Private ruling: Early Stage Innovation Company
Date of advice: 29 September 2017
Published: February 2018
Ruling period: 1 July 2017 to 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1:  | A2: Yes

Relevant facts and circumstances: The Company 1. The Company is incorporated in Australia and is a private company with none of its equity interests listed on any stock exchange. 2. The Company is developing an enhanced device (The Device) within the health industry. 3. The Company will be raising capital through the issue of new shares to produce tooling so that the device can be mass produced, complete a major clinical trial and obtain regulatory approvals. The Device 4. The Device will be different from existing devices available in the market. The core device is patented and additional provisional patents have been applied for. 5. The prototype is planned to be suitable for use by a greater range of people. 6. Some similar devices require professional intervention to be used. It is anticipated that The Device will be able to be purchased over the counter from a pharmacy without the need for professional intervention. The Company will therefore introduce a new and more accessible clinical pathway for such devices. 7. A small number of prototype devices have been produced. The selling price of The Device will be significantly lower than existing devices. 8. A proof of concept study was completed on a prototype of The Device demonstrating its efficacy. 9. The Device will be ideally marketed as an over the counter product and also as a device that can be prescribed by a General Practitioner (GP). You state there is demand within the global market for an improved device that provides better long term patient compliance. 10. The development of The Device is still in the research and development (R&D) phase. The following activities will be undertaken: a. Clinical trial: A clinical trial will be undertaken to assess the efficacy of the device. This trial will enhance the commercialisation potential with the data to support the device claims. b. Regulatory approval: the data from the clinical trials will provide input into the dossier for submission to regulatory bodies such as the Food and Drugs Administration (FDA), European Conformity (CE) and Therapeutic Goods Administration (TGA) in Australia. These approvals are required to allow the final product to be sold as a medical device. c. Manufacturing transition: The Company is undertaking a program of R&D to transform the manufacturing process. This will enhance the competitiveness of the device by reducing cost and also allow The Company to supply demand. d. Unique hardware and software will be developed to revolutionise The Company product by undertaking further design, development and testing activities. This will enhance the current prototype and potentially open an additional offering within the sleep clinic market. Intellectual property 11. The Company has acquired a number of rights, title and interest to certain patents and patent applications resulting from national or regional phase applications. The Company has also submitted another patent application. 12. The Company will own the rights, title and interest to any new intellectual property it develops. Information provided 13. The ruling is based on the information provided by The Taxpayer.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subdivision 360-A | 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. | 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. Broadly, 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 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. It is considered that a company will satisfy the incorporation test in subparagraph 360-40(1)(a)(i) where, immediately after the issue of shares to the investor, the company had been incorporated in either: ● that part of the current year which precedes the issue of shares; or ● one of the two income years prior to that year 6. 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): 7. 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): 8. 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): 9. 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: 10. 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: 11. 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 (iv): 12. 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. 13. 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. 14. 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 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: 15. For the purposes of Subdivision 360-A, an innovation is considered to be a new or significantly improved product, process, service, marketing or organisational method. 16. 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. 17. 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. 18. 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. 19. ‘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: 20. 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: 21. 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: 22. 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: 23. 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 - Application to your circumstances: Test time 24. For the purposes of this ruling, the test time for determining if The Company is a qualifying ESIC will be a particular date before 30 June 2018. Current year 25. For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 2018 (the 2018 income year). For clarity, in relation to particular requirements within subsection 360-40(1), the income year before the current year will be the year ending 30 June 2017 (the 2017 income year). | Detailed Reasoning - Early stage test: 26. The Company earned no income and incurred expenses of under $100,000 for the 2017 income year. The Company is privately owned and none of its equity interests are listed on any stock exchange. 27. The Company will satisfy the early stage test for the 2018 income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - 100 point test: 28. The Company has not provided any evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 2018. For The Company to be a qualifying ESIC it will need to satisfy the principles-based test. | Detailed Reasoning - Principles based test: Developing new or significantly improved innovation for commercialisation – subparagraph 360-40(1)(e)(i) 29. The device being developed by The Company operates on a different premise to those currently on the market. The core device is patented and additional provisional patents have been applied for. 30. It is hoped the prototype will be suitable for use by a larger range of patients. 31. Current devices require professional intervention. It is anticipated that The Device can be purchased over the counter from a pharmacy without the need for professional intervention. The Company will therefore introduce a new and more accessible clinical pathway for such devices. 32. The taxpayer states there is demand within the global market for a lower cost product with proven efficacy that provides better long term patient compliance. 33. The Device is patented or validated in a number of countries. The Company is the owner of the intellectual property relating to The Device and has submitted a patent application for additional components to the device. 34. Based upon the above facts, The Device will be a new or significantly improved product compared to current products currently used around the world. Genuinely focussed on developing for commercialisation 35. The Company is still within the research and development (R&D) phase of developing The Device. 36. The activities already undertaken to develop The Device include: a. design and development of prototype device b. a proof of concept study was completed on the prototype device, and c. assignment of patents to The Company, along with patent applications, to protect the intellectual property of the device. 37. The Company will be undertaking a number of activities as described in the facts to continue developing the product. 38. Following the completion of these activities it is expected the device will be ready for wider commercial sale and will begin to generate economic value for The Company. 39. The above facts demonstrate that The Company is taking tangible steps to lead to the development and commercialisation of The Device. Conclusion on subparagraph 360-40(1)(e)(i) 40. The Company is genuinely focussed on developing The Device for commercialisation. The Device will be a new or significantly improved product compared to current options. Therefore, subparagraph 360-40(1)(e)(i) will be satisfied for the year ending 30 June 2018. High growth potential – subparagraph 360-40(1)(e)(ii) 41. There is potentially a large commercial value in the global target market. 42. You state there is a demand in the market for a lower cost, more effective product. 43. The product distribution strategy for The Company will be via leading global, medical technology companies. There are a number of distribution channels within these areas. 44. The Device being developed by The Company presents a new option for individuals in the target market. The Company’s business relating to the development of The Device has a high growth potential in a large global market. Therefore, subparagraph 360-40(1)(e)(ii) will be satisfied. Scalability – subparagraph 360-40(1)(e)(iii) 45. The Company is currently undertaking a program of R&D to transform the manufacturing process into a low cost mass production protocol. This will enhance the competitiveness of the device by reducing costs and also allow The Company to supply demand. 46. The selling price of The Device is estimated to be significantly lower than currently available options, making it an affordable option for a number of patients and demographics in Australia and overseas who cannot afford current available treatments. 47. The Company holds multiple patents to protect its intellectual property. It is envisaged that once regulatory approval has been gained, The Company will be in a position to distribute and sell its product to the market. 48. The nature of Device being low cost, mass produced, its particular design, and availability over the counter and online also assist with enabling the scale up and globalisation of the device. 49. The equity funding received by The Company will be primarily expended upon industrial manufacturing design, production of The Device, clinical trial, regulatory approval and consultation, software development and other organisational costs. 50. Once the development of the device has been completed and regulatory approval has been received, The Company will be in a position to expand sales of a developed product resulting in increased revenue with a proportionately lower increase in its operating costs due to the technology already being tested and finalised. 51. The Company has the potential to successfully scale its business, therefore, subparagraph 360-40(1)(e)(iii) will be satisfied. Broader than local market – subparagraph 360-40(1)(e)(iv) 52. The Device being developed by The Company has the potential to address a global market. The Company currently holds product patents in a number of countries, including Australia. The addressable market is on a global scale and is not confined to a local city, area or region. Therefore, subparagraph 360-40(1)(e)(iv) will be satisfied. Competitive advantages – subparagraph 360-40(1)(e)(v) 53. The potential benefits of The Device compared to existing products in the market include: a. Lower cost. b. Additional technology to existing products. c. Compliance and comfort - The Company device will address the issues of non-compliance through improved comfort. d. The device will be suitable for use by a larger range of patients. e. The device can be purchased over the counter from a pharmacy or prescribed by a GP, creating a new clinical pathway for patients. Current devices require professional intervention. 54. The Company own the rights to the intellectual property underpinning the technology relating to The Device. These intellectual property rights represent a competitive advantage for The Company over its competitors. 55. Additionally, The Company has the benefit of an experienced management team including executives with experience in a range of relevant fields. This experienced management team is expected to generate further advantages for The Company. 56. The Company has demonstrated the potential for the developed product to have competitive advantages within the global market, satisfying subparagraph 360-40(1)(e)(v). Conclusion on principles test 57. The Company satisfies the principles based test as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the time period 1 July 2017 to 30 June 2018. Conclusion 58. The Company meets the eligibility criteria of an ESIC under subsection 360-40(1) for the time period 1 July 2017 to 30 June 2018.

Answer: Does The Company qualify as an Early Stage Innovation Company pursuant to section 360-40(1) of the Income Tax Assessment Act 1997 ?