Private ruling: Early Stage Innovation Company qualification
Date of advice: 14 March 2018
Published: June 2018
Ruling period: 1 July 20XX to 30 June 20XX
Date scheme commenced: The scheme has commenced.

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)? | A1: Yes.

Relevant facts and circumstances: 1. Company X was incorporated in Australia in 20XY. Its equity interests are not listed for quotation in the official list of any stock exchange. 2. Company X has a wholly owned subsidiary, Subsidiary X, which was incorporated in Australia in 20XY and together they had expenses of less than $1 million in the previous income year, i.e. the year ended 30 June 20XZ. For the year ended 30 June 20XZ the combined assessable income of Company X and Subsidiary X was less than $xxx. 3. Company X is working with Y and Z in developing a new product (‘Product’). 4. The first prototype was trialled. Based on the positive response to the trial, it was anticipated limited production would commence. 5. Company X has as its main target market the D industry, both locally and internationally. 6. The founders have extensive experience. 7. All the intellectual property is owned or will be owned by Company X. 8. Company X has identified its primary addressable market in Australia. Commercialisation strategy 9. Company X is currently working with Z to commercialise the Product in the G market. 10. The manufacturing capacity of Z is sufficient to support the Australian market and international markets. 11. In line with common industry practice within the market, promotion of the Product will occur either directly to the end users, or in some cases through a third party consultant. 12. At the date of the application for the private ruling, Company X was in the final stage of testing the first version of the Product. 13. The Product is intended to be officially launched. Company X is currently in the process of raising capital from third parties to pursue the international commercialisation of the Product. 14. Company X has estimated that a number of end users in Australia have an immediate need for the Product. This represents the primary addressable market. 15. There are significantly more end users in Country A and Area B and therefore these regions represent a significant market opportunity for Company X. 16. The technology will also likely have utility in other markets. 17. The next steps involve a technology gateway to other products. 18. The commercialisation strategy of Company X starts from the development stage where it entered into a commercial profit-sharing arrangement with Z for the production of the Product. 19. Company X has engaged with Q which has expressed its interest in purchasing the Product. 20. Company X is initially targeting the market via involvement with Z. 21. A market segment has been identified as an initial target. 22. Within the segment, Company X has identified specific potential customers. Information provided 23. You have provided information in a number of documents in relation to the Product. 24. You propose to issue new shares in Company X to investors to assist in funding the continued development and commercialisation of the Product.

Relevant legislative provisions: ITAA 1997 Subdivision 360-A | ITAA 1997 Subsection 360-40(1)

Reasons for decision: Detailed Reasoning - Test time: 1. For the purposes of this ruling, the test time for determining if Company X is a qualifying ESIC will be a particular date during the income year ending 30 June 2018. | Detailed Reasoning - Current year: 2. For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 2018 (the 2018 income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last three income years will include the year ending 30 June 2018, the years ended 30 June 2017 and 30 June 2016, and the income year before the current year will be the year ended 30 June 2017 (the 2017 income year). | Detailed Reasoning - Incorporation or Registration – paragraph 360-40(1)(a): 3. As Company X was incorporated within the last 3 income years, subparagraph 360-40(1)(a)(i) is satisfied. | Detailed Reasoning - Total expenses – paragraph 360-40(1)(b): 4. As Company X and Subsidiary X together had expenses of less than $1 million in the prior income year, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income – paragraph 360-40(1)(c): 5. As Company X and Subsidiary X together had a total assessable income for the prior income year of less than $200,000 paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No stock exchange listing – paragraph 360-40(1)(d): 6. As Company X is privately owned and is not listed on any stock exchange in Australia or a foreign country, subparagraph 360-40(1)(d) is satisfied. | Detailed Reasoning - Conclusion on early stage test: 7. Company X will satisfy the early stage test for the entire 2018 income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) has been satisfied. | Detailed Reasoning - Developing new or significantly improved innovations for commercialisation – subparagraph 360-40(1)(e)(i): 8. According to Company X the Product is the first product with the capabilities to meet the needs of the market. Although it will initially be targeted at the Australian market the Product has been identified as having a wider international addressable market. | Detailed Reasoning - Genuinely focussed on developing for commercialisation –subparagraph 360-40(1)(e)(i): 9. Company X has taken the following steps in developing the Product: a. Undertaken extensive research throughout the world which found that a solution did not exist to the market need. Thus there is no technology currently available. b. Entered into separate agreements with Y and Z in the process of developing a product to service the gap in the market. This has resulted in a significant competitive advantage. c. Produced a first prototype and trialled it d. Performed extensive research and determined that the primary addressable market is in Australia. 10. The founders have already begun to promote the Product to interested parties. Company X has also been approached to provide quotes for the Product. 11. The timeline provided indicates that Company X is in the final stages of testing the first version of the product. Company X expected limited production could commence. The product is to be officially launched. 12. Company X is currently in the process of raising capital from third parties to pursue the international commercialisation of the Product. | Detailed Reasoning - Conclusion on subparagraph 360-40(1)(e)(i): 13. Company X is genuinely focussed on developing the Product for a commercial purpose. The Product will be a new product compared to existing products. 14. Therefore, subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 1 July 2017 until 30 June 2018 or the date when the Product has been fully developed, whichever occurs earlier. Once the Product has been fully developed, Company X will no longer be ‘developing’ the product for commercialisation and subparagraph 360-40((1)(e)(i) will no longer be satisfied. | Detailed Reasoning - High growth potential – subparagraph 360-40(1)(e)(ii): 15. Company X expects the Product to appeal to end users. This aids decision making and is particularly useful when assessing product viability in particular markets. 16. Through its commercialisation and marketing strategy, Company X hopes to foster widespread use of the Product by selling the Product into the international market,. Company X anticipates there will be high demand for the Product internationally as there is no such product available worldwide. Furthermore, the total market in Country A for example, is significantly larger than that in Australia due to the size of the population. 17. Company X is developing the Product by contracting stages of the development to Y but Company X owns or will own all the intellectual property. The manufacture of the product will be performed under contract with Z. Company X will make its revenue through sales at a price above the production costs. 18. If the commercialisation strategy is successful, this may give Company X the ability to increase sales through referrals. 19. Therefore, subparagraph 360-40(1)(e)(ii) will be satisfied. | Detailed Reasoning - Scalability – subparagraph 360-40(1)(e)(iii): 20. The Product business model provided illustrates the increase in projected sales. 21. Given that the Product will be available domestically and internationally, it is expected that Company X has the potential to successfully scale up its business. 22. ‘The Company X strategy for the use of the Product will be able to generate increased revenue with increased sales due to access to a large and stable labour force which can quickly and easily be increased in line with demand. Further Company X will not need to hire significant levels of staff as the sales increase. Lastly, as production increases Company X will be able to generate economies of scale with respect to purchasing stock and other overhead costs. This operating leverage affords Company X the potential to successfully scale up its business. Therefore, subparagraph 360-40(1)(e)(iii) will be satisfied. | Detailed Reasoning - Broader than local market- subparagraph 360-40(1)(e)(iv): 23. The Product will initially be targeted at the Australian market (but is intended for international use). It will be released to the Country A market following the initial targeted market. 24. The Product can be used worldwide by any end user. Thus, the ultimate addressable market is on an international scale and is not confined to a local city, area or region. 25. Company X has demonstrated the 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. | Detailed Reasoning - Competitive advantages – subparagraph 360-40(1)(e)(v): 26. The Product has the following differentiating features which may give it a competitive advantage: a. A cost advantage; b. Company X will have rights to the intellectual property underpinning the technology. Protection of the intellectual property will be sought by way of patents. c. As the Product does not currently exist in the market, Company X will have a differential competitive advantage. 27. Furthermore, Company X has significant competitive advantages due to the contract with Z; a. Company X has access to a readily available labour market to scale up and down the workforce with demand for the product. b. Company X does not have to tie up capital in stock and equipment. c. The relationship with Z provides Company X access to end users in Australia. d. The closest competitors to Company X do not offer an appropriate solution to the issue which the Product will address, based on both an outcome and cost basis. 28. Being the first of such a product, Company X has the first mover advantage. Company X has demonstrated the potential for the Product to have competitive advantages within the community, satisfying subparagraph 360-40(1)(e)(v). | Detailed Reasoning - Conclusion on principles test: 29. Company X 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 2017 and ending 30 June 2018. | Detailed Reasoning - Conclusion: 30. Company X meets the eligibility criteria of an ESIC under subsection 360-40(1) for the period commencing 1 July 2017 and ending 30 June 2018 .