Private ruling: Early stage innovation company
Date of advice: 22 June 2021
Published: August 2021
Ruling period: Income year ended 30 June 2020 | Income year ended 30 June 2021
Date scheme commenced: During the income year ended 30 June 2020

Ruling: Q1: Does the Company meet the eligibility requirements of an Early Stage Innovation Company under subsection 360-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes

Relevant facts and circumstances: The Company was incorporated during the 2020 income year and is a private company not listed on a recognised stock exchange. The Company shareholders acquired their initial shares during the year ended 30 June 2020. Further shares have been issued to shareholders in the year ended 30 June 2021. The Company is the parent company of a group structure which contains a sole subsidiary company. The subsidiary company was incorporated in the 2021 income year and is 100% owned by the Company. For the year ending 30 June 2020, the Company had expenditure of less than $1 million and income of less than $200,000. The private ruling application has advised the following details: According to the Company, 'the Innovation' is the development of new products and the Company is genuinely focused on developing their products for an applicable addressable market. The Company has the ability to rapidly expand its business and has identified that it has a high growth potential within its addressable market. The projections and business model provided illustrates the increase in projected sales. Given that 'the Innovation' will be available domestically and globally, it is expected that 'the Innovation' has the potential to successfully scale up its business. According to the ruling application, there are currently limited competitors involved in the production of 'the Innovation' This allows ample opportunity to go to a global market with limited direct competition.

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 360-40(1) | Income Tax Assessment Act 1997 paragraph 360-40(1)(a) | Income Tax Assessment Act 1997 paragraph 360-40(1)(b) | Income Tax Assessment Act 1997 paragraph 360-40(1)(c) | Income Tax Assessment Act 1997 paragraph 360-40(1)(d) | Income Tax Assessment Act 1997 paragraph 360-40(1)(e) | Income Tax Assessment Act 1997 subparagraph 360-40(1)(e)(i) | Income Tax Assessment Act 1997 subparagraph 360-40(1)(e)(ii) | Income Tax Assessment Act 1997 subparagraph 360-40(1)(e)(iii) | Income Tax Assessment Act 1997 subparagraph 360-40(1)(e)(iv) | Income Tax Assessment Act 1997 subparagraph 360-40(1)(e)(v) | Income Tax Assessment Act 1997 section 360-45

Reasons for decision: Summary: The Company is an Early Stage Innovation Company (ESIC) for the income years ending 30 June 2020 and 30 June 2021, having met the eligibility requirements under subsection 360-40(1) of the ITAA 1997 for each year. Detailed reasoning , Subsection 360-40(1) of the ITAA 1997 outlines the criteria for a company to qualify as an ESIC at a particular time in an income year. 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. A company qualifies as an ESIC if it satisfies the early stage test and one of two 'innovation' tests which are the 100-point innovation test or the principles-based innovation test. | Detailed Reasoning - Early stage test: The early stage test requirements are specified in paragraphs 360-40(1)(a) to (d) of the ITAA 1997 and are outlined below. | 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: • incorporated in Australia within the last three income years (the latest being the current year); or • 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 • registered in the Australian Business Register within the last three income years (the latest being the current year). 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. 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): 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): 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): 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: If the company satisfies the early stage test, it must also satisfy one of two innovation tests being: 1. The objective (100 point) test; or 2. The principles-based test. The Company seeks this Ruling in relation to the principles-based test. | Detailed Reasoning - 'Principles-based test' - paragraph 360-40(1)(e): To satisfy the principles-based test, the company must meet the 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. 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. The five requirements of the principles-based test in subparagraphs 360-40(1)(e)(i) to (v) 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. The five requirements in paragraph 360-40(1)(e) are outlined below. | Detailed Reasoning - Developing new or significantly improved innovations for commercialisation: 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] 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. 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. 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] 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." 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." 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. '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: 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: The company must be able to demonstrate that it has the potential to successfully scale up the business. The company must have operating leverage, 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: 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: 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): At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001. The dictionary in section 9 of the Corporations Act 2001 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 - Application to your circumstances: Test time 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 2020, and a particular date during the income year ending 30 June 2021. Current year For the purposes of subsection 360-40(1) of the ITAA 1997, the current year will be either of the years ending 30 June 2020 (the 2020 income year), or the year ending 30 June 2021 (the 2021 income year). For clarity, in relation to particular requirements within subsection 360-40(1): | Detailed Reasoning - Early stage test: Incorporation or Registration - paragraph 360-40(1)(a) The Company was incorporated within the last three income years, therefore, paragraph 360-40(1)(a) is satisfied. Total expenses - paragraph 360-40(1)(b) For the 2020 income year, in applying the requirements of paragraph 360-40(1)(b), the Company and any of its 100% subsidiaries must have incurred expenses of less than $1 million in the 2019 income year, being the income year before the current year. The Company was incorporated in the 2020 income year and its subsidiary company was incorporated in the 2021 income year. As neither the Company nor its subsidiary were trading in the 2019 income year, no expenses were incurred in the 2019 income year. Consequently, paragraph 360-40(1)(b) is satisfied for the 2020 income year. For the 2021 income year, in applying the requirements of paragraph 360-40(1)(b), the Company and any of its 100% subsidiaries must have incurred expenses of less than $1 million in the 2020 income year, being the income year before the current year. The Company incurred expenses totalling less than $1 million in the 2020 income year. The Company's subsidiary was not incorporated until the 2021 income year and, therefore, did not incur any expenditure in the 2020 income year. Consequently, paragraph 360-40(1)(b) is satisfied for the 2021 income year. Paragraph 360-40(1)(b) is, therefore, satisfied for this case. Assessable income - paragraph 360-40(1)(c) For the 2020 income year, in applying the requirements of paragraph 360-40(1)(c), the Company and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the 2019 income year, being the income year before the current year. The Company was incorporated in the 2020 income year and its subsidiary company was incorporated in the 2021 income year. As neither the Company nor its subsidiary were trading in the 2019 income year, there was no derived income in the 2019 income year. Consequently, paragraph 360-40(1)(c) is satisfied for the 2020 income year. For the 2021 income year, in applying the requirements of paragraph 360-40(1)(c), the Company and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the 2020 income year, being the income year before the current year. The Company derived assessable income totalling less than $200,000 in the 2020 income year. The Company's subsidiary company was not incorporated until the 2021 income year and, therefore, did not derive any income in the 2020 income year. Consequently, paragraph 360-40(1)(c) is satisfied for the 2021 income year. Paragraph 360-40(1)(c) is, therefore, satisfied for this case. No stock exchange listing - paragraph 360-40(1)(d) The Company is privately owned and is not listed on any stock exchange in Australia or a foreign country at the test time, therefore paragraph 360-40(1)(d) is satisfied. Conclusion on early stage test The Company satisfies the early stage test for the 2020 and the 2021 income years as each of the requirements in paragraphs 360-40(1)(a) to (d) have been satisfied for the relevant year. | Detailed Reasoning - 100-point test: The Company has not provided evidence of satisfying the 100-point test under section 360-45 of the ITAA 1997 for the years ending 30 June 2020 and 30 June 2021. For it to be a qualifying ESIC it will, therefore, need to satisfy the principles-based test. The Company 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 - Principles-based test: To satisfy the principles-based test, the Company must meet the five requirements in paragraph 360-40(1)(e) of the ITAA 1997. Each of these is discussed below. Developing new or significantly improved innovations for commercialisation - subparagraph 360-40(1)(e)(i) According to the Company, 'the Innovation' is the development of new products. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) The Company is genuinely focused on developing their products for an applicable addressable market, so subparagraph 360-40(1)(e)(i) is satisfied. High growth potential - subparagraph 360-40(1)(e)(ii) The Company has identified that it has the ability to rapidly expand its business and has also identified that it has high growth potential within its addressable market. The Company has demonstrated a high growth potential for their products. Therefore, subparagraph 360-40(1)(e)(ii) is satisfied. Scalability - subparagraph 360-40(1)(e)(iii) The projections and business model provided illustrates the increase in projected sales. Given that 'the Innovation' will be available domestically and globally, it is expected that 'the Innovation' has the potential to successfully scale up its business. Therefore, subparagraphs 360-40(1)(e)(iii) will be satisfied. Broader than local market- subparagraph 360-40(1)(e)(iv) The Company has demonstrated that 'the Innovation' 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. Competitive advantages - subparagraph 360-40(1)(e)(v) According to the ruling application, there are currently limited competitors involved in the production of 'the Innovation' This allows ample opportunity to go to a global market with limited direct competition. Therefore, subparagraph 360-40(1)(e)(v) will be satisfied. Conclusion on principles test The Company satisfies the principles-based test because it satisfies the requirements in subsection 360-40(1)(e) for the years ending 30 June 2020 and 30 June 2021. | Detailed Reasoning - Foreign Company Test: As the Company was incorporated in Australia it is not a Foreign Company and paragraph 360-40(1)(f) is, therefore, satisfied. Conclusion The Company meets the eligibility criteria of an ESIC under section 360-40 for the years ending 30 June 2020 and 30 June 2021. [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.

This ruling applies for the following periods: | for the 2020 income year the last three years will include the income years ending 30 June 2020, 2019 and 2018, and the income year before the current year will be the year ending 30 June 2019 (the 2019 income year); and | for the 2021 income year the last three years will include the income years ending 30 June 2021, 2020 and 2019, and the income year before the current year will be the year ending 30 June 2020 (the 2020 income year).