Edited version of private advice

Authorisation Number: 1052140788876

Date of advice: 27 July 2023

Ruling

Subject: Early stage innovation company eligibility

Question

Does Company A satisfy the criteria of an Early Stage Innovation Company (ESIC) pursuant to subsection 360-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997) for the income years ending DD MM YYYY and DD MM YYYY?

Answer

Yes.

This ruling applies for the following periods:

1.Year ending ended DD MM YYYY

2.Year ending ended DD MM YYYY

The scheme commenced on:

DD Month YYYY

Relevant facts and circumstances

Background facts

1.      Company A ('the Company') is an Australian proprietary company which was incorporated in Australia and registered on the Australian Business Register on DD Month YYYY. Its equity interests are not listed for quotation in the official list of any stock exchange in Australia or overseas.

2.         Company A has two wholly owned subsidiary companies:

•         Company B

•         Company C

3.            The current director of Company A is Individual 1.

4.            Company A's registered office is situated in Australia.

5.            Company A's principal place of business is situated in Australia.

6.            Company A and its two wholly owned subsidiaries incurred total expenses of less than $1M in the each of the income years ending DD MM YYYY and DD MM YYYY.

7.            Company A and its two wholly owned subsidiaries generated total assessable income of less than $200,000 in each of the income years ended DD MM YYYY and DD MM YYYY.

Development of new or significantly improved innovations

8.      Company A aims to develop new technology for an all-in-one solution that will achieve automation in service and risk management within its industry by utilising real-time data and big data analytic capabilities developed by the Company.

9.      Company A's product is a digital platform that supports its clients by providing solutions beyond the scope of the solutions currently available within its industry.

10.   The Company's platform will offer functionality in a software as a service (SaaS) cloud environment delivering new and significantly improved innovation compared to what is currently available in the market.

11.   It is an integrated platform that will offer the following features:

•           Company A will be establishing a partnership with over 15 software providers that will enable a start-to-end solution to enable an autonomous process to its clients.

•           The state-of-the-art architecture of the Platform includes a novel decision engine and bespoke algorithms in its client assessment process. The decision engine integrates with external agencies that will enable the Platform to provide a streamlined and comprehensive risk analysis process.

•           The Platform uses a model developed using big data analytics, artificial intelligence and machine learning techniques that will be able to analyse relevant consumer behaviour once they are linked to the platform.

•           The technology is designed to enable rapid interaction between the Platform and other databases so that the entire process can be completed within 24 hours, providing users with a seamless experience in obtaining a result.

•           Company A is also working on integrating additional cutting edge artificial intelligence capabilities to provide guidance to end-consumers so that the Company's services can be made seamlessly through the Platform with minimum human intervention.

12.   Company A's target market consists of three main groups that they have identified will benefit from the use of the Platform.

13.   Company A's latest research shows that the addressable market for the Platform has enormous market demand based on statistics reflecting the current trend away from the services that it offers being provided by traditional providers within its industry.

Genuinely focussed on developing innovations for commercialisation

14.  Company A state that it is developing the innovations for commercialisation on the following basis:

•         Appointment of senior executives that are highly recognized in the industry with the view to commercialise the Platform.

•         Establishing partnerships with industry leaders to commercialise the Platform

•         Company A is seeking to actively grow its partnership to a large network of exclusive partners across Australia by the end of the YYYY income year, who will be using the Platform. The growth will be assisted by the industry leading State Business Development Managers recruited by the Company.

15. Company A submit that actions detailed above demonstrate its intention to commercialise their innovations which will have a direct competitive advantage over its competitors and generate significant economic value.

High growth potential

16. Company A has prepared detailed financial forecasts for the first two years of the Platform's release which demonstrates the Platform's high growth potential.
17. Company A is expected to reach the breakeven point within first year of the Platform's launch.
18. The growth in the company's net income will be facilitated by exponential growth in the number of registered users, its licensee network and income from product uptake. Following the breakeven point, the company is forecasted to deliver significant net operating profit per month in the 2nd year after launch.

Scalability

19. As a true-cloud platform with a broad addressable market, Company A's offering is inherently scalable. Spending typically peaks at the launch stage, followed by a decline. New users can be acquired for minimal incremental cost, while providing increased revenue opportunities as the Platform launches in new overseas markets or targets additional market segments.
20. Company A will continue to scale up the business through capital raising. The Company has been successful in capital raising approximately $X in the Series A fundraise. The Series A funding will enable Company A to complete its initial system release. Company A is also in the process of raising an additional $Y in capital by issuing shares in its Series A+ fundraise once the Platform is released to the public in non-beta form. The additional Series A+ funding will assist the company to successfully scale the Platform and its business nationally in Australia. Subsequently, Series B funding will enable the Company to launch its platform overseas.

Broader than local market

21. For Company A to engage in activities within its industry, it is generally required to have a licence from the relevant authorities in the jurisdiction it operates in. The Company currently holds a licence to undertake its activities within Australia, and it is in the process of applying for an additional licensing authorisation.
22. After obtaining additional licensing authorisation, the Company's initial markets will be a number of the capital cities in Australia. However, from the outset, its customers need not be confined to these markets, as the Platform will be available on launch to anyone in Australia accessible via the cloud.
23. Company A has also been in discussion with potential partners in a number of overseas countries to launch its platform in these markets. The company will seek to obtain the relevant regulatory approval in foreign markets.

Competitive advantages

24. Company A's business model focuses on solving pain points arising from traditional product offerings by competitors in the market. The Company's Platform aims to provide a differential advantage over its competitors as follows:

a.    Fast and automated process

b.    Integrated platform for related services

The Company's Platform is intended to be one-for-all services tool within its industry. It will achieve this by using big data analytics, artificial intelligence and machine learning techniques to facilitate the Platform's various features.

Information provided

25. You have provided information in a number of documents in relation to Company A's innovation.

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

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 criteria of an ESIC under subsection 360-40(1) of the ITAA 1997 for the income years ending 30 June YYYY and 30 June YYYY or the date when its innovation has been fully developed and is ready for sale, whichever occurs earlier.

DETAILED REASONING

Qualifying Early Stage Innovation Company

1.     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.

'EARLY STAGE TEST'

2.     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)

3.     To meet the requirement in paragraph 360-40(1)(a), at a particular time (the test time) in an income year (the current year) the company must have been either:

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

                ii.       incorporated in Australia within the last six income years (the latest being the current year), and across the last three of those income years before the current year the company and its 100% subsidiaries incurred total expenses of $1 million or less; or

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

4.     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.

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

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

6.     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)

7.     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)

8.     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'

9.     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

10.  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)

11.  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.

12.  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.

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

               i.         the company must be genuinely focused on developing one or more new or significantly improved innovations for commercialisation

                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

14.  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..."[1]

15.  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 the revenue opportunity or market demand arising from the innovation or the related business. The addressable market must be objective and realistic.

16.  Improvements must be significant in nature to meet this requirement. 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.

17.      The OECD Oslo Manual 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.[2]

18.      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."

19.      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."

20.  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.

21.  '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

22.  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.

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

23.  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.

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

24.  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

25.  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)

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

27.  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

28.  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 DD MM YYYY, and on or before DD MM YYYY.

Current year

29.  For the purposes of subsection 360-40(1), the current year will be the year ending DD MM YYYY (the YYYY income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last three income years will include the years ending DD MM YYYY, YYYY and YYYY, and the income year before the current year will be the year ending DD MM YYYY (the YYYY income year).

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

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

30.  Company A was incorporated in Australia on DD MM YYYY, which is within the last three income years (the latest being the current year). Therefore, the requirements of subparagraph 360-40(1)(a)(i) are satisfied.

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

31.  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 YYYY income year, being the year before the current income year.

32.  Company A and its subsidiaries incurred total expenses of less than $1M in the YYYY income year. Therefore, paragraph 360-40(1)(b) is satisfied.

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

33.  In applying the requirements of paragraph 360-40(1)(c), Company A and its 100% subsidiaries must have derived total assessable income of $200,000 or less in the YYYY income year.

34.  Company A and its subsidiaries derived less than $200,000 assessable income in the YYYY income year. Therefore, paragraph 360-40(1)(c) is satisfied.

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

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

Company A was not listed on any stock exchange in Australia or a foreign country at the test time. Therefore, subparagraph 360-40(1)(d) is satisfied.

CONCLUSION FOR EARLY STAGE TEST

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

'100 POINT TEST' - PARAGRAPH 360-40(1)(e) AND SECTION 360-45

37.  Company A has submitted that it will not by applying for ESIC status under the100-point test under section 360-45 for the years ending DD MM YYYY and DD MM YYYY. 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.

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

Developing new or significantly improved innovations - subparagraph 360-40(1)(e)(i)

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

39.  Company A is developing a digital platform that supports its clients by providing solutions beyond the scope of the solutions currently available within its industry. The Company's platform will offer functionality in a software as a service (SaaS) cloud environment delivering new and significantly improved innovation compared to what is currently available in the market.

40.  Company A has provided details substantiating that it is developing a product that is either new or significantly improved for an applicable addressable market.

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

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

42.  Company A state that it is genuinely focussed in developing the innovations for commercialisation on the following basis:

•         Appointment of senior executives that are highly recognized in the industry with the view to commercialise the Platform.

•         Establishing partnerships with industry leaders to commercialise the Platform

•         The Company is seeking to actively grow its partnership to a large network of exclusive partners by the end of the YYYY income year across Australia, who will be using the Platform.

43.  Company A has provided details substantiating that that it is genuinely focussed on developing its innovation for commercial purpose in order to generate economic value and revenue for the company.

Conclusion on subparagraph 360-40(1)(e)(i)

44.  Company A is genuinely focussed on developing their product, a digital platform that supports its clients by providing solutions beyond the scope of the solutions currently available within its industry for commercialisation. The Product will be a significantly improved product compared to existing products in their addressable market.

45.  Therefore, subparagraph 360-40(1)(e)(i) is satisfied for the period DD MM YYYY to DD MM YYYY. Once the product has been fully developed, Company A 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)

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

47.  Company A has provided details substantiating that it meets this requirement.

48.  Therefore, subsection 360-40(1)(e)(ii) is satisfied.

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

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

50.  Company A has provided details substantiating that it meets this requirement.

51.  Therefore, subsection 360-40(1)(e)(iii) is satisfied.

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

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

53.  Company A has provided details substantiating that it meets this requirement.

54.  Therefore, subsection 360-40(1)(e)(iv) is satisfied.

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

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

56.  Company A has provided details substantiating that it meets this requirement.

57.  Therefore, subsection 360-40(1)(e)(v) is satisfied.

Conclusion on principles-based test

58.  Company A satisfies the principles-based test as it satisfies the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period commencing DD MM YYYY until DD MM YYYY or the date when its innovation/process has been fully developed and is ready for sale, whichever occurs earlier.

'FOREIGN COMPANT TEST' - subparagraph 360-40(1)(f) ITAA 1997

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

CONCLUSION

60.  Company A meets the eligibility criteria of an ESIC under section 360-40 of the ITAA 1997 for the period commencing DD MM YYYY to DD MM YYYY or the date when its innovation/process has been fully developed and is ready for sale, whichever occurs earlier.

[1] See Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.76.

[2] OECD Oslo Manual, paragraph 124 and paragraph 151.