Edited version of private advice

Authorisation Number: 1051922653517

Date of advice: 16 November 2021

Ruling

Subject: Early stage innovation company

Question 1

Does the Company satisfy the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the Income Tax Assessment Act 1997?

Answer

Yes, the Company is an ESIC for the period from 1 July 2021 until 30 June 2022, or the date when its innovation has been fully developed, whichever occurs earliest.

This ruling applies for the following period:

Year ended 30 June 2022

The scheme commences on:

1 July 2021

Relevant facts and circumstances

The Company was incorporated in Australia in the year ended 30 June 2021 and its Australian Business Number is active from the date of incorporation. Its equity interests are not listed for quotation in the official list of any stock exchange.

The Company does not have subsidiaries.

The Company derived no assessable income and incurred total expenses of less than $1 million in the year ended 30 June 2021.

The Company's primary goal is developing a low-cost green hydrogen energy system which can flexibly be adapted for multiple uses. The Company is the first company in Australia to develop this system.

Hydrogen is one of the leading options for storing energy from renewables and promises to be the clean energy option for storing electricity over days, weeks or even months. The current global market for hydrogen is approximately $110.5 billion. Green hydrogen currently represents only about 1% of this market. The emerging markets for green hydrogen include renewable hydrogen fuel cell cars, renewable energy storage, load levelling, gas turbines, injection into natural gas pipeline, and for the export sector (e.g. green ammonia, liquid hydrogen). Green hydrogen has potential wide application in:

•                 transport (e.g. road, mining, railways, shipping, aviation fuel)

•                 power (e.g. grid balancing, remote power)

•                 feedstock (e.g. oil refining, methanol, ammonia, steel mills, high grade heat, CHP, alumina calcining)

The versatile uses of hydrogen in providing transport, heat and power will create a demand surge globally and the global green hydrogen market is projected to grow rapidly over the next few years. Hydrogen will play a key role in a clean, secure and affordable energy future and green hydrogen can fuel a decarbonized Australian economy. The potential for Australia to play a key role in the expanding global hydrogen market creates a broad market for the Company. The Company expects to have a share in this market.

The technologies currently dominating the market have varying attributes (e.g. high capital expenditure and reliability) which are limiting factors in the hydrogen market. The Company estimates that in the long run, its system will produce green hydrogen for a lower price. The Company's new system will provide a pathway towards producing clean hydrogen under $2 per kilogram (H2 under 2) as part of the Australia National Hydrogen Roadmap (www.industry.gov.au/policies-and-initiatives/growing-australias-hydrogen-industry).

The Company has identified potential initial customers as being those customers within a specified market segment in Australia.

To commercialise its system the Company has undertaken various activities, including:

•                 The Company has engaged a team and advisors with proven expertise in hydrogen technologies and Australian financial and capital markets.

•                 The Company has established strategic alliances to develop its system.

•                 The Company is seeking affiliation and contract research.

•                 The Company is in advanced discussions with commercial partners.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 360-A

Income Tax Assessment Act 1997 subsection 360-40(1)

Income Tax Assessment Act 1997 paragraph 360-40(1)(a)

Income Tax Assessment Act 1997 paragraph 360-40(1)(b)

Income Tax Assessment Act 1997 paragraph 360-40(1)(c)

Income Tax Assessment Act 1997 paragraph 360-40(1)(d)

Income Tax Assessment Act 1997 paragraph 360-40(1)(e)

Income Tax Assessment Act 1997 paragraph 360-40(1)(f)

Income Tax Assessment Act 1997 subparagraphs 360-40(1)(e)(i) to (v)

Reasons for decision

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

Question 1

Summary

The Company is an Early Stage Innovation Company (ESIC) for the period from 1 July 2021 until 30 June 2022, or the date when its innovation has been fully developed, whichever occurs earliest.

Detailed reasoning

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.

A company qualifies as an ESIC if it satisfies the early stage test, is not a foreign company and satisfies one of two 'innovation' tests which are the 100-point innovation test or the

principles-based innovation test.

Early stage test

The early stage test requirements are specified in paragraphs 360-40(1)(a) to (d) and are outlined below.

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

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:

•                 incorporated in Australia within the last three income years (the latest being the current year); or

•                 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

•                 registered in the Australian Business Register within the last three income years (the latest being the current year).

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.

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

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

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)

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)

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.

Not a foreign company

Paragraph 360-40(1)(f) requires that at the test time, the company is not a foreign company (within the meaning of the Corporations Act 2001).

Innovation test

The company must also satisfy one of two innovation tests, the 100-point test or the 'principles-based test'. The 100-point innovation test is an objective test and is self-assessed by the company at a time immediately after the relevant shares are issued. For the purposes of this ruling the principles-based test is considered.

Principles-based test

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.

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.

The five requirements of the principles-based test, are stated in paragraph 360-40(1)(e):

(i)               the company is genuinely focused on developing for commercialisation one or more new, or significantly improved products, processes, services or marketing or organisational methods; and

(ii)             the business relating to those products, processes, services or methods has a high growth potential; and

(iii)            the company can demonstrate that it has the potential to be able to successfully scale that business; and

(iv)            the company can 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 can demonstrate that it has the potential to be able to have competitive advantages for that business;...

The requirements in sub-paragraphs 360-40(1)(e)(i) to (v) are outlined below.

(i) Developing new or significantly improved innovations for commercialisation

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...

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 identified by making a realistic and objective assessment of the company's intended market for its innovation. It includes identification of the immediately accessible market to which the innovation will initially be introduced, or a new market which may be created by the innovation. Factors in identifying the addressable market may include the location of the company's potential customers, the type of industry to be served and the geographical area it will serve. The addressable market must be objective and realistic.

A 'new' innovation means novel or introduced to the addressable market for the first time. It must be compared to the products, services, processes or methods that may or may not exist in the intended market for the innovation.

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, changes to pricing strategies or changes to goods resulting from seasonal change are examples of improvements that would not be considered significant.

The OECD Oslo Manual (paragraphs 124 and 151) 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.

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.

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.'

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. '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.

The EM does not define the meaning of the term 'genuinely focussed' within the context of subparagraph 360-40(1)(e)(i). 'Genuine' is defined in the online Macquarie Dictionary as "Being truly such; real; authentic." 'Focus' is defined as "3. a central point, as of attraction, attention, or activity. ... 8. to concentrate; to focus one's attention." In essence, the phrase 'genuinely focussed' is looking to what the company is truly concentrating and focussing their attention on or, put another way, what is the real central point of the company's activities. That is, the central activities of the company must be truly concentrated on developing their innovation for a commercial purpose. Developing an innovation for commercialisation in relation to a new innovation refers to the process of creating that innovation, and it includes a range of activities such as proof of concept activities, market research, prototyping, pilots and user testing, and other activities to prepare for the launch of the new innovation.

(ii) High growth potential

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.

(iii) Scalability

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.

(iv) Broader than local market

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.

(v) Competitive advantages

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 of subsection 360-40(1) to the Company

Test time

For the purposes of this ruling, the test time for determining if the Company is a qualifying ESIC will be a particular date (i.e. the time immediately after the relevant shares are issued by the Company) during the income year ending 30 June 2022.

Current year

For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 2022.

Early stage test

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

Paragraph 360-40(1)(a) specifies three ways in which it can be satisfied. One way a company will satisfy the requirement in paragraph 360-40(1)(a) is if it was incorporated in Australia within the last three income years (the latest being the current year).

The Company satisfies paragraph 360-40(1)(a) because the Company was incorporated in Australia in the year ended 30 June 2021.

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

To satisfy this requirement a company and its 100% owned subsidiaries must have incurred total expenses of $1 million or less in the income year before the current year.

The Company does not have subsidiaries and for the year ended 30 June 2021 incurred total expenses of less than $1 million. The Company satisfies the requirement in paragraph 360-40(1)(b).

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

To satisfy this requirement the Company must have derived total assessable income of $200,000 or less in the income year before the current year.

The Company did not derive assessable income in the year ended 30 June 2021 therefore the Company satisfies paragraph 360-40(1)(c).

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

The Company is not listed on any stock exchange in Australia or a foreign country, therefore paragraph 360-40(1)(d) is satisfied.

Conclusion on early stage test

The Company satisfies the early stage test for the 2022 income year, as each of the requirements in paragraphs 360-40(1)(a) to (d) have been satisfied.

Not a foreign company

Paragraph 360-40(1)(f) requires that the company is not a foreign company. The Company was incorporated in Australia in 20XX. The Company is not a foreign company. This requirement is satisfied.

Principles-based test

The Company must meet the five requirements in paragraph 360-40(1)(e) to satisfy the principles-based test. Each of these is discussed below.

Genuinely focussed on developing new or significantly improved innovations for commercialisation - subparagraph 360-40(1)(e)(i)

The Company's primary goal is developing a low-cost green hydrogen energy system which can flexibly be adapted for multiple uses. The Company is the first company in Australia to develop this system.

The technologies currently dominating the market have varying attributes (e.g. high capital expenditure and reliability) which are limiting factors in the hydrogen market. The Company estimates that in the long run, its system will produce green hydrogen for a lower price. The Company's new system will provide a pathway towards producing clean hydrogen under $2 per kilogram as part of the Australia National Hydrogen Roadmap.

The Company has formed strategic alliances and partnerships to develop and commercialise its system and continues to be in discussions with institutions and other commercial partners for this purpose. The Company has engaged a team and advisors with proven expertise in hydrogen technologies and Australian financial and capital markets.

The Company has demonstrated that it has taken tangible steps to identify a gap in the market, to create an innovative product to fill the gap in the market and to commercialise the innovation to generate revenue. The Company is 'genuinely focussed on developing new or significantly improved innovations for commercialisation'. Subparagraph 360-40(1)(e)(i) will therefore be satisfied for the time period from 1 July 2021 until 30 June 2022, or the date when its innovation has been fully developed, whichever occurs earliest.

Once the 'innovation' has been fully developed, the Company will no longer be 'developing' the product for commercialisation and subparagraph 360-40((1)(e)(i) will no longer be satisfied.

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

Hydrogen is one of the leading options for storing energy from renewables. The current use of hydrogen is largely as chemical feedstock however the emerging markets for green hydrogen include renewable hydrogen fuel cell cars, renewable energy storage, load levelling, gas turbines, injection into natural gas pipeline, and for the export sector (e.g. green ammonia, liquid hydrogen). Green hydrogen has potential wide application in transport (e.g. road, mining, railways, shipping, aviation fuel), power (e.g. grid balancing, remote power), feedstock (e.g. oil refining, methanol, ammonia, steel mills, high grade heat, CHP, alumina calcining).

The current global market for hydrogen is approximately $110.5 billion. Green hydrogen currently represents only about 1% of this market but is projected to grow rapidly over the next few years. The versatile uses of hydrogen in providing transport, heat and power will create a demand surge globally. The potential for Australia to play a key role in the expanding global hydrogen market creates a broad market for the Company and high growth potential for the Company. The Company expects to have a share in this market.

The addressable market for the Company in the first instance is the Australian market with a focus on a specified market segment. The Company is also planning to establish a global footprint by establishing an office globally and/or forming alliances with local partners in the respective regions. The Company's addressable market therefore includes both the Australian market and overseas markets.

The Company demonstrates that its innovation has the potential for high growth within a broad addressable market. Therefore subparagraph 360-40(1)(e)(ii) will be satisfied.

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

The global green hydrogen market is projected to grow rapidly over the next few years and the Company expects to have a share in this market. The Company estimates that in the long run, its system will produce green hydrogen for a lower price, creating a huge opportunity in the market for the Company.

The Company's addressable market includes both the Australian market and overseas markets therefore there is potential to successfully scale the business. Projections indicate increases in projected revenue and profits. The Company demonstrates it is able to successfully scale its business, therefore subparagraph 360-40(1)(e)(iii) is satisfied.

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

The current global market for hydrogen is approximately $110.5 billion and whilst green hydrogen currently represents only about 1% of this market, the global green hydrogen market is projected to grow rapidly over the next few years. The Company is anticipating this growth and intends to play a part in Australia becoming a leading player in the global hydrogen market.

The Company has identified its potential initial customers as being those within a specified market segment in Australia. Huge export potential also exists therefore the Company is also planning to establish a global footprint by setting up an office globally and/or forming alliances with local partners in the respective regions.

The Company demonstrates that its innovation has the potential for high growth within a broad addressable market, its ultimate addressable market being both Australian and global markets. The Company therefore addresses a broader market than just the local market and is not confined to a local city, area or region. The Company's market can clearly be expanded to a broader market in the future. Subparagraph 360-40(1)(e)(iv) will therefore be satisfied.

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

The Company is the first company in Australia to develop this system and therefore has first mover market advantage in Australia.

The Company has sought strategic alliance partnerships with institutions and engineering specialists to bring its product to market and to give it competitive advantages. The Company has engaged a team and advisors with proven expertise in hydrogen technologies and Australian financial and capital markets and has established a strategic alliance to develop its system. The Company is also securing affiliation and contract research and is in advanced discussions with commercial partners. The Company is also planning to establish a global footprint by setting up an office globally and/or forming alliances with local partners in the respective regions.

The Company has demonstrated the potential for it to have competitive advantage within the market, satisfying subparagraph 360-40(1)(e)(v).

Conclusion on principles-based test

The Company satisfies the principles-based test for the period from 1 July 2021 until 30 June 2022, or the date when its innovation has been fully developed, whichever occurs earliest.

When the Company's innovation has been fully developed, the Company will no longer be 'developing' the product for commercialisation and the principles-based test will no longer be satisfied.

Overall Conclusion- ESIC

The Company satisfies the early stage test requirements in paragraphs 360-40(1)(a) to (d), is not a foreign company as required by paragraph 360-40(1)(f) and will satisfy the principles-based test in paragraph 360-40(1)(e) until such time that its innovation has been fully developed.

The Company therefore satisfies the eligibility criteria for an ESIC in subsection 360-40(1) and is an ESIC for the period from 1 July 2021 until 30 June 2022, or the date when its innovation has been fully developed, whichever occurs earliest.