Edited version of private advice

Authorisation Number: 1051587555490

Date of advice: 27 September 2019

Ruling

Subject: Early stage innovation company

Question

Does the Company qualify as an Early Stage Innovation Company pursuant to section 360-40 of the Income Tax Assessment Act 1997 (ITAA 1997) at any time during the income year ending 30 June 2020?

Answer

No

This ruling applies for the following period

1 July 20XX to 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

The Company was registered in the Australian Business Register during the 20XX income year.

The Company has two 100% wholly owned subsidiaries.

Neither the Company nor its subsidiaries are listed on any stock exchange.

The Company and one of its subsidiaries have lodged company income tax returns for the years ended 30 June 20XX and 20XX.

The total expenses declared at item 6 of the tax returns for the years ended 30 June 20XX and 20XX for the respective companies exceeds $XXX.

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

Income Tax Assessment Act 1997 section 975-505

Income Tax Assessment Act 1997 section 975-150

Reasons for decision

All legislative references are to the ITAA1997 unless otherwise stated.

Summary

The Company does not meet the eligibility requirements of an ESIC under subsection 360-40(1) since it does not satisfy the requirements of the early stage test within paragraph 360-40(1)(a).

Detailed reasoning

Qualifying early stage innovation company (ESIC)

1.    Generally, Subdivision 360-A sets out the main requirements for being eligible for either the early stage investor tax offset or the modified capital gains tax (CGT) treatment on eligible equity interests.

2.    Subsection 360-15(1) outlines the requirements for an investor to assess entitlement to the tax offset. The relevant point in time is when the newly issued shares are issued. It is also immediately after that time the company would need to meet the requirements of being an Early Stage Innovation Company (ESIC).

3.    Section 360-40 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

4. The early stage test determines if the company is at an early stage in its development. In short, the company must satisfy the following requirements at a particular time in an income year:

·                     Recent incorporation or registration in the Australian Business Register

·                     Total expenses of $1 million or less

·                     Assessable income of $200,000 or less, and

·                     Not listed on a stock exchange.

5.      These requirements are outlined in detail within paragraphs 360-40(1)(a) to (d).

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

6.      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).

7.      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.

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

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

9.      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)

10.   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)

11.   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

12.   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. The Company has applied for this ruling on the basis that it meets the 100 point test.

100% subsidiary

13.   A 100% subsidiary is defined in section 975-505.

14.   Subsection 975-505(1) provides a company (the subsidiary company) is a 100% subsidiary of another company (the holding company) if all of the shares in the subsidiary company are beneficially owned by

a)         the holding company

b)         one or more 100% subsidiaries of the holding company, or

c)         the holding company and one or more 100% subsidiaries of the holding company.

15.   Subsections 975-505(2) and (3) provide the subsidiary company will not be a 100% subsidiary of the holding company if a person is, or will be, in a position to affect certain rights in relation to the subsidiary company. Section 975-150 outlines the circumstances in which a person will be in such a position.

Total expenses

16.   Some of the early stage criteria within section 360-40 require calculation of the total expenses incurred by the company and its 100% subsidiaries.

17.   The term 'total expenses' is not defined for the purposes of Subdivision 360-A. However, guidance on the meaning of the term can be found in Draft Taxation Determination TD 2019/D5 Income tax: tax incentives for early stage investors: what is an 'expense' that is 'incurred' for the early stage test?. Paragraph 8 of TD 2019/D5 states:

The word 'expenses' in the expense tests is not a defined term and so has its ordinary meaning in the context in which it appears. Our view is that in the context of the early stage investor incentive, a meaning consistent with the general accounting concept of expense is the most appropriate.

18.   TD 2019/D5 goes on to explain that an interpretation which adopts the commercial meaning of the word is appropriate in the context of legislation concerned with business activities. For support the Explanatory Memorandum (EM) to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 is referred to, which states at paragraph 1.64:

The ATO's company tax return requires companies to report 'total expenses' at item six as part of the total profit or loss calculation. A company that has submitted a company tax return in the previous income year must rely on the amount reported in item six for the purposes of this test. Alternatively, if the company was not required to submit a company tax return, it may use the amount corresponding to this item.

Application to your circumstances

19.   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 1 July 20XX, but before 30 June 20XX.

20.   Therefore, for the purposes of subsection 360-40(1), the current year will be the year ending 30 June 20XX (20XX income year). For clarity, in relation to the requirements in paragraph 360-40(1)(a),

a)            the last 3 income years will include the years ending 30 June 20XX, 20XX and 20XX

b)            the last 6 income years will include the years ending 30 June 20XX, 20XX, 20XX, 20XX, 20XX and 20XX.

Paragraph 360-40(1)(a) - Incorporation or Registration

21.   The Company was registered in the ABR during the 20XX income year.

22.   Therefore, the Company does not satisfy subparagraphs 360-40(1)(a)(i) or (iii) as it was not incorporated in Australia or registered on the ABR within the last 3 income years.

23.   The Company will need to satisfy the element in subparagraph 360-40(1)(a)(ii). This element is made up of two parts, being time of incorporation and expenses incurred across 3 years by the company and its 100% subsidiaries.

24.   The Company satisfies the first requirement of subparagraph 360-40(1)(a)(ii), as it was incorporated in Australia within the last 6 income years.

25.   The second requirement of subparagraph 360-40(1)(a)(ii) is that the Company and its 100% subsidiaries must have incurred total expenses of $1 million or less across the last 3 income years. The relevant 3 income years in this circumstance are the years ending 30 June 20XX, 20XX and 20XX. These three years include the current year.

26.   The Company has two 100% wholly owned subsidiaries. Item 6 of the tax returns for the Company and one of the subsidiaries show that expenses for the 20XX and 20XX income years exceeds $XXX.

27.   Therefore, the Company does not satisfy subparagraph 360-40(1)(a)(ii).

28.   Consequently, the Company does not satisfy paragraph 360-40(1)(a) and will not qualify as an ESIC at any time during the income year ending 30 June 20XX.