Arm’s Length Principle

The arm’s length principle (ALP) is the condition or the fact that the parties to a transaction are independent and on an equal footing. It is used specifically in contract law wish to arrange an equitable 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).

A simple example is the sale of real property from parents to children. The parents might wish to sell the property to their children at a price below market value, but such a transaction might later be classified by a court as a gift rather than a bona fide sale, which could have tax and other legal consequences. To avoid such a classification, the parties need to show that the transaction was conducted no differently than it would have been for an arbitrary third party. This can be done, for example, by hiring a disinterested third party such as an appraiser or broker, who can offer a professional opinion that the sale price is appropriate and reflects the true value of the property.

The principle is often invoked to avoid undue government influence over other bodies, such as the legal system, the press, or the arts. For example, in the United Kingdom Arts Councils operate “at arm’s length” in allocating the funds they receive from the government.

The Organisation for Economic Co-operation and Development (OECD) has adopted the principle in Article 9 of the OECD Model Tax Convention, to ensure that transfer prices between companies of multinational enterprises are established on a market value basis. In this context, the principle means that prices should be the same as they would have been, had the parties to the transaction not been related to each other. This is often seen as being aimed at preventing profits being systematically deviated to lowest tax countries, although most countries are also concerned about prices that fail to meet the arm’s length test due to inattention rather than by design and that shifts profits to any other country (whether it has low or high tax rates). It provides the legal framework for governments to have their fair share of taxes, and for enterprises to avoid double taxation on their profits.

The use of “arm’s length principle” is extended as a new concept in tort law. A person should keep an “arm’s length” distance from another to avoid offensive or harmful contact, otherwise, a battery or assault may result if one person goes too close to another without consent. To keep an “arm’s length” from another person is respect to his/her bounds of dignity.

In the workplace, supervisors and managers deal with employee discipline and termination of employment at arm’s length through the human resources department, if the company has one. In such cases, terminations and discipline must be rendered by staff who have the training and certification to do so legally. This is intended to protect the employer from legal recourse that employees may otherwise have in the event that it can be demonstrated that such discipline or terminations were not handled in accordance with the latest labour laws. For employees in unionised environments, shop stewards can represent the employee, whereas the HR department represents the company, so that both sides are on a more equal footing and can resolve matters outside of court, using informal negotiations or a grievance, saving both sides time and money. The arm’s length dealings, in this case, mean that both an employee and a supervisor each have a qualified advocate.

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