Private ruling: Early stage innovation company
Date of advice: 11 March 2024
Published: 22 April 2024
Ruling period: Year ending 30 June 20YY
Date scheme commenced: Year ending 30 June 20YY

Ruling: Q1: Does X Pty Ltd meet the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the Income Tax Assessment Act 1997 for the financial year ending DD MM YYYY? | A1: Yes

Relevant facts and circumstances: X Pty Ltd (X) is an Australian tax resident company that was incorporated in the 20YY/YY financial year. The expenses for X (and any wholly owned subsidiaries) for the year ending 30 June 20YY will be below $1 million. The income of X (and any wholly owned subsidiaries) for the year ending 30 June 20YY will be below $200,000. No equity interests in X are, or have ever been, listed on any Australian or foreign stock exchange and X will not list any equity interests on any Australian or foreign stock exchange in the 20YY/YY financial year. X has not received an Accelerating Commercialisation Grant known as the Entrepreneur's Program Overview X is focused on the commercialisation of technology Z in Australia, through the brand Y, and will undertake the following activities for the 20YY/YY financial year. Development of new or significantly improved innovations, and genuinely focused on developing innovations for Commercialisation Redacted By significantly improving the decision-making process, X expects that technology Z will revolutionise industries on a global scale. High Growth Potential Redacted X's business relating to the innovation of the technology Z exhibits high growth potential. With a ground-breaking technology, a robust business strategy, and a booming market, we are well-positioned for significant growth and success. Scalability X is well-positioned to scale up its innovative business successfully. Redacted. Furthermore, X has established a strategic partnership with Company W. This relationship provides X with a ready channel to scale operations. Company W's global marketing footprint offers X access to markets beyond its current reach, facilitating the company's ability to scale not only locally but also internationally. X has provided information that demonstrates a strong potential for successfully scaling up its business. With a combination of innovative, scalable technology, a skilled and growing team, and strategic partnerships, The company is equipped to expand operations and make a significant impact in the area of technology Z. Broader than local market The technology developed by X is not only scalable but also highly adaptable to markets beyond our local area, including global markets. Redacted Competitive Advantages X possesses the potential to build a strong competitive advantage, largely attributable to its potential to create unique intellectual property rights. Redacted Finally, X's focus on creating patented technology offers exclusive rights to the company's innovations, preventing competitors from using X technology and providing X with a unique market position. X's blend of intellectual assets, team expertise, early market entry, strategic partnerships, scalability, customizability, and focus on patent-protected innovation all contribute to a robust competitive advantage. As X continues to drive innovation and adapt to market needs, the company is well-positioned to maintain and enhance this competitive edge.

Relevant legislative provisions: 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

Reasons for decision: Summary: X meets the criteria of an ESIC under subsection 360-40(1) of the ITAA 1997 for the year ending 30 June 20YY. | Detailed Reasoning - Detailed reasoning: Subsection 360-40(1) ITAA 1997 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. For an investor to be entitled to the early stage investor tax incentives, the company must qualify as an ESIC immediately after the new shares are issued to the investor. If the company no longer meets the ESIC requirements after this test time, this won't affect the investor's potential entitlement to the early stage investor tax incentives. The criteria are based on a series of tests to identify if the company is at an early stage of its development, and if it is developing new or significantly improved innovations to generate an economic return. | Detailed Reasoning - Early Stage Test: The early stage test requirements are outlined in detail within subsections 360-40(1)(a) to (d). Incorporation or Registration - subsection 360-40(1)(a) To meet the requirement in subsection 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). 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 - subsection 360-40(1)(b): To meet the requirement in subsection 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 - subsection 360-40(1)(c): To meet the requirement in subsection 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 - subsection 360-40(1)(d): To meet the requirement in subsection 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, 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 - subsection 360-40(1)(e) and section 360-45: 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 - subsections 360-40(1)(e)(i) to (v): To satisfy the principles-based test, the company must meet five requirements in subsections 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, as outlined in subsections 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 - subsection 360-40(1)(e)(i) ITAA 1997: 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..." 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 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 - subsection 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. 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 - subsection 360-40(1)(e)(iii): 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 - subsection 360-40(1)(e)(iv): 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 - subsection 360-40(1)(e)(v): 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 - subsection 360-40(1)(f): At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth). 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: For the purposes of this ruling, the 'test time' for determining if X is a qualifying ESIC, will be upon the issue of qualifying shares on a particular date or dates on or after 1 July 20YY and on or before 30 June 20YY. | Detailed Reasoning - Current year: For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 20YY (the 20YY 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 20YY, 20YY and 20YY, and the income year before the current year will be the year ending 30 June 20YY (the 20YY income year). | Detailed Reasoning - Incorporation or Registration - subsection 360-40(1)(a): X was incorporated in Australia on day/month 20YY, which is within the last three income years (the latest being the current year). Therefore, the requirements of s360-40(1)(a)(i) are satisfied. | Detailed Reasoning - Total expenses - subsection 360-40(1)(b): In applying the requirements of paragraph 360-40(1)(b), X and any of its 100% subsidiaries must have incurred total expenses of $1 million or less in the 20YY income year, being the year before the current income year. Therefore, s360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - subsection 360-40(1)(c): In applying the requirements of s360-40(1)(c), X and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the 20YY income year. Therefore, s360-40(1)(c) is satisfied. | Detailed Reasoning - No stock exchange listing - subsection 360-40(1)(d): In applying the requirements of s360-40(1)(c), X must not be listed on any Stock Exchange in Australia or a foreign country at the test time. X was not listed on any stock exchange in Australia or a foreign country at the test time and will not be listed on any stock exchange in the 20YY/YY year. Therefore, s360-40(1)(d) is satisfied. | Detailed Reasoning - Conclusion for Early Stage Test: X satisfies the early stage test for the entire 'test time', as each of the requirements within s360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - 100 Point Test s360-40(1)(e) and s360-45: X has not sought to be tested against the 100-point test under section 360-45 for the 'test period'. X is electing to seek eligibility by satisfying the principles-based innovation test under subsections 360-40(1)(e)(i)-(v) in order to be issued with a Private Binding Ruling. | Detailed Reasoning - Developing new or significantly improved innovations - subsection 360-40(1)(e)(i): In applying the requirements of s360-40(1)(e)(i), X must be developing an innovation which is either new or significantly improved for an applicable addressable market. X has provided details asserting that it is developing a product that is either new or significantly improved for an applicable addressable market for the 20YY income year. | Detailed Reasoning - Genuinely focussed on developing for commercialisation - subsection 360-40(1)(e)(i): In applying the requirements of s360-40(1)(e)(i), X must be genuinely focussed on developing an innovation for commercial purpose in order to generate economic value and revenue for the company. X has provided details asserting that it meets this requirement for the 20YY income year. Therefore, s360-40(1)(e)(i) is satisfied. Once the product has been fully developed, X will no longer be 'developing' the product for commercialisation and s360-40(1)(e)(i) will no longer be satisfied. | Detailed Reasoning - High growth potential - subsection 360-40(1)(e)(ii): In applying the requirements of s360-40(1)(e)(ii), X must be able to demonstrate that it has high potential growth within a broad addressable market. X has provided details asserting that it meets this requirement for the 20YY income year. Therefore, s360-40(1)(e)(ii) is satisfied. | Detailed Reasoning - Scalability - subsection 360-40(1)(e)(iii): In applying the requirements of s360-40(1)(e)(iii), X must be able to demonstrate that it has the potential to scale up the business. X has provided details asserting that it meets this requirement for the 20YY income year. Therefore, s360-40(1)(e)(iii) is satisfied. | Detailed Reasoning - Broader than local market - subsection 360-40(1)(e)(iv): In applying the requirements of s360-40(1)(e)(iv), X must be able to demonstrate that it has the potential to address a broader than local market, including global markets. X has provided details substantiating that it meets this requirement for the 20YY income year. Therefore, s360-40(1)(e)(iv) is satisfied. | Detailed Reasoning - Competitive advantages - subsection 360-40(1)(e)(v): In applying the requirements of s360-40(1)(e)(v), X must be able to demonstrate that it has the potential to be able to have competitive advantages for that business. X has provided details asserting that it meets this requirement for the 20YY income year. Therefore, s360-40(1)(e)(v) is satisfied. | Detailed Reasoning - Conclusion on principles-based test: X satisfies the principles-based test as it meets the requirements within subsections 360-40(1)(e)(i) to (v) for the 20YY income year. | Detailed Reasoning - Foreign Company Test - subsection 360-40(1)(f): As X was incorporated in Australia, it is not a Foreign Company and therefore paragraph 360-40(1)(f) is satisfied. | Detailed Reasoning - Final Conclusion: X meets the eligibility criteria of an ESIC under subsection 360-40(1) for the 20YY income year.