The Sri Lankan officer was taken into custody Friday following the discovery of 73 would-be illegal immigrants in a trawler off the island's southern coast six weeks ago, a police officer said.
Four navy sailors were taken into custody last month following the trawler's interception.
But Lieutenant Commander Sanjeewa Annatugoda is the most senior officer to be arrested in connection with people smuggling, police said.
A navy official, who declined to be named, confirmed the officer's arrest, and said internal investigations were underway.
The latest arrest of a navy officer is an embarrassment for Colombo which has maintained that there is no senior level official collusion with people smugglers.
Australia has said it will transfer all asylum seekers to impoverished Papua