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What can an arm’s length transaction mean for a small business?

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The business community can feel more personal than professional at times because small and medium enterprises (SMEs) need to support one another to survive. Australian Bureau of Statistics’ research shows sole proprietor businesses had a 16 per cent exit rate within their first year in 2017. This shows many entrepreneurs are unaware of the pitfalls that come from mixing personal relationships with business dealings – typified by business deals not conducted at arm’s length.
Our guide will show what an arm’s length transaction is and demonstrate the dangers of a personal relationship between buyer and seller.


What is an arm’s length transaction?

This financial arrangement covers parties that have a personal relationship, or a buyer and seller who have a mutual interests in the other’s fortunes. An arm’s length transaction ensures distance between groups to mitigate any conflict of interest and protect the personal relationship.

Neither party should have vested interest in the consequences of a transaction to the other. In an open market, the buyer will seek the lowest price possible, while the seller will charge the highest possible, with negotiations moderating the agreed figure. If a sale is between family, friends or personal acquaintances, it’s seen as unbalanced and unfair to others in the same market, leaving arrangements open to claims of corruption or unprofessional conduct.

An arm’s length transaction is proof your business deal wasn’t made through the influence of any personal relationships.

What can an arm’s length transaction mean for small businesses?

In a family business, or smaller enterprise communities, it can be difficult to arrange a sale without the risk of personal relationships compromising integrity. While these transactions aren’t illegal, there are consequences if a financial audit by Fair Trading NSW or the Australian Competition and Consumer Commission proves unprofessional conduct. These consequences include:

  • Increased distrust from the business community and time-consuming third party scrutiny to assess a business’ operations.
  • Disqualification from participating in lending programs, especially for charities and Not for Profit organisations.
  • Tax at the highest marginal rates, to discourage businesses from continuing trading.

How to identify if you’re trading arm-in-arm

It often surprises small businesses, especially family-owned operations trading between shareholders, to learn their transactions can be considered unprofessional. Even if neither party expect to benefit personally, certain red flags will make a transaction seem suspicious:

  • If one party has significant power over the other. In this case, the transaction bears evidence of external influence to the benefit of either buyer or seller.
  • If the transaction leads to the instant and mutual benefit of both parties. This is commonly seen in shareholder disputes, where stakeholders trade with one another tactically to gain a majority say in business decisions.
  • If the both individuals or entities involved in a transaction are affiliated. This covers sales between parent companies and subsidiaries, or a trust and its beneficiaries.

Once small businesses have identified that their transactions can be seen as arm-in-arm, the burden of proof falls on SME owners to demonstrate that sales have been conducted fairly.

How to prove trading has been at arm’s length

A small business’ arm’s length transaction requires independent audit services to ensure both parties involved were trading on equal market terms. A sales appraisal from an third party expert is a good start. Whether purchasing a property, goods or shares, businesses can easily demonstrate their transfer pricing if a neutral corroborates the methods used to reach a sales figure.
If the transaction has major ramifications for both parties, seeking the help of solicitors or a mediator is another crucial factor in helping prove the sale was impartial. Further, all contractual clauses in the transaction should be made in writing and signed by both parties with neutral witnesses.

However, the best way to prove trading has been conducted at arm’s length and reduce your tax margin is to use independent auditing. A finance expert will be able to analyse all transactions within your small business and identify signs your motives could be questioned. They can also look at fringe benefits and other factors to determine whether the transaction is arm’s length.

For help with expert auditing, contact DFK Crosbie today.

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Specialist accounting and business advice, knowledge and experience for businesses and professionals.


Level 5, 12 Stewart Avenue, Newcastle West NSW 2302


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