CUP Method: The Often Overlooked First Choice

The Comparable Uncontrolled Price (CUP) method is often overlooked in favour of profit-based approaches like TNMM or CPM. Yet, when reliable comparable data exists, the CUP method is typically the preferred method under OECD Guidelines, IRS rules, and local regulations worldwide. For middle-market and entrepreneurial companies, correctly applying CUP can reduce risk, support pricing decisions, and improve audit defensibility.

What is the CUP method?

The CUP method determines whether an intercompany transaction is arm’s length by directly comparing the price charged between related parties with the price charged in a comparable transaction between independent parties under similar circumstances. If a sufficiently comparable uncontrolled transaction exists, the CUP method uses that price as the benchmark.

CUPs can be available externally or internally. An external CUP compares the intercompany transaction price to the pricing of the same (or similar) transaction evidenced between two unrelated parties. An internal CUP compares the intercompany transaction price to the price for the same (or similar) transaction between the tested party and an unrelated party.

Favoured but underused

Unlike profit-based methods, CUP focuses directly on pricing actual transactions. If sufficiently comparable uncontrolled transactions can be found, intercompany prices can be benchmarked without relying on margins or broad financial data.

Many tax authorities favour the CUP method - the OECD Guidelines, IRS regulations, and most local country rules explicitly prioritise the CUP method when meaningful comparable data exists as it is considered the most reliable method to assess the arm's length nature of transfer prices.

Despite this clear preference by tax authorities, the CUP method remains underused. In our experiences this is often because advisors simply do not ask if any CUPs exist and go straight to a profit-based analysis. Other times, companies may themselves overlook internal CUP data. From a technical perspective, it may be decided that adjustments that would be necessary to make CUP data more reliable is too complex or vague.

Use cases

The CUP method is most appropriate in situations where products, services, or financing terms are highly standardised - for example:

• Commodity trading: Metals, energy, chemicals, and agricultural products.

• Financial transactions: Intercompany loans, guarantees, and cash pooling arrangements.

• Franchising and licensing: Royalty rates for trademarks, software, or know-how.

• Intercompany services: where published price lists or rate cards exist.

Notwithstanding, the CUP method should be the first consideration for analysing intercompany transactions outside these more narrow use cases, given its acceptability under audit where robust and meaningful data is available.

Practical challenges

While the CUP methods sounds simple enough, practical application requires caution.

Identifying comparable third party transactions is difficult. Internal CUPs are often easier to identify, but may still need adjustments.

Adjusting for differences that can materially affect pricing such as geography, volume, contract terms or timing can also be a technical challenge.

And for smaller and mid-sized organisations, where resources may be limited, detailed evidence and documentation related to application of the CUP method may be particularly burdensome.

Some jurisdictions (e.g. India, Brazil, Mexico) have a stricter interpretation or preferences as to how the CUP method is applied, so a "double-sided" analysis using a CUP approach may be more challenging in these cases.

Pragmatic considerations for middle-market and smaller companies

At the very least, a search for internal CUPs should be performed, if for no other reason than to actively exclude its application. This process should be documented as part of the companies annual transfer pricing compliance cycle.

Where the tested party sells / buys similar products / services to third parties as well as related parties, the process of assessing the appropriateness of these potential CUPs, considering any adjustments to increase comparability, should also obviously be clearly documented.

Where CUP data is directional but incomplete, consider combining or supporting the analysis with a profit -based method to strengthen defensibility.

Key Takeaway

For any new or existing intercompany transactions, first confirm whether any potential internal or external CUPs exist. Even if the CUP method is ultimately set aside, documenting that review strengthens compliance and reduces audit risk. Profit-based methods should not be the default starting point for establishing or testing arm's length intercompany pricing.