CUP: Comparable Uncontrolled Price

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Same thing, same terms, same price

The comparable uncontrolled price methodComparable uncontrolled price (CUP)A method that compares the related-party price with the price charged in a comparable deal between unrelated parties. It is the most direct method when good comparables exist.Open in the Glossary (CUP) compares the price in the deal between related companies with the price in a comparable deal between unrelated parties. If the deals match, the outside price is the arm's length price. The formula is short:

Arm's length price = outside price ± adjustments for differencesComparability adjustmentA change made to a comparable's price or results to remove the effect of a difference from the tested deal, such as freight, payment terms or working capital. It should only be made when the effect can be measured reliably.Open in the Glossary

In the calculator the only difference was freight. The outside price included $40 of delivery, and Mexico Plant's price did not. Freight has a clear, measurable effect on price, so you take it out: $1,000 - $40 = $960. Mexico Plant pays $950, $10 a tonne too little. On 12,000 tonnes a year, that is $120,000 of profit in Mexico that belongs in the US.

Internal CUP or external CUP? An internalInternal comparableA comparable deal between one of the related companies and an unrelated party, such as the same seller selling the same goods to an outsider. Its facts are easy to check, so it is often, but not always, the most reliable comparable.Open in the Glossary CUP is a deal where the same company sells the same thing to an unrelated party. That is this lesson: US Resin's own sales to outside factories. An external CUP is a deal between two unrelated companies, such as a published commodity price or another resin maker's sales to its customers.

Internal CUPs are often more reliable. The seller is the same, the product is the same, and the invoices and contracts are already on hand, so you can see every term of the deal. With an external CUP you often see only a price and must guess at the terms behind it. But internal is not automatically better. The US rules do not rank them: a sale to an unrelated party counts as an uncontrolled transaction either way, and it must meet the same comparability standard.

For both kinds, these differences matter: the product (grade and quality), the contract terms (volume, payment terms, warranties), freight and delivery terms, timing (prices move, so compare deals from about the same date), and the market (country, and wholesale or retail).

Other differences you may need to adjust for. Volume: Mexico Plant buys 12,000 tonnes a year, far more than any outside customer. If US Resin gives big outside buyers a volume discount, take that discount off the outside price too. If it does not sell such volumes to outsiders, research typical volume discounts in the market. Payment terms: if outside factories pay in 30 days but Mexico Plant pays in 90, the seller waits 60 days longer for its money. An independent seller would charge for that, so the outside price goes up by about the interest on 60 days. A different product: if the outside factories bought a cheaper recycled grade, the deals are not comparable. Nobody can say reliably how much less recycled resin is worth, so no adjustment fixes the gap.

CUP needs very close comparability, because even small differences move a price. You may adjust only for differences with a definite and reasonably ascertainable effect on price. If the only differences are minor and you adjust for them, CUP is usually the most direct and reliable measure under the best method ruleBest method ruleThe US rule that the arm's length result must be set using the method that gives the most reliable measure on the facts. There is no strict order of methods (Treas. Reg. § 1.482-1(c)).Open in the Glossary. A product difference you cannot reliably price ordinarily makes CUP unreliable.

Strengths: it tests the price itself, so it is easy to explain and hard to argue with. Weaknesses: truly comparable deals are rare outside commodities, and branded or unique goods almost never have one. When CUP fails, try resale price, cost plus or the CPM. For a license of a patent or brand, the matching method is the CUT.

Source: Treas. Reg. § 1.482-3(b), the CUP method, its comparability factors (product, volume, credit and transport terms, market, date) and quoted prices; § 1.482-1(c), the best method rule