ARM's LENGTH

What is an 'Arm's Length Transaction'

The transactions between affiliated firms must be made purely on commercial basis both firms trying to maximize their advantage, and neither firm accommodating or favoring the other in any way.

It is the description of an agreement made by two parties freely and independently of each other, and without some special relationship, such as being a relative, having another deal on the side or one party having complete control of the other. It becomes important to determine if an agreement was freely entered into to show that the price, requirements, and other conditions were fair and real. Example: if a man sells property to his son the value set may not be the true value since it may not have been an "arm's length" transaction.


The arm’s length principle requires that transaction with a related party be entered into under comparable conditions and circumstances as a transaction with an independent party. It is founded on the premise that when market forces drive the terms and conditions agreed to in an independent party transaction, the pricing of the transaction would reflect the true economic value of the contributions made by each party to the transaction. Essentially, this means that if two associated enterprises derive profits at a level above or below the comparable market level solely by reason of the special relationship between them, the profits will be deemed non-arm’s length. In such a case, the tax authorities may make the necessary adjustments to the taxable profit of the related parties in their jurisdiction so as to reflect the true value that would otherwise be derived on an arm’s length basis.

Click here and Deloitte: Arm's length standardfor more.