Edited version of your written advice

Authorisation Number: 1013141368917

Date of advice: 20 December 2016

Ruling

Subject: Early Stage Investment Company (ESIC)

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:

20XX

Relevant facts and circumstances

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

2. The Company has no subsidiaries and has nil expenses and nil assessable income for the previous income year.

3. The Company is developing a technology system (the system).

4. The Company is currently at the stage of finalising the development of an application for the system.

5. The intellectual property (IP) of the business is owned by the Company. There is a Provisional Patent Application which restricts competitor duplication of the product and early competitor entry in the same market.

Commercialisation strategy

6. The system is currently operational on a proof of concept; stand-alone basis.

7. The Company has identified market segments as initial targets for the system.

8. Within each of the identified market segments, the Company has identified specific potential customers.

Information provided

9. This ruling relies on the information provided by the applicant.

10. You propose to issue new shares in the Company to various investors to assist in funding the continued development and commercialisation of the system.

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 the 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 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 within the last 3 income years, subparagraph 360-40(1)(a)(i) is satisfied.

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

1. As the Company did not incur any expenses in prior financial years, paragraph 360-40(1)(b) is satisfied.

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

26. 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)

27. 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

28. 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

29. 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)

30. The Company is developing a technology system. The Company has identified its current addressable market as the global market.

31. You have stated that the system is designed to assist in customer service and retention.

32. You have stated the system is the first system to offer such features.

33. The Company is the owner of the IP for the system.

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

34. The Company has taken the following steps in developing the system:

a. Scoping of market opportunity, potential and unmet need.

b. Pilot operation of prototype system.

c. System development and implementation strategy.

d. Identification of key personnel for the Company - a team has been engaged with experience in start-up technology development, implementation and delivery to market.

e. Preliminary budgeting and business plan preparation.

f. Information memorandum preparation to raise capital.

35. The Company is currently finalising the development of the iOS version of their application, android application code development and network solution development for enterprise clients.

36. The timeline provides that the Company plans to continue developing the system for commercialisation, the following steps are planned for the 20YY calendar year:

a. Complete iOS application.

b. Source supported devices and finalise system settings.

c. Android application code development.

d. Develop network solutions for enterprise deployment.

e. Finalise sales and marketing plan.

37. The Company has entered into discussions with potential customers to increase direct sales.

38. The above facts demonstrate that the Company has taken tangible steps to lead to the sale of its products, which demonstrate a genuine focus on developing the system for commercial sale.

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

39. The Company is genuinely focussed on developing the system for a commercial purpose. The system will be a significantly improved product compared to existing systems.

40. Therefore, subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 20XX until 20YY or the date when the system has been fully developed, whichever occurs earliest. Once the system 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 system has potential to improve on the customer experience at a low cost and will appeal to any business with a customer service component.

42. There is potentially a large commercial value in utilising the system in a retail transaction or customer check in process to enhance customer loyalty, recognition and enable efficient delivery of services to the customer. Ultimately the key benefit is increased repeat purchase behaviour and revenue opportunities.

43. The system is a technology driven product and easily replicable and marketable in local markets globally.

44. The Company has stated there will be low upfront software costs.

45. The system is currently operational on a proof of concept; stand-alone basis in. The Company has stated that the system has significantly increased customer retention and repeat purchase behaviour, lifting both revenue and profit in the business.

46. The Company is developing the system themselves and is initially targeting the global market. They will pursue product sales through:

a) Distribution of the iOS application via an online App Store.

b) Distribution of the android application online.

c) Network solutions for enterprise deployment.

47. The above factors indicate that the Company has the potential to rapidly expand its customer base across the global market. Therefore, subparagraph 360-40(1)(e)(ii) will be satisfied.

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

48. Given that the system will be available globally via distribution through an online App Store and via the internet , it is expected that the Company has the potential to successfully scale up its business through established channels.

49. The Company's projections have been provided to us.

50. By using the approach of sales of the system as an application and as a network solution, The Company states that as it expands its sales, it will be able to generate increased revenue with only a minimal increase in its operating costs.

51. 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)

52. The system will initially be targeted at the global market and is intended for worldwide use.

53. The system largely leverages off existing technology.

54. As the system is application based and distributed via existing established channels it can be used by any retail/customer service business. Thus, the ultimate addressable market is on a global scale and is not confined to a local city, area or region.

55. The Company has demonstrated the system 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)

56. You have stated that the Company currently has no direct competitors in the global market. The Company therefore has first mover advantage which is a considerable competitive advantage.

57. The system, has differentiating features which may give it a competitive advantage:

58. The intellectual property (IP) of the business was transferred to the Company. The IP includes an Australian Provisional Patent Application which restricts competitor duplication of the product and early competitor entry in the same market. You have stated that the business owns all core source code and has acquired the rights for the algorithms in use in the system.

59. The Company's competitive advantages of being first to market will be maintained through a combination of its IP protection, low application software costs and network solutions as well as the opportunity afforded by being first to market of building and maintaining a large customer base.

60. The Company has demonstrated the potential for the system to have competitive advantages within the retail/customer service community, satisfying subparagraph 360-40(1)(e)(v).

Conclusion on principles test

61. 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 20XX until 20YY or the date when the system has been fully developed and is ready for sale, whichever occurs earlier.

Conclusion

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