Private ruling: Early stage innovation company
Date of advice: 19 November 2020
Published: January 2021
Ruling period: 1 July 20XX to 30 June 20YY
Date scheme commenced: 1 July 20XX

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 20YY financial year? | A1: Yes

Relevant facts and circumstances: 1. Company A is an Australian proprietary company registered with the Australian Securities and Investments Commission (ASIC) on z zz 20ZZ. 2. Company A's director is Taxpayer A. 3. Company A has no ultimate holding company and no subsidiaries. 4. For the financial year ending 30 June 20XX, Company A incurred and earned the following: a. Total expenses of $x.xx b. Total income of $y.yy 5. 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. 6. Company A plans to issue further shares in the 20XX/YY financial year as and when terms are agreed with new investors. 7. Company A is developing a composite type system, components and method of creation (the 'Product'). Company A's goal is to simplify current processes to improve efficiency, quality and value by becoming a global producer of the Product. 8. Company A has identified its ultimate market as being the domestic and global market, with its initial target being both Australian and international markets. 9. Company A's Product uses innovation in design to leverage existing products and materials into a whole-of-system approach and provides a cost-effective mechanism to create using high quality, more robust, time-durable materials. 10. The breadth of Company A's consumer markets is such that it includes many consumers in the community. 11. On z zz 20ZZ, Company A received a private ruling for the financial year ended 30 June 20XX (authorisation number xyzxyz) that the company qualified as an ESIC at relevant test times. The basis for the decision was that the company satisfied the principles-based test in respect of their Product being developed. 12. This application is an extension for the previous ruling (authorisation number xyzxyz) which was delayed and interrupted by the COVID-19 pandemic. 13. Since the previous ruling issued, on z zz 20ZZ, Company A has continued to develop their Product. Company A predicts that there are approximately x months of development required before their Product is fully developed (by approximately mid-20YY). Information provided 14. You have provided a number of documents containing detailed information in relation to Company A, including: a. Private Binding Ruling Application, dated x xx 20XX b. Further details outlined in separate documents provided c. A business outline d. Financial details e. A document with further information f. Responses to further information as requested by the ATO in an email dated 20 xx 20XX 15. We have referred to the relevant information within these documents 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 360-15 | 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 Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated. Company A meets the eligibility requirements of an ESIC pursuant to subsection 360-40(1). | Detailed Reasoning - Qualifying Early Stage Innovation Company: 16. 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': 17. 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): 18. 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). 19. 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. 20. 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): 21. 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): 22. 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): 23. 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: 24. 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: 25. 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): 26. 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. 27. 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. 28. 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 - TEST TIME: 29. 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 20XX, and on or before 30 June 20YY, that is, within the 20XX/YY financial year. | Detailed Reasoning - Current year: 30. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , 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 3 income years will include the years ending 30 June 20YY, 20XX and 20ZZ, 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) ITAA 1997: 31. Company A was incorporated and registered with the Australian Securities and Investment Commission (ASIC) on z zz 20ZZ, which is within the 3 income years outlined above, therefore the requirements of subparagraph 360-40(1)(a)(i) are satisfied. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b) ITAA 1997: 32. 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. 33. Company A incurred $x.xx in expenses in the 20XX income year. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c) ITAA 1997: 34. 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. 35. Company A earned $y.yy in 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) ITAA 1997: 36. 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. 37. Company A is not listed on any Stock Exchange in Australia or a foreign country at the test time, so paragraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: 38. Company A satisfies the early stage test for the 20YY 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: 39. Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 20YY. For Company A to be a qualifying ESIC, it will need to satisfy the principles-based test. | Detailed Reasoning - THE 'PRINCIPLES-BASED TEST' - paragraph 360-40(1)(e) ITAA 1997: 40. In the ruling dated z zz 20ZZ, (authorisation number xyzxyz) the Commissioner concluded that Company A satisfied the principles based test in respect of their Product being developed. While the Product is still being developed, Company A will continue to satisfy the requirements of the principles-based test, within subparagraphs 360-40(1)(e)(i) to (v). 41. Prior to the previous ruling dated z ZZ 20ZZ being issued, Company A was involved in the initial design of their Product. From an initial Australian Innovation Patent #xyzxyz relating to an early version, significant changes were made leading to the application and eventually granting of a patent, now registered in xy countries. 42. As working samples were produced, difficulties in processing were eventually overcome by changing from the use of already-processed materials to mixing their own combination of materials, using it as a strengthening element. This new production process has only been tested in small segments for basic purposes. 43. To fulfil the system, further design issues were addressed to anticipate actual independent design activities, whereby the system had answers for all likely scenarios raised by designers. 44. Since the ruling dated z zz 20ZZ was issued, Company A's development work has been delayed and interrupted by the COVID-19 pandemic. Proposed work for broadening the number of products has been held off due to pandemic related closure of suppliers and travel restrictions. 45. Currently, as pandemic related restrictions are lifted, Company A propose to recommence the manufacturing of test products in a number of locations using locally sourced materials that are already certified for use in their respective countries. National testing bodies can then confirm certification for use. 46. The next step in the current financial year is the completion of the Product that will meet the various requirements in each country, providing a tangible example to satisfy potential customers. 47. Further testing and certification will be undertaken. The demonstration Products will then be used for marketing until actual sales of products leads to completion by customers. 48. If Company A can successfully negotiate around the travel restrictions, they expect to have the development programme completed by mid-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, or the date when their Product has been fully developed and is ready for client use, whichever occurs earlier.