Private ruling: Income tax: Tax Incentive for Early Stage Investors
Date of advice: 7 August 2017
Published: November 2017
Ruling period: Year ending 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Does the Company 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. The Company was registered in the Australian Business Register (ABR) during the year ending 30 June 2016. Its equity interests are not listed for quotation in the official list of any stock exchange. 2. The Company has no subsidiaries and had expenses of less than $1 million, and assessable income of less than $200,000, in the previous income year, ie the year ended 30 June 2016. 3. The Company is developing a process ('the Process’), which aims to offer a novel proprietary low-cost technology/process for the production of materials which have a wide range of industrial applications. 4. The Company’s goal is to provide the Process to customers/users under licence, allowing them to employ the technology/process in the manufacture of a range of products. 5. The Company has identified its ultimate addressable market as being the both the domestic and international/global market, with the Australian market as its initial target market. 6. The individual ('X’) who discovered/conceived the Process, is the founder, managing director (sole director) and chief scientist of the Company. A family trust currently owns 100% of the shares in The Company. X is the controlling director and trustee of the aforementioned family trust. 7. X has extensive prior experience as a research scientist. 8. X also has extensive previous experience in project management of multi million dollar projects, and a proven world class track record in 'innovation’. 9. The Company owns all intellectual property (IP) rights in relation to the Process 10. The Company has highlighted the key differentiators to alternate processes as being, the Process: ● has the ability to enable low cost production of materials based on a range of low-cost precursor materials ● allows the characteristics of the products to be controlled ● has the ability to produce complex materials ● enables the economically viable production of a range of materials which cannot be produced economically using existing processes ● is a one step process, whereas alternate processes for producing comparable products are multi-step processes ● produces higher quality products ● has lower capital and labour production costs ● has lower energy requirements ● produces zero waste. 11. The Process is a process for the production of a wide range of products with a wide range of industrial applications. 12. The Company believes that there is a domestic and international/global market for their products within a range of niche markets and manufacturing industries/sectors. Commercialisation strategy 13. The Company has prepared a comprehensive development and commercialisation business plan. 14. The Company has also undertaken extensive techno-economic analysis in relation to a large range of its products using both Greenfield and Brownfield approximations, and market analysis of competing technologies/companies. Its analysis suggests that the technology under development is capable of reducing production costs by between 50% to 90% (depending on product characteristics), in addition to enabling economic production of other new materials that would otherwise not have been possible to produce on a commercial scale. 15. The Company has currently: ● had experimental R & D tests carried out under contractual arrangement by their sister company at an experimental facility set up by their sister company ● developed and validated a new proprietary concept for the production of its products ● filed a provisional patent with IP Australia covering the basic concepts underlying the intended work ● established scientific proof of concept for the production of a large number of products ● conducted an exhaustive literature search and established Freedom to Operate (FTO) with regard to its R&D approach. 16. The Company’s R&D effort is divided into three coherent programs (Pr1, Pr2 and Pr3), which is aimed at bringing the Company’s technology to TRL6 (Technology Readiness Level 6: System prototype demonstrated in a controlled application environment). 17. The three programs can be summarised as follows: Pr1 - aims to obtain a preliminary proof of concept for the low-cost process and to demonstrate production of a number of materials with the overall objective of minimising/eliminating technical risks before committing external funding. Pr2 – will use the results from Pr1 to set up a first generation production system, with the aim of demonstrating continuous processing at predetermined levels, and then refining the control mechanisms and design features. Pr3 – in Pr3 the aim is to design, build and demonstrate a pilot demonstration facility (PDF) at a predetermined level. The PDF will establish a TRL6 and demonstrate production on a semi industrial level in a simulated production environment. 18. The Company is currently at the Pr1 stage of its R&D effort. 19. The Company plans to start its commercialisation strategy during the final period of the Pr1 stage of its R&D effort. 20. The Company has determined that its business orientation will be a strategy based on licensing its process and products. It intends to develop its technology at a pilot demonstration level for a number of products and then license the technology to local and international manufacturers. 21. The Company’s marketing plan will be dominated by efforts to establish a strategic partnership with one or multiple partners with an interest in its planned range of products. It defines its addressable market as Australia initially, with a view towards quick expansion into the international/global market. 22. The Company has a comprehensive marketing strategy which is outlined in its business plan. 23. The Company has engaged in non-confidential discussions in relation to commercialisation of its process/products with a number of companies. 24. X has had /made a number of preliminary communications/approaches with/to a number of local and international producers / end users to investigate /establish potential partnering/licensing arrangements. However, the Company needs to establish minimum sample production capabilities before it can approach potential partners for in-depth commercial discussions. 25. The Company is planning to address the international market through partnership with one or multiple international manufacturers. 26. The Company has identified a number of specific market segments as initial targets, and identified potential customers/partners within each of the market segments. 27. The Company is planning to register with AusIndustry and claim R&D tax offsets. Information provided 28. You have provided information in a number of documents and phone conversations in relation to the Company’s qualification as an ESIC, including: ● your private ruling application ● document entitled 'ESIC – Background Information’ ● document referred to as the Company’s 'Investor Presentation’ ● document referred to as the Company’s 'Business Plan’ ● Deed of Assignment of Australian provisional patent application between X and the Company ● our phone conversations with your representative (accountant) ● supplementary information provided by X (as the Company’s contact person) – including details of provisional patent applications filed with IP Australia by the Company and its two sister companies ● supplementary information provided by X – including details of the Company’s current and proposed 'after investment’ shareholding and company structure. 29. We have referred to the relevant information within these documents and conversations in applying the relevant tests to your circumstances. 30. You propose to issue new shares in the Company to various investors to assist in funding the continued development and commercialisation of the Process. Assumption(s) N/A

Relevant legislative provisions: Income Tax Assessment Act 1997 Subdivision 360-A | Income Tax Assessment Act 1997 section 360-40 | Income Tax Assessment Act 1997 section 360-45 Further issues for you to consider | N/A

Reasons for decision: Summary: All legislative references are to the ITAA 1997 unless otherwise indicated. | Summary: The Company meets the eligibility requirements of an ESIC 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. 8. In determining the company’s assessable income, any amount of Accelerating Commercialisation Grant that the company received in that year can be disregarded. | Detailed Reasoning - No stock exchange listing - paragraph 360-40(1)(d): 9. 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: 10. 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: 11. 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 (iv): 12. 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. 13. 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. 14. 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: 15. 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…” 16. 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. 17. 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. 18. 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. 19. '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: 20. 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: 21. 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. | Detailed Reasoning - Broader than local market: 22. 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: 23. 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 - Application to your circumstances: Test time 24. For the purposes of this ruling, the test time for determining if the Company is a qualifying ESIC will be a particular date during the income year ending 30 June 2017. Current year 25. For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 2017 (the 2017 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 2017, 2016 and 2015, and the income year before the current year ('the prior income year’) will be the year ending 30 June 2016 (the 2016 income year). | Detailed Reasoning - Early stage test: Incorporation or Registration – paragraph 360-40(1)(a) 26. As the Company was registered in the Australian Business Register in the year ending 30 June 2016, which is within the last 3 income years, subparagraph 360-40(1)(a)(iii) is satisfied. Total expenses – paragraph 360-40(1)(b) 27. As the Company had no subsidiaries and incurred total expenses less than $1 million in the prior income year, paragraph 360-40(1)(b) is satisfied. Assessable income – paragraph 360-40(1)(c) 28. As the Company had no subsidiaries and had total assessable income for the prior income year of less than $200,000 paragraph 360-40(1)(c) is satisfied. No stock exchange listing – paragraph 360-40(1)(d) 29. As the Company 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 30. The Company will satisfy the early stage test for the entire 2017 income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - 100 point test: 31. The Company has not provided any evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 2017. For the Company to be a qualifying ESIC it will need to satisfy the principles-based test. | Detailed Reasoning - Principles based test: Developing new or significantly improved innovations for commercialisation – subparagraph 360-40(1)(e)(i) 32. According to the Company, the Process is a new, novel, low-cost technology/process for direct production of materials which have a wide range of industrial applications. Although it will initially be targeted at the Australian market, the Process has been identified as having a wider international/global addressable market. 33. The Company’s research indicates that it will be the first company/entity to offer such a process. New, or significantly improved, products, processes, services or marketing or organisational methods – subparagraph 360-40(1)(e)(i) 34. The Company has highlighted the key differentiators of the Process to existing alternate processes to include, the Process: ● has the ability to enable low cost production of materials based on a range of low-cost precursor materials ● allows the characteristics of the products to be controlled ● has the ability to produce complex materials ● enables the economically viable production of a range of materials which cannot be produced economically using existing processes ● is a one step process, whereas alternate processes for producing comparable products are multi-step processes ● produces higher quality products ● has lower capital and labour production costs ● has lower energy requirements ● produces zero waste. 35. The Company has also undertaken extensive techno-economic analysis in relation to a large range of its products using both Greenfield and Brownfield approximations, and market analysis of competing technologies/companies. Its analysis suggests that the technology under development is capable of reducing production costs by between 50% to 90% (depending on product characteristics), in addition to enabling economic production of other new materials that would otherwise not have been possible to produce on a commercial scale. Genuinely focussed on developing for commercialisation – subparagraph 360-40(1)(e)(i) 36. The Company has taken the following steps in developing the Process: ● prepared a comprehensive development and commercialisation business plan ● undertaken extensive techno-economic analysis in relation to a large range of its products using both Greenfield and Brownfield approximations, and market analysis of competing technologies/companies ● had experimental R & D tests carried out under contractual arrangement by their sister company at an experimental facility set up by their sister company ● filed a provisional patent application with IP Australia covering the basis concepts underlying the intended work ● established scientific proof of concept for the production of a large number of products ● conducted an exhaustive literature search and established Freedom to Operate (FTO) with regard to its R&D approach ● developed a comprehensive R&D strategy which is divided into three coherent programs (Pr1, Pr2 and Pr3), aimed at bringing the Company’s technology to TRL6: (Technology Readiness Level 6: System prototype demonstrated in a controlled environment). 37. The Company is currently at the Pr1 stage of its R&D effort. 38. The Company plans to start its commercialisation strategy during the final period of the Pr1 stage of its R&D effort. 39. The Company has determined that its business orientation will be a strategy based on licensing its process and products. It intends to develop its technology at a pilot demonstration level for a number of products and then license the technology to local and international manufacturers. 40. The Company’s marketing plan will be dominated by efforts to establish a strategic partnership with one or multiple partners with an interest in its planned range of products. It defines its addressable market as Australia initially, with a view towards quick expansion into the international/global market. 41. The Company has engaged in non-confidential discussions in relation to commercialisation of its process/products with a number of companies. Conclusion on subparagraph 360-40(1)(e)(i) 42. The Company is genuinely focussed on developing the Process for a commercial purpose. The Process will be a significantly improved process compared to existing processes. 43. Therefore, subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 1 July 2016 until 30 June 2017 or the date when the Process has been fully developed, whichever occurs earliest. Once the Process has been fully developed, the Company will no longer be 'developing’ the product for commercialisation and subparagraph 360-40((1)(e)(i) will no longer be satisfied. High growth potential – subparagraph 360-40(1)(e)(ii) 44. The Company’s process is designed to be capable of producing thousands of products, with a wide range of industrial applications. 45. The Company’s R&D program is directed towards demonstrating process capabilities, low production cost and high technological impact, and its marketing and commercialisation efforts are aimed at converting findings from the R&D work into immediate market opportunities. 46. The Company expects the Process to appeal to a wide/diverse range of global market sectors. 47. Through its commercialisation/marketing strategy, the Company hopes to foster widespread use of its products by licensing its technology to existing local and international manufacturers/end users who are already established in the market. It plans to generate its revenue predominantly from licence fees/royalties. 48. A major component of the Company’s marketing/commercialisation strategy is partnering with existing major materials producers and/or major manufacturers, which the Company believes will help overcome/minimise market inertia towards new technologies and new products. 49. If the Company commercialisation strategy is successful, its techno-economic and market analysis indicates that it will be able to rapidly expand its activities / generation of revenue within both the Australian and international/global markets. 50. Therefore, subparagraph 360-40(1)(e)(ii) will be satisfied. Scalability – subparagraph 360-40(1)(e)(iii) 51. The Company has undertaken extensive techno-economic analysis in relation to a large range of its products using both Greenfield and Brownfield approximations, and market analysis of competing technologies/companies. Its analysis indicates that the technology under development is capable of reducing production costs within the range of 50% to 90% (depending on product characteristics), in addition to enabling economic production of other new materials that would otherwise not have been possible to produce on a commercial scale. 52. Projections provided by the Company, based on the techno-economic analysis that it has undertaken, indicate that its technology will create significant value within five years. 53. Given that the Process will have a wide range of applications both domestically and globally, it is expected that the Company has the potential to successfully scale up its business. 54. The Company’s projections are that it will be able to increase its revenue as it expands its client base, by capitalising on the low capital and production costs of its process, and its capability to produce high-quality products, and additionally, the unique capacity of its process to enable the economic production of a range of new high value materials on a commercial scale. This operating leverage affords the Company the potential to successfully scale up its business. Therefore, subparagraph 360-40(1)(e)(iii) will be satisfied. Broader than local market- subparagraph 360-40(1)(e)(iv) 55. The Company will initially target its marketing of the Process at the Australian market. However, the Company has identified its ultimate market as being both the Australian and international/global markets. Its marketing plan will be dominated by efforts to establish a strategic partnership with one or multiple partners with an interest in its planned range of products. The Company defines its addressable market as Australia initially, with a view towards quick expansion into the global market. 56. According to the market analysis and research undertaken by the Company, the market for its products is highly diverse and international/global in nature 57. The Company’s commercialisation strategy is based on licensing its technology to existing local and international manufacturers / end users who are already established in the market. Its market analysis has identified that it is likely that the Process will have significant technical and cost advantages to enable it to access a range of market segments. 58. The Company has identified a number of specific market segments as initial targets, and identified potential customers/partners within each of the market segments. 59. The Process has application within a diverse range of industries/markets which are international/global in nature. Thus, the ultimate addressable market of the Company is on a global scale and is not confined to a local city, area or region. 60. The Company has demonstrated that the Process has the potential to address a broader market than just the local market, including global markets. Therefore, subparagraph 360-40(1)(e)(iv) will be satisfied. Competitive advantages – subparagraph 360-40(1)(e)(v) 61. The Process has the following differentiating features which may give it a competitive advantage, it: ● has the ability to enable low cost production of materials based on a range of low-cost precursor materials ● allows the characteristics of the products to be controlled ● has the ability to produce complex materials ● enables the economically viable production of a range of materials which cannot be produced economically using existing processes ● is a one step process, whereas alternate processes for producing comparable products are multi-step processes ● produces higher quality products ● has lower capital and labour production costs ● has lower energy requirements ● produces zero waste. 62. Therefore, as the Process is the first process with these differentiating features, the Company has the first mover advantage. The Company has demonstrated the potential for the Process to have competitive advantages within a range of industries/markets, satisfying subparagraph 360-40(1)(e)(v). Conclusion on principles test 63. The Company 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 2016 until 30 June 2017, or the date when the Process has been fully developed and is ready for sale, whichever occurs earlier. | Detailed Reasoning - Conclusion: 64. The Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 2016 until the earlier of 30 June 2017, or the date when the Process has been fully developed and is ready for sale, whichever occurs earlier. | Detailed Reasoning - Other references (non ATO view): Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 Oslo Manual published by the OECD

Tax incentives for Early Stage Investors