Private ruling: Early stage innovation company
Date of advice: 5 February 2021
Published: March 2021
Ruling period: 1 July 20XX to 30 June 20YY
Date scheme commenced: 1 July 20XX

Ruling: Q1: Does Company A satisfy the criteria of an Early Stage Innovation Company (ESIC) pursuant to subsection 360-40(1) of the Income Tax Assessment Act 1997 (' ITAA 1997 ') for the period 1 July 20XX to 30 June 20YY? | A1: Yes

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. 1. Company A is an Australian proprietary company incorporated on x XX 20XX. 2. Company A's directors are Taxpayer A and Taxpayer B. 3. Company A is not a foreign company pursuant to the Corporations Act 2001 (Cth). 4. Company A has full ownership of a subsidiary, Company B, which was incorporated on the y YY 20YY. Company B currently remains dormant. 5. Company A had planned to raise capital in 20XX, however its development activities were delayed to 20YY due to COVID-19. The majority of its innovation criteria descriptions remain the same as in its previous ruling application. 6. For the financial year ending 30 June 20XX (the previous income year), Company A and its wholly owned subsidiary incurred and earned the following: a. Total expenses of $xx b. Total income of $yy 7. Company A's equity interests are not listed for quotation in the official list of any stock exchange, either in Australia or a foreign country. 8. Company A is developing a novel product for medical treatment for certain diseases ('the Product'). 9. Company A is developing a novel product which it believes can both prevent and cure certain diseases. Competitors produces a different form of medical treatments, and some are at clinical trial stage. 10. Competitors in the field have so far failed to achieve successful clinically trialled outcomes. Company A predicts it can produce its product cost effectively. 11. Company A's General Manager is responsible for the program that identified the key compound in the treatment. The Board itself is comprised of people with significant expertise in research, business development in the pharmaceutical industry and patent protection knowledge. 12. The patent held by the inventor Company C, was assigned to Company A on y YY 20YY. Subject to Clauses x and y of the Deed of Assignment that deal with royalties and non-commercial use of the patent, Company C assigned at Clause z all of its legal and beneficial interest in the patent and all of its right to sue for or recover damages and other relief in relation to patent infringements that may have occurred prior to z ZZ 20YY. 13. Company A filed a formal Patent Co-operation Treaty ('PCT') patent on x XX 20XX. 14. In addition to the above, Company A has highlighted other key differentiators. 15. Company A has identified its addressable market as the population of all countries affected by a particular disease. 16. Company A's goal is to licence the treatment ('the Product') allowing customers to sell it through their existing established networks. 17. Company A predicts that there is approximately x period of development required before their Product is fully developed for commercialisation. Information provided 18. You have provided a number of documents containing detailed information in relation to Company A's Product, including: a. Private Binding Ruling ('PBR') Application, dated xx YY 20XX b. Details of the Innovation c. Financial Statements d. Narrative outlining further details 19. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances. 20. You propose to issue new shares in Company A to various investors to assist in funding the continued development and commercialisation of the 'Product' during the period x 20XX to y 20YY.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subdivision 360-A | Income Tax Assessment Act 1997 section 360-15 | Income Tax Assessment Act 1997 section 360-40 | Income Tax Assessment Act 1997 section 360-45

Reasons for decision: Summary: All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated. Company A meets the eligibility requirements of an ESIC pursuant to subsection 360-40(1) for the period 1 July 20XX to 30 June 20XX. | Detailed Reasoning - Qualifying Early Stage Innovation Company: 21. Subsection 360-40(1) outlines the criteria required for a company to qualify as an Early Stage Innovation Company (ESIC) at a particular time in an income year. This time is referred to as the 'test time'. The criteria are based on a series of tests to identify if the company is at an early stage of its development and it is developing new or significantly improved innovations to generate an economic return. | Detailed Reasoning - 'THE EARLY STAGE TEST': 22. The early stage test requirements are outlined in detail within paragraphs 360-40(1)(a) to (d). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a): 23. To meet the requirement in paragraph 360-40(1)(a), at a particular time (the test time) in an income year (the current year) the company must have been either: i. incorporated in Australia within the last three income years (the latest being the current year); or ii. incorporated in Australia within the last six income years (the latest being the current year), and across the last three of those income years before the current year, the company and its 100% subsidiaries incurred total expenses of $1 million or less; or iii. registered in the Australian Business Register (ABR) within the last three income years (the latest being the current year). 24. The term 'current year' is defined in subsection 360-40(1) with reference to the 'test time'; the 'current year' being the income year in which the company issues shares to the investor. 25. A company that does not meet any of these conditions will not qualify as an ESIC. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b): 26. To meet the requirement in paragraph 360-40(1)(b), the company and its 100% subsidiaries must have incurred total expenses of $1 million or less in the income year before the current year. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c): 27. To meet the requirement in paragraph 360-40(1)(c), the company and its 100% subsidiaries must have derived total assessable income of $200,000 or less in the income year before the current year. | Detailed Reasoning - No stock exchange listing - paragraph 360-40(1)(d): 28. To meet the requirement in paragraph 360-40(1)(d), the company must not be listed on any stock exchange in Australia or a foreign country. | Detailed Reasoning - INNOVATION TESTS: 29. If the company satisfies the early stage test, the company must also satisfy one of two innovation tests: the objective (100 point) test or the principles-based test. | Detailed Reasoning - '100 POINT TEST' - PARAGRAPH 360-40(1)(e) AND SECTION 360-45: 30. To satisfy the 100 point test the company must obtain at least 100 points by meeting the innovation criteria in the table within section 360-45. The criteria are tested at a time immediately after the relevant shares are issued. If a company satisfies this test it does not need to satisfy the principles-based test. | Detailed Reasoning - 'PRINCIPLES-BASED TEST' - SUBPARAGRAPHS 360-40(1)(e)(i) TO (v): 31. To satisfy the principles-based test, the company must meet five requirements in paragraph 360-40(1)(e). This is tested at a time immediately after the relevant new shares are issued to the investor. 32. The company can demonstrate that it meets each requirement through existing documentation such as a business plan, commercialisation strategy, competition analysis or other company documents. The company must be able to show that tangible steps have been or will be taken in relation to each of the requirements. 33. The five requirements of the principles-based test, as outlined in paragraph 360-40(1)(e) are: i. the company must be genuinely focussed on developing for commercialisation one or more new or significantly improved products, processes, services or marketing or organisational methods ii. the business relating to that innovation must have a high growth potential iii. the company must demonstrate that it has the potential to be able to successfully scale up the business relating to the innovation iv. the company must demonstrate that it has the potential to be able to address a broader than local market, including global markets, through that business, and v. the company must demonstrate that it has the potential to be able to have competitive advantages for that business. | Detailed Reasoning - Developing new or significantly improved innovations for commercialisation: 34. For the purposes of Subdivision 360-A, the Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 ('EM') provides the following at paragraph 1.76 in relation to the definition of innovation: "Implicit in the definition of innovation is the requirement that the company is developing a new or significantly improved type of innovation such as a product, process, service, marketing or organisational method. This list of various types of innovations provides flexibility for innovation companies and is adaptable to current and future innovations. The Oslo Manual, published by the Organisation for Economic Co-operation and Development (OECD) provides a description of these different types of innovations..." 35. The innovation being developed by the company must either be new or significantly improved for an applicable addressable market. [1] The company's addressable market is the revenue opportunity or market demand arising from the innovation or the related business. The addressable market must be objective and realistic. 36. Improvements must be significant in nature to meet this requirement. Significant is defined in the online Macquarie Dictionary as " important; of consequence ." Customising existing products or minor changes resulting from software updates, pricing strategies or seasonal changes are examples of improvements that would not be considered significant. 37. The OECD Oslo Manual, in relation to defining innovative services, states at paragraph 161 that "innovations in services can include significant improvements in how they are provided (for example, in terms of their efficiency or speed), the addition of new functions or characteristics to existing services, or the introduction of entirely new services." 38. The company must be genuinely focussed on developing the innovation for a commercial purpose in order to generate economic value and revenue for the company. This requirement draws the distinction between simply having an idea and commercialising an idea. 39. For a company to qualify as an ESIC under the principles based test, the company must be "genuinely focussed on developing for commercialisation" their innovation. That is, the central activities of the company must be truly concentrated on developing their innovation for a commercial purpose. 'Commercialisation' includes a range of activities that involve the implementation or sale of a new or significantly improved innovation that will directly lead to the generation of economic value for the company. | Detailed Reasoning - High growth potential: 40. The company must be able to demonstrate that the business relating to the innovation has a high growth potential within a broad addressable market. This refers to the company's ability to rapidly expand its business. Companies that are limited to supplying local customers will not meet this requirement. | Detailed Reasoning - Scalability: 41. The company must be able to demonstrate that it has the potential to successfully scale up the business relating to the innovation. The company must have operating leverage, where as it increases its market share or enters into new markets, its existing revenues can be multiplied with a reduced or minimal increase in operating costs. | Detailed Reasoning - Broader than local market: 42. The company must be able to demonstrate that it has the potential to address a market that is broader than a local city, area or region. The company does not need to have a serviceable market at a national, multinational or global scale at the test time. However, it does need to show that the business is capable of addressing a market that is broader than a local market and that the business can be adapted to a broader scale in the future. | Detailed Reasoning - Competitive advantages: 43. The company must be able to demonstrate that it has the potential to have competitive advantages, such as a cost or differential advantage over its competitors which are sustainable for the business as it expands. The company can analyse what competitors in the market offer and consider whether the company has a differentiating advantage that would allow it to outperform these competitors. | Detailed Reasoning - Foreign Company test - paragraph 360-40(1)(f): 44. At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth). 45. The dictionary in section 9 of the Corporations Act 2001 (Cth) defines a foreign company to mean: (a) a body corporate that is incorporated in an external Territory, or outside Australia and the external Territories, and is not: (i) a corporation sole; or (ii) an exempt public authority; or (b) an unincorporated body that: (i) is formed in an external Territory or outside Australia and the external Territories; and (ii) under the law of its place of formation, may sue or be sued, or may hold property in the name of its secretary or of an officer of the body duly appointed for that purpose; and (iii) does not have its head office or principal place of business in Australia. | Detailed Reasoning - TEST TIME: 46. For the purposes of this ruling, the 'test time' for determining if Company A is a qualifying ESIC, will be upon the issue of qualifying shares on a particular date or dates on or after 1 July 20XX, and on or before 30 June 20YY. | Detailed Reasoning - Current year: 47. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the current year will be the year ending 30 June 20YY (the 20YY income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last 3 income years will include the years ending 30 June 20YY, 20XX and 20ZZ, and the income year before the current year will be the year ending 30 June 20XX (the 20XX income year). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a) ITAA 1997: 48. Company A was incorporated on x XX 20XX, which is within the 3 income years outlined above, therefore the requirements of subparagraph 360-40(1)(a)(iii) are satisfied. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b) ITAA 1997: 49. In applying the requirements of paragraph 360-40(1)(b), Company A and any of its 100% subsidiaries must have incurred total expenses of $1 million or less in the 20XX income year, being the income year before the current year. 50. Company A incurred expenses of $x in the 20XX income year. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c) ITAA 1997: 51. In applying the requirements of paragraph 360-40(1)(c), Company A and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the 20XX income year, being the income year before the current year. 52. Company A earned $y in income in the 20XX income year. Consequently, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No Stock Exchange listing - paragraph 360-40(1)(d) ITAA 1997: 53. In applying the requirements of paragraph 360-40(1)(d), Company A must not be listed on any Stock Exchange in Australia or a foreign country at the test time. 54. Company A is not listed on any Stock Exchange in Australia or a foreign country at the test time, so paragraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: 55. Company A satisfies the early stage test for the 20YY income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - THE '100 POINT TEST' - PARAGRAPH 360-40(1)(E) AND SECTION 360-45: 56. Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 20Y. Company A is electing to seek eligibility by satisfying the Principles based Innovation test under section 360-40(1)(e)(i)-(v), in order to be issued with a Private Binding Ruling. | Detailed Reasoning - Developing new or significantly improved innovations for applicable addressable market - subparagraph 360-40(1)(e)(i) ITAA 1997: 57. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be developing an innovation/product which is either new or significantly improved for an applicable addressable market. 58. Company A is developing a medical treatment ('the Product') for certain diseases. 59. Although it will initially be targeted at the Australian market, the Product has been identified as having a wider global addressable market. 60. The Product will be the first to offer such a product for licence. 61. Company A is developing an entirely new class of treatment for certain diseases. 62. Company A is genuinely focussed on developing their Product, a medical treatment for certain diseases for an applicable addressable market, so subparagraph 360-40(1)(e)(i) is satisfied for the period 1 July 20XX to 30 June 20YY. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997 63. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be genuinely focussed on developing an innovation for a commercial purpose in order to generate economic value and revenue for the company. 64. Company A has taken a number of steps in developing the Product. 65. Company A's activities over the next x to y months will be to continue the development of the Products to prove their efficacy, with the view to then engaging in the commercial licensing and / or sale of the Products. 66. A number of tasks will be undertaken over the next x months. 67. Company A is initially targeting the Australian and nearby markets. Company A will pursue product sales through entering into partnering and co-development arrangements with third parties that have the scale and commercial reach to market and sell the products when Company A licences the product at the end of successful Phase II clinical trials. 68. Market segments have been identified. 69. Potential customers have been identified. 70. The product offering of a licence will be made with a major pharmaceutical at the completion of Phase II clinical trials. 71. The timeline provides that Company A expects Phase I clinical testing of x patients in Australia in 20YY, and Phase II planning to commence in 20ZZ. 72. Company A anticipate that the current programme of development will be completed within the next x - y years. 73. Company A is genuinely focussed on developing their Product, for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period 1 July 20XX to 30 June 20YY, or the date when the Product has been fully developed, whichever occurs earliest. Once the Product has been fully developed, Company A will no longer be 'developing' the product for commercialisation and subparagraph 360-40((1)(e)(i) will no longer be satisfied. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997: 74. In applying the requirements of subparagraph 360-40(1)(e)(ii), Company A must be able to demonstrate that it has the potential for high growth within a broad addressable market. 75. Company A expects the Product to appeal to many pharmaceutical companies and countries. This aids decision making and is particularly useful when assessing product viability in particular markets. 76. Through its commercialisation strategy, Company A hopes to foster widespread use of its product by licencing to major pharmaceuticals who have the existing networks to market the product globally. 77. Company A is developing the Product themselves and contracting stages of the development to third parties to perform Phase II clinical trials more broadly in other regions. They will make their revenue through licencing the product and further developing other medical products. 78. If the commercialisation strategy is successful, this may give Company A the ability to increase sales through the development of further similar products to address major unmet market needs. 79. Company A has demonstrated a high growth potential for their Product, so subparagraph 360-40(1)(e)(ii) is satisfied for the period 1 July 20XX to 30 June 20YY. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997: 80. In applying the requirements of subparagraph 360-40(1)(e)(iii), Company A must be able to demonstrate that it has the potential to successfully scale up the business. 81. The Product projections provided illustrate the increase in projected sales. 82. Given that the Product will be available globally, it is expected that the treatment has the potential to successfully scale up its business. 83. Company A's strategy for the sale and use of the Product will be able to generate increased revenue with its licencing to major pharmaceutical companies. 84. This leverage ensures that Company A has the potential to successfully scale up its business, so subparagraph 360-40(1)(e)(iii) is satisfied for the period 1 July 20XX to 30 June 20YY. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997: 85. In applying the requirements of subparagraph 360-40(1)(e)(iv), Company A must be able to demonstrate that it has the potential to be able to address a broader than local market, including global markets. 86. Company A's Product will initially be targeted at the Australian and nearby markets (but is intended for worldwide use). It will be released globally once it gains traction in the initial targeted markets. 87. The Product can be produced worldwide by any pharmaceutical company. Therefore, the ultimate addressable market is on a global scale and is not confined to a local city, area or region. 88. From Company A's perspective, the development of a pharmaceutical drug through to Phase II has a global focus due to the cost of development. The information provided highlights that potentially the new drug would be made available to at least x% of the world population. 89. Company A has demonstrated that it has the capacity to address a broader than local market, so subparagraph 360-40(1)(e)(iv) is satisfied for the period 1 July 20XX to 30 June 20YY. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v) ITAA 1997: 90. In applying the requirements of subparagraph 360-40(1)(e)(v), Company A must demonstrate that it has potential to be able to have competitive advantage for that business. 91. The Product has a number of differentiating features. 92. Company A has demonstrated the potential for the Product to have competitive advantages over its competitors within the 'addressable market' thereby satisfying subparagraph 360-40(1)(e)(v) for the period 1 July 20XX to 30 June 20YY. 93. Company A predicts that there is a period of time for development required before their Product is fully developed for commercialisation. | Detailed Reasoning - CONCLUSION FOR PRINCIPLES BASED TEST: Company A satisfies the principles based test as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period 1 July 20XX to 30 June 20YY, or the date when their Product has been fully developed and is ready for sale/use, whichever occurs earlier. | Detailed Reasoning - Foreign Company Test - subparagraph 360-40(1)(f)) ITAA 1997: 94. As Company A was incorporated in Australia, it is not a Foreign Company and therefore paragraph 360-40(1)(f) is satisfied. | Detailed Reasoning - CONCLUSION: Company A meets the eligibility criteria of an ESIC under section 360-40 for the period 1 July 20XX to 30 June 20YY, or the date when the Product has been fully developed and is ready for sale, whichever occurs earlier. | Detailed Reasoning - Other references (non ATO view): Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 [1] Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.79.