Private ruling: Early stage innovation company
Date of advice: 20 June 2023
Published: 7 August 2023
Ruling period: Year ending 30 June 2023
Date scheme commenced: 13 August 2021

Ruling: Q1: Does XXXX meet the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the Income Tax Assessment Act 1997 for the financial year ending 30 June 2023? | A1: Yes

Relevant facts and circumstances: Company A Pty Ltd (Company A) is an Australian tax resident company that was incorporated on DD/MM/XXXX. As at 30 June YYYY a total of 1,200,000 ordinary shares have been issued since incorporation, for a total paid-up amount of $120. Company A has a single shareholder: 1,200,000 ordinary shares are held by Company B Pty Ltd as trustee for the for B Trust; No equity interests in Company A are, or have ever been, listed on any Australian or foreign stock exchange and Company A does not intend to list any equity interests on any Australian or foreign stock exchange prior to 30 June ZZZZ. Company A has acquired 100% of the share capital of three subsidiaries since incorporation: • Company C Pty Ltd • Company D Pty Ltd • Company E Pty Ltd Company A incorporated the following wholly owned subsidiaries: • Company F Pty Ltd on DD/MM/XXXX • Company G Pty Ltd on DD/MM/ZZZZ The founder, AA, is the sole director of Company A and all subsidiary companies. Financial Information For the income year ended 30 June YYYY, Company A and all subsidiaries (collectively the Company A Group): • Had total assessable income of $0 • Incurred total expenses of less than $1 milllion The above amounts of income and expenses incurred agree to the amounts declared in the income tax returns lodged for the income year ended 30 June YYYY for Company A and its subsidiaries (where applicable). In respect of the financial years ended 30 June ZZZZ and 30 June WWWW Company A has forecast the following: • Financial year ended 30 June ZZZZ: Turnover of $X and operating profit of $XX • Financial year ended 30 June WWW: Turnover of $Y and operating profit of $YY Company A has not received an Accelerating Commercialisation Grant known as the Entrepreneur's Program. Overview The Company A Group (Group) was established for the sole purpose of developing technology AAA. AA has extensive experience in the technology. Development of new or significantly improved innovations XXXX. Genuinely focussed on developing innovations for Commercialisation XXXX. High Growth Potential XXXX. Scalability XXXX. Broader than local market XXXX. Competitive Advantages XXXX.

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 criteria of an ESIC under subsection 360-40(1) of the ITAA 1997 for the year ending 30 June ZZZZ. | Detailed Reasoning - Detailed reasoning: Subsection 360-40(1) ITAA 1997 outlines the criteria required for a company to qualify as an ESIC at a particular time in an income year. This time is referred to as the test time. For an investor to consider entitlements to the tax incentives, the company must qualify as an ESIC immediately after the new shares are issued to the investor. If the company no longer meets the ESIC requirements after this test time, this won't affect the investor's potential entitlement to the early stage investor tax incentives. The criteria are based on a series of tests to identify if the company is at an early stage of its development, and if it is developing new or significantly improved innovations to generate an economic return. | Detailed Reasoning - Early Stage Test: The early stage test requirements are outlined in detail within subsections 360-40(1)(a) to (d). | Detailed Reasoning - Incorporation or Registration - s360-40(1)(a): To meet the requirement in subsection 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 - subsection 360-40(1)(b): To meet the requirement in subsection 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 - subsection 360-40(1)(c): To meet the requirement in subsection 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 - subsection 360-40(1)(d): To meet the requirement in subsection 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 - subsection 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 - subsections 360-40(1)(e)(i) to (v): To satisfy the principles-based test, the company must meet five requirements in subsections 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 subsections 360-40(1)(e) are: i. the company must be genuinely focused on developing one or more new or significantly improved innovations for commercialisation 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 - subsection 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. 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. 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 company must be genuinely focused 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. '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 - subsection 360-40(1)(e)(ii): The company must be able to demonstrate that it has the potential for high growth 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 - subsection 360-40(1)(e)(iii): The company must be able to demonstrate that it has the potential to successfully scale up the business. 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 per unit. | Detailed Reasoning - Broader than local market - subsection 360-40(1)(e)(iv): 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 - subsection 360-40(1)(e)(v): 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 - subsection 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). 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 1 July YYYY and on or before 30 June ZZZZ. | Detailed Reasoning - Current year: For the purposes of subsection 360-40(1), the current year will be the year ending 30 June ZZZZ (the ZZZZ income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last three income years will include the years ending 30 June ZZZZ, YYYY and XXXX, and the income year before the current year will be the year ending 30 June YYYY (the YYYY income year). | Detailed Reasoning - Early Stage Test: Incorporation or Registration - subsection 360-40(1)(a) Company A was incorporated in Australia on 13 August XXXX, which is within the last three income years (the latest being the current year). Therefore, the requirements of s360-40(1)(a)(i) are satisfied. | Detailed Reasoning - Total expenses - subsection 360-40(1)(b): 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 YYYY income year, being the year before the current income year. Company A and its subsidiaries incurred total expenses of $904,477 for the year ended 30 June YYYY. Therefore, s360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - subsection 360-40(1)(c): In applying the requirements of s360-40(1)(c), Company A and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the YYYY income year. Company A and its subsidiaries did not derive any assessable income in the YYYY income year. Therefore, s360-40(1)(c) is satisfied. | Detailed Reasoning - No stock exchange listing - subsection 360-40(1)(d): In applying the requirements of subsection 360-40(1)(c), Company A must not be listed on any Stock Exchange in Australia or a foreign country at the test time. Company A was not listed on any stock exchange in Australia or a foreign country at the test time. Therefore, s360-40(1)(d) is satisfied. | Detailed Reasoning - Conclusion for Early Stage Test: Company A satisfies the early stage test for the entire 'test time', as each of the requirements within s360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - 100 Point Test s360-40(1)(e) and s360-45: Company A has not sought to be tested against the 100-point test under section 360-45 for the 'test period'. Company A is electing to seek eligibility by satisfying the principles-based innovation test under subsections 360-40(1)(e)(i)-(v) in order to be issued with a Private Binding Ruling. | Detailed Reasoning - Developing new or significantly improved innovations - subsection 360-40(1)(e)(i): In applying the requirements of s360-40(1)(e)(i), Company A must be developing an innovation which either new or significantly improved for an applicable addressable market. Company A has provided details substantiating that it is developing a product that is either new or significantly improved for an applicable addressable market. | Detailed Reasoning - Genuinely focussed on developing for commercialisation - subsection 360-40(1)(e)(i): In applying the requirements of s360-40(1)(e)(i), Company A must be genuinely focussed on developing an innovation for commercial purpose in order to generate economic value and revenue for the company. Company A has provided details substantiating that it meets this requirement. Therefore, s360-40(1)(e)(i) is satisfied for the ZZZZ income year. Once the product has been fully developed, Company A will no longer be 'developing' the product for commercialisation and s360-40(1)(e)(i) will no longer be satisfied. | Detailed Reasoning - High growth potential - subsection 360-40(1)(e)(ii): In applying the requirements of s360-40(1)(e)(ii), Company A must be able to demonstrate that it has high potential growth within a broad addressable market. Company A has provided details substantiating that it meets this requirement. Therefore, s360-40(1)(e)(ii) is satisfied. | Detailed Reasoning - Scalability - subsection 360-40(1)(e)(iii): In applying the requirements of s360-40(1)(e)(iii), Company A must be able to demonstrate that it has the potential to scale up the business. Company A has provided details substantiating that it meets this requirement. Therefore, s360-40(1)(e)(iii) is satisfied. | Detailed Reasoning - Broader than local market - subsection 360-40(1)(e)(iv): In applying the requirements of s360-40(1)(e)(iv), Company A must be able to demonstrate that it has the potential to address a broader than local market, including global markets. Company A has provided details substantiating that it meets this requirement. Therefore, s360-40(1)(e)(iv) is satisfied. | Detailed Reasoning - Competitive advantages - subsection 360-40(1)(e)(v): In applying the requirements of s360-40(1)(e)(v), Company A must be able to demonstrate that it has the potential to be able to have competitive advantages for that business. Company A has provided details substantiating that it meets this requirement. Therefore, s360-40(1)(e)(v) is satisfied. | Detailed Reasoning - Conclusion on principles-based test: Company A satisfies the principles-based test as it satisfies the requirements within subsections 360-40(1)(e)(i) to (v) for the ZZZZ income year. | Detailed Reasoning - Foreign Company Test - subsection 360-40(1)(f): As Company A was incorporated in Australia, it is not a Foreign Company and therefore paragraph 360-40(1)(f) is satisfied. | Detailed Reasoning - Final Conclusion: Company A meets the eligibility criteria of an ESIC under section 360-40 for the ZZZZ income year.