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Edited version of private advice
Authorisation Number: 1051603186064
Date of advice: 31 October 2019
Ruling
Subject: Early Stage Innovation Company
Question
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)?
Answer
Yes
This ruling applies for the following periods:
Year ending 30 June 2019
Year ending 30 June 2020
The scheme commences on:
1 July 2018
Relevant facts and circumstances
1. Company A was incorporated in Australia on Date X. Its equity interests are not listed for quotation in the official list of any stock exchange.
2. Company A has no subsidiaries and in respect of the year ended 30 June 2018 had total expenses of $X and total income of $Y in the previous income year i.e. the year ended 30 June 2017.
3. In respect of the year ended 30 June 2019 Company A had total expenses of $X and total income of $Y in the previous income year, i.e. the year ended 30 June 2018.
4. Documents in respect of the innovation being developed by Company A was provided and the relevant information within these documents in applying the relevant tests to their circumstances.
Information provided
5. You have provided information in a number of documents and phone conversations in relation to your Product, including:
a. your private ruling application dated xx October 2019.
b. phone conversation with you on xx October 2019.
c. supplementary information provided on xx October 2019.
6. We have referred to the relevant information within these documents and conversations in applying the relevant tests to your circumstances.
Relevant legislative provisions
Income Tax Assessment Act 1997 Subdivision 360-A
Income Tax Assessment Act 1997 section 360-40
Reasons for decision
All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.
Summary
Company A meets the eligibility requirements of an ESIC under subsection 360-40(1).
Detailed reasoning
Qualifying Early Stage Innovation Company
7. 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'
8. 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)
9. 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).
10. 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.
11. A company that does not meet any of these conditions will not qualify as an ESIC.
Total expenses - paragraph 360-40(1)(b)
12. 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)
13. 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)
14. 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
15. 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.
'Principles-based test' - subparagraphs 360-40(1)(e)(i) to (v)
16. 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.
17. 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.
18. 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.
Application to your circumstances
Test time
19. For the purposes of this ruling, the test time for determining if Company A is a qualifying ESIC will be a particular date during the income years 30 June 2019 and 30 June 2020.
Current year
20. For the purposes of subsection 360-40(1), the current year will be either the year ending 30 June 2019 (the 2019 income year) or the year ending 30 June 2020 (the 2020 income year).
Early stage test
Incorporation or Registration - paragraph 360-40(1)(a)
21. In respect of the 2019 and 2020 income years, as Company A was incorporated on Date X, which was within the last 3 income years, subparagraph 360-40(1)(a)(i) is satisfied.
Total expenses - paragraph 360-40(1)(b)
22. In respect of the 2020 income year, as Company A had expenses of $1 million or less in the prior income years (the 2019 income year) paragraph 360-40(1)(b) is satisfied.
23. In respect of the 2019 income year, as Company A had expenses of $1 million or less in the prior income years (the 2018 income year) paragraph 360-40(1)(b) is satisfied.
Assessable income - paragraph 360-40(1)(c)
24. In respect of the 2020 income year, as Company A's assessable income in the prior income year (the 2019 income year) is $200,000 or less paragraph 360-40(1)(c) is satisfied.
25. In respect of the 2019 income year, as Company A's assessable income in the prior income year (the 2018 income year) is $200,000 or less paragraph 360-40(1)(c) is satisfied.
No stock exchange listing - paragraph 360-40(1)(d)
26. As Company A 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
27. Company A will satisfy the early stage test for the entire 2019 and 2020 income years, 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)
28. Information provided by Company A demonstrated that their innovation will be a significant improvement within their target market.
Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i)
29. Information provided by Company A demonstrated that they are genuinely focused on developing the product which includes their innovation within their target market.
Conclusion on subparagraph 360-40(1)(e)(i)
30. Company A is genuinely focussed on developing their innovation for a commercial purpose.
31. Therefore subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 1 July 2018 until 30 June 2019 and 1 July 2019 until 30 June 2020.
High growth potential - subparagraph 360-40(1)(e)(ii)
32. Information provided by Company A demonstrated the potential for high growth.
33. Therefore subparagraph 360-40(1)(e)(ii) will be satisfied.
Scalability - subparagraph 360-40(1)(e)(iii)
34. Information provided by Company A demonstrated that it should be able to generate increased revenue without increasing its operating costs affording it 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)
35. Information provided by Company A has demonstrated that their business has the potential to address a broader market than just the local market. Therefore subparagraph 360-40(1)(e)(iv) will be satisfied.
Competitive advantages - subparagraph 360-40(1)(e)(v)
36. Information provided by Company A has demonstrated the potential for their product to have competitive advantages within their target market satisfying subparagraph 360-40(1)(e)(v).
Conclusion on principles test
37. Company A satisfies the principles based test as it satisfies the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the 2019 and 2020 income years.
Conclusion
38. Company A meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 2018 until the earlier of 30 June 2019 and for the period commencing 1 July 2019 until the earlier of 30 June 2020 income years, or the date when the Product has been fully developed and is ready for sale, whichever occurs earlier.