Edited version of your written advice

Authorisation Number: 1051180958979

Date of advice: 20 January 2017

Ruling

Subject: Early Stage Innovation Company qualification

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 period:

Year ending 30 June 201Z

The scheme commences on:

1 July 201Y

Relevant facts and circumstances

1. The Company was incorporated in Australia during the 201X income year. Its equity interests are not listed for quotation in the official list of any stock exchange.

2. The Company has no subsidiaries and had expenses of less than $20,000 in the previous income year, i.e. the year ended 30 June 201Y. It has not yet generated any revenue.

3. The Company is developing a software application as well as a website.

4. The Company has identified its market as being the global online market.

5. The software is in the developmental stage and a provisional patent application has been submitted.

6. The Company has a commercialisation strategy and scheduled a demo release during the 201Z income year.

7. The next steps involve seeking investors to finance the development and completion of the Company's software products.

Information provided

8. The Company has provided information in a number of documents and conversations in relation to the software.

9. We have referred to the relevant information within these documents and conversations in applying the relevant tests to the Company's circumstances.

10. The Company proposes to issue new shares 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.

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 201Z.

Current year

24. For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 201Z (the 201Z 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 201Z, 201Y and 201X, and the income year before the current year will be the year ending 30 June 201Y (the 201Y income year).

Early stage test

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

25. As the Company was incorporated in the 201X income year, 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's assessable income for the prior income year is less than $200,000, paragraph 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 201Z 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 201Z. 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. According to the Company, their software is the first of its kind.

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

32. The Company has taken the following steps in developing the software: testing, a provisional patent application and a marketing strategy.

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

33. The Company is genuinely focussed on developing the software for a commercial purpose. The software will be a significantly improved product compared to existing products.

34. Therefore, subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 1 July 201Y until 30 June 201Z 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)

35. The Company expects the software to appeal to a wide range of users.This aids decision making and is particularly useful when assessing the software viability in the global online market.

36. Through its commercialisation / marketing strategy, the Company hopes to foster widespread use of its product.

37. The Company is developing the software themselves and contracting stages of the development.

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

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

39. The Company's projections / business model provided illustrates the increase in projected sales.

40. Given that the software will be available globally, it is expected that the software has the potential to successfully scale up its business.

41. The Company's strategy for the use of the software will be able to generate increased revenue with deployment across a wide range of digital media and websites. 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)

42. The Company's software will be targeted at the online market.

43. 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.

44. 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)

45. The software has differentiating features which may give it a competitive advantage.

46. Being the first of such, the Company's software has the first mover advantage. 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

47. 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 201Y until 30 June 201Z or the date when the software has been fully developed and is ready for sale, whichever occurs earlier.

Conclusion

48. The Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 201Y until the earlier of 30 June 201Z or the date when the software has been fully developed and is ready for sale, whichever occurs earlier.