The world would be a better place, at least hygienically, if we could keep everyone at a distance equal to the length of an arm—the literal meaning of this tem. In contract law, an agreement is considered to be “arms-length” if the parties acted independently and the resulting agreement reflects what would be negotiated on the open market. Whether an agreement is “arms-length” is sometimes an issue of great interest to the government.
EXAMPLE. A grandfather wants to give his granddaughter $100,000 but he is concerned about gift taxes. Instead, he prepares a “loan” agreement, lending her $100,000 interest free and with no schedule for repayment. The IRS would not consider that to be an arms-length agreement and would instead insist that the amount be treated as a gift for tax purposes.
Contracts made with the U.S. government should be arms-length and federal law determines what is and isn’t arms-length by using a “standard of comparability,” in which the arrangement is measured against similar transactions on the open market.[i] When courts measure an arms-length decision, they commonly use three factors: market price, relationship of the parties, and comparable agreements.
[i] 26 CFR Section 1.482