Edited version of private advice

Authorisation Number: 1051992468915

Date of advice: 9 June 2022

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

Answer

Yes, for test times after the incorporation date.

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 (the incorporation date) and registered in the Australian Business Register on y YY 20XX.

2.      Company A's directors are Taxpayer A, Taxpayer B, Taxpayer C, Taxpayer D and Taxpayer E.

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

4.      Company A has a wholly owned subsidiary, Company B. Company A and Company B formed an income tax consolidated group on y YY 20XX.

5.      Company A has developed a software platform which enables customers to make particular transactions.

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

•           Total expenses of $xx

•           Total income of $yy

7.      Company A issued shares on three dates in the 20YY income year: x XX 20XX (the incorporation date), y YY 20YY and z ZZ 20YY.

8.      As at y YY 20YY, Company A received a total of $xxx for the issue of ordinary shares to shareholders that:

•           were not associates of Company A or each other immediately before the issue of the relevant shares; and

•           acquired the shares primarily for investment purposes and not to assist another entity become entitled to a tax offset under Subdivision 360-A of the ITAA 1997.

9.      As at y YY 20YY, Company A also received a total of $yyy in share premium payment from some of the shareholders who were issued the abovementioned ordinary shares.

10.    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

11.    Company A is developing a software platform which enables customers to make particular transactions in real-time. Company A is the first to offer an Australian made consumer-to-business solution using two platforms.

12.    Company A's Product will provide a new alternative to established systems.

13.    Through its software platform, Company A, with its initial product, Product A, is able to dynamically create a unique identifier per transaction.

14.    Each unique Product A can only be used for a particular transaction. The system is the first of its kind to enable customers to perform functions.

15.    Company A has built and commercialised two products to date - Product A(launched YY 20XX) and Product B (launched YY 20ZZ). Product C, a third product, is planned for release in ZZ 20ZZ.

16.    Product C is a product under development - Company A expect to soft launch this product in YY 20ZZ after completing the development, testing and certification of the platform.

Commercialisation Strategy

17.    Company A is genuinely focused on the development for commercialisation of a software platform to make innovative use of certain capabilities.

18.    Company A is at the forefront of the digital technology and is constantly innovating on its platform based on customer feedback, research and surveys.

19.    The platform is built on AWS (Amazon Web Services) and has been designed as cloud native providing the highest flexibility and scalability.

20.    Company A's first keystone client, Company X is using Product A.

21.    Prior to engaging Company A, Company X conducted a due diligence exercise, but their service provider didn't have the technology, solution or capability to provide the service that Company A was able to render.

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

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

High Growth Potential

24.    Company A aims to revolutionize transactions in Australia and there is a large addressable market.

25.    The market for the online retail space alone is xx billion transactions a year, and the other areas totalling an estimated yy million transactions a year.

Scalability

26.    Company A has the potential to successfully scale its business as it has already secured significant investor interest and has a board of directors comprising persons with significant experience in executive/leadership roles of major companies.

27.    The design philosophy of Company A's products is focused on scalability and the ability to quickly and easily on-board clients.

28.    Company A's software is built on AWS (Amazon Web Services) and takes full advantage of this modern cloud technologically stack in terms of scalability, security, availability, and costs.

Broader than Local Market

29.    Company A has a global outlook. Company A's software has been designed to be fully compliant with the internationally recognised standard.

Competitive advantages

30.    Company A has potential to have competitive advantages due to its unique transaction capabilities.

31.    The technology that Company A is developing is unprecedented and gives Company A the first-mover's advantage in breaking into the industry.

Information provided

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

•           Private Binding Ruling ('PBR') Application, dated x XX 20ZZ

•           Response to further questions provided

•           Responses to various emails

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

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 Pty Ltd meets all the eligibility requirements of an ESIC under subsection 360-40(1) for the 2 test time dates after the incorporation date.

DETAILED REASONING

Qualifying Early Stage Innovation Company

34.    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'

35.    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)

36.    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).

37.    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.

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

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

39.    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)

40.    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)

41.    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'

42.    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

43.    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)

44.    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.

45.    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.

46.    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

47.    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..."

48.    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.

49.    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.

50.    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."

51.    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.

52.    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

53.    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

54.    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

55.    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

56.    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)

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

58.    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

59.    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 in the period on or after x XX 20XX, and on or before y YY 20YY. In particular, Company A issued shares at 3 test times in this period - x YY 20XX (the incorporation date), y YY 20YY and z ZZ 20YY.

Current year

60.    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, 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

61.    Company A was incorporated on z ZZ 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

62.    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.

63.    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

64.    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.

65.    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

66.    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.

67.    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

68.    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

69.    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 are 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

70.    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.

71.    Company A is developing a software platform which enables customers to make particular transactions.

72.    Company A's Product will provide a new alternative to provide a new alternative to established systems.

73.    Through its software platform, Company A, with its initial product, Product A, is able to dynamically create a unique identifier per transaction.

74.    Each unique Product A can only be used for a particular transaction.

75.    The system is the first of its kind to enable customers to perform functions.

76.    Company A has built and commercialised two products to date - Product A(launched YY 20XX) and Product B (launched YY 20ZZ). Product C, a third product, is planned for release in ZZ 20ZZ.

77.    Product C is a product under development - Company A expect to soft launch this product in YY 20ZZ after completing the development, testing and certification of the platform.

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

79.    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

80.    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, at certain test times, in order to generate economic value and revenue for the company.

81.    Company A's products development roadmap spans across the last x fiscal years. The first two products have been released and commercialised, the third product is currently in its design and development phase with an expected launch date of YY 20ZZ.

82.    Company A is concurrently developing value add features as well as conducting end user research with enterprise teams.

83.    Company A was genuinely focussed on developing their Product for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the test time dates after the incorporation date.

84.    At the test time of the incorporation date, the shares were issued at a time Company A was formed as a company and before the central activities of the company could be concentrated on developing their products. Company A was not genuinely focussed on developing their Product for a commercial purpose on that date.

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

85.    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.

86.    Company A's Product is easily and infinitely scalable to a global audience.

87.    Company A has demonstrated that it has a high growth potential for their Product, so subparagraph 360-40(1)(e)(ii) is satisfied for the test time dates after the incorporation date.

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

88.    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.

89.    Company A has already secured significant investor interest and has a board of directors comprising persons with significant experience in executive/leadership roles of major financial sector companies.

90.    The design philosophy of Company A's products is focused on scalability and the ability to quickly and easily on-board clients.

91.    Company A has the potential to successfully scale up its business, so subparagraph 360-40(1)(e)(iii) is satisfied for the test time dates after the incorporation date.

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

92.    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.

93.    Company A has a global outlook. Their software has been designed to be fully compliant with the internationally recognised standard for the industry.

94.    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 test time dates after the incorporation date.

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

95.    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.

96.    Company A has unique transaction capabilities.

97.    The technology that Company A is developing is unprecedented and gives Company A the first-mover's advantage in breaking into the industry.

98.    Company A has demonstrated that it has competitive advantages for its business, so subparagraph 360-40(1)(e)(v) is satisfied for the test time dates after the incorporation date.

CONCLUSION FOR PRINCIPLES BASED TEST

Company A satisfies the principles based test as it has satisfied all the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the test time dates after the incorporation date. Company A does not satisfy the requirement within subparagraph 360-40(1)(e)(i) for the test time of the incorporation date.

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

99.    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 all the eligibility criteria of an ESIC under section 360-40 for the test times after the incorporation date as it commenced activities at a time after the incorporation date. Company A was not genuinely focussed on developing products immediately after shares were issued to members on the incorporation date.

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