Edited version of private advice

Authorisation Number: 1052202204488

Date of advice: 8 December 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?

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

2.      The Company is a privately owned company and is the head of a tax consolidated group.

3.      Company X is a wholly owned subsidiary of the Company. The Company is developing the Product, but Company X will be the eventual trading company which will access the technology through an exclusive license agreement with the Company.

4.      The Company's Founder and director is Taxpayer X.

5.      The Company's registered office and principal place of business is situated at XXX.

6.      For the financial year ending DD MM YYYY, the Company and its subsidiary incurred and earned:

•           Total expenses of $xxx

•           Total income of $yyy

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

Product Development

8.      The Company is developing a software platform which facilitates and streamlines information sharing for individuals of particular events ('the Product').

9.      The Product addresses two long standing problems which arise in the case of these particular events.

10.   Whilst the Product provides an administrative benefit by facilitating certainty and control to manage a person's affairs when they are experiencing a particular event, it also assists with reducing the likelihood of disputes following these events.

Product Development Stages

11.   In MM YYYY, the Company commenced construction of its Product. This has primarily been undertaken by the Founder. Over the course of the past xx months, the Founder has:

•         Constructed and almost completed an initial Platform, with one primary functional element, the ability to formally extract available data, remaining to be completed, alongside a small number of administrative action capabilities, most notably billing integrations;

•         Developed a proprietary, zero-knowledge encryption framework for securing user data;

•         Commenced initial discussions with certification providers to support the Product being certified;

•         Engaged with service providers, including insurance providers, to support a robust risk management framework for the Product.

12.   The Company hopes to complete development of the first element by the end of the first quarter of the YYYY calendar year.

Commercialisation Strategy

13.   The Company's sole focus is on developing the Product for commercialisation. The commercialisation of the Product is premised on the innovative features it includes. By providing a new solution to challenges which have existed for a long time, and which are expensive to resolve, the Product will ensure the wishes of participants are carried out.

14.   The Company is of the belief that the service provided is well suited to a subscription based model and is thus focussed on developing the innovation for a commercial purpose to generate revenue for the Company.

High Growth Potential

15.   The Company expects the Product to appeal to a specific target market within their target industry. The financial projections of the Company show that for the next five years there is continued steady growth.

16.   The Company believes there to be demand for this product and believes there is the potential for considerable take-up.

Scale up the Business

17.   The Company has considerable scope to successfully scale up its business.

18.   Whilst there will be investment in continuous development, and potentially the release of new features as developed, there is limited additional development cost to provide the Product to users.

19.   Consequently, revenues can grow significantly with limited increase in operating costs required.

Broader than Local Market

20.   The Company has identified its ultimate market as being the domestic market, with its initial target being Australian markets.

21.   In theory the offering has application in almost any market globally, as it is able to be easily tweaked to local market settings in offshore jurisdictions.

22.   The limiting factor will be the ability to map the relevant data points to capture in each jurisdiction.

Competitive Advantages

23.   There are currently no direct competitors in the Australian market of any scale that the Company is aware of.

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

25.   Being the first of such, the Product, the Company has first mover advantage over its competitors.

Previous private ruling

26.   On DD MM YYYY, the Company submitted an application for a private ruling to the Commissioner of Taxation seeking ESIC eligibility.

27.   On DD MM YYYY, the Commissioner of Taxation issued a private ruling that the Company met the criteria of Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the ITAA 1997.

Information provided

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

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

•           Response to further questions provided

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

30.   There has only been one issue of shares so far, being the initial issue on incorporation of the Company on DD MM YYYY. The Company proposes to issue new shares to various investors to assist in funding the continued development and commercialisation of their Product.

Assumption(s)

Not applicable.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 360-A

Income Tax Assessment Act 1997 section 360-15

Income Tax Assessment Act 1997 section 360-40

Income Tax Assessment Act 1997 section 360-45

Further issues for you to consider

Not applicable.

REASONS FOR DECISION

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

SUMMARY

The Company 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

31.   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'

32.   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)

33.   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).

34.   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.

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

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

36.   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)

37.   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)

38.   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'

39.   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

40.   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)

41.   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.

42.   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.

43.   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

44.   For the purposes of this ruling, the 'test time' for determining if the Company 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. There has only been one issue of shares so far, being the initial issue on incorporation of the Company on DD MM YYYY.

Current year

45.   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

46.   The Company 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

47.   In applying the requirements of paragraph 360-40(1)(b), the Company 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.

48.   The Company 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

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

50.   The Company did not earn any assessable income in the YYYY income year. Consequently, paragraph 360-40(1)(c) is satisfied.

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

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

52.   The Company 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

53.   The Company 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

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

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

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

57.   The Company 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

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

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

60.   The Company's sole focus is on developing the Product for commercialisation.

61.   The Company 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, the Company will no longer be 'developing' the product for commercialisation.

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

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

63.   The Company has high growth potential as the Product is easily and infinitely scalable to a global audience.

64.   The Company has provided details to satisfy this requirement.

65.   The Company 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

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

67.   The Company has provided details to satisfy this requirement.

68.   This leverage ensures that the Company 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

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

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

71.   The Company 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

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

73.   The Company has provided details to satisfy this requirement.

74.   The Company 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

The Company 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

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

CONCLUSION

The Company 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.