Edited version of your written advice

Authorisation Number: 1013124734037

Date of advice: 7 December 2016

Ruling

Subject: Early stage investment company (ESIC) eligibility

Question 1

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

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1. The Company was incorporated during the year ended 30 June 20YY. Its equity interests are not listed for quotation in the official list of any stock exchange.

2. The Company has no subsidiaries and has expenses of less than $1 million in the previous income year, i.e. the year ended 30 June 20XX. It has not yet generated any revenue.

3. The Company is developing a software product, the Software, which aims to offer an analytical engine that will allow a business to assess market potential and focus their resources on the market segment that is predicted to deliver the best returns.

4. The Company's goal is to provide a software solution allowing users to analyse their own business, customers, products or services against competitors, financial factors, asset capabilities and timeframes to determine the market segments representing the best opportunity for growth. The expected user base will be all levels of management, various consultants, and sales and marketing divisions. The Company has identified its ultimate market as being the global market, with its initial target being the Australian and Country A markets.

5. The Company's team have extensive experience in the software industry and have prior experience with creating and growing a successful software company. Members of the team have been involved in the development and management of a number of other software companies across a range of industries.

The Company

6. The Software will allow better informed decisions to be made regarding resource allocation. Ultimately the software aims to ensure the focus of the business is on those market segments which represent the most profitable opportunities.

7. The Software offers a significantly improved way to analyse businesses.

8. The Company is developing its own complex algorithms that will consider a varying number of factors.

9. The Company is developing the Software itself and will ultimately own the Software and its related intellectual property, including any patents. The venture has thus far been funded, or services provided at no cost, by members of the Company's team.

10. The Company has performed a comparative analysis and found that the Software differs from the products already in the relevant markets.

Commercialisation strategy

11. The Company has completed the database design for the Software and established the objective and reactive framework which will allow for the dynamic use of data. It has scheduled a demo release for early 20YY and intends to invite a number of interested companies to attend a presentation regarding the product in late 20YY.

12. The next steps involve developing a working prototype before a beta version can be released in readiness for the Software's general release in late 20YY.

13. The Company's commercialisation strategy starts from the development stage where the possible purchasers are directly involved in the product's development. Currently there are a number of such participants including CEOs, CFOs, accounting and consulting companies, and product managers. The Company will look to leverage these relationships to encourage sales of the Software.

14. The Company has already engaged with a range of potential customers, ranging from small start-ups to multinational companies with global reach, who have expressed their interest in the Software.

15. The Company is initially targeting the Australian and Country A markets. They will pursue product sales through:

a. targeted direct sales

b. partner program sales through third parties

c. relationships that staff may have

d. the website.

16. The following market segments have been identified as initial targets:

a. software sector

b. large corporations with high cost of sale

c. specific investors

d. product managers

e. accounting and consulting companies

f. users of current relevant systems.

17. Within each of the above segments, The Company has identified specific potential customers.

18. The Software is a X based software product that will be licensed for use by many clients. This will allow for an increase in sales without the need to increase direct sales cost. Being X based will also allow the Software to be available globally through X hosting.

19. The product offering will be the same for all customers, ensuring the level of additional back office support is minimised. The Company plans to move away from direct sales and toward partnership programs and web sales. In particular, The Company intends to use the Accounting and Consultancy sector as the distributors and implementers of the Software.

Information provided

20. These facts are based on the comments made and information provided by you.

21. You have provided information in a number of documents and phone conversations in relation to the Software, including:

a. your private ruling application.

b. phone conversations in 20XX.

c. supplementary information provided .

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

23. You propose to issue new shares in The Company to various investors to assist in funding the continued development and commercialisation of the Software.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 360-A

Income Tax Assessment Act 1997 section 360-40

Income Tax Assessment Act 1997 section 360-45

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise indicated.

Question 1:

Summary

The Company meets the eligibility requirements of, an ESIC under, subsection 360-40(1).

Detailed reasoning

Qualifying Early Stage Innovation Company

1. 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'

2. 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)

3. 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 the company and its 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).

4. 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.

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

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

6. To meet the requirement in paragraph 360-40(1)(b), the company and its 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)

7. To meet the requirement in paragraph 360-40(1)(c), the company and its 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)

8. 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

9. 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

10. 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 (iv)

11. To satisfy the principles-based test, the company must meet five requirements in paragraph 360-40(1)(e). This is tested at a time immediately after the relevant new shares are issued to the investor.

12. 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.

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

i. the company must be genuinely focused on developing one or more new or significantly improved innovations for commercialisation

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

14. For the purposes of Subdivision 360-A, an innovation is considered to be a new or significantly improved product, process, service, marketing or organisational method.

15. The innovation being developed by the company must either be new or significantly improved for an applicable addressable market. 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.

16. Improvements must be significant in nature to meet this requirement. 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.

17. The company must be genuinely focused 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.

18. '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

19. The company must be able to demonstrate that it has the potential for high growth 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

20. The company must be able to demonstrate that it has the potential to successfully scale up the business. The company must have operating leverage, where as 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 per unit.

Broader than local market

21. 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

22. 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.

Application to your circumstances

Test time

23. For the purposes of this ruling, the test time for determining if The Company is a qualifying ESIC will be a particular date during the income year ending 30 June 20YY.

Current year

24. For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 20YY (the 20YY income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last three income years will include the years ending 30 June 20YY, 20XX and 20WW, and the income year before the current year will be the year ending 30 June 20XX (the 20XX income year).

Early stage test

Incorporation or Registration - paragraph 360-40(1)(a)

25. As The Company was incorporated in mid 20XX, which is within the last 3 income years, subparagraph 360-40(1)(a)(i) is satisfied.

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

26. As The Company had expenses less than $20,000 in the prior income year, paragraph 360-40(1)(b) is satisfied.

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

27. As The Company did not derive any assessable income during the 20XX income year, its assessable income for the prior income year is less than $200,000 and paragraphs 360-40(1)(c) is satisfied.

No stock exchange listing - paragraph 360-40(1)(d)

28. As The Company is privately owned and is not listed on any stock exchange in Australia or a foreign country, subparagraph 360-40(1)(a)(d) is satisfied.

Conclusion on early stage test

29. The Company will satisfy the early stage test for the entire 20YY income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied.

100 point test

30. The Company has not provided any evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 20YY. For the Company to be a qualifying ESIC it will need to satisfy the principles-based test.

Principles based test

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

31. The Company is developing the Software to be the first holistic analytical system that will identify, for a given business, the market segment that offers the greatest chances of success by using both data inputted by the user and external data that it will automatically gather. Although it will initially be targeted at the Australian and Country A markets, the Software has been identified as having a global addressable market.

32. The Software is a decision making support program that will enable businesses to identify the optimal market segment to target to maximise their profitability. It is designed to force businesses to more completely analyse their business along with the gathered information to allow better decisions to be made regarding the allocation of the business's resources.

33. This Software will be the first to offer such a broad and in depth automated analysis of a business and its environment to determine the best way to allocate resources.

34. The Software's automated real-time dynamic analysis allows continual up to date forecasts to be produced for businesses. These features are expected to popularise the Software for commercialisation globally.

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

35. The Company has taken the following steps in developing the Software:

● market research with potential clients to confirm and extend the value and purpose of the proposed product

● selected and validated suitable technologies

● established hosting environments

● completed the visual design of the program and the database design

● completed the object and reactive framework.

36. This has led to The Company developing a 'minimum viable product', which provides a limited set of services launched to test for market feedback. They also have a number of potential clients who have already expressed interest in the product and to whom this product will be presented.

37. The timeline provides that The Company expects a working prototype to be available for testing in early 20YY, a beta version in mid 20YY and a version ready for general release in later 20YY.

38. The Company will develop and utilise relationships with potential customers to increase direct sales. They will also use their website to support their client base.

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

39. The Company is genuinely focussed on developing the Software for a commercial purpose. The Software will be a significantly improved product compared to existing client relationship management and data analytics software.

40. Therefore, subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 1 July 20XX until 30 June 20YY or the date when the Software has been fully developed, whichever occurs earliest. Once the Software has been fully developed, The Company will no longer be 'developing' the product for commercialisation and subparagraph 360-40((1)(e)(i) will no longer be satisfied.

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

41. The Company expects the Software to appeal to a wide range of businesses as it provides a more holistic approach that provides an analysis of a wider range of factors using newly developed algorithms to provide users with the best market segments in which to invest their resources. This aids decision making and is particularly useful when assessing product or service viability in particular markets, making it attractive for established and new businesses alike.

42. Through its commercialisation strategy, The Company hopes to foster widespread use of its product. The Software's holistic analysis and ease of use may well popularise it widely.

43. The Company are developing the Software themselves. They will make their revenue through licensing fees for the use of their product.

44. If their commercialisation strategy, including its partnership program with the early engagement of customers and its plan to utilise accountancy and consultancy firms, is successful, this may give The Company the ability to quickly increase sales through referrals.

45. Therefore, subparagraph 360-40(1)(e)(ii) will be satisfied.

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

46. The Software will be X based and available for use via licensing. This will allow an increase in sales without increasing direct sales cost while allowing the Software to be available globally.

47. Given that the same Software will be available globally, it is expected that the level of back office support will rise marginally relative to the increase in sales.

48. The Company's strategy for the use of the Software will be able to generate increased revenue with only a minimal increase in operating costs. This operating leverage affords The Company the potential to successfully scale up its business. Therefore, subparagraph 360-40(1)(e)(iii) will be satisfied.

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

49. The Company's Software will initially be targeted at the Australian and Country A markets but is intended for worldwide use. It will be released globally once it gains traction in the initial targeted markets.

50. The Software can be used worldwide by any business. Thus, the ultimate addressable market is on a global scale and is not confined to a local city, area or region.

51. The Company has demonstrated the Software has the potential to address a broader market than just the local market, including international markets. Therefore, subparagraph 360-40(1)(e)(iv) will be satisfied.

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

52. The Software has the following differentiating features which may give it a competitive advantage:

● holistic analysis of the business and the environment it operates in

● real-time dynamic predictive analysis of success in given market segments

● use of simple visual aids, such as specific diagrams, to show users the most effective use of their resources.

53. Being the first of such a comprehensive automated analysis of market opportunities for particular business gives The Company a first mover advantage. They could use this in conjunction with their partnership program to establish the use of the Software in the market.

54. The Company has demonstrated the potential for the Software to have competitive advantages within the professional business community, satisfying subparagraph 360-40(1)(e)(v).

Conclusion on principles test

55. The Company satisfies the principles based test as it satisfies the requirements within subparagraphs 360-40(1)(e)(i)to (v) for the period commencing 1 July 20XX until 30 June 20YY or the date when the Software has been fully developed and is ready for sale, whichever occurs earlier.

Conclusion

56. The Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 20XX until the earlier of 30 June 20YY or the date when the Software has been fully developed and is ready for sale, whichever occurs earlier.