Edited version of your written advice

Authorisation Number: 1013125486489

Date of advice: 21 November 2016

Ruling

Subject: Early Stage Innovation Company eligibility

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

1. Company A was incorporated and registered in the Australian Business Register in 20XX

2. The directors of Company A are X and Y.

3. Company A is 100% owned by Company B, whose directors are X and Y.

4. While studying at University Z, X and Y commenced developing the C product, which was intended to provide a service.

5. X and Y entered their C product into the University Z competition. Two weeks into the competition, they realised that there was an insufficient market for the product, and there would be significant costs involved.

6. X and Y changed their C product and commenced developing the D product and this was then substituted into the competition.

7. Company A is currently developing an online marketplace, the D Service, which will provide a one-stop-shop system.

8. The D Service provides a method and solution for providing clients to gain access to business opportunities.

9. Company A is the company currently undertaking the development of the D Service.

20XX income year

10. Company A is currently developing the D Service by using a website to generate databases and are engaging in testing with their clients.

11. Company A is engaging in manual interactions with their clients seeking their opinions, which then provides feedback which they can use for further product design and refinement.

12. Company A found that the feedback from customers shows that they value convenience more than product variety. Company A is building this information into the specifications to make the service quick and reliable via the website.

13. Company A entered their D Service into a state based start-up competition and won the competition.

14. Company A entered their D Service into the international competition and were selected for the finals from more than 5,000 applications.

15. Company A provided a financial report for the year ending 30 June 20XX which stated the following:

a. total assessable income of $xxx.

b. Total expenses of $yyy - primarily comprised of incorporation and registration fees, branding costs, website management costs and sundries.

16. Company A did not receive any other income during the 20XX income year.

17. Company A own the intellectual property related to the D Service, in the form of copyright for software, branding, the website and business and technical process documentation.

18. The D Service logo is informally trademarked by Company A.

Current structure

19. The directors of Company A are X and Y.

20. Company A has XXXX ordinary shares on issue, which are X % owned by Company B.

21. X Family Trust and Y Family Trust each hold X% of the issued shares in Company B.

22. Company A does not own shares in any subsidiary companies.

Proposed structure

23. You are proposing to issue new shares in Company A to potential investors.

24. The current plans for the immediate future are for Company B to hold the majority X% of shares for approximately X to X years.

25. The current plan for the future is to sell off interests in Company A in approximately X years' time when the company value is higher.

Information provided

26. You have provided a number of documents containing detailed information in relation to the D Service.

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

28. You propose to issue new shares in Company A to various investors to assist in funding the continued development and commercialisation of the D Service.

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

DETAILED REASONING

29. For the purpose of this ruling, a determination is to be made regarding the eligibility of Company A as an Early Stage Innovation Company under subsection 360-40(1).

QUALIFYING EARLY STAGE INNOVATION COMPANY

30. 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'

31. 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) ITAA 1997

32. 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).

33. 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.

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

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

35. 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) ITAA 1997

36. 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) ITAA 1997

37. 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

38. If the company satisfies the early stage test, the company must also satisfy one of two innovation tests: either the objective (100 point) test or the principles-based test.

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

39. 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.

THE 'PRINCIPLES-BASED TEST' - subparagraphs 360-40(1)(e)(i) - (v) ITAA 1997

40. 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.

41. 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.

42. 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 products, processes, services, marketing or organisational methods for commercialisation

ii. The business relating to those products, processes, services, or methods 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

43. 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.

44. 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.

45. 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.

46. 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.

47. '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

48. 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 - subparagraph 360-40(1)(e)(iii) ITAA 1997

49. 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 - subparagraph 360-40(1)(e)(iv) ITAA 1997

50. 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

51. 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

52. For the purposes of this ruling, the test time for determining if Company A is a qualifying ESIC will be a particular date on or after 1 July 2016, but before 30 June 2017.

Current year

53. Therefore, for the purposes of subsection 360-40(1) ITAA 1997, the current year will be the year ending 30 June 2017 (the 2017 income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last 3 income years will include the years ending 30 June 2017, 2016 and 2015.

THE 'EARLY STAGE TEST' - paragraphs 360-40(1)(a) - (d) ITAA 1997

Incorporation or Registration - paragraph 360-40(1)(a) ITAA 1997

54. Company A was incorporated in 2016, which is within the 3 income years outlined above, therefore the requirements of subparagraph 360-40(1)(a)(i), as set out in paragraphs 32 through to 33 above, are satisfied.

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

55. In applying the requirements of paragraph 360-40(1)(b) as set out in paragraph 35 above, Company A and any of its X% subsidiaries must have incurred total expenses of $1 million or less in the 2016 income year, being the income year before the current year.

56. Company A did not own any X% subsidiaries during the 2016 income year.

57. The total expenses incurred by Company A in the 2016 income year was $xxx, which is less than $1 million, so paragraph 360-40(1)(b) is satisfied.

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

58. In applying the requirements of paragraph 360-40(1)(c) as set out in paragraph 36 above, Company A and any of its X% subsidiaries must have derived total assessable income of $200,000 or less in the income year before the current year.

59. Company A did not own any X% subsidiaries during the 2016 income year.

60. The total assessable income reported by Company A for the 2016 income year was $yyy, which is less than $200,000, so paragraph 360-40(1)(c) is satisfied.

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

61. In applying the requirements of paragraph 360-40(1)(d) as set out in paragraph 37 above, Company A must not be listed on any Stock Exchange in Australia or a foreign country at the test time.

62. Company A is not listed on any Stock Exchange in Australia or a foreign country, so paragraph 360-40(1)(d) is satisfied.

CONCLUSION FOR EARLY STAGE TEST

63. Company A will satisfy the early stage test for the entire 2017 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

64. Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 2017. For Company A to be a qualifying ESIC, it will need to satisfy the principles-based test.

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

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

65. In applying the requirements of subparagraph 360-40(1)(e)(i) as set out in paragraphs 40 through to 42, Company A must be developing an innovation which is either new or significantly improved for an applicable addressable market.

66. Company A is currently developing an online marketplace, a service which will provide a one-stop-shop system.

67. The D Service provides a service in just a few clicks on their computer.

68. The D Service:

a. Can offer clients an efficient, single 'marketplace' for their needs, by registering for and accessing the D Service.

b. Allows clients to order with ease.

c. Provides an increase in customer satisfaction due to the variety and quality of product on offer to them.

d. Provides a user rating system, which allows dependable quality assurance.

e. Allows a mutual rating system, for both the clients and the providers, which encourages good behaviour and professional dealings.

f. Can offer providers direct access to every opportunity in their city and easy access to potential clients.

g. Allows providers to focus on their core business by greatly reducing their business development/marketing efforts, which takes approximately 50% of their time presently.

h. Allows the prepayment of customers' orders online to Company A, who then pay the provider directly.

i. Allows corporate payment terms for the registered providers.

j. Alleviates the major barrier of the procurement process for registered providers.

69. Company A has identified its current addressable market as the Australian market, which is highly regulated for providers but not organised efficiently to provide easy access between providers and potential clients.

70. You have provided documentation in support of the D Service's innovativeness as recognised by different institutions.

71. You have provided documentation in support of the D Service's innovativeness as recognised by a government department.

72. The D Service will be a new product compared to any similar system currently used in the Australian market. Company A is developing a new innovation in its D Service, an online marketplace.

Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997

73. In applying the requirements of subparagraph 360-40(1)(e)(i) as set out in paragraphs 46 through to 47 above, Company A must be genuinely focused on developing an innovation for a commercial purpose in order to generate economic value and revenue for the company.

74. Company A has taken the following steps in developing the D Service:

a. Preliminary Planning - included preliminary development of the initial concept of the C product; testing hypotheses and evaluating the market need for the product at frequent meetings.

b. Secondary Planning - included re-evaluating the market need for a system which would consolidate the current fractured market; the planning and development of the secondary concept of the D Service, testing hypotheses and quantifying potential cost savings and benefits for providers and their clients. They wanted to look at a service oriented business which was socially responsible, globally relevant (across different cultures and economies) and scalable.

c. Design - including the development and design of the C Product, the development and design of the D Service, further development of the product and engaging a design specialist company. They continued with structured experimentation and improvisation of the core value proposition.

d. Technology and Infrastructure Preparation - including the development of the product, branding and developing the Company A website, the D Service and business and technical process documentation.

e. Validation - the engagement with third party independent providers and clients to validate and test hypotheses and working with a pilot customer, Company E.

f. Staffing - Company has a team of staff/contractors who have been working together to initially develop the C product, and then to develop the D Service.

75. Company A is currently at the stage of further development of the D Service:

a. Company A is undertaking further market research on the D Service.

b. Company A has created a business model and this has been validated using a Minimum Viable Product (MVP) of a concierge approach with product automation.

c. Company A is currently working on securing further funding, and creating a Minimum Lovable Product (MLP) with product automation.

76. Company A is forecasting that it will generate income via two revenue streams:

a. Subscriptions - there are three plans being developed as advised.

b. Transaction Commission - there are two plans being developed as advised.

77. The D Service will be a new product compared to any similar system currently used in the Australian market. Company A is genuinely focused on developing the D Service, an online marketplace, a new innovation for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period 1 July 2016 to 30 June 2017.

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

78. In applying the requirements of subparagraph 360-40(1)(e)(ii) as set out in paragraph 48 above, Company A must be able to demonstrate that it has the potential for high growth within a broad addressable market.

79. The D Service will appeal to providers and customers, within the Australian market, based on the following:

a. The current market is not organised efficiently to provide easy and reliable access between providers and potential customers, resulting in difficulties with providers having access to potential customers and customers having limited access to reliable and well rated providers.

b. The D Service is unique that it allows both providers and customers to register their details, allowing access to each other, and also allowing the easy transmission of requirements and quotes to requesting parties.

80. Industry reports 2016 for similar services have identified that the addressable market in Australia is worth $x million, with y% of the market controlled by the top z providers, and yy% of the market covered by zz other businesses.

81. Company A are planning to market the D Service directly to providers and customers. There would be demand in the current market, as there is currently no service in place which provides easy and reliable access to providers and customers in the marketplace.

82. Company A has the ability to enter into the marketplace with the new D Service and to provide a service which is currently not available. The D Service will greatly broaden the customer base and drive high growth for Company A.

83. Company A has noted that the market in Australia is worth $x billion. Company A has identified that many customers are currently using this market for their needs. Company A estimates that they have the potential to grow to register and control approximately X% of that market, worth $xx billion

84. Company A has identified a total addressable market of approximately $z billion in Australia to which they will provide the D Service.

85. Company A has demonstrated a high growth potential for its D Service, an online marketplace, so subparagraph 360-40(1)(e)(ii) is satisfied.

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

86. In applying the requirements of subparagraph 360-40(1)(e)(iii) as set out in paragraph 49 above, Company A must be able to demonstrate that it has the potential to successfully scale up the business.

87. The core of the D Service is the D Service product which uses specific framework to provide an effective and reliable service which provides a one-stop-shop system for providers and customers for all their requirements.

88. Once the product and technology has been fully designed and tested with target customers, Company A will be able to market and increase sales to customers.

89. You state that when Company A creates a successful MLP, you will then be able to scale the business, by expanding your sales and generating increased revenue with only a minimal increase in your operating costs, due to the D Service interface being completed.

90. This operating leverage ensures that Company A has the potential to successfully scale up its business, so subparagraph 360-40(1)(e)(iii) is satisfied.

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

91. In applying the requirements of subparagraph 360-40(1)(e)(iv) as set out in paragraph 50, 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.

92. The D Service product which Company A are developing has been designed to be used as a national and global service.

93. Growth of the use of the D Service is expected to be rapid with X% of the local market by the end of 2017.

94. Company A has completed financial projections showing a launch in A initially, followed by expansion to B, then C, then the rest of Australia, followed by a global release some 12 months after initial release.

95. You state that there is a definite intention to expand the D Service to both national and international markets.

96. The business relating to the D Service innovation is capable of being successfully adapted to supply national and global markets in the future.

97. Company A has demonstrated that the D Service has the potential to address a broader market than just the Australian market, including global markets, so subparagraph 360-40(1)(e)(iv) is satisfied.

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

98. In applying the requirements of subparagraph 360-40(1)(e)(v) as set out in paragraph 51, Company A must demonstrate that it has potential to be able to have competitive advantage for that business.

99. Company A has identified a number of competitive advantages it has in the market:

a. The D Service will have a cost advantage, a lower cost per service access, as it currently has no competitors. Access to the D Service will be available via a membership.

b. The D Service will have a differential advantage, as the D Service will be able to deliver benefits to both providers and customers as there are currently no competing products or services.

c. The D Service will allow providers to focus on their core business by greatly reducing their marketing efforts.

d. Company A have stated that they own the intellectual property related to the D Service, in the form of copyright and trademark for the product, branding, the website and business and technical process documentation, and so have taken steps to prevent any future competitors from replicating their innovation.

100. Company A has demonstrated that the D Service has the potential to have competitive advantages which are sustainable for the business, so subparagraph 360-40(1)(e)(v) is satisfied.

CONCLUSION FOR PRINCIPLES BASED TEST

Company A satisfies the principles based test as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period commencing 1 July 2016 until 30 June 2017 or the date when the system has been fully developed and is ready for client use, whichever occurs earlier.

CONCLUSION

Company A meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 2016 until the earlier of 30 June 2017 or the date when the D Service has been fully developed and is ready for client use, whichever occurs earlier.