Private ruling: Early stage innovation company
Date of advice: 15 March 2023
Published: 1 May 2023
Ruling period: x XX 20XX to yy YY 20ZZ | x XX 20ZZ to yy YY 20YY
Date scheme commenced: x XX 20XX

Ruling: Q1: Does Company X meet the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the Income Tax Assessment Act 1997 ('ITAA 1997') for the period x XX 20XX to yy YY 20YY (x years)? | A1: Yes

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect, and you cannot rely on it. The fact sheet has more information about relying on your private ruling. Background Facts 1. Company X is an Australian proprietary company incorporated in XYZ on x YY 20VV. 2. Company X's directors are Taxpayer A, Taxpayer B, Taxpayer C and Taxpayer D. 3. Company X's registered office and principal place of business is situated at XYZ. 4. Company X currently owns xx% of one subsidiary company, Company A, which is currently a dormant company that Company X are planning to use to conduct trial work to separate risk from IP ownership in the head company. Company X will be the head company of a group of subsidiaries planned to be incorporated in future years. Company X will conduct all R&D activities, will own all IP and will be fully focused on developing their product and applications. Future subsidiaries will be incorporated to commercialise specific market segments under license from Company X. No decisions have yet been made on the need to consolidate the group for tax purposes. 5. For the financial year ending yy YY 20ZZ, Company X incurred and earned the following: • Total expenses of $xx • Total income of $yy 6. For the financial year ending yy YY 20VV, Company X incurred and earned the following: • Total expenses of $yy • Total income of $xx 7. Company X's equity interests are not listed for quotation in the official list of any stock exchange, either in Australia or a foreign country. Development of Product 8. Company X is developing an innovation known as 'Product X', a biological process. Product X is an early stage technology. The commercial application of Product X is globally significant with a core focus on addressing specific problems in partnership with global companies, health providers in developing countries, NGOs, and philanthropic foundations. 9. 'Product Y', the lead compound in the class of product X compounds, is a soluble compound with specific efficacy. 10. Company X was established for the sole purpose of developing, protecting, and commercialising the innovation developed by one of the Founders while working as a researcher for Company Y 11. Company Y formally transferred the IP to Company X by formal contract on xx XX 20XX in return for a xx% shareholding. 12. The work conducted by Company Y involved the identification of Product Y, a lead candidate for a class of specific agent. 13. Ongoing research and development undertaken by Company X since the IP transfer from Company Y includes: • Identification of additional candidate biological processes; • Testing of the specific activity of Product Y against other products; • Independent validation of the efficacy and boosting efficacy of the Product X candidates with third party laboratories; and • Assessment of available safety data for Product Y in advance of conducting trials for its use in the experimental treatment of a number of diseases. Product Development Stages 14. Major milestones already achieved that are relevant for commercialisation activities include: • Identification of Product Y and determination of its specific activities; • Demonstration that product Y enhances the activity of a specific biological process; and • Establishment of a specific model that enables visualisation of the compound. 15. Major milestones to be met before Company X can commence commercialisation activities include: • Adapting the model to a high throughput format for enhanced screening capabilities; • Establishing the mechanism of action of Product Y; and • Determining whether Product Y is active against additional biological processes. 16. Prior to Company X's incorporation and the assignment of relevant IP to Company X by Company Y, research and developmental work was conducted by Company Y researchers as part of their usual research activities. This work was conducted over the period 20TT - 20VV and was completed with the lodgement of the provisional patent in YY 20VV. Commercialisation strategy 17. Before Company X can commence commercialisation of Product Y, additional research and development is required to determine: • The molecular mechanism of action of Product Y in specific biological processes; • Adaption of the developed biological model to a high throughput format to enable: o Screening of a wider range of biological processes; o Screening of combinations of Product Y and other candidate processes in combination with known specific processes; and o Screening of new compound libraries or biological processes. • Conducting trials with Product Y in specific communities to determine its safety and efficacy in the treatment of various diseases; • Conducting clinical trials with Product Y in healthy volunteers to demonstrate its safety; and • Conducting larger trials with Product Y either alone or in combination with existing biological processes to determine its safety and efficacy. High growth potential 18. The Product innovation is a potent technology that can be cost effectively produced on an industrial scale for application across industries affected by specific biological processes. 19. The largest market opportunity for Company X is in the specific global market (estimated to be USDXXX by 20AA) where problems are outpacing new process development. The Product will be made available to large companies through Joint Ventures and Licensing models to develop cost‐effective, long‐term solutions to these issues. Scale up the business 20. Company X has an advanced and proven life science strategy to scale the business model rapidly. 21. Company X will focus on discovery R&D to broaden its IP position to new methods of use. 22. The Product will be licensed to multiple, multinational companies seeking to enhance proprietary product performance, competitive advantage and patent life. 23. Company X will develop and supply specific products in Australia and out license international marketing and distribution to various multinational companies. 24. Company X will develop large and small specific applications and then codevelop products with partners to regulatory approval, then out license marketing and distribution. 25. Company X has an engaged and motivated investor group seeking to increase funding to scale to business 26. Company X's CEO has xx years multinational experience in the specific industry. Broader than local market 27. Company X's primary markets are global and partnerships with large multinational companies will be required to address these global markets effectively. 28. Specific Australian industry applications will be pursued in partnership with Australian companies as appropriate. 29. Commercial, scaled production of the Product's raw material will be located in Australia with a global supply market. Competitive advantages 30. Company X has full ownership rights to the Product's innovation through patents providing a significant competitive advantage. 31. Once the Product's applications are developed and commercialised, any party looking to access the technology will need to negotiate access with Company X. 32. Company X is developing their Product to address a number of discrete markets and is continuing to develop their Product. 33. Company X's Product has been identified as having an international addressable market. Information provided 34. You have provided a number of documents containing detailed information in relation to Company X's Product, including: • Private Binding Ruling ('PBR') Application, dated xx YY 20ZZ • Response to further questions provided 35. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances. 36. Company X issued shares to investors on yy YY 20ZZ (Series A capital raise, issued xxx shares to xx investors, raising $xyz in cash equity) and xx YY YY (issued yy shares to y investors, raising $zyx in cash equity). Assumption(s) 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

Reasons for decision: Summary: All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated. Company X meets the eligibility requirements of an ESIC under subsection 360-40(1) for the period x XX 20XX to yy YY 20YY. | Detailed Reasoning - Qualifying Early Stage Innovation Company: 37. 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': 38. 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): 39. 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 any 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). 40. 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. 41. 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): 42. To meet the requirement in paragraph 360-40(1)(b), the company and any 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): 43. To meet the requirement in paragraph 360-40(1)(c), the company and any 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): 44. 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': 45. 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: 46. 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): 47. To satisfy the Principles-based Innovation 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. 48. 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. 49. 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 - Developing new or significantly improved innovations for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997: 50. 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..." 51. The innovation being developed by the company must either be new or significantly improved for an applicable addressable market. [1] 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. 52. Improvements must be significant in nature to meet this requirement. Significant is defined in the online Macquarie Dictionary as " important; of consequence ." 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. 53. 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." 54. The company must be genuinely focussed 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. 55. For a company to qualify as an ESIC under the principles based test, the company must be "genuinely focussed on developing for commercialisation" their innovation. That is, the central activities of the company must be truly concentrated on developing their innovation for a commercial purpose. '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: 56. The company must be able to demonstrate that the business relating to the innovation has a high growth potential 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: 57. 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. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997: 58. 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: 59. 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): 60. At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth). 61. 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: 62. For the purposes of this ruling, the 'test time' for determining if Company X is a qualifying ESIC, will be upon the issue of qualifying shares on a particular date or dates on or after x XX 20XX, and on or before yy YY 20YY. Company X issued shares to investors on yy YY 20ZZ and xx XX 20ZZ. | Detailed Reasoning - Current year(s): 63. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the current year (for the first period) will be the year ending yy YY 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 yy YY 20YY, 20ZZ and 20VV, and the income year before the current year will be the year ending yy YY 20ZZ (the 20ZZ income year). 64. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the current year (for the second period) will be the year ending yy YY 20ZZ (the 20ZZ income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last 3 income years will include the years ending yy YY 20ZZ, 20VV and 20TT, and the income year before the current year will be the year ending yy YY 20VV (the 20VV income year). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a) ITAA 1997: 65. Company X was incorporated in XXX on x YY 20VV, 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: 66. In applying the requirements of paragraph 360-40(1)(b), Company X and any of its 100% subsidiaries must have incurred total expenses of $1 million or less in the 20ZZ and 20VV income years, being the income year before the two current years. 67. Company X incurred expenses of $xyz in the 20ZZ income year and $zyx in the 20VV income year. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c) ITAA 1997: 68. In applying the requirements of paragraph 360-40(1)(c), Company X and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the 20ZZ and 20VV income years, being the income year before the two current years. 69. Company X did not earn any assessable income in the 20ZZ and 20VV income years. Consequently, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No Stock Exchange listing - paragraph 360-40(1)(d) ITAA 1997: 70. In applying the requirements of paragraph 360-40(1)(d), Company X must not be listed on any Stock Exchange in Australia or a foreign country at the test time. 71. Company X 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: 72. Company X satisfies the early stage test for the 20ZZ and 20YY income years, 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: 73. Company X has not provided sufficient evidence of satisfying the 100-point test under section 360-45 for the year ending yy YY 20ZZ and 20YY. Company X are 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 for applicable addressable market - subparagraph 360-40(1)(e)(i) ITAA 1997: 74. In applying the requirements of subparagraph 360-40(1)(e)(i), Company X must be developing an innovation which is either new or significantly improved for an applicable addressable market. 75. Company X is developing an innovation known as 'Product X', a biological process. Product X is an early stage, proprietary technology. The commercial application of Product X is globally significant. 76. Company X was established for the sole purpose of developing, protecting, and commercialising the innovation developed by one of the Founders while working as a researcher for Company Y 77. Company Y formally transferred the IP to Company X by formal contract in return for a xx% shareholding. 78. The work conducted by Company Y involved the identification of Product Y, a lead candidate for a class of novel agent that is not toxic. 79. Research and development undertaken by Company X since the IP transfer from Company Y continues. 80. Company X is developing their Product to address a number of discrete markets and is continuing to develop their Product. 81. Company X is genuinely focussed on developing their Product for an applicable addressable market. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997 82. In applying the requirements of subparagraph 360-40(1)(e)(i), Company X must be genuinely focussed on developing an innovation for a commercial purpose in order to generate economic value and revenue for the company. 83. Company X commenced research and development work in XX 20ZZ and work conducted to date includes a number of different processes. 84. Current activities in the further development of Product Y toward commercialisation are being conducted in three streams in parallel. 85. There are a number of steps which are required to be completed into the future, before the Product is considered to be fully developed for commercialisation. 86. Company X anticipate that the current programme of development will be completed in the 20SS financial year. This is due to the complex nature of the regulation of these specific products. 87. Company X 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 yy YY 202YY, or the date when their Product has been fully developed and is ready for client use, whichever occurs earlier. Once the Product has been fully developed, Company X will no longer be 'developing' the product for commercialisation. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997: 88. In applying the requirements of subparagraph 360-40(1)(e)(ii), Company X must be able to demonstrate that it has the potential for high growth within a broad addressable market. 89. Company X has high growth potential as the Product is easily and infinitely scalable to a global audience. 90. Company X has provided details to satisfy this requirement. 91. Company X has demonstrated a high growth potential for their Product, so subparagraph 360-40(1)(e)(ii) is satisfied for the period x XX 20XX to yy YY 20YY. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997: 92. In applying the requirements of subparagraph 360-40(1)(e)(iii), Company X must be able to demonstrate that it has the potential to successfully scale up the business. 93. Company X has provided details to satisfy this requirement. 94. This leverage ensures that Neolixir 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 yy YY 20YY. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997: 95. In applying the requirements of subparagraph 360-40(1)(e)(iv), Company X must be able to demonstrate that it has the potential to be able to address a broader than local market, including global markets. 96. Company X has provided details to satisfy this requirement. 97. Company X 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 yy YY 20YY. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v) ITAA 1997: 98. In applying the requirements of subparagraph 360-40(1)(e)(v), Company X must demonstrate that it has potential to be able to have competitive advantage for that business. 99. Company X has provided details to satisfy this requirement. 100. Company X has demonstrated that it has competitive advantages for its business, so subparagraph 360-40(1)(e)(v) is satisfied for the period x XX 20XX to yy YY 20YY. | Detailed Reasoning - CONCLUSION FOR PRINCIPLES BASED TEST: Company X satisfies the Principles-based Innovation test as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period x XX 20XX to yy YY 20YY, or the date when their Product has been fully developed and is ready for client use, whichever occurs earlier. | Detailed Reasoning - Foreign Company Test - subparagraph 360-40(1)(f) ITAA 1997: 101. As Company X was incorporated in Australia, it is not a Foreign Company and paragraph 360-40(1)(f) is satisfied. | Detailed Reasoning - CONCLUSION: Company X meets the eligibility criteria of an ESIC under section 360-40 for the period x XX 20XX to yy YY 20YY, or the date when their Product has been fully developed and is ready for client use, whichever occurs earlier. | Detailed Reasoning - Other references (non ATO view): Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 [1] Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.79.