Arm's Length Principle (ALP)
An Arm's Length Principle (ALP) is a business transaction that can be used to create a legal agreements where parties acting independently and without significant relationships, ensuring that both act in their self-interest without any pressure or duress.
- AKA: Arm's Length Deal, Fair Market Transaction.
- Context:
- It can be used to create fair market value agreements that support equitable dealing tasks.
- It can create special rules for contracts and agreements, binding parties to terms even if they fail to read the contract.
- It can ensure that deals are fair and serve the interests of all involved parties.
- It can help establish a fair market value for the item or service being transacted.
- It can be applied in various industries, with real estate being a common application.
- It can involve parties with approximately equal bargaining power and symmetric information.
- It can prevent conflicts of interest by maintaining independence between the parties.
- It can be voluntary, taking place on the open market without compulsion or duress.
- It can affect not only the directly involved parties but also other stakeholders, such as lenders in real estate transactions.
- It can have implications for property taxes and the value of a property at the time of sale.
- It can have significant legal and tax implications, as many regulations require transactions to be at arm's length to prevent manipulation.
- It can serve as a benchmark in transfer pricing and international taxation to avoid profit shifting.
- ...
- Example(s):
- Real Estate Short Sales, which enable fair property valuation systems.
- Peer-to-Peer Marketplace Transactions, which enable independent buyer-seller interactions.
- Corporate Mergers between unrelated companies, which enable fair business valuation systems.
- ...
- Counter-Example(s):
- Family Property Transfer, which lacks the independence required for an arm's length transaction.
- Employer-Employee Sale, which involves parties with a pre-existing relationship.
- Parent-Subsidiary Transaction, which lacks equal bargaining power between parties.
- Related-Party Transactions, where companies within the same corporate group trade with each other, potentially not reflecting market conditions.
- Insider Trading cases, where transactions involve undisclosed advantages due to non-public information.
- ...
- See: Fair Market Value, Contract Law, Business Ethics, Real Estate Appraisal, Negotiation Strategy, Market Efficiency, Related-Party Transaction, Transfer Pricing.
References
2025
- (Wikipedia, 2025) ⇒ https://en.wikipedia.org/wiki/Arm's_length_principle Retrieved:2025-2-16.
- The arm's length principle (ALP) is the condition or the fact that the parties of a transaction are independent and on an equal footing. Such a transaction is known as an "arm's-length transaction". It is used specifically in contract law to arrange an agreement that will stand up to legal scrutiny, even though the parties may have shared interests (e.g., employer-employee) or are too closely related to be seen as completely independent (e.g., the parties have familial ties). An arm's length relationship is distinguished from a fiduciary relationship, where the parties are not on an equal footing, but rather, power and information asymmetries exist. It is also one of the key elements in international taxation as it allows an adequate allocation of profit taxation rights among countries that conclude double tax conventions, through transfer pricing, among each other. Transfer pricing and the arm's length principle were one of the focal points of the base erosion and profit shifting (BEPS) model developed by the OECD and endorsed by the G20.
2024a
- (Indeed, 2024) ⇒ Indeed. (2024). "Arm's Length Transaction: Definition, Importance and Process". In: Indeed Career Guide.
- QUOTE: An arm's length transaction is any deal, contract or agreement between parties who have no significant relationship with each other [1]. This means that in this sort of sales transaction, no party has influence or control over another. They're independent entities, each acting in their own self-interest.
An example of an arm's length transaction is a home buyer and a stranger who's selling a house. Each is offering what the other wants, but neither has any obligation to the other. Without having a previous relationship, both parties can try to reach a deal that serves them equally.
- QUOTE: An arm's length transaction is any deal, contract or agreement between parties who have no significant relationship with each other [1]. This means that in this sort of sales transaction, no party has influence or control over another. They're independent entities, each acting in their own self-interest.
2024b
- (Legal Dictionary, 2024) ⇒ Legal Dictionary. (2024). "Arm’s Length". In: Legal Dictionary.
- QUOTE: The idea of an arm's length transaction relates to an agreement between two people or entities that are independent of one another. This means that they do not have a prior relationship with one another, such as being related to each other, having a prior deal with each other, or that one party controls the other in some way. In certain situations, it is important to be able to prove that an agreement was entered into freely by both parties, to prove that the price, requirements, and conditions set within the transaction were fair and real at the time the transaction was made.
Arm's length transactions are transactions wherein the buyers and sellers to the transaction have no prior relationship with each other. Arm’s length transactions ensure that each party is acting in his own self-interest, and that neither party is being pressured by the other party to go ahead with the transaction. This also reassures any potential third parties to the transaction that no collusion exists between the buyer and the seller.
- QUOTE: The idea of an arm's length transaction relates to an agreement between two people or entities that are independent of one another. This means that they do not have a prior relationship with one another, such as being related to each other, having a prior deal with each other, or that one party controls the other in some way. In certain situations, it is important to be able to prove that an agreement was entered into freely by both parties, to prove that the price, requirements, and conditions set within the transaction were fair and real at the time the transaction was made.
2022a
- (Corporate Finance Institute, 2022) ⇒ Corporate Finance Institute. (2022). "Arm's Length Transaction - Definition, Example". In: Corporate Finance Institute.
- QUOTE: An arm's length transaction, also known as the arm's length principle (ALP), indicates a transaction between two independent contracting parties in which both parties are acting in their own self-interest. Both buyer and seller are independent, possess equal bargaining power, are not under pressure or duress from the opposing party, and are acting in their own self-interest to attain the most beneficial deal.
Due to both parties acting independently and in their self-interest, an arm's length transaction is a transaction that closely matches the fair market value of the consideration.
- QUOTE: An arm's length transaction, also known as the arm's length principle (ALP), indicates a transaction between two independent contracting parties in which both parties are acting in their own self-interest. Both buyer and seller are independent, possess equal bargaining power, are not under pressure or duress from the opposing party, and are acting in their own self-interest to attain the most beneficial deal.
2022b
- (Cornell Law School, 2022) ⇒ Cornell Law School. (2022). "Arm’s Length". In: Legal Information Institute.
- QUOTE: “Arm's length” is an expression which is commonly used to refer to transactions in which two or more unrelated and unaffiliated parties agree to do business, acting independently and in their self-interest. In transactions “at arm’s length”, the parties involved should have equal bargaining power and symmetric information, leading the parties to agree upon fair market terms.
Whether a transaction is done at “arm’s length” matters because it may have legal and tax implications. In many countries, tax laws require holding companies or corporations to engage in business transactions with their subsidiaries at “arm’s length”. The “arm’s length” principle seeks to guarantee fair market conditions and that taxes are correctly allocated in those transactions in which potential conflicts of interest may arise.
- QUOTE: “Arm's length” is an expression which is commonly used to refer to transactions in which two or more unrelated and unaffiliated parties agree to do business, acting independently and in their self-interest. In transactions “at arm’s length”, the parties involved should have equal bargaining power and symmetric information, leading the parties to agree upon fair market terms.