Edited version of private advice

Authorisation Number: 1051874200533

Date of advice: 23 July 2021

Ruling

Subject: ESIC eligibility

Question:

Does Company A 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') for the period x XX 20XX to y YY 20YY?

Answer:

Yes

This ruling applies for the following periods

x XX 20XX to y YY 20YY

The Scheme commences on

x XX 20XX

RELEVANT FACTS AND CIRCUMSTANCES

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

1.       Company A is an Australian proprietary company incorporated in State X on x XX 20ZZ.

2.       Company A was registered in the Australian Business Register and issued an ABN on x XX 20YY. Company A's ABN is xyz xyz xyz.

3.       The trading name of Company A is XYZ.

4.       Company A's director is Taxpayer A.

5.       Company A is not part of a consolidated group and is not planning to join a tax consolidated group.

6.       For the financial year ending x XX 20XX, Company A has incurred and earned the following:

•        Total expenses of $xxx

•        Total income of $yyy

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

8.       Company A is not a foreign company pursuant to the Corporations Act 2001 (Cth).

9.       Company A is developing an online platform that is focused on a particular experience for the consumer ('the Product'). This platform will utilise contemporary market leading technology to deliver a user experience unique to its customers.

10.    This platform will encompass online sales, education and a communications platform, plus other innovative vertically integrated elements, to be commercialised as XYZ.

11.    Company A is developing and commercialising the intellectual property ('IP') owned by Taxpayer A to develop a significant, world-leading innovation in sales and marketing. The IP, which is exclusively licensed to Company A, provides the genesis of a system being developed to offer a unique user experience.

12.    The innovation is a world-first process that will utilise the platform developed by Company A to promote sales suggestions to individuals, based on information provided by individual users and matched with XYZ's IP. The platform will use artificial intelligence to enable users to interrogate the IP and to provide feedback to the suggestions provided.

13.    Company A's concept is being thoroughly scoped, key personnel at Board and Operations level have been engaged, and the company is completing capital raising. Capital is required to provide seed funding to enable payment from the commencement of trading for key personnel, stock and marketing resources.

14.    Company A is developing their online platform to address a number of discrete markets and is continuing to develop their Product.

15.    Company A's Product has been identified as having an international addressable market.

16.    On x XX 20XX, Company A received a private ruling for the year ended y YY 20XX (authorisation number xyz) that the company qualified as an ESIC at relevant test times. The basis for the decision was that the company satisfied the principles based test in respect of the online platform being developed.

17.    Since the ruling issued, Company A has continued to develop their online platform. Over the last xx months the company has been working with their IT provider to refine its personalised tool. This development is shortly to be completed, since the final stage in a process of a number of stages, will be completed in approximately 20YY.

18.    The next phase of development will involve the entire online platform and the integration into this platform of the unique AI technology. Once Company A has completed its capital raising, this integration process should take around xx months of development and yy months of testing.

19.    On y YY 20YY, the state government imposed a lockdown. This lock down, along with the ongoing restrictions, immediately impacted in a powerful negative manner on the ability of Company A to raise capital and effectively curtailed the initial opportunity to do so. For this reason, an extension to the previous ruling has been sought by Company A.

Information provided

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

•          Private Binding Ruling ('PBR') Application, dated y YY 20YY

•          Response to further questions provided on x XX 20XX

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

22.    You propose to issue new shares in Company A to various investors to assist in funding the continued development and commercialisation of the 'Product'.

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

Company A meets the eligibility requirements of an ESIC pursuant to subsection 360-40(1) for the period x XX 20XX to y YY 20YY.

DETAILED REASONING

Qualifying Early Stage Innovation Company

23.    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'

24.    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)

25.    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 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).

26.    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.

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

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

28.    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)

29.    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)

30.    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

31.    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

32.    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)

33.    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.

34.    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.

35.    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.

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

36.    At the test time, the company must not be a foreign company within the meaning defined in section 9 of the Corporations Act 2001 (Cth).

APPLICATION TO YOUR CIRCUMSTANCES

TEST TIME

37.    For the purposes of this ruling, the 'test time' for determining if Company A is a qualifying ESIC, will be upon the issue of qualifying shares on a particular date or dates on or after x XX 20XX, and on or before y YY 20YY.

Current year

38.    Therefore, for the purposes of subsection 360-40(1) ITAA 1997, the current year will be the year ending y YY 20YY (the 20YY income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last 3 income years will include the years ending y YY 20YY, 20XX and 20ZZ, and the income year before the current year will be the year ending x XX 20XX (the 20XX income year).

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

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

39.    Company A was registered in the ABR and issued an ABN on x XX 20YY, 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

40.    In applying the requirements of paragraph 360-40(1)(b), Company A and any of its 100% subsidiaries must have incurred total expenses of $1 million or less in the 20XX income year, being the income year before the current year.

41.    Company A incurred expenses of $xxx in the 20XX income year. Consequently, paragraph 360-40(1)(b) is satisfied.

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

42.    In applying the requirements of paragraph 360-40(1)(c), Company A and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the 20XX income year, being the income year before the current year.

43.    Company A did not earn any assessable income in the 20XX income year. Consequently, paragraph 360-40(1)(c) is satisfied.

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

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

45.    Company A was not listed on any Stock Exchange in Australia or a foreign country at any test time, so paragraph 360-40(1)(d) is satisfied.

CONCLUSION FOR EARLY STAGE TEST

46.    Company A satisfies the early stage test for the 20YY income year, 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

47.    Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending y YY 20YY. For Company A to be a qualifying ESIC, it will need to satisfy the principles-based test.

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

48.    In the ruling dated x XX 20XX (authorisation number xyz), the Commissioner concluded that Company A satisfied the principles based test in respect of the online platform being developed. While the online platform is still being developed, Company A will continue to satisfy the requirements of the principles based test, within subparagraphs 360-40(1)(e)(i) to (v).

49.    Company A is developing an online platform (the 'Product'), via a software system that can uniquely sell products to every individual user or customer of the site.

50.    The innovation being developed is a world-first process that will utilise the platform to output unique recommendations to individuals, based on information provided by individual users and matched with XYZ's IP which is exclusively licensed to Company A.

51.    XYZ's system enables each product to be classified according to designated variables. The nature of this IP is highly confidential and highly valuable. It forms the basis of the unique engine being developed for Company A's platform.

52.    These tables are being refined by XYZ, who is working with software engineers to ensure the effectiveness of the build and the ability of the system to be fine-tuned once it has been constructed.

53.    XYZ is working with Company A's chosen Artificial Intelligence ('AI') provider to develop a means by which AI can be deployed to enhance the system's ability to generate additional information by which it can better achieve its objective of providing the best possible experience to each individual user.

54.    Company A aims to deliver a new and innovative platform for commercialisation to drive the generation of income in a number of phases:

•          Phase 1 - World-leading model. This phase will adopt advanced technology and AI to develop an app that meets the requirements of each unique customer

•          Phase 2 - Personalised model. This phase will develop a Virtual Assistant ('VA'), which is a text-based system of direct engagement with VA with Machine Learning ('ML') capability to analyse customer purchases

•          Phase 3- Voice recognition model. This phase will integrate voice recognition capability, allowing a user to ask XYZ a question, and the system would then be able to respond with a live answer from XYZ.

55.    Company A is developing their online platform to address a discrete market and is continuing to develop their Product through to mid-20YY.

49.    Since the ruling dated x XX 20XX was issued, Company A has continued to develop their online platform. Over the last xx months the company has been working with their IT provider to refine its personalised tool. This development is shortly to be completed, since the final stage in a process of a number of stages, will be completed in approximately 20YY.

50.    The next phase of development will involve the entire online platform and the integration into this platform of the unique AI technology. Once Company A has completed its capital raising, this integration process should take around xx months of development and yy months of testing.

51.    On y YY 20YY, the state government imposed a lockdown. This lock down, along with the ongoing restrictions, immediately impacted in a powerful negative manner on the ability of Company A to raise capital and effectively curtailed the initial opportunity to do so. For this reason, an extension to the previous ruling has been sought by Company A.

52.    Company A is genuinely focussed on developing their Product, an online platform, for an applicable addressable market, so subparagraph 360-40(1)(e)(i) is satisfied for the period x XX 20XX to y YY 20YY.

CONCLUSION FOR PRINCIPLES BASED TEST

53.    Company A satisfies the principles based test as it will satisfy the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period commencing x XX 20XX until y YY 20YY, or the date when their online platform has been fully developed and is ready for client use, whichever occurs earlier.

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

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

CONCLUSION

Company A meets the eligibility criteria of an ESIC under section 360-40 for the period x XX 20XX to y YY 20YY, or the date when their Product has been fully developed and is ready for client use, whichever occurs earlier.

ATO view documents

Not applicable

Other relevant comments

Not applicable

Key words

Early Stage Innovation Company

Tax incentives for Early Stage Investors

Early Stage Test

Principles Based Innovation Test

Test Time