Private ruling: Early stage innovation company eligibility
Date of advice: 7 October 2021
Published: December 2021
Ruling period: X XX 20XX to z ZZ 20ZZ | Z ZZ 20ZZ 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') for the period x XX 20XX to y YY 20YY? | A1: Yes

Relevant facts and circumstances: Company A is an Australian proprietary company incorporated in XYZ on y ZZ 20XX. Company A's director is Taxpayer A. Company A's registered office and principal place of business is situated at XYZ. For the financial year ending x XX 20XX, Company A incurred and earned the following: • Total expenses of $xx • Total income of $yy For the financial year ending z ZZ 20ZZ, Company A incurred and earned the following: • Total expenses of $xx • Total income of $yy 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. Company A is not part of a tax consolidated group, nor planning to join a tax consolidated group. Progressively, wholly owned trading subsidiaries will be established in key target markets in XXX and YYY. Company A will retain beneficial ownership of Intellectual Property ('IP'), software and enabling technology developed in-house at all times, through either subsidiaries or via contracted third party suppliers. Company A is developing a digital services platform ('the Product'), catering to particular markets. Company A's digital platform will bring marketplace transparency, equity and liquidity for retailers and wholesalers represented by and transacting on the platform. Company A will generate fee income from transaction volumes executed and settled across the platform. Company A is developing their digital services platform to address a number of discrete markets and is continuing to develop their Product. Company A's Product has been identified as having an international addressable market. Information provided You have provided a number of documents containing detailed information in relation to Company A's Product, including: • Private Binding Ruling ('PBR') Application, dated x YY 20ZZ • Response to further questions provided We have referred to the relevant information within these documents in applying the relevant tests to your circumstances. Company A has issued shares to various investors in the year ending z ZZ 20ZZ and they propose to issue further shares to additional investors during the year ending y YY 20YY to assist in funding the continued development and commercialisation of their 'Product'. 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

Reasons for decision: Summary: Company A meets the eligibility requirements of an ESIC pursuant to subsection 360-40(1) of the Income Tax Assessment Act 1997 for the period x XX 20XX to y YY 20YY. | 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 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 - subparagraph 360-40(1)(e)(i) ITAA 1997: 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 - subparagraph 360-40(1)(e)(ii) ITAA 1997: 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 - subparagraph 360-40(1)(e)(iii) ITAA 1997: 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, whereas 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 - subparagraph 360-40(1)(e)(iv) ITAA 1997: 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 - subparagraph 360-40(1)(e)(v) ITAA 1997: 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 - Foreign Company test - paragraph 360-40(1)(f): At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth). The dictionary in section 9 of the Corporations Act 2001 (Cth) defines a foreign company to mean: (a) a body corporate that is incorporated in an external Territory, or outside Australia and the external Territories, and is not: (i) a corporation sole; or (ii) an exempt public authority; or (b) an unincorporated body that: (i) is formed in an external Territory or outside Australia and the external Territories; and (ii) under the law of its place of formation, may sue or be sued, or may hold property in the name of its secretary or of an officer of the body duly appointed for that purpose; and (iii) does not have its head office or principal place of business in Australia. | Detailed Reasoning - Test time: 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 in the following periods: • After x XX 20XX and on or before z ZZ 20ZZ, and • After z ZZ 20ZZ and on or before y YY 20YY. | Detailed Reasoning - Current year: Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the 'current year' will be the following for the two periods, as follows: • For the year ending z ZZ 20ZZ (the 20ZZ income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last 3 income years will include the years ending z ZZ 20ZZ, 20XX and 20VV, and the income year before the current year will be the year ending x XX20XX (the 20XX income year). • For 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, 20ZZ and 20XX, and the income year before the current year will be the year ending z ZZ 20ZZ (the 20ZZ income year). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a) ITAA 1997: Company A was incorporated in XYZ 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 for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b) ITAA 1997: 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 and the 20ZZ income years, being the income years before the current years. Company A incurred $xx in expenses in the 20XX income year. Company A incurred expenses of $2yy in the 20ZZ income year. Consequently, paragraph 360-40(1)(b) is satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c) ITAA 1997: 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 and the 20ZZ income years, being the income years before the current years. Company A earned $yy in assessable income in the 20XX and the 20ZZ income years. Consequently, paragraph 360-40(1)(c) is satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - No Stock Exchange listing - paragraph 360-40(1)(d) ITAA 1997: 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. Company A is not listed on any Stock Exchange in Australia or a foreign country at any test time, so paragraph 360-40(1)(d) is satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: Company A satisfies the early stage test for the relevant test times, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied for the period x XX 20XX to y YY 20YY. | Detailed Reasoning - THE '100 POINT TEST' - PARAGRAPH 360-40(1)(e) AND SECTION 360-45: Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the years ending z ZZ 20ZZ and y YY 20YY. Company A are 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 applicable addressable market - subparagraph 360-40(1)(e)(i) ITAA 1997: 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. Company A is developing a digital services platform ('the Product'), catering to a particular market. Company A's digital platform will bring marketplace transparency, equity and liquidity for retailers and wholesalers represented by and transacting on the platform. Company A will generate fee income from transaction volumes executed and settled across the platform. Company A believes that they will provide a host of major improvements versus the way most transactions are currently facilitated. At the same time, competitors that have tried to solve some of the pain points have failed to gain significant traction. Company A believes that the reason for this is twofold. Firstly, in order to launch a useful market that makes use of network effects effectively, a sufficient variety of offering is required. Company A address this by closely engaging with industry stakeholders pre-launch and going to market with a broad and strong offering. Secondly, Company A believe that their competitors do not address major pain points effectively, in part due to their attempt to launch a single global market. Company A is developing their digital services platform to address a number of discrete markets and is continuing to develop their Product. Company A is genuinely focussed on developing their Product 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 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. Considerable development has already been undertaken by Company A in developing their Product. In mid-20XX, Company A started meeting with key stakeholders in the particular industry to explore the appetite for, and commercial viability of the proposed platform. After positive stakeholder feedback, Company A commenced its conceptual design work, defining the 'beta phase' key functionality of the platform across Qx and Qy 20XX. Over the same period, the core platform design work was coupled with business formation activities, including formalising the founder team, securing seed funding and establishing organisational business process and team accountability frameworks. Across Qx 20ZZ Company A further intensified their organisational and conceptual platform development, which was designed, iterated and documented using contemporary business process and software design tools. Across Qy 20YY, Company A deepened their engagement with key industry stakeholders through small, self-funded research projects and the launch of their 'Industry Innovator Program' which engages with progressive sellers and buyers to explore their current workflow, interactions, and pain points to assist in the development of the platform. There are a number of steps which are required to be completed into the future, before the Product is considered to be fully developed for commercialisation: Company A anticipates that the current programme of development will be completed in the 20YY financial year. Company A is genuinely focussed on developing their Product for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period x XX 20XX to y YY 20YY, or the date when their Product has been fully developed and is ready for client use, whichever occurs earlier. Once the Product has been fully developed, Company A will no longer be 'developing' their Product for commercialisation and subparagraph 360-40((1)(e)(i) will no longer be satisfied. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997: 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. Company A has extremely high growth potential as their Product is easily scalable to a global audience. Company A's primary commercial aim is to address and fulfil the growing expectation of industry participants; namely, that supply chain processes are digitally enabled and integrated, allow for increased transparency and speed, and are easy to use. Company A has demonstrated a high growth potential for their Product, 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: 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. Company A's Product is a software product, naturally allowing for rapid scaling which will occur in two dimensions: First, the platform will be rolled out in the same domain in several markets and regions. Second, the platform will be applied to different domains. Scaling will occur initially in XXX (20YY), YYY and ZZZ (20WW) and VV (20TT). The scenario also does not include other potentially attractive markets. The first year of operation will only include a half year worth of transactions in XXX. 20TT entails stronger traction in XXX and a launch in YYY and ZZZ. The majority of contribution margin will come from fee income. Company A assumes a x% transaction-based fee for facilitating transactions. Further commercialisation potential lies in premium listings as well as a range of supplementary lines of business. Design, development maintenance expenditure will be ongoing, but only incremental to the original investment. As a result, each unit of revenue growth (after marketing, sales and support costs) will progressively contribute relatively more to Company A's bottom line as they leverage the core platform into regional and global markets. 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: 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. As this particular trading is inherently global, Company A will automatically and immediately address global markets. Company A's engagements with industry stakeholders provide a clear picture: A significant majority of stakeholders that Company A have conducted exploratory interviews with are confident that the future of this particular trade will be facilitated through an online platform. 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: 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. Company A's primary competitor, through its online service, is the only prominent provider of digitised service in the particular market. As a wholly independent platform, first mover advantage will accrue to Company A as it builds out a thick market (established through firstly gaining critical mass in the XXX market, then leveraging 'network effects' to expand) of stakeholders that utilise, inform development and advocate for Company A's capability. 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 x XX 20XX to y YY 20YY, or the date when their Product has been fully developed and is ready for client use, whichever occurs earlier. | Detailed Reasoning - Foreign Company Test - subparagraph 360-40(1)(f) ITAA 1997: As Company A was incorporated in Australia, it is not a Foreign Company and paragraph 360-40(1)(f) is satisfied for the period x XX 20XX to y YY 20YY. | 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, or the date when their Product has been fully developed and is ready for client use, whichever occurs earlier. [1] Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.79.

Reasons for decisions: All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.