Edited version of private advice

Authorisation Number: 1051960930757

Date of advice: 26 April 2022

Ruling

Subject: Early stage innovation company

Question 1

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') 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

1.      Company A is a proprietary company incorporated in XYZ on x XX 20XX.

2.      Company A's director is Taxpayer B.

3.      Company A's registered office and principal place of business is situated at XYZ.

4.      Company A has no wholly or partly owned subsidiaries. Company A is not part of an income tax consolidated group.

5.      For the financial year ending y YY 20XX, Company A was not incorporated and did not incur expenses nor earn income.

6.      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.

Product Development

7.      Company A is undertaking development to become the major producer of a sustainable particular product as a replacement for another high grade product (the 'Product).

8.      Company A has been established to develop and commercialise a Government Department's technology for a particular process. The rate of the process can be varied as a function of temperature. Additionally, the traditional process needs large cuts of wood, whereas Company A can use waste products.

9.      A particular product is the main product, but other products are also produced.

10.   Company A has assembled a team with complementary experience in commercialisation, innovation and technology, as well as a Government Department's alumni with experience in the technology.

11.   After a competitive process, the Government Department selected Company A as the exclusive commercialisation partner for this technology.

12.   Company A's activities address the global need for this sustainably produced particular product, with other sustainable products as by-products.

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

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

High growth potential

15.   Company A has high growth potential as the global market for this particular product is USD$xyz and estimated to continue growing at xx% per annum.

16.   A large corporation has also expressed interest, and an NDA has been executed. As a result, the business commercialising the innovation has extremely high growth potential.

Scalability

17.   Company A has the potential to successfully scale up as the majority of the cost of building plants is off-the-shelf equipment, with many global suppliers of the required equipment.

18.   The production parameters are customized to suit the application and the local green waste. Availability of sustainable green and forestry waste, with an unlimited potential to scale to sustainably sourced seaweed via marine permaculture.

19.   A team of innovation scale-up professionals has been assembled.

20.   There is an increasing demand for this particular product as leading firms work towards their commitments. There is interest from a large corporation and Company M, both are companies with early net zero commitments.

Broader than local market

21.   Company A's CEO has a global outlook, is based in an overseas country and ideally situated to start developing global markets.

22.   A large corporation has expressed interested in the technology, and Company A is working with them on life cycle assessments (LCAs).

Competitive advantages

23.   Company A has potential to have competitive advantages for that business as they have exclusive rights to the Government Department's IP for the self-sustaining process.

24.   Company A has employed the Government Department's alumni with experience on the self-sustaining process plant.

25.   Company A has first mover advantage in this particular product.

Information provided

26.   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

•           Responses to various emails

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

28.   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 under subsection 360-40(1) for the period x XX 20XX to y YY 20YY.

DETAILED REASONING

Qualifying Early Stage Innovation Company

29.   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'

30.   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)

31.   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 any 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).

32.   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.

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

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

34.   To meet the requirement in paragraph 360-40(1)(b), the company and any 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)

35.   To meet the requirement in paragraph 360-40(1)(c), the company and any 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)

36.   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'

37.   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

38.   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 (v)

39.   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.

40.   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.

41.   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.

Developing new or significantly improved innovations for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997

42.   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..."

43.   The innovation being developed by the company must either be new or significantly improved for an applicable addressable market.[1] 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.

44.   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, pricing strategies or seasonal changes are examples of improvements that would not be considered significant.

45.   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."

46.   The company must be genuinely focussed 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.

47.   For a company to qualify as an ESIC under the principles based test, the company must be "genuinely focussed on developing for commercialisation" their innovation. That is, the central activities of the company must be truly concentrated on developing their innovation for a commercial purpose. '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 - subparagraph 360-40(1)(e)(ii) ITAA 1997

48.   The company must be able to demonstrate that the business relating to the innovation has a high growth potential 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 - subparagraph 360-40(1)(e)(iii) ITAA 1997

49.   The company must be able to demonstrate that it has the potential to successfully scale up the business relating to the innovation. The company must have operating leverage, whereas 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.

Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997

50.   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 - subparagraph 360-40(1)(e)(v) ITAA 1997

51.   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.

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

52.   At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth).

53.   The dictionary in section 9 of the Corporations Act 2001 (Cth) defines a foreign company to mean:

(a) a body corporate that is incorporated in an external Territory, or outside Australia and the external Territories, and is not:

(i) a corporation sole; or

(ii) an exempt public authority; or

(b) an unincorporated body that:

(i) is formed in an external Territory or outside Australia and the external Territories; and

(ii) under the law of its place of formation, may sue or be sued, or may hold property in the name of its secretary or of an officer of the body duly appointed for that purpose; and

(iii) does not have its head office or principal place of business in Australia.

APPLICATION TO YOUR CIRCUMSTANCES

TEST TIME

54.   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

55.   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 y YY 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

56.   Company A was incorporated in XYZ on y YY 20XX, 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

57.   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.

58.   Company A did not incur any expenses in the 20XX income year. Consequently, paragraph 360-40(1)(b) is satisfied.

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

59.   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.

60.   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

61.   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.

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

CONCLUSION FOR EARLY STAGE TEST

63.   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

64.   Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending y YY 20YY. Company A is electing to seek eligibility by satisfying the Principles based Innovation test under section 360-40(1)(e)(i)-(v), in order to be issued with a Private Binding Ruling.

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

Developing new or significantly improved innovations for applicable addressable market - subparagraph 360-40(1)(e)(i) ITAA 1997

65.   In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be developing an innovation which is either new or significantly improved for an applicable addressable market.

66.   Company A is undertaking development to become the major producer of a particular sustainable product as a replacement for another product (the 'Product).

67.   Company A has been established to develop and commercialise a Government Department's technology for a particular process. The rate of the process can be varied as a function of temperature of the equipment. Additionally, the traditional process needs large cuts of wood, whereas Company A can use waste products.

68.   This particular product is the main product, but other by-products are also produced.

69.   Company A has assembled a team with complementary experience in commercialisation, innovation and technology, as well as the Government Department's alumni with experience in the technology.

70.   After a competitive process, the Government Department selected Company A as the exclusive commercialisation partner for this technology.

71.   Company A's activities address the global need for a sustainably produced particular product, with other sustainable products as by-products.

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

73.   Company A is genuinely focussed on developing their Product for an applicable addressable market.

Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997

74.   In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be genuinely focussed on developing an innovation for a commercial purpose in order to generate economic value and revenue for the company.

75.   Prior to the present time, Company A recruited a Government Department's alumni who designed, built and operated the pilot plant over the previous x years. Company A are negotiating premises and purchasing equipment to scale up their business. A large corporation's representatives are visiting Australia in QX 20XX to inspect the pilot plant.

76.   Currently, development work is continuing. A large corporation emailed Company A with queries about their operation. The large corporation needs to 'green' their supply chain.

77.   A major input into this particular product's production is xxx. Company A is in the right location to enable net zero xxx. This is highly attractive to overseas operators that have a net zero target by 20ZZ.

78.   At this stage, Company A are developing the life cycle assessments (LCA) for the large corporation. This enables the large corporation to move forward and help commercialise Company A. The large corporation have referred Company A to another company retained by Company A for that purpose.

79.   Company A is acquiring the Government Department's built pilot plant as a product development platform. Only limited feedstocks have been studied to date. Company A is planning a testing campaign to validate different feedstocks for different markets.

80.   There are a number of steps which are required to be completed into the future, before the Product is considered to be fully developed for commercialisation. Company A has potential as a replacement for a particular product across the globe.

81.   Development will be required in each region to find suitable green waste for this particular product, and other by-products production. The product quality and mix of the products in different regions is strongly dependent on the feedstock and the parameters used during the process.

82.   Company A is genuinely focussed on developing their Product for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied 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. Once the Product has been fully developed, Company A will no longer be 'developing' the product for commercialisation.

High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997

83.   In applying the requirements of subparagraph 360-40(1)(e)(ii), Company A must be able to demonstrate that it has the potential for high growth within a broad addressable market.

84.   Company A has high growth potential as the Product is easily and infinitely scalable to a global audience.

85.   Company A has high growth potential as the global market for this particular product is USD$xxx and estimated to continue growing at x% per annum

86.   As the global community transitions to meet net zero commitments, sustainable alternatives are required. This high grade particular product is produced from a range of sustainably sourced green and forestry waste rather than fossil resources.

87.   The first customer, Company M, are committed to net zero production of a particular product. Each plant scales up to requiring more than xx tonnes of this particular product per annum.

88.   A large corporation has also expressed interest, and an NDA has been executed. As a result, the business has extremely high growth potential.

89.   Company A has demonstrated a high growth potential for their Product, so subparagraph 360-40(1)(e)(ii) is satisfied for the period x XX 20XX to y YY 20YY.

Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997

90.   In applying the requirements of subparagraph 360-40(1)(e)(iii), Company A must be able to demonstrate that it has the potential to successfully scale up the business.

91.   Company A's business has the potential to successfully scale up because the majority of the cost of building plants is off-the-shelf equipment, with multiple global suppliers of required equipment.

92.   The production parameters are customized to suit the application and the local green waste. Availability of sustainable green and forestry waste, with an unlimited potential to scale to sustainably sourced seaweed via marine permaculture.

93.   A team of innovation scale-up professionals has been assembled.

94.   There is an increasing demand for net zero supply chains as leading firms work towards their net zero commitments. There is interest from a large corporation and Company M, both which are companies with early net zero commitments.

95.      This leverage ensures that Company A has the potential to successfully scale up its business, so subparagraph 360-40(1)(e)(iii) is satisfied for the period x XX 20XX to y YY 20YY.

Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997

96.      In applying the requirements of subparagraph 360-40(1)(e)(iv), Company A must be able to demonstrate that it has the potential to be able to address a broader than local market, including global markets.

97.      Company A has the potential to address broad and global markets, as this particular product is needed in Australia and globally for production of many other products.

98.      Company A's CEO has a global outlook, is based in an overseas country and ideally situated to start developing global markets.

99.      A large corporation has expressed interested in the technology, and Company A is working with them on life cycle assessments (LCA).

100.    Company A has demonstrated that it has the capacity to address a broader than local market, so subparagraph 360-40(1)(e)(iv) is satisfied for the period x XX 20XX to y YY 20YY.

Competitive advantages - subparagraph 360-40(1)(e)(v) ITAA 1997

101.    In applying the requirements of subparagraph 360-40(1)(e)(v), Company A must demonstrate that it has potential to be able to have competitive advantage for that business.

102.    Company A has potential to have competitive advantages for that business as they have exclusive rights to the Government Department's IP for the self-sustaining process.

103.    Company A has employed the Government Department's alumni with experience on the self-sustaining process plant.

104.    Company A has first mover advantage in this particular product.

105.    Company A has demonstrated that it has competitive advantages for its business, so subparagraph 360-40(1)(e)(v) is satisfied for the period x XX 20XX to y YY 20YY.

CONCLUSION FOR PRINCIPLES BASED TEST

Company A satisfies the principles based test as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) 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.

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

106.    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.

[1] Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.79.