Non-arm’s length income

Income tax purposes

For income tax purposes, self-managed super funds (SMSFs) and parties to any scheme should deal with each other on an arm's-length basis to avoid any application of the non-arm's length income (NALI) provisions.

There may also be regulatory consequencesExternal Link if SMSFs do not act at arm's length.

Definition of non-arm's length income

Broadly, income is NALI for a complying SMSF if:

• an amount of ordinary or statutory income was derived as a result of a scheme in which the parties weren't dealing with each other at arm's length in relation to the scheme and one or more of the following applies:
  • that income is more than the SMSF might have been expected to derive if the parties had been dealing with each other at arm's length in relation to the scheme
  • from 1 July 2018, in gaining or producing the income, the SMSF incurs a loss, outgoing or expenditure (including nil expense) that is less than what the SMSF might have been expected to incur if the parties were dealing on an arm's-length basis in relation to the scheme. The types of expenses are:
    • specific expenses - are in relation to a particular asset or assets of the fund (for example, maintenance expenses for a rental property)
    • when an SMSF incurs a specific expense, all income in relation to the particular asset or assets will be NALI
    • general expenses - have a sufficient nexus to the entirety of the income of the fund. These expenses usually relate to the operation or obligations of the fund as a whole (for example, accountancy fees).
    • when an SMSF incurs a general expense, the NALI will be calculated as twice the difference between the amount of the actual expense and the expected market value of the expense.
• dividends are paid to a SMSF by a private company (unless the dividend is consistent with arm's length dealing - see TR 2006/7Opens in a new window)
• income is derived by an SMSF as a beneficiary of a trust, other than because of holding a fixed entitlement to the income. For example income derived as a beneficiary of a discretionary trust
• income is derived by an SMSF as a beneficiary of a trust through holding a fixed entitlement to the income of the trust if, as a result of a scheme in which the parties were not dealing at arm's length in relation to the scheme and one or more the following applies:
  • income that is more than the SMSF might have been expected to derive if the parities had been dealing with each other at arm’s length in relation to the scheme
  • from 1 July 2018, in acquiring the entitlement or in gaining or producing the income, the SMSF incurs a loss, outgoing or expenditure (including a nil expense), that is less than what the SMSF might have been expected to be incurred if the parties were dealing on an arm's length basis in relation to the scheme.

Non-arm's length component

Any NALI forms part of the non-arm's length component (NALC) of the SMSF's taxable income which is taxed at the highest marginal tax rate. However, the SMSF’s total NALC can't exceed the SMSF’s assessable income minus deductions, excluding assessable contributions and deductions against them.

For more information about how the NALC is calculated, refer to the return instructions for the relevant year.

See: Self-managed superannuation fund annual return instructionsExternal Link

For more information see:

• TR 2006/7 Special income (special income was the predecessor to non-arm's length income)
• LCR 2021/2 Non-arm’s length income - expenditure incurred under a non-arm’s length arrangement Opens in a new window
• PCG 2020/5 Applying the non-arm's length income provisions to 'non arm's length expenditureOpens in a new window.