of CUP MethodConclusion

► Rejection of CUP related to Supplier B: the significant difference in volume

render the Supplier B transactions unreliable as suitable adjustments cannot

be made to account for the difference

► Acceptance of CUP related to Supplier A: the uncontrolled transaction with

Supplier A is comparable with the controlled transactions with ForCo.

Although, certain adjustments need to be made

Adjustments

► Difference in pricing basis (FOB vs CIF) – add freight and insurance cost

to ForCo transaction

► Difference in alloy mix – adjust Supplier A‟s price to exclude price for

higher content of gold

Page 16 CUP Method

Some Key Indian Judicial Precedents

Page 17 CUP Method

Geographical difference

► Internal CUP not suitable where uncontrolled transactions are undertaken with

unrelated foreign entities (Gharda Chemicals Ltd)

► Sale to AE in Thailand and Non AE in Vietnam cannot be considered under CUP

Method. Mere geographical contiguity in two countries need not mean similarity in

economic and market conditions when retail price was different (Intervet India Pvt.

Ltd)

► CUP Method using foreign comparable / industry practice valid for logistics industry –

Geographical difference immaterial (Agility Logistics Pvt Ltd and Toll Global

Forwarding India Pvt Ltd)

► Geographical difference removed by comparing prices at FOB value in case of sales

of goods (Isagro Asia Agrochemicals Pvt Ltd)

Comparability Factors

Page 18 CUP Method

Characteristics of the products

► Rejection of CUP Method asserted by the revenue over TNMM adopted by the taxpayer

for purchase of APIs since revenue did not produce data of the supplier, credentials,

product efficacy, purity, R & D activity, contractual terms etc. (UCB India Pvt. Ltd)

► CUP Method is more appropriate than TNMM where reliable data is available. CUP

Method was used in the context of purchase of API for generic drugs (Serdia

Pharmaceuticals (India) Private Limited)

► Purchase from newly developed third party Chinese supplier cannot be used on grounds

of risk associated with uncertain quality standard vis-à-vis AE (Cheminova India Ltd)

► CUP method using TIPS database (based on data maintained by Customs Department)

acceptable. Exact product comparability not required – Generic goods even with

different brands comparable unless impact of intangibles substantial (Tilda Riceland

Pvt Ltd)

Comparability Factors

Page 19 CUP Method

Volume and market condition

► Rejection of CUP Method over TNMM due to significant volume and geographical

differences between sales to AEs and Non AE‟s (Dishman Pharmaceuticals &

Chemicals Ltd)

► Non-AEs order quantity restrictions justify higher purchase price paid to AEs (Intimate

Fashion India Pvt Ltd)

► The relevant market condition for testing a transaction is the market where goods are

sold and not the place of origin (Clear Plus India Pvt. Ltd and Mosaic India Pvt Ltd)

► CUP for benchmarking of copper-ingots imported by assessee at rates higher than

rates at which AE sold to third parties in India considered – Claim for adjustment for

fluctuations in market rates of copper rejected (Vipin Enterprises – Supreme Court)

Comparability Factors

Page 20 CUP Method

Payment for know-how

► Difference in manner of computation of royalty and number of years of agreement

validity different and hence, not comparable (Kirlosker Ebara Pumps)

► For benchmarking the royalty, effective royalty rate to be considered and not quoted

rate (Hitachi Home and Life Solutions)

► Ministry of commerce and industry press note allowing automatic approval not

relevant for ALP without furnishing comparable data (SKOL Breweries)

► Payment of model fees approved by ministry of heavy industries after detailed

examination and hence, justified (Hero Motocorp Ltd)

Other transactions

Page 21 CUP Method

Payment for know-how (Cont….)

► RBI approval for royalty relied on for determination of arm‟s length (Air Liquide

Engineering, Thyssenkrupp Industries) – Contrary view - RBI permission is not

sacrosanct for purposes of IT Act & is merely persuasive & not conclusive (LG

Electronics – HC decision in Nestle India & Coca Cola relied)

Intangible Assets

► Excess Earnings Method supplements the CUP method (Tally Solutions Pvt Ltd)

► Discounted cash flow method more appropriate for determining the value of shares

(Ascendas India Pvt Ltd) – CCI valuation not acceptable (VIHI LLC)

► Internal CUP based on non-compete fees & control premium paid to Indian promoter

group (Lanxess India Pvt Ltd)

Other transactions

Page 22 CUP Method

Financial Transactions

► Use of interest rate on foreign currency loan to be considered as comparable for

benchmarking interest on loan to foreign subsidiary (VVF Ltd)

► LIBOR to be used for determining ALP of foreign currency loan and domestic PLR is

not relevant (Hinduja Global Solutions Limited – Supported by decisions in case

of Aurionpro Solutions, Cotton Naturals, Siva Industries, Mahindra & Mahindra,

Four Soft)

► Interest on bank deposit considered as ALP - PLR not appropriate (Dr. Reddy’s

Laboratories Limited and VIP Industries)

► For benchmarking of brokerage, Internal CUP should be used over TNMM –

Adjustment for differences in activities allowed (J P Morgan India Pvt Ltd, RBS

Equities India Ltd)

Other transactions

Page 23 CUP Method

Use of quotes

► Determining arm‟s length guarantee commission based on quote on bank‟s website

without considering terms and conditions not accepted (Everest Kanto Cylinder) -

Internal CUP accepted (Asian Paints Limited)

► Quotation which has not fructified into a transaction not acceptable as CUP (Sinostell

India Pvt. Ltd). List price are only indicative, cannot be sole basis for analysis under

CUP method (Redington India Limited)

► Price quotation from non-government agency can be considered, unless proved

unreliable - Argument of rates merely a quotation not raised by TPO (Adani Wilmar )

► Using of quotation from Asian Metal Market (leading marketing researchers) accepted

for determining ALP of raw materials imported – Rule 10AB „Other Method‟ relied on

(KTC Ferro Alloys Pvt. Ltd.)

Other key points

Page 24 CUP Method

Use of industry averages

► Use of NASSCOM man-hour rates as CUP (3 Global Services Private Limited)

► Shipping magazine rates for charter hire payment for vessels (Reliance Industries

Limited)

► Value accepted by the Insurance Company for the ship could be considered as a

reasonable value to compute ALP vis-a-vis an estimation on the basis of the quoted

figures in a monthly magazine (Tolani Shipping Co. Ltd.)

Controlled transactions with other AEs

► Cannot be considered as a CUP (Skoda Auto India, Tecnimont, Sabic)

► Allowed where the assessee or TPO was unable to identify comparables (Bayer

Material Science)

Other key points

Page 25 CUP Method

Timing

► The date on which the purchase order is received constitutes the correct date for

determination of the arm‟s length price and not the date of invoice or shipment (A.M.

Tod Company India Pvt. Ltd)

► CUP based on prices on date of contract, invoice date prices irrelevant (Ambo Agro)

Average of price vs transaction by transaction

► Average of the prices charged by the assessee from its non-AEs in the same period

should be considered for benchmarking the product sold to AE in the same period

(ITW India Ltd and Essar Steel Ltd)

► Though yearly average is a good and reasonable indicator, a transaction based

approach is more appropriate where prices were open for fluctuations and not

decided in advance (Saertex India Pvt Ltd)

Other key points

Thank You