Private ruling: Early stage innovation companies
Date of advice: 20 September 2017
Published: February 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Does Company A meet the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: 1. Company A was incorporated in Australia on Date X. Its equity interests are not listed for quotation in the official list of any stock exchange. 2. Company A has no subsidiaries and in the previous income year, i.e. the year ended 30 June 2016 it has expenses of $X and assessable income of $X. 3. Company A received a private ruling for the year ended 30 June 2016 (authorisation number for that ruling was 1051202224629) that they were an ESIC on the basis that they passed the principles based test in respect of the innovation being developed. 4. Since the ruling issued Company A has continued to develop their innovation and have begun product testing. They predict that there is still development to be done before the product can be marketed. Information provided 5. You have provided information in a number of documents and phone conversations in relation to ‘The Innovation’, including: a. your original private ruling application. b. phone conversations. c. supplementary information provided in respect of original application d. your new private riling application e. supplementary information provided in respect of new application 6. We have referred to the relevant information within these documents and conversations 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 360-40

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 under, subsection 360-40(1). | Detailed Reasoning - Qualifying Early Stage Innovation Company: 7. 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’: 8. 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): 9. 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). 10. 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. 11. 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): 12. 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): 13. 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): 14. 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: 15. 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 (iv): 16. 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. 17. 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. 18. 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 - Application to your circumstances: Test time 19. For the purposes of this ruling, the test time for determining if Company A is a qualifying ESIC will be a particular date during the income year ending 30 June 2018. Current year 20. 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 last three income years will include the years ending 30 June 2018, 2017 and 2016, and the income year before the current year will be the year ending 30 June 2017 (the 2017 income year). | Detailed Reasoning - Early stage test: Incorporation or Registration – paragraph 360-40(1)(a) 21. As Company A was incorporated on date X, which is within the last 3 income years, subparagraph 360-40(1)(a)(i) is satisfied. Total expenses – paragraph 360-40(1)(b) 22. As Company A’s expenses in the prior income year was below $1 million paragraph 360-40(1)(b) is satisfied. Assessable income – paragraph 360-40(1)(c) 23. As Company A’s assessable income for the prior income year was below $200,000 paragraph 360-40(1)(c) is satisfied. No stock exchange listing – paragraph 360-40(1)(d) 24. As Company A is an unlisted public company which is not listed on any stock exchange in Australia or a foreign country paragraph 360-40(1)(a)(d) is satisfied. Conclusion on early stage test 25. Company A will satisfy the early stage test for the entire 2018 income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - Principles based test: 26. In the ruling dated for the year ended 30 June 2017 we concluded that Company A passed the principles based test in respect of the innovation they are developing. While the innovation is still being ‘developed’ they will continue to satisfy the principle bases test. 27. Company A provided an outline of the progress made since the ruling for the year ended 30 June 2017 issued and details of how long they think it will take to fully develop their innovation. 28. Therefore Company A meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 2017 until the earlier of 30 June 2018 or the date when their innovation has been fully developed and are ready for use, whichever occurs earlier.