Private ruling: Early stage innovation company
Date of advice: 25 June 2021
Published: September 2021
Ruling period: 1 July 20XX to 30 June 20XX
Date scheme commenced: 1 July 20XX

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? | A1: Yes

Relevant facts and circumstances: Object As are at risk of damage as they are moved between storage, transport, and delivery. The global Object A market spends billions of dollars each year on protection, security and insurance of Object A. For example, in 20XX, the global Object A market spent $xxx billion in Country B currency on the protection and transport of Object A. The Company is developing a product ('the Company's System') which provides a non-contact movement system for Object A from production, through to transportation and delivery. The Company: • was incorporated in Australia during the 20XX income year • had no 100% subsidiaries in the 20XX income year • had assessable income of less than $200,000 and total expenses of less than $1 million in the 20XX income year • was not, and will not be, listed on any stock exchange, either in Australia or in a foreign country, at any time during the 20XX income year. The Company's System will be designed so that Object A can be moved without contact. The Company is also developing other components that allow Object A to be moved without contact with the floor, and which will allow integration with relevant hardware. The Company owns the intellectual property. The Company has identified its customers as including: • venues and institutions which hold or are associated with Object A • logistics providers who transport Object A • insurers • professionals who create or maintain Object A. The Company has: • performed searches of major Object A hardware manufacturers and suppliers • consulted with C, an expert in Object A maintenance, and a founding Chair of Institution D • engaged E (a patent and trademark firm), who conducted a preliminary novelty search. Based on this research, the Company has concluded that there are currently no existing products available on the market, or patents filed for products in development, which provide non-contact movement of Object A from production through shipping through to delivery. According to the Company's analysis, equipment commonly used in moving Object A includes Product F, Product G, Product H, Product I, Product J, and Product K. The Company's System offers several points of difference with this equipment: • existing movement hardware (Product F, Product G, Product H) do not provide non-contact movement • Product F carries a risk of permanent damage to Object A • Product I does not offer non-contact movement • Product F and Product I are disposable and harmful to the environment • shipping hardware, such as Product J and Product K offer non-contact shipping and storage. In comparison, the Company's System offers non-contact delivery, trading, storage, shipping. The Company submits that it has the potential to establish 'first mover advantage' in the industry. The Company has a two stage commercialisation and marketing strategy. First, it will target major Object A centres in City L, City M and City N. The Company considers that: • these centres have a high concentration of key customers in the Object A industry • customers in these centres have a global market reach which will facilitate international awareness of the Company's System. Second, the Company intends to expand by marketing its product to other cities across Country B, Region O and Country P , as product awareness increases, and eventually other markets such as Country Q, Country R, and Country S. The Company intends to address markets in most developed countries. The Company has budgeted for an initial production run to provide first sales, and then generate pre-orders for a second production run. The Company expects that manufacturing costs for the second run will be lower per unit than the first run, because tooling costs will not be required. The Company has estimated these manufacturing/production costs in collaboration with T, a product and industrial design and engineering firm. The Company submits that the expected lower manufacturing/production costs will increase profit margin as its market reach expands. The Company has engaged a patent attorney, and commenced patents proceedings for the Company's System. The Company intends its patent claims to be broad, and considers that competitors will be unable to copy the design to achieve similar functionality.

Relevant legislative provisions: Section 360-40 of the Income Tax Assessment Act 1997 | Section 6 of the Corporations Act 2001

Reasons for decision: Summary: Yes. The Company meets the criteria of an ESIC under subsection 360-40(1) . It meets the principles-based innovation test in paragraph 360-40(1)(e), and all other necessary requirements in subsection 360-40(1). | Detailed Reasoning - Background: Broadly, Division 360 provides a tax offset to entities which make qualifying investments in ESICs. One of the relevant requirements is that subsection 360-40(1) applies to the company: see paragraph 360-15(1)(c). Subsection 360-40(1) will apply to a company if it meets requirements in that provision: • at the test time, it meets at least one of two alternative tests in paragraph 360-40(1)(e): (collectively, 'the ESIC tests') - it has at least 100 points under section 360-45 ('the 100 points innovation test'), or - meets all the requirements in subparagraphs 360-40(1)(e)(i) through 360-40(1)(e)(v) ('the principles-based innovation test'). • at least one of three alternative incorporation/business registration requirements ('the incorporation requirements') in paragraph 360-40(1)(a), to the effect that the company was - incorporated in Australia within the last 3 income years, the latest being the current year: subparagraph 360-40(1)(a)(i) - incorporated in Australia within the last 6 income years, the latest being the current year, and across the last 3 of those income years it, and its 100% subsidiaries (if any) incurred total expenses of $1 million or less: subparagraph 360-40(1)(a)(ii) - registered in the Australian Business Register within the last 3 income years, the latest being the current year: subparagraph 360-40(1)(a)(iii) • in the previous income year, the company, and its 100% subsidiaries: - incurred total expenses of $1 million or less: paragraph 360-40(1)(b) ('the total expenses requirement') - had total assessable income of $200,000 or less: paragraph 360-40(1)(c) ('the assessable income requirement') • at the test time, its equity interests are not listed on a stock exchange: paragraph 360-40(1)(d) ('the non-listing requirement') • at the test time, the company is not a foreign company within the meaning of the Corporations Act 2001 : paragraph 360-40(1)(f) ('the domestic company requirement'). 1. The Company submits that it meets the principles-based innovation test. We will address this test first. | Detailed Reasoning - The principles-based innovation test: The principles-based innovation test requirements in paragraph 360-40(1)(e) are that at the test time, the company meets five requirements: • the company is genuinely focussed on developing for commercialisation one or more new, or significantly improved, products, processes, services or marketing or organisational methods: subparagraph 360-40(1)(e)(i) ( ' the new or significantly improved requirement ' ) • the business relating to those products, processes, services or methods has a high growth potential: subparagraph 360-40(1)(e)(ii) ('the high growth potential requirement') • the company can demonstrate that it has the potential to be able to successfully scale that business: subparagraph 360-40(1)(e)(iii) ( ' the scalability requirement') • the company can demonstrate that it has the potential to be able to address a broader than local market, including global markets, through that business: subparagraph 360-40(1)(e)(iv) ('the broader than local market requirement') • the company can demonstrate that it has the potential to be able to have competitive advantages for that business: subparagraph 360-40(1)(e)(v) ( 'the competitive advantages requirement' ). We discuss and apply each requirement to the Company at paragraphs 21 through 40. | Detailed Reasoning - The new or significantly improved requirement: subparagraph 360-40(1)(e)(i): The Macquarie Dictionary says that meanings of 'new' include: • 'of recent origin or production, or having only lately come or been brought into being' • 'of a kind now existing or appearing for the first time; novel' • 'having only come lately or only now come into knowledge' • 'recently arrived or established'. [1] Meanings of 'improve' include: • 'to bring into a more desirable or excellent condition' • 'to increase in value, excellence etc.; become better'. [2] Paragraphs 1.79 to 1.81 of the Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 ('the EM'), which introduced Division 360, when explaining the new or significantly improved requirement, say that: • the relevant innovation must be new or significantly improved for the applicable 'addressable market' • the 'addressable market' means the available revenue opportunity or market demand arising from the innovation • the addressable market must be objective and realistic • improvements from customisation, minor extensions or updates to existing products, where these changes are similar to the approach of competitors, are unlikely to satisfy the 'significantly improved' threshold • the 'commercialisation' requirement means the innovation must be developed for the purpose of generating economic value and revenue for the ESIC. The Company's addressable market will include many participants across the Object A industry, throughout the world. Potential customers include institutions and venues that hold Object A, logistics providers who transport Object A, insurers, and professionals who create or maintain Object A. The Company is developing a product: the Company's System. Information provided by the Company suggest that developing and selling the Company's System is the Company's primary (if not exclusive) objective. The Company intends to sell the Company's System to customers. It follows that the Company is genuinely focussed at developing the Company's System for commercialisation. Therefore, we need to determine if the product is 'new or improved' for the global Object A market. The Company's System provides non-contact movement for Object A from production through shipping through to delivery. The Company's market analysis shows that no existing products provide this functionality. Existing movement equipment does not provide non-contact movement. While Product J and Product K provide non-contact movement, this is limited to when Object A is travelling, and doesn't extend to delivery, or removal. The Company's System is arguably 'new' because no existing product provides non-contact movement at all points in the Object A movement life. However, it could be characterised as a variant of existing products which already provide non-contact movement, such as Product J and Product K. The Company's System can be distinguished from these products, because it allows non-contact movement before and after transportation. (Where Product J or Product K products are used, the Object A would still experience contact in placing Object A, and removing them after transportation.) We consider that this difference goes beyond 'customisation' or 'minor' updates' to an existing product. Therefore, the Company's System has the potential to be at least a significantly improved product. We conclude that the Company is genuinely focussed on developing a new or significantly improved product for commercialisation. It meets the new or significantly improved requirement. | Detailed Reasoning - The high growth potential requirement: subparagraph 360-40(1)(e)(ii): The EM (at paragraph 1.82) says the high growth potential requirement requires an ESIC to show that it has the potential for high growth within a broad addressable market, and that ESICs should be distinct from typical small to medium enterprises which service a 'single local market.' The Company's addressable market includes many participants throughout the global Object A industry, which spent $xxx billion in Country B currency on protection and transport of Object A in the 20XX year. We accept that this is a broad addressable market. Based on the information provided by the Company, there is currently no product available which provides non-contact movement throughout the movement life of an Object A. Therefore, the Company's System has the potential to fill a global market gap. Further, the Company plans to market the Company's System to leading Object A centres in City L, City M and City N before expanding to cities elsewhere in Country B, Region O and Country P. It eventually intends to market the Company's System to other countries, such as Country Q, Country R, and Country S, and ultimately most developed countries. We conclude that the Company's business has high growth potential within a broad addressable market. It meets the high growth potential requirement. | Detailed Reasoning - The scalability requirement: subparagraph 360-40(1)(e)(iii): The scalability requirement is about demonstrating the potential to successfully scale the business. The EM (at paragraph 1.83) suggests this means the expanding business must be able to have 'operating leverage' as it increases its market share or enters new markets, through multiplying existing revenues while incurring reduced or minimal increases in operating costs. In other words, it is not enough to 'scale up': an ESIC must also have the potential to achieve economies of scale as it scales up. The Company has estimated manufacturing and production costs in collaboration with firm T. These estimates show that the second and subsequent production runs will have lower costs per unit, because the Company will not need to incur additional tooling costs. We consider that reduced manufacturing/production costs will increase profit margin, and allow for economies of scale, as it expands. Therefore, the Company has the potential to successfully scale its business, and meets the scalability requirement. | Detailed Reasoning - The broader than local market requirement: subparagraph 360-40(1)(e)(iv): The EM (at paragraph 1.84) says that says that the broader than local market requirement doesn't require the entity to have a national, multinational or global market at the test time, simply that it has the capability to be adapted to a national, multinational or global scale in the future. For the same reasons mentioned at paragraph 31, we accept that the Company's System has the potential to be adapted to a global market. The broader than local market requirement is met. | Detailed Reasoning - The competitive advantages requirement: subparagraph 360-40(1)(e)(v): The EM (at paragraph 1.85) when explaining the competitive advantages requirement says that: • examples of competitive advantage include 'cost' or 'differential' advantage • the competitive advantages must be sustainable • possible measures to evaluate competitive advantage include the level of value for customers, rarity, imitability and sustainability. The Company's System offers several points of difference with existing Object A movement and shipping equipment: • existing movement hardware (Product F, Product G, Product H) do not allow non-contact movement or delivery • shipping hardware, such as Product J and Product K offer non-contact shipping and storage, but do not provide any non-contact movement before and after transportation. Therefore, the Company's System has the potential to establish differential competitive advantages. The Company has engaged a patent attorney, and commenced patents proceedings to establish and maintain intellectual property rights in the Company's System. If successful, this will give the Company some protection for any competitive advantages it establishes, so that they are potentially sustainable. We conclude that the Company has the potential to establish sustainable competitive advantages. It meets the competitive advantages requirement. | Detailed Reasoning - Conclusion on the principles-based innovation test: The Company meets all the requirements set out in subparagraphs 360-40(1)(e)(i) through 360-40(1)(e)(v), so it passes the principles-based innovation test. Since we consider that the Company passes the principles-based innovation test, we will not address the 100 points innovation test. | Detailed Reasoning - Other requirements in subsection 360-40(1): The Company passes one of the ESIC tests in paragraph 360-40(1)(e). However, it must also meet the remaining conditions in subsection 360-40(1): the incorporation/registration, total expenses, assessable income, non-listing and domestic company requirements. We apply these requirements to the Company in the Table. | Detailed Reasoning - Table: requirements in subsection 360-40(1), apart from the ESIC tests: Requirement in subsection 360-40(1) Application a) the company was: (i) incorporated in Australia within the last 3 income years (the latest being the current year); or (ii) incorporated in Australia within the last 6 income years (the latest being the current year), and across the last 3 of those income years before the current year it and its *100% subsidiaries (if any) incurred total expenses of $1 million or less; or (iii) registered in the *Australian Business Register within the last 3 income years (the latest being the current year); The Company was incorporated in Australia in the 2020 income year. This is within the last 3 income years (the current year being the 2021 income year). The incorporation requirement in subparagraph 360-40(1)(a) is met. (b) the company and its 100% subsidiaries (if any) incurred total expenses of $1 million or less in the income year before the current year; The Company had total expenses of less than $1 million and no 100% subsidiaries in the 2020 income year. The total expenses requirement in subparagraph 360-40(1)(b) is met. (c) the company and its 100% subsidiaries (if any) had a total assessable income of $200,000 or less in the income year before the current year; The Company had assessable income of less than $200,000 and no 100% subsidiaries in the 2020 income year. The assessable income requirement in subparagraph 360-40(1)(c) is met. (d) at the test time, none of the company's *equity interests are listed for quotation in the official list of any stock exchange in Australia or a foreign country; The Company was not, and will not be, listed on any stock exchange, either in Australia or in a foreign country, at any time during the 2021 income year. The non-listing requirement in subparagraph 360-40(1)(d) is met. (f) at the test time, the company is not a foreign company (within the meaning of the Corporations Act 2001 ) [3] The Company was incorporated in Australia. The domestic company requirement in subparagraph 360-40(1)(f) is met. Therefore, all the remaining requirements in subsection 360-40(1) are met. | Detailed Reasoning - Conclusion: The Company meets all the requirements in paragraphs 360-40(1), including one of the ESIC tests in subparagraph 360-40(1)(e), namely, the principles-based innovation test. Therefore, the Company meets the criteria of an ESIC under subsection 360-40(1). [1] Macmillan Publishers Australia, The Macquarie Dictionary online, accessed 16 June 2021. [2] Macmillan Publishers Australia, The Macquarie Dictionary online, accessed 16 June 2021. [3] Note that broadly, section 6 of the Corporations Act 2001 defines 'foreign company' as a body corporate that is formed or incorporated in an external territory or outside Australia.

This ruling applies for the following period : | Reasons for decision: Legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated. | Question: Does the Company meet the criteria of an ESIC under subsection 360-40(1)?