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.
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.