Arm's length principle
Encyclopedia
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. Such a transaction is known as an "arm's-length transaction". It is used specifically in contract law 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).
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 Council
s 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, supervisor
s 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 law
s. 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 negotiation
s 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.
Examples
A simple example of not at arm's length is the sale of real propertyReal property
In English Common Law, real property, real estate, realty, or immovable property is any subset of land that has been legally defined and the improvements to it made by human efforts: any buildings, machinery, wells, dams, ponds, mines, canals, roads, various property rights, and so forth...
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
Gift (law)
A gift, in the law of property, is the voluntary transfer of property from one person to another without full valuable consideration...
rather than a bona fide
Bona Fide
Bona Fide is a studio album from rock band Wishbone Ash. It is the first studio album in six years and is the only studio album to feature guitarist Ben Granfelt...
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 Council
Arts council
An arts council is a government or private, non-profit organization dedicated to promoting the arts mainly by funding local artists, awarding prizes, and organizing events at home and abroad...
s operate "at arm's length" in allocating the funds they receive from the government
Government
Government refers to the legislators, administrators, and arbitrators in the administrative bureaucracy who control a state at a given time, and to the system of government by which they are organized...
.
The Organisation for Economic Co-operation and Development
Organisation for Economic Co-operation and Development
The Organisation for Economic Co-operation and Development is an international economic organisation of 34 countries founded in 1961 to stimulate economic progress and world trade...
(OECD) has adopted the principle in Article 9 of the OECD Model Tax Convention, to ensure that transfer prices
Transfer pricing
Transfer pricing refers to the setting, analysis, documentation, and adjustment of charges made between related parties for goods, services, or use of property . Transfer prices among components of an enterprise may be used to reflect allocation of resources among such components, or for other...
between companies of multinational enterprises
Multinational corporation
A multi national corporation or enterprise , is a corporation or an enterprise that manages production or delivers services in more than one country. It can also be referred to as an international corporation...
are established on a market value
Market value
Market value 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 these terms have distinct definitions in different standards, and may differ in some...
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
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
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
Profit (economics)
In economics, the term profit has two related but distinct meanings. Normal profit represents the total opportunity costs of a venture to an entrepreneur or investor, whilst economic profit In economics, the term profit has two related but distinct meanings. Normal profit represents the total...
to any other country
Country
A country is a region legally identified as a distinct entity in political geography. A country may be an independent sovereign state or one that is occupied by another state, as a non-sovereign or formerly sovereign political division, or a geographic region associated with a previously...
(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
Company
A company is a form of business organization. It is an association or collection of individual real persons and/or other companies, who each provide some form of capital. This group has a common purpose or focus and an aim of gaining profits. This collection, group or association of persons can be...
to avoid double taxation
Double taxation
Double taxation is the systematic imposition of two or more taxes on the same income , asset , or financial transaction . It refers to taxation by two or more countries of the same income, asset or transaction, for example income paid by an entity of one country to a resident of a different country...
on their profits
Profit (economics)
In economics, the term profit has two related but distinct meanings. Normal profit represents the total opportunity costs of a venture to an entrepreneur or investor, whilst economic profit In economics, the term profit has two related but distinct meanings. Normal profit represents the total...
.
The use of "arm's length principle" is extended as a new concept in tort
Tort
A tort, in common law jurisdictions, is a wrong that involves a breach of a civil duty owed to someone else. It is differentiated from a crime, which involves a breach of a duty owed to society in general...
law. A person should keep an "arm's length" distance from another to avoid offensive or harmful contact, otherwise a battery
Battery (tort)
At common law, battery is the tort of intentionally and voluntarily bringing about an unconsented harmful or offensive contact with a person or to something closely associated with them . Unlike assault, battery involves an actual contact...
or assault
Assault
In law, assault is a crime causing a victim to fear violence. The term is often confused with battery, which involves physical contact. The specific meaning of assault varies between countries, but can refer to an act that causes another to apprehend immediate and personal violence, or in the more...
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
Dignity
Dignity is a term used in moral, ethical, and political discussions to signify that a being has an innate right to respect and ethical treatment. It is an extension of the Enlightenment-era concepts of inherent, inalienable rights...
.
In the workplace, supervisor
Supervisor
A supervisor, foreperson, team leader, overseer, cell coach, facilitator, or area coordinator is a manager in a position of trust in business...
s and managers
Management
Management in all business and organizational activities is the act of getting people together to accomplish desired goals and objectives using available resources efficiently and effectively...
deal with employee
Employment
Employment is a contract between two parties, one being the employer and the other being the employee. An employee may be defined as:- Employee :...
discipline and termination of employment
Termination of employment
-Involuntary termination:Involuntary termination is the employee's departure at the hands of the employer. There are two basic types of involuntary termination, known often as being "fired" and "laid off." To be fired, as opposed to being laid off, is generally thought of to be the employee's...
at arm's length through the human resources
Human resources
Human resources is a term used to describe the individuals who make up the workforce of an organization, although it is also applied in labor economics to, for example, business sectors or even whole nations...
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
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* Many contracts require mediation or arbitration before a dispute can go to court...
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 law
Labour law
Labour law is the body of laws, administrative rulings, and precedents which address the legal rights of, and restrictions on, working people and their organizations. As such, it mediates many aspects of the relationship between trade unions, employers and employees...
s. For employees in unionised
Trade union
A trade union, trades union or labor union is an organization of workers that have banded together to achieve common goals such as better working conditions. The trade union, through its leadership, bargains with the employer on behalf of union members and negotiates labour contracts with...
environments, shop stewards
Union steward
A union representative, union steward, or shop steward is an employee of an organization or company, who represents and defends the interests of her/his fellow employees but who is also a labor union official...
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
Negotiation is a dialogue between two or more people or parties, intended to reach an understanding, resolve point of difference, or gain advantage in outcome of dialogue, to produce an agreement upon courses of action, to bargain for individual or collective advantage, to craft outcomes to satisfy...
s or a grievance
Grievance
A grievance is a wrong or hardship suffered, which is the grounds of a complaint.-History and politics:A grievance may arise from injustice or tyranny, and be cause for rebellion or revolution....
, 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.