Arm's length transaction definition

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What is an Arm’s Length Transaction?

An arm's length transaction is a negotiation between two parties where the parties are not related. This type of event does not involve any insider trading between the parties, and there is no undue influence on either party to accept terms that differ from those currently accepted in the market. Both parties to the transaction are assumed to be well-informed. Since each party is presumed to be acting to maximize its own self-interest, the result should be a price that reflects the market rate. The presumption in an arm’s length transaction is that there is no collusion between the parties that would result in a skewed pricing outcome.

It can be important to prove that a transaction was completed at arm's length, so that beneficiaries of the outcome cannot complain that they did not receive full payment from the deal. For example, the sale of an asset at a very low price could be considered a gift, rather than a sale transaction, which could have adverse tax effects for the buyer. The concept is also used in establishing transfer prices between subsidiaries, so that prices are not unusually high or low (which can impact a subsidiary's taxable income).

Example of an Arm’s Length Transaction

Here are several examples of arm’s length transactions:

  • Securities purchase. Transactions on stock exchanges involve arm's length transactions, since securities are being traded among many parties based solely on the offered prices.

  • Raw materials purchase. A company purchases raw materials from a supplier. There is no personal or financial relationship between the company's owners and the supplier. The price of the materials is based on prevailing market rates, and the company compares bids from multiple suppliers before choosing one.

Conversely, the sale of an asset within a family is unlikely to be an arm's length transaction, since the seller may be offering  the item at a much lower price than could be obtained if the buyer had not been a family member.