Private ruling: Early stage innovation company
Date of advice: 29 August 2019
Published: October 2019
Ruling period: Year ended 30 June 2019
Date scheme commenced: 1 July 2018

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 on xx June 2016. Its equity interests are not listed for quotation in the official list of any stock exchange. 2. The Company has no subsidiaries. It had total expenses of less than $1million for 2017 to 2019 income years and assessable income of less than $200,000 for the year ended 30 June 2018. 3. In July 2017 the Company received a private ruling for the year ended 30 June 2016 that they were an ESIC on the basis that they passed the principles based test in respect of the first Product being developed. 4. Since the ruling issued, the Company continued to develop their Product and has launched the first Product on both iOS and Android systems in June 2018 and on other systems in April 2019. 5. The Company is developing a second new Product. 6. The Company highlighted that the second new Product will have key differentiators. 7. The Company holds an Australian patent and an international patent for the second new Product. 8. The Company has identified its addressable market for the second new Product as the global market. Information provided 9. You have provided information in a number of documents and phone conversations in relation to the second new Product, including: a. your private ruling application dated xx June 2019. b. supplementary information provided on xx July 2019 and xx August 2019. c. phone conversation with you on xx July 2019. 10. We have referred to the relevant information within these documents and conversations in applying the relevant tests to your circumstances. Assumption(s) N/A

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. The Company meets the eligibility requirements of, an ESIC under, subsection 360-40(1). | Detailed Reasoning - Qualifying Early Stage Innovation Company: 11. 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': 12. 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): 13. 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). 14. 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. 15. 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): 16. 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): 17. 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): 18. 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: 19. 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): 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 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 23. 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 2019. Current year 24. For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 2019 (the 2019 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 2019, 2018 and 2017, and the income year before the current year will be the year ending 30 June 2018 (the 2018 income year). | Detailed Reasoning - Early stage test: Incorporation or Registration - paragraph 360-40(1)(a) 25. As the Company was incorporated in June 2016, which is within the last 6 income years, and across the last 3 of those income years it incurred total expenses of less than 1million, subparagraph 360-40(1)(a)(ii) is satisfied. Total expenses - paragraph 360-40(1)(b) 26. As the Company's expenses in the prior year was $1 million or less paragraph 360-40(1)(b) is satisfied. Assessable income - paragraph 360-40(1)(c) 27. As the Company's assessable income for the prior income year was $200,000 or less paragraph 360-40(1)(c) is satisfied. No stock exchange listing - paragraph 360-40(1)(d) 28. As the Company is a private company it is not listed on any stock exchange in Australia or a foreign country, subparagraph 360-40(1)(a)(d) is satisfied. Conclusion on early stage test 29. The Company will satisfy the early stage test for the entire 2019 income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - Principles based test: Developing new or significantly improved innovations for commercialisation - subparagraph 360-40(1)(e)(i) 30. According to the Company, the second new Product is significantly improved product and has been identified as having a global addressable market. 31. The second new Product will be the first to offer such a significantly improved product. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) 32. The company has taken the following steps in developing the second new Product: a. Market research b. Competitor Analysis 33. The timeline provides that the Company expects to launch the second new Product in December 2019. Conclusion on subparagraph 360-40(1)(e)(i) 34. The Company is genuinely focussed on developing the second new Product for a commercial purpose. The second new Product will be a significantly improved product compared to existing products. 35. Therefore subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 1 July 2018 until 30 June 2019 or the date when the second new Product has been fully developed, whichever occurs earliest. Once the second new Product 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. High growth potential - subparagraph 360-40(1)(e)(ii) 36. The Company expects the second new Product appeal to a wide range of clients. This aids decision making and is particularly useful when assessing product or service viability in particular markets. 37. The Company is developing the second new Product in-house. 38. If the commercialisation strategy is successful, this may give the Company the ability to increase sales through other channels. 39. Therefore subparagraph 360-40(1)(e)(ii) will be satisfied. Scalability - subparagraph 360-40(1)(e)(iii) 40. The second new Product's projection provided illustrates the increase in projected sales. 41. The Second new Product is a computer technology. By nature, this means it will easily scale with customers utilising the software on user-pays subscription basis. Its business model means the software is developed and then can be distributed many times in response to customer demand with minimal increases in costs per unit. The operating leverage affords the Company the potential to successfully scale up its business. 42. Given that the second new Product will be available globally, it is expected that the second new Product has the potential to successfully scale up its business. 43. Therefore subparagraph 360-40(1)(e)(iii) will be satisfied. Broader than local market- subparagraph 360-40(1)(e)(iv) 44. The Company's second new Product will be targeted at the International markets. 45. The second new Product can be used worldwide by any users. Thus, the ultimate addressable market is on a global scale. 46. The Company has demonstrated the second new Product has the potential to address a broader market than just the local market, including international markets. Therefore subparagraph 360-40(1)(e)(iv) will be satisfied. Competitive advantages - subparagraph 360-40(1)(e)(v) 47. The second new Product has differentiating features which may give it a competitive advantage. 48. Being the first of such significantly improved product, the Company has the first mover advantage. The Company has demonstrated the potential for the second new Product to have competitive advantages within its addressable market, satisfying subparagraph 360-40(1)(e)(v). Conclusion on principles test 49. 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 2018 until 30 June 2019 or the date when the second new Product has been fully developed and is ready for sale, whichever occurs earlier. Conclusion 50. The company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 2018 until the earlier of 30 June 2019 or the date when the second new Product has been fully developed and is ready for sale, whichever occurs earlier.