Edited version of private advice

Authorisation Number: 1052203468713

Date of advice: 15 December 2023

Ruling

Subject: Early stage innovation company

Question

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') for the period DD MM YYYY to DD MM YYYY (x years)?

Answer

Yes.

This ruling applies for the following periods:

DD MM YYYY to DD MM YYYY

The Scheme commences on:

DD MM YYYY

RELEVANT FACTS AND CIRCUMSTANCES

1.      The Company is an Australian proprietary company incorporated in XXX on DD MM YYYY.

2.      The Company's directors are Director A, Director B, Director C and Director D.

3.      The Company's registered office is located at XXX.

4.      The Company's principal place of business is situated at YYY.

5.      The Company has no wholly or partly owned subsidiaries. The Company is not part of an income tax consolidated group.

6.      For the financial year ending DD MM YYYY, the Company incurred and earned the following:

•           Total expenses of $xxx

•           Total income of $xxx

7.      For the financial year ending DD MM YYYY, the Company incurred and earned the following:

•           Total expenses of $xxx

•           Total income of $xxx

8.      The Company's equity interests are not listed for quotation in the official list of any stock exchange, either in Australia or a foreign country.

Product Development

9.      The Company is developing a flexible and cost-effective solution for the transport and permanent storage of a particular element in a particular industry. It is an innovative hardware system. There are two main Products - Product 1 and Product 2.

10.   The Products will solve critical storage capacity with rapid deployment and permanent storage of industrial volumes of a particular element to meet urgent global need.

11.   The Products will be flexible, cost effective and permanent, with key cost advantage creating potential for strong profitability and robust investment returns.

12.   The Products will create a breakthrough innovation creating an industry advantage. There will be competitive advantages of speed, cost, and flexibility underpinned by an exclusive worldwide license to patented technology.

13.   All Intellectual Property ('IP') relating to Product 2 is owned by Company X. All IP relating to the system (x2 patent applications) is owned by Company X and licensed to the Company on an exclusive world-wide basis.

14.   The Company is developing IP relating to Product 2 design and operation and aims to create IP rights which can be used to deal with third parties and create competitive advantage.

Product Development Stages

15.   The Company needs to re-engineer and modify Product 1 to transfer particular elements.

16.   To achieve a fully developed status, further steps are required. Product 1 is currently undertaking testing and certification to achieve technical readiness, which means that a full-scale prototype has been certified, and can then be used in an operational setting. This is currently underway and expected to be completed by DD MM YYYY.

17.   Further engineering by the Company will then be undertaken to finalise any modifications to enable the safe operation of the Products. This is anticipated to be completed during YYYY.

18.   Once these engineering and certification tasks are completed, the Company's Products are fully developed and will be ready for operations.

Commercialisation Strategy

19.   The Company is solely focused on commercialising its novel and innovative technology. The Company is in the early phases of raising capital and conducting research and development and supporting activities to bring its technology to market.

20.   Activities include independent assessment of technical risk, market assessment, patent protection assessment, preparation of detailed system and component designs.

21.   Further research and development will be required on the Products.

22.   Because Product 1 is novel and yet to be fully commercialised, there are no options that have been designed to work in tandem with Product 1.

High Growth Potential

23.   The value proposition of the Company's system addresses an international and readily addressable market opportunity of approximately $xxx billion based on research.

24.   Billions of dollars are being invested in these particular projects globally.

25.   The Company's current financial feasibility has been completed using one Product 1 and one Product 2. Once operational, this configuration will enable the sequestration of up to x million tonnes of element at one particular site.

Scale up the Business

26.   The Company's Products are scalable within the addressable market because they can transfer large volumes of particular element and can be deployed much cheaper and faster than other competing technologies which require fixed systems to be installed.

27.   The world is recognising that this type of storage is a vital strategy, so the Company is working to scale up the business.

Broader than Local Market

28.   There is a huge opportunity for the Company to roll this solution out at a global level by developing many regional 'Hub' projects.

29.   The Company is currently actively engaged with a consortium of complimentary service providers to develop a solution in the southern hemisphere region and are in the process of promoting that to investors. The consortium includes two overseas companies involved with this particular technology and heavy infrastructure engineering.

30.   The Company's business model is capable of global expansion to any suitable location.

Competitive Advantages

31.   Product 1 used by the Company is both inventive and innovative and has significant advantages over conventional systems used in the particular industry.

32.   Based on the knowledge of the Directors who are active in the particular industry, no directly competing products exist in the market.

33.   Company X has applied for two Australian patents to protect two inventions underpinning the technology, which are then exclusively licensed to the Company for commercialisation. One of these patent applications has been granted overseas

34.   A detailed competitor analysis report analysing potentially competing systems has been prepared by Company X.

35.   The Company's patent pending system has a clear economic advantage over these systems, being the lowest cost development concept.

36.   The combination of Product 1 and Product 2 is what creates the competitive advantage, and the Company has the exclusive rights, and mandate, to bring this novel solution to the market.

37.   The Company is developing their Products to address a number of discrete markets and is continuing to develop their Product.

38.   The Company's Products have been identified as having an international addressable market.

Information provided

39.   You have provided a number of documents containing detailed information in relation to the Company's Product, including:

•           Private Binding Ruling ('PBR') Application, dated DD MM YYYY

•           Responses to further questions provided

40.   We have referred to the relevant information within these documents in applying the relevant tests to your circumstances.

41.   The Company have issued shares in the company in the YYYY and YYYY financial years (during the period DD MM YYYY to DD MM YYYY) to various investors to assist in funding the continued development and commercialisation of the Products. These funds are being used to for the Company's research and development activities.

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

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

SUMMARY

The Company meets the eligibility requirements of an ESIC under subsection 360-40(1) for the period dd MM YYYY to DD MM YYYY.

DETAILED REASONING

Qualifying Early Stage Innovation Company

42.   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'

43.   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)

44.   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).

45.   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.

46.   A company that does not meet any of these conditions will not qualify as an ESIC.

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

47.   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.

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

48.   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.

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

49.   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'

50.   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

51.   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 (v)

52.   To satisfy the Principles-based Innovation 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.

53.   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.

54.   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.

Developing new or significantly improved innovations for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997

55.   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..."

56.   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.

57.   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.

58.   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."

59.   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.

60.   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.

High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997

61.   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.

Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997

62.   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.

Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997

63.   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 - subparagraph 360-40(1)(e)(v) ITAA 1997

64.   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.

Foreign Company test - paragraph 360-40(1)(f)

65.   At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth).

66.   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.

APPLICATION TO YOUR CIRCUMSTANCES

TEST TIME

67.   For the purposes of this ruling, the 'test time' for determining if the Company 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 DD MM YYYY. The Company have issued shares in the company in the YYYY and YYYY financial years (during the period DD MM YYYY to DD MM YYYY) to various investors to assist in funding the continued development and commercialisation of the Products.

Current year

68.   Therefore, for the purposes of subsection 360-40(1) ITAA 1997, the current year (for shares issued on or after DD MM YYYY, and on or before DD MM YYYY) will be the year ending DD MM YYYY (the YYYY income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last 3 income years will include the years ending DD MM YYYY, YYYY and YYYY, and the income year before the current year will be the year ending DD MM YYYY (the YYYY income year) (first period).

69.   Therefore, for the purposes of subsection 360-40(1) ITAA 1997, the current year (for shares issued on or after DD MM YYYY, and on or before DD MM YYYY) will be the year ending DD MM YYYY (the YYYY income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last 3 income years will include the years ending DD MM YYYY, YYYY and YYYY, and the income year before the current year will be the year ending DD MM YYYY (the YYYY income year) (second period).

THE 'EARLY STAGE TEST' - PARAGRAPHS 360-40(1)(a) - (d) ITAA 1997

Incorporation or Registration - paragraph 360-40(1)(a) ITAA 1997

70.   The Company was incorporated in XXX on DD MM YYYY, which is within the 3 income years outlined above, therefore the requirements of subparagraph 360-40(1)(a)(i) are satisfied.

Total expenses - paragraph 360-40(1)(b) ITAA 1997

71.   In applying the requirements of paragraph 360-40(1)(b), the Company and any of its 100% subsidiaries must have incurred total expenses of $1 million or less in the YYYY and YYYY income years, being the income year before the current year for the two periods in the application.

72.   The Company incurred expenses of $xxx in the YYYY income year. Consequently, paragraph 360-40(1)(b) is satisfied for the YYYY income year.

73.   The Company incurred expenses of $xxx in the YYYY income year. Consequently, paragraph 360-40(1)(b) is satisfied for the YYYY income year.

Assessable income - paragraph 360-40(1)(c) ITAA 1997

74.   In applying the requirements of paragraph 360-40(1)(c), the Company and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the YYYY and YYYY income years, being the income year before the current year in the application.

75.   The Company earned assessable income in the amount of $xx in the YYYY income year. Consequently, paragraph 360-40(1)(c) is satisfied for the YYYY income year.

76.      The Company earned assessable income in the amount of $xx in the YYYY income year. Consequently, paragraph 360-40(1)(c) is satisfied for the YYYY income year.

No Stock Exchange listing - paragraph 360-40(1)(d) ITAA 1997

77.      In applying the requirements of paragraph 360-40(1)(d), the Company must not be listed on any Stock Exchange in Australia or a foreign country at the test time.

78.      The Company 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.

CONCLUSION FOR EARLY STAGE TEST

79.      The Company satisfies the early stage test for the YYYY and YYYY income years, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied.

THE '100 POINT TEST' - PARAGRAPH 360-40(1)(e) AND SECTION 360-45

80.      The Company has not provided sufficient evidence of satisfying the 100-point test under section 360-45 for the years ending DD MM YYYY and YYYY. The Company 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.

THE 'PRINCIPLES-BASED TEST' - PARAGRAPH 360-40(1)(e) ITAA 1997

Developing new or significantly improved innovations for applicable addressable market - subparagraph 360-40(1)(e)(i) ITAA 1997

81.      In applying the requirements of subparagraph 360-40(1)(e)(i), the Company must be developing an innovation which is either new or significantly improved for an applicable addressable market.

82.      The Company is developing a flexible and cost-effective solution for the transport and permanent storage of a particular element in a particular industry. It is an innovative hardware system. There are two main Products - Product 1 and Product 2.

83.      The Products will solve critical storage capacity with rapid deployment and permanent storage of industrial volumes of a particular element to meet urgent global need.

84.      The Products will be flexible, cost effective and permanent, with key cost advantage creating potential for strong profitability and robust investment returns.

85.      The Products will create a breakthrough innovation creating an industry advantage. There will be competitive advantages of speed, cost, and flexibility underpinned by an exclusive worldwide license to patented technology.

86.      The Company is developing their Product to address a number of discrete markets and is continuing to develop their Product.

87.      The Company 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

88.      In applying the requirements of subparagraph 360-40(1)(e)(i), the Company must be genuinely focussed on developing an innovation for a commercial purpose in order to generate economic value and revenue for the company.

89.      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.

90.      The Company is solely focused on commercialising its novel and innovative technology. The Company is in the early phases of raising capital and conducting research and development and supporting activities to bring its technology to market.

91.      Activities include independent assessment of technical risk, market assessment, patent protection assessment, preparation of detailed system and component designs.

92.      The Company anticipate that the current programme of development will be completed by DD MM YYYY.

93.      The Company is genuinely focussed on developing their Product for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period DD MM YYYY to DD MM YYYY. Once the Product has been fully developed, the Company will no longer be 'developing' the product for commercialisation.

High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997

94.      In applying the requirements of subparagraph 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.

95.      The Company has high growth potential as the Product is readily and infinitely scalable to a global audience.

96.      The Company has provided details to satisfy this requirement.

97.      The Company has demonstrated a high growth potential for their Product, so subparagraph 360-40(1)(e)(ii) is satisfied for the period DD MM YYYY to DD MM YYYY.

Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997

98.      In applying the requirements of subparagraph 360-40(1)(e)(iii), the Company must be able to demonstrate that it has the potential to successfully scale up the business.

99.      The Company has provided details to satisfy this requirement.

100.    This leverage ensures that the Company has the potential to successfully scale up its business, so subparagraph 360-40(1)(e)(iii) is satisfied for the period DD MM YYYY to DD MM YYYY.

Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997

101.    In applying the requirements of subparagraph 360-40(1)(e)(iv), the Company must be able to demonstrate that it has the potential to be able to address a broader than local market, including global markets.

102.    The Company has provided details to satisfy this requirement.

103.    The Company 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 DD MM YYYY to DD MM YYYY.

Competitive advantages - subparagraph 360-40(1)(e)(v) ITAA 1997

104.    In applying the requirements of subparagraph 360-40(1)(e)(v), the Company must demonstrate that it has potential to be able to have competitive advantage for that business.

105.    The Company has provided details to satisfy this requirement.

106.    The Company has demonstrated that it has competitive advantages for its business, so subparagraph 360-40(1)(e)(v) is satisfied for the period DD MM YYYY to DD MM YYYY.

CONCLUSION FOR PRINCIPLES BASED TEST

The Company satisfies the Principles-based Innovation test as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period DD MM YYYY to DD MM YYYY.

Foreign Company Test - subparagraph 360-40(1)(f) ITAA 1997

107.    As the Company was incorporated in Australia, it is not a Foreign Company and paragraph 360-40(1)(f) is satisfied.

CONCLUSION

The Company meets the eligibility criteria of an ESIC under section 360-40 for the period DD MM YYYY to DD MM YYYY.

[1] Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.79.

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