Private ruling: Does a company satisfy the criteria of an Early Stage Innovation Company
Date of advice: 18 November 2019
Published: February 2020
Ruling period: X XX 20XX to Y YY 20YY
Date scheme commenced: X XX 20XX

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: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. 1. Company A is a proprietary company incorporated and registered in the Australian Business Register on x XX 20XX. 2. Company A's director is Taxpayer B. 3. Company A is a standalone company with no subsidiaries. 4. For the financial year ending x XX 20XX, Company A incurred and earned the following: · Total expenses of $xx · Total income of $yy 5. 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. 6. Company A is a company which is developing next generation and proprietary strategies for people in a particular class. Description of Company A's business 7. In order to optimise their strategies and management, Company A is planning to structure three independent identities within their company, being Identity A, Identity B and Identity C. 8. Company A is developing three innovations for commercialisation, namely: Product A; Product B and Product C. 9. The Product A products which Company A is developing are specifically formulated to rebalance the needs of people in a particular class. 10. Company A is also aiming to develop Product B, allowing people in a particular class to become independent from their therapy and minimising associated complications. 11. Company A is also developing Product C that will restore the lost function of particular faulty items. 12. Product C and Product A would enable people of a particular class to become problem free. 13. None of Company A's products are available on the market at this stage. Company A's products are still in the discovery/research stage. 14. Company A is planning to apply for government funding to help build and scale-up their research. 15. Company A is planning to progressively build up its operating team. 16. Company A has determined that there are not any other similar services currently available around the world. 17. Company A is developing their products to address a number of discrete markets and is continuing to develop their products. 18. Company A's products have been identified as having an international addressable market. Information provided 19. You have provided a number of documents containing detailed information in relation to Company A, including: a. Private Binding Ruling ('PBR') Application dated x XX 20XX. b. Your replies to our further information requests, including details of development work being undertaken and relevant financial statements. 20. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances. Assumption(s) Not applicable.

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 Further issues for you to consider | Not applicable.

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: 21. 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': 22. 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): 23. 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). 24. 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. 25. 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): 26. 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): 27. 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): 28. 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: 29. 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: 30. 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): 31. 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. 32. 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. 33. 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 - Developing new or significantly improved innovations for commercialisation: 34. 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..." 35. 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. 36. 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. 37. 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." 38. 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. 39. 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: 40. 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: 41. 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: 42. 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: 43. 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: 44. 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 x XX 20XX, and on or before y YY 20YY. | Detailed Reasoning - Current year: 45. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the current year will be the year ending y YY 20YY (the 20YY income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last 3 income years will include the years ending y YY 20YY, 20XX and 20ZZ, and the income year before the current year will be the year ending x XX 20XX (the 20XX income year). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a) ITAA 1997: 46. 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: 47. 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 20XX income year, being the income year before the current year. 48. Company A incurred expenses of $xxx in the 20XX income year. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c) ITAA 1997: 49. 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 20XX income year, being the income year before the current year. 50. Company A earned nil assessable income in the 20XX income year. Consequently, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No Stock Exchange listing - paragraph 360-40(1)(d) ITAA 1997: 51. 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. 52. Company A was not listed on any Stock Exchange in Australia or a foreign country at any test time during the 20XX-YY year, so paragraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: 53. Company A satisfies the early stage test for the 20YY 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: 54. Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending y YY 20YY. For Company A to be a qualifying ESIC, it will need to satisfy the principles-based test. Company A is electing to seek eligibility by satisfying the Principles based Innovation test under section 360-40(1)(e)(i)-(v), in order to be issued with a Private Binding Ruling. | Detailed Reasoning - Developing new or significantly improved innovations for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997: 55. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be developing an innovation which is either new or significantly improved for an applicable addressable market. 56. Company A is developing three innovations for commercialisation, namely: Product A, Product B and Product C. 57. The Product A products which Company A is developing are specifically formulated to rebalance the needs of people in a particular class. 58. Company A is also aiming to develop Product B allowing people in a particular class to become independent from their therapy and minimising associated complications. 59. Company A is also developing Product C that will restore the lost function of particular faulty items. 60. Company A has pursued the establishment of Product D. The Product D intellectual property was patented and commercialised in 20VV and subsequently assigned to Company A at the end of 20WW. 61. Company A will use Product D for further development as potential sources. 62. The proprietary Product D technology platform, in contrast to those from other international competitors, is focused on developing solutions to the particular issue. 63. The Product D technology suggests that it is ideally positioned to develop particular items in this class. 64. Company A is genuinely focused on developing their products for an applicable addressable market, so subparagraph 360-40(1)(e)(i) is satisfied for the period x XX 20XX to y YY 20YY. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997 65. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be genuinely focussed on developing an innovation for a commercial purpose in order to generate economic value and revenue for the company. 66. In order to optimise their strategies and management, Company A is planning to structure three independent identities within the company, being Identity A, Identity B and Identity C. 67. Company A will progressively build up its operating team to ensure the successful launch and scale-up of Product A business. 68. Company A is focused on development and has provided a timeline for their proposed research program: i. For Year 1 and 2, they will be developing further techniques for the effective development of Product A, Product B and Product C. ii. Following the successful conclusion of these projects, Company A will be initiating and conducting fast-tracked trials of the products that would ultimately lead to the achievement of the following objectives for people in a particular class: a. Safe, effective and cost-acceptable treatment b. Being free from certain products c. Restoring a normal lifestyle d. Eliminating unawareness episodes e. Eliminating severe complications f. Minimising the effect on life expectancy 69. Company A is genuinely focussed on developing their products for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997: 70. In applying the requirements of subparagraph 360-40(1)(e)(ii), Company A must be able to demonstrate that it has the potential for high growth within a broad addressable market. 71. Company A has predicted that it will have net income of $xyz before tax for the Product A products in x years in Australia alone, thereby indicating a high growth potential within a broad addressable market. 72. The key customers for the products would be various companies in Australia, and similar schemes in other countries as the issue is spread world-wide, allowing Company A to rapidly expand its business. 73. Company A has demonstrated a high growth potential for their products, so subparagraph 360-40(1)(e)(ii) is satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997: 74. In applying the requirements of subparagraph 360-40(1)(e)(iii), Company A must be able to demonstrate that it has the potential to successfully scale up the business. 75. Company A will create a tri-business self-accelerating model with an aim to reduce risks and capital requirements, thereby providing power for exponential growth and the potential to successfully scale up the business relating to the products. 76. Company A will apply for funding to help build-up and scale-up their product development. 77. Company A's targeted customers include various companies in Australia and similar schemes in other countries. 78. Company A will aim to increase its market share and to enter into new markets and its existing revenues will be multiplied with a reduced /minimal increase in operating costs, thereby increasing its operating leverage. 79. This leverage ensures that Company A has the potential to successfully scale up its business, so subparagraph 360-40(1)(e)(iii) is satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997: 80. In applying the requirements of subparagraph 360-40(1)(e)(iv), Company A must be able to demonstrate that it has the potential to be able to address a broader than local market, including global markets. 81. Company A indicates that its product will be suitable for people of a particular class from all over the world, therefore it has the potential to address a market that is broader than a local city, area or region. 82. As the relevant issue is prevalent all over the world, Company A will be 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. 83. Company A has demonstrated that it has the capacity to address a broader than local market, so subparagraph 360-40(1)(e)(iv) is satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v) ITAA 1997: 84. In applying the requirements of subparagraph 360-40(1)(e)(v), Company A must demonstrate that it has potential to be able to have competitive advantage for that business. 85. Company A has not identified any direct competitors in the current market. 86. Company A states that its technology is more advanced than those that are currently available in the market, and so considers that it has a differentiating advantage that will allow it to outperform its competitors. 87. Company A considers that this differentiating advantage over its competitors will be sustainable as the company expands its business. 88. Company A has demonstrated that it has competitive advantages over its competitors, so subparagraph 360-40(1)(e)(v) is satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - CONCLUSION FOR PRINCIPLES BASED TEST: Company A satisfies the principles based test as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period commencing x XX 20XX until y YY 20YY, or the date when their Product A, Product B and Product C have been fully developed and are ready for client use, whichever occurs earlier. | Detailed Reasoning - CONCLUSION: Company A meets the eligibility criteria of an ESIC under section 360-40 for the period x XX 20XX to y YY 20YY.

REASONS FOR DECISION: All legislative references are to the Income Tax Assessment Act 1997 ( ITAA 1997 ) unless otherwise stated. | Tax incentives for Early Stage Investors