Private ruling: Early stage innovation company
Date of advice: 24 October 2022
Published: 9 January 2023
Ruling period: x XX 20XX to yy YY 20YY
Date scheme commenced: x 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 x XX 20XX to yy YY 20YY? | A1: Yes.

Relevant facts and circumstances: Background facts 1. Company A is an Australian proprietary company incorporated in XYZ on xx YY 20ZZ. 2. Company A's directors are Taxpayer A and Taxpayer B. 3. Company A's registered office is situated at XXX. 4. Company A's principal place of business is situated at YYY. 5. Company A has no wholly or partly owned subsidiaries. Company A is a wholly owned subsidiary of Company B. 6. Company A is not part of a tax consolidated group, nor is it planning to join a tax consolidated group. 7. For the financial year ending yy YY 20XX, Company A incurred and earned the following: • Total expenses of $xx • Total income of $yy 8. 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. 9. Shares were issued to investors in the current year. Development of Product 10. Company A is developing specific capabilities and services that extend beyond current technologies (the 'Product'). Company A is developing a particular platform that is capable of detecting, identifying and informing a user of the presence of a particular element. 11. The development of the specific platform will involve two key inter-related steps, as outlined below: • Design and development of specific characteristics • Development and testing of the specific platform. Development stages 12. Stage 1 • Company A will focus its development on a specific characteristic for the purpose of detecting particular elements 13. Stage 2 • This stage of testing will require the detailed design and development of an innovative platform and if successful, this work will culminate in the development of a new product. • The Minimal Viable Product ('MVP') to be offered by Company A is a long range, high endurance service that has highly adaptable options. 14. Subject to receiving favourable results from the initial phases, Company A will complete a series of scaled up trials to prove the technology. If this is successful, it will look to apply its solution to a range of industries and markets. Commercialisation strategy 15. Company A has engaged with industry to assess interest in this MVP and received positive feedback. In many cases, industry see significant potential for large operations however such services are not yet offered on the Australian market. 16. The future work structure and framework will be formulated by the business post initial concept design and post the minimum viable product ('MVP') testing. 17. Company A will progress towards market entry in January 20TT. 18. Company A is awaiting milestones, budget and research agreements from multiple institutions, and is in the process of screening several key leading experts in the required fields. High growth potential 19. The global market for the Product is estimated to be valued at USD $xyz by 20UU. In addition, when considering peripheral services to the specific market, risk free solutions are currently lacking. 20. Company A is initially targeting two key markets through this project, as follows: • Market A. This market is comprised of xx specific platforms in Australia, and yy specific platforms globally. • Market B. This market relates to the collection of data. This will be a secondary focus for Company A if and when the platform is developed. 21. Once traction has been gained in the Australian platform market, Company A will seek to expand overseas. It will then broaden its offering to the specific market. Scale up the business 22. Company A has assembled an Executive Team with extensive experience and a proven track record in technology development. 23. All founding members of Company A's Board have led multiple businesses and bring solid corporate governance competency to the company. 24. Further, Company A's project has been endorsed by Company X, a leader in this field. With this added collaboration, Company A will be well placed to scale once its platform is successfully developed. Broader than local market 25. Company A is targeting a market that is estimated to be valued at USD $xxx in 20UU. 26. Company A are targeting the two largest sectors through offering its solution to particular platforms and services. 27. Company A is confident that the solution can address much broader than purely a local market. If and when success is achieved in the Australian market, Company A will expand into other key jurisdictions. Competitive advantages 28. Company A's project will ultimately culminate in the development of a platform, offering far superior characteristics when compared to products currently in the market. 29. This new product presents a significant competitive advantage for the business. 30. It would take a competitor both significant capital and expertise to develop a similar product. Given the scale of the market, various strategies are currently being tested, in Australia and around the world. 31. Company A is also in the process of completing letters of endorsement with state and federal government agencies. If and when these are executed, this will provide another layer to its competitive advantage. 32. Company A is developing their capabilities and services to address a number of discrete markets and is continuing to develop their Product. 33. Company A's Product has been identified as having an international addressable market. Information provided 34. You have provided a number of documents containing detailed information in relation to Company A's Product, including: • Private Binding Ruling ('PBR') Application, dated xx YY 20YY • Response to further questions provided 35. 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 x XX 20XX to yy YY 20YY. | Detailed Reasoning - Qualifying Early Stage Innovation Company: 36. 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': 37. 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): 38. 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). 39. 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. 40. 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): 41. 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): 42. 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): 43. 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': 44. 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: 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): 46. 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. 47. 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. 48. 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: 49. 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..." 50. 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. 51. 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. 52. 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." 53. 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. 54. 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: 55. 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: 56. 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: 57. 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: 58. 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): 59. At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth). 60. 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: 61. 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 yy YY 20YY. Shares were issued to investors in this period. | Detailed Reasoning - Current year: 62. Therefore, for the purposes of subsection 360-40(1) ITAA 1997, the current year will be the year ending yy 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 yy YY 20YY, 20XX and 20ZZ, and the income year before the current year will be the year ending yy YY 20XX (the 20XX income year). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a) ITAA 1997: 63. Company A was incorporated in XYZ on xx YY 20ZZ, 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: 64. 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. 65. Company A incurred expenses of $xx in the 20XX income year. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c) ITAA 1997: 66. 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. 67. Company A earned assessable income of $yy 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: 68. 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. 69. 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: 70. 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: 71. Company A has not provided sufficient evidence of satisfying the 100-point test under section 360-45 for the year ending yy 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: 72. 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. 73. Company A is developing specific capabilities and services that extend beyond current technologies (the 'Product'). Company A is developing a platform that is capable of detecting, identifying and informing a user of the presence of a particular element. 74. The development of the specific platform will involve two key inter-related steps, as outlined below: • Design and development of specific characteristics • Development and testing of the specific platform. | Detailed Reasoning - Development stages: 75. Stage 1 • Company A will focus its development on a specific characteristic for the purpose of detecting particular elements 76. Stage 2 • This stage of testing will require the detailed design and development of an innovative platform and if successful, this work will culminate in the development of a new product. • The Minimal Viable Product ('MVP') to be offered by Company A is a long range, high endurance service that has highly adaptable options. 77. Subject to receiving favourable results from the initial phases, Company A will complete a series of scaled up trials to prove the technology. If this is successful, it will look to apply its solution to a range of industries and markets. 78. Currently there is no accurate system that can detect and track specific elements. 79. Company A is developing their capabilities and services to address a number of discrete markets and is continuing to develop their Product. 80. Company A is genuinely focussed on developing their Product for an applicable addressable market. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997 81. 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. 82. Company A has engaged with industry to assess interest in this minimum viable product ('MVP') and received positive feedback. In many cases, industry see significant potential for large operations, however such services are not yet offered on the Australian market. 83. There are a number of steps which are required to be completed into the future, before the Product is considered to be fully developed for commercialisation. The future work structure and framework will be formulated by the business post initial concept design and post the MVP testing. 84. Company A will progress towards market entry in YY 20UU. 85. Company A is awaiting milestones, budget and research agreements from multiple institutions, and is in the process of screening several key leading experts in the required fields. 86. Company A anticipate that the current programme of development will be completed in the 20TT financial year. 87. 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 yy YY 20YY. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997: 88. 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. 89. Company A has high growth potential as their Product is easily and infinitely scalable to a global audience. 90. Company A has provided details to satisfy this requirement. 91. Company A has demonstrated a high growth potential for their Product, subparagraph 360-40(1)(e)(ii) is satisfied for the period x XX 20XX to yy YY 20YY. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997: 92. 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. 93. Company A has provided details to satisfy this requirement. 94. 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 x XX 20XX to yy YY 20YY. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997: 95. 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. 96. Company A has provided details to satisfy this requirement. 97. 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 yy YY 20YY. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v) ITAA 1997: 98. 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. 99. Company A has provided details to satisfy this requirement. 100. Company A has demonstrated that it has competitive advantages for its business, so subparagraph 360-40(1)(e)(v) is satisfied for the period x XX 20XX to yy YY 20YY. | Detailed Reasoning - CONCLUSION FOR PRINCIPLES BASED TEST: Company A satisfies satisfy 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 yy YY 20YY. | Detailed Reasoning - Foreign Company Test - subparagraph 360-40(1)(f) ITAA 1997: 101. 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 of the ITAA 1997 for the period x XX 20XX to yy YY 20YY. [1] Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.79.