Private ruling: Early stage innovation company eligibility
Date of advice: 8 July 2021
Published: September 2021
Ruling period: Year ended 30 June zzzz
Date scheme commenced: 1 July yyyy

Ruling: Q1: Does the Company 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? Summary The Company meets the eligibility requirements of an ESIC pursuant to subsection 360-40(1) of the ITAA 1997 for the period 1 July yyyy to 30 June zzzz.

Relevant facts and circumstances: 1. The applicant ('the Company') is an Australian proprietary company which was incorporated in Australia and registered on the Australian Business Register during the year ending 30 June xxxx, which is within the last three income years (the latest being the current year) Its equity interests are not listed for quotation on the official list of any stock exchange in Australia or overseas. 2. The Company has no subsidiaries and is not part of a consolidated group or planning to join a consolidated group. 3. The Company has two directors, Taxpayer A and Taxpayer B. 4. The Company's registered office and principal place of business is in Australia. 5. The Company incurred total expenses of less than $1 million and derived total assessable income of less than $200,000 in the year ending 20 June yyyy, ie. the year before the current year. 6. The Company is developing software/technology designed to provide high level cyber security by filtering dangerous and unwanted computer traffic. The technology will be offered to a range of client groups. 7. The Company is developing a proprietary user interface which significantly reduces complexity and improves operations while also vastly improving security. 8. The Company is developing a proprietary appliance that combines a combination of capabilities to defeat an adversary's reconnaissance 9. The Company will deliver its technology via a security appliance that incorporates a number of discrete, yet heavily integrated, functions built within a secure enclave. This enables the delivery of a high level of security at scale and at a price that brings it within reach of various clients. 10. The Company believes that its technology will ultimately allow its users to be confident that their data will remain private. 11. The appliance contains a number of specific discreet functional elements or modules. 12. The Company states that the functional elements are, individually and of themselves, not unique, however, there are some specific innovations in the manner in which the Company has implemented them. 13. The Company's market analysis/comparison has identified that there are many venders in the cyber security space, each with products and services that perform a wide array of functions. 14. The Company believes that when fully developed, its product will be the only product on offer that provides all the features and functions provided by its various competitors. 15. Future development efforts will also include additional features not currently provided by its competitors. 16. The Company believes the appliance is subject to a substantial and robust roadmap of improvements and developments and has already taken over x months of development effort to bring it to market. 17. The Company owns all rights to all IP relating to the its technology/product. 18. The Company has not lodged patents for the technology for the invention and commercially sensitive designs up until this time. This delay is in part due to concerns due to public disclosure (as this may run counter to security outcomes). 19. The Company has not registered any trademark associated with the Company. 20. The Company states that they are run by security protection experts, and that the highest levels of practical and procedural protection measures have been applied to protect the Company's IP from competitors replicating their product. 21. The Company identifies its initial addressable market as various sectors within specific areas of Australia. However, as its product is a cyber security technology designed to protect all users of the internet, the Company has identified its addressable market as being both the Australian and international/global market. Commercialisation strategy 22. The Company commenced development of the product in the yyyy income year after a successful Proof of Concept using multiple physical devices. The company subsequently successfully achieved a number of development milestones later in that year and commenced further development and enhancement activities, and a production version of the product was produced and deployed in the zzzz income year. 23. Since then, the Company secured a small/medium business customer and plans to expand sales into other specific markets. 24. The technology has been validated by enquiries and pre-conditional consulting sales with major corporate and government clients. 25. The Company believes that its initial addressable market is likely to expand quickly into other markets. 26. The early success in commercialisation is still considered internally as 'the beta version', with ongoing development and additions to the tech team helping to ensure that the business can continue to develop its offering and grow its capacity to service multiple customer channels. 27. To this end, the Company has signed a reseller agreement with an international cyber security company who will sell the products and security-as-a-service. Similar negotiations are underway with an international telecommunications company. 28. The Company's aspirations after the end of its initial commercialisation plan include an Initial Public Offering on the Australian Stock Exchange, depending on market opportunity and business performance. 29. The Company believes that it has high growth potential and ample capacity to scale due to the inherently advantaged software element of its product offering. Its existing costing estimates indicate a gross profit in year one, and substantially increasing profits in subsequent years. Further, it believes that COGS will decrease further with volume discounts triggered by increased turnover and associated production. 30. The Company believes that the natural barriers to their addressable market are extremely high, though it is expected that competitors will attempt to mimic some elements of the Company's solution over an extended period of time, critical elements of the technology will be protected by patents. In addition, the Company is aggressively taking further steps to add to the barriers to maintain its first mover / competitive advantage. Information provided You have provided a number of documents containing detailed information in relation to the Company's product. 31. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances. 32. You propose to issue new shares in the Company to various investors to assist in funding the continued development and commercialisation of its product offering.

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

Reasons for decision: Summary: All legislative references are to the ITAA 1997 unless otherwise indicated. | Detailed Reasoning - Qualifying Early Stage Innovation Company: 33. 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': 34. 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): 35. 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). 36. 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. 37. 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): 38. 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): 39. 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): 40. 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': 41. 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 - 'PRINCIPLES-BASED TEST' - SUBPARAGRAPHS 360-40(1)(e)(i) TO (v): 43. 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. 44. 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. 45. The five requirements of the principles-based test, as outlined in paragraph 360-40(1)(e) are: i. the company must be genuinely focussed on developing for commercialisation one or more new or significantly improved products, processes, services or marketing or organisational methods 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: 46. 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..." 47. The innovation being developed by the company must either be new or significantly improved for an applicable addressable market. [1] 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. 48. Improvements must be significant in nature to meet this requirement. Significant is defined in the online Macquarie Dictionary as " important; of consequence ." 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. 49. 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." 50. The company must be genuinely focussed 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. 51. For a company to qualify as an ESIC under the principles based test, the company must be "genuinely focussed on developing for commercialisation" their innovation. That is, the central activities of the company must be truly concentrated on developing their innovation for a commercial purpose. '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: 52. The company must be able to demonstrate that the business relating to the innovation has a high growth potential 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: 53. The company must be able to demonstrate that it has the potential to successfully scale up the business relating to the innovation. The company must have operating leverage, whereas 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. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997: 54. 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: 55. 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): 56. At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth). 57. 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: 58. For the purposes of this ruling, the 'test time' for determining if the Company 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. | Detailed Reasoning - Current year: 59. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , 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 3 income years will include the years ending 30 June zzzz, yyyy and xxxx, 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) ITAA 1997: 60. The Company was registered in the Australian Business Register (ABR) during the year ending 30 June yyyy, which is within the 3 income years outlined above, therefore the requirements of subparagraph 360-40(1)(a)(i) are satisfied. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b) ITAA 1997: 61. In applying the requirements of paragraph 360-40(1)(b), the Company and any of its 100% subsidiaries must have incurred total expenses of $1 million or less in the yyyy income year, being the income year before the current year. 62. The Company did not have any subsidiaries, and incurred expenses of less than $1 million in the yyyy income year. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c) ITAA 1997: 63. 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 yyyy income year, being the income year before the current year. 64. The Company did not have any subsidiaries, and derived assessable income of less than $200,000 in the yyyy income year. Consequently, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No Stock Exchange listing - paragraph 360-40(1)(d) ITAA 1997: 65. In applying the requirements of paragraph 360-40(1)(d), the Company must not be listed on any Stock Exchange in Australia or a foreign country at the test time. 66. The Company is not listed on any Stock Exchange in Australia or a foreign country at the test time, consequently paragraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: 67. The Company satisfies the early stage test for the 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: 68. The Company has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June zzzz. 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 - Developing new or significantly improved innovations - subparagraph 360-40(1)(e)(i) ITAA 1997: 69. In applying the requirements of subparagraph 360-40(1)(e)(i), the Company must be developing an innovation which is either new or significantly improved for an applicable addressable market. 70. The Company is developing software/technology designed to provide high level cyber security by filtering dangerous and unwanted computer traffic. The technology will be offered to a range of client groups. 71. The Company is developing a proprietary user interface which significantly reduces complexity and improves operations while also vastly improving security. 72. The Company is developing a proprietary appliance that combines a combination of capabilities to defeat an adversary's reconnaissance. 73. The Company believes that its technology will ultimately allow anyone to communicate across any network confident that their data will remain private. 74. The Company's market analysis/comparison has identified that there are many venders in the cyber security space, each with products and services that perform a wide array of functions. 75. The Company believes that when fully developed, its product will be the only product on offer that provides all the features and functions provided by its various competitors. 76. The Company is genuinely focussed on developing their software/technology product, which is a new or significantly improved innovation, so subparagraph 360-40(1)(e)(i) is satisfied for the period 1 July yyyy to 30 June zzzz. | Detailed Reasoning - Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997: 77. In applying the requirements of subparagraph 360-40(1)(e)(i), the Company must be genuinely focussed on developing an innovation for a commercial purpose in order to generate economic value and revenue for the company. 78. The Company commenced development of the product in the yyyy income year after a successful Proof of Concept using multiple physical devices. The Company subsequently successfully achieved a number of development milestones later in that year and commenced further development and enhancement activities, and a production version of the product was produced and deployed in the zzzz income year. 79. Since then, the Company secured a small/medium business as customers and plans to expand sales into other specific markets. 80. The technology has been validated by enquiries and pre-conditional consulting sales with major corporate and government clients. 81. The Company's aspirations after the end of its initial commercialisation plan include an Initial Public Offering on the Australian Stock Exchange, depending on market opportunity and business performance. 82. The Company is genuinely focussed on developing their software/technology product, for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period 1 July yyyy to 30 June zzzz, or the date when their product has been fully developed and is ready for client use, whichever occurs earlier. Once the product 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. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997: 83. In applying the requirements of subparagraph 360-40(1)(e)(ii), the Company must be able to demonstrate that it has the potential for high growth within a broad addressable market. 84. The Company believes that it has extremely high growth potential due to the inherently advantaged software element of its product offering, and the fact that its product is easily and infinitely scalable to a global audience. 85. As previously stated, the Company identifies its initial addressable market as various sectors within specific areas of Australia. However, as its product is a cyber security technology designed to protect all users, the Company has identified its addressable market as being both the Australian and international/global market. 86. While it is impossible to know the size of the potential market, it is noted that all businesses who rely on or utilise the internet in conducting their business can benefit from the protection afforded by effective cyber security technology. The ability for the Company to customise and tailor their product offering means that their cyber security solutions cut across different industries and are therefore industry agnostic. 87. The Company has demonstrated a high growth potential for their software/technology product, so subparagraph 360-40(1)(e)(ii) is satisfied for the period 1 July yyyy to 30 June zzzz. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997: 88. In applying the requirements of subparagraph 360-40(1)(e)(iii), the Company must be able to demonstrate that it has the potential to successfully scale up the business. 89. The Company states that it has ample capacity to scale up the business due to the inherently advantaged software element of its product offering. 90. The Company also believes that as it increases its market share, the hardware element of its costs will drop rapidly. This will be expediated by its unique format server which allows for deployment in any size organisation, without the need for extensive modification or facilities. 91. Existing cost estimates undertaken by the Company indicate a gross profit in year one and substantially increasing profits in the following years. 92. The Company believe that their COGS will decrease further with volume discounts triggered by increased turnover and associated production. 93. This leverage ensures that the Company has the potential to successfully scale up its business, generating increased revenue with a less than proportionate increase in operating costs, so subparagraph 360-40(1)(e)(iii) is satisfied for the period 1 July yyyy to 30 June zzzz. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997: 94. In applying the requirements of subparagraph 360-40(1)(e)(iv), the Company must be able to demonstrate that it has the potential to be able to address a broader than local market, including global markets. 95. As stated above, the Company is developing their software/technology to address the needs of a range of client groups, and is continuing to develop their product offering. 96. The Company identifies its initial addressable market as various sectors within specific areas of Australia. However, as its product is a cyber security technology designed to protect any users of the internet from cyber-attacks, the Company has identified its addressable market as being both the Australian and international/global market. 97. The Company believes that the initial addressable market is likely to expand quickly into other markets. 98. The early success in commercialisation is still considered internally as 'the beta version', with ongoing development and additions to the tech team helping to ensure that the business can continue to develop its offering and grow its capacity to service multiple customer channels. 99. The Company has demonstrated that it has the capacity to address a broader than local market, including international and global markets. Therefore, subparagraph 360-40(1)(e)(iv) is satisfied for the period 1 July yyyy to 30 June zzzz. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v) ITAA 1997: 100. In applying the requirements of subparagraph 360-40(1)(e)(v), the Company must demonstrate that it has potential to be able to have competitive advantages for that business. 101. The Company's market analysis/comparison has identified that there are many venders in the cyber security space, each with products and services that perform a wide array of functions. 102. The Company believes that when fully developed, its product will be the only product on offer that provides all the features and functions provided by its various competitors. 103. Future development efforts will also include additional features not currently provided by its competitors. 104. The Company believes that the natural barriers to their addressable market are extremely high, though it is expected that competitors will attempt to mimic some elements of the Company's solution over an extended period of time, critical elements of the technology will be protected by patents. In addition, the Company is aggressively taking further steps to add to the barriers to maintain its first mover / competitive advantage. 105. The Company has demonstrated that it has competitive advantages over its competitors, so subparagraph 360-40(1)(e)(v) is satisfied for the period 1 July yyyy to 30 June zzzz. | Detailed Reasoning - CONCLUSION FOR PRINCIPLES BASED TEST: 106. The Company satisfies the principles based test as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period 1 July yyyy to 30 June zzzz, or the date when their product has been fully developed and is ready for client use, whichever occurs earlier. | Detailed Reasoning - Foreign Company Test - subparagraph 360-40(1)(f) ITAA 1997: 107. The Company was incorporated in Australia, it is not a Foreign Company and therefore paragraph 360-40(1)(f) is satisfied. | Detailed Reasoning - CONCLUSION: 108. The Company meets the eligibility criteria of an ESIC under section 360-40 for the period 1 July yyyy to 30 June zzzz, or the date when their product has been fully developed and is ready for client use, whichever occurs earlier.

This ruling applies for the following period: | 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. | Tax incentives for Early Stage Investors | [1] Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.79.