What is an arm’s length transaction?
Arm’s length transactions are legal business deals in which buyers and sellers don’t influence each other’s decisions during the transaction and make decisions independently. The term comes from the idiom “at an arm’s length,” which means to maintain distance.
Arm’s length transactions minimize, if not eliminate, ethical concerns that come with dealing with people who have a prior business or personal relationship.
These are a few examples of arm’s length transactions:
- A real estate transaction between a buyer and seller who have never met before.
- A public stock offering in which buyers and sellers are anonymous.
- A contract between two companies that are not affiliated with each other.
Why is having an arm’s length transaction important?
Arm’s length transactions help determine a fair market price for both the buyer and seller. They impact other parties, such as banks and municipalities involved in procuring loans and paying taxes, respectively. The final agreed-upon price can influence the item’s fair market value. Fair market value is the price at which an asset would sell in a competitive market with both buyer and seller acting in their own best interests. With an arm’s length transaction, the final price would generally be close to, but not the same as the fair market.
Arm’s length transactions have legal and tax implications for businesses. They encourage reasonable and fair business practices, like paying the correct taxes in each jurisdiction and following regulations.