Edited version of private advice

Authorisation Number: 1052179008316

Date of advice: 11 October 2023

Ruling

Subject: Early stage innovation company - eligibility renewal

Question:

Does Company X 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?

Answer:

Yes

This ruling applies for the following periods:

DD MM YYYY to DD MM YYYY

The Scheme commences on:

DD MM YYYY

Relevant facts and circumstances

Background information

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

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

3.      Company X's registered office and principal place of business is situated at XXX.

4.      For the financial year ending DD MM YYYY, Company X incurred and earned the following:

•                     Total expenses of $xxx

•                     Total income of $yyy

5.      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.

6.      Company X has purchased a xx% stake in Company Y (a company that went into voluntary administration in MM YYYY following the sudden collapse of a long-term funding deal) which includes its fintech origination and servicing platform and integrations, its proprietary modelling software and calculators (integrated into the platform), its trademark and branding, all the company's intellectual property, and its suite of products which includes an Australian-first hybrid product designed specifically for a particular market - a product innovation specific to Company X and still in development. Company X is aiming to launch in XXX and YYY in late YYYY / early YYYY.

Previous private ruling issued

7.      On DD MM YYYY, Company X received a private ruling for the financial year ended DD MM YYYY 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 service delivery and products to this particular market, being developed.

8.      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

9.      Company X is developing both service delivery and products for a particular market. While there are a handful of providers of such products in Australia and only xx in YYY, most of the methods of delivery are through traditional channels which are often slow, largely analogue, and touch heavy.

10.   The purchase of Company Y included all intellectual property and their suite of products, which was still in the development stage. Company X will continue to develop the proprietary software, originally developed in Company Y.

11.   Company X stated that the proprietary software enables the company to develop and distribute particular products for those in a particular demographic, which are not currently available in the market.

12.   Company X is currently working on securing funding and is presenting its business case, end-to-end technology platform and new products to funders in Australia and overseas. This work requires ongoing and constant modelling and remodelling of the business case and alternatives, as well as the particular products.

13.   Company X stated that the following development work on the platform needs to be completed, including:

•                     Ongoing Product Design and Contracts

•                     IP updates & Integration

•                     Early operational feedback and improvements

•                     Enhanced integrations and scale-up

•                     B2B technology solution implementation

•                     Implementation of Integrated Data Platform

•                     End-to-End User Acceptance Testing (UAT) where all components of the platform and customer journey are tested.

14.   Company X estimated that the market size of their 'serviceable' market is xx m households.

15.   Company X estimated that xx% of those in the particular demographic are their potential customers.

16.   Company X stated that the company's technology platform allows scaling up, hiring and training staff to be executed efficiently.

17.   Company X is targeting rapid growth and aims to have a combined book of $x billion within xx months from launch.

18.   Company X is planning to launch in Australia and YYY market in late YYYY or early YYYY.

19.   Company X stated that the platform and the business model have been designed to be scalable and adaptable to other overseas markets.

20.   Company X intends to expand further and replicate the model in other overseas countries following Australian and YYY launch.

21.   Company X stated that their ability to provide end-to-end, highly automated onboarding and processes lead to superior client education, tailored planning and quicker turnaround times.

Commercialisation Strategy

22.   Company X has successfully secured all the development work and IP created to date on the specialist end-to-end platform, customisations, integrations, and proprietary software, as well as the new particular products - to be distributed via the platform.

23.   The objective now is to complete the development and testing of both the products and platform and successfully launch them to market in Australia and other jurisdictions.

24.   Company X has successfully negotiated with other companies to temporarily "mothball" the technology platform. The integrations with third-party applications have been discontinued (unsubscribed and on hold) and will require new and significant development work and testing to be undertaken to successfully reinstate these applications and ensure they are all functioning to required specifications.

25.   Working towards relaunch and commercialisation, Company X has undertaken significant remodelling work on its business model as well as its unique products.

26.   Company X is currently working on securing funding and is presenting its business case, end-to-end technology platform and new products to funders in Australia and overseas. This work requires ongoing and constant modelling and remodelling of the business case and product alternatives.

High Growth Potential

27.   Company X estimates a current "serviceable available market" of x mill households: that is - prospective customers that have an existing product.

28.   xx% or x mill are potential Company X customers.

29.   Company X is working to scale to a national launch with a focus on backing existing products for particular customers. With current market estimated at more than $xx bn, there is enormous growth potential in the Australian market.

Scale up the Business

30.   Company X's technology platform allows scaling up and hiring and training staff to be executed extremely efficiently - minimising downtime, costs, and lost opportunities.

31.   The technology platform was developed over x years and was within one month of launch before it was required to enter Voluntary Administration when the anticipated funder abruptly and unexpectedly withdrew its customer funding and option for cornerstone investment.

32.   Company X is raising both the equity funding and customer funding required in order to complete the launch. The technology platform includes critical components required for scale.

33.   Company X has established the business to scale-up and is targeting rapid growth and a combined book of $x bn within xx months representing xxx+ customers subject to successfully securing working capital and customer funding for launch.

Broader than Local Market

34.   Company X is planning to launch simultaneously in YYY and Australia in late YYYY / early YYYY. The platform and the business model have been designed to be highly scalable and adaptable to other similar overseas markets.

35.   Company X will utilise its technology and executives to launch the YYY business but will have a local leadership team based in YYY.

36.   There is a distinct lack of competition within the particular sector in YYY with only x companies providing products to the market. The market dynamics are similar to Australia; the banks are reluctant to enter the market due to a mix of reputation, regulator-imposed capital requirement criteria, and regulatory risk.

37.   Following a successful Australian and YYY launch, it is the intention to expand further and replicate the model in other overseas countries.

Competitive Advantages

38.   While there are a number of indirect competitors in the particular space, Company X has no direct competitors in the particular space for its unique product.

39.   Company X's products are designed to appeal directly to a market which is currently underserved with optimal products that provide the appropriate flexibility and structure.

40.   Company X has the brand, technology, and experience to grasp rapid market share as this trend accelerates.

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

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

Information provided

43.   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

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

45.   You propose to issue new shares in Company X to various investors to assist in funding the continued development and commercialisation of the 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

46.   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'

47.   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)

48.   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).

49.   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.

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

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

51.   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)

52.   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)

53.   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'

54.   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

55.   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)

56.   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.

57.   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.

58.   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

59.   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. Company X issued shares in MM YYYY and propose to issue new shares to various investors to assist in funding the continued development and commercialisation of the Product in the YYYY financial year.

Current year

60.   Therefore, for the purposes of subsection 360-40(1) ITAA 1997, 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 3 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

61.   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.

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

62.   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.

63.   Company X incurred expenses of $xxx in the YYYY income year. Consequently, paragraph 360-40(1)(b) is satisfied.

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

64.   In applying the requirements of paragraph 360-40(1)(c), Company 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.

65.   Company X earned assessable income of $yyy in the YYYY income year. Consequently, paragraph 360-40(1)(c) is satisfied.

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

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

67.   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

68.   Company X 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.

THE '100 POINT TEST' - paragraph 360-40(1)(e) and section 360-45

69.   Company X has not provided sufficient evidence of satisfying the 100-point test under section 360-45 for the year ending DD MM YYYY. Company X 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.

THE 'PRINCIPLES-BASED TEST' - paragraph 360-40(1)(e) itaa 1997

Developing new or significantly improved innovations for applicable addressable market - subparagraph 360-40(1)(e)(i) ITAA 1997

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

71.   Company X is developing both service delivery and products for a particular Australian and YYY markets. While there are a handful of providers of such products in Australia and only x in YYY, most of the methods of delivery are through traditional channels which are often slow, largely analogue, and touch heavy.

72.   The purchase of Company Y included all intellectual property and Company Y's suite of products, which was still in the development stage. Company X will continue to develop the proprietary modelling software, originally developed in Company Y.

73.   Company X stated that the proprietary software enables the company to develop and distribute products for those in the particular demographic which are not currently available in the market.

74.   Company X is currently working on securing funding and is presenting its business case, end-to-end technology platform and new products to funders in Australia and overseas. This work requires ongoing and constant modelling and remodelling of the business case and product alternatives.

75.   Company X stated that the following development work on the platform needs to be completed, including:

•                     Salesforce updates

•                     Ongoing Product Design and Contracts

•                     IP updates & Integration

•                     Early operational feedback and improvements

•                     Enhanced integrations and scale-up

•                     B2B technology solution implementation

•                     Implementation of Integrated Data Platform

76.   Company X estimated that the market size of their 'serviceable' market is x million households.

77.   Company X estimated that xx% of those in the particular demographic are their potential customers.

78.   Company X stated that the company's technology platform allows scaling up, hiring and training staff to be executed efficiently.

79.   Company X is targeting rapid growth and aims to have a combined book of $x billion within xx months from launch.

80.   Company X is planning to launch in Australia and YYY market in late YYYY or early YYYY.

81.   Company X stated that the platform and the business model have been designed to be scalable and adaptable to other overseas markets.

82.   Company X intends to expand further and replicate the model in other overseas countries following Australian and YYYY launch.

83.   Company X does not identify any direct competitors in the particular market for their product.

84.   Company X stated that their ability to provide end-to-end, highly automated onboarding and lending processes lead to superior client education, tailored planning and quicker turnaround times.

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

86.   Company X 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

87.   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.

88.   There are a number of steps which are required to be completed into the future, before Company X's Product is considered to be fully developed for commercialisation.

89.   Company X technology platform is currently in a state of "hiatus" and will need to be reinstated for launch which will require significant further and new development, and user acceptance testing.

90.   All third-party integrations will need to be reinstated and tested and the company's proprietary modelling software, which powers the customer facing calculations, Customer Information Form, product eligibility assessment and distribution of Company X's unique products, will need to be remodelled to suit the specific requirements of any new funder(s).

91.   In addition, Company X will continue to advance its proprietary modelling software and calculators and test them against user scenarios, with these tests culminating in delivering one of Company X's new products.

92.      Company X's products require innovative modelling approaches as they are non-standard offerings. For example, existing products are presently available predominantly via rigid products without the flexibility offered to "regular" forward products, whereas Company X hypothesises that its Proprietary Modelling Software and calculators delivered via its unique Platform will provide more appropriate and flexible offerings and take particular customers through the process in a simple and automated process.

93.      Further testing is therefore required to evaluate if its Products will provide the intended target market with the intended outcomes, through a simple and automated process.

94.      Company X is genuinely focussed on developing their Product for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period DD MM YYYY to DD MM YYYY, 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' the product for commercialisation.

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

95.      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.

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

97.      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

98.      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.

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

100.    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

101.    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.

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

103.    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

104.    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.

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

106.    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 period DD MM YYYY to DD MM YYYY, 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

107.    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 period DD MM YYYY to DD MM YYYY, or the date when their Product has been fully developed and is ready for client use, whichever occurs earlier.

Other references (non ATO view)

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