Private ruling: Early Stage Innovation tax incentive
Date of advice: 16 August 2017
Published: December 2017
Ruling period: Year ending 30 June 201D
Date scheme commenced: 1 July 201C

Ruling: Q1: For the income year ending 30 June 201D, does Company P meet the early stage test requirements at paragraphs 360-40(1)(a) to (d) of the Income Tax Assessment Act 1997? | A1: Yes | Q2: For the purposes of item 10 of the table in section 396-55 of Schedule 1 to the Tax Administration Act 1953 (TAA), will the issuing of Series B Preference Shares (the shares) by Company P be an equity interest in Company P as required under paragraph 360-15(1)(b) of the Income Tax Assessment Act 1997? | A2: 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. 1. Company P was incorporated in Australia on Date X. Its equity interests are not listed for quotation in the official list of any stock exchange. 2. Company P is not a subsidiary of another company and does not own shares in another company. 3. Company P’s assessable income is less than $200,000 and has expenses of less than $1,000,000 in the previous income year, i.e. the year ended 30 June 201C. 4. Company P has an exclusive worldwide license in relation to a Standard Patent to their technology. This standard patent was granted in Australia in mid 201A. 5. As at 30 June 201C, Company P’s share capital was $X. Company P has the following classes of shares on issue ordinary shares, Series A Preference shares and Series B Preference shares. 6. Under the Constitution of the company: All shares have the same rights to dividends. a) There are preferential rights to return of capital in the following order: preference shares, then ordinary shares. b) Each member holding shares may at any time after the maturity date (being 5 years after the issue date) require the company to redeem all or any of their preference shares. On the redemption date, the company must redeem (only out of profits of the company) for the redemption amount (being the issue price). If at the redemption date there are insufficient profits available to the company to pay the redemption amount for all redemption shares, then the company must pay such amount out of available profits and continue to apply profits to pay the redemption amount. c) Each member holding Preference shares is entitled at any time to convert the shares into ordinary shares. Information provided 7. You have provided information in a number of documents and phone conversations in relation to your ruling application, including: a) your private ruling application. b) our phone conversation with you. c) supplementary information provided. 8. We have referred to the relevant information within these documents and conversations 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 974 | Income Tax Assessment Act 1997 section 995 | Taxation Administration Act 1953 section 396-55

Reasons for decision: Summary: All legislative references are to the ITAA 1997 unless otherwise indicated. | Summary: Company P meets the eligibility requirements of, an ESIC/ Early Stage Test under, subsection 360-40(1). | 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 - 'The 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 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 - Application to your circumstances: Test time 9. For the purposes of this ruling, the test time for determining if Company P satisfies the early stage test will be a particular date during the income year ending 30 June 201D. Current year 10. For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 201D (the 201D 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 201D, 201C and 201B, and the income year before the current year will be the year ending 30 June 201C (the 201C income year). | Detailed Reasoning - Early stage test: Incorporation or Registration – paragraph 360-40(1)(a) 11. As Company P was incorporated on Date X, which is within the last 3 income years, subparagraph 360-40(1)(a)(i) is satisfied. Total expenses – paragraph 360-40(1)(b) 12. As Company P had expenses less than $1,000,000 in the prior income year, paragraph 360-40(1)(b) is satisfied. Assessable income – paragraph 360-40(1)(c) 13. As Company P’s assessable income for the prior income year is less than $200,000 and paragraph 360-40(1)(c) is satisfied. No stock exchange listing – paragraph 360-40(1)(d) 14. As Company P is privately owned and is not listed on any stock exchange in Australia or a foreign country, paragraph 360-40(1)(d) is satisfied. Conclusion on early stage test 15. Company P will satisfy the early stage test for the entire 201D income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Summary: For the purposes of item 10 of the table in section 396-55 of schedule 1, the issue of Series B Preference shares by Company P will be equity interests as required under paragraph 360-15(1)(b). | Detailed Reasoning - Detailed reasoning: 16. Section 995-1(1) defines a “scheme” as any arrangement or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. | Detailed Reasoning - Equity interests in companies: 17. Subsection 974-70(1) provides that a scheme gives rise to an equity interest in a company if, when the scheme comes into existence: a. The scheme satisfies the equity test in subsection 974-75(1) in relation to the company because of the existence of an interest; and b. The interest is not characterised as, and does not form part of a larger interest that is characterised as, a debt interest in the company, or a connected entity of the company, under subdivision 974-B. | Detailed Reasoning - Debt interests: 18. Subsection 974-15(1) provides that a scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1) in relation to the entity. 19. Subsection 974-20(1) sets out the requirements of the debt test. 20. A scheme satisfies the debt test in this subsection in relation to an entity if: a. The scheme is a financing arrangement for the entity; and b. The entity, or a connected entity of the entity, receives, or will receive, a financial benefit or benefits under the scheme; and c. The entity has, or the entity and a connected entity of the entity each has, an effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when: i. The financial benefit referred to in paragraph (b) is received if there is only one; or ii. The first of the financial benefits referred to in paragraph (b) is received if there are more than one; and d. It is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and e. The value provided (worked out under subsection (2)) and the value received (worked out under subsection (3)) are not both nil. 21. The scheme does not need satisfy paragraph (a) if the entity is a company and the interest arising from the scheme is an interest covered by item 1 of the table in subsection 974-75(1) (interest as a member of the company) | Detailed Reasoning - Reporting tax-related information about transactions to the Commissioner: 22. Section 396-55 of the TAA 1953 states that an entity mentioned in column 1 of an item in the table must prepare a report in the approved form setting out information about any transactions described in that item that happened during this period: i. A financial year; or ii. Such other period as the Commissioner specifies by legislative instrument for that item. 23. Paragraph 396-55(b) of the TAA 1953 also states that an entity mentioned in column 1 of the table must give the report to the Commissioner on or before: i. The 31 st day after the end of that period; or ii. Such other time after the end of that period as the Commissioner specifies by legislative instrument for that item. 24. The entity in question for the purposes of this ruling is a company. A company is mentioned in column 1 at item 10 of the table in section 396-55 of the TAA 1953. Item 10 states that the issuing by the company of a share that could give rise to an entitlement to a tax offset under Subdivision 360-A. | Detailed Reasoning - Entitlement to the tax offset: General case 25. Section 360-15 outlines the criteria required for an entity to be entitled to the early stage tax offset at a particular time in an income year. 26. Subsection 360-15(1) states an entity (other than a trust, partnership or a widely held company) is entitled to a tax offset for an income year if during that year the entity was issued with shares by a qualifying ESIC, provided the entity was not in an affiliate relationship at the relevant time. 27. Paragraph 360-15(1)(b) states that at a particular time during the income year, a company issues you with equity interests that are shares in the company. | Detailed Reasoning - Application to your circumstances: 28. The arrangement in relation to the issuing of Series B Preference shares falls within the definition of a 'scheme’ as stated in subsection 995-1(1). Equity 29. The Preference shares being issued by Company P are a current class of shares that are held by shareholders. Therefore they satisfy item 1 in the table at subsection 974-75(1). 30. The scheme satisfies paragraph 974-70(1)(a) and will be an equity interest provided it is not also characterised as and forms part of a larger interest that is characterised as a debt interest. Debt test 31. As mentioned in paragraph 29 the Preference shares meets the definition of a scheme as per subsection 995-1(1). a) Is the scheme a financing arrangement for the entity? 32. Subsection 974-20(1) provides that a scheme need not be a financing arrangement for the entity if the entity is a company and the interest arising from the scheme is an interest as a member or shareholder of the company. 33. As Company P is a company, and the Preference shares are interests that are covered by item 1 of the table at subsection 974-75(1), the scheme does not have to satisfy the financing arrangement requirement. b) Does or will the entity, or connected entity of the entity, receive a financial benefit or benefits under the scheme? 34. The issue price for the Preference shares is $3.66; this means that Company P will receive a share subscription amount. 35. Paragraph 974-160(1)(a) states that a financial benefit will include 'anything of economic value’. As Company P will receive a subscription amount, it is sufficient to say that they will receive a financial benefit for each Preference share that is issued. c) Does the entity have, or the entity and a connected entity of the entity each have, an effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities? 36. An 'effectively non-contingent obligation’ is defined in subsection 995-1(1) to have the meaning given by section 974-135. It is further discussed in Taxation Ruling TR 2010/5. 37. Subsection 974-135(1) provides that there is an effectively non-contingent obligation to take an action under a scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation to that that action. 38. In determining whether an 'effectively non-contingent obligation’ exists under the scheme the pricing, terms and conditions of the relevant scheme must be considered. Taxation Ruling TR 2010/5 discusses the application of section 974-135 and the economic substance of non-contingent obligation from the issuer’s position. 39. Specifically in relation to the economic substance of the rights and obligations arising from the pricing terms and conditions of the scheme, namely the issuing of the Preference shares. 40. The primary terms and conditions that specifically relate to the Preference shares in determining if there is a non-contingent obligation on Company P to provide a financial benefit are detailed below: i. Conversion of the Preference shares 41. The Preference shares can be converted into ordinary shares only at the option of the holders at any time. Such a conversion option is not available to Company P as the issuer; therefore there is no effectively non-contingent obligation on the issuer to convert the shares. ii. Redemption of the Preference shares 42. Company P’s constitution states that the Preference shares may only be redeemed for the subscription price at the holders’ option after the fifth anniversary of issue of the Preference shares. 43. As the issuer, Company P is under no obligation to redeem the Preference Shares unless the holders exercise their option after the fifth anniversary of issue (as per clause 6.11 of the Constitution). Payment in relation to the redemption of the Preference shares can only be made out of profits; hence there is not an effectively non-contingent obligation on Company P to provide a financial benefit by way of redemption. iii. Dividends 44. As per clause 6.7 of the Company P’s Constitution, the Preference shares do not have any preferential dividend entitlement. Any dividend is dependent on usual contingencies. As a result the payment of dividends by Company P is considered contingent and there is no non-contingent obligation to provide a financial benefit by way of a dividend. 45. The requirements of paragraph 974-20(1)(c) have not been met. d) Is it substantially more likely than not that the value of the benefit provided will at least be equal to the value of benefit received and neither value will be nil. 46. As paragraph 974-20(1)(c) has not been met, this requirement has not been considered. 47. It is sufficient to conclude from the above that the scheme is not characterised as and forms part of a larger interest that is characterised as a debt interest, therefore, the scheme is considered to be an equity interest in line with section 974-75(1). Reporting to the Commissioner 48. Item 10 of the table in section 396-55 of the TAA 1953 states that the issuing by the company of a share could give rise to an entitlement to a tax offset under Subdivision 360-A. 49. Company P is a company who has issued Preference shares to investors during the 201D income year. In line with section 396-55 if the TAA 1953, Company P must prepare a report in the approved form in relation to the Preference shares issued during the 201D financial year if they could give rise to a tax offset under Subdivision 360-A. This report must be provided to the Commissioner 31 days after the end of the financial year. 50. The Preference shares issued during the 201D financial year by Company P are equity interests as required by paragraph 360-15(1)(b) and Company P satisfies the early stage test (paragraphs 360-40(1)(a) to (d)). If Company P satisfies paragraph 360-40(1)(e) then the Preference shares could be eligible to a tax offset under Subdivision 360-A. Conclusion 51. For the purposes of item 10 of the table in section 396-55 of Schedule 1 to the TAA 1953 the issuing of Preference shares by Company P are an equity interest as per the requirement at 360-15(1) .