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What is an Arm's Length Transaction?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 13 September 2016
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An arm’s length transaction involves the buying and selling of goods, services, properties, or stocks between two parties that are completely separate from one another. Generally speaking, an arm’s length transaction is the most common of all types of transactions. Here are some examples of qualifications that must be met in order for the activity to be defined as an arm’s length transaction.

Arm’s length transactions are generally thought to only take place between parties that have no kind of familial or business connection to one another. For example, purchasing goods from a company owned by a relative, even if both entities are not affiliated parties, would not be considered a true arm’s length transaction. In like manner, purchasing goods or services from a company that is owned by the same parent organization is often thought to not qualify as an arm’s length transaction, even if the two companies operate independently.

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The main purpose of the arm’s length transaction is to ensure there are no hints of a conflict of interest that would give one or both companies an undue advantage in the market. This means that the type of discounts or special offers that are employed will be the same kinds of offers that would be extended to any potential customer. Because the idea of discounts between related parties does not come into play with an arm’s length transaction, neither the buyer nor the seller has to deal with any suspicion of anything unethical in the business arrangement.

While not universally true, there are places around the world where local laws and customs tend to encourage the use of the arm’s length transaction. Higher taxes and stiffer regulations may cause the business environment to be such that doing business with a related entity is simply not cost efficient. Part of the reasoning for this is to prevent the formation of any type of business cliques, even informal ones. Minimizing this type of activity is thought to be in the best interests of the local economy, since it tends to foster competition among a wider range of businesses.

In some places around the world, an arm’s length transaction is considered to be possible between two companies with some sort of distant connection. Often, this is defined as a situation where companies that operate in two different countries, but are part of the same international conglomerate, may conduct business with one another. However, it is understood that the distant connection is not to influence the charges associated with the purchase or the delivery of the goods and services. Business is to be conducted as if there is no connection between the two corporations in any form or fashion.

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anon118928
Post 3

A couple not married but have kids together short sale there home to the other partner.

Would this be considered an arm's length transaction or not?

mdt
Post 2

This would probably not be considered an arm's length transaction, since the seller and the potential buyer are related. On the subject of taxes, this could get involved, depending on the exact nature of the taxes owed. Are they taxes collected from the payroll for employees, or does this involve employer taxes? The best bet is to talk with a financial accountant and see who ends up with the obligation.

mountainview
Post 1

A family, who has some problems with IRS over unpaid taxes (they are still fighting this claim) want to sell their business to their son (who is presently working in the business as an employee) at Arm's length will the IRS claim move along to the buyer (son)?

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