Private ruling: Income tax: tax incentive for early stage investors
Date of advice: 5 October 2018
Published: November 2018
Ruling period: Year ending 30 June 20YY
Date scheme commenced: I July 20XX

Ruling: Q1: Does the Company 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. The Company was incorporated in Australia and registered in the Australian Business Register during the year ending 30 June 20WW. Its equity interests are not listed for quotation in the official list of any stock exchange in Australia or a foreign country. 2. The Company has no subsidiaries and had expenses of less than $1 million, and assessable income of less than $200,000 in the previous income year, ie the year ended 30 June 20XX. 3. The Company is developing technology (‘the technology’), which aims to be able to rapidly calculate the economically optimum fertiliser application rates for a variety of agricultural crops. 4. The Company’s goal is to be able to provide information to primary producers to enable them to apply the economically optimum fertiliser rates, based on data from a range of sources, to their crops. 5. There are two co-founders of the Company (individuals A and B). Each of the co-founders currently holds 50% of the shares (ordinary) in the Company and are directors of the Company. 6. The Company believes that it has a management team with the skills, technical knowledge and understanding of the market to grow the business, and provide the following background information: Individual A – Co-Founder Individual A is an independent nutrition consultant with extensive experience in agriculture who has been involved in the successful commercialisation of a number of agricultural products, who has an extensive knowledge and understanding of crop nutrition and fertiliser responsiveness, and well established relationships with an extensive network of farmers. Individual B – Co-Founder Individual B has a background in research and business management, and has extensive experience in the agriculture industry in both technical and management roles. He has worked as a consultant working with both public and private organisations in agriculture, and has experience managing large portfolios of projects conducting research into agronomy, soils, farming systems and crop nutrition. Individual B also has expertise in managing complex projects, building and leading teams, developing and executing strategy, and an extensive network throughout the Australian agricultural industry. Individual C – Manager Data Analytics Individual C has a background in data analytics and has expertise in software development and quantitative interpretation of geo-referenced maps. Advisory Committee The Company are currently in the process of establishing an advisory committee comprised of highly successful business leaders and entrepreneurs with skills and experience relevant to the agriculture industry. The Company has access to an extensive network of mentors and contact with very successful entrepreneurs. 7. The Company states that all of the intellectual property (IP) associated with the technology: ● is owned by the Company, and that the Company has freedom to operate with all the IP in the Company ● was not transferred from another entity ● was valued at $X as at 30 June 20XX. 8. The Company’s systems and processes associated with the technology are currently being managed as a trade secret. The Company is applying for a grant for funds to enable it to put more formal protection strategies in place for the IP for the technology, and will consider patenting the technology if appropriate. 9. The Company have highlighted the key differentiators and competitive advantages of their technology to that of their competitors, and believe that their technology will be able to provide a far superior product to their customers. 10. The Company’s target market is a specific sector of the agricultural industry, however it believes that with additional R&D and market development that there are potentially other markets for the Company’s technology within other agricultural sectors. 11. The Company has identified its addressable market as being both the Australian and the international/global market. Its business strategy is initially to prove the technology and establish a market in Australia before potentially expanding into international markets. 12. The Company estimates that the total addressable market for its technology globally and in Australia is substantial. Commercialisation strategy 13. The Company’s business strategy in the short term (1-2 years) is to prove the technology, establish the market, and revenue and business model. In the medium term (3-5 years) the focus will be on expanding into other agricultural markets within Australia, and potentially expanding into international markets. 14. The Company still has further R&D to be completed to further develop and improve the technology from the ‘minimal viable product’ version of the technology that the Company are currently trialling. 15. The Company has partnered with a large Australian agribusiness to undertake small scale commercial trials of the technology in 20XX. The agribusiness is currently evaluating the technology to assess its commercial potential, with a view to considering an expanded commercial purchase of the technology in the future. 16. The company state that they are developing two paths to market for the technology, as follows: 1) Direct sales to farmers/agronomists. 2) Wholesale to large Australian agribusinesses. 17. The Company plans to derive revenue from the technology in their ‘direct to farmers/agronomists’ market by offering a subscription service, on a dollar per hectare basis - consist with similar business in the market. Its ‘wholesale to agribusinesses’ pricing strategy will vary according to the customer’s requirements, volume of purchase and market conditions, but they believe that their wholesale customers are likely to offer the product to farmers on a dollar per hectare basis. Information provided 18. You have provided information in a number of documents and phone conversations in relation to the technology.. 19. We have referred to the relevant information within these documents and conversations in applying the relevant tests to your circumstances. 20. You propose to issue new shares in the Company to various investors to assist in funding the continued development and commercialisation of the technology.

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 ITAA 1997 unless otherwise indicated. | Summary: The Company meets the eligibility requirements of an ESIC under, subsection 360-40(1). | 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 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…” 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. 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 - Test time: 25. For the purposes of this ruling, the test time for determining if the Company is a qualifying ESIC will be a particular date during the income year ending 30 June 20YY. | Detailed Reasoning - Current year: 26. For the purposes of subsection 360-40(1), 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 three income years will include the years ending 30 June 20YY, 20XX and 20WW, 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): 27. As the Company was incorporated and registered on a date in the year ending 30 June 20WW which is within the last 3 income years, and has no subsidiaries, subparagraph 360-40(1)(a)(i) and (iii) are satisfied. | Detailed Reasoning - Total expenses – paragraph 360-40(1)(b): 28. As the Company had expenses less than $1 million in the prior income year, and it did not have any subsidiaries, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income – paragraph 360-40(1)(c): 29. As the Company’s assessable income for the prior income year is less than $200,000, and it did not have any subsidiaries, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No stock exchange listing – paragraph 360-40(1)(d): 30. As the Company is privately owned and is not listed on any stock exchange in Australia or a foreign country, subparagraph 360-40(1)(d) is satisfied. | Detailed Reasoning - Conclusion on early stage test: 31. The Company will satisfy the early stage test for the entire 20YY income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - 100 point test: 32. The Company states that it can only qualify for 50 points under the 100 point innovation test under section 360-45 for the year ending 30 June 20XX. Therefore, for the Company to be a qualifying ESIC it will need to satisfy the principles-based test. | Detailed Reasoning - Developing new or significantly improved innovations for commercialisation – subparagraph 360-40(1)(e)(i): 33. The Company is developing technology (‘the technology’), which aims to be able to rapidly calculate the economically optimum fertiliser application rates for a variety of agricultural crops. 34. The Company’s goal is to be able to provide information to primary producers to enable them to apply the economically optimum fertiliser rates, based on data from a range of sources, to their crops. 35. The Company has identified its addressable market as being both the Australian and the international/global market. Its business strategy is initially to prove the technology and establish a market in Australia before potentially expanding into international markets. 36. The Company believe that it will be the first to offer such a product. | Detailed Reasoning - New or significantly improved, products, processes, services or marketing or organisational methods – subparagraph 360-40(1)(e)(i): 37. The Company have highlighted the key differentiators and competitive advantages of their technology to that of their competitors, and believe that their technology will be able to provide a far superior product to their customers. | Detailed Reasoning - Genuinely focussed on developing for commercialisation subparagraph 360-40(1)(e)(i): 38. The Company has taken the following steps in developing the technology and preparing for its commercialisation: ● undertaken extensive market research ● prepared a comprehensive development and commercialisation plan ● established a website which invites ‘leading Australian primary producers’ to apply to partner with them to help develop the technology ● completed an accelerator program ● established links with an extensive network of mentors successful entrepreneurs ● established an experienced management team that they believe have the skills, technical knowledge and understanding of the market to grow the business, and are in the process of establishing an advisory committee with the expertise and experience to provide guidance which they believe will greatly improve their chance of becoming successful ● developed an investor ‘pitch deck’, and is actively seeking capital investment in the Company to enable it to further develop the technology to scale the business and capture the Australian market ● prepared a DRAFT application for a funding grant to further develop the technology 39. The Company has developed the ‘minimum viable product’ version of the technology, and achieved close to AUD$Y in revenue through a combination of sales and grants since being founded. However, the Company still has further R&D to be completed on the technology. With the funds from the grant the Company has applied for, it is planning to conduct replicated field trials around Australia. This will gather the performance data the Company needs to sell the technology and will also provide new data which will be used to improve the technology’s algorithms. The Company also has further R&D work to undertake with its artificial intelligence researcher, which includes incorporating data from additional sources. This will improve the algorithms ability to more accurately predict fertiliser response in crops. These would be considered major updates to the minimal viable product version of the technology that the Company are currently trialling. 40. The Company has partnered with a large Australian agribusiness to undertake small scale commercial trials of the technology in 20XX. The agribusiness is currently evaluating the technology to assess its commercial potential, with a view to considering an expanded commercial purchase of the technology in the future. 21. The company state that they are developing two paths to market for the technology, as follows: 1) Direct sales to farmers/agronomists. 2) Wholesale to large Australian agribusinesses. 41. The Company has identified its addressable market as being both the Australian and the international/global market. Its business strategy is initially to prove the technology and establish a market in Australia before potentially expanding into international markets. | Detailed Reasoning - Conclusion on subparagraph 360-40(1)(e)(i): 42. The Company is genuinely focussed on developing the technology for a commercial purpose. The technology will be a significantly improved product compared to existing products available to the Company’s target markets. 43. Therefore, subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 1 July 20XX until 30 June 20YY, or the date when the technology has been fully developed, whichever occurs earliest. Once the technology 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): 44. The Company expects its technology to have wide appeal within its target market within the agricultural industry, as it will provide them with the information, based on data from a range of sources, to enable them to apply the economically optimum fertiliser rates to their crops. 45. It believes that with additional R&D and market development that there are potentially other markets for the Company’s technology within other agricultural sectors. 46. Through its commercialisation/marketing strategy, the company hopes to foster widespread use of its product by initially selling the product directly to farmers/agronomists and then on a wholesale basis through large Australian agribusinesses. 47. The Company plans to derive revenue from the technology in their ‘direct to farmers/agronomists’ market by offering a subscription service, on a dollar per hectare basis - consist with similar business in the market. Its ‘wholesale to agribusinesses’ pricing strategy will vary according to the customer’s requirements, volume of purchase and market conditions, but the Company believe that their wholesale customers are likely to offer the product to farmers on a dollar per hectare basis. 48. If the commercialisation strategy is successful, this may give the Company the ability to increase sales both through its ‘direct sales’ and ‘wholesale sales’ markets. 49. Therefore, subparagraph 360-40(1)(e)(ii) will be satisfied. | Detailed Reasoning - Scalability – subparagraph 360-40(1)(e)(iii): 50. The Company estimates that the total addressable market for its technology globally and in Australia is substantial. 51. The Company believe that as the technology is data/software based which is designed to be able to be ‘plugged-in’ into existing agricultural IT platforms, it has a product with the potential to efficiently tap into its target market. 52. The Company believe that their strategy to commercialise the technology substantially through wholesale sales to large Australian agribusinesses will enable them to generate increased revenue with a less than proportionate increase in operating costs. This operating leverage has the potential to afford the Company the ability to successfully scale up its business. Therefore, subparagraph 360-40(1)(e)(iii) will be satisfied. | Detailed Reasoning - Broader than local market- subparagraph 360-40(1)(e)(iv): 53. The Company’s target market is a specific sector of the agricultural industry, however it believes that with additional R&D and market development that there are potential other markets for the Company’s technology within other agricultural sectors. 54. The Company has identified its addressable market as being both the Australian and the international/global market. Its business strategy is initially to prove the technology and establish a market in Australia before potentially expanding into international markets. 55. The Company estimates that the total addressable market for its technology globally and in Australia is substantial. 56. The Company’s technology will initially be targeted at the Australian and then international markets. The Company states that globally its target market is significantly larger than its Australian target market, and believe that it’s technology has the potential for application within its specific target sector in the global market. 57. The technology has the potential for worldwide application within the within its specific target sector of the global agricultural market. Thus, the ultimate addressable market is on a global scale and is not confined to a local city, area or region. 58. The Company has demonstrated that its technology has the potential to address a broader market than just the local market, including international and global markets. Therefore, subparagraph 360-40(1)(e)(iv) will be satisfied. | Detailed Reasoning - Competitive advantages – subparagraph 360-40(1)(e)(v): 59. The Company have highlighted the key differentiators and competitive advantages of their technology to that of their competitors, and believe that their technology will be able to provide a far superior product to their customers. 60. Therefore, as the technology is the first product which offers these differentiating features, the Company will have the first mover advantage. The Company has demonstrated the potential for the technology to have competitive advantages within its target sector of the agricultural industry within the market of providing fertiliser recommendations to farmers, satisfying subparagraph 360-40(1)(e)(v). | Detailed Reasoning - Conclusion on principles test: 61. 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 20XX until 30 June 20XYY or the date when the technology has been fully developed and is ready for sale, whichever occurs earlier. | Detailed Reasoning - Conclusion: 62. The Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 20XX until the earlier of 30 June 20YY, or the date when the technology has been fully developed and is ready for sale, whichever occurs earlier.