Private ruling: Early stage innovation company eligibility
Date of advice: 14 April 2023
Published: 29 May 2023
Ruling period: Year ending 31 December ZZZZ
Date scheme commenced: DD/MM/ZZZZ

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 DD/MM/ZZZZ to 31 December ZZZZ? | A1: Yes.

Relevant facts and circumstances: Background facts 1. Company A ('the Company') is an Australian public company which was incorporated in Australia on DD/MM/ZZZZ and registered on the Australian Business Register on DD/MM/ZZZZ. Its equity interests are not listed for quotation in the official list of any stock exchange in Australia or overseas. 2. Company A is not a foreign company pursuant to the Corporations Act 2001 (Cth) . 3. Company A has a number of 100% owned subsidiaries. 4. Company A's directors during the current year were Individual 1 and Individual 2. 5. Company A's registered office is situated in Australia. 6. Company A's principal place of business is situated in Australia. 7. All Company As development and commercialisation activities in relation to its innovation are carried out by the company and not by its subsidiaries. 8. Company A owns the intellectual property (IP) to its technology/innovation. 9. Company A and its subsidiaries did not incur any expenses in the income year before the current year. 10. Company A and its subsidiaries did not generate any assessable income in the income year before the current year. Development of new or significantly improved innovations 11. Company A is developing an enterprise grade data storage infrastructure and software ('the Product') within Australia and globally. The Company believes that if it successfully develops its Product, it can provide accelerated and more robust storage growth on an open source system intended to be a blockchain-based data retrieval method ('the System/Application'). 12. The key innovations of the Product are detailed in the private ruling application and includes the identification of a combination of hardware and software which provides it with several advantages compared to other competitors operating in the same space. 13. The Company believes that the infrastructure and software that it has developed is not limited for use with the System/Application that it was initially developed to enhance, and can be applied to other high compute, artificial intelligence or machine learning applications. Genuinely focussed on developing innovations for commercialisation 14. Company A has refined its infrastructure and software to ensure that it is effective to generate revenue. 15. In developing its infrastructure, the Company has formulated a strategy to ensure that the infrastructure and use of the System/Application is commercially sound. Part of the design of the storage infrastructure developed by the Company is to ensure that it is sustainable and is a long-term and low-cost enterprise within its operating space. 16. With these objectives, the Company believes that it will provide a viable and commercial solution for longstanding internet inefficiencies. High growth potential 17. At present, the data storage infrastructure developed by the Company is limited to the System/Application that it was designed to enhance. However, as previously stated, the Company believes there is scope for their infrastructure to be applied to multiple different areas including digital asset mining and artificial intelligence. 18. The 'Data Storage Services' provided by the Company are already accessible to markets outside of Australia, with a capacity to expand further. 19. There are two potential immediate areas for growth as follows: a. as the System/Application's network of storage providers grows, the competitive advantages of the Company that has resulted from its development activities will lead to it receiving a large proportion of the network growth; and b. the Company will be able to offer data storage services to customers outside of the System/Application. Scalability 20. The Company has developed a software with supporting hardware that, once fully developed, is relatively low cost compared to other products available to work in conjunction with the System/Application. In doing so, the Company has developed a sustainable enterprise data storage solution with low operating costs. 21. A significant quantum of the Company costs are, and will be, in connection with developing and testing its storage infrastructure solutions. The storage infrastructure solutions are not bespoke or customised to a specific 'Storage Client' and the solution can be produced on a scalable basis. 22. Once the Company has fully developed its storage infrastructure solution, it anticipates that increases in revenue can be achieved through minimal incremental increases in operating costs. The only additional costs it will incur will be the underlying computing processing equipment required to undertake the relevant computing tasks. 23. The significant up-front investment that the Company has made in developing the infrastructure storage solutions means that the Company anticipates there will be limited recurring spend on the storage infrastructure solutions. Broader than local market 24. The Company has developed its Product to be available across Australian and global markets that use the System/Application that the Product has been developing with the aim of enhancing its capabilities. 25. The Company currently has existing Storage Clients throughout the world. Competitive advantages 26. The Company believes that there is an opportunity to utilise the open-source application to enable the participants of the System/Application to gain a commercial advantage through customisation of the application and improved infrastructure compared to the baseline requirements of the application. 27. In particular, the Company believes that it will have the following commercial advantages: a. the Company will be able to provide a faster data storage infrastructure compared to its competitors b. the Company will be able to offer a more robust and secure data storage environment to users c. the infrastructure offered by the Company provides storage capacity at a lower relative cost compared to its competitors. 28. With the ability to achieve advances in the proof of space compute process, being the mechanism used to provide storage capacity and stored data to Storage Clients, the Company will gain a material commercial advantage both domestically and globally. 29. The Company also believes that it will obtain a competitive advantage as an early adopter and participant in the System/Applications's network, particularly within Australia. The infrastructure will also enable improved performance in this space compared with the Company's competitors. 30. In its objective to replace traditional centralised data storage infrastructure, the Company aims to disrupt the duopolistic cloud storage industry. 31. The Company provides services to global markets beyond Australia. Information provided 32. You have provided information in a number of documents in relation to Company A's product. 33. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances. Assumptions: 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: SUMMARY Company A meets the criteria of an ESIC under subsection 360-40(1) of the ITAA 1997 for the ZZZZ income year. DETAILED REASONING | Detailed Reasoning - Qualifying Early Stage Innovation Company: 1. 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 - 'EARLY STAGE TEST': 2. 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): 3. 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). 4. 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. 5. 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): 6. 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): 7. 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): 8. 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': 9. 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: 10. 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): 11. 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. 12. 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. 13. 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 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 - subparagraph 360-40(1)(e)(i) ITAA 1997: 14. 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..." [1] 15. 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. 16. 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. 17. The OECD Oslo Manual defines innovations as significant changes, with the intention of distinguishing significant changes from routine minor changes. However, it is important to recognise that an innovation can also consist of a series of smaller incremental changes that together constitute a significant change. [2] 18. In discussing services innovation activity, paragraph 111 of the OECD Oslo Manual states, "Innovation activity in services also tends to be a continuous process, consisting of a series of incremental changes in products and processes. This may occasionally complicate the identification of innovations in services in terms of single events, i.e. as the implementation of a significant change in products, processes or other methods." 19. 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." 20. 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. 21. '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: 22. 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 - subparagraph 360-40(1)(e)(iii) ITAA 1997: 23. 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. Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997 han local market 24. 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: 25. 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' - SUBPARAGRAPH 360-40(1)(f): 26. At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth). 27. 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: 28. 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 DD/MM/YYYY, and on or before 31 December YYYY. | Detailed Reasoning - Current year: 29. For the purposes of subsection 360-40(1), the current year will be the year ending 31 December YYYY (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 31 December YYYY, WWWW and VVVV, and the income year before the current year will be the year ending 31 December XXXX (the YYYY income year). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a): 30. Company A was incorporated in Australia on DD/MM/YYYY, which is within the last three income years (the latest being the current year). Therefore, the requirements of subparagraph 360-40(1)(a)(i) are satisfied. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b): 31. 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. 32. Company A and its subsidiaries were not in existence in the YYYY income year and therefore did not derive any assessable income in the YYYY income year. Therefore, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c): 33. 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 YYYY income year. 34. Company A and its subsidiaries were not in existence in the YYYY income year and therefore did not derive any assessable income in the YYYY income year. Therefore, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No stock exchange listing - paragraph 360-40(1)(d): 35. In applying the requirements of paragraph 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, subparagraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: 36. Company A satisfies the early stage test for the entire 'test time', as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - '100 POINT TEST' - PARAGRAPH 360-40(1)(e) AND SECTION 360-45: 37. Company A has stated that it would not satisfy 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 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 - subparagraph 360-40(1)(e)(i): 38. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be developing an innovation which either new or significantly improved for an applicable addressable market. 39. Company A is developing an enterprise grade data storage infrastructure and software ('the Product') within Australia and globally. The Company believes that if it successfully develops its Product, it can provide accelerated and more robust storage growth on an open source system intended to be a blockchain-based data retrieval method ('the System/Application'). 40. 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 - subparagraph 360-40(1)(e)(i): 41. In applying the requirements of subparagraph 360-40(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. 42. In developing its infrastructure, the Company has formulated a strategy to ensure that its data storage infrastructure and software and use of the System/Application is commercially sound. Part of the design of the storage infrastructure developed by the Company is to ensure that it is sustainable and is a long-term and low-cost enterprise within its operating space. 43. With these objectives, the Company believes that it will provide a viable and commercial solution for delivering longstanding internet inefficiencies. 44. Company A has provided details substantiating that that it is genuinely focussed on developing its innovation for commercial purpose in order to generate economic value and revenue for the company. | Detailed Reasoning - Conclusion on subparagraph 360-40(1)(e)(i): 45. Company A is genuinely focussed on developing their product, an enterprise grade data storage infrastructure and software for commercialisation. The product will be a significantly improved product compared to existing products in their addressable market. 46. Therefore, subparagraph 360-40(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 subparagraph 360-40(1)(e)(i) will no longer be satisfied. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii): 47. In applying the requirements of subparagraph 360-40(1)(e)(ii), Company A must be able to demonstrate that it has high potential growth within a broad addressable market. 48. Company A has provided details substantiating that it meets this requirement. 49. Therefore, subsection 360-40(1)(e)(ii) is satisfied. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii): 50. In applying the requirements of subparagraph 360-40(1)(e)(iii), Company A must be able to demonstrate that it has the potential to scale up the business. 51. Company A has provided details substantiating that it meets this requirement. 52. Therefore, subsection 360-40(1)(e)(iii) is satisfied. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv): 53. In applying the requirements of subparagraph 360-40(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. 54. Company A has provided details substantiating that it meets this requirement. 55. Therefore, subsection 360-40(1)(e)(iv) is satisfied. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v): 56. In applying the requirements of subparagraph 360-40(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. 57. Company A has provided details substantiating that it meets this requirement. 58. Therefore, subsection 360-40(1)(e)(v) is satisfied. | Detailed Reasoning - Conclusion on principles-based test: 59. Company A satisfies the principles-based test as it satisfies the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the ZZZZ income year. | Detailed Reasoning - 'FOREIGN COMPANY TEST' - subparagraph 360-40(1)(f): 60. As Company A was incorporated in Australia, it is not a Foreign Company and therefore paragraph 360-40(1)(f) is satisfied. | Detailed Reasoning - CONCLUSION: 61. Company A meets the eligibility criteria of an ESIC under section 360-40 for the ZZZZ income year. [1] See Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.76. [2] OECD Oslo Manual, paragraph 124 and paragraph 151.

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.