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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 A contract is a legally enforceable agreement between two or more parties that creates, defines, and governs mutual rights and obligations between them. A contract typically involves the transfer of goods, services, money, or a promise to tran ...
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 A fiduciary is a person who holds a legal or ethical relationship of trust with one or more other parties (person or group of persons). Typically, a fiduciary prudently takes care of money or other assets for another person. One party, for exampl ...
relationship, where the parties are not on an equal footing, but rather, power and
information asymmetries In contract theory and economics, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. Information asymmetry creates an imbalance of power in transactions, which ca ...
exist. It is also one of the key elements in
international taxation International taxation is the study or determination of tax on a person or business subject to the tax laws of different countries, or the international aspects of an individual country's tax laws as the case may be. Governments usually limit the ...
as it allows an adequate allocation of profit taxation rights among countries that conclude double tax conventions, through
transfer pricing In taxation and accounting, transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control. Because of the potential for cross-border controlled transactions to distort ...
, among each other. Transfer pricing and the arm's length principle was one of the focal points of the
Base Erosion and Profit Shifting Base erosion and profit shifting (BEPS) refers to corporate tax planning strategies used by multinationals to "shift" profits from higher-tax jurisdictions to lower-tax jurisdictions or no-tax locations where there is little or no economic a ...
(BEPS) project developed by the
OECD The Organisation for Economic Co-operation and Development (OECD; french: Organisation de coopération et de développement économiques, ''OCDE'') is an intergovernmental organisation with 38 member countries, founded in 1961 to stimulate e ...
and endorsed by the
G20 The G20 or Group of Twenty is an intergovernmental forum comprising 19 countries and the European Union (EU). It works to address major issues related to the global economy, such as international financial stability, climate change mitigatio ...
.


Examples in contract law

A simple example of not at arm's length is the sale of
real property In English common law, real property, real estate, immovable property or, solely in the US and Canada, realty, is land which is the property of some person and all structures (also called improvements or fixtures) integrated with or affixe ...
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 A gift or a present is an item given to someone without the expectation of payment or anything in return. An item is not a gift if that item is already owned by the one to whom it is given. Although gift-giving might involve an expectation ...
rather than a
bona fide In human interactions, good faith ( la, bona fides) is a sincere intention to be fair, open, and honest, regardless of the outcome of the interaction. Some Latin phrases have lost their literal meaning over centuries, but that is not the case ...
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 from how it would have been for an arbitrary third party. This could be done, for example, by hiring a disinterested third party, such as an appraiser or broker, who could 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 any undue government influence over other bodies, such as the
legal system The contemporary national legal systems are generally based on one of four basic systems: civil law, common law, statutory law, religious law or combinations of these. However, the legal system of each country is shaped by its unique history an ...
, 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 A government is the system or group of people governing an organized community, generally a state. In the case of its broad associative definition, government normally consists of legislature, executive, and judiciary. Government is a ...
. In the workplace,
supervisor A supervisor, or lead, (also known as foreman, boss, overseer, facilitator, monitor, area coordinator, line-manager or sometimes gaffer) is the job title of a lower-level management position that is primarily based on authority over workers or ...
s and
managers Management (or managing) is the administration of an organization, whether it is a business, a nonprofit organization, or a government body. It is the art and science of managing resources of the business. Management includes the activities o ...
deal with
employee Employment is a relationship between two parties regulating the provision of paid labour services. Usually based on a contract, one party, the employer, which might be a corporation, a not-for-profit organization, a co-operative, or any other ...
discipline and
termination of employment Termination of employment or separation of employment is an employee's departure from a job and the end of an employee's duration with an employer. Termination may be voluntary on the employee's part, or it may be at the hands of the employer, of ...
at arm's length through the
human resources Human resources (HR) is the set of people who make up the workforce of an organization, business sector, industry, or economy. A narrower concept is human capital, the knowledge and skills which the individuals command. Similar terms include m ...
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 A legal recourse is an action that can be taken by an individual or a corporation to attempt to remedy a legal difficulty. * A lawsuit if the issue is a matter of civil law * Contracts that require mediation or arbitration before a dispute can go ...
that employees may otherwise have if it can be demonstrated that such discipline or terminations were not handled in accordance with the latest
labor law Labour laws (also known as labor laws or employment laws) are those that mediate the relationship between workers, employing entities, trade unions, and the government. Collective labour law relates to the tripartite relationship between employee, ...
s. For employees in
unionized A trade union (labor union in American English), often simply referred to as a union, is an organization of workers intent on "maintaining or improving the conditions of their employment", ch. I such as attaining better wages and benefits ( ...
environments,
shop stewards A union representative, union steward, or shop steward is an employee of an organization or company who represents and defends the interests of their fellow employees as a labor union member and official. Rank-and-file members of the union hold ...
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
negotiation Negotiation is a dialogue between two or more people or parties to reach the desired outcome regarding one or more issues of conflict. It is an interaction between entities who aspire to agree on matters of mutual interest. The agreement c ...
s or a
grievance A grievance () is a wrong or hardship suffered, real or supposed, which forms legitimate grounds of complaint In legal terminology, a complaint is any formal legal document that sets out the facts and legal reasons (see: cause of actio ...
, 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.


International tax law

The
Organisation for Economic Co-operation and Development The Organisation for Economic Co-operation and Development (OECD; french: Organisation de coopération et de développement économiques, ''OCDE'') is an intergovernmental organization, intergovernmental organisation with 38 member countries ...
(OECD) has adopted the principle i
Article 9 of the OECD Model Tax Convention
to ensure that transfer prices between companies of multinational enterprises are established on a
market value Market value or OMV (Open Market Valuation) is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with ''open market value'', ''fair value'' or ''fair market value'', although the ...
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 A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, or n ...
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 A country is a distinct part of the world, such as a state, nation, or other political entity. It may be a sovereign state or make up one part of a larger state. For example, the country of Japan is an independent, sovereign state, while the ...
(whether it has low or high tax rates). The OECD Model Tax Convention provides the legal framework for
governments A government is the system or group of people governing an organized community, generally a state. In the case of its broad associative definition, government normally consists of legislature, executive, and judiciary. Government is a ...
to have their fair share of
taxes A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, or ...
, and for enterprises to avoid
double taxation Double taxation is the levying of tax by two or more jurisdictions on the same income (in the case of income taxes), asset (in the case of capital taxes), or financial transaction (in the case of sales taxes). Double liability may be mitigated i ...
on their profits. The arm's length standard is instrumental to determine ''how much'' of the profits should be attributed to one entity and, consequently, the extent of a country's tax claim on such entity. The OECD has developed thoroug
guidelines
on how the arm's length principle should be applied in this context. Under this approach, a price is considered appropriate if it is within a range of prices that would be charged by independent parties dealing at arm's length. This is generally defined as a price that an independent buyer would pay an independent seller for an identical item under identical terms and conditions, where neither is under any compulsion to act. Transfer pricing became a highly controversial topic in the last years, which contributed to the development of the
Base Erosion and Profit Shifting Base erosion and profit shifting (BEPS) refers to corporate tax planning strategies used by multinationals to "shift" profits from higher-tax jurisdictions to lower-tax jurisdictions or no-tax locations where there is little or no economic a ...
(BEPS) project by the OECD and with the endorsement of the G20. The
World Customs Organization The World Customs Organization (WCO) is an intergovernmental organization headquartered in Brussels, Belgium. The WCO works on customs-related matters including the development of international conventions, instruments, and tools on topics suc ...
(WCO) and
World Trade Organization The World Trade Organization (WTO) is an intergovernmental organization that regulates and facilitates international trade. With effective cooperation in the United Nations System, governments use the organization to establish, revise, and e ...
(WTO) have also adopted, in effect, the arm's length principle in
Customs valuation Customs valuation is the process where customs authorities assign a monetary value to a good or service for the purposes of import or export. Generally, authorities engage in this process as a means of protecting tariff concessions, collecting reven ...
s. The Agreement on Implementation of Article VII (known as the WTO Agreement on Customs Valuation or the “Valuation Agreement”) ensures that determinations of the customs value for the application of duty rates to imported goods are conducted in a neutral and uniform manner, precluding the use of arbitrary or fictitious customs values.


See also

*
English contract law English contract law is the body of law that regulates legally binding agreements in England and Wales. With its roots in the lex mercatoria and the activism of the judiciary during the industrial revolution, it shares a heritage with countries ...
*
Say on pay Say on pay is a term used for a role in corporate law whereby a firm's shareholders have the right to vote on the remuneration of executives. Often described in corporate governance or management theory as an agency problem, a corporation's manag ...
*
Transfer pricing In taxation and accounting, transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control. Because of the potential for cross-border controlled transactions to distort ...
*
Customs valuation Customs valuation is the process where customs authorities assign a monetary value to a good or service for the purposes of import or export. Generally, authorities engage in this process as a means of protecting tariff concessions, collecting reven ...


References


External links


Transfer pricing: Keeping it at arm’s length
*[http://www.wcoomd.org/en/topics/valuation/overview/~/media/WCO/Public/Global/PDF/Topics/Valuation/Instruments%20and%20Tools/GATT/arti7_gen_agreemt.ashx Article 7 of the General Agreement on Tariffs and Trade (GATT)]
WCO: Brief Guide to the Customs Valuation AgreementWCO: Guide to Customs Valuation and Transfer Pricing
{{Authority control Contract law International taxation