Private ruling: Early Stage Innovation Company - eligibility renewal.
Date of advice: 16 November 2017
Published: April 2018
Ruling period: DDMMYY to 30 YY 20YY
Date scheme commenced: DDMMYY

Ruling: Q1: Does Company A 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 ’)? | A1: Yes

Relevant facts and circumstances: 1. Company A is a proprietary company incorporated and registered in the Australian Business Register on DDMMYY. 2. Company A has issued ordinary shares to various shareholders since its registration in XX 20XX. 3. Company A’s equity interests are not listed for quotation in the official list of any stock exchange, either in Australia or a foreign country. 4. Company A is developing a ‘service’ to bring together third-party vendors on products and services in a market – by consolidating products to a one-stop shop website. 5. In a ruling for a previous period, Company A qualified as an ESIC at relevant test times. The basis for the decision was that the company satisfied the principles based test in respect of the ‘service’ being developed. 6. Since the ruling issued, Company A has continued to develop their ‘service’. They predict that there is still approximately x months of development required before the ‘service’ is fully developed. Company A expects to have a usable prototype by XX 20XX and a completed product closer to YY 20YY. Information provided 7. You have provided a number of documents containing detailed information in relation to Company A, including: a. Private Binding Ruling (‘PBR’) Application, dated XX XX 20XX b. Appendix A – A Memorandum to Company A’s Director, dated Y YY 20YY c. Responses to further information as requested by the ATO d. Responses to numerous telephone conversations and emails 8. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances.

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: Company A meets the eligibility requirements of an ESIC pursuant to subsection 360-40(1). | Detailed Reasoning - Qualifying Early Stage Innovation Company: 9. 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. ‘ The early stage test’ 10. 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): 11. 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). 12. 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. 13. 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): 14. 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): 15. 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): 16. 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: 17. 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: 18. 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): 19. 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. 20. 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. 21. 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 - TEST TIME: 22. For the purposes of this ruling, the ‘test time’ for determining if Company A is a qualifying ESIC, will be upon the issue of qualifying shares on a particular date or dates on or after DDMMYY and on or before 30 YY 20YY. | Detailed Reasoning - Current year: 23. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the current year will be the year ending 30 June 2018 (the 2018 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 2018, 2017 and 2016, and the income year before the current year will be the year ending 30 June 2017 (the 2017 income year). | Detailed Reasoning - Incorporation or Registration – paragraph 360-40(1)(a) ITAA 1997: 24. Company A was incorporated on X XX 20XX, 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: 25. In applying the requirements of paragraph 360-40(1)(b), Company A and any of its 100% subsidiaries must have incurred total expenses of $1 million or less in the 2017 income year, being the income year before the current year. 26. Company A incurred expenses of $xx.00 in the 20XX income year. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income – paragraph 360-40(1)(c) ITAA 1997: 27. In applying the requirements of paragraph 360-40(1)(c), Company A and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the 2017 income year, being the income year before the current year. 28. Company A earned $yy.00 assessable income in the 2017 income year. Consequently, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No Stock Exchange listing – paragraph 360-40(1)(d) ITAA 1997: 29. In applying the requirements of paragraph 360-40(1)(d), Company A must not be listed on any Stock Exchange in Australia or a foreign country at the test time. 30. Company A was not listed on any Stock Exchange in Australia or a foreign country at either test time, so paragraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: 31. Company A satisfies the early stage test for the 2018 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: 32. Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 2018. For Company A to be a qualifying ESIC, it will need to satisfy the principles-based test. | Detailed Reasoning - THE ‘PRINCIPLES-BASED TEST’ – paragraph 360-40(1)(e) ITAA 1997: 33. In a ruling for a previous period, the Commissioner concluded that Company A satisfied the principles based test in respect of the ‘service’ being developed. While the ‘service’ is still being developed, Company A will continue to satisfy the requirements of the principles based test, within subparagraphs 360-40(1)(e)(i) to (v). 34. Since the previous ruling was issued, Company A has completed integrations with Company B and Company C and now has the ability to provide various options.. 35. For the 2018 financial year, Company A plans to integrate with other partners such as Company D, Company E, Company F, Company G and Company H, as well as various individual partners. 36. Company A are now collating additional information to be provided to its customers. 37. Company A have recently hired 2 additional full-time front-end developers to assist with the development of the ‘service’. Company A expect a usable prototype by XX 20XX and a completed product closer to YY 20YY. | Detailed Reasoning - CONCLUSION FOR PRINCIPLES BASED TEST: Company A satisfies the principles based test as it will satisfy the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period commencing 1 July 2017 until 30 June 2018, or the date when their ‘service’ has been fully developed and is ready for client use, whichever occurs earlier.

REASONS FOR DECISION: All legislative references are to the Income Tax Assessment Act 1997 ( ITAA 1997 ) unless otherwise stated.