Private ruling: Early stage innovation company
Date of advice: 14 May 2021
Published: July 2021
Date scheme commenced: X XX 20XX

Ruling: A1: Yes This ruling applies for the following periods X XX 20XX to y YY 20YY


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: 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 on or after x XX 20XX, 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 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: 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. | 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 2020 income year, being the income year before the current year. 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: 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 assessable income of $yyy 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 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: Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending 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 software platform leveraging ML and AI to address particular issues (the 'Product'). Further, Company A is currently performing integrations with other online platforms that will allow its users to access assistance in real time via the app. This may be self-initiated or suggested, based on activity in the app. Company A believes they have a unique value proposition relative to other services on the market, and in fact has created a new category or service. This is a markedly different proposition to anything that exists on the market. There are no direct competitors to Company A in this space. Company A is utilising significant innovations in developing 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. | Detailed Reasoning - 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. Company A is continuing to execute on their Product pipeline for their target launch date in YY 20YY. Their key remaining features are increasing the capability of the platform. There are a number of tangible steps which are required to be completed into the future, before the Product is considered to be fully developed for commercialisation: • Expanding the platform coverage • Expanded insights engine - greater ability to detect issues • Improved functionality Company A currently has numerous personnel resources developing the Product to the scope outlined above. Company A anticipate that the current programme of development will be completed at the start of the 20ZZ 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' the 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 high growth potential as their Product is easily and infinitely scalable to a global audience. Company A believe there is significant growth potential for their platform, both domestically and internationally. There is global customer demand for solutions that address these particular issues. Company A's technology is designed to be scalable and portable into multiple geographies from a capability perspective. Therefore, whilst some incremental work may be required from a policies and compliance perspective in order to operate in different geographies, the barriers to global expansion are quite low. 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 has provided the following as key factors in their ability to scale up their business: • An experienced starting team - Company A's founder and CEO has built and scaled a number of start-up businesses in the past x years • Company A operates with a range of global partners and under the leadership of their CEO • Company A's founding team also includes a number of seasoned personnel, with deep experience in scaling start-ups. This leverage ensures that Company A has the potential to successfully scale up their 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. Company A has a strong go to market strategy that heavily leverages marketing, and will expand their activities to focus on affiliates and partnerships with businesses with similar customers. Company A do not believe that they have any direct competitors at a global level, as they see their value proposition as distinct from other apps. 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 have submitted that they believe their proposition provides unique benefits to their customers that other products are failing to service in the market. Company A also believe that they can provide this service at a premium price. Company A's pricing can withstand compression, allowing them to compete on both price and quality if and when required. 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 YY20YY. | 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. | 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.

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? | Relevant facts and circumstances | Company A is an Australian proprietary company incorporated in XYZ on x XX 20XX. | Company A's directors are Taxpayer A and Taxpayer B. | For the financial year ending x XX20XX, Company A incurred and earned the following: | 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 a software platform leveraging Machine Learning ('ML') and Artificial Intelligence ('AI') to address particular issues (the "Product'). | The Product will leverage ML / AI technology to engage a broader set of data points to drive insights into the user's issues and provide tailored engagement. | Company A's Product is a software platform contribution that users purchase to assist in addressing particular issues. Company A's app is installed on mobile phones belonging to the users. | The app integrates with their social media accounts and other communications platforms. The integrations enable data to be analysed by Company A's proprietary algorithms. | In Australia, where Company A will seek to incubate in the initial stages of the business, there are a large number of households in a certain demographic according to the last census. | Company A is able to differentiate from their competitors by taking a particular first approach and building a customer experience that users actually want to use. | Company A believes they have a unique value proposition relative to other services on the market, and in fact has created a new category or service. There are no direct competitors to Company A in this particular space. | Company A is continuing to develop their Product which 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: | a. Private Binding Ruling ('PBR') Application, dated y YY 20YY | b. Response to further questions provided | c. Responses to various emails | We have referred to the relevant information within these documents in applying the relevant tests to your circumstances. | You propose to issue new shares in Company A to various investors to assist in funding the continued development and commercialisation of the 'Product'. | REASONS FOR DECISION: All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.