Private ruling: Early stage innovation company qualification
Date of advice: 6 November 2018
Published: February 2019
Ruling period: Year ended 30 June 2019
Date scheme commenced: 1 July 2018

Ruling: Q1: Will Company A obtain 50 points under item 5 of the table in subsection 360-45(1) of the Income Tax Assessment Act 1997 (ITAA 1997) if they received an investment of at least $50,000 from a developer for shares in Company A? | A1: Yes. Company A will obtain 50 points from the time a developer has paid them at least $50,000 for the shares issued by Company A. These points apply to shares that are issued at least a day after the developer had their shares issued. | Q2: By entering into an intellectual property licencing agreement with Company B, will Company A obtain 50 points under item 6 of the table in subsection 360-45(1) of the ITAA 1997)? | A2: Yes. Company A will obtain 50 points from when the intellectual property licencing agreement is executed. | Q3: If the answers to Questions 1 and 2 are yes, does Company A meet the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the ITAA 1997? | A3: Yes. Company A will qualify as an ESIC from the date points are obtained under items 5 and 6.

Relevant facts and circumstances: 1. Company A 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 A has no subsidiaries and as it was incorporated in the year ended 30 June 2019 it has no income or expenses in the previous income year, i.e. the year ended 30 June 2018. 3. Company A was established to commercialise product A using patents owned by Company B. 4. Company A is now seeking third party investors. Question 1 specific facts 5. Company A is looking to acquire the development rights from a third-party developer. 6. As part of the sale negotiations Company A will offer shares to the developer to provide the developer with the opportunity to participate in the potential success of product A. 7. The developer’s minimum investment in Company A will be $50,000. 8. At least one day after issuing the shares to the developer Company A will begin issuing shares to other investors. 9. A Shareholder Deed will be entered into between the shareholders, which will include as signatories the developer and other investors. Question 2 specific facts 10. Company A will enter into an Intellectual Property Licence agreement (IP Licence Agreement) with Company B in which Company b Will grant Company A the rights to exploit three patents owned by Company B. 11. Of the three patents patent A and patent B are innovation patents. Patent C is a United States utility patent granted on Date Y and lists the Assignee as Company B. 12. IP Australia states that a utility patent is equivalent to an Australian standard patent. Information provided 13. You have provided information in a number of documents and phone conversations in relation to ‘The Innovation’, including: a. Early engagement conversations on information provided on multiple dates b. Your private ruling application. c. Draft Shareholder deed/agreement d. Draft IP Licence agreement 14. 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 360-40 | Income Tax Assessment Act 1997 subsection 360-45(1) | Income Tax Assessment Act 1936 subsection 318(2)

Reasons for decision: Summary: All legislative references are to the ITAA 1997 unless otherwise indicated. | Summary: Company A will obtain 50 points under item 5 of the table in subsection 360-45(1) when they received an investment of at least $50,000 from a developer for shares in Company A. However the points will only apply to shares issued at least a day after Company A has issued the shares to the developer. | Detailed Reasoning - Detailed reasoning: 1. 50 points are obtained by a company under item 5 of the table in subsection 360-45(1) where: i. a total of at least $50,000 has been paid for equity interests that are shares in the company; ii. the company issued those shares to one or more parties that were not associates of the company immediately before the issue of those shares; iii. to one or more of those parties the parties did acquire those shares primarily to assist another entity become entitled to a tax offset (or a modified CGT treatment) under Subdivision 360-A; and iv. the company issued those shares at least one day before the test time. At least $50,000 has been paid for equity interests that are shares in the company 2. The developer will pay at least $50,000 for shares in Company A. The definition of shares in the Shareholder Deed states that the shares will be equity interests. Parties that were not associates of the company immediately before the issue of those shares 3. An associate of a company is defined under subsection 318(2) of the Income Tax Assessment Act 1936 . 4. Examples of entities that would be an associate of a company include: ● a partner of the company or a partnership in which the company is a partner ● a trustee of a trust estate under which the company or associate benefits ● another entity (including a person) that, acting alone or with another entity or entities, sufficiently influences the company ● an entity (including a person) that, either alone or together with associates, holds a majority voting interest in the company ● a second company that is sufficiently influenced by the company or the company's associates ● a second company in which a majority voting interest is held by the company or the company's associates 5. As stated in the application the developer will be an unrelated third party who will acquire shares to participate in the potential success of the project. Therefore when the developer acquired their shares under the Shareholder Deed they will not have been an associate immediately prior to the shares being issued. Acquire those shares primarily to assist another entity become entitled 6. The developer is being offered shares as an opportunity to participate in the potential success of the project. 7. It could not be concluded that in agreeing to participate in the potential success of the project that the developer’s primary purpose in acquiring shares is to assist other investors to gain access to the offset. The company issued those shares at least one day before the test time 8. Company A will issue the shares to the developer at least one day before they issue any shares to the other signatories to the Shareholder Deed. Conclusion Item 5 9. Company A will obtain 50 points under item 5 when the developer pays Company A $50,000 for their shares. However these points only apply to shares that are issued at least a day after the shares (that the developer paid $50,000 to acquire) were issued to the developer. | Summary: Company A will obtain 50 points under item 6 of the table in subsection 360-45(1) once they have entered into the intellectual property licencing agreement with Company B. | Detailed Reasoning - Detailed reasoning: 10. 50 points are obtained by a company under item 6 of the table in subsection 360-45(1) where: the company has enforceable rights (including a licence) on an innovation through either i. a standard patent granted in Australia in the last five years; ii. a plant breeder's right that has been granted in Australia in the last five years; or iii. an equivalent intellectual property right granted in another country. 11. Company B will enter into an IP Licence Agreement in which it will provide rights to Company A in respect of three patents owned by Company B. 12. Of these three patents, patent A and B are innovation patents. Innovation patents are covered by item 7 of the table in subsection 360-45(1) rather than item 6. 13. The US patent is a utility patent which IP Australia has determined to be the equivalent to an Australian standard patent. 14. The US patent was granted on Date Y. For the whole of the year ended 30 June 2019 this patent was granted in the last five years. The 5 th anniversary of the US patent being granted will not be reached until a date after 30 June 2019. 15. Therefore for the year ended 30 June 2019, Company A will obtain (and hold) 50 points from the date of execution of the IP Licence Agreement until 30 June 2019. | Summary: Company A meets the eligibility requirements of an ESIC under 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 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 - Application to your circumstances: Test time 25. For the purposes of this ruling, the test time for determining if Company A is a qualifying ESIC will be a particular date during the income year ending 30 June 2019. Current year 26. 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) 27. As Company A 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) 28. As Company A was incorporated in the current income year it had no expenses in the prior income year and paragraph 360-40(1)(b) is satisfied. Assessable income – paragraph 360-40(1)(c) 29. As Company A was incorporated in the current income year it had assessable income in the prior income year and paragraph 360-40(1)(c) is satisfied. No stock exchange listing – paragraph 360-40(1)(d) 30. As Company A 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 31. Company A 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 - 100-point test: 32. As concluded in our reasons for Question 1, Company A can apply the 50 points under item 5 of table in subsection 360-45(1) at least day after the shares are issued by Company A to the developer. 33. As concluded in our reasons for Question 2, Company A can apply the 50 points under item 6 of table in subsection 360-45(1) from when they have executed the draft IP Licence Agreement. Conclusion 34. Company A meets the eligibility criteria of an ESIC under section 360-40 from when they can apply the points under both items 5 and 6 of the table in subsection 360-45(1) until 30 June 2019.