Edited version of your written advice

Authorisation Number: 1051376116707

Date of advice: 21 May 2018

Ruling

Subject: Early Stage Innovation Company eligibility

Question:

Does Company A satisfy the criteria of an Early Stage Innovation Company (ESIC) pursuant to subsection 360-40(1) of the Income Tax Assessment Act 1997 (‘ITAA 1997’)?

Answer:

Yes

This ruling applies for the following period

1 July 20XX to 30 June 20YY

The Scheme commences on

1 July 20XX

RELEVANT FACTS AND CIRCUMSTANCES

Background

1. Company A is a proprietary company, limited by shares, incorporated on xx xx 20XX.

2. The directors of Company A are Ms B and Ms C.

3. Company A has no subsidiaries.

4. For the financial year ending 30 June 20XX, Company A has incurred and earned the following:

a. Total expenses of $xx.xx

b. Total income of $yy.yy

5. 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.

6. An innovation patent in respect of the invention was granted to one of Company A’s directors, Ms B, by IP Australia on ww ww 20WW.

Description of the Company’s business premise

7. Company A is a technology business.

8. Company A is developing an original software platform, known as “Platform A”.

9. The initial addressable market is Australia.

10. Presently, customers are lacking in a way to successfully manage all aspects of their business. All parties need to be held accountable for their actions, and require the ability to track everything that occurs throughout the lifespan of their business.

11. Platform A is comprised of a desktop dashboard for business operators, and a mobile application for their customers, providing a direct connection between them through one product.

12. For the business operators, a desktop dashboard houses all the information they need, eliminating the need for multiple communication channels, and easily being able to manage their workload with a glance.

13. For their customers, a mobile app makes it easy to access documents, and communicate with their business operator. Customers receive an invitation code from their business operator, and after downloading the Platform A mobile application, they are connected.

14. Platform A intends to eventually replace the entire suite of products with one easy to use, cloud based platform. Company A intends to achieve this by:

a. Replacing all communication channels with one secure platform, ensuring an organised and efficient process for business operators.

b. Giving their customers access to their own data and documents, and ensuring they have an easy way to track communications relating to their business interactions.

c. Giving both the power to utilise their data to show their performance how they wish.

Information provided

15. You have provided a number of documents containing detailed information in relation to Company A, including:

a. Private Ruling Application (the “Application”), dated yy yy 20YY.

b. Numerous emails and telephone conversations during March and April 20YY, including attachments.

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

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.

QUESTION:

Summary

Company A meets the eligibility requirements of an ESIC under subsection 360-41(1).

DETAILED REASONING

Qualifying Early Stage Innovation Company

17. 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’

18. 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)

19. 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).

20. 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.

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

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

22. 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)

23. 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)

24. 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

25. 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

26. 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)

27. 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.

28. 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.

29. 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

30. 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…”¹

31. 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.

32. 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.

33. 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.”

34. 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.

35. 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

36. 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

37. 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, 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.

Broader than local market

38. 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

39. 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

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

Current year

41. Therefore, for the purposes of subsection 360-40(1) ITAA 1997, 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 3 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).

THE ‘EARLY STAGE TEST’ – paragraphs 360-40(1)(a) - (d) ITAA 1997

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

42. Company A was incorporated on x xx 20XX, 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

43. In applying the requirements of paragraph 360-40(1)(b), Company A and any of its 100% subsidiaries must have incurred total expenses of $1 million or less in the 20XX income year, being the income year before the current year.

44. The 20XX Company income tax return indicates that Company A had total expenses of $xx.xx in the 20XX financial year. Consequently, paragraph 360-40(1)(b) is satisfied.

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

45. 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 $200,000 or less in the income year before the current year.

46. The 20XX Company income tax return indicates that Company A had total income of $yy.yy in the 20XX financial year. Consequently, paragraph 360-40(1)(c) is satisfied.

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

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

CONCLUSION FOR EARLY STAGE TEST

48. Company A satisfies the early stage test for the 20YY 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

49. Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 20XX. 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 – subparagraph 360-40(1)(e)(i) ITAA 1997

50. 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.

51. Company A is currently developing an original cloud-based software platform for business operators and their customers, known as “Platform A”.

52. Platform A is comprised of a desktop dashboard for business operators, and a mobile application for their customers, providing a direct connection between them through one product.

53. For business operators, a desktop dashboard houses all the information they need, eliminating the need for multiple communication channels, and easily being able to manage their workload with a glance.

54. Business operators use the desktop dashboard, a cloud based platform accessible at any time, to manage all of their customers in one place. From the desktop dashboard, they can access features such as:

a. Real time dashboard showing data and performance metrics, such as “Average Message Response Time”.

b. Automatically generated reports, logs, and ledgers.

c. Digital reports.

d. Messaging/Communication tools.

e. Maintenance requests centre.

f. Push notification centre.

g. Data, analytics, and reporting.

h. Task allocation and management.

i. Business transactions management.

j. Secure document storage and creation.

k. Levels of access.

55. Customers receive an invitation code from their business operator, and after downloading the Platform A mobile application, they are connected.

56. The mobile app for the customers includes features such as:

a. Messaging centre.

b. Appointment calendar.

c. Notifications and reminders.

d. Digital reports.

e. Automatically generated reports, logs, and ledgers.

f. Secure document storage.

g. Interaction history profile.

57. While there are other solutions currently available for business operators, the additional features and focus on the relationship provides a significant degree of improvement in relation to the addressable market.

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

58. 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.

59. Version 1 of the platform and beta development was completed in yy 20YY.

60. Trials and beta testing with business operators commenced in yy 20YY, which will take approximately three months, before the platform is launched publicly.

61. Company A will continue to develop the platform throughout the period of the trials.

62. It is anticipated that Platform A will launch publicly in Australia in yy 20YY.

63. It is clear that Company A is genuinely focussed on developing the innovation for commercialisation.

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

64. 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.

65. Company A is well geared to expand its reach immediately as it is focussed on targeting business communities.

66. The market in Australia is large, with approximately xx,xxx registered business operators managing approximately zz,zzz customers.

67. By focussing on business communities, Company A can look to convert anywhere from xx to x,xxx billable transactions with every operator that they sign on.

68. Company A has already signed on four business communities from WW and VV for trial.

69. The company has already established a number of key relationships which will assist in their rapid growth potential, as noted below:

a. Company M – some of their services being implemented into the platform. This relationship provides an avenue to further enhance Company A’s growth, both in funding, corporate backing, and by utilising their client portfolio (which currently stands at approximately xy% of the market).

b. Company H – an Australian company that is currently based out of UU, an integration partner for Company A.

c. Company G – partnered to offer CCC, a connection service that compliments Company A’s current offering, in addition to serving as another source of revenue.

70. Company A is currently in the process of formally appointing advisors/non-executive board members.

71. These key relationships and advisors will assist Company A in its rapid expansion.

72. Company A has demonstrated a high growth potential for Platform A, so subparagraph 360-40(1)(e)(ii) is satisfied.

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

73. 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.

74. Company A does not seek to rely on a sole revenue stream, and therefore has the ability to scale quickly with multiple future revenue opportunities.

75. The current planned subscription costs is $zz.zz AUD per transaction/month.

76. Once a Chief Technology Officer and an internal development team is onboarded, Company A’s external costs are extremely minimal, capped at hosting data, security, and operational expenses.

77. With minimal hosting and server costs, it is anticipated that costs will increase at a minimal rate compared to the rising revenue from those using the platform and storing their data.

78. Total revenue is projected to increase exponentially, with an optimistic projection of $zz.zz per month by 20QQ. Even by adopting a conservative projection, total revenue is projected at $qq.qq per month.

79. Given the above, subparagraph 360-40(1)(e)(iii) will be satisfied.

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

80. 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.

81. Platform A is being designed to be used as both a national and global product.

82. Company A’s target market in the first instance is Australia, with four business communities already signed on for trial in WW and VV.

83. Company A has a strategy for global expansion, with its second priority to expand into TTT following launch in Australia.

84. Following launch in TTT, the Company’s third priority is to expand into OOO. While the management process is different in OOO to Australia, there is the same appetite for better solutions for these business interactions. With the guidance of the Company advisors and key partners, Company A will seek to utilise the data from Australian and TTT use to both raise capital, and launch in OOO in 20YY.

85. The infrastructure of the platform is suited to all business agreements, meaning that only slight customisation will be required to suit geographical nuances.

86. 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.

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

87. 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.

88. While there are competitors in the particular business space generally, Company A focuses on an easy to use solution. Intellectual property underpinning the platform is subject to an Innovation Patent, which has been obtained by one of Company A’s directors.

89. Company A has identified a number of competitive advantages it has due to its differentiating features, as follows:

a. Original mobile app – none of Company A’s competitors have a customer facing mobile app or focus. The focus amongst competitors is primarily on business operators, with limited solutions available for their customers. Platform A has numerous unique features available, allowing business operators to easily communicate with their customers, and vice versa. No other platform allows for this two-way interaction.

b. Access to data sets from both business operators and their customers – competitors only have access to data from business operators, due to not having a customer facing platform.

c. Premium design – none of Company A’s competitors have built a product with such a focus on modern clean design.

90. Company A has demonstrated that it has competitive advantages over its competitors, 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 xx 20XX until 30 yy 20YY.

CONCLUSION

Company A meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 xx 20XX until 30 yy 20YY.

ATO view documents

Not applicable

Other references (non ATO view)

Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016