Private ruling: Early stage innovation company eligibility
Date of advice: 4 September 2020
Published: October 2020
Ruling period: 1 July 20XX to 30 June 20XX
Date scheme commenced: 10 May 20 XX

Ruling: Q1: Does Company MPty Ltd satisfy the criteria of an Early Stage Innovation Company (ESIC) pursuant to section 360-40 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: The Company is a proprietary limited company incorporated and registered in the Australian Business Register. The Company has no subsidiaries and is not listed on any stock exchange. The Company has prior year expenses of less than $1 million. The Company has prior year income of less than $200,000. The Company is developing a unique product that is reusable across multiple and different markets.

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 | Income Tax Assessment Act 1997 section 360-40(1)(e)(i-v)

Reasons for decision: Detailed Reasoning - Qualifying Early Stage Innovation Company: All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated. | Summary: 'The Company' meets the eligibility requirements of an ESIC under, subsection 360-40(1). | Detailed Reasoning - Qualifying Early Stage Innovation Company: 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: 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): 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). 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, 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: 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 (v): 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. 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 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 - 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..." 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. 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. 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 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. 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: 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: 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, whereby it increases its market share or enters into new markets and its existing revenues can be multiplied with a reduced or minimal increase in operating costs. | 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 - Test time: For the purposes of this ruling, the test time for determining if your Company is a qualifying ESIC will be a particular date during the income year ending 30 June 20XX. | Detailed Reasoning - Current year: For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 20XX (the 20XX 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 20XX, 20XX and 20XX. | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a): Your Company was incorporated in 2019, which is within the last 3 income years. Therefore, subparagraph 360-40(1)(a)(i) is satisfied. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b): 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 20XX income year which is the income year before the current year. The Company incurred expenses of less than $1 million in the 20XX income year. Therefore, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c): 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 income year before the current year. The Company earned assessable income of less than $200,000 in the 20XX income year. Therefore, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No stock exchange listing - 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. As the Company is not listed on any stock exchange in Australia or a foreign country, subparagraph 360-40(1)(d) is satisfied. | Detailed Reasoning - Conclusion on Early Stage Test: The Company satisfies the Early Stage Test for the 20XX income year as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - The 100-Point Test: The Company has not provided sufficient evidence of satisfying the 100-point test under section 360-45 for the year ending 30 June 2020. For the Company to be a qualifying ESIC, it will need to satisfy the Principles-Based Test. | Detailed Reasoning - Developing new or significantly improved innovations for commercialisation - subparagraph 360-40(1)(e)(i): 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. The Company is focused on developing new innovations for commercialisation as it offers an alternative to current products. The Company provides high integrity, cutting edge products and insights that help its clients maximise returns-on-investment. The Company has shown its product is new or significantly improves what is currently in the marketplace. Therefore, subparagraph 360-40(1)(e)(i) is satisfied. | Detailed Reasoning - High Growth Potential - subparagraph 360-40(1)(e)(ii): In applying the requirements of subparagraph 360-40(1)(e)(ii), the Company must be developing an innovation that has a high growth potential. The product is expected to have high growth potential in the Australian and overseas markets within a short period of time. The Company will also strategically expand across Australia and other overseas markets where the potential for growth is huge. The Company has demonstrated that it has high growth potential its product both in Australia and overseas. Therefore, subparagraph 360-40(1)(e)(ii) is satisfied. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii): In applying the requirements of subparagraph 360-40(1)(e)(iii), the Company must demonstrate that it has the potential to successfully scale up the business. The Company's product is to progressively translate the team's industry expertise into scalable and repeatable products that can deliver value for clients. The Company is moving towards a revenue mix that is primarily driven by its product set rather than the team. The Company has demonstrated that it has the potential to scale up its business. Therefore, subparagraph 360-40(1)(e)(iii) is satisfied. | Detailed Reasoning - Broader than Local Market - subparagraph 360-40(1)(e)(iv): In applying the requirements of subparagraph 360-40(1)(e)(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 The Company expects to operate in Australia and overseas. The Company has demonstrated the potential to address a broader than local market. Therefore, subparagraph 360-40(1)(e)(iv) is satisfied. | Detailed Reasoning - Competitive Advantages - subparagraph 360-40(1)(e)(v): In applying the requirements of subparagraph 360-40(1)(e)(v), the Company must demonstrate that it has the potential to have competitive advantages in the business. The Company has no known competitors that offer the same comprehensive, consistent and efficient quantification. The Company is focussed on measurement and insights that relate to the commercial value of its product. The Company has developed proprietary, repeatable and scalable data products to solve challenges more rapidly and more cost efficiently. The Company products provide objective, consistent and market-wide approaches to quantifying and optimising its value. The Company has demonstrated that its product has competitive advantages within its markets. Therefore, subparagraph 360-40(1)(e)(v) is satisfied. | Detailed Reasoning - Conclusion on Principles-Based Test: 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 commencing 1 July 20XX till 30 June 20XX. | Detailed Reasoning - Conclusion: The Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 20XX till 30 June 20XX. [1] Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.79.