Edited version of private advice

Authorisation Number: 1052020787713

Date of advice: 18 October 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 an Australian proprietary company incorporated in XYZ on x YY 20XY.

2.      Company A's director is Taxpayer A.

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

4.      Company A does not have any wholly or partly owned subsidiaries. Company A is not part of an income tax consolidated group. Company A is not planning to join an income tax consolidated group in the future.

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

•           Total expenses of $xyz

•           Total income of $xyz

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

•           Total expenses of $xyz

7.      For the financial year ending y YY 20VV, Company A incurred the following:

•           Total expenses of $xyz

8.      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.

Development of Product

9.      Company A is developing a product that offers a shared technological experience for a number of participants, which allows each participant to connect and communicate in a particular platform.

10.   Company A is currently developing, with the intention to commercialise, technology that is specifically tailored for a particular group of users. This tailored technology is in direct comparison to generic technology that is targeted at being used and enjoyed by all users.

11.   Company A's technology allows for connection and shared experiences among particular participants, and as research suggests, this has been shown to improve the overall wellbeing of this group of participants.

12.   There is currently no such technology available in Australia or in the international market that is tailored specifically to this particular group of users in terms of user accessibility and sharing. Company A's purpose is to improve the lives of this type of participant, with all aspects of the technological solution specifically tailored for them, including hardware, software, content, training and support.

13.   Company A provides a specific solution for customers through selling hardware and a subscription service. The subscription service includes access to a number of services.

Future development

14.   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.

15.   Company A is working with Company B on a project for joint development of devices that will enable quantification of reactions to the platform.

16.   Company A is working on a range of innovative applications in this technology to help grow and scale solutions in the nearby geographical region with a host of valuable partners involved in the program.

17.   Company A has been successful in a grant application in a joint research study with Company C and Company D for the implementation of an innovative technological experience for a particular group of people. This project will implement and evaluate innovative technological experiences for this particular group of people.

Commercialisation strategy

18.   Company A offers technological content in a way that makes it easier and more meaningful for particular users to consume, coupled with an extensive program and support resources.

19.   Company A has also been given the exclusive opportunity to commercialise and integrate additional technology and intellectual property created by Company B. This technology has been created and will integrate into the product, sensors that capture particular markers. Company A is working with Company B to integrate these sensors into the program, so that the product can capture participants' particular markers before and after sessions.

20.   Company A currently works with a number of providers to pilot their product offering. Additionally, the business is poised to expand within Australia.

21.   Company A experienced x% growth month on month in the 20ZZ financial year. Company A forecasts sales revenue to grow at yy% over the next x years and expect that operating expenses will reduce by xx%, over the same period due to the achieving economies of scale within the business.

22.   Company A has first mover advantage and intend to stay ahead by continuing to add value to customers over and above existing offerings with further development of features, including software, premium content services, enhanced communication and experience based services, integration of data and analytics services.

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

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

Information provided

25.   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 YY 20XX

•           Response to further questions provided

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

27.   Company A propose to issue new shares in their company to various investors to assist in funding the continued development and commercialisation of their Product in the current financial year.

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

28.   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'

29.   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)

30.   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).

31.   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.

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

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

33.   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)

34.   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)

35.   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'

36.   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

37.   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)

38.   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.

39.   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.

40.   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

41.   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..."

42.   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.

43.   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.

44.   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."

45.   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.

46.   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

47.   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

48.   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

49.   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

50.   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)

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

52.   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

53.   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

54.   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 6 income years will include the years ending y YY 20YY, 20XX, 20ZZ, 20VV, 20WW and 20UU, 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

55.   Company A was incorporated in XYZ on x YY 20XY, which is within the 6 income years outlined above, and across the last 3 of those years before the current year, it incurred total expenses of $1 million or less therefore the requirements of subparagraph 360-40(1)(a)(ii) are satisfied.

Total expenses - paragraph 360-40(1)(b) ITAA 1997

56.   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.

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

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

58.   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.

59.   Company A earned assessable income of $xyz in the 20XX income year. Consequently, paragraph 360-40(1)(c) is satisfied.

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

60.   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.

61.   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

62.   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

63.   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

64.   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.

65.   Company A is developing a product that offers a shared technological experience for a number of participants, which allows each participant to connect and communicate in a particular platform.

66.   Company A is currently developing, with the intention to commercialise, technology that is specifically tailored for a particular group of users. This tailored technology is in direct comparison to generic technology that is targeted at being used and enjoyed by all users.

67.   Company A's technology allows for connection and shared experiences among particular participants, and as research suggests, this has been shown to improve the overall wellbeing of this group of participants.

68.   There is currently no such technology available in Australia or in the international market that is tailored specifically to this particular group of users in terms of user accessibility and sharing. Company A's purpose is to improve the lives of this type of participant, with all aspects of the technological solution specifically tailored for them, including hardware, software, content, training and support.

69.   Company A provides a specific solution for customers through selling hardware and a subscription service. The subscription service includes access to a number of services.

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

71.   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

72.   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.

Previous development

73.   Company A has already undertaken extensive work to develop their Product, including investing $xyz into R&D to develop the overall solution.

74.   Company A has worked on the customisation of software to offer enhanced features suitable for a particular group of users. This has included significant hours invested to develop:

•           Specific content experiences

•           An extensive library of resources to support the successful roll out of this program

•           Further enhancements and developments planned on a roadmap and built based on customer feedback loops and BETA testing

Current development

75.   Company A is currently developing their Product for commercialisation. Company A has found that as the amount of equipment in market scales, the number of hours customers spend, increases significantly and offers increased opportunities for customer engagement and communication, feedback loops and co-design opportunities as well as commercialisation.

76.   Company A is working with a number of providers across Australia and New Zealand with the technological solution and is continuously investing in time for communication, feedback loops and co-design opportunities with these organisations.

Future development

77.   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.

78.   Company A continues to expand to new verticals for solution and offering opportunities for further innovation, R&D, and development.

79.   Company A anticipates that the current programme of development will be completed within x - y months.

80.   Company A has provided details of development activities to satisfy this requirement.

81.   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

82.   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.

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

84.   Company A currently works with a number of providers to pilot their product offering. Additionally, the business is poised to expand within Australia.

85.   Company A was endorsed and successfully selected by a government department to be showcased at the XYZ. Company A secured the company's first customer in XYZ. This customer contract represents a group with over xx collections, as such this will provide potential expansion opportunities.

86.   Company A has already had discussions with a series of sophisticated investors, with regards to investment and the provision of capital, which will enable Company A to scale rapidly in different markets, as well as internationally.

87.   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

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 enterprise agreements in place with content providers, IT SAAS providers, hardware distributors and partners. These enterprise agreements ensure that all operating costs are reduced and allow Company A to achieve economies of scale.

90.   Company A is also able to reduce expenses, as the business operates without physical locations.

91.   Company A's model requires that customers sign multi-year subscription deals. Within Company A's annual recurring revenue, x% of the subscription services have x-year subscription terms, while the remaining y% have y-year subscription terms.

92.   Company A forecasts that within x months, this spilt of annual recurring revenue will be xx% subscription service offerings and yy% hardware sales.

93.   Company A experienced x% growth month on month in the 20ZZ financial year. Company A forecasts sales revenue to grow at yy% over the next x years and expect that operating expenses will reduce by xx%, over the same period due to the achieving economies of scale within the business.

94.   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

95.      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.

96.      Company A is endeavouring to expand into several targeted international markets over the next x years.

97.      Company A currently is the only global competitor offering full autonomy and independent controls, with a particular option, controlled by specific tracking.

98.      Company A also is currently the only global technological provider that includes specific support tools and personalisation of the service with the personal space function, which is specifically designed and tailored to particular users.

99.      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

100.    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.

101.    Company Ais the leading provider of this particular technological solution for the specific group of users, within Australia and New Zealand. Company A has identified four factors which contribute to the company's competitive advantage:

•           Company A has found a gap in the market. All services and offerings that Company A provides are with a commitment to enrich the quality of life for particular users, through shared experiences.

•           Company A are creating and sharing new stories. Company A empower teams with innovative tools and solutions specifically designed for particular users, to enable them to match their experiences to participant's identities and deliver meaningful experiences and activities.

•           Company A is breaking into new sectors. Company A is adding valuable features to the platform solution and expanding services.

102.    Company A have industry experience. Company A work closely with teams and embrace feedback opportunities. This has helped shape the business' comprehensive training and technical support and ensures that customers get the best out of the platform solution.

103.    Company A has first mover advantage and intend to stay ahead by continuing to add value to customers over and above existing offerings with further development of features, including software, premium content services, enhanced communication and experience based services, integration of data and analytics services.

104.    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

105.    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.