Private ruling: Early stage innovation company eligibility
Date of advice: 22 February 2022
Published: May 2022
Ruling period: XX XX 20XX to XX XX 20XX
Date scheme commenced: XX XX 20XX

Ruling: Q1: Does Company A meet the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the Income Tax Assessment Act 1997 ('ITAA 1997') for the period XX XX 20XX to XX XX 20XX? | 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. Company A is a proprietary company incorporated in XYZ on XX XX 20XX. Company A's directors are Taxpayer A and Taxpayer B. Company A's registered office and principal place of business is situated at XYZ. Company A has no wholly or partly owned subsidiaries. Company A is not part of an income tax consolidated group. For the financial year ending XX XX 20XX, Company A incurred and earned the following: • Total expenses of $xyz • Total income of $zyx For the financial year ending XX XX 20XX, Company A incurred expenses of $xyz. For the financial year ending XX XX 20XX, Company A incurred expenses of $zyx. 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 developing three innovative products, as follows: • Product 1 : This is a business-to-business 'Software as a Service' ('SaaS') application that is used by particular professionals and their support teams. • Product 2 : An 'Integration Platform as a Service' ('IPaaS') that will provide a range of capabilities. • Product 3 : A solution tailored to the needs of particular professionals. Company A has conducted prototyping and a pilot in 20XX and 20XX with approximately X users across the industry. Active engagement program conducted with users to provide feedback and insight on a broad range of issues. Company A is developing their Products to address a number of discrete markets and is continuing to develop their Products. Company A has outlined a commercialisation strategy which includes significant engagement with the local industry leaders and associations to understand both the extreme diversity of practices across the industry and core compliance challenges experienced in the industry and have conducted extensive international research to ensure the needs of global markets were understood and product developments were configurable to international requirements. Company A's Products have been identified as having an international addressable market. Company A has conducted a number of activities to scale up their business through strategic partnerships & pilots and are marketing their Products through various channels. Company A's Products are already suitable for the entire Australian market. In addition, they are not specifically tied to the Australian market and can be successfully ported to any other attractive market. Each of Company A's Products have a competitive advantage. Product 1 has four key elements that gives this Product a strong competitive advantage - flexibility, simplicity, depth and intelligence. Product 2 - In the particular business market, there is currently no "app independent" API on the market. Product 3 - there is no industry specific application available in the Australian particular market. Company A propose to issue new shares to various investors to assist in funding the continued development and commercialisation of their 'Products'. Information provided You have provided a number of documents containing detailed information in relation to Company A's Products, including: • Private Binding Ruling ('PBR') Application, dated XX XX 20XX • Response to further questions provided 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: All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated. Company A meets the eligibility requirements of an ESIC under subsection 360-40(1) for the period XX XX 20XX to XX XX 20XX. | 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 any 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 any 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 any 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 on or after XX XX 20XX, and on or before XX XX 20XX. | Detailed Reasoning - Current year: Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the current year will be the year ending XX XX 20XX (the 20XX income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last 6 income years will include the years ending XX XX 20XX, 20XX, 20XX, 20XX, 20XX and 20XX and the income year before the current year will be the year ending XX XX 20XX (the 20XX income year). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a) ITAA 1997: Company A was incorporated in XYZ on XX XX 20ZZ, which is within the x income years outlined above, and across the last y of those years before the current year, it and its subsidiaries incurred total expenses of $1 million or less, therefore the requirements of subparagraph 360-40(1)(a)(ii) are satisfied. | 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 income year, being the income year before the current year. Company A incurred expenses of $xyz in the 20XX income year. Consequently, paragraph 360-40(1)(b) is satisfied. | 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 income year, being the income year before the current year. Company A earned $xyz in 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: 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 the test time, so paragraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: Company A 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' - 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 year ending XX XX 20XX. 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 three innovative products, as follows: • Product 1 : This is a business-to-business 'Software as a Service' ('SaaS') application that is used by particular professionals and their support teams. • Product 2 : An 'Integration Platform as a Service' ('IPaaS') that that will provide a range of data integration and data management capability. • Product 3 : A powerful and flexible data visualisation solution tailored to the needs of particular professionals. Company A has conducted prototyping and a pilot in 20XX and 20XX with approximately X users across the industry. Active engagement program conducted with users to provide feedback and insight on a broad range of issues. Company A is developing their application to address a number of discrete markets and is continuing to develop their Products. Company A is genuinely focussed on developing their Products for an applicable addressable market. 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. Progress made by Company A in their commercialisation strategy is as follows: • Product 1 : This Product is currently in the market with strong early revenue growth. This Product is competing in a new market segment with outdated and inferior solutions and other very early market entrants. • Product 2 : Company A have developed a range of capability that supports their application. This has been developed in a standalone manner to enable a separate offering and business model. • Product 3 : A non-integrated free Minimum Viable Product of this solution is already being supplied to Company A's clients since mid-20XX as part of their digital fact find. AdviceRev are collecting user feedback to develop the solution in line with professionals' needs. Further details of Company A's commercialisation strategy are: • Significant engagement with the local industry leaders and associations to understand both the extreme diversity of practices across the industry and core compliance challenges experienced in the industry. • International research conducted to ensure the needs of global markets were understood and product developments were configurable to international requirements. • These activities enabled Company A to: - Understand the current gaps in the market and target their innovations on core problems experienced across global markets. - Develop a deeper understanding of the current and evolving compliance requirements that needed to be considered in the development of their solutions. - Appreciate the key dimensions of diversity across the industry and leverage this to design their solution such that it caters for this diversity and enables their solution to be attractive to the broadest possible range of industry practitioners. - Develop strong relationships that have been a source of leverage and connection as they have progressed with their product development and market entry. | Detailed Reasoning - Conclusion on subparagraph 360-40(1)(e)(i): 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 XX XX 20XX to XX XX 20XX, or the date when all Products have been fully developed and are ready for client use, whichever occurs earlier. Once each Product has been fully developed, Company A will no longer be 'developing' that product for commercialisation. | 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 high growth potential as their Products are easily and infinitely scalable to a global audience. Company A has high growth potential as they will target two key broad markets globally with their Products, being: • Particular Professionals, and • Their support teams In developing the differentiation in Products 1 and 3, Company A have leaned on two core strengths: • Having an Adviser as Chief Product Officer and Chief Technology Officer • Their combined set of industry relationships, set across current and future leaders of the industry Thanks to these strengths, Company A managed to shorten the product development cycle by reducing the need for communication between parties. Company A's ability to put the product design through faster and more effective design cycles enables them to deliver a product that is strongly differentiated from their competition, cheaper to develop, and extremely well received by practitioners. Company A has demonstrated a high growth potential for their Products, so subparagraph 360-40(1)(e)(ii) is satisfied for the period XX XX 20XX to XX XX 20XX. | 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 has conducted a number of activities to scale up their business, in relation to the launch of their Products with strategic partnerships and pilots, which provide considerable leverage to Company A. 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 XX XX 20XX to XX XX 20XX. | 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. Company A's Products are already suitable for the entire Australian market. In addition, they are not specifically tied to the Australian market and can be successfully ported to any other attractive market. The timeline for Company A's global expansion is as follows: • Inception years - Prototyping and free pilot of prototype with X users • 20XX - Initial domestic market entry • 20XX - Evolution of application and the release of Product 3 domestically • 20XX - Launch Product 2 as standalone capability in Australia (sales start) • 20XX - Global expansion of Product 2 begins with overseas market entry • Beyond - Expansion into further global region 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 XX XX 20XX to XX XX 20XX. | 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. Each of Company A's Products have a competitive advantage as follows: Product 1 : There are four key elements to Company A's product differentiation that gives their product a strong competitive advantage and enables them to meet the needs of the market that none of their competitors have been able to achieve: - Flexibility - Company A's solution can be configured to meet the individual practitioner's or the end-user's needs, using simple settings frameworks. - Simplicity -Company A's product has been designed to be incredibly simple to use. This is highly important as the biggest barrier to adoption of these solutions is the human change required to adopt the technology. - Integration depth - The data set that is used for this particular field is incredibly broad and deep. Competitors have integrated directly with other applications. (instead of creating an 'Integration Platform as a Service') and have not for a - Intelligence -Company A are actively scoping out a range of ways that they can develop machine learning within their system. Product 2 : In this particular business market, there is currently no "app independent" API on the market that enables the translation between various applications. Product 3 : There is no industry specific application available in the particular Australian market. Company A has demonstrated that it has competitive advantages for its business, so subparagraph 360-40(1)(e)(v) is satisfied for the period XX XX 20XX to XX XX 20XX. | 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 XX XX 20XX to XX XX 20XX, or the date when their Products have been fully developed and are 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. | Detailed Reasoning - CONCLUSION: Company A meets the eligibility criteria of an ESIC under section 360-40 for the period XX XX 20XX to XX XX 20XX, or the date when their Products have been fully developed and are ready for client use, whichever occurs earlier.

Tax incentives for Early Stage Investors | [1] Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.79.