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Edited version of your written advice

Authorisation Number: 1051260111576

Date of advice: 7 August 2017

Ruling

Subject: Income Tax: Tax Incentive for Early Stage Investors

Question 1

Does the Company meet the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

Commercialisation strategy

Information provided

Assumption(s)

N/A

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 360-A

Income Tax Assessment Act 1997 section 360-40

Income Tax Assessment Act 1997 section 360-45

Further issues for you to consider

N/A

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise indicated.

Question 1:

Summary

The Company meets the eligibility requirements of an ESIC under subsection 360-40(1).

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.

'The early stage test’

2. The early stage test requirements are outlined in detail within paragraphs 360-40(1)(a) to (d).

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:

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.

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.

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.

8. In determining the company’s assessable income, any amount of Accelerating Commercialisation Grant that the company received in that year can be disregarded.

No stock exchange listing - paragraph 360-40(1)(d)

9. 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.

Innovation tests

10. 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.

'100 point test’ – paragraph 360-40(1)(e) and section 360-45

11. 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.

'Principles-based test’ – subparagraphs 360-40(1)(e)(i) to (iv)

12. 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.

13. 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.

14. The five requirements of the principles-based test, as outlined in paragraph 360-40(1)(e) are:

Developing new or significantly improved innovations for commercialisation

15. 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:

16. 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.

17. 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.

18. 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.

19. '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.

High growth potential

20. 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.

Scalability

21. 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

22. 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.

Competitive advantages

23. 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.

Application to your circumstances

Test time

24. For the purposes of this ruling, the test time for determining if the Company is a qualifying ESIC will be a particular date during the income year ending 30 June 2017.

Current year

25. For the purposes of subsection 360-40(1), 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 three income years will include the years ending 30 June 2017, 2016 and 2015, and the income year before the current year ('the prior income year’) will be the year ending 30 June 2016 (the 2016 income year).

Early stage test

Incorporation or Registration – paragraph 360-40(1)(a)

26. As the Company was registered in the Australian Business Register on 5 September 2016, which is within the last 3 income years, subparagraph 360-40(1)(a)(iii) is satisfied.

Total expenses – paragraph 360-40(1)(b)

27. As the Company had no subsidiaries and incurred total expenses less than $1 million in the prior income year, paragraph 360-40(1)(b) is satisfied.

Assessable income – paragraph 360-40(1)(c)

28. As the Company had no subsidiaries and had total assessable income for the prior income year of less than $200,000 paragraph 360-40(1)(c) is satisfied.

No stock exchange listing – paragraph 360-40(1)(d)

29. As the Company is privately owned and is not listed on any stock exchange in Australia or a foreign country, paragraph 360-40(1)(d) is satisfied.

Conclusion on early stage test

30. The Company will satisfy the early stage test for the entire 2017 income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied.

100 point test

31. The Company has not provided any evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 2017. For the Company to be a qualifying ESIC it will need to satisfy the principles-based test.

Principles based test

Developing new or significantly improved innovations for commercialisation – subparagraph 360-40(1)(e)(i)

32. According to the Company, the (OSM) Process is a new, novel, low-cost technology/process for direct production of materials which have a wide range of industrial applications. The technology is mostly intended for a specific industry as a replacement for the material/s that are currently used in that industry. However, there are also other significant potential applications within a range of industrial sectors. Although it will initially be targeted at the Australian market, the (OSM) Process has been identified as having a wider international/global addressable market.

33. The Company’s research indicates that it will be the first company/entity to offer such a process.

New, or significantly improved, products, processes, services or marketing or organisational methods –

subparagraph 360-40(1)(e)(i)

34. The Company has highlighted the key differentiators of the (OSM) Process to existing alternate processes to include, the (OSM) Process:

35. The Company has also undertaken extensive techno-economic analysis in relation to a large range of its products using both Greenfield and Brownfield approximations, and market analysis of competing technologies/companies. Its analysis suggests that the technology under development is capable of reducing production costs by between 50% to 95% (depending on product characteristics), in addition to enabling economic production of other new materials that would otherwise not have been possible to produce on a commercial scale.

Genuinely focussed on developing for commercialisation –

subparagraph 360-40(1)(e)(i)

36. The Company has taken the following steps in developing the (OSM) Process:

37. The Company is currently at the Pr1 stage of its R&D effort.

38. The Company plans to start its commercialisation strategy during the final period of the Pr1 stage of its R&D effort.

39. The Company has determined that its business orientation will be a strategy based on licensing its process and products. It intends to develop its technology at a pilot demonstration level for a number of products and then license the technology to local and international manufacturers.

40. The Company’s marketing plan will be dominated by efforts to establish a strategic partnership with one or multiple partners with an interest in its planned range of products. It defines its addressable market as Australia initially, with a view towards quick expansion into the international/global market.

41. The Company has engaged in non-confidential discussions in relation to commercialisation of its process/products with a number of companies.

Conclusion on subparagraph 360-40(1)(e)(i)

42. The Company is genuinely focussed on developing the (OSM) Process for a commercial purpose. The (OSM) Process will be a significantly improved process compared to existing processes.

43. Therefore, subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 1 July 2016 until 30 June 2017, or the date when the (OSM) Process has been fully developed, whichever occurs earliest. Once the (OSM) Process has been fully developed, the Company will no longer be 'developing’ the product for commercialisation and subparagraph 360-40((1)(e)(i) will no longer be satisfied.

High growth potential – subparagraph 360-40(1)(e)(ii)

44. The Company’s process is designed to be capable of producing thousands of products, with a wide range of industrial applications.

45. The Company’s R&D program is directed towards demonstrating process capabilities, low production cost and high technological impact, and its marketing and commercialisation efforts are aimed at converting findings from the R&D work into immediate market opportunities.

46. The Company expects the (OSM) Process to appeal to a wide/diverse range of global market sectors.

47. Through its commercialisation/marketing strategy, the Company hopes to foster widespread use of its products by licensing its technology to existing local and international manufacturers/end users who are already established in the market. It plans to generate its revenue predominantly from licence fees/royalties.

48. A major component of the Company’s marketing/commercialisation strategy is partnering with existing major materials producers and/or major manufacturers, which the Company believes will help overcome/minimise market inertia towards new technologies and new products.

49. If the Company’s commercialisation strategy is successful, its techno-economic and market analysis indicates that it will be able to rapidly expand its activities / generation of revenue within both the Australian and international/global markets.

50. Therefore, subparagraph 360-40(1)(e)(ii) will be satisfied.

Scalability – subparagraph 360-40(1)(e)(iii)

51. The Company has undertaken extensive techno-economic analysis in relation to a large range of its products using both Greenfield and Brownfield approximations, and market analysis of competing technologies/companies. Its analysis indicates that the technology under development is capable of reducing production costs within the range of 50% to 95% (depending on product characteristics), in addition to enabling economic production of other new materials that would otherwise not have been possible to produce on a commercial scale.

52. Projections provided by the Company, based on the techno-economic analysis that it has undertaken, indicate that its technology will create significant value within five years.

53. Given that the (OSM) Process will have a wide range of applications both domestically and globally, it is expected that the Company has the potential to successfully scale up its business.

54. The Company’s projections are that it will be able to increase its revenue as it expands its client base, by capitalising on the low capital and production costs of its process, and its capability to produce high-quality products, and additionally, the unique capacity of its process to enable the economic production of a range of new high value materials on a commercial scale. This operating leverage affords the Company the potential to successfully scale up its business. Therefore, subparagraph 360-40(1)(e)(iii) will be satisfied.

Broader than local market- subparagraph 360-40(1)(e)(iv)

55. The Company will initially target its marketing of the (OSM) Process at the Australian market. However, the Company has identified its ultimate market as being both the Australian and international/global markets. Its marketing plan will be dominated by efforts to establish a strategic partnership with one or multiple partners with an interest in its planned range of products. The Company defines its addressable market as Australia initially, with a view towards quick expansion into the global market.

56. According to the market analysis and research undertaken by the Company, the market for its products is highly diverse and international/global in nature

57. The Company’s commercialisation strategy is based on licensing its technology to existing local and international manufacturers / end users who are already established in the market. Its market analysis has identified that it is likely that the (OSM) Process will have significant technical and cost advantages to enable it to access a range of market segments.

58. The Company has identified a number of specfic market segments as initial targets, and identified potential customers/partners within each of the market segments.

59. The (OSM) Process has application within a diverse range of industries/markets which are international/global in nature. Thus, the ultimate addressable market of the Company is on a global scale and is not confined to a local city, area or region.

60. The Company has demonstrated that the (OSM) Process has the potential to address a broader market than just the local market, including global markets. Therefore, subparagraph 360-40(1)(e)(iv) will be satisfied.

Competitive advantages – subparagraph 360-40(1)(e)(v)

61. The (OSM) Process has the following differentiating features which may give it a competitive advantage, it:

62. Therefore, as the (OSM) Process is the first process with these differentiating features, the Company has the first mover advantage. The Company has demonstrated the potential for the (OSM) Process to have competitive advantages within a range of industries/markets, satisfying subparagraph 360-40(1)(e)(v).

Conclusion on principles test

63. The Company satisfies the principles based test as it satisfies the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period commencing 1 July 2016 until 30 June 2017, or the date when the (OSM) Process has been fully developed and is ready for sale, whichever occurs earlier.

Conclusion

64. The Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 2016 until the earlier of 30 June 2017, or the date when the (OSM) Process has been fully developed and is ready for sale, whichever occurs earlier.


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