Private ruling: Early stage innovation company eligibility
Date of advice: 26 October 2022
Published: 9 January 2023
Ruling period: Year ending 30 June ZZZZ
Date scheme commenced: 1 July 2022

Ruling: Q1: Does the Company satisfy the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997) for the period 1 July YYYY to 30 June ZZZZ? Summary The Company satisfy the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997) for the period 1 July YYYY to 30 June ZZZZ.

Relevant facts and circumstances: 1. The Company is an Australian proprietary company which was incorporated in Australia and registered on the Australian Business Register during the year ending 30 June UUUU. Its equity interests are not listed for quotation in the official list of any stock exchange in Australia or overseas. 2. The Company is not a foreign company pursuant to the Corporations Act 2001 (Cth) . 3. The Company has no subsidiaries and is not part of a consolidated group or planning to join a consolidated group. 4. The co-founders and current directors of the Company are: - Individual A - Individual B; and - Individual C. 5. The Company has no subsidiaries and incurred expenses of less than AU$1 million across each of the last three income years before the current year (the ZZZZ income year), detailed as follows: Income year ending 30 June Total expenses incurred WWWW $W XXXX $X YYYY $Y Total expenses incurred for the last three years < AU$ 1 million 6. The Company generated gross revenue of less than $200,000 in the income year ended 30 June YYYY. 7. The primary objective of the Company is to commercialise the cultivation of by-products. This creates an opportunity to remove the cost barriers for commercial purposes, whilst also utilising the process to produce baseload renewable energy. 8. The Company and an Australian University have entered into a license and research agreement in which the Company has the rights to commercialise the outcome of the R&D process. Additionally, it has also received an Advanced Finding Certificate from Aus-Industry in relation to eligible R&D activities conducted during its pilot project. 9. The Company is currently working on a pilot project. The benefits of this project are detailed in submission provided. 10. The Company believe that it will have a considerable number of opportunities to grow its business in multiple jurisdictions across the globe pending the successful completion of its pilot project. 11. The Company believe that given the nature of their industry, the initial cost of researching and developing their pilot project, is high. However, once completed, these R&D costs can be leveraged to reduce the cost per unit of producing the final products. 12. Once approved for use in a market, the Company believe it can expand its business into other markets either through licensing of IP, or through the establishment of an overseas branch or subsidiary, owned or controlled by its Australian parent company. 13. The Company has based its business concept around a comparison of its proposed products with existing products / commodity markets. Its research indicates that there are no comparable products within those marketplaces currently. Information provided 14. You have provided information in a number of documents in relation to the Company's product/process. 15. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances.

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: Detailed Reasoning - Qualifying Early Stage Innovation Company: 1. 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': 2. 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): 3. 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). 4. 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. 5. 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): 6. 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): 7. 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): 8. 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: 9. 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 - 'Principles-based test' - subparagraphs 360-40(1)(e)(i) to (v): 10. 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. 11. 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. 12. The five requirements of the principles-based test, as outlined in paragraph 360-40(1)(e) are: i. the company must be genuinely focused on developing one or more new or significantly improved innovations for commercialisation 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: 13. 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..." [1] 14. The innovation being developed by the company must either be new or significantly improved for an applicable addressable market. 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. 15. Improvements must be significant in nature to meet this requirement. 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. 16. The OECD Oslo Manual defines innovations as significant changes, with the intention of distinguishing significant changes from routine minor changes. However, it is important to recognise that an innovation can also consist of a series of smaller incremental changes that together constitute a significant change. [2] 17. In discussing services innovation activity, paragraph 111 of the OECD Oslo Manual states, "Innovation activity in services also tends to be a continuous process, consisting of a series of incremental changes in products and processes. This may occasionally complicate the identification of innovations in services in terms of single events, i.e. as the implementation of a significant change in products, processes or other methods." 18. 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." 19. The company must be genuinely focused 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. 20. '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: 21. The company must be able to demonstrate that it has the potential for high growth 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: 22. The company must be able to demonstrate that it has the potential to successfully scale up the business. 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 per unit. | Detailed Reasoning - Broader than local market: 23. 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: 24. 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): 25. At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth). 26. 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: 27. For the purposes of this ruling, the 'test time' for determining if the Company is a qualifying ESIC, will be upon the issue of qualifying shares on a particular date or dates on or after 1 July YYYY, and on or before 30 June ZZZZ. | Detailed Reasoning - Current year: 28. For the purposes of subsection 360-40(1), the current year will be the year ending 30 June ZZZZ (the ZZZZ income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last three income years will include the years ending 30 June ZZZZ, YYYY and XXXX, and the income year before the current year will be the year ending 30 June YYYY (the YYYY income year). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a): 29. The Company was incorporated in Australia during the year ending 30 June UUUU, which is 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 (which has no subsidiaries) incurred total expenses of less than $ 1 million. Therefore, the requirements of subparagraph 360-40(1)(a)(ii) are satisfied. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b): 30. In applying the requirements of paragraph 360-40(1)(b), the Company and any of its 100% subsidiaries must have incurred total expenses of $1 million or less in the YYYY income year, being the year before the current income year. 31. The Company did not have any subsidiaries and incurred total expenses of less than $1 million in the YYYY income year. Therefore, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c): 32. In applying the requirements of paragraph 360-40(1)(c), the Company and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the YYYY income year. 33. The Company does not have any subsidiaries and derived assessable income of less than $200,000 in the YYYY income year. Therefore, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No stock exchange listing - paragraph 360-40(1)(d): 34. In applying the requirements of paragraph 360-40(1)(c), the Company must not be listed on any Stock Exchange in Australia or a foreign country at the test time. The Company is not listed on any stock exchange in Australia or a foreign country at the test time. Therefore, subparagraph 360-40(1)(d) is satisfied. | Detailed Reasoning - Conclusion on early stage test: 35. The Company satisfies the early stage test for the entire ZZZZ 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: 36. The Company has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June ZZZZ. The Company 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 - subparagraph 360-40(1)(e)(i): 37. In applying the requirements of subparagraph 360-40(1)(e)(i), the Company must be developing an innovation which is either new or significantly improved for an applicable addressable market. 38. The Company's pilot project is currently developing a process which involves the cultivation of by-products. 39. The project is focused on testing the growth of selected by-products and is one of the fastest growing agricultural sectors in Australia, based on information available from the Australia Bureau of Statistics (ABS). 40. The Company's pilot project was sufficiently detailed in submissions. | Detailed Reasoning - Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i): 41. In applying the requirements of subparagraph 360-40(1)(e)(i), the Company must be genuinely focussed on developing an innovation for commercial purpose in order to generate economic value and revenue for the company. 42. Once this innovation is proven and can be patented, the Company will also have an opportunity to license this innovation to other parties. As such, this pilot project should also satisfy the definition of innovative services provided by the OECD Oslo Manual. 43. Further, the Company has engaged with a number of third-party Schedule 1 research institutes to perform specific research and development activities on a consulting basis, as the Company intends to patent the process if and when it becomes successful. 44. The Company and an Australian University have entered into a license and research agreement in which the Company has the rights to commercialise the outcome of the R&D. Additionally, it has also received an Advanced Finding Certificate from Aus-Industry in relation to eligible R&D activities conducted during its pilot project. 45. An Advanced Finding Certificate is intended to provide companies with certainty that planned activities are eligible under the R&D Tax Incentive Programme. The year ended 30 June YYYY will be the first year the Company will claim the R&D tax incentive, for expenditure incurred on the eligible activities conducted as part of its pilot project. 46. The steps taken by the Company on obtaining this Advanced Finding Certificate and the research conducted by it while engaging with a number of Schedule 1 research institutes, demonstrate that the Company is genuinely focused on commercialising the product. | Detailed Reasoning - Conclusion on subparagraph 360-40(1)(e)(i): 47. The Company is genuinely focussed on developing their product for commercialisation, Therefore, subparagraph 360-40(1)(e)(i) is satisfied for the period 1 July YYYY to 30 June ZZZZ, or the date when their product has been fully developed and ready for client use, whichever occurs earlier. Once the product has been fully developed, the Company 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): 48. In applying the requirements of subparagraph 360-40(1)(e)(ii), the Company must be able to demonstrate that it has high potential growth within a broad addressable market. 49. The Company believes that its innovation has high growth potential across multiple jurisdictions in Australia and overseas, with its preliminary research work performed during the financial years ended 30 June WWWW and WWWW orientated towards understanding the scalability and applications for the innovation. 50. The Company is also in early negotiations with another Schedule 1 research institute to undertake further research activities under a consulting arrangement in Australia. A Schedule 1 research institute is recognised as an established and leading scientific research and development facility and accordingly this stage of research will be under similar contractual terms to those agreed between the Company and the Australian University referred to above. 51. Therefore, subsection 360-40(1)(e)(ii) is satisfied. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii): 52. In applying the requirements of subparagraph 360-40(1)(e)(iii), the Company must be able to demonstrate that it has the potential to scale up the business. 53. The Company believe that given the nature of their industry, the initial cost of researching and developing their pilot project is high. However, once completed, these R&D costs can be leveraged to reduce the cost per unit of producing the final products. 54. These factors all point to the Company having the potential to successfully achieve economies of scale as the business grows. 55. Therefore, subsection 360-40(1)(e)(iii) is satisfied. | Detailed Reasoning - Broader than local market- subparagraph 360-40(1)(e)(iv): 56. In applying the requirements of subparagraph 360-40(1)(e)(iv), the Company must be able to demonstrate that it has the potential to address a broader than local market, including global markets. 57. The Company holds proprietary intellectual property from the reconnaissance work it has performed in multiple states of Australia. 58. It believes that its business model has applications for growth in both local and global markets, either through the establishment of overseas subsidiaries or the licencing of its innovation in return for royalty streams once it is proven and can be patented. 59. However, to enter new markets, the pilot project needs to deliver an outcome where the operational activities and end products are considered safe and meet relevant environmental and food safety regulations. 60. Once approved for use in a market, the Company believe it can expand its business into that particular market either through licensing of IP, or through the establishment of an overseas branch or subsidiary, owned or controlled by its Australian parent company. 61. The Company has demonstrated its business has the potential to address a market broader than a local, or wholly domestic market, including international markets. 62. Therefore, subsection 360-40(1)(e)(iv) is satisfied. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v): 63. In applying the requirements of subparagraph 360-40(1)(e)(v), the Company must be able to demonstrate that it has the potential to be able to have competitive advantages for that business. 64. The Company has based its business concept around a comparison of its proposed products with existing products / commodity markets. Its research indicates that there are no comparable products within those marketplaces currently. 65. The business has engaged technical advisors to independently validate its competitive advantage. 66. Additionally, no party has created similar products. 67. Consequently, the Company has demonstrated the potential to have a strong competitive advantage. 68. Therefore, subsection 360-40(1)(e)(v) is satisfied. | Detailed Reasoning - Conclusion on principles based test: 69. The Company satisfies the principles based test as it satisfies the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period commencing 1 July YYYY until 30 June ZZZZ or the date when its innovation/process has been fully developed and is ready for sale, whichever occurs earlier. | Detailed Reasoning - Foreign Company Test - subparagraph 360-40(1)(f) ITAA 1997: 70. As the Company was incorporated in Australia, it is not a Foreign Company and therefore paragraph 360-40(1)(f) is satisfied. | Detailed Reasoning - Conclusion: 71. The Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July YYYY to 30 June ZZZZ or the date when their 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

Subject: Early stage innovation company eligibility: All legislative references are to the ITAA 1997 unless otherwise stated. | Tax incentives for Early Stage Investors | [1] See Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.76. | [2] OECD Oslo Manual, paragraph 124 and paragraph 151.