ZWBX and Commissioner of Taxation (Taxation)

ZWBX and Commissioner of Taxation (Taxation) [2024] AATA 2065 (18 June 2024)
Division:TAXATION AND COMMERCIAL DIVISION
File Numbers:2022/5600
Re:ZWBX
APPLICANT

AndCommissioner of Taxation
RESPONDENT

DECISION
Tribunal:Member D Mitchell
Date:18 June 2024
Place:Brisbane

The Tribunal affirms the decisions under review.
.................................[SGD].....................................
Member D Mitchell

CATCHWORDS
TAXATION – early stage investor tax offset – early stage innovation company – are the company or the group activities taken into consideration for the purposes of the innovation test outlined in section 360-40(1)(e) of the Income Tax Assessment Act 1997 (Cth) – question of statutory interpretation – decision under review affirmed
LEGISLATION
Corporations Act 2001 (Cth)
Income Tax Assessment Act 1997 (Cth)
Taxation Administration Act 1953 (Cth)
CASES
Danmark Pty Ltd v FCT; Forestwood Pty Ltd v FCT (1944) 7 ATD 333; (1944) AITR 517
Federal Commissioner of Taxation v Dalco (1990) 168 CLR 614
Trautwein v Federal Commissioner of Taxation (1936) 56 CLR 63
LEGISLATION
Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 (Cth)
REASONS FOR DECISION
Member D Mitchell
18 June 2024
INTRODUCTION

ZWBX (the Applicant) is seeking review of an objection decision[1] made by the Commissioner of Taxation (the Respondent) dated 22 February 2022.[2]
[1] Exhibit 1, Tribunal Book, Tab 1.7, T Documents, page 57, Notice of Objection Decision.
[2] Exhibit 1, Tribunal Book, Tab 1.1, T Documents T1, pages 3-12, Application for Review.
The reviewable objection decision relates to the Applicant’s objection to a notice of amended income tax assessment for the income year ended 30 June 2017.[3] The reviewable objection decision disallowed the Applicant’s objection on the basis it found that they were not eligible for the claimed early stage investor (ESI) tax offsets totalling $39,705 for the income year ended 30 June 2017.[4]
[3] Exhibit 1, Tribunal Book, Tab 1.6, T Documents, T6, pages 39-56, Objection application and attachments.
[4] Exhibit 1, Tribunal Book, Tab 1.2, T Documents, T2, pages 13-14, Reasons for Decision.
BACKGROUND
This matter involves the development of ZYX Software (the Software), which is a cloud-based client communications management platform developed by the Applicant and others.[5] The involved individuals (of whom includes the Applicant) sought accounting advice in relation to the appropriate corporate structure within which to own and operate the ZYX Software business to reduce risk and provide flexibility.[6]
[5] Exhibit 1, Tribunal Book, Tab 2.1, Supplementary T Documents, ST1, page 60, Holding Co ESIC Report.
[6] Exhibit 2, Applicant’s Written Submissions, page 5, paragraph 27.
On 4 July 2016, the engaged accountant provided advice and recommended a corporate structure with key features being:[7]
·     A holding company (Holding Co) and two wholly-owned subsidiaries where one subsidiary company holds the IP (IP Co) and the other carries on the business (Trading Co).
·     Investor money would be received by the Holding Co and investors would be issued shares in the Holding Co in return for their investment.
·     Founders would also be issued shares in the Holding Co in return for their investment of time and expertise to date.
·     Further subsidiaries of the Holding Co could be added at any time to accommodate the effective execution of strategy in line with the forward planning of the group – for example to accommodate overseas expansion.
[7]
The accountant outlined that the objectives of the structure were to:[8]
… enable the group to reduce overall risk, to separate different classes of risk and enjoy structural flexibility, tax effectiveness and simplicity both during ownership of the Business and upon any exit.
[8]
The accountant’s advice recommended a corporate structure and outlined the purpose of the proposed structure to be:[9]
The ability to declare fully franked dividends from the subsidiary companies to Holding Co without creating any immediate tax implications for the shareholders gives the group the ability to move accumulated profits to the Holding Co level where they are safely quarantined from the ongoing risk of say, Trading Co. This could be done on some regular basis, say quarterly or bi-annually.
Holding Co can then choose to retain that money, pay dividends to its shareholders (either now or in the future) or loan that money back to the subsidiary if needed for operations. A loan back to the subsidiary can be a secured loan which therefore ranks ahead of unsecured creditors.
Including a holding company in the structure thus enables the group to reduce risk and provides greater structural flexibility. The establishment of IP Co and Trading Co will allow for the separation of different classes of risk.
Any property, plant and equipment (expected to be only a minor consideration given the nature of the Business) could also be acquired by IP Co, thereby separating the trading risk from the infrastructure used to produce the services and ultimately, income.
This means that even if an event that causes the failure of Trading Co occurs, the business will be able to survive because its assets are safely quarantine from that trading risk.
The architecture of a holding company with subsidiaries creates a level of structural flexibility. This framework can be used to ‘spin off’ parts of the operation into their own subsidiaries and likewise accommodate any future acquisitions or international expansion.
The Board may wish to spin off parts of the business for which they would like to create clearer accountabilities and/or parts that could potentially be sold as a ‘stand-alone’ business, should it make sense to do so at some point in the future.
[Emphasis added]
[9]     Exhibit 1, Tribunal Book, Tab 6.4, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(j), Letter of 4 July 2016 from the accountant, pages 872-873.
The accountant recommended that the group consolidate from a taxation perspective.[10]
[10] Exhibit 1, Tribunal Book, Tab 6.4, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(j), Letter of 4 July 2016 from the accountant, page 873.
On 27 July 2016, ABC Pty Ltd was incorporated and 10 ordinary shares (100% of capital) were issued to the Applicant.[11] The Applicant is the sole director and secretary of ABC Pty Ltd.[12]
[11] Exhibit 1, Tribunal Book, Tab 1.5, T Documents, T5, page 36, MASCOT search – ABC Pty Ltd.
[12] Exhibit 1, Tribunal Book, Tab 1.5, T Documents, T5, page 36, MASCOT search – ABC Pty Ltd.
On 27 July 2016, BC Trust was established with ABC Pty Ltd appointed as trustee.[13] The Applicant is the appointer and principal beneficiary of the BC Trust.[14]
[13] Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(uu), Trust Deed of ABC Pty Ltd, page 459.
[14] Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(uu), Trust Deed of ABC Pty Ltd, page 459.
On 14 September 2016, Holding Co Pty Ltd (Holding Co) was incorporated.[15] The directors of Holding Co were the Applicant, Mr EE, Mr EF and Mr F.[16] Mr F retired as a director on 30 May 2018.[17] Holding Co’s constitution allowed it to issue ordinary shares and shares of various classes and set out the terms if shares were issued partly paid.[18]
[15]    Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(d), ASIC Historical Extract – Holding Co, page 199.
[16]    Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(d), ASIC Historical Extract – Holding Co, page 200.
[17]    Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(d), ASIC Historical Extract – Holding Co, page 200.
[18]    Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(yy), First constitution of Trading Co, page 557.
On 14 September 2016, Holding Co issued shares to various members which relevantly included 50,000 “A” Class shares at $0.01 per share to the BC Trust.[19]
[19] Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(l), Minutes of first meeting of directors of Holding Co. pages 274 and 280.
On 14 September 2016, IP Co Pty Ltd (IP Co) was incorporated.[20] The directors of IP Co were the Applicant, Mr EE, Mr EF and Mr F.[21] Mr F retired as a director on 30 May 2018.[22] All of IP Co’s shares were issued to Holding Co.[23]
[20]    Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(e), ASIC Historical Extract – IP Co, page 215.
[21]    Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(e), ASIC Historical Extract – IP Co, page 216-217.
[22]    Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(e), ASIC Historical Extract – IP Co, page 217.
[23]    Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(e), ASIC Historical Extract – IP Co, page 217.
Trading Co Pty Ltd (Trading Co) had been incorporated on 16 January 2015[24] and on
[24]    Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(c), ASIC Historical Extract – Trading Co, page 192.
[25]    Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(c), ASIC Historical Extract – Trading Co, page s 193-194.
[26]    Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(c), ASIC Historical Extract – Trading Co, page 194.
15 September 2016, the Applicant, Mr EE, Mr EF and Mr F were appointed as directors of Trading Co to replace the previous director.[25] Mr F retired as director on 30 May 2018.[26]
On 19 September 2016, the 100 issued shares (100% of capital) in Trading Co were transferred to Holding Co.[27]
[27] Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(c), ASIC Historical Extract – Trading Co, page 194-195.
On 15 September 2016, the Applicant’s accountant issued a letter certifying that for the purposes of sections 708(8)(c) and 761G(7)(c) of the Corporations Act 2001 (Cth), the Applicant[28] was a sophisticated investor who held net assets of at least $2,500,000.[29]
[28] Exhibit 2, Applicant’s Written Submissions, page 6, paragraph 30, notes that the certificate for unknown reasons incorrectly displays the Applicant’s name wrong.
[29] Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(iii),Letter from the accountant with respect to “Sophisticated Investor” treatment, page 724.
In an agreement, headed 16 September 2016, Holding Co shareholders and directors on behalf of Holding Co executed a Shareholder’s Agreement (the Shareholder’s Agreement).[30] The Shareholder’s Agreement sets out various aspects of Holding Co’s share ownership and directorships, which included the requirement that a company officer observe their fiduciary duty to Holding Co.[31]
[30] Exhibit 1, Tribunal Book, Tab 6.4, Mr EE’s Affidavits and Exhibits, Exhibit ZWBX-1(ww), Shareholder Agreement – Holding Co, pages 1153-1191.
[31] Exhibit 1, Tribunal Book, Tab 6.4, Mr EE’s Affidavits and Exhibits, Exhibit ZWBX-1(ww), Shareholder Agreement – Holding Co, page 1164.
The timing for the payment of any partly paid shares was outlined in Schedule 2 to the Shareholder’s Agreement. Relevantly, Items 1 and 13 of that Schedule provided that in relation to 150,000 Ordinary shares issued by Holding Co to BC Trust it was required to pay $96,000 by 1 October 2016 and $96,000 by 1 October 2017.[32]
[32] Exhibit 1, Tribunal Book, Tab 6.4, Mr EE’s Affidavits and Exhibits, Exhibit ZWBX-1(ww), Shareholder Agreement – Holding Co, pages 1153-1191. 1189.
On 22 September 2016, IP Co and Trading Co entered into a Software Licence Agreement (the Licence Agreement).[33]
[33] Exhibit 1, Tribunal Book, Tab 6.4, Mr EE’s Affidavits and Exhibits, Exhibit ZWBX-1(pp), Software Licence Agreement between IP Co and Trading Co, pages 1108-1121.
Under the Licence Agreement, Trading Co was entitled to use the licence of the ZYX Software, as a service to third parties, in accordance with Clause 3.1 in return for payment of fees to IP Co as set out in Clause 4.[34]
[34] Exhibit 1, Tribunal Book, Tab 6.4, Mr EE’s Affidavits and Exhibits, Exhibit ZWBX-1(pp), Software Licence Agreement between IP Co and Trading Co, pages 1112-1113.
On 22 September 2016, the Holding Co’s Board appointed the Applicant as Chair of the Board of Holding Co’s directors.[35]
[35] Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(m), Minutes of meeting of board of Holding Co, page 297.
On 22 September 2016, the Members of Holding Co passed a special resolution altering the shareholding of Holding Co such that “A” Class shares were varied to “Ordinary F” Class shares and” D” Class shares were varied to “F” Class shares.[36]
[36] Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(ccc), ASIC form 211 – Trading Co, pages 695-715.
By agreement dated 26 September 2016, between IP Co and DEF Pty Ltd, DEF Pty Ltd agreed to provide IP Co with services that were stated to include “Research into the potential use of [redacted] architecture to increase ZYX Software scalability in the [redated] cloud” and to provide a report and prototype code for a fixed sum payable at the end of the research.[37]
[37] Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(f), Services Agreement between IP Co and DEF Pty Ltd, pages 220-224.
In an unsigned agreement between IP Co and GHI Pty Ltd, GHI Pty Ltd agreed to provide software development services to IP Co.[38]
[38] Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(g), Services Agreement between IP Co and GHI Pty Ltd, pages 225-229.
On 2 December 2016 and 9 January 2017, Mr G was appointed as a director of IP Co[39] and Trading Co[40] respectively.
[39] Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(e), ASIC Historical Extract – IP Co, page 216.
[40] Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(c), ASIC Historical Extract – Trading Co, page 193.
A Holding Co director’s minute dated 2 December 2016 records the creation of an ESIC compliance document.[41] The Applicant submitted that Holding Co’s draft business plans were the ESIC compliance documents.
[41] Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(n), Minutes of meeting of boad of Holding Co, page 304.
On 15 December 2016, Holding Co notified ASIC of the share conversion whereby:[42]
(a)All 300,000 Class “A” shares were replaced with “Ordinary Class F” shares; and
(b)All 20,000 “D” Class shares were replaced with “F” Class shares.
[42] Exhibit 1, Tribunal Book, Tab 6.2, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(ccc), ASIC form 211 – Holding Co, pages 695-715.
Two deeds were executed on or around 8 December 2016, between Mr EE and IP Co[43] and Mr EF and IP Co.[44] Under the deeds Mr EE and Mr EF assigned their respective intellectual property rights in the patents, trademarks and domain names associated with the

ZYX Software and ZYX.biz, including any copyright works and software source code to IP Co.
[43] Exhibit 1, Tribunal Book, Tab 6.4, Mr EE’s Affidavits and Exhibits, Exhibit ZWBX-1(ll), Deed of Assignment of Intellectual Property between Mr EE and IP Co, pages 1070-1076.
[44] Exhibit 1, Tribunal Book, Tab 6.4, Mr EE’s Affidavits and Exhibits, Exhibit ZWBX-1(ll), Deed of Assignment of Intellectual Property between Mr EE and IP Co, pages 1077-1085.
On 23 March 2017, Holding Co issued further shares to its then members. Holding Co issued the following shares to BC Trust:[45]
(a)4,706 Ordinary F Class shares, of which the amount of $1.28 per share, as stated in the share certificate was fully paid; and
(b)150,000 Ordinary F Class shares, of which $0.64 of the $1.28 per share, as stated in the share certificate was paid.
[45] Exhibit 1, Tribunal Book, Tab 1.6, T Documents, T6, pages 53-54, Holding Co Share Certificate.
On 23 May 2017, Holding Co was registered in the United States Patent and Trademark Office as holding the term “ZYX”.[46] The register notes that the date of the marks first use and its use in commerce as 1 September 2015, and although filed on 24 September 2016, the mark was not registered until 23 May 2017.[47]
[46] Exhibit 1, Tribunal Book, Tab 6.4, Mr EE’s Affidavits and Exhibits, Exhibit ZWBX-1(vv), United States trade mark, page 1152.
[47] Exhibit 1, Tribunal Book, Tab 6.4, Mr EE’s Affidavits and Exhibits, Exhibit ZWBX-1(vv), United States trade mark, page 1152.
Holding Co’s trademark registration relates to the name ZYX, not to the copyright in
ZYX Software and related intellectual property rights.
On 29 June 2017, ABC Pty Ltd as trustee of BC Trust resolved to distribute 100% of the
[48] Exhibit 1, Tribunal Book, Tab 1.6, T Documents, T6, page 51, BC Trust resolution.
[49] Exhibit 1, Tribunal Book, Tab 1.6, T Documents, T6, page 52, BC Trust resolution.
BC Trust’s net profits and ESI Tax Offset for the year ended 30 June 2017 to the Applicant.[48] The amount of the ESI Tax Offset being distributed was $39,704.80.[49]
On 28 July 2017, Holding Co lodged with the Respondent an ESIC report pursuant to Item 10 of section 396-55(b) of Schedule 1 to the TAA 1953 stating it self-assessed on the basis that it considered it had satisfied the ‘principle-based test’ of section 360-40(1) of the ITAA 1997.[50]
[50] Exhibit 1, Tribunal Book, Tab 2.1, Supplementary T Documents ST1, pages 60-68, Trading Co – ESIC Report.
On 27 November 2017, the Applicant lodged their income tax return for the 2017 income year.[51]
[51] Exhibit 4, Respondent’s Submissions, page 3, paragraph 11.
On 27 February 2018, Trading Co lodged a R&D Incentive Application: Registration of R&D Activities claim to the Department of Industry, Innovation and Science in relation to research and development of the ZYX Software in the 2016-2017 income tax year.[52] In the claim, Trading Co outlined that it did not have an Ultimate Holding Company,[53] and that it as the R&D entity incurred expenditure in undertaking its R&D activity.[54] Trading Co in completing and lodging the claim declared that the information in the claim was true and correct and accurate in all material details.[55]
[52]    Exhibit 1, Tribunal Book, Tab 6.4, Mr EE’s Affidavits and Exhibits, Exhibit ZWBX-1(x), Tax Accountants Pack – Trading Co - R&D Tax Incentive Claim – Financial year ended 30 June 2017, pages 1539-1559.
[53]    Exhibit 1, Tribunal Book, Tab 6.4, Mr EE’s Affidavits and Exhibits, Exhibit ZWBX-1(x), Tax Accountants Pack – Trading Co - R&D Tax Incentive Claim – Financial year ended 30 June 2017, page 15483-1555.
[54]    Exhibit 1, Tribunal Book, Tab 6.4, Mr EE’s Affidavits and Exhibits, Exhibit ZWBX-1(x), Tax Accountants Pack – Trading Co - R&D Tax Incentive Claim – Financial year ended 30 June 2017, pages 1543-1555.
[55]    Exhibit 1, Tribunal Book, Tab 6.4, Mr EE’s Affidavits and Exhibits, Exhibit ZWBX-1(x), Tax Accountants Pack – Trading Co - R&D Tax Incentive Claim – Financial year ended 30 June 2017, pages 1556-1559.
On 8 March 2018, after reviewing the Applicant’s ESI tax offset claim of $39,705 the Respondent issued a notice of assessment for the 2017 income year based on the Applicant’s self-assessed entitlement to the ESI tax offset.[56]
[56] Exhibit 1, Tribunal Book, Tab 1.2, T Documents, T2, page 13, Reasons for decision.
On 17 May 2018, the Respondent commenced a review of Holding Co in respect of whether it qualified as an ESIC within the meaning of section 360-40 of the ITAA 1997.[57]
[57] Exhibit 1, Tribunal Book, Tab 1.6, T Documents, T6, page 47, paragraph 10, ATO position paper regarding Holding Co for the 2017 income year.

On 22 October 2018, the Respondent advised Holding Co by telephone that it had concluded that Holding Co did not qualify as an ESIC.[58]
[58] Exhibit 1, Tribunal Book, Tab 1.6, T Documents, T6, page 47, paragraph 14, ATO position paper regarding Holding Co for the 2017 income year.
On 13 December 2018, the Respondent issued to Holding Co reasons for the decision explaining why Holding Co did not qualify as an ESIC.[59] The Respondent determined that at the test time Holding Co had:[60]
…. provided sufficient evidence to establish that the [ZYX] platform is a new or significantly improved product and that the potential exists for high growth, scalability, addressing a broader than local market and competitive advantage.
[59] Exhibit 1, Tribunal Book, Tab 1.6, T Documents, T6, page 44, ATO position paper regarding Holding Co for the 2017 income year.
[60] Exhibit 1, Tribunal Book, Tab 1.6, T Documents, T6, page 49, ATO position paper regarding Holding Co for the 2017 income year.
The Respondent, however, determined that Holding Co was not genuinely focussed on developing the innovation for commercialisation at any time during the 2017 income year.[61]
[61] Exhibit 1, Tribunal Book, Tab 1.6, T Documents, T6, page 49, ATO position paper regarding Holding Co for the 2017 income year.
The Respondent explained that:[62]
[62] Exhibit 1, Tribunal Book, Tab 1.6, T Documents, T6, page 50, ATO position paper regarding Holding Co for the 2017 income year.
47.In this case, [IP Co] owns the innovation by virtue of owning the IP relevant to the [ZYX Software]. [Trading Co] conducts development activities, including research and development for the [ZYX Software]. Development activities are funded by a loan from the holding company, [Holding Co]. However the real central point of the activities of [Holding Co] appears to be:
·Holding the registration for the [ZYX] trademark in the USA;
·owning 100% of the shares in the company that owns the IP; and
·providing funds to the company conducting development activities.
48.This is insufficient to establish that [Holding Co], in its own right, is genuinely focussed on developing the [ZYX Software] for commercialisation.
49.The requirements for the Early Stage Test in subparagraphs 360-40(1)(b) and (c) do consider the income and expenses of 100% subsidiaries of a potential ESIC. However, one other requirement relates to the high growth potential of the business and all remaining requirements of the ESIC tests in sections 360-40 and 360-45 of the ITAA 1997 relate to the company seeking to qualify as an ESIC.
50.As stated in paragraph 42 “…no evidence has been provided that [Holding Co] is conducting development activities in its own right.”
51.Therefore, subparagraph 360-40(1)(e)(i) has not been satisfied by Holding Co] at any time in the year ended 30 June 2017. Consequently [Holding Co] does not satisfy the principles based test and does not qualify as an ESIC at any time in the year ended 30 June 2017. Specifically, [Holding Co] was not an ESIC at the ‘test time’ immediately after shares were issued on 23 March 2017.
As a result, the Applicant lodged an amended income tax return for the 2017 income year on 11 March 2019.[63]
[63] Exhibit 1, Tribunal Book, Tab 3.2, Applicant’s Statement of Issues, Facts and Contentions, page 115, paragraph 10.
On 4 April 2019, a notice of amended assessment for the 2017 income year was issued to the Applicant. The amended notice of assessment calculated the Applicant’s taxation liability on the basis that they were not entitled to the ESI tax offset in the claimed amount of $39,705.[64]
[64] Exhibit 1, Tribunal Book, Tab 1.6, T Documents, T6, page 42, 2017 Amended Notice of Assessment.
On 25 August 2021, the Applicant made an application for an extension of time and objected to the notice of amended assessment for the 2017 income year.[65]
[65] Exhibit 1, Tribunal Book, Tab 1.6, T Documents, T6, pages 39-41, Applicant’s Objection application.
The Respondent allowed the Applicant’s application to have their objection treated as having been lodged within time.[66]
[66] Exhibit 4, Respondent’s Submissions, page 3, paragraph 20.
On 22 February 2022, the Respondent disallowed the Applicant’s objection.[67]
[67] Exhibit 1, Tribunal Book, Tabs 1.2 and 1.7, T Documents, T2 and T7, pages 13-14 and 57-58, Reasons for decision and Notice of Objection decision.
On 24 June 2022, the Applicant sought review of the Respondent’s objection decision by way of application to this Tribunal.[68]
[68] Exhibit 1, Tribunal Book, Tab 1.1, T Documents, T1, pages 3-12, Application for review of decision and attachments.
On 5 and 6 March 2024, an in-person Hearing was held. At the Hearing, the Applicant, was represented by Mr Christopher Catt and Ms Fiona McNeil of Counsel, instructed by

Mr Rod Hawkins of Z45 Law Pty Ltd. The Respondent was represented at the Hearing by

Mr Michael Ballans of Counsel, instructed by Ms Eva Huang on behalf of the Respondent.
THE LAW
The relevant law in this matter includes the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) and the Taxation Administration Act 1953 (Cth) (TAA 1953).
Where a taxpayer is dissatisfied with an assessment, they may object against it in accordance with the requirements set out in Part IVC of the TAA 1953.
The Respondent must decide whether to allow, wholly or in part, or disallow, the taxpayer’s objection.[69]
[69] Section 14ZY of the TAA 1953.
A taxpayer dissatisfied with the Respondent’s objection decision may apply to the Tribunal for a review of the decision or appeal to the Federal Court against it.[70]
[70] Section 14ZZ of the TAA 1953.
Section 14ZZK(b)(i) of the TAA 1953 provides that on application for review of a reviewable objection decision, the Applicant has the burden of proving that the assessment is excessive or otherwise incorrect and what the assessment should have been.
As such to discharge the Applicant’s onus of proof they must establish the necessary facts and explain why the assessment should not have been made, and also what the assessment should be.[71] Where the Applicant is required to establish a fact to demonstrate the assessment is excessive, then the onus rests on them to establish that fact.[72]
[71] Federal Commissioner of Taxation v Dalco (1990) 168 CLR 614 at pages 621 and 624-625; Trautwein v Federal Commissioner of Taxation (1936) 56 CLR 63 at 87.
[72] Danmark Pty Ltd v FCT; Forestwood Pty Ltd v FCT (1944) 7 ATD 333 at 337; (1944) AITR 517 at 586.
Subdivision 360-A of the ITAA 1997 provides the framework for tax incentives for early stage investors in innovation companies. It provides that:[73]
You may be entitled to a tax offset if you are, or a trust or partnership of which you are a member is, issued with certain kinds of equity interests in a small Australian company with high‑growth potential that is engaging in innovative activities.
A modified CGT treatment may also apply to those equity interests.
[73] Section 360-5 of the ITAA 1997.
Section 360-15 of the ITAA 1997 provides the tax offset entitlement requirements. It provides:
General case
(1)       You are entitled to a *tax offset for an income year if:
(a)       you are none of the following:
(i)        a trust or a partnership;
(ia)      an *ESVCLP;
(ii)a *widely held company or a *100% subsidiary of a widely held company; and
(b)at a particular time during the income year, a company issues you with *equity interests that are *shares in the company; and
(c)subsection 360‑40(1) (about early stage innovation companies) applies to the company immediately after that time; and
(d)neither you nor the company is an *affiliate of each other at that time; and
(e)the issue of those shares is not an *acquisition of *ESS interests under an *employee share scheme; and
(f)immediately after the issue of those shares, you do not hold equity interests in the company, or in an entity *connected with the company, that carry the right to:
(i)receive more than 30% of any distribution of income by the company or the entity; or
(ii)receive more than 30% of any distribution of capital by the company or the entity; or
(iii)exercise, or control the exercise of, more than 30% of the total voting power in the company or the entity.
Members of trusts or partnerships
(2)A *member of a trust or partnership (other than a partnership that is an *ESVCLP) at the end of an income year is entitled to a *tax offset for the income year if:
(a)the trust or partnership would be entitled to a tax offset, under this section, for the income year if the trust or partnership were an individual; and
(b)the member is not a *widely held company or a *100% subsidiary of a widely held company.
Trustees
(3)       A trustee of a trust is entitled to a *tax offset for an income year if:
(a)the trustee would be entitled to a tax offset, under subsection (1), for the income year if the trustee were an individual; and
(b)the trustee is liable to be assessed or has been assessed, and is liable to pay *tax, on a share of, or all or a part of, the trust’s *net income under section 98, 99 or 99A of the Income Tax Assessment Act 1936 for the income year.
[Emphasis added]
Section 360-40 of the ITAA 1997 provides the requirements for a company to be considered as an early stage innovation company. It provides:
(1)This subsection applies to a company at a particular time (the test time) in an income year (the current year) if:
(a)       the company was:
(i)incorporated in Australia within the last 3 income years (the latest being the current year); or
(ii)incorporated in Australia within the last 6 income years (the latest being the current year), and across the last 3 of those income years before the current year it and its *100% subsidiaries (if any) incurred total expenses of $1 million or less; or
(iii)registered in the *Australian Business Register within the last 3 income years (the latest being the current year); and
(b)the company and its 100% subsidiaries (if any) incurred total expenses of $1 million or less in the income year before the current year; and
(c)the company and its 100% subsidiaries (if any) had a total assessable income of $200,000 or less in the income year before the current year; and
(d)at the test time, none of the company’s *equity interests are listed for quotation in the official list of any stock exchange in Australia or a foreign country; and
(e)at the test time, the company has at least 100 points under section 360‑45, or:
(i)the company is genuinely focussed on developing for commercialisation one or more new, or significantly improved, products, processes, services or marketing or organisational methods; and
(ii)the business relating to those products, processes, services or methods has a high growth potential; and
(iii)the company can demonstrate that it has the potential to be able to successfully scale that business; and
(iv)the company can 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 can demonstrate that it has the potential to be able to have competitive advantages for that business; and
(f)at the test time, the company is not a foreign company (within the meaning of the Corporations Act 2001).
Note:For the purposes of paragraph (e), one way a company can demonstrate something is by engaging the services of another entity.
(2)       For the purposes of paragraph (1)(c), disregard any of the following:
(a)an Accelerating Commercialisation Grant under the program administered by the Commonwealth known as the Entrepreneurs’ Programme;
(b)an amount required to be included in the company’s assessable income under subsection 355‑450(1).
(3)       Subparagraphs (1)(e)(i) to (v) cannot be satisfied for:
(a)       a product, process, service or method; or
(b)       an improvement to a product, process, service or method;
that is of a kind prescribed by regulations made for the purposes of this subsection.
(4)Subsection (1) does not apply to a company if, before the test time, the company engaged in an activity of a kind prescribed by regulations made for the purposes of this subsection.
[Emphasis added]
To qualify as an ESIC a company must satisfy both limbs in section 360-40(1) of the ITAA 1997. It appears to be common ground that these limbs are referred to as the early-stage limb[74] and the innovation limb.[75]
[74] Exhibit 6, List of Authorities, Tab 51, Explanatory Memorandum to the Taxation Laws Amendment (Tax Incentives for Innovation ) Bill 2016 (Cth), pages 2302-2303 at paragraphs 1.62-170.
[75] Exhibit 6, List of Authorities, Tab 51, Explanatory Memorandum to the Taxation Laws Amendment (Tax Incentives for Innovation ) Bill 2016 (Cth), pages 2303-2308, at paragraphs 1.71-1.85.
The early stage limb refers to the requirements of section 360-40(1)(a) to (d) of the ITAA 1997. There is no dispute that Holding Co satisfies these requirements. Based on the evidence before it, the Tribunal finds that Holding Co at the test times met those requirements.
The innovation limb is made up of two alternate tests, being the principle-based tests or the 100-points innovation test. To meet the principle-based tests the requirements in section 360-40(1)(e) of the ITAA 1997 must be met, whereas to meet the 100-point innovation test the company is required to obtain at least 100 points pursuant to section 360-45 of the ITAA 1997.
The Applicant indicated that they do not rely on Holding Co satisfying the 100-points innovation test pursuant to section 360-45 of the ITAA 1997.
The Explanatory Memorandum to the Tax Laws Amendment (Tax Incentive for Innovation) Bill 2016 (Cth) (Explanatory Memorandum) which inserted Division 360-A into the ITAA 1997 relevantly provides:[76]
[76]    Exhibit 6, List of Authorities, Tab 51, Explanatory Memorandum to the Taxation Laws Amendment (Tax Incentives for Innovation ) Bill 2016 (Cth), pages 2301-2307.
What is a qualifying ESIC?
1.61 Generally, an Australian-incorporated company will qualify as an ESIC if it is at an early stage of its development (the early stage limb) and it is developing new or significantly improved innovations with the purpose of commercialisation to generate an economic return (the innovation limb). Specific, objective threshold tests apply to determine if the company is at an early stage of its development whereas a combination of tests may apply to determine if the company is developing a type of innovation. These different tests recognise that whilst objective tests are easier to apply in Australia’s self-assessment income tax system, companies may be innovating in a variety of different ways and so may need to apply a combination of different tests depending on their circumstances.
……..
The innovation limb
1.71 The principle-based definition of innovation is designed to provide enough legislative flexibility to accommodate both existing and future forms of innovations while specifically targeting high growth potential companies based on the innovation company’s focus and potential business capabilities.
…….
The principles-based test
1.76 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 and a copy of this manual is available on the OECD website (
1.77 A qualifying ESIC will need to be genuinely focused on developing its new or significantly improved innovation for the purpose of commercialisation and show that the business relating to that innovation:
•          has the potential for high growth;
•          has scalability;
•          can address a broader than local market; and
•          has competitive advantages.
Further information about these elements is set out below. [Schedule 1, item 1, paragraph 360-40(1)(e)]
1.78 A qualifying ESIC could demonstrate how it satisfies the different elements of this test through the use of its existing documentation such as business plans, commercialisation strategies, competition analysis or other company documents. In addition, the company must show that tangible steps have been or will be undertaken in relation to that focus or capability.
New or significantly improved
1.79 The innovation that is being developed by a qualifying ESIC must either be new or significantly improved for the applicable addressable market. A company’s addressable market refers to the available revenue opportunity or market demand arising from the innovation, or the business relating to that innovation. The addressable market identified by the ESIC must be objective and realistic. For example, if the addressable market for the innovation was the Australian market, then the innovation must be new or significantly improved for that market. [Schedule 1, item 1, paragraph 360-40(1)(e)(i)]
1.80 Improvements resulting from the customisation of existing products, minor extensions such as updates to existing equipment or software, changes to pricing strategies, changes to goods resulting from cyclical or seasonal change and the trading of new products for a wholesaler, retail outlet or distribution business where activities are similar to the approach of competitors are unlikely to satisfy the significantly improved threshold. Further, ceasing to utilise a process or method will not satisfy the new or significantly improved thresholds.
………..
Commercialisation
1.81 In addition, the company must be focussed on developing its innovation for a commercial purpose, or in other words, for the purpose of generating economic value and revenue for the ESIC. This requirement draws the distinction between simply having an idea and generating economic value from that idea. Commercialisation encompasses a spectrum of activities including those leading to the sale of new or significantly improved product, process or service as well as activities involving the implementation of a new, or significantly improved, process or method, where the process, or method directly leads to the generation of economic value for the company. [Schedule 1, item 1, paragraph 360-40(1)(e)(i)]
……….
High growth potential
1.82 The TIFESI is specifically designed to encourage capital investment into innovative companies with high growth potential, as distinct from typical small to medium enterprises such as cafes, local retail stores, local service providers that service a single local market. Specifically, a qualifying ESIC would need to show that it has the potential for high growth within a broad addressable market. [Schedule 1, item 1, paragraph 360-40(1)(e)(ii)]
…………
Scalability
1.83     A qualifying ESIC must have the potential to successfully scale its business. As the company increases its share of the market or enters into new markets, the company needs to have operating leverage, where existing revenues can be multiplied through incurring a reduced or minimal increase in operating costs. [Schedule 1, item 1, paragraph 360-40(1)(e)(iii)]
………….
Broader than local market
1.84 A qualifying ESIC would need to demonstrate that it has the potential to address a market that is broader than a local city, area or region. While the company does not need to have a serviceable market at a national, multinational or global scale at the test time, it does need to show the capability to address a market that is broader than a local market and also show that this business can be adapted to a national, multinational or global scale in the future. [Schedule 1, item 1, paragraph

360-40(1)(e)(iv)]
……………
Competitive Advantage
1.85 A qualifying ESIC will need 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. A method of evaluating a competitive advantage can be through the measures of the level of value for customers, rarity, imitability and substitutability of the advantage. [Schedule 1, item 1, paragraph

360-40(1)(e)(v)]
…………
[Emphasis added]
ISSUES

The issue before the Tribunal is whether the Applicant’s notice of amended assessment for the income year ended 30 June 2017 (2017 income year) is excessive or otherwise incorrect.
To decide this issue, the parties agree that the Tribunal must determine:[77]
[77]    Exhibit 1, Tribunal Book, Tab 3.2, Applicants Statement of Issues, Facts and Contentions, page 114, paragraphs 1-5 and Tab 3.4, Respondent’s Statement of Issues, Facts and Contentions, page 129, paragraph 10.
a.Issue 1 - Whether Holding Co is an early stage innovation company as defined in section 360-40(1) of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) and, in particular:
(i)     whether, at the test time, Holding Co meets the early stage limb/tests, and
(ii)    whether, at the test time, Holding Co meets the innovation limb/principle based innovation tests in s360-40(1)(e) of ITAA 1997.
b.Issue 2
- Whether, as a member of the BC Trust (within the meaning of section

960-130 of the ITAA 1997), the Applicant satisfied the requirements for an entitlement to the member's ESI tax offset for the 2017 income year?
c.Issue 3 - Whether the amount of the ESI tax offset is 20% of the total amount paid for the shares that were issued by Holding Co in the 2017 income year?
d.Issue 4 - Whether a lesser amount of the ESI tax offset can be claimed in the 2017 income year where the relevant shares are issued partly paid at the test time in the 2017 income year and the unpaid balance was paid in the 2018 income year?[78]
[78] The Tribunal notes that the Applicant sought leave to amend its grounds of objection pursuant to section 14ZZK(a) of the TAA 1953 to include this issue. As granting such leave has no impact on the outcome of this matter, the Tribunal grants leave to the Applicant to rely on its amended grounds of objection.
In written submissions provided by the parties prior to the Hearing the issues were narrowed. The Applicant withdrew issue three as a ground of objection.[79] Further for the purpose of issue four, the parties agree that the quantum of the ESI tax offset that would be available if the Tribunal found that Holding Co was an ESIC would be $20,505.00.[80] The ESI tax offset being calculated as 20% of the amount paid by ABC Pty Ltd as Trustee for the BC Trust in the year ended 30 June 2017 for the shares that were issued by Holding Co in that income year. The Tribunal accepts the parties’ submissions in these regards.
[79] Exhibit 2, Applicant’s Written Submissions, page 13, paragraph 74.
[80] Exhibit 2, Applicant’s Written Submissions, page 37, paragraphs 165-167 and Exhibit 4, Respondent’s Submissions, pages 41-42, paragraphs 215-216.
CONSIDERATION
Having reviewed the totality of the evidence[81] and contentions before it the Tribunal notes that in determining whether Holding Co is an ESIC the Applicant has asked that the activities of individual companies within the group be considered as if they were actually activities for the group as a whole, as one. The difficulty is that it is not disputed that they are three separate companies, being three separate legal entities of which do not have an agency, partnership or joint venture agreement in place.
[81] Exhibit 1, Tribunal Book, pages 1-1591; Exhibit 2, Applicant’s Written Submissions, pages 1-37, Exhibit 3, Applicant’s Tender Bundle, pages 1-5; Exhibit 4, Respondent’s Submissions, pages 1-42; Exhibit 5, Applicant’s Submissions in Reply, pages 1-10 and Exhibit 6, List of Authorities, pages 1-2538.
The Tribunal acknowledges the extensive case law referred to by the Applicant, amongst other principles, outlining various principles regarding activities and treatment of company groups. The Tribunal notes the relevance of the principles however is mindful that they were not established in relation to the ESIC requirements or specifically the principle-based tests of the innovation limb of section 360-40(1)(e) of the ITAA 1997. As such in circumstances where the Tribunal considers the requirements of section 360-40(1) of the ITAA 1997 to be clear, it finds that those principles do not assist the Applicant.
Despite the Applicant’s contentions otherwise, based on the evidence before it, the Tribunal is not satisfied that where there are three separate legal entities each with a distinctive role, that one company undertook their role for and on behalf of one of the other companies or that its actions were attributable to that other company.
There is no dispute that at the test time (which in the Applicant’s case are the two occasions immediately after the issuing of shares by Holding Co to ABC Pty Ltd as trustee for the

BC Trust in the 2017 income year)[82] Holding Co satisfied the requirements of the early stage limb set out in section 360-40(1)(a) to (d) of the ITAA 1997.[83] Based on the evidence before it the Tribunal finds that at the test time, Holding Co:
(a)had been incorporated in Australia within the previous 3 income years; and
(b)together with IP Co and Trading Co (as Holding Co’s 100% subsidiaries) incurred total expenses of $1 million or less in the 2016 income year; and
(c)together with IP Co and Trading Co (as Holding Co’s 100% subsidiaries) had a total assessable income of $200,000 or less in the 2016 income year; and
(d)had no equity interest listed for quotation in the official list of any stock exchange in Australia or a foreign country.
[82] The test time is determined by the entitlement to the ESI tax offset set out in section 360-15 of the ITAA 1997 and as such is immediately after the time when a company issues shares in the company.
[83] Exhibit 4, Respondent’s Submissions, page 19, paragraph 122.
The primary issue before the Tribunal is whether Holding Co satisfied the principle-based tests pursuant to section 360-40(1)(e) of the ITAA 1997. This issue is one of statutory construction.
Based on the contentions of the parties, it is not the principles of statutory interpretation in relation to that issue that are in dispute. What is in dispute is their application to the facts and circumstances of the case.
To assist the Tribunal the Respondent provided (of which is not inconsistent with that outlined by the Applicant)[84] the following summary of relevant principles for construing subdivision 360-A of the ITAA 97:[85]
[84]    Exhibit 2, Applicant’s Written Submissions, page 16, paragraph 87.
[85]    Exhibit 4, Respondent’s Submissions, paragraph 107, pages 16-17.
(a)       “The primary object of statutory construction is to construe the relevant provision so that it is consistent with the language and purpose of all the provisions of the statute. The meaning of the provision must be determined "by reference to the language of the instrument viewed as a whole”.
(b)       “The starting point for the ascertainment of the meaning of a statutory provision is the text of the statute whilst, at the same time, regard is had to its context and purpose. Context should be regarded at this first stage and not at some later stage and it should be regarded in its widest sense.”
(c)       “That context includes legislative history and extrinsic materials. Understanding context has utility if, and in so far as, it assists in fixing the meaning of the statutory text. Legislative history and extrinsic materials cannot displace the meaning of the statutory text. Nor is their examination an end in itself.”
(d)       “In particular it is, of course, necessary to have regard to the subject matter, scope and purpose of the relevant statute.”
(e)       “A legislative instrument must be construed on the prima facie basis that its provisions are intended to give effect to harmonious goals. Where conflict appears to arise from the language of particular provisions, the conflict must be alleviated, so far as possible, by adjusting the meaning of the competing provisions to achieve that result which will best give effect to the purpose and language of those provisions while maintaining the unity of all the statutory provisions.”
(f)        A court must strive to give meaning to every word of the provision.
(g)       “Where the text read in context permits of more than one potential meaning, the choice between those meanings may ultimately turn on an evaluation of the relative coherence of each with the scheme of the statute and its identified objects or policies”
(h)       The objective approach is used to determine the meaning of the provision.
[Footnotes omitted]
The Tribunal agrees that these principles are relevant to the statutory interpretation task at hand.
At its highest level, the Tribunal understands the Respondent’s contention to be that the requirements of section 360-40(1) of the ITAA 1997 apply to a specific company not a group of companies. Meaning Holding Co does not meet the requirements set out in section

360-40(1)(e) of the ITAA 1997 as it did not develop the innovation.[86] The Respondent’s view is that the company is the company.
[86] Exhibit 4, Respondent’s Submissions, pages 14-39, paragraphs 94-199.
In contrast, at its highest level, the Tribunal understands the Applicant’s contention to be that a unity of purpose or single business approach should be taken so that the actions of the group are taken into consideration in assessing whether the requirements of section 360-40(1)(e) of the ITAA 1997 are met.[87] The Applicant contented that Holding Co, IP Co and Trading Co have the same business and the same common purpose, being to develop and commercialise the ZYX Software.
[87] Exhibit 2, Applicant’s Written Submissions, pages 23-29, paragraphs 104-151.
The Applicant contended that ordinary meaning, text and context should be applied, outlining that:[88]
[88]    Exhibit 2, Applicant’s Written Submissions, pages 23-29, paragraphs 104-109, 114-119 and 127-132.
104.     If the parent company with 100% subsidiaries is not excluded under the early-stage test [see [77] above], it is submitted that there is no compelling reason to exclude it under the innovation test simply by reason of the proposed involvement of the 100% subsidiaries in the development/commercialisation of the new innovation.
105.     Applying an ordinary meaning to the statutory text in sec 360-40(1)(e), [Holding Co] is asked to demonstrate the elements of the innovation test, ie 5 questions of fact as to its genuine focus, and the potentiality of certain matters. It is submitted that the innovation test is looking at the substance of what occurred or would occur, and whether the company is truly concentrating their attention the development/commercialisation, and ensuring that this is not contrived.
…..
107.     The Applicant submits that sec 360-40(1)(e) should be given its broadest meaning in order to encourage investment by sophisticated investors (such as the Applicant) having both the requisite funds and business experience to assist the start-up company.
108.     The Respondent’s ordinary meaning looks at form rather than substance. However, the provision does not use the words “in its own right” and contains no express requirement that the company issuing shares, rather than its 100% subsidiary(s), owns the innovation that is to be developed, and/or the business relating to the innovation.
109.     It would be tantamount to a logical fallacy to impute that ownership requirement, and then deny a company which did not meet such requirement from ever answering the questions of fact actually asked by sec 360-40(1)(e)(i) to (v).
…..
114.     Addressing the Respondent’s concerns that the Applicant’s contentions were “remarkable”; it is submitted that, in the circumstances, looking only at what the company does “in its own right”, and thereby imputing an ownership requirement, is contrary to general taxation law principles that:
(a)       it is not the function of the ITAA 1997 or of the Commissioner to dictate to taxpayers in business how to run their business profitably or economically (or prudently);
(b)       nor is it appropriate for the Commissioner to engage in “nominalism” in the sense that it describes the parameters for conducting the business under the statutory test in a manner that the Commissioner permits; and the consequences if the taxpayer’s activities do not fit that description; and
(c)       the Commissioner ought to recognise, as the courts do, the ordinary features of Australian commercial life, and that there will frequently be informality in the dealings of small medium enterprises, especially group companies and in circumstances where the relevant corporate actors are represented by the same individuals.
115.     The Applicant submits that Parliament’s intention was to encourage him to make a risk- taking investment in [Holding Co], and to provide the company with his business expertise/experience; and there was no indication that Parliament intended to deny him (and the other investors) taking sensible commercial measures, permitted by Australia law, to mitigate risks inherent in their investment.
116.     It is submitted that the correct approach to look at the substance of the proposed activities, and to address the elements in the innovation test, ie the 5 questions of fact raised by sec 360-40(1)(e)(i) to (v), by reference to the circumstances of each case.
117.     The Applicant submits that the innovation test should be applied on the basis that where there is a “single business approach”, the genuine focus of a parent company as to how it proposes to pursue that single business would ordinarily include the proposed inter-related business activities of its 100% subsidiaries. Even when it is proposed that discrete business activities are separated into different 100% subsidiaries, the Applicant submits that the proposed actions of those 100% subsidiaries will be relevant to characterising the focus/activities of [Trading Co] for the purposes of the innovation test.
118.     Employing a broader, rather than a narrower, ordinary meaning to the innovation test as they apply to [Holding Co] must also encompass those activities which [Holding Co] directs its 100% subsidiaries to conduct. [Holding Co] can demonstrate that it is “genuinely focused …” by means of the directions it makes to achieve the development/commercialisation of the new innovation.
119.     It is submitted that this alternative ordinary meaning of sec 360-40(1)(e) would permit rather than penalise the involvement of 100% subsidiaries; and that the alternative ordinary meaning promotes rather than defeats the purpose of the legislation (to encourage investment in ESIC’s); and that the alternative ordinary meaning would not give rise to “absurd results and inequitable outcomes”.
…..
127.     This is not to say, and it is not contended that [Holding Co] by virtue of being a holding company itself carries on all of the business activities of its 100% subsidiaries, especially [Trading Co]. However, here there was the stated intention at the test time that:
“[IP Co] sole focus is to research and develop Intellectual Property on behalf of [Holding Co] and to eventually provide a source of licensing revenue from external organisations.”
128.     This is consistent with the risk management strategy, ie to protect the assets of [Holding Co] (including the IP held by [IP Co]) from the perceived risks of the proposed trading operations of [Trading Co].
129.     After the test time, [Trading Co] applied for and was registered for R&D tax concessions on 3 March 2018, and later the intellectual property was recognised as an asset in its 30 June 2018 financial statements. Whilst [IP Co] was apparently treated as having incurred R&D expenses in draft 2017 accounts this was not shown in [IP Co’s] 2017 final accounts, and instead was shown in the accounts of [Trading Co].
……
132.     It is submitted that the application of conventional legal principles concerning parent company/subsidiaries does not preclude a finding that a parent company (by close involvement/direction) and its 100% subsidiary were participating in a common enterprise or jointly conducting the business or a relevant part of the business. It is submitted that companies within a corporate group can conduct a common plan, scheme or strategy determined by a common board or management team, and each company will have their own taxable income or losses (at least pre-consolidation).
[Footnotes omitted]
At the Hearing, in response to questions asked by the Tribunal, the Applicant outlined that:[89]
[89] Transcript, Day 2, pages 32-33.
MR CATT: We’re saying that it’s a single business. This is the approach we are saying – we’re submitting should be applied to the meaning of the company for the purposes of paragraph (e) of the definition. So we’re saying that it’s focussed on something being done, which is a development of intellectual property, we focus – and it’s focussed on potential, it’s focussed on business, and it’s focussed on a number of other features.
And the purpose of the legislation, in context, is to encourage an investment in a small company; it’s not to discourage or to dictate how those things occur; how the development occurs; how the commercialisation occurs. The purpose of the definition is to say, ‘Is there sufficient indications of innovation to attach the tax concession?’
MEMBER: Sure, but I just want to be clear that then – so the company – what you’re suggesting is the way that I should be looking at the company is from the unity of purpose perspective so that that includes the whole business rather than just the holding company?
MR CATT: Yes. The holding company sits as part of the whole business. There is a whole business that’s the business of the holding company, because it is – there is a unity of purpose. They’ve all got the same business, they’ve got the same common purpose, and that’s the – that’s what you found in Visy and what you saw in the Commonwealth Bank. There was a business created; various players had different parts of the business.
In the JH Rail case, two distinct separate – a parent and a subsidiary of the company – of the group played a part in an overall business. No indication that they had to be agents or partners, because, in fact, in Revill, it would – they would – the corporate veil would’ve been lifted and Revill would’ve prevailed with the – in his action or certainly not received a summary dismissal. It doesn’t say that the business ceased or the business wasn’t viable or it shouldn’t occur just because it’s two companies that have come together to do it.
MEMBER: Sure. No, and I appreciate that, and I guess I’m just trying to get my mind around how it is that you’re saying that that whole of business approach is also a suitable approach under the ESIC requirements.
MR CATT: Well, we say that the ESIC requirements are based on a substance approach rather than the form approach. The form approach that the respondent takes is to say, ‘It refers to a company,’ then to take you to the explanatory memorandum and say, ‘The company did this,’ and all these things, whereas we say the substance approach – and we’ve given you the authorities for where we get there under ‘genuine’ – would look more broadly at what has occurred rather than who actually did it.
Then going back to the purpose, the purpose is to encourage somebody to make an investment; investor. The purpose isn’t to tell you, ‘You have to do this under – as a particular manner.’ There’s no indication in the legislation and scant indication in the explanatory memorandum that those prescriptions exist. Okay.
[Emphasis added]
The Tribunal having had its attention drawn to Trading Co having made an R&D application and outlining that they were conducting the ZYX Software research and development on their own behalf, sought clarification from the Applicant in relation to their whole of business contentions.[90] The following explanation was provided:[91]
[90] Exhibit 1, Tribunal Book, T6.6, Second Affidavit of Mr EE, Exhibit EE-2(x), Tax Accountants Pack – Trading Co – R&D Tax Incentive Claim – Financial Year ended 30 June 2017, pages 1544-1560.
[91] Transcript, Day 2, pages 38-39.
MEMBER: I understand that, but then that means the whole of business argument isn’t applying here. In this instance, we’re just applying the ‘they’re doing it for their own purpose because that’s their part of the plan’, right?
MR CATT: But if - - -
MEMBER: But then in the ESIC capacity, you’re suggesting that we look at the global picture of the whole business.
MR CATT: The R&D provisions, with respect, are to identify a particular party which is the R&D entity which seeks registration. If you’re a consolidated entity, it can only be the head company.
MEMBER: Yes.
MR CATT: If you’re not consolidated, which it appears that we were not consolidated at that particular point in time, you have to choose an entity. You choose it on the basis of criteria set out in section 355. It has no regard to criteria that might exist under 360. It has its own pathway to who is - - -
MEMBER: That’s exactly right, but I guess what I can’t see is the – what’s the distinction then you’re making in relation to the fact that the subsidiary has, for R&D purposes, said that the R&D that they have undertaken, they’ve undertaken on their own behalf for their own purpose and not for – not to be a major – not for a different major benefactor. If that be the position for R&D, I understand that’s for the R&D provisions, but then on the other hand, you say they’re not doing it primarily for that; they’re doing it for the whole business of which [Holding Co] is part and that’s part of the company.
MR CATT: Overall business plan put in place by [the accountant] referred to by my learned friend is to use the IP to trade. You protect the IP by putting it into [IP Co] for the benefit of [Holding Co]. The whole business is development and use of the IP, commercialisation of the IP. The substance of the plan is it’s one entity, one unified business, but your point is correct. If it comes down to form, we fail.
MEMBER: Right, because I appreciate that and I understand that, especially when you have the calibre of people involved in this organisation and the intellectual prowess they’re bringing to it, that that’s how the whole model works effectively and practically, but then, for other purposes, that model gets broken down into their own individual pieces, be it for R&D to avoid risk or for other things. In situations where whatever it is you’re doing allows it to be approached from a whole of business perspective, then, okay, but then when you need to break it down, you break it down.
MR CATT: When you go back to Visy Packaging, you see the common plan or scheme, and each company plays its part in the common plan or scheme.
MEMBER: Absolutely. But - - -
MR CATT: And if you look at Blue Corp, there’s the common enterprise and each company plays its part in that because it has advantages, but that’s the holistic commercial baseness, and that’s what we are. We are a single entity - - -
MEMBER: Which - - -
MR CATT: - - - a single business.
MEMBER: Which may work for certain aspects of different things, but won’t necessarily work for absolutely every single scenario or scheme or entitlement, necessarily, and that’s why all of those pieces come together to give you the global or the full business, but when you’ve got to break it into your bits to do individual things, then you break it into the bits.
[Emphasis added]

The corporate structure put in place by the Applicant and his co-investors/co-innovators relied upon the advice provided by their accountant. The accountant outlined that the “…. Objectives of the structure are to enable the group to reduce overall risk, to separate different classes of risk and enjoy structural flexibility, tax effectiveness and simplicity both during ownership of the Business and upon any exit.”[92] The accountant explained that “[t]his means that even if an event that causes the failure of Trading Co occurs, the business will be able to survive because its assets are safely quarantined from that trading risk.”[93]
[92] Exhibit 1, Tribunal Book, Tab 6.4, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(j), Letter of 4 July 2016 from the accountant, page 872.
[93] Exhibit 1, Tribunal Book, Tab 6.4, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(j), Letter of 4 July 2016 from the accountant, page 873.
The Applicant contended and brought to the Tribunal’s attention several supporting Federal Court precedents, that it is not the purpose of the Respondent or the tax laws to tell taxpayers how to arrange their business affairs or how to run their businesses. The Tribunal agrees in principle with that contention, however with the qualification that with the freedom of how taxpayers arrange their business affairs also comes the responsibility of assuring that the way in which they do so accords with the applicable laws in place.
In this instance it was the Applicant, Mr EE, Mr EF and Mr F’s, decision to put in place the business structure they did, at the time they did. The accountant’s advice made no reference to consideration having been given to subdivision 360-A of the ITAA 1997 and the ESIC requirements. While the structure is sensible given the overall business of the innovation activity from a risk and taxation perspective, for the reasons that follow the Tribunal finds that it did not fit with the ESIC requirements.
The intention of Parliament in introducing the ESI tax offset provisions was to encourage innovation. The Explanatory Memorandum provided that:[94]
1.6. The tax incentive for early stage investors (TIFESI) is designed to promote this culture by connecting relevant start-up companies with investors that have both the requisite funds and business experience to assist entrepreneurs in developing successful innovative companies, particularly at the pre-commercialisation phase where a concept is in development, but the company requires additional investment to assist with commercialisation.
[94] Exhibit 6, List of Authorities, Tab 51, Explanatory Memorandum to the Taxation Laws Amendment (Tax Incentives for Innovation ) Bill 2016 (Cth), pages 2290-2291 at paragraph 1.6.
It is noted that consultation was undertaken by the government before finalising the legislation introducing the TIFESI initiative. The intention to encourage innovation through tax incentives were put in place with parameters regarding eligibility for the ESI tax offset.
The Tribunal observes that the Explanatory Memorandum provides several examples while dealing with the requirements of section 360-40(1)(e), none of which make reference to a company and its subsidiaries meeting the specific requirements, rather they relate to a particular company.
The Tribunal does not accept the Applicant’s contention that making reference to a company and its wholly owned subsidiaries in section 360-40(1)(a) to (c) of the ITAA 1997 also means that section 360-40(1)(e) requirements extend to the group. In the Tribunal’s view section 360-40(1)(e) of the ITAA 1997 makes it clear that it is the actions of the company in relation to the focus on development of the innovation and it must be the company who can demonstrate it has the potential to meet the associated requirements.
The Tribunal agrees with the Respondent’s contention that section 360-40(1)(e) of the ITAA 1997 requires Holding Co and only Holding Co, to satisfy the requirements. The Respondent contended that section 360-40(1)(e) of the ITAA 1997 references to only ‘the company’ demonstrates a clear legislative intent that the ‘principle-based tests’ of section 360-40(1)(e) be satisfied by only the company, being Holding Co, and not with “its 100% subsidiaries”, as it is the company that undertakes the development and business relating to the innovation.[95] The Respondent contended that its construction of section
[95]    Exhibit 4, Respondent’s Submissions, pages 19-29, paragraphs 122-135.

360-40(1)(e):[96]
[96]    Exhibit 4, Respondent’s Submissions, page 21, paragraph 131.
(a)       is consistent with s. 360-40’s internal operation as:
(i)s. 360-40(1)(e)’s reference to alternate tests of either the ‘principle-based tests’ or the ‘100-point tests’ would apply incongruently if the 100-point innovation test applied to ‘the company’, while the ‘principle based test’ considered a company and its 100% subsidiaries;
(ii)s. 360-40(4)’s function to restrict specified activities for [Holding Co], where regulations so prescribe, would have anomalous outcomes where the principle-based test’s operation extended to subsidiaries, but the restricted activities referred to in s. 360-40(4) was limited to ‘the company’.
(b)is confirmed by Subdivision 360-A’s purpose and other relevant provisions, for example:
(i)section 360-5 stating that the small Australia company, as the entity that is to engage in the “innovation activities”;
(ii)the entitlement to the ESI tax offset in s. 360-15 is by reference to the shares issued by a company, with the amount of the tax offset as calculated in s. 360-25, by reference to a percentage of the amount paid for those shares in the company.
(iii)The modified CGT treatment pursuant to s. 360-50, where it arises, could only apply to the shares in the company;
(c)Is confirmed by the 2016 EM, which refers to the company as requiring to develop ‘its’ innovation. Such examples include:
…….
Having reviewed the evidence before it, the Tribunal agrees with the Respondent’s contentions that the evidence does not establish that Holding Co rather than Trading Co (in its own right, not on behalf of Holding Co) developed the innovation.[97] The Tribunal, based on the evidence before it further accepts the Respondent’s contention that Holding Co did not satisfy sections 360-40(1)(e)(iii) to (v) of the ITAA 1997 to be able to:[98]
(a)Scale the business relating to ZYX Software;
(b)Address markets that are broader than local markets through that business;
(c)Have a competitive advantage for the business.
[97] Exhibit 4, Respondent’s Submissions, pages 29-35, paragraphs 156-172.
[98] Exhibit 4, Respondent’s Submissions, pages 35-39, paragraphs 173-198.
The Tribunal accepts the Respondent’s contentions that:[99]
[99]    Exhibit 4, Respondent’s Submissions, pages 35-37, paragraphs 174-182.
174.     It must be kept firmly in mind that a business is a course of conduct undertaken by an entity with a view to profit. It follows that to undertake or have the potential to undertake the activity of scaling a business, addressing broader markets through that business or potentially having a competitive advantage for that business, [Holding Co] must undertake those activities and have those qualities, or have an entity undertake activities on [Holding Co’s].
175.     The Applicant’s assertion that [Holding Co] does not need to own the business, as such matters are not requirements of the principle-based test, ignores the fact that [Holding Co] must still undertake the actions.
176.     Further, such an assertion is contradicted by the words of the text of

s. 360-40(1)(e), when considered in their context, including the 2016 EM which provides:
(a)       At paragraphs 1.81, that “the company must be focussed on developing its innovation” [Emphasis added].
(b)       At paragraph 1.83 which refers to the company scaling its business, which denotes [Holding Co] as the business owner having the potential to increase its market share for its business:
………
177.     The 2016 EM’s consistent reference to [Holding Co] potentially scaling “its” [Holding Co’s] business relating to [ZYX Software], “it” [Holding Co] having the potential to address a broader market and "it” [Holding Co] having the potential competitive advantage over “its” [Holding Co’s] competitors, confirms clear words of the section requiring [Holding Co] to have such qualities and undertake such actions.
178.     [Holding Co’s] ability to undertake such actions and have such qualities could only arise if it was the owner of the business relating to [ZYX Software], which is confirmed by the 2016 EM.
179.     [Holding Co] failed to satisfy ss. 360-40(1)(e)(iii)-(v) as the Licence Agreements, [Trading Co’s] financial statements, and [Holding Co’s] loans to [Trading Co] and [Trading Co’s] R&D application make it clear that [Trading Co] owned and conducted the business relating to [ZYX Software] on its own behalf.
180.     [Holding Co] financed [Trading Co], who operated the business relating to [ZYX Software]. [Holding Co’s] interest and source of income was potential dividends it may receive from [Trading Co] and/or [IP Co], not the revenue from a business it owns and operates, relating to [ZYX Software] per se. [Holding Co] liability to any business failure and costs associated with the operations of [Trading Co’s], was limited to its investment in [Trading Co’s] shares and the loan it had made to [Trading Co].
181.     As [Holding Co] neither carried on the business relating to [ZYX Software], and [Trading Co] did not operate the business relating to [ZYX Software] for

[Holding Co] or on [Holding Co’s] behalf, [Holding Co] did not (and cannot) satisfy the requirements of ss. 360-40(1)(e)(iii) to (v) during the Income Year.
182.     Any contention by the Applicant that [Holding Co’s] directors could self-assess, and thereby satisfy s.360-40, misapprehends the operation of s. 360-40. It is irrelevant whether [Holding Co’s] directors consider [Holding Co] satisfied the requirements of the ‘principle-based tests’.
……..
[Footnotes omitted]
Based on the evidence before it, the Tribunal finds that the role of Holding Co at the test times was to finance and oversee the corporate group by the provision of loans to Trading Co. Holding Co’s source of income was potential dividends from IP Co and/or Trading Co, not from revenue from a business it owned or operated. It was Trading Co that was undertaking the development and commercialisation of ZYX Software. As previously outlined, the Applicant and other founders of ZYX Software chose the corporate structure within which to operate. The risk to Holding Co in relation to the activities of Trading Co was limited to the value of its shares in Trading Co and the loan it provided.
The whole group purpose may be the business of ZYX Software however each entity is separate and has distinctive roles, the Tribunal finds that the intention to create such separation was intended. The Tribunal is not swayed by the similarity of the directors and management of the group.
As a result, the Tribunal finds that Holding Co did not at the test times meet the requirements of section 360-40(1)(e) of the ITAA 1997. The Tribunal finds that Holding Co at the test times did not hold an interest in ZYX Software, did not develop ZYX Software and did not undertake or have the potential to undertake specified business activities relating to scaling of the business, addressing broader markets or having a competitive advantage and as such was not a ESIC company.[100]
[100]
CONCLUSION
For the reasons set out above, the Tribunal is not satisfied that Holding Co is an early stage innovation company as defined in section 360-40(1) of the ITAA 1997. Consequently, the practical implication is that an ESI tax offset it not available in relation to investment into Holding Co, as such there is no need for the Tribunal to consider Issues 2 or 4.
The Tribunal finds that the Applicant has not discharged his onus to prove that the amended assessments for the income year ending 30 June 2017 is excessive or otherwise incorrect.
Accordingly, the decision under review is affirmed.

I certify that the preceding 93 (ninety-three) paragraphs are a true copy of the reasons for the decision herein of Member D Mitchell

.............................[SGD]...................................
Associate
Dated: 18 June 2024

Date of hearing:

Counsel for the Applicant:

5 and 6 March 2024

Mr Christopher Catt
Ms Fiona McNeill

Solicitors for the Applicant:
Mr Rod Hawkins
Z45 Law Pty Ltd

Counsel for the Respondent:
Mr Michael Ballans

Solicitors for the Respondent: Ms Eva Huang
Australian Taxation Office

Exhibit 1, Tribunal Book, Tab 6.4, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(j), Letter of

4 July 2016 from the accountant, pages 871-872.

T Exhibit 1, Tribunal Book, Tab 6.4, Applicant’s Affidavits and Exhibits, Exhibit ZWBX-1(j), Letter of

4 July 2016 from the accountant, page 872,

The Tribunal notes that the Applicant conceded that Holding Co did not meet the requirement of the

100-points innovation test pursuant to section 360-45 of the ITAA 1997. In making its findings the Tribunal accepts that concession.

[2024] AATA 2065

18 June 2024

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Tax Law

Statutory Interpretation

Administrative Law

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Appeal

Standing

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Date of hearing: Counsel for the Applicant:	5 and 6 March 2024 Mr Christopher Catt Ms Fiona McNeill
Solicitors for the Applicant:	Mr Rod Hawkins Z45 Law Pty Ltd
Counsel for the Respondent:	Mr Michael Ballans
Solicitors for the Respondent:	Ms Eva Huang Australian Taxation Office