The CUP Method With Example

If you are looking for an explanation of the CUP Method with an example, you have come to the right place. Below, we explain the CUP Method in more detail, and when and how to use it.

Before we continue, it is important to understand that the CUP Method is one of the common transfer pricing methods that are used to examine the “arm’s-length” nature of “controlled transactions.” If these terms do not ring a bell, we advise you to first read our articles What Is Transfer Pricing? and Five Transfer Pricing Methods With Examples.

What Kind Of Transfer Pricing Method Is The CUP Method?

The OECD Transfer Pricing Guidelines provide 5 common transfer pricing methods, accepted by nearly all tax authorities. These methods split into two categories: “traditional transaction methods” and or “transactional profit methods.” The CUP Method is a traditional transaction method.

Traditional transaction methods measure terms and conditions of actual transactions between independent enterprises and compares these with those of a controlled transaction.

The CUP Method

The CUP Method compares the terms and conditions (including the price) of a controlled transaction to those of a third party transaction. There are two kinds of third party transactions.

Firstly, a transaction between the taxpayer and an independent enterprise (Internal Cup).
Secondly, a transaction between two independent enterprises (External Cup).

The below example shows the difference between the two types of CUP Methods:

CUP Method Example

With this in mind, let”s look at an example of the application of the CUP method:

A manufacturing company (X) manufactures the “Buster 3.0.” This is a high-quality vacuum cleaner. It is up to 10 times stronger than the models of most competitors. The only competing manufacturer that can provide a vacuum cleaner performing similarly is the Dust Company, with its renowned “Dragon Buster.” X and Z sell their vacuum cleaners via both associated and third party distributors. X and Y operate completely similar.

Now say that X has received an order from distribution company Y for the supply of 1 Buster 3.0. X and Y have the same shareholder (Z). X wonders what transfer price it should apply. This means that X should find the terms and conditions (here: the price) of a comparable transaction. Under the CUP method, there are now 2 options:

X looks at the price for which it sells 1 “Buster 3.0” to a third party distributor (Internal CUP).
X looks at the price for which Z sells 1 “Dragon Buster” to a third party distributor (External CUP).

Obviously, option 1 is the easy option here and would be acceptable. But option 2 would also be acceptable and provides a better defense towards tax authorities (because “X is doing what an independent enterprise does”).

The below example summarizes the use of the CUP Method in this case:

Use of CUP Method In Practice

The CUP method is the most direct and reliable way to apply the arm’s length principle to a controlled transaction. However, it is often difficult to find a transaction that is sufficiently comparable to a controlled transaction. Therefore, this method is used when there is a lot of available data.

In practice, the CUP method is often used for financial transactions such as group loans. For these types of transactions there is a lot of data available and market standards help determine terms and conditions. For example, most banks work with the same formulas to determine credit ratings of borrowers. This serves as a basis for the interest rate of a loan.

This method is also often used to determine prices of intellectual property (IP) charged for the use of brands and licenses.