Any non-arm’s length income (NALI) is taxed at the highest marginal rate.

A fund has NALI if it has:

• an amount of ordinary or statutory income derived from a scheme where:
  • the parties did not deal with each other at arm’s length, and
  • the amount of income earned by the SMSF from the scheme is more than would be expected if the parties had been dealing at arm's length
• a dividend paid to an SMSF by a private company that isn’t consistent with an arm’s length dealing
• income derived by an SMSF as a beneficiary of a trust (other than through holding a fixed entitlement to the income).

From 1 July 2018, a fund also has NALI if:

• an amount of income is derived from a scheme where the parties weren't dealing with each other at arm's length, and
• the fund incurs expenses when deriving the income and the amount of the expenses is less than would have been expected if the parties were dealing at arm's length (including nil expenses).

These expenses are classified as either:

• specific expenses, which are related to earning income from a particular asset of the fund (for example, maintenance expenses for a rental property), or
• general expenses, which are related to all expenses incurred otherwise than in gaining or producing income from a particular asset (for example, accountant fees).

When an SMSF incurs a non-arm’s length specific expense, all income in relation to the particular asset or assets will be NALI.

When an SMSF incurs a non-arm’s length 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.

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 cannot exceed the SMSF’s assessable income minus deductions, excluding assessable contributions and deductions against them.