Private ruling: Early stage innovation company eligibility
Date of advice: 28 November 2022
Published: 30 January 2023
Ruling period: Year ending 30 June ZZZZ
Date scheme commenced: 1 July 2022

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 period 1 July YYYY to 30 June ZZZZ? | A1: Yes.

Relevant facts and circumstances: Background facts 1. Company A is an Australian proprietary company which was incorporated in Australia on dd/mm/yyyy and registered on the Australian Business Register on dd/mm/yyyy. Its equity interests are not listed for quotation in the official list of any stock exchange in Australia or overseas. 2. Company A is not a foreign company pursuant to the Corporations Act 2001 (Cth). 3. Company A has no subsidiaries and is not part of a consolidated group or planning to join a consolidated group. 4. The current director of Company A is Individual 1. 5. Company A's registered office is situated in Australia. 6. Company A's principal place of business is situated in Australia. 7. None of Company A's current or proposed shareholders are exempt, (under section 66A of the Corporations Act 2001 ) or overseas entities. 8. Company A's offering of shares did not require a disclosure under section 708 of the Corporations Act 2001 (Cth). 9. Shares were issued to Individual 2 on a date in the year ending 30 June ZZZZ. 10. Company A has not generated any intellectual property at this time. 11. Company A has no subsidiaries and has incurred expenses of less than AU$1 million across the last three income years before the current year (being the ZZZZ income year), detailed as follows: Income year ending 30 June Total expenses incurred WWWW $W XXXX $X YYYY $Y Total expenses incurred for the last three years $Total 12. Company A did not have any subsidiaries and incurred expenses of less than $1M in the income year ended 30 June YYYY (the year before the current year). 13. Company A did not have any subsidiaries and did not generate any assessable income in the income year ended 30 June YYYY. Development of Product 14. Company A is developing an all-in-one business management solution ('the Product') that is designed specifically for small to medium enterprises. The Product will allow users to streamline their business operations and digitalise their administrative procedures. 15. The key innovations of the Product are detailed in the private ruling application and include the development of features which enables their solution to provide innovative technology that simplifies administration and minimises risk. 16. The objectives of the Product are detailed in the private ruling application and aim to provide innovative, affordable, disruptive technology with multi-user cross platform accessibility to reduce time and cost of administration Commercialisation strategy 17. Company A's commercialisation strategy is currently in the market, targeting small to medium businesses in specific industries. The Company is collecting user feedback on the Product in line with users' needs. 18. Company A has developed a pricing strategy which it believes will be more attractive to its prospective clients than its competitors. 19. Other details of the Company's commercialisation strategy include: • Conducting continuous in-house testing and third-party load testing to ensure product stability. • Implementing various market research methods to identify the target market • Partnering with local and overseas companies to leverage and combine data resources in order to deliver an automated sales funnel. • Undertaking strategic rebranding activities to increase brand awareness. High growth Potential 20. Company A are in their early growth stage in the Australian market and believe that the Product can be successfully ported to any other attractive market. 21. Company A currently run the marketing of their product through a variety of channels in Australia Scale up the business 22. As stated above, Company A are in their early growth in the Australian market and believe that the Product can be successfully ported to any other attractive market. 23. Company A's timeline and strategy for scaling up their business is detailed in their private ruling application and includes their goals from their inception year to the time of their planned expansion to the global market. Broader than local market 24. Company A are targeting an estimated $X Australian market and a US$Y World Market. 25. Company A's Australian marketing strategy (refer above) will be mirrored for use in the global market. Competitive advantages 26. There are 4 elements to Company A's product differentiation which it believes will give the Product a strong competitive advantage and enable them to meet the needs of their users in a way that none of their competitors have been able to achieve, as listed below: • Affordability • Accessibility • Personalised onboarding and training • Simplicity 27. Company A has undertaken an extensive competitor analysis, which has enabled them to identify the strengths and weaknesses of their current and potential competitors in relation to their products. They are developing their offering to be an affordable product that is suited to small and mid-size enterprises, with a variety of key features that are simple to use. Information provided 28. You have provided information in a number of documents in relation to Company A's product. 29. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances. Assumptions: 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 Further issues for you to consider: | Not applicable.

Reasons for decision: Summary: All legislative references are to the Income Tax assessment Act 1997 (ITAA 1997) unless otherwise stated. Company A meets the criteria of an ESIC under subsection 360-40(1) of the ITAA 1997 for the period 1 July 20YY to 30 June 20ZZ. | 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 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). 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 - 'INNOVATION TESTS': 9. 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: 10. 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): 11. 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. 12. 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. 13. The five requirements of the principles-based test, as outlined in paragraph 360-40(1)(e) are: i. the company must be genuinely focused on developing one or more new or significantly improved innovations for commercialisation 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: 14. 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..." [1] 15. The innovation being developed by the company must either be new or significantly improved for an applicable addressable market. 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. 16. Improvements must be significant in nature to meet this requirement. 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. 17. The OECD Oslo Manual defines innovations as significant changes, with the intention of distinguishing significant changes from routine minor changes. However, it is important to recognise that an innovation can also consist of a series of smaller incremental changes that together constitute a significant change. [2] 18. In discussing services innovation activity, paragraph 111 of the OECD Oslo Manual states, "Innovation activity in services also tends to be a continuous process, consisting of a series of incremental changes in products and processes. This may occasionally complicate the identification of innovations in services in terms of single events, i.e. as the implementation of a significant change in products, processes or other methods." 19. 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." 20. The company must be genuinely focused 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. 21. '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: 22. The company must be able to demonstrate that it has the potential for high growth 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: 23. The company must be able to demonstrate that it has the potential to successfully scale up the business. The company must have operating leverage, where as 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 per unit. Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997 han local market 24. 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: 25. 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): 26. At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth). 27. 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: 28. 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 YYYY, and on or before 30 June ZZZZ. In particular, shares were issued to an investor at the 'test time' of dd/mm/yyyy. | Detailed Reasoning - Current year: 29. For the purposes of subsection 360-40(1), the current year will be the year ending 30 June ZZZZ (the ZZZZ 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 WWWW, XXXX and YYYY, and the income year before the current year will be the year ending 30 June YYYY (the YYYY income year). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a): 30. Company A was incorporated in Australia on dd/mm/yyyy, which is 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 (which has no subsidiaries) incurred total expenses of less than $1 million. Therefore, the requirements of subparagraph 360-40(1)(a)(ii) are satisfied. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b): 31. 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 YYYY income year, being the year before the current income year. 32. Company A did not have any subsidiaries and incurred total expenses of less than $1M in the YYYY income year. Therefore, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c): 33. 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 YYYY income year. 34. Company A does not have any subsidiaries and did not derive any assessable income in the YYYY income year. Therefore, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No stock exchange listing - paragraph 360-40(1)(d): 35. In applying the requirements of paragraph 360-40(1)(c), Company A must not be listed on any Stock Exchange in Australia or a foreign country at the test time. Company A is not listed on any stock exchange in Australia or a foreign country at the test time. Therefore, subparagraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: 36. Company A satisfies the early stage test for the entire ZZZZ 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: 37. Company A has stated that it would not satisfy the 100-point test under section 360-45 for the year ending 30 June ZZZZ. Company A is 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 - subparagraph 360-40(1)(e)(i): 38. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be developing an innovation which either new or significantly improved for an applicable addressable market. 39. Company A is developing an all-in-one business management solution that is designed specifically for small to medium enterprises. The Product will allow users to streamline their business operations and digitalise their administrative procedures. 40. Company A has provided details substantiating that it is developing a product that is either new or significantly improved for an applicable addressable market. | Detailed Reasoning - Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i): 41. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be genuinely focussed on developing an innovation for commercial purpose in order to generate economic value and revenue for the company. 42. Company A has provided details substantiating that that it is genuinely focussed on developing its innovation for commercial purpose in order to generate economic value and revenue for the company. | Detailed Reasoning - Conclusion on subparagraph 360-40(1)(e)(i): 43. Company A is genuinely focussed on developing their product, an all-in-one business management solution that is designed specifically for small to medium enterprises, for a commercialisation. The product will be a significantly improved product compared to existing products in their addressable market. 44. Therefore, subparagraph 360-40(1)(e)(i) is satisfied for the period 1 July YYYY to 30 June ZZZZ. Once the product has been fully developed, Company A 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): 45. In applying the requirements of subparagraph 360-40(1)(e)(ii), Company A must be able to demonstrate that it has high potential growth within a broad addressable market. 46. Company A has provided details substantiating that it meets this requirement. 47. Therefore, subsection 360-40(1)(e)(ii) is satisfied. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii): 48. In applying the requirements of subparagraph 360-40(1)(e)(iii), Company A must be able to demonstrate that it has the potential to scale up the business. 49. Company A has provided details substantiating that it meets this requirement. 50. Therefore, subsection 360-40(1)(e)(iii) is satisfied. | Detailed Reasoning - Broader than local market- subparagraph 360-40(1)(e)(iv): 51. In applying the requirements of subparagraph 360-40(1)(e)(iv), Company A must be able to demonstrate that it has the potential to address a broader than local market, including global markets. 52. Company A has provided details substantiating that it meets this requirement. 53. Therefore, subsection 360-40(1)(e)(iv) is satisfied. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v): 54. In applying the requirements of subparagraph 360-40(1)(e)(v), Company A must be able to demonstrate that it has the potential to be able to have competitive advantages for that business 55. Company A has provided details substantiating that it meets this requirement. 56. Therefore, subsection 360-40(1)(e)(v) is satisfied. | Detailed Reasoning - Conclusion on principles test: 57. Company A 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 YYYY until 30 June ZZZZ or the date when its innovation/process has been fully developed and is ready for sale, whichever occurs earlier. | Detailed Reasoning - Foreign Company Test - subparagraph 360-40(1)(f) ITAA 1997: 58. As Company A was incorporated in Australia, it is not a Foreign Company and therefore paragraph 360-40(1)(f) is satisfied. | Detailed Reasoning - CONCLUSION FOR PRINCIPLES BASED TEST: 59. Company A meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July YYYY to 30 June ZZZZ and specifically at the 'test time' of dd/mm/yyyy. [1] See Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.76. [2] OECD Oslo Manual, paragraph 124 and paragraph 151.