Private ruling: Early stage innovation company
Date of advice: 10 February 2021
Published: April 2021
Ruling period: Year ended 30 June 20XX | Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: For the years ended 30 June 20XX and 30 June 20XX 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 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: 1. The Company was incorporated in the 20XX income year. 2. The Company has one subsidiary. The entity has remained dormant as at the date of this ruling submission. 3. The Company is not listed on any stock exchange. 4. The Company and its subsidiary incurred expenditure for the years ended 30 June 20XX, 20XX, 20XX and 20XX totalling less than $1 million. 5. For the year ended 30 June 20XX the Company had assessable income of less than $200,000. 6. For the year ended 30 June 202XX the Company and its subsidiary had no assessable income. 7. The Company is aiming to commercialise its patented technology. The product is an Australian product made according to proprietary techniques that can be used in treating certain diseases and disorders. 8. The Company holds patents for the manufacturing processes across Australia and various other countries, with patents pending elsewhere. 9. The Company plans to develop the product for treatment of these conditions and will seek to licence intellectual property (IP) for use in other conditions. 10. The Company is in the clinical stages of developing the product. 11. The Company's product is significantly farther ahead in clinical development than any other known product for commercial indications. The key competitive advantage will be its first-mover advantage when compared to competitors, in addition to its patents across Australia and multiple other countries. Relevant legislative provisions Income Tax Assessment Act 1997 Subdivision 360-A 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. Summary The Company meets the eligibility requirements of an ESIC under subsection 360-40(1). Detailed reasoning | Detailed Reasoning - Qualifying Early Stage Innovation Company: 1. 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': 2. 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): 3. 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). 4. 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. 5. 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): 6. 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): 7. 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): 8. 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: 9. 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. The Company has applied for this ruling on the basis that it meets the principles-based test. | Detailed Reasoning - 'Principles-based test' - subparagraphs 360-40(1)(e)(i) to (v): 10. 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. 11. 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. 12. 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: 13. 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..." [1] 14. 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. 15. 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. 16. The OECD Oslo Manual defines innovations as significant changes, with the intention of distinguishing significant changes from routine minor changes. An innovation can also consist of a series of smaller incremental changes that together constitute a significant change. [2] 17. 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. 18. The EM does not define the meaning of the term 'genuinely focussed' within the context of subparagraph 360-40(1)(e)(i). Genuine is defined in the online Macquarie Dictionary as " Being truly such; real; authentic ." Focus is defined as " 3. a central point, as of attraction, attention, or activity. ... 8. to concentrate; to focus one's attention. " In essence, the phrase "genuinely focussed" is looking to what the company is truly concentrating and focussing their attention on or, put another way, what is the real central point of the company's activities. 19. 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. 20. 'Commercialisation' is discussed further at paragraph 1.81 in the EM which states "Commercialisation encompasses a spectrum of activities including those leading to the sale of new or significantly improved product, process or service as well as activities involving the implementation of a new, or significantly improved, process or method, where the process or method directly leads to the generation of economic value for the company." | Detailed Reasoning - High growth potential: 21. 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: 22. 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, 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. | Detailed Reasoning - Broader than local market: 23. 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: 24. 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 - Application to your circumstances: Test time 25. For the purposes of this ruling, the test time for determining if The Company is a qualifying ESIC will be a particular date during the income years ended 30 June 20XX and 20XX. Current year 26. For the purposes of subsection 360-40(1), the current year will be either the year ended 30 June 20XX (the 20XX income year) or the year ended 30 June 20XX (the 20XX income year), depending which year is being tested. For clarity, in relation to particular requirements within subsection 360-40(1), the last three income years will include: • for the 20XX income year - the years ended 30 June 20XX, 20XX and 20XX, and the income year before the current year will be the year ended 30 June 20XX (the 20XX income year). • for the 20XX income year - the years ended 30 June 20XX, 20XX and 20XX, and the income year before the current year will be the year ended 30 June 20XX (the 20XX income year). | Detailed Reasoning - Early stage test: Incorporation or Registration - paragraph 360-40(1)(a) 27. The Company was incorporated in the 2015 income year. 28. The Company does not satisfy subparagraphs 360-40(1)(a)(i) or (iii) as it was not incorporated in Australia or registered on the ABR within the last 3 income years. 29. The Company will need to satisfy the element in subparagraph 360-40(1)(a)(ii). This element is made up of two parts, being time of incorporation and expenses incurred across 3 years by the company and its 100% subsidiaries. 30. The Company satisfies the first requirement of subparagraph 360-40(1)(a)(ii), as it was incorporated in Australia within the last 6 income years. 31. The second requirement of subparagraph 360-40(1)(a)(ii) is that the Company and its 100% subsidiaries must have incurred total expenses of $1 million or less across the last 3 income years before the current year. The relevant 3 income years in this circumstance are the years ended 30 June 20XX, 20XX, 20XX and 20XX. 32. The Company has one 100% wholly owned subsidiary. The combined expenses for the 20XX, 20XX, 20XX and 20XX income years were less than $1 million. 33. As the Company had expenses totalling less than $1 million in the three income years prior to the current year being tested, paragraph 360-40(1)(a)(ii) is satisfied. Total expenses - paragraph 360-40(1)(b) 34. As the Company had expenses below $1 million in each of the respective prior income years, paragraph 360-40(1)(b) is satisfied. Assessable income - paragraph 360-40(1)(c) 35. As the Company's assessable income was less than $200,000 in the 20XX income year and zero in the 20XX income year, paragraph 360-40(1)(c) is satisfied. No stock exchange listing - paragraph 360-40(1)(d) 36. As the Company is privately owned and is not listed on any stock exchange in Australia or a foreign country, subparagraph 360-40(1)(d) is satisfied. Conclusion on early stage test 37. The Company will satisfy the early stage test for the entire 20XX and 20XX income years, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - Principles based test: Developing new or significantly improved innovations - subparagraph 360-40(1)(e)(i) 38. The Company plans to develop, commercialise and market its technology which can be used in treating certain diseases and disorders. The Company plans to maintain operations and ongoing research and development in Australia while gaining global reach for product sales. 39. The Company is in the clinical stages of developing the product for use in disorders and disease. To date, there have been several clinical trials and studies conducted. 40. The Company has entered into a license agreement with a hospital to manufacture the product under special access. 41. As the Company has been undertaking clinical trials in development of a patented product and manufacturing process to meet a currently unmet medical need, it is considered that the Company is developing an innovation. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) 42. To satisfy this part of test, it is not sufficient for a company to have an innovative idea - instead it must be taking or planning to take tangible steps to develop an innovation to the point where it will generate revenue for the company. The pre-commercialisation stage may involve a range of activities such as market research, developing a proof of concept, prototyping, user testing, setting up manufacturing and marketing processes, and other business development activities to prepare for the launch of a product or service. 43. In order to commercialise the technology, the Company intends to apply for Therapeutic Goods Administration (TGA) for marketing approval to supply its product to treat disease. 44. Furthermore, the Company has entered into a license agreement with a hospital to manufacture its product under special access. 45. Based on the above, the Company is clearly genuinely focussed on developing the innovation for commercial purposes. Therefore, subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 1 July 20XX until 30 June 20XX. Conclusion on subparagraph 360-40(1)(e)(i) 46. The Company is genuinely focussed on developing the product and manufacturing process for a commercial purpose. The process is an innovation and consequently subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 1 July 2018 until 30 June 2020. High growth potential - subparagraph 360-40(1)(e)(ii) 47. Once commercialised, the product will have the potential to access a significant share of global markets. 48. In short, with TGA approval, there is potential for high growth in the global market. 49. The Company can reasonably demonstrate a high growth potential exists. Subparagraph 360-40(1)(e)(ii) is satisfied. Scalability - subparagraph 360-40(1)(e)(iii) 50. Scalability is evidenced through the Company's major focus on scaling up its manufacturing ability to ensure commercial demands will be able to be satisfied upon receiving regulatory approvals. Due to the Company's particular focus in ensuring it will be able to mass produce the product it will be able to benefit from the improved gross margins achieved through increased demand due to minimal increase in variable costs. 51. It is accepted that the Company can demonstrate the potential to successfully scale up its business. Subparagraph 360-40(1)(e)(iii) is satisfied. Broader than local market- subparagraph 360-40(1)(e)(iv) 52. The Company has plans to commercialise the product globally via out-license arrangements with global partners, primarily in the EU and the USA. 53. In short, the market for the Company's product is broader than the local market. Subparagraph 360-40(1)(e)(iv) is satisfied. Competitive advantages - subparagraph 360-40(1)(e)(v) 54. The Company's product is significantly farther ahead in clinical development than any other for the conditions it is intended to treat. The Company therefore will enjoy the benefit of first-mover advantage. 55. Further, the Company holds patents for the manufacturing processes across Australia and other countries. 56. These factors demonstrate the potential for the product to have competitive advantages, satisfying subparagraph 360-40(1)(e)(v). Conclusion on principles test 57. The Company satisfies the principles based test as it satisfies the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period commencing 1 July 20XX until 30 June 20XX. Conclusion 58. The Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 20XX until 30 June 20XX.