Braxton Consulting

The Case
German Co. (GCO), a German company, manufactures a special chemical product in China and ships them to related and unrelated businesses in Europe. The chemical product that GCO ships to its unrelated and related party customers are identical in every respect. Moreover, the terms and conditions of the sales are also identical, except that the related party customers are given payment terms of 120 days as opposed to only 60 days for unrelated party customers. Based on this information, it is determined that the unrelated party sales represent a comparable uncontrolled price (CUP) for the intercompany transfer price.

Método de Precio Comparado no Controlado
The comparable uncontrolled price (CUP) method was one of the preferred guidelines established by the OECD in transfer pricing. It offers the most direct way of determining an arm’s length price. It compares the price charged for goods or services transferred in a controlled transaction to the price charged for property or services transferred in a comparable uncontrolled transaction. The OECD report states that, if it can be used, ‘the CUP method is preferable over all other methods’. In practice, this method is often very
difficult to apply as it is unusual for multinationals to have access to sufficient details of appropriately comparable third party transactions. In response to this, the OECD report suggests that multinationals and tax authorities should take a more adaptable approach to the use of this method, possibly working with data prepared for CUP purposes supplemented by other appropriate methods. The extent of the OECD’s support for the CUP method can be seen from the comment that ‘every effort should be made to adjust the data so that it may be used appropriately in a CUP method’.

The OCDE current Guidelines’ preference for transactional transfer pricing methods over profit based methods may be changed in the future. The Guidelines suggest that the Profit Split Method and the Transactional Net Margin Method (“TNMM”) should be used as methods of last resort when it is not possible to rely solely on transactional methods like the Comparable Uncontrolled Price Method, the Cost Plus Method and the Resale Price Method. However, in practice, the TNMM is frequently applied due to the lack of available transactional data. Although the decision-making process still has a long way to go, it is expected that profit-based methods may be “brought to the same level” as the transactional methods, which would make the guidelines more similar to the US transfer pricing regulations.

Using the CUP method for sales to affiliates, potentially comparable sales include sales made by a member of the controlled group to an unrelated party, sales made to a member of the controlled group by an unrelated party, and sales made between parties that are not related to each other. Any of these potential CUPs may provide an arm’s length price for use in the sale between related parties if the physical property and circumstances involved in the unrelated party sales are identical to the physical property and circumstances involved in the sales between the related companies.

Transfer pricing regulations in most countries allow CUPs to be adjusted if differences between the CUP and the related party transaction can be valued and have a reasonably small effect on the price.

Differences in respect of which adjustments are difficult or impossible to make include:
• differences in the geographic markets;
• differences in the quality of the products;
• differences in the level of the market; and
• differences in the amount and type of intangible property involved in the sale.

The outcome

The difference in payment terms must be taken into account, however, before the actual arm’s length inter-company price can be determined.

Based on prevailing interest rates, it is determined that the difference in payment terms is worth 0.5 per cent of the chemical product price. Adjusting the unrelated party price for this difference, it is established that the inter-company price should reflect the unrelated party price plus 0.5 per cent.

Because the tax authorities or taxpayer only need to analyse one method in depth, this was the only method used.