Private ruling: Early stage innovation company
Date of advice: 16 October 2023
Published: 27 November 2023
Ruling period: Year ending 30 June 20XX
Date scheme commenced: 1 July 2022

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 is a proprietary company incorporated and registered in the Australian Business Register on XX XX 20XX. 2. For year ended 30 June 20XX, the company earned and incurred the following: • Total expenditure: $XX • Total income: XX 3. Company A's equity interests are not listed for quotation in the official list of any stock exchange, either in Australia or a foreign country. 4. The Company is developing a product and information that details its development was provided. 5. Company A is developing their product to address a number of discrete markets and is continuing to develop their product. 6. Company A's products have been identified as having an international addressable market. 7. Company A has identified that it has the ability to rapidly expand its business. 8. Company A has also identified that it has high growth within its addressable market. 9. Company A has identified its product has competitive advantage over any similar product.

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: Summary: Company A meets the eligibility requirements of an ESIC pursuant to subsection 360-40(1). | Detailed Reasoning - Qualifying Early Stage Innovation Company: 10. Subsection 360-40(1) outlines the criteria required for a company to qualify as an 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': 11. 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): 12. 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 ABR within the last three income years (the latest being the current year). 13. 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. 14. 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): 15. 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): 16. 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): 17. 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: 18. 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: 19. 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): 20. 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. 21. 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. 22. The five requirements of the principles-based test, as outlined in paragraph 360-40(1)(e) are: i. the company must be genuinely focussed 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 - Foreign Company test - paragraph 360-40(1)(f): 23. At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth). 24. 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: 25. 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 XX 20XX, and on or before 30 YY 20YY. | Detailed Reasoning - Current year: 26. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the current year will be the year ending 30 June 20XX. For clarity, in relation to particular requirements within subsection 360-40(1), the last 3 income years will include the years ending 30 June 20XX, 20XX and 20XX, and the income year before the current year will be the year ending 30 June 20XX. | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a): 27. Company A was incorporated in Australia on x XX 20XX which is within the 3 income years. 28. Company A satisfies the requirements of subparagraph 360-40(1)(a)(i). | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b): 29. 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 20XX income year, being the income year before the current year. 30. Company A incurred expenses of $xx.00 in the 20XX income year. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c): 31. 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 20XX income year, being the income year before the current year. 32. Company A earned $XX.00 assessable income in the 20XX income year. Consequently, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No Stock Exchange listing - paragraph 360-40(1)(d): 33. In applying the requirements of paragraph 360-40(1)(d), Company A must not be listed on any stock exchange in Australia or a foreign country at the test time. 34. Company A was not listed on any stock exchange in Australia or a foreign country at relevant test times, so paragraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: 35. Company A satisfies the early stage test for the 20XX 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. Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 20XX. For Company A 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): 37. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be developing an innovation which is either new or significantly improved for an applicable addressable market. 38. Company A is commercialising its product. 39. Company A is genuinely focused on developing their products for an applicable addressable market, so subparagraph 360-40(1)(e)(i) is satisfied for the period x XX 20XX to y YY 20YY. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) 40. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be genuinely focussed on developing an innovation for a commercial purpose in order to generate economic value and revenue for the company. 41. Company A is genuinely focussed on developing their product for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii): 42. In applying the requirements of subparagraph 360-40(1)(e)(ii), Company A must be able to demonstrate that it has the potential for high growth within a broad addressable market. 43. Company A has identified that is has the ability to rapidly expand its business. 44. Company A has also identified that it has high growth within its addressable market. 45. Company A has demonstrated a high growth potential for their products, so subparagraph 360-40(1)(e)(ii) is satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997: 46. The company must be able to demonstrate that it has the potential to successfully scale up the business relating to the innovation. The company must have operating leverage, whereas 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. 47. Company A has the potential to successfully scale up its business. 48. Company A has the potential to successfully scale up its business, so subparagraph 360-40(1)(e)(iii) is satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv): 49. In applying the requirements of subparagraph 360-40(1)(e)(iv), Company A must be able to demonstrate that it has the potential to be able to address a broader than local market, including global markets. 50. Company A will be 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. 51. Company A has demonstrated that it has the capacity to address a broader than local market, so subparagraph 360-40(1)(e)(iv) is satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v): 52. In applying the requirements of subparagraph 360-40(1)(e)(v), Company A must demonstrate that it has potential to be able to have competitive advantage for that business. 53. Company A has identified its product has competitive advantage: 54. Company A has demonstrated that it has competitive advantages over its competitors, so subparagraph 360-40(1)(e)(v) is satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - CONCLUSION FOR PRINCIPLES BASED TEST: Company A satisfies the principles based test as it will satisfy the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period commencing 1 July 20XX until 30 June 20YY. | Detailed Reasoning - Foreign Company Test - subparagraph 360-40(1)(f) ITAA 1997: As Company A was incorporated in Australia, it is not a Foreign Company and paragraph 360-40(1)(f) is satisfied. | Detailed Reasoning - CONCLUSION: Company A meets the eligibility criteria of an ESIC under section 360-40 for the period 1 July 20XX to 30 June 20YY.