What is Arm's Length?

What is Arm's Length Transactions?

What do we mean by Related Party?


Arm's Length:

Suppose, Two persons are not relatives/friends to each other. They are standing by face to face. They don't have any relationship between them. Persons who are unrelated to each others will treat each other in different way, than persons known to each other. it means they will talk to each other by standing on a distance of Arm's length.

on the other side, Two persons who are relatives/family friends of each others, will always meet and great each others by hug. there is no arm's length distance between them as we envisaged in case of unrelated persons.


Arm's Length Transactions:

in common business parlance, when two related/associated persons enters into commercial transactions, it is obvious that they may benefit each other by manipulating prices, credit periods, interest rates and expenses.

while in unrelated parties transactions these benefits can't be reaped by the parties. Those transactions will reflect normal market conditions and trends but in case of Associated/Related party transactions it will not be reflected.

Due to globalization, multinational companies expanded their businesses globally and Tax structures are not symmetrical to country to country. it is obvious that MNC may mold or distort transactions in such a way that both countries or at least one country may lose its part of taxation only because of the fact that Both the parties are related/associated (Parent or Subsidiary to other).

Hence, it was recommended that all associate/related party transactions must be at Arm's Length like transactions between unrelated parties.

Associated / Related Parties:

Who are Associated / Related?
Associated parties or enterprises are those which are owned or controlled by the same or common entity / person.

As per Section 92A,


an enterprise which participates, directly or indirectly, or through one or more intermediaries in:

• management of other enterprise, or
• control of the other enterprise, or
• capital of the other enterprise.

if one or more persons participates, directly or indirectly, or through one or more intermediaries in:

• management of the two different enterprises,
• control of two different enterprises
• capital of two different enterprises

then those two enterprises are associated / related enterprises.