Edited version of your written advice

Authorisation Number: 1051350664917

Date of advice: 16 March 2018

Ruling

Subject: Early stage innovation company eligibility

Question

Does the Company 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)

Answer

Yes

This ruling applies for the following period:

XX XX 20XX to XX XX 20XX

The scheme commences on:

XX XX 20XX

Relevant facts and circumstances

The Company

1. The Company was registered on DDMMYY.

2. The Company’s stated market is a particular food consumer. The Company intends to produce this food product from a process that incorporates the use of specialised equipment.

3. The design for the specialised equipment is largely based on the experience of those operating similar equipment overseas over the past 25 years.

Branded product

4. The Company will be introducing its own brand of food to the market. The brand guarantees consumers particular characteristics of the food product. A trademark application has been filed.

5. The Company’s business model will control the value chain. The Company can also be a service provider to market participants who have their own brand and sales operations.

Commercialisation strategy

6. The Company is currently participating in an incubator program. The Company is currently in the seed round funding stage. Construction of specialised equipment will only occur once seed funding of a specified amount has been secured.

7. Efforts to develop the innovation for commercialisation include:

● Basic CAD designs have been drafted and the services of an Industrial Designer engaged to design the specialised equipment for Australian conditions;

● A trademark for the brand name has been filed

● The Company has secured interest from a number of stakeholders to register their interest in utilising their specialised equipment

● The Company’s co-founder has been on a sponsored tour of a relevant region.

8. The Company will be providing a particular technology in relation to a characteristic of the food product.

Projections

9. The Company has projections of the number of the specialised equipment and associated facilities it will seek to employ in the first three years of operation as well as the number of retail stores and regarding the commencement of exports.

Addressable market

10. The Company’s strategy is to initially launch in the relevant state and then expand Australia wide. The Company’s broad addressable market is a particular food consumer and within this broader market the niche market pertaining to a specific consumer group.

11. The domestic market is the initial and key focus of the Company, though the Company has definite plans to export the product to overseas high-end markets. The Company’s plans to target offshore markets is evidenced by its three year goals which include obtaining an export licence in the second year and exporting the food product and ready built specialised equipment in the third year.

Share issue

12. The Company proposes to issue new shares to various investors to assist in funding the continued development and commercialisation of its business and innovation.

The Food Product

In Australia the food product is already marketed and sold by a number of producers, many of which have their own retail stores.

Concept of the specialised equipment

13. The concept of producing the food product in a particular way using specialised equipment is not new in Australia.

Legislative framework around the slaughter of animals for human consumption

14. Currently under the relevant state Act and industry guidelines there is a prohibition on the provision of the food produced through the Company’s specialised equipment for human consumption. There is no current prohibition on the sale of the food product by competitors using other equipment. Legislation presently before the relevant State parliament will formally recognise and allow the food product produced by the Company’s specialised equipment to be provided for human consumption.

The Company’s Competitors

15. In its business proposal the Company identifies competitors looking to develop similar specialised equipment or selling similar products.

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 1 997 Section 360-45

Reasons for decision

Question 1

Does the Company 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)?

Summary

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

Detailed reasoning

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

16. Subsection 360-40(1) outlines the criteria required for a company to qualify as an ESIC at a particular time in an income year. This time is referred to as the ‘test time’. 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’

17. 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)

18. 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 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).

19. 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.

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

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

21. 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)

22. 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.

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

23. 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

24. 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

25. 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)

26. 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.

27. 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.

28. 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.

Developing new or significantly improved innovations for commercialisation

29. 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…”

30. 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.

31. 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.

32. 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.

33. 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.”

34. 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.”

35. 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.

36. ‘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

37. 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

38. 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

39. 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

40. 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

41. For the purposes of this ruling, the ‘test time’ for determining if the Company is a qualifying ESIC will be a particular date on or after XX XX 20XX, but before XX XX 20XX.

Current year

42. For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 20XX (the 20XX 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 20XX, 20XX and 20XX, and the income year before the current year will be the year ending 30 June 20XX (the 20XX income year).

The Early Stage test

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

43. The Company was incorporated on XX XX 20XX which is within the last three income years required to satisfy subparagraph 360-40(1)(a)(i).

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

44. The Company did not exist in the 20XX income year. Consequently no expenses were incurred in the prior income year and paragraph 360-40(1)(b) is satisfied.

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

45. The Company did not exist in the 20XX income year. Consequently no income was derived in the prior income year and paragraph 360-40(1)(c) is satisfied.

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

46. The Company was not listed on any Stock Exchange in Australia or a foreign country at any of the test times, so paragraph 360-40(1)(d) is satisfied.

Conclusion on early stage test

47. The Company satisfies the early stage test for the 20XX income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied.

Principles based test

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

48. The Company have identified their innovation as a product and also as a process.

Product innovation

49. The Company has identified its product innovation as a new category of food labelled a particular way and produced by a certain practice. There is nothing new or significantly improved about the Company’s food product. Competitors already sell and market similar branded food products. A directory of suppliers of similar food products is available on the internet.

50. Therefore, the new category of food product that the Company seeks to introduce is not an innovation, as it is substantially similar to products that already exist.

Process Innovation

51. The Company considers that it has an innovative process to supply its food product to consumers. This innovation is in the form of a novel value chain that incorporates the use of specialised equipment, associated facilities, marketing of the food product under its own brand name and opening retail stores.

52. No other business in Australia owns a value chain that incorporates all the features of the Company’s process including:

● use of the specialised equipment;

● partnering with industry participants to sell the product under the common brand; and

● the utilisation of a particular technology.

53. Based on the above observable points of difference, it is considered that the Company’s process is innovative.

Genuinely focused on developing for commercialisation – subparagraph 360-40(1)(e)(i)

54. Efforts to develop the innovation for commercialisation include:

● Basic CAD designs have been drafted and the services of Industrial Designer engaged to design the specialised equipment for Australian conditions;

● A trademark for the brand name has also been filed;

● The Company has secured interest from a number of participants to register their interest in utilising their specialised equipment; and

● The Company co-founder has been on a sponsored tour of the relevant region.

55. The Company is currently participating in an incubator program. This program has the financial backing of the relevant state Government, venture capital, industry companies and an industry body.

56. The Company anticipates that revenue from a single specialised equipment and associated equipment is $XX million annually. The specialised equipment is designed to operate in a commercially viable fashion without the need for ongoing government support and grants.

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

57. The Company is genuinely focussed on developing the innovation for a commercial purpose. Therefore, subparagraph 360-40(1)(e)(i) will be satisfied for the time period from XX XX 20XX until 30 June 20XX or the date when the innovation has been fully developed, whichever occurs earliest. Once the innovation has been fully developed, the Company will no longer be ‘developing’ the process for commercialisation and subparagraph 360-40(1)(e)(i) will no longer be satisfied.

High Growth Potential – subparagraph 360-40(1)(e)(ii)

58. 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.

59. The Company reports that the relevant Australian industry is currently valued at $XX billion, with the export market valued at considerably more. The Company will initially address the domestic Australian market and then scale to commence exports.

60. The Company has high growth potential and subparagraph 360-40(1)(e)(ii) will be satisfied.

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

61. 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. i.e. can existing revenues be multiplied while incurring a reduced or minimal increase in operating costs.

62. The Company believes it can scale up the business by having multiple units of specialised equipment servicing a single associated facility. This model is then expandable across the relevant areas of Australia.

63. The Company has demonstrated scalability of its business. Therefore, subparagraph 360-40(1)(e)(iii) will be satisfied.

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

64. It is accepted that the Company has satisfied the requirement under subparagraph 360-40(1)(e)(iv). Though the Company’s operations commence initially in Australian, it is expected to market its products overseas by the third year.

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

65. In Australia, the Company’s value chain process offers a significant improvement to its competitors. No other business in Australia owns a meat producing value chain that incorporates all the features of the Company. The Company has demonstrated that it has competitive advantages over its competitors, so subparagraph 360-40(1)(e)(v) is satisfied.

Conclusion on principles test

66. The Company satisfies the principles-based innovation test for its novel process as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period commencing XX XX 20XX until XX XX 20XX, or the date when the process has been fully developed, whichever occurs earliest.

Conclusion

67. The Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing XX XX 20XX until the earlier of XX XX 20XX or the date when the innovation has been fully developed, whichever occurs earlier.