Private ruling: Early Stage Innovation Company
Date of advice: 1 February 2017
Published: July 2017
Ruling period: 1 July 20CC to 30 June 20DD
Date scheme commenced: 1 July 20CC

Ruling: Q1: Does the company qualify as an Early Stage Innovation Company pursuant to section 360-40 of the Income Tax Assessment Act 1997 at any time during the income year ending 30 June 20DD? | A1: No

Relevant facts and circumstances: The company was incorporated and registered in early-mid 201X. The company has no subsidiaries and is not listed on any stock exchange. The company has lodged company income tax returns for the years ended 30 June 20AA, 20BB, and 20CC. Total expenses for 20AA and 20BB exceeded $1 million.

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 | Income Tax Assessment Act 1997 section 975-505 | Income Tax Assessment Act 1997 section 975-150

Reasons for decision: Summary: All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated. | Detailed Reasoning - Qualifying early stage innovation company (ESIC): Generally, Subdivision 360-A sets out the main requirements for being eligible for either the early stage investor tax offset or the modified capital gains tax (CGT) treatment on eligible equity interests. Subsection 360-15(1) outlines the requirements for an investor to assess entitlement to the tax offset. The relevant point in time is when the newly issued shares are issued. It is also immediately after that time the company would need to meet the requirements of being an Early Stage Innovation Company (ESIC). Section 360-40 outlines the criteria required for a company to qualify as an 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: The early stage test determines if the company is at an early stage in its development. In short, the company must satisfy the following requirements at a particular time in an income year: ● Recent incorporation or registration in the Australian Business Register ● Total expenses of $1 million or less ● Assessable income of $200,000 or less, and ● Not listed on a stock exchange. These requirements are outlined in detail within paragraphs 360-40(1)(a) to (d). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a): 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). For paragraph 360-40(1)(a) the current income year counts as the latest of the income years to be considered. A company that does not meet any of these conditions will not qualify as an ESIC. | Detailed Reasoning - Test time and current year: For the purposes of determining entitlement to the tax offset, paragraph 360-15(1)(c) requires the company issuing shares to be an ESIC immediately after the issue of the shares. This time is referred to as the test time. Subdivision 360-A applies in relation to shares issued on or after the later of 1 July 20CC or Royal Assent. Subdivision 360-A received royal assent on 5 May 20CC. Therefore, the earliest point in time for determining whether a company qualifies as an ESIC will be 1 July 20CC. For the purposes of subsection 360-40(1), when the test time occurs between 1 July 20CC and 30 June 20DD, the current year will be the income year ending 30 June 20DD. | Detailed Reasoning - 100% subsidiary: A 100% subsidiary is defined in section 975-505. Subsection 975-505(1) provides a company (the subsidiary company) is a 100% subsidiary of another company (the holding company) if all of the shares in the subsidiary company are beneficially owned by a) the holding company b) one or more 100% subsidiaries of the holding company, or c) the holding company and one or more 100% subsidiaries of the holding company. Subsections 975-505(2) and (3) provide the subsidiary company will not be a 100% subsidiary of the holding company if a person is, or will be, in a position to affect certain rights in relation to the subsidiary company. Section 975-150 outlines the circumstances in which a person will be in such a position. | Detailed Reasoning - Total expenses: Some of the early stage criteria within section 360-40 require calculation of the total expenses incurred by the company and its 100% subsidiaries. The term 'total expenses' is not defined for the purposes of Subdivision 360-A. However, guidance on the meaning of the term can be found in the Explanatory Memorandum (EM) to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, which states at paragraph 1.64: The ATO's company tax return requires companies to report 'total expenses' at item six as part of the total profit or loss calculation. A company that has submitted a company tax return in the previous income year must rely on the amount reported in item six for the purposes of this test. Alternatively, if the company was not required to submit a company tax return, it may use the amount corresponding to this item. Application to your circumstances For the purposes of this ruling, the test time for determining if the company is a qualifying ESIC will be a particular date on or after 1 July 20CC, but before 30 June 20DD. Therefore, for the purposes of subsection 360-40(1), the current year will be the year ending 30 June 20DD (20DD income year). For clarity, in relation to the requirement in subparagraph 360-40(1)(a)(ii), a) the last 3 income years will include the years ending 30 June 20DD, 20CC and 20BB b) the last 6 income years will include the years ending 30 June 20DD, 20CC, 20BB, 20AA, 201Y and 201X. | Detailed Reasoning - Paragraph 360-40(1)(a) - Incorporation or Registration: The company was incorporated in Australia and registered in the ABR in early-mid 201X. Therefore, the company does not satisfy subparagraphs 360-40(1)(a)(i) or (iii) as it was not incorporated in Australia or registered on the ABR within the last 3 income years. The company will need to satisfy the element in subparagraph 360-40(1)(a)(ii). This element is made up of 2 parts, being time of incorporation and expenses incurred across 3 years by the company and its 100% subsidiaries. The company satisfies the first requirement of subparagraph 360-40(1)(a)(ii), as it was incorporated in Australia within the last 6 income years. The second requirement of subparagraph 360-40(1)(a)(ii) is that EEPL and its 100% subsidiaries must have incurred total expenses of $1 million or less across the last 3 income years. The relevant 3 income years in your circumstance are the years ending 30 June 20DD, 20CC and 20BB. These three years include the current year. The company does not have any subsidiaries. To satisfy subparagraph 360-40(1)(a)(ii), the total expenses incurred by the company for the 20DD, 20CC and 20BB income years must not exceed $1 million. The total expenses for 20BB and 20CC exceed $1 million. Even without knowing the total expenses at any point in the 20DD income year, the total expenses of the company across the 20CC and 20BB income years exceeds the threshold of $1 million. Therefore, the company does not satisfy subparagraph 360-40(1)(a)(ii). Consequently, the company does not satisfy paragraph 360-40(1)(a) and will not qualify as an ESIC at any time during the income year ending 30 June 20DD.