The ATO’s focus on non-arm’s-length income (NALI) and expenditure (NALE) continues to sharpen, and the legislative framework has evolved again in 2025 to clarify how these rules apply in practice. Advisers must now ensure all dealings between an SMSF and related parties are demonstrably commercial — or risk punitive tax at up to 45% on affected income.
Non-arm’s-length income remains a critical compliance issue for SMSFs in 2025. Here’s what advisers need to understand about the latest legislative changes and how to manage the risks.
Background — Why NALI Exists
Superannuation funds normally enjoy a concessional 15% tax rate (or 0% in pension phase). However, where income is deemed non-arm’s-length, that concessional rate is lost. Instead, the income is taxed at the top marginal rate of 45%.
The policy intent is to stop taxpayers from diverting income into super funds to access lower tax rates — for example, by artificially inflating investment returns or minimising expenses.
The NALI rules are contained in s.295-550 of the Income Tax Assessment Act 1997 (ITAA 1997). From 1 July 2018, the regime expanded to also capture non-arm’s-length expenditure (NALE).
Four Key NALI Categories
An SMSF’s income may be classified as NALI if it arises from any of the following categories, which include:
- Non-arm’s-length transactions — where income is higher, or expenditure lower, than what would occur in a genuine commercial dealing
- Private company dividends — unless the amount is consistent with arm’s-length terms
- Discretionary trust distributions — always NALI if the fund doesn’t have a fixed entitlement
- Fixed trust income — if the fund or the trust has non-arm’s-length dealings in relation to that income
“Income” in this context includes both ordinary income (rent, interest, dividends) and statutory income (capital gains, franking credits).
Determining Arm’s-Length Dealings
The ATO expects trustees to be able to demonstrate that transactions are consistent with what independent parties would agree to.
Factors include:
- Whether the parties are related under SIS s.10 or s.70B
- Mutual obligations or influence between the parties
- Commercial comparability of terms such as pricing, timing, and risk
Where related parties are involved, the presumption is not arm’s-length unless evidence (e.g. independent valuation, market quotes) proves otherwise.
NALE — When Expenses Are Too Low
The NALE provisions target situations where an SMSF incurs less expenditure than would occur in a comparable commercial transaction — including where no payment is made.
Two types of NALE now exist, and the tax outcome differs significantly.
1. Specific Expenses — Revenue vs Capital Account
Specific expenses are those that relate directly to a particular asset or investment, such as property management fees, loan interest, or repair costs.
If a fund incurs less than arm’s-length expenditure (or none at all) on these asset-specific costs, the impact depends on whether the expense is on revenue or capital account.
Revenue Account: Ongoing Income Is Affected
Where the expense is revenue in nature — for example:
- discounted property management fees
- undercharged rent collection or maintenance, or
- reduced brokerage on a specific share parcel —
the income from that asset (such as rent, dividends, or interest) will be treated as non-arm’s-length income (NALI) for the period the non-commercial dealing continues.
If the arrangement is corrected and future dealings are at market value, later income from that asset will no longer be NALI.
In other words, revenue-type NALE produces a temporary taint that ends when the fund resumes commercial terms.
Capital Account: The Asset Becomes Permanently Tainted
Where the expense is capital in nature, the consequences are far more severe.
Capital expenses are those that improve, acquire, or enhance an asset rather than maintain it — for example:
- building or renovation works
- capital improvements or structural upgrades, or
- an asset purchased below market value or financed under a favourable related-party loan (LRBA)
If a fund benefits from non-commercial terms on these capital transactions, the ATO treats all present and future income and capital gains from the asset as NALI — forever.
Once tainted, the asset’s income and any gain on sale will be taxed at 45%, even if the arrangement is later corrected.
Example: Asset Acquisition Below Market Value
If an SMSF buys a property from a member for $700,000 when the market value is $1 million, the $300,000 shortfall is NALE on capital account.
The property is permanently tainted, and all rental income and future sale gains are taxed at 45%.
2. General Expenses
General expenses have a nexus to all of the fund’s income — such as accounting, audit, actuarial, or investment administration fees.
From 1 July 2023, legislation introduced the “two-times approach”:
NALI = 2 × (the difference between the market value of the expense and the amount actually paid).
This formula effectively doubles the shortfall amount when calculating NALI.
For instance, if a fund pays $1,000 for accounting services that are normally $2,500 (and there’s no valid discount policy), the $1,500 shortfall triggers $3,000 of NALI, taxed at 45%.
Importantly, if the undercharging ceases in a later year and arm’s-length fees are paid, income from subsequent years is not affected.
Services Provided by Trustees or Related Parties
One of the most frequent traps involves trustees who use their professional skills to assist their own SMSF.
Under SIS s.17A, trustees cannot receive remuneration for services performed in their trustee capacity.
However, under SIS s.17B, payment is allowed where:
- The individual is properly qualified and licensed
- The service is provided as part of a business that offers the same services to the public, and
- The remuneration is on an arm’s-length basis
Determining capacity is critical:
- Trustee capacity: activities such as maintaining records, collecting rent, formulating the investment strategy, or preparing the fund’s accounts are generally trustee duties. No NALE applies even if performed using personal skills.
- Individual (non-trustee) capacity: where services are provided using business equipment, a professional licence (e.g. real estate, financial advice, accounting), or business insurance, and the fund is under-charged or not charged at all, NALE applies.
The ATO’s Law Companion Ruling LCR 2021/2 (finalised September 2025) provides 13 examples illustrating this distinction.
Related-Party LRBAs and Asset Acquisitions
Assets purchased under non-commercial limited recourse borrowing arrangements (LRBAs) remain a major NALI risk.
If loan terms (e.g. 100% LVR, below-market interest, annual repayments) are more favourable than market, all income and capital gains from the property will be NALI — permanently, even if the loan is later refinanced on commercial terms.
Similarly, where an SMSF acquires an asset for less than market value, the fund cannot treat the difference as an in-specie contribution unless the contract clearly identifies that only part of the asset is being purchased. Otherwise, the underpayment is treated as NALE, tainting all future income from the asset.
The Two-Times Rule and Capping the NALI Component
To prevent disproportionate outcomes, the 2024 amendments introduced a cap on how much NALI can apply to general expenses.
Under the 2024 amendments (Treasury Laws Amendment – Support for Small Business and Charities Act 2024), general expense shortfalls are now capped to prevent excessive taxation.
An SMSF’s “non-arm’s-length component” equals the lesser of:
- The sum of NALI amounts (including twice any general expense shortfall), or
- The fund’s taxable income (excluding contributions).
This ensures that contributions themselves are never taxed at 45%.
Key Practical Takeaways
- Keep every SMSF arrangement commercial — document valuations, rental appraisals, and service quotes
- Identify the provider’s capacity — trustee duties vs professional services
- Review related-party LRBAs — ensure they meet safe harbour terms
- Check fee policies — only documented, broad employee discounts will prevent NALE
- Rectify early: revert to commercial terms as soon as an error is found; future income won’t remain tainted if corrected promptly
- Educate trustees — many inadvertent breaches arise from well-meaning members doing unpaid work for their fund
In Summary
The 2025 NALI and NALE reforms bring long-awaited certainty but also reinforce the ATO’s zero-tolerance stance on non-commercial SMSF dealings. Advisers must help trustees adopt robust documentation and pricing practices to protect concessional tax outcomes.
When in doubt, assume the ATO will ask:
Would this transaction stand up between two strangers in the open market?
If the answer isn’t an easy “yes”, it’s time to review the arrangement — before a 45% tax bill does it for you.
Learn more about SuperConcepts SMSF administration services
We specialise in the end-to-end administration of SMSFs, including funds that hold collectables. We also work closely with your adviser to keep your fund compliant. Find out more here or call us on 1300 023 170.
Disclaimer: General information only. SuperConcepts does not provide financial product advice. Consider your circumstances and seek licensed advice where appropriate.
