Edited version of private advice

Authorisation Number: 1051562483280

Date of advice: 9 October 2019

Ruling

Subject: Income Tax: Tax incentive for early stage investors

Question

Does the Company 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:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

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.

1.       The Company is a proprietary company incorporated in Australia in 20XX.

2.       The Company issued shares to investors on 30 June 20XX.

3.       The Company in the financial year ending 30 June 20XX has incurred and earned the following:

·        Total expenses of $XX

·        Total income of $0 Nil

4.       The Company equity interests are not listed for quotation in the official list of any stock exchange, either in Australia or a foreign country.

5.       The Company is developing a product that is a mobile platform device for smartphones ('Product').

6.       The Product is different from anything else currently offered in the market.

7.       The unique features in the smartphone app makes the Product cutting edge. The Company has not been able to find a competitor that has developed anything similar.

8.       The Company is developing their platform to address a growing market of smartphone users and is continuing to develop their Product.

9.       The Company has established partnerships with significant industry participants to provide an advantage over potential new entrants to the industry. This includes the entering of a commercial contract for advertising over the next 12 months allowing for the exposure of the app.

10.    The app has established itself within the top 100 productivity apps with the rating continuously improving.

11.    The Product has been identified as having an international addressable market. The global expansion will commence in those countries with developed economies. In particular, the global expansion will focus on providers which operate nationally and internationally.

12.    Domain names have been acquired for the purpose of global expansion into various countries.

13.    The budget for the year ended 30 June 20XX is predicted to maintain steady costs and expenses relative to the user base.

14.    The Company has engaged experts in this field to ensure it has the necessary competitive advantage to ensure global success. The executive team have expertise and experience with technology, development, advertising and marketing.

Information provided

15.    You have provided a number of documents containing detailed information in relation to the Company's Product, including:

a.       Private Binding Ruling ('PBR') Application, dated 1 August 20XX

b.       Response to further questions provided

c.        Responses to various emails

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

17.    You have issued new shares in the Company to investors to assist in funding the continued development and commercialisation of the Product.

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

Reasons for Decision

These reasons for decision accompany the Notice of private ruling for Company.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.

Summary

The Company meets the eligibility requirements of an ESIC pursuant to 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 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

14.    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..."

15.    The innovation being developed by the company must either be new or significantly improved for an applicable addressable market.^[1] 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. 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.

17.    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."

18.    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.

19.    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

20.    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

21.    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

22.    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

23.    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

24.    For the purposes of this ruling, the 'test time' for determining if the Company is a qualifying ESIC, will be upon the issue of qualifying shares on a particular date or dates on or after 1 July 20XX, and on or before 30 June 20XX. In particular, shares were issued on 30 June 20XX.

Current year

25.    Therefore, for the purposes of subsection 360-40(1) ITAA 1997, the current year will be the year ending 30 June 20XX (the 20XX 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 20XX, 20XX and 20XX, 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

26.    The Company was registered in the Australian Business Register (ABR) on 1 July 20XX, which is within the 3 income years outlined above, therefore the requirements of subparagraph 360-40(1)(a)(iii) are satisfied.

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

27.    In applying the requirements of paragraph 360-40(1)(b), the Company 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.

28.    The Company incurred expenses of $X in the 20XX income year. Consequently, paragraph 360-40(1)(b) is satisfied.

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

29.    In applying the requirements of paragraph 360-40(1)(c), the Company and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the 20XX income year, being the income year before the current year.

30.    The Company did not earn any assessable income in the 20XX income year. Consequently, paragraph 360-40(1)(c) is satisfied.

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

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

32.    The Company is not listed on any Stock Exchange in Australia or a foreign country at the test time, so paragraph 360-40(1)(d) is satisfied.

CONCLUSION FOR EARLY STAGE TEST

33.    The Company satisfies the early stage test for the 20XX 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

34.    The Company are electing to seek eligibility by satisfying the Principles based Innovation test under section 360-40(1)(e)(i)-(v), in order to be issued with a Private Binding Ruling.

THE 'PRINCIPLES-BASED TEST' - PARAGRAPH 360-40(1)(E) ITAA 1997

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

35.    In applying the requirements of subparagraph 360-40(1)(e)(i), the Company must be developing an innovation which is either new or significantly improved for an applicable addressable market.

36.    The Company is still in the process of developing a unique platform ('Product').

37.    The Product is different from anything else currently offered in the market.

38.    The unique combination of the two features in one smartphone app makes the platform development by the Company cutting edge. The Company has not been able to find a competitor that has developed anything similar.

39.    The Company is developing their platform to address a growing market of smartphone users and is continuing to develop their Product.

40.    The Company is genuinely focussed on developing their Product, for an applicable addressable market, so subparagraph 360-40(1)(e)(i) is satisfied for the period 1July 20XX to 30 June 20XX.

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

41.    In applying the requirements of subparagraph 360-40(1)(e)(i), the Company must be genuinely focussed on developing an innovation for a commercial purpose in order to generate economic value and revenue for the company.

42.    The Company has already released version 1.0 in December 20XX allowing user access to part of the system. The current release is intended to grow the user base while stage two of the app development is being incorporated. An established user base is required to attract potential clients to the platform.

43.    There are a number of steps which are required to be completed into the future, before the Product is considered to be fully developed for commercialisation:

a.     Product 2.0 release: October 20XX. There is a new app functionality and design.

                                     I.          The Product will become accessible from global app store (6 new countries added) and an upgrade will commence.

                                   II.          The second part of the app will allow the following:

                                                              i.     Creation of a content management platform

                                                             ii.     impression reporting system to target user segment.

                                                            iii.     automated invoicing system to allow for the commercialisation of the app allowing users to add a cost to each transaction and see a total value.

b.       Product 2.1 release: April 20XX: This will refresh the app design and improve functionality.

44.    The Company anticipates that the current programme of development will be completed in the 20XX financial year.

45.    The Company is genuinely focused on developing their Product, for a commercial purpose, so subparagraph 360- 40(1)(e)(i) is satisfied for the period 1July 20XX to 30 June 20XX.

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

46.    In applying the requirements of subparagraph 360-40(1)(e)(ii), the Company must be able to demonstrate that it has the potential for high growth within a broad addressable market.

47.    The Company has extremely high growth potential as the Product is easily and infinitely scalable to a global audience.

48.    The unique business approach enables the Company to charge a fee to reach the purchase ready audience.

49.    The addressable market for the business is adults. The total addressable market is estimated to be 1,000,000 in Australia.

50.    The Company is focusing on 3 key growth elements

·        Strategic partners

·        International expansion

·        Increase in visibility and usage

51.    The 3-year business plan forecasts double-digit growth in users and revenues with sustainable ongoing growth thereafter.

52.    Given the product is a mobile platform it can be scaled very quickly. This high growth potential is clear from the following early activities of the company:

·        Achieved a spot within the top 100 productivity apps

·        Commenced commercial negotiations with partners:

˗        has a commercial contract in 20XX with a well-known commercial contractor's $2.8 million user database

˗        further commercial contract imminent

·        View to have optimal sales by the end of the financial year

53.    The Company has demonstrated a high growth potential for their Product, so subparagraph 360-40(1)(e)(ii) is satisfied for the period 1 July 20XX to 30 June 20XX.

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

54.    In applying the requirements of subparagraph 360-40(1)(e)(iii), the Company must be able to demonstrate that it has the potential to successfully scale up the business.

55.    The Executive team has proven experience with successfully scaling up technology companies.

56.    The aggregated marketing expenditure for the Company is built on known return on investment outcomes with proven cost per acquisition metrics that have been derived from small-scale marketing campaigns between October 20XX and March 20XX.

57.    The Company has a growth plan with key growth metrics that indicate the inherent scalability of the concept.

58.    The combination of accelerated customer adoption, growth in revenues and launch into offshore markets are the levers of scalability that the Company has identified.

59.    The budget for the year ended 30 June 20XX is expected to maintain steady costs and expenses relative to the user base.

60.    Technology expenses remain steady up to a user base of 250,000 and 500,000 users with the incremental cost increase per user nominal.

61.    The current expenditure is also expected to generate momentum with future growth to be generated organically, significantly reducing the cost of acquisition per user.

62.    This leverage ensures that Company has the potential to successfully scale up its business, so subparagraph 360-40(1)(e)(iii) is satisfied for the period 1 July 20XX to 30 June 20XX.

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

63.    In applying the requirements of subparagraph 360-40(1)(e)(iv), the Company must be able to demonstrate that it has the potential to be able to address a broader than local market, including global markets.

64.    The Product is a new and there is no evidence of direct competition in the Australian market or globally, so the export potential is significant.

65.    The global expansion will commence in those countries with developed economies that have access to digital transactions. In particular, the global expansion will focus on service providers which operate nationally and internationally.

66.    The global expansion will commence in countries similar to Australia. Domain names have been acquired to reflect this strategy.

67.    The Company has demonstrated that it has the capacity to address a broader than local market, so subparagraph 360-40(1)(e)(iv) is satisfied for the period 1 July 20XX to 30 June 20XX.

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

68.    In applying the requirements of subparagraph 360-40(1)(e)(v), the Company must demonstrate that it has potential to be able to have competitive advantage for that business.

69.    The Company will hold a technology platform with valuable user data and market insights allowing for optimisation of the current market opportunity.

70.    Competitive advantage will result from the Company's first mover advantage by securing the available customer base before the concept can be copied.

71.    As the Company is the first to identify this market opportunity there is an expectation they will continue to be the first in the market, with upgrades and improvements, adding new functionality and access to further geographical areas before competitors are ready to enter.

72.    The app has established itself within the top 100 productivity apps with the rating continuously improving. It is establishing itself as a trusted app within the community.

73.    The Company has already established partnerships with significant industry participants which will provide an advantage over potential new entrants to the industry.

74.    The Company is trying to establish itself as a one-stop shop by continuously expanding its offerings. The more entrenched users become in the Product the less likely the user will switch at a later stage.

75.    The Company has engaged experts in this field to ensure it has the necessary competitive advantage to make the Product a global success story. In addition to the above, the executive team have expertise and experience with technology development, advertising and marketing that could be used to build the Product.

76.    The Company has demonstrated that it has competitive advantages over its competitors, so subparagraph 360-40(1)(e)(v) is satisfied for the period 1 July 20XX to 30 June 20XX.

CONCLUSION FOR PRINCIPLES BASED TEST

The Company satisfies the principles based test as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period 1 July 20XX to 30 June 20XX.

CONCLUSION

The Company meets the eligibility criteria of an ESIC under section 360-40 for the period 1 July 20XX to 30 June 20XX.

[1] Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.79.