“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. In contrast, a transaction not conducted “at arm’s length” may happen between parties that may have a personal or close relationship; for example, transactions between family members, personal friends, or the parent company and its subsidiaries. In one case, it was held that “an ‘arm's-length’ transaction refers to dealings between two parties who are not related and not in a confidential relationship, and who are presumed to have roughly equal bargaining power. Additionally, an ‘arm's-length’ transaction generally must be voluntary (without compulsion or duress), take place on the open market, and the parties must act in their own self-interest.”
In another case, it was held that “an arm's-length transaction is a transaction between unrelated parties who are not involved in a confidential relationship and who have roughly equal bargaining power. An arm's-length transaction is "characterized by three elements: [(1)] it is voluntary, i.e., without compulsion or duress; [(2)] it generally takes place in an open market; and [(3)] the parties act in their own self-interest."
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.
[Last updated in May of 2022 by the Wex Definitions Team]