SMSF non-arm's length income (NALI): how the 45% tax trap works in 2026

Non-arm's length income (NALI) is one of the harshest penalties in the Australian super system. Income classified as NALI is taxed at the top marginal rate of 45% inside the SMSF — not the usual 15% accumulation rate or 0% pension rate. The rules are in section 295-550 of the Income Tax Assessment Act 1997 and were tightened in 2018 to also capture non-arm's length expenses (NALE). Trustees who run businesses, own property, or transact with related parties need to understand how the rules apply before they sign anything.

What is the arm's length principle?

An arm's length dealing is one where both parties act independently and the terms reflect what unrelated commercial parties would agree to. When an SMSF deals with a related party — a member, relative, related trust, or related company — every term of the deal must mirror what a stranger would have negotiated. Rent, interest rates, sale prices, service fees, and even labour rates all need to be benchmarked.

What income gets caught by NALI?

• Rent received from a related party at above-market rates on a business real property lease
• Distributions from a related trust where the SMSF's entitlement is disproportionate to its capital contribution
• Dividends from a private company where the SMSF's shareholding terms are not commercial
• Interest received on a loan to a related party at above-market rates
• Capital gains on the disposal of an asset acquired on non-arm's length terms

NALE — the 2018 expansion that surprised many trustees

The NALE rules extend NALI to situations where an SMSF incurs an expense that is less than what an arm's length party would have charged — including a nil expense. A common trap: a member who is a licensed real estate agent manages the fund's investment property for free. The ATO's view (TR 2010/1 and LCR 2021/2) is that all rental income from that property may then be taxed as NALI at 45%. The same risk applies to a member-accountant who prepares the fund's own financials in their personal capacity rather than through their firm.

General vs specific NALE

There are two flavours of NALE. Specific NALE relates to a particular asset (e.g. free property management for one rental) and taints only the income from that asset. General NALE relates to fund-wide expenses (e.g. free bookkeeping for the entire SMSF). For the 2024-25 income year and later, general NALE is taxed at twice the difference between the market rate and the actual expense, capped at the fund's total taxable income — a softening compared with the original drafting but still material.

Common NALI/NALE traps to avoid

• Buying a related-party property at less than market value without a current independent valuation
• Charging the fund below-market rent for a property the member's business occupies, then later raising it
• A member-tradesperson doing renovation work on a fund property without invoicing through their business
• Related-party loans at below the safe-harbour interest rate published by the ATO each year (PCG 2016/5)
• Free or discounted accounting, audit, or legal work provided to the fund by a member's firm

How to stay safe

Document everything. For property, get a written market rent appraisal from an independent agent at the start of each lease. For services from a member's business, invoice the fund at the firm's standard rate. For related-party loans, follow the ATO safe-harbour terms in PCG 2016/5 exactly. Keep contemporaneous trustee minutes recording why each price or rate is considered commercial. Auditors look for this evidence at every annual audit.

Sources: Income Tax Assessment Act 1997, section 295-550; ATO Law Companion Ruling LCR 2021/2 — Non-arm's length income and expenses; ATO Practical Compliance Guideline PCG 2016/5 — Related-party LRBAs.