Private ruling: Early Stage Innovation Company eligibility
Date of advice: 9 June 2017
Published: October 2017


Relevant facts and circumstances: Background 1. Company A is a proprietary company incorporated in Australia. 2. Company A is an Australian company with a focus on developing 'products’. Company A’s vision is to provide “free energy” 'products’. 3. Company A lodged their company income tax return and research and development (R&D) schedule for the year ending 30 June 20xx on 26 July 20xx and declared the following: a. total income at item 6 of $x.xx b. total expenses at item 6 of $y.yy c. accounting expenditure in item 6 subject to R&D tax incentive of $z.zz added-back at item 7 in the reconciliation statement d. non-deductible expenses of $w.ww added back at item 7 in the reconciliation statement e. deduction for decline in value of depreciating assets of $v.vv subtracted at item 7 in the reconciliation statement, and f. total notional R&D deductions of $z.zz of accounting R&D expenses 4. 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. Research Collaboration Agreement 5. Company A entered into a Research Collaboration Agreement ('Agreement’) with University B, to collaborate on the design and implementation of a control interface to the 'product’. 6. The effective date of the agreement is 1 X 201X and it was executed by authorised representatives of Company A and University B. 7. Company A hypothesise that a new category of 'product’ can be developed from their research, which is price competitive with similar 'products’. Information provided 8. 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 xxx 201X b) Research Collaboration Agreement between Company A and University B c) Information describing the research and development on the 'product’ d) Our phone conversation with your representative XX on xxx 201x. 9. We have referred to the relevant information within these documents/discussions 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. | Detailed Reasoning - Qualifying Early Stage Innovation Company: 10. 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’: 11. 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): 12. 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). 13. 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. 14. 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): 15. 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): 16. 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): 17. 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: 18. 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: 19. 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. A company can choose to self-assess that it has the points mentioned in an item, in the table within section 360-45. | Detailed Reasoning - 'PRINCIPLES-BASED TEST’ – subparagraphs 360-40(1)(e)(i) to (iv): 20. 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. 21. 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. 22. The five requirements of the principles-based test, as outlined in paragraph 360-40(1)(e) are: i. the company must be genuinely focused on developing 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 - TEST TIME: 23. For the purposes of this ruling, the test time for determining if Company A is a qualifying ESIC will be a particular date on or after 1 July 20xx, but before 30 June 20xx. | Detailed Reasoning - Current year: 24. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the current year will be the year ending 30 June 2017 (the 2017 income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last 3 income years will include the years ending 30 June 20xx, 20xx and 20xx. | Detailed Reasoning - Incorporation or Registration – paragraph 360-40(1)(a) ITAA 1997: 25. Company A was incorporated on xx 20xx, which is within the 3 income years outlined above, therefore the requirements of subparagraph 360-40(1)(a)(i), as set out in paragraphs 12 through to 14 above, are satisfied. | Detailed Reasoning - Total expenses – paragraph 360-40(1)(b) ITAA 1997: 26. In applying the requirements of paragraph 360-40(1)(b) as set out in paragraph 15 above, 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. 27. Company A did not own any 100% subsidiaries during the 20xx income year. 28. The total expenses incurred by Company A in the 20xx income year was less than $1 million, so paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income – paragraph 360-40(1)(c) ITAA 1997: 29. In applying the requirements of paragraph 360-40(1)(c) as set out in paragraph 16 above, Company A and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the income year before the current year. 30. Company A did not own any 100% subsidiaries during the 20xx income year. 31. The total assessable income reported by Company A for the 20xx income year was less than $200,000, so paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No Stock Exchange listing – paragraph 360-40(1)(d) ITAA 1997: 32. In applying the requirements of paragraph 360-40(1)(d) as set out in paragraph 17 above, Company A must not be listed on any Stock Exchange in Australia or a foreign country at the test time. 33. Company A is not listed on any Stock Exchange in Australia or a foreign country, so paragraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: 34. Company A will satisfy the early stage test for the entire 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: 35. Company A considers that it will be able to satisfy the 100 point test by conducting research and development activities and by having a written agreement with University B. The Commissioner has not considered the evidence provided by Company A, and as such, Company A is entitled to self- assess whether it satisfies this test. | Detailed Reasoning - THE 'PRINCIPLES-BASED TEST’ – paragraph 360-40(1)(e) ITAA 1997: 36. As Company A expects to satisfy the 100 point test, the Commissioner has not considered evidence of the company satisfying the Principles Based test under section 360-40 for the year ending 30 June 20xx. | Detailed Reasoning - CONCLUSION: As Company A has satisfied the early stage test, the company must also satisfy the objective (100 point) test or the principles-based test to be considered an ESIC.