Edited version of private advice

Authorisation Number: 1052172045284

Date of advice: 22 September 2023

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')?

Answer

Yes

This private ruling applies for the following period:

30 June 20XX

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

1.    Company A is an Australian proprietary company incorporated and registered in the Australian Business Register (ABR) on XX XX 20XX.

2.    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.

3.    Company A is not a subsidiary of another company. Company A does not have any subsidiaries or hold any equity interests in underlying companies or trusts.

4.    Company A's income for the year ending 30 June 20XX was $XXXXX and the total expenditure incurred for 20XX, 20XX and 20XX income years was $XXXXX.

5.    Company A has projected solid revenue growth.

6.    The revenue projections by the company (at XX% Net Margin) are:

•                     2023 - 2024 = AUD XXX

•                     2024 - 2025 = AUD XXX

•                     2025 - 2026 = AUD XXX

•                     2026 - 2027 = AUD XXX

7.    Company A stated that its executive team has a broad range of expertise ranging from CEO, CCO, CMO in Listed Companies, Private Companies and Self-Owed Companies. Its executive team has been part of the Fortune 500 companies and are internationally recognised. It also has extensive background in marketing and product development for scale between the current team.

8.    Company A is developing their product to address several discrete markets and is continuing to develop their product.

9.    Company A's products have been identified as having an international addressable market.

10.  Company A has identified that it has the ability to rapidly expand its business.

11.  Company A has also identified that it has high growth within its addressable market.

12.  A comparative analysis of the features in XXXXX with other operators can be seen on Page XX of Company A's Information Memorandum in detail showing a clearcut competitive advantage.

13.  Company A's closest competitor in the market only provides XXXX services.

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

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 1 July 20XX to 30 June 20XX?

Summary

Company A meets the eligibility requirements of an ESIC pursuant to subsection 360-40(1) of the Income Tax Assessment Act 1997 for the period 1 July 20XX to 30 June 20XX.

Detailed reasoning

14.  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'

15.  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)

16.  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).

17.  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.

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

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

19.  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)

20.  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)

21.  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'

22.  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

23.  To satisfy the 100 points 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)

24.  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.

25.  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.

26.  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)

27.  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:

28.  "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..."

29.  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.

30.  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.

31.  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."

32.  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.

33.  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)

34.  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)

35.  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)

36.  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)

37.  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)

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

39.  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

40.  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 following period:

•                     After 1 XX 20XX and on or before 30 XX 20XX.

Current year

41.  Therefore, for the purposes of sub paragraph 360-40(1)(a)(ii) ITAA 1997, the 'current year' will be the year ending 30 June 20XX (the 20XX income year). For clarity, in relation to particular requirements within sub paragraph 360-40(1)(a)(ii), the last six income years will include the years ending 30 June 20XX, 20XX, 20XX, 20XX, 20XX and 20XX (the latest being the current year), and the year before the current year will be the year ending 30 June 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)

42.  Company A was incorporated in Australia on XX XX 20XX, which is within the last six income years outlined above and the expenditure incurred in the last three income years (20XX, 20XX and 20XX) was $XXXX; therefore, the requirements of subparagraph 360-40(1)(a)(ii) are satisfied.

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

43.  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 years before each current year.

44.  Company A had a total expense of less than $1 million in the 20XX income year. Consequently, paragraph 360-40(1)(b) is satisfied.

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

45.  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, income year before the current year.

46.  Company A derived total assessable income of less than $200,000 in the 20XX income year. Consequently, paragraph 360-40(1)(c) is satisfied.

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

47.  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.

48.  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 at the test time, so paragraph 360-40(1)(d) is satisfied.

Conclusion for early stage test

49.  Company A satisfies the early stage test for the 20XX 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

50.  Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 20XX. Company A has elected 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)

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

51.  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.

52.  Company A is commercialising its product.

53.  Company A is genuinely focused on developing their products for an applicable addressable market, so subparagraph 360-40(1)(e)(i) is satisfied for the period XX XX 20XX to XX XX 20XX.

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

54.  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 to generate economic value and revenue for the company.

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

55.  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 XX XX 20XX to XX XX 20XX. 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)

56.  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.

57.  Company A has projected solid revenue growth.

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

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

59.  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.

60.  Company A has the potential to successfully scale up its business.

61.  This 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 XX XX 20XX to XX XX 20XX.

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

62.  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.

63.  Company A will be 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.

64.  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 XX XX 20XX to XX XX 20XX.

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

65.  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 advantages for that business.

66.  Company A has identified its product has competitive advantage.

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

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 XX XX 20XX to XX XX 20XX.

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

68.  As Company A was incorporated in Australia, it is not a Foreign Company as a result paragraph 360-40(1)(f) is satisfied.

Conclusion

Company A meets the eligibility criteria of an Early Stage Innovation Company (ESIC) under section 360-40 of ITAA 1997 for the period XX XX 20XX to XX XX 20XX.

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