Comparable Uncontrolled Price (CUP) Method: The Gold Standard in Applying the Arm’s Length Principle

In the hierarchy of transfer pricing methods, the Comparable Uncontrolled Price (CUP) method is often considered the most direct and reliable method for determining whether the price in an affiliated transaction is fair. Unlike other methods that compare profit margins (such as TNMM or Cost Plus), the CUP method compares the price of the goods or services themselves.

In Indonesia, this method receives special priority in the latest regulations, especially for commodity transactions.

Definition and Basic Concept of the CUP Method

The CUP method compares the price charged for goods or services transferred in a transaction influenced by a special relationship (controlled transaction) with the price charged for goods or services transferred in a comparable independent transaction (uncontrolled transaction) under comparable conditions.

Philosophy of the CUP Method

If two independent parties sell identical products under the same conditions (same market, same volume, same payment terms), then the price formed should be the same.

Based on MoF Regulation (PMK) 172 of 2023, the CUP method is defined as a transfer pricing determination method carried out by comparing the price between the transaction influenced by a special relationship being tested and an independent transaction.

Usage Criteria: When is CUP Mandatory?

Although Indonesia adheres to the The Most Appropriate Method principle, the regulation gives "preference" or priority to the CUP method in certain situations.

A. Main Priority for Commodities

The CUP method is highly prioritized and considered most appropriate for commodity product transactions (such as crude palm oil/CPO, coal, tin, etc.). This is because commodity products have standard physical characteristics and their market prices are widely available on exchanges or price indices (quoted price).

B. Equality of Reliability

If the CUP method and another method (e.g., TNMM) can be applied with an equal level of reliability, then the CUP method must be prioritized over the other methods. This aligns with OECD guidance stating that CUP is the most direct way to prove the arm's length price.

Types of Comparables in the CUP Method

In applying the CUP method, there are two sources of comparable data that can be used:

1. Internal CUP (Internal Comparable)

Comparing the transaction price between the Taxpayer and an affiliated party, against the transaction price between the same Taxpayer and an independent party.

Example: PT A sells shoes to its subsidiary (PT B) for $10. PT A also sells the same shoes to a third party (PT C) for $12.

2. External CUP (External Comparable)

Comparing the Taxpayer's affiliated transaction price, against the transaction price between two independent parties unrelated to the Taxpayer.

Example: PT A sells coal to its parent. The comparable is the market price on the GlobalCoal index or HBA.

Strict Comparability Requirements

The biggest challenge of the CUP method is its very high comparability standards. Two transactions are considered comparable if:

1. There are no material differences in conditions that could significantly affect the price; or
2. If there are differences, reasonably accurate adjustments can be made.

Sensitive factors in the CUP method:

• Product Characteristics: Physical differences, quality, and durability.
• Contractual Terms: FOB vs CIF (shipping costs and insurance).
• Volume: Discounts for bulk purchases.
• Transaction Timing: Especially for commodities with daily fluctuations.
• Market Level: Manufacturer vs wholesale vs retail price.

Case Examples and Application

The CUP method is the method most preferred by tax authorities because of its objective nature and direct targeting of price. However, this method carries high risk if the Taxpayer ignores details of transaction condition differences. The key to successful use of the CUP method lies in strong documentation regarding adjustments. Taxpayers must be able to prove quantitatively that every difference has been calculated and adjusted accurately to achieve reliable comparability.

References

1. Ministry of Finance of the Republic of Indonesia. (2023). Regulation of the Minister of Finance of the Republic of Indonesia Number 172 of 2023 concerning the Application of the Principle of Fairness and Business Prevalence in Transactions Influenced by a Special Relationship.
2. OECD. (2022). OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022. OECD Publishing, Paris.
3. United Nations. (2021). Practical Manual on Transfer Pricing for Developing Countries (2021).
4. Directorate General of Taxes. (2013). Regulation of the Director General of Taxes Number PER-22/PJ/2013 concerning Guidelines for Audit of Taxpayers Having a Special Relationship.