Forman Financial Services

Navigating the SMSF Tax Trap: Understanding NALI and NALE

Self-Managed Super Funds (SMSFs) give you control, flexibility, and choice over how your retirement savings are invested. But with that control comes responsibility—and if the rules aren’t followed carefully, the tax consequences can be severe.

Two of the most common (and costly) traps are NALI and NALE. Many trustees fall into these without realising it.

The Simple Rule: Everything Must Be Commercial

The ATO expects your SMSF to operate as if it were dealing with strangers.

That means:

  • Income must be at market value
  • Expenses must be paid at market value
  • Related-party dealings must be strictly commercial

If something is too cheap, too generous, or too informal, it can trigger a tax penalty.

What Is NALI?

NALI (Non-Arm’s Length Income) is income your SMSF earns from a deal that isn’t on commercial terms—often involving a related party.

Why Is NALI So Serious?

Normally, SMSF income is taxed at 15%.
But if income is classified as NALI, the tax rate jumps to 45%.

Even worse:

  • The entire income amount is taxed at 45%
  • Not just the “extra” above market value

Example

If your SMSF receives:

  • $160,000 in rent from a related party
  • When the market rent should be $100,000

The full $160,000 is taxed at 45%, not just the $60,000 difference.

What Is NALE?

NALE (Non-Arm’s Length Expenses) happens when your SMSF:

  • Pays less than market value for a service or asset, or
  • Doesn’t pay at all when it should

This can be just as dangerous as NALI.

Revenue vs Capital Expenses

Not all NALE is treated the same:

Revenue expenses (e.g. ongoing services)

  • Usually affect income from that asset for that year only

Capital expenses (e.g. buying or improving an asset)

  • Can permanently taint the asset
  • All future income and capital gains may be taxed at 45%

This means one mistake today can have consequences for decades.

“But I Did the Work Myself…” — A Common Trap

Trustees often assume they can use their own skills to save money. This is where many SMSFs get caught.

When It’s Usually OK

  • Minor, infrequent tasks
  • No business tools, staff, or invoices
  • Acting clearly as a trustee

Example: a plumber trustee fixing a small leak once.

When It Becomes a Problem

  • Major works or renovations
  • Using business equipment or employees
  • Work done during business hours
  • No commercial invoice or market-rate charge

In these cases, the ATO may say you acted in a professional capacity, not as a trustee—triggering NALE and potentially NALI on the asset’s income.

Why This Matters

NALI and NALE are often:

  • Unintentional
  • Discovered years later
  • Extremely expensive to fix

Once income is classified as NALI, the tax outcome cannot be reversed.

A Simple Way to Think About It

Think of your SMSF like a high-performance engine designed to run on 15% tax fuel.

If you add:

  • Discounted services
  • Below-market deals
  • Informal arrangements

It’s like contaminating the fuel.

The result?
The entire engine is forced to run on 45% tax fuel—and in some cases, it stays that way permanently.

How to Protect Your SMSF

To avoid nasty surprises:

  • Always document related-party transactions
  • Charge and pay market rates
  • Get independent valuations where required
  • Seek advice before doing work or entering arrangements
  • Never assume “saving money” is safe inside an SMSF

Final Thought

SMSFs are powerful wealth-building vehicles—but only when managed correctly. NALI and NALE are among the most severe tax traps in super, and they often catch well-meaning trustees off guard.

Getting advice upfront is far cheaper than paying 45% tax later.

 

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Disclaimer and Warning
The information above is of a general nature only.  It should not be used as a source to make financial decisions.  It’s also important to note that the legislation and figures related to this topic tend to change regularly and therefore the information above may not reflect the current status.  We recommend that if you are looking for advice on this matter, you should contact us