Private ruling: Early Stage Innovation Company
Date of advice: 13 March 2018
Published: June 2018
Ruling period: Year ended 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Does the Company meets the ‘Principle Based Test’ under subsection 360-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997) to be considered an Early Stage Innovation Company (ESIC)? | A1: Yes

Relevant facts and circumstances: 1. The Company was incorporated in Australia within the last 3 income years. Its equity interests are not listed for quotation in the official list of any stock exchange. The Company has no subsidiaries. 2. In the previous year i.e. the year ended 30 June 2017 the Company has expenses of more than $1,500 and assessable income of less than $90.00. 3. The Company has identified its ultimate market as being the global market, with its initial target being Australian markets. 4. The Company holds the intellectual property rights to the innovative product. 5. The Company has been developing of an innovative product for commercialisation. Commercialisation strategy 6. The Company has completed part of the development and scheduled to release the innovative product in mid-2018. 7. The Company is initially targeting the Australian market. They will pursue product sales through: a. targeted direct sales b. website c. customer referrals. 8. The Company has identified specific potential customers. Information provided 9. The Company has provided information in a number of documents and phone conversations in relation to the innovative product, including: a. your private ruling application. b. supplementary information. 10. 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 and | Income Tax Assessment Act 1997 Subsection 360-40(1).

Reasons for decision: Summary: All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated. 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 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. | 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 (iv): 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 - Application to your circumstances: Test time 14. 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 2018. Current year 15. For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 2018. For clarity, in relation to particular requirements within subsection 360-40(1), the last three income years will include the years ending 30 June 2018, 2017 and 2016, and the income year before the current year will be the year ending 30 June 2017. | Detailed Reasoning - Early stage test: Incorporation or Registration – paragraph 360-40(1)(a) 16. As the Company was incorporated in Australia within the last 3 income years, subparagraph 360-40(1)(a)(i) is satisfied. Total expenses – paragraph 360-40(1)(b) 17. As the Company had expenses of less than $1 million in the income year ended 30 June 2017, paragraph 360-40(1)(b) is satisfied. Assessable income – paragraph 360-40(1)(c) 18. As the Company’s assessable income was than $200,000 for the income year ended 30 June 2017, paragraph 360-40(1)(c) is satisfied. No stock exchange listing – paragraph 360-40(1)(d) 19. As the Company is privately owned and is not listed on any stock exchange in Australia or a foreign country, subparagraph 360-40(1)(d) is satisfied. Conclusion on early stage test 20. The Company will satisfy the early stage test for the entire 2018 income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - Principles based test: 21. In the ruling issued in mid-2017, we concluded that the Company passed the principles based test in respect of the innovative product they are developing. While product is still being ‘developed’ they will continue to satisfy the principle bases test. 22. The Company provided an outline of the progress and achievements made since the ruling for the year ended 30 June 2017 was issued. An updated development timeline was also provided showing the work done between mid-2017 and early 2018 as well as planned activities to be undertaken to fully develop the innovative product. 23. Therefore, the Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 2017 until the earlier of 30 June 2018 or the date when innovative product has been fully developed and are ready for use, whichever occurs earlier.