Edited version of private advice

Authorisation Number: 1052124924612

Date of advice: 31 May 2023

Ruling

Subject: Early stage innovation company eligibility

Question

Does Company A meet the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the Income Tax Assessment Act 1997 ('ITAA 1997') for the period 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

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect, and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Background Facts

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

2.      Company A's director is Taxpayer A.

3.      Company A's registered office and principal place of business is situated in XXX.

4.      Company A has no wholly or partly owned subsidiaries. Company A is not part of an income tax consolidated group.

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

•           Total expenses of $xxx

•           Total income of $yyy

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

Development of Product

7.      Company A is developing a software system (the 'Product') that serves a particular customer type.

8.      Company A's solution offers a SaaS-powered, vertically integrated operating system that enables customers to streamline operations and operate cost-efficiently.

9.      The software system provides different modules across particular systems.

10.   Software exists to conduct some tasks within an organisation. Much of this software is built for enterprise.

11.   Over the past xx months, Company A have acquired beta customers, set up a manual template that they are testing with their beta customers and refined their product development framework.

Product Development Stages

12.   There have been a number of development stages which have been completed to date, as follows:

Phase 1 - Prototype development and Customer Beta Testing.

•           Phase 2- Build.

13.   Future development for Company A's product includes work on:

•           Predictive product management

•           AI risk identification

•           Calculating data with carbon savings

•           Application integration and Community platform

•           Verified supply network

•           Inventory planning

14.   Each of the previous product development items will be added incrementally. The product will be saleable and scalable in the MVP purposes.

15.   Company A aim to be a data repository for these businesses, which means that they will be able to use AI to predict future issues as well as to create a database of customers.

16.   Any meaningful changes will occur from MM YYYY to MM YYYY, where Company A will look to scale, and as they do this, the primary changes will only be to benefit the user / customer experience.

Commercialisation Strategy

17.   Company A have been developing their Product for commercialisation in four key stages:

•           Designing, mapping and curating the screens of the products

•           External market facing assets - they have been curating their external presence

•           Advertisement - They have launched test ads

•           Beta Program provides customers access

18.   Company A predict that the Product will be fully developed by M YYYY.

High Growth Potential

19.   Like many other SaaS solutions, Company A can scale and grow rapidly domestically and globally.

20.   Company A operates recurring and one-off revenue models, meaning that it can target different kinds of businesses in marketplaces.

21.   Company A is being piloted in Australia, which has over xxx wholesalers. The opportunities globally exist in areas such as marketplaces, which for example, have a global opportunity.

22.   Company A is targeting a growing area, with the global wholesale market expected to grow to $xx billion in YYYY at a Compound Annual Growth Rate (CAGR) of xx%. The respective figures show the potential that Company A has because of the volume of potential customers with limited geographic barriers.

Scale up the Business

23.   Company A has been built from the group using a network effect model. This means for every SME that joins the platform, there is a likely increase in suppliers that are invited and join the platform.

24.   So, at this stage, for their xx beta customers, Company A have at least xx factories to be onboarded.

25.   Connecting with partners such as Company B and Company C also enables Company A to scale up rapidly. Since it is a digital platform with a network effect, capital requirements are relatively small compared to bricks and mortar businesses.

26.   With similar processes used in most countries and direct expenses in software development, marketing and support, the opportunity for global scale is a reality.

Broader than Local Market

27.   The value of Company A is that when they onboard one customer, they will onboard their stakeholders (such as suppliers), creating an ecosystem for each business. As the business is a software solution, there are limited barriers that would prevent the business from addressing global boundaries.

28.   Further, Company A's team has relationships with suppliers, wholesalers and major retailers across Australia and overseas. The other sectors are precious, given their language barriers, which means that a software solution that makes communication easier and clear will have significant scope to penetrate those markets.

29.   Company A's revenue model is split into subscriptions and additional services. Company A's revenue strategy aims to grow with their users.

30.   Company A's subscriptions offer a range of SaaS services:

•           Premium - Access to unlimited products

•           Basic - Access to xx products

•           Viewer Only - Free viewership

31.   The additional services which Company A will provide are:

•           Testing Aggregator - xx % saved on Testing Report Costs

•           Find a Supplier - xx % Up Front + xx % Trial Commission

•           Testing Plan Creation - xx % savings on Testing Costs or Test Reports

32.   Ultimately, the solution is viable for domestic and global adoption.

Competitive Advantages

33.   Taxpayer A, the CEO of Company A, has managed Company D for xx+ years (managing shareholder for x+ years), a product development business that has consistently sourced and supplied to major retailers in Australia and XYZ.

34.   Typically, Company D sources provide high-risk category items which have stringent testing requirements.

35.   Taxpayer A has been able to demonstrate a consistent history of being able to run product businesses through developing a proprietary product development framework.

36.   Further, Taxpayer A and Company A's team also founded a successful digital marking agency, which has been growing at xx % Compound Annual Growth Rate ('CAGR') since its launch in YYYY. The team has grown numerous e-commerce businesses across sectors, geographies and product types.

37.   Together, with product development backgrounds and technology backgrounds, the team has the right combination to grow a software as a service business.

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

39.   Company A's Product has been identified as having an international addressable market.

Information provided

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

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

•           Response to further questions provided

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

42.   Company A has xxx ordinary shares on issue.

43.   Company A proposes to issue additional new shares to various investors to assist in funding the continued development and commercialisation of the Product. Company A is looking to raise outside investment to commence operations in DD YYYY.

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

Company A 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

44.   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'

45.   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)

46.   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).

47.   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.

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

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

49.   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)

50.   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)

51.   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'

52.   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

53.   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)

54.   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.

55.   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.

56.   The five requirements of the principles-based test, as outlined in paragraph 360-40(1)(e) are:

              i.       the company must be genuinely focussed on developing for commercialisation one or more new or significantly improved products, processes, services or marketing or organisational methods

             ii.      the business relating to that innovation must have a high growth potential

           iii.       the company must demonstrate that it has the potential to be able to successfully scale up the business relating to the innovation

           iv.      the company must demonstrate that it has the potential to be able to address a broader than local market, including global markets, through that business, and

            v.       the company must demonstrate that it has the potential to be able to have competitive advantages for that business.

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

57.   For the purposes of Subdivision 360-A, the Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 ('EM') provides the following at paragraph 1.76 in relation to the definition of innovation:

"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..."

58.   The innovation being developed by the company must either be new or significantly improved for an applicable addressable market.[1] The company's addressable market is the revenue opportunity or market demand arising from the innovation or the related business. The addressable market must be objective and realistic.

59.   Improvements must be significant in nature to meet this requirement. Significant is defined in the online Macquarie Dictionary as "important; of consequence." Customising existing products or minor changes resulting from software updates, pricing strategies or seasonal changes are examples of improvements that would not be considered significant.

60.   The OECD Oslo Manual, in relation to defining innovative services, states at paragraph 161 that "innovations in services can include significant improvements in how they are provided (for example, in terms of their efficiency or speed), the addition of new functions or characteristics to existing services, or the introduction of entirely new services."

61.   The company must be genuinely focussed on developing the innovation for a commercial purpose in order to generate economic value and revenue for the company. This requirement draws the distinction between simply having an idea and commercialising an idea.

62.   For a company to qualify as an ESIC under the principles based test, the company must be "genuinely focussed on developing for commercialisation" their innovation. That is, the central activities of the company must be truly concentrated on developing their innovation for a commercial purpose. 'Commercialisation' includes a range of activities that involve the implementation or sale of a new or significantly improved innovation that will directly lead to the generation of economic value for the company.

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

63.   The company must be able to demonstrate that the business relating to the innovation has a high growth potential within a broad addressable market. This refers to the company's ability to rapidly expand its business. Companies that are limited to supplying local customers will not meet this requirement.

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

64.   The company must be able to demonstrate that it has the potential to successfully scale up the business relating to the innovation. The company must have operating leverage, whereas it increases its market share or enters into new markets, its existing revenues can be multiplied with a reduced or minimal increase in operating costs.

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

65.   The company must be able to demonstrate that it has the potential to address a market that is broader than a local city, area or region. The company does not need to have a serviceable market at a national, multinational or global scale at the test time. However, it does need to show that the business is capable of addressing a market that is broader than a local market and that the business can be adapted to a broader scale in the future.

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

66.   The company must be able to demonstrate that it has the potential to have competitive advantages, such as a cost or differential advantage over its competitors which are sustainable for the business as it expands. The company can analyse what competitors in the market offer and consider whether the company has a differentiating advantage that would allow it to outperform these competitors.

Foreign Company test - paragraph 360-40(1)(f)

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

68.   The dictionary in section 9 of the Corporations Act 2001 (Cth) defines a foreign company to mean:

(a) a body corporate that is incorporated in an external Territory, or outside Australia and the external Territories, and is not:

(i) a corporation sole; or

(ii) an exempt public authority; or

(b) an unincorporated body that:

(i) is formed in an external Territory or outside Australia and the external Territories; and

(ii) under the law of its place of formation, may sue or be sued, or may hold property in the name of its secretary or of an officer of the body duly appointed for that purpose; and

(iii) does not have its head office or principal place of business in Australia.

APPLICATION TO YOUR CIRCUMSTANCES

TEST TIME

69.   For the purposes of this ruling, the 'test time' for determining if Company A is a qualifying ESIC, will be upon the issue of qualifying shares on a particular date or dates on or after DD MM YYYY, and on or before DD MM YYYY.

Current year

70.   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

71.   Company A was incorporated in XYZ 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

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

73.   Company A did not incur any expenses in the YYYY income year. Consequently, paragraph 360-40(1)(b) is satisfied.

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

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

75.   Company A 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

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

77.   Company A 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

78.   Company A 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

79.   Company A has not provided sufficient evidence of satisfying the 100-point test under section 360-45 for the year ending DD MM YYYY. Company A are electing to seek eligibility by satisfying the Principles-based Innovation test under section 360-40(1)(e)(i)-(v), in order to be issued with a Private Binding Ruling.

THE 'PRINCIPLES-BASED TEST' - PARAGRAPH 360-40(1)(e) ITAA 1997

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

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

81.   Company A is developing a software system (the 'Product') that serves a particular customer type.

82.   Company A's solution offers a SaaS-powered, vertically integrated operating system that enables customers to streamline operations and operate cost-efficiently.

83.   The software system provides different modules across particular systems.

84.   Software exists to conduct some tasks within an organisation. Much of this software is built for enterprise.

85.   Over the past xx months, Company A have acquired beta customers, set up a manual template that they are testing with their beta customers and refined their product development framework.

86.   Company A is developing their Product, a software system, to address a number of discrete markets and is continuing to develop their Product.

87.   Company A 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

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

89.   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:

•           Predictive product management

•           AI risk identification

•           Calculating data with carbon savings

•           Application integration and Community platform

•           Verified supply network

•           Inventory planning

90.   Each of the previous product development items will be added incrementally.

91.   Company A anticipate that the current programme of development will be completed in the YYYY financial year.

92.   Company A is genuinely focussed on developing their Product for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period DD MM YYYY to DD MM YYYY, or the date when their Product has been fully developed and is ready for client use, whichever occurs earlier. Once the Product has been fully developed, Company A will no longer be 'developing' the product for commercialisation.

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

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

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

95.   Company A has provided details to satisfy this requirement.

96.   Company A has demonstrated a high growth potential for their Product, a software system, 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

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

98.      Company A has provided details to satisfy this requirement.

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

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

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

101.    Company A has provided details to satisfy this requirement.

102.    Company A has demonstrated that it has the capacity to address a broader than local market, so subparagraph 360-40(1)(e)(iv) is satisfied for the period DD MM YYYY to DD MM YYYY.

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

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

104.    Company A has provided details to satisfy this requirement.

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

CONCLUSION FOR PRINCIPLES BASED TEST

Company A 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

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

CONCLUSION

Company A 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.

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

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