Edited version of private advice

Authorisation Number: 1052158965056

Date of advice: 21 August 2023

Ruling:

Subject: Early stage innovation company eligibility

Question

Does the Company 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 DD MM YYYY to DD MM YYYY (x years)?

Answer

Yes

This ruling applies for the following periods:

DD MM YYYY to DD MM YYYY (first period)

DD MM YYYY to DD MM YYYY (second period)

The Scheme commences on:

DD MM YYYY

Relevant facts and circumstances

Background Information

1.      Company A is an Australian proprietary company incorporated in XXX on DD MM YYYY.

2.      On DD MM YYYY, Company A filed a Notification of Resolution of Company Name Change with Australian Securities and Investments Commission ('ASIC'). From DD MM YYYY, Company A is now named Company X.

3.      Company X's directors are Taxpayer A and Taxpayer B.

4.      Company X's registered office and principal place of business is situated at XYZ.

5.      For the financial year ending DD MM YYYY (Year 1), Company X and its 100% owned subsidiary incurred and earned the following:

•                     Total expenses of $xxx

•                     Total income of $yyy

6.      For the financial year ending DD MM YYYY (Year 2), Company X and its 100% owned subsidiary incurred and earned the following:

•                     Total expenses of $xxx

•                     Total income of $yyy

7.      For the financial year ending DD MM YYYY (Year 3), the Company X and its 100% owned subsidiary incurred and earned the following:

•                     Total expenses of $xxx

•                     Total income of $yyy

8.      Company X is not part of a tax consolidated group, nor planning to join a tax consolidated group.

9.      To comply with YYY employment law, Company X is currently in the process of establishing a wholly owned YYY subsidiary for the specific purpose of retaining/hiring the YYY based co-founders and software development team.

10.   Progressively, wholly owned trading subsidiaries will be established in key target markets in YYY and ZZZ.

11.   The Company will retain beneficial ownership of Intellectual Property ('IP'), software and enabling technology developed in-house at all times, through either subsidiaries or via contracted third party suppliers.

12.   Company X's equity interests are not listed for quotation in the official list of any stock exchange, either in Australia or a foreign country.

Previous Ruling

13.   On DD MM YYYY, Company X received a private ruling for the financial year ended DD MM YYYY and DD MM YYYY (x years) that the company qualified as an ESIC at relevant test times. The basis for the decision was that the company satisfied the principles-based test in respect of the digital services platform ('the Product'), catering to particular markets.

14.   This application is a request for an extension to the previous ruling issued on DD MM YYYY, to cover the period DD MM YYYY to DD MM YYYY.

Product Development

15.   Company X is developing a digital services platform ('the Product'), catering to particular markets.

16.   Company X's Product will bring marketplace transparency, equity and liquidity for retailers, wholesalers and producers represented by and transacting on the platform.

17.   Company X will generate fee income from transaction volumes executed and settled across the platform.

18.   Company X's initial rollout will target the global xxx trade. In the medium term (out to YYYY), Company X will be rolled out for other markets.

19.   Company X is developing their digital services platform to address a number of discrete markets and is continuing to develop their Product. Company X's Product has been identified as having an international addressable market.

Product Development Stages

20.   Since the previous ruling issued, on DD MM YYYY, Company X has continued to develop their Product, a digital services platform.

21.   Substantial development has been undertaken since MM YYYY, when Company X's platform was in the early stages of its development. At the time, the founding team had undertaken significant work conceptualising the core technology and undertaking research through over xx focus group sessions with industry stakeholders.

22.   Since MM YYYY, a number of goals have been achieved. The first deployment of Company X's technology has been launched in Australia in MM YYYY, with a substantial number of registered users.

23.   The ultimate goal of Company X is to provide full connectivity and data insight in particular supply chains. The first milestone was to build a functioning procurement platform (MVP) that enables streamlined transactions using structured data.

Commercialisation Strategy

24.   Company X's platform has significantly matured since MM YYYY. The founding team had developed the technology from its concept phase to a successful MVP by launching the platform in the Australian market operating in the particular market under Company B (100% owned subsidiary).

25.   Using Company X's proprietary technology, 'XYZ' has launched as a procurement platform in the Australian market in MM YYYY. The platform significantly simplifies and de-risks the procurement process of a particular market by using structured data, automation, and simple forecasting methods.

High Growth Potential

26.   SquareX has received interest to use its technology for other commodity spaces. An Australian incumbent in the particular industry and a cooperative in the other space have inquired about licensing Company X's technology for procurement in Australia and overseas. Additionally, an overseas player in XXX has expressed similar interest.

27.   This interest is in line with expectations that particular industries are on the brink of a digital revolution, unlocking substantial opportunities for efficiency gains through the use of data and connectivity. Company X provides the digital infrastructure for digital supply chains in these particular supply chains.

Scale up the Business

28.   By MM YYYY, xx Australian traders have either pre-registered (pre-launch) or registered to the 'XYZ' (post-launch), equating to approximately xx% of all Australian traders (in this particular market).

29.   This significantly surpasses early growth forecasts (approx. xx traders by mid-YYYY). The founding team expects to achieve xxx registered Australian traders by Qx, YYYY.

Broader than Local Market

30.   Particular traders from around the world have registered for launch in other markets, paving the way for international expansion. This is in line with Company X's longstanding strategy to launch localised versions of 'XYZ' (and potentially platforms for other commodities) in consumption markets.

Competitive Advantages

31.   Company X has substantial competitive advantages compared to the status quo. By digitising and streamlining procurement processes, Company X has access to structured data, providing value to its users by providing tracked transactions and data insight.

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

33.   Company X's Product has been identified as having an international addressable market.

Information provided

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

•                     Private Binding Ruling ('PBR') Application, dated DD MM YYYY

•                     Response to further questions provided

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

36.   Company X had initial seed capital raised by x investors, and the total amount of equity paid was $xxx. In addition to the initial seed capital raised, Company X has taken investment from xx investors between DD MM YYYY and DD MM YYYY.

37.   Company X proposes to issue new shares to various investors in the coming years to assist in funding the continued development and commercialisation of their Product.

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

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.

Summary

Company X meets the eligibility requirements of an ESIC under subsection 360-40(1) for the period DD MM YYYY to DD MM YYYY.

Detailed reasoning

Qualifying Early-Stage Innovation Company

38.   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'

39.   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)

40.   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).

41.   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.

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

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

43.   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)

44.   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)

45.   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'

46.   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

47.   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)

48.   To satisfy the principles-based Innovation 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.

49.   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.

50.   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.

Application to your circumstances

TEST TIME

51.   For the purposes of this ruling, the 'test time' for determining if Company X 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. Shares in Company X were issued as initial seed capital in the total amount of $xxx, prior to MM YYYY. Additional shares have been issued between DD MM YYYY and DD MM YYYY.

Current year

52.   Therefore, for the purposes of subparagraph 360-40(1)(a)(ii) ITAA 1997 relevant to the second period, the current year (for shares issued on or after DD MM YYYY, and on or before DD MM YYYY) 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 x income years will include the years ending DD MM YYYY, YYYY, YYYY, YYYY, YYYY and YYYY, and the income year before the current year will be the year ending DD MM YYYY (the YYYY income year).

53.   Therefore, for the purposes of subparagraph 360-40(1)(a)(i) ITAA 1997 relevant to the first period, the current year (for shares issued on or after DD MM YYYY, and on or before DD MM YYYY) 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 x 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).

THE 'EARLY-STAGE TEST' - paragraphs 360-40(1)(a) - (d) itaa 1997

Incorporation or Registration - paragraph 360-40(1)(a) ITAA 1997

54.   Company X was incorporated in XXX on DD MM YYYY, which is within the 6 income years outlined above, and across the last x of those years before the current year, it incurred total expenses of $1 million or less ($xxx for FY YYYY, $yyy for FY YYYY and $zzz for FY YYYY = Total of $xyz) therefore the requirements of subparagraph 360-40(1)(a)(ii) are satisfied for the second period.

55.   For the shares issued on or after DD MM YYYY, and on or before DD MM YYYY, we look at subparagraph 360-40(1)(a)(i). Company X was incorporated in XXX on DD MM YYYY, which is within the 3 income years outlined above, therefore the requirements of subparagraph 360-40(1)(a)(i) are satisfied for the first period.

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

56.   In applying the requirements of paragraph 360-40(1)(b), Company X and any of its 100% subsidiaries must have incurred total expenses of $1 million or less in the YYYY income year, being the income year before the current year for the second period.

57.   Company X incurred expenses of $xxx in the YYYY income year and $yyy the YYYY income year. Consequently, paragraph 360-40(1)(b) is satisfied for the first period.

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

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

59.   Company X earned assessable income in the amount of $yyy in the YYYY income year and $xxx in the YYYY income year. Consequently, paragraph 360-40(1)(c) is satisfied for both periods.

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

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

61.   Company X 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 X satisfies the early-stage test for the YYYY and YYYY income years, 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 X has not provided sufficient evidence of satisfying the 100-point test under section 360-45 for the years ending DD MM YYYY and DD MM YYYY. Company X 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 X must be developing an innovation which is either new or significantly improved for an applicable addressable market.

65.   Company X is developing a digital services platform ('the Product'), catering to a particular market.

66.   Company X's digital platform will bring marketplace transparency, equity and liquidity for retailers, wholesalers and producers represented by and transacting on the platform.

67.   Company X will generate fee income from transaction volumes executed and settled across the platform.

68.   Company X is developing their digital services platform to address a number of discrete markets and is continuing to develop their Product. Company X's Product has been identified as having an international addressable market.

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

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

70.   Company X has provided details to satisfy this requirement.

71.   Company X anticipate that the current programme of development will be completed later in the YYYY financial year (x years).

72.   Company X is genuinely focussed on developing their Product for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the second period, 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 X will no longer be 'developing' their Product for commercialisation. Company X was genuinely focussed on developing their Product for a commercial purpose for the first period, so subparagraph 360-40(1)(e)(i) is also satisfied for the period DD MM YYYY to DD MM YYYY.

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

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

74.   Company X has provided details to satisfy this requirement.

75.   Company X has demonstrated a high growth potential for their Product, so subparagraph 360-40(1)(e)(ii) is satisfied for the period DD MM YYYY to DD MM YYYY.

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

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

77.   Company X has provided details to satisfy this requirement.

78.   This leverage ensures that Company X has the potential to successfully scale up its business, so subparagraph 360-40(1)(e)(iii) is satisfied for the period DD MM YYYY to DD MM YYYY.

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

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

80.   Company X has provided details to satisfy this requirement.

81.   Company X 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 DD MM YYYY to DD MM YYYY.

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

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

83.   Company X has provided details to satisfy this requirement.

84.   Company X has demonstrated that it has competitive advantages for its business, so subparagraph 360-40(1)(e)(v) is satisfied for the period DD MM YYYY to DD MM YYYY.

Conclusion for principles based test

Company X satisfies the Principles-based Innovation test as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the second period, or the date when their Product has been fully developed and is ready for client use, whichever occurs earlier. Company X also satisfies the Principles-based Innovation test as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the first period.

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

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

Conclusion

Company X meets the eligibility criteria of an ESIC under section 360-40 for the second period or the date when their Product has been fully developed and is ready for client use, whichever occurs earlier. Company X meets the eligibility criteria of an ESIC under section 360-40 for the first period.

Other references (non ATO view)

Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016