Private ruling: Early stage innovation company eligibility
Date of advice: 3 May 2023
Published: 19 June 2023
Ruling period: Year ended 30 June ZZZZ
Date scheme commenced: DD/MM/YYYY

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 YYYY to 30 June ZZZZ? | A1: Yes.

Relevant facts and circumstances: Background facts 1. Company A ('the Company') is an Australian proprietary company which was incorporated in Australia on DD/MM/YYYY and registered on the Australian Business Register on DD/MM/YYYY. Its equity interests are not listed for quotation in the official list of any stock exchange in Australia or overseas. 2. Company A is not a foreign company pursuant to the Corporations Act 2001 (Cth). 3. Company A has no subsidiaries and is not part of a consolidated group or planning to join a consolidated group. 4. Company A's board of directors is comprised of multiple individuals. 5. Company A has currently issued X ordinary shares. 6. The intellectual property associated with the products developed by the Company A will vest with the Company. 7. Company A did not have any subsidiaries and did not incur any expenses or generate any income in the income year ended 30 June YYYY (the year before the current year). Development of new or significantly improved innovations 8. The Company is developing a solution for disaster relief and remote communities. 9. Not only is the product fully portable and lightweight, but by using solar-generated power and other features, this will enable the modular design to operate, whilst maintaining required road and vehicle safety. 10. A comprehensive market research and competitor analysis for the Company's product has been undertaken, which demonstrates how the new design is a new and significantly improved invention when compared with the industry-leading solutions that are currently available on the market. 11. Existing solutions for disaster relief and remote communities are limited. No competitors can provide the solution at the scale intended by the Company. 12. The Company has conducted extensive research into farming and remote communities, universities, and industry experts on components, who have advised on the limitations of existing solutions. Genuinely focussed on developing innovations for commercialisation 13. Prior to the incorporation of the Company, significant work had already been conducted to assess the market and commercial opportunity. In addition, research had already been conducted to identify and ensure the ability to procure the materials required to enable the product to be developed, tested, and manufactured. 14. As part of their development and commercialisation timeline, the Company plans for the minimum viable product of its product to be available by the end of the current calendar year, with the product selling in Australia by the middle of the next calendar year. 15. The Company has also created a ten-year plan, which summarises the Company's planned commercialisation trajectory over the next ten years. This includes the initial sale of the product to Australian customers in the current year. 16. The Company is currently in collaboration with two industry-leading companies located overseas to assist in the design and manufacture key components of the Company's product. 17. Further, negotiations are also in progress with respect to contractual terms in relation employees, a warehouse premise, and another key component manufacturer. 18. The Company's revenue model projects turnover on the back of projected sales per unit. This revenue model projects significant revenue to be generated within ten years. High growth potential Market Gaps and Problems 19. Market research indicates that there is a large gap in the market for the Company's solution. 20. The Company has conducted extensive market research across remote communities, literature reviews and industry collaboration to determine that there is currently no viable solution to the provision of the essential resource. A summary of the key research points have been outlined below. 21. According to a recent government report, remote Indigenous communities in some areas of Australia were in need of a solution to the provision of the essential resource. 22. Current solutions to Australia's need for a solution to the provision of the essential resource are limited and ineffective 23. Unlike existing solutions, the Company's products are fully solar powered, do not require any pre-existing infrastructure, making them easily transportable and applicable for any environment. 24. The Company has not identified any competitors in the market that have been able to achieve the portable capabilities achieved by its proprietary technology Evidence of Demand for the Product and Addressable Market 25. Studies by an Australian university reveal that there is a strong connection between a lack of accessibility to the essential resource and community health, with many Australians, mostly in remote communities, not having access to required amounts of the resource during natural disasters. 26. The Company's product can be utilised as an alternative inferior solutions. 27. The Company intends to expand internationally to regions where communities' accessibility to the essential resource are often compromised during cyclone season and other natural disasters. 28. Currently, the Company has received expressions of interest from Indigenous leaders, regions that are prone to floods, and international governments. Scalability 29. The Company's product will consist of five key components to produce its solution. 30. With the design phase completed, the Company is exploring existing manufacturers and machinery to produce the different components of the product via a standardised assembly line. 31. Additionally, like other manufacturing products, the Company believes that increased product demand will lead to greater economies of scale and increased buying power, reducing both material and manufacturing costs. 32. By working in conjunction with a large pre-existing leading original equipment manufacturer and third-party logistics supplier, the Company believes that it can easily increase their capacity to meet increased demand for their product. Broader than local market 33. The Company believes that its product is highly scalable. The Company plans to use existing manufacturers of machinery components to produce the new design, and that there is strong evidence of demand across global markets. 34. Analysis of foreign markets demonstrates it is foreseeable that the Company's products will be as saleable in other regions as they are in Australian markets. 35. The Company has created a ten-year plan that summarises their main commercialisation activities or trajectory over the next ten years. This includes the initial sale of the solution to Australian customers in the current year, with further plans for expansion into overseas markets in future periods. 36. The Company has received global interest from overseas governments, demonstrating the potential for the Company's global expansion. Competitive advantages First in the World Solution 37. The Company's solution is the world's only fully portable, sustainable, and off-grid solution to the identified need. The most comparable competitors that rely on solutions that are not portable and require diesel generators to obtain the requisite energy levels to operate. 38. This new solution will be the first in the market that is truly 'portable'. Unlike others in the market, there is no on-ground or pre-existing infrastructure that is required for the product to be operable, allowing it to be accessible in remote or diverse areas. 39. Additional barriers to entry to another participant seeking to enter the new category of product are having the requisite know-how to ensure components meet performance and spatial requirements, accessing the required contracts to manufacture the product, and gaining traction in the market after the Company's first-mover advantage. Board of Directors and unrivalled experience 40. The Company consists of a team of professionals which the Company believes has unrivalled experience with the know-how, contacts, and influence to ensure that the Company's product and business is successful. Unique Technology and Business Model 41. The Company's technology is uniquely positioned in the market. Their product is substantially differentiated from other solutions existing in the market as it has a considerable competitive advantage. 42. The world-first design, which leverages five core components, can be easily replicated for use across different countries and environments. Information provided 43. You have provided information in a number of documents in relation to Company A's product. 44. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances. Assumptions Not applicable.

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 Further issues for you to consider | Not applicable.

Reasons for decision: Summary: All legislative references are to the Income Tax assessment Act 1997 (ITAA 1997) unless otherwise stated. Summary Company A meets the criteria of an ESIC under subsection 360-40(1) of the ITAA 1997 for the ZZZZ income year. DETAILED REASONING | 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 - '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 - '100 POINT TEST' - PARAGRAPH 360-40(1)(e) AND SECTION 360-45: 10. 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): 11. 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. 12. 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. 13. 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 - subparagraph 360-40(1)(e)(i) ITAA 1997: 14. 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] 15. 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. 16. 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. 17. 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] 18. 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." 19. 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." 20. 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. 21. '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 - subparagraph 360-40(1)(e)(ii) ITAA 1997: 22. 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 - subparagraph 360-40(1)(e)(iii) ITAA 1997: 23. 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. Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997 han local market 24. 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 - subparagraph 360-40(1)(e)(v) ITAA 1997: 25. 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) ITAA 1997: 26. At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth). 27. 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: 28. 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 YYYY, and on or before 30 June ZZZZ. | Detailed Reasoning - Current year: 29. 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 ZZZZ, 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): 30. Company A was incorporated in Australia on DD/MM/YYYY, which is within the last three income years (the latest being the current year). Therefore, the requirements of subparagraph 360-40(1)(a)(i) are satisfied. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b): 31. 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 YYYY income year, being the year before the current income year. 32. Company A did not have any subsidiaries and incurred total expenses of less than $1M in the YYYY income year. Therefore, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c): 33. 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 YYYY income year. 34. Company A did not have any subsidiaries and derived assessable total 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): 35. In applying the requirements of paragraph 360-40(1)(c), Company A must not be listed on any Stock Exchange in Australia or a foreign country at the test time. Company A was 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 FOR EARLY STAGE TEST: 36. Company A 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 - '100 POINT TEST' - PARAGRAPH 360-40(1)(e) AND SECTION 360-45: 37. Company A has not provided sufficient evidence of having satisfied the 100-point test under section 360-45 for the year ending 30 June ZZZZ. 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 - subparagraph 360-40(1)(e)(i): 38. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be developing an innovation which either new or significantly improved for an applicable addressable market. 39. Company A is developing the world's first fully portable, sustainable product, a solution for disaster relief and remote communities. 40. Current solutions are limited and ineffective. 41. Unlike existing solutions, the Company's product is fully solar powered and does not require any pre-existing infrastructure, making it easily transportable and applicable for any environment. | Detailed Reasoning - Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i): 42. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be genuinely focussed on developing an innovation for commercial purpose in order to generate economic value and revenue for the company. 43. Company A has provided details substantiating that that it is genuinely focussed on developing its innovation for commercial purpose in order to generate economic value and revenue for the company. | Detailed Reasoning - Conclusion on subparagraph 360-40(1)(e)(i): 44. Company A is genuinely focussed on developing their product, for commercialisation. The product will be a significantly improved product compared to existing products/solutions in their addressable market. 45. Therefore, subparagraph 360-40(1)(e)(i) is satisfied for the ZZZZ income year. 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): 46. In applying the requirements of subparagraph 360-40(1)(e)(ii), Company A must be able to demonstrate that it has high potential growth within a broad addressable market. 47. Company A has provided details substantiating that it meets this requirement. 48. Therefore, subsection 360-40(1)(e)(ii) is satisfied. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii): 49. In applying the requirements of subparagraph 360-40(1)(e)(iii), Company A must be able to demonstrate that it has the potential to scale up the business. 50. Company A has provided details substantiating that it meets this requirement. 51. Therefore, subsection 360-40(1)(e)(iii) is satisfied. | Detailed Reasoning - Broader than local market- subparagraph 360-40(1)(e)(iv): 52. In applying the requirements of subparagraph 360-40(1)(e)(iv), Company A must be able to demonstrate that it has the potential to address a broader than local market, including global markets. 53. Company A has provided details substantiating that it meets this requirement. 54. Therefore, subsection 360-40(1)(e)(iv) is satisfied. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v): 55. In applying the requirements of subparagraph 360-40(1)(e)(v), Company A must be able to demonstrate that it has the potential to be able to have competitive advantages for that business 56. Company A has provided details substantiating that it meets this requirement. 57. Therefore, subsection 360-40(1)(e)(v) is satisfied. | Detailed Reasoning - Conclusion on principles-based test: 58. Company A satisfies the principles-based test as it satisfies the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the ZZZZ income year. | Detailed Reasoning - 'FOREIGN COMPANY TEST' - subparagraph 360-40(1)(f) ITAA 1997: 59. 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: 60. Company A meets the eligibility criteria of an ESIC under section 360-40 of the ITAA 1997 for the ZZZZ income year. [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.