Edited version of private advice

Authorisation Number: 1051698678099

Date of advice: 12 June 2020

Ruling

Subject: Subject: Early Stage Innovation Company - Eligibility Renewal

Question

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

Answer

Yes.

This ruling applies for the following period

March 2020 to 30 June 2020

The scheme commenced on

March 2020

Relevant facts and circumstances

1.       The Company is a proprietary limited company incorporated and registered in the Australian Business Register.

2.       The Company does not have any prior year expenses.

3.       The Company does not have any prior year income.

4.       The Company is developing a sport booking platform.

5.       The platform introduces new innovations that improve the consumer experience.

6.       The platform is a mobile-first social network for users to interact, create and play games together. It uses data to match users for games.

7.       The Company will expand the sport booking platform to cater for destination users.

8.       Packages and deals which include accommodation, flights, transport and meals will be offered on your platform.

9.       There is a major market for weekend domestic destination which is currently under serviced.

10.    The platform will have real time pricing calculated based on demand, last minute inventory and the margins on each component of the package.

2 key innovations not currently available.

Key Innovation 1

11.    The platform is a one stop shop for all users to meet old and new users.

12.    The platform seeks to drastically improve the experience with key functions such as:

·        Each user having a profile.

·        The Company will leverage user data. You aim to achieve this by developing a machine learning model.

·        Users will be able to create games which are available for other users to join. There will be chat functionality for users who have joined the same game to communicate and interact.

·        There will be an incentive structure for regular users who host and play games. The platform will gamify the user experience and create long term value for users based on milestones.

·        The Company will be fostering more competitive play and increasing user engagement via a system of achievements and unlockable badges.

·        Functionality will be built in for users to comment and review. You can then leverage this data to make recommendations.

13.    The platform will be made available online as both a web application and a mobile application.

Key Innovation 2

14.    The Company sent out a product viability survey to users. The top two most desired features for a holiday was a one-stop-shop to book an all-inclusive package around the world and instant online booking confirmation for their chosen package.

15.    The Company will be integrating the platform to access live inventory available, ancillary products and pricing. Your platform will also make users available to your ancillary products. You will extend your product offering to cater for domestic destination users who want a complete all-inclusive holiday by packaging transportation, lodging and meals.

16.    The Company's proprietary 'Product' solves the cancellation problem and commercializes this in an attractive package with high value proposition to consumers.

17.    The Product finds unutilised sessions and updates the prices based on historical demand. The commercialisation is achieved by packaging hotels and other ancillary products to be distributed to the end user via your website and mobile app.

18.    There is currently no product on the market that acts as a one-stop shop for users to meet new users, organise a game and purchase a complete package instantaneously. The platform seeks to revolutionise the industry by developing technology to make this happen.

19.    The Company will initially provide the services to a select number of partners overseas. The business has high growth potential in scaling into other places overseas. There are millions of users actively participating overseas.

20.    The Company will strategically expand internationally and in Australian Markets. The potential for growth is exponential.

21.    The Company is planning a staggered launch of the application with limited features scheduled in 2021. You will then focus on growing your user base as well as expanding on your product offering to include packages.

22.    The Company will leverage its online e-commerce platform to distribute the services into new markets in a very cost-effective manner.

23.    The company's founding employees have between them over ten years' experience in large scale application design and implementation. They are also supported by a specialist mobile app designer who is on contract.

24.    The Company has a very robust digital go to market strategy which the founders have experience in executing. This allows your product to have a global reach with the potential to enter any English-speaking market.

25.    The online nature of the business allows the product to address markets both locally and at an international level. The services will first be rolled out overseas and then can be easily expanded to markets in Australia.

26.    Relative to the competitors, the Company has a competitive advantage in providing through unrivalled value to your customers and has a cost-effective platform to expand rapidly to different markets. You are not aware of any other online services that can deliver this service in one ready to purchase package.

27.    The Company aims to build a booking engine that will enable destination users to search for and book complete packages including, flights, accommodation and car rentals with up-to-date pricing. No such product currently exists to service this market segment.

28.    Your social platform with its gamification will also be an industry-first.

Information Provided

29.    You have provided the following documents:

·        Profit and loss statements for three consecutive years.

·        Competitor Analysis Table detailing features of the sport booking platform.

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

Income Tax Assessment Act 1997 section 360-40(1)(e)(i-v)

Reasons for Decision

Qualifying Early Stage Innovation Company

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 under, subsection 360-40(1).

Detailed reasoning

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)

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 before the current year 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)

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)

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)

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: the objective (100 point) test or the 'Principles-Based Test'.

'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.

Principles-Based Test - subparagraphs 360-40(1)(e)(i) to (v)

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 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

43.    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..."

44.    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.

45.    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.

46.    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."

47.    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.

48.    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

49.    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

50.    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, whereby it increases its market share or enters into new markets and its existing revenues can be multiplied with a reduced or minimal increase in operating costs.

Broader than local market

51.    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

52.    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

53.    For the purposes of this ruling, the test time for determining if your Company is a qualifying ESIC will be a particular date during the income year ending 30 June 2020.

Current year

54.    For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 2020 (the 2020 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 2020, 2019 and 2018.

Early Stage Test

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

55.    Your Company was incorporated in 2020, which is within the last 3 income years. Therefore, subparagraph 360-40(1)(a)(i) is satisfied.

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

56.    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 2019 income year which is the income year before the current year.

57.    As the Company was not incorporated until 2020, it did not incur any expenses in the 2019 income year. Therefore, paragraph 360-40(1)(b) is satisfied.

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

58.    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 income year before the current year.

59.    As the Company was not incorporated until 2020, it did not earn any assessable income in the 2019 income year. Therefore, paragraph 360-40(1)(c) is satisfied.

No stock exchange listing - paragraph 360-40(1)(d)

60.    The Company must not be listed on any Stock Exchange in Australia or a foreign country at the test time.

61.    As the Company is not listed on any stock exchange in Australia or a foreign country, subparagraph 360-40(1)(d) is satisfied.

Conclusion on Early Stage Test

62.    The Company satisfies the Early Stage Test for the 2020 income year as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied.

The 100-Point Test

63.    The Company has not provided sufficient evidence of satisfying the 100-point test under section 360-45 for the year ending 30 June 2020. 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)

64.    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.

65.    The Company is genuinely focused on developing for commercialisation one or more new or significantly improved products, processes, services, marketing or organisational methods. The product being developed introduces a number of new innovations which significantly improve on consumer experience in the sport booking platform.

66.    The company's product (sport booking platform) seeks to develop a 'mobile-first social network' for users to interact, create and play games together. Users can among other things, purchase ancillary products.

67.    You will be expanding your product offering to cater for destination users. Packages include:

·        Accommodation

·        Flights

·        Transport

·        Meals

68.    There are two key innovations not currently available in the market. These are:

·        Key Innovation 1

·        Key Innovation 2

Key Innovation 1

69.    Your platform will be the one stop shop for all users to meet old and new users and create and join public games. Your product seeks to drastically improve the user's experience by including a profile which details key functions such as:

·        Level of play

·        Game preference

·        Game history

·        Peer rating

70.    The platform will be made available online as both a web application and a mobile application.

Key Innovation 2

71.    You will integrate your platform directly with systems to access live inventory, ancillary products and pricing. Your platform will also make available to your users' ancillary products such as equipment rental and lessons and any other services offered.

72.    The Company's proprietary 'Engine' identifies cancelled and un-booked sessions and commercialises this in an attractive package with a high value proposition to consumers.

73.    The Engine will connect to reservation systems. The Engine finds times at the connected locations and updates the prices based on criteria such as historical demand and location capacity. The commercialisation is achieved by packaging the experience with hotels and other ancillary products to be distributed to the end user via your website and mobile app.

Genuine focus for commercialisation - subparagraph 360-40(1)(e)(i)

74.    There are two types of competitors, namely online travel agents and wholesalers.

Online Travel Agents

75.    Online travel agents are not able to offer instantaneous pricing due to legacy systems. Their current processes require the consumer to either submit details online or by phone to request a quote which would be manually processed by a travel agent. Turnaround times for this process ranges anywhere from two hours to a few days depending on seasonality.

Wholesalers

76.    Wholesalers deal with locations and focus on selling inventory. They do not service domestic destination users who want a full package and ancillary products/services. Their product is limited to selling, penetrating the mobile space and relying on their existing customers for recurring sales.

77.    There is currently no product on the market that acts as a one-stop shop for users to meet new users, organise a game and purchase a complete package instantaneously.

78.    The sport booking platform seeks to revolutionise the industry by developing technology to make this happen. Therefore, subparagraph 360-40(1)(e)(i) is satisfied.

High Growth Potential - subparagraph 360-40(1)(e)(ii)

79.    The company has high growth potential overseas by scaling into other locations.

80.    The Company will also strategically expand across major sporting hubs in Australia and other overseas markets where the potential for growth is exponential.

81.    Your market research has identified that destination users is an under-served niche market. The components of the destination package include flights, accommodation and ancillary products.

82.    The Company is planning a staggered launch of the application with limited features scheduled in 2021. You will initially sell and then focus on growing your user base as well as expanding on your product offering to include packages.

83.    The Company has demonstrated that it has a high growth potential in selling its destination packages both in Australia and overseas. Therefore, subparagraph 360-40(1)(e)(ii) is satisfied.

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

84.    The Company will be able to leverage its online e-commerce platform to distribute the services into new markets in a very cost-effective manner. The platform identifies unutilised products and dynamically updates pricing and availability.

85.    The Company's founding directors have collective experience in technology, e-commerce and business operations.

86.    Product development is currently headed by your full stack software engineer with experience in large scale web application design and implementation. The employee is working full time on the sport booking platform and is supported by a specialist mobile app designer who is on contract.

87.    Commercially, you are performing outreach to major suppliers, specifically individual locations, lodging providers, transportation companies and travel wholesalers.

88.    You are designing the software architecture with high scalability and high availability in mind. By leveraging cloud infrastructure providers, you will be able to quickly scale your platform to service global audiences. The booking engine will allow users to package and purchase accommodation, flights and other ancillary products in a fully online and frictionless manner. With your technology-based approach, you will be able to eventually expand your product offering to include all locations in the world while maintaining low operational costs. As your product is entirely technology-based, engineering resourcing will be your primary expenditure as the company grows and improves its product.

89.    The company will be able to leverage off its mobile social network to identify global locations and competitive online packages. This ensures that you will be able to scale up the enterprise. Therefore, subparagraph 360-40(1)(e)(iii) is satisfied.

Broader than Local Market - subparagraph 360-40(1)(e)(iv)

90.    You have a very robust digital go-to market strategy via an organic Search Engine Optimisation for key terms. This allows your product to have a global reach with the potential to enter any English-speaking market.

91.    The Company's online nature of the business allows product to address markets both locally and at an international level. Therefore, subparagraph 360-40(1)(e)(iv) is satisfied.

Competitive Advantages - subparagraph 360-40(1)(e)(iv

92.    The Company has a competitive advantage in providing through unrivalled value to your customers and has a cost-effective platform to expand rapidly to different markets. You are not aware of any other online services that can deliver underutilized packages with lodging and equipment hire in one ready to purchase package.

93.    The Company aims to build a booking engine that will enable destination users to search for and book complete packages including flights, accommodation and car rentals with up-to-date pricing. Currently no such product exists to service this market segment.

94.    The Company's social platform with matching and gamification will be an industry-first. You plan to build a data-driven matching system that will allow users to quickly find compatible competitors for their games. The system will leverage player metrics such as location, usual time of play and peer ratings to find the most suitable matches.

95.    The Company has demonstrated that it has competitive advantages over its competitors. Therefore, subparagraph 360-40(1)(e)(v) is satisfied.

Conclusion on Principles-Based Test

96.    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 commencing in March 2020 till 30 June 2020.

Conclusion

97.    The Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing in March 2020 till 30 June 2020 or the date when their service has been fully developed and is ready for client use, whichever occurs earlier.

ATO view documents

Not applicable

Key words

Early Stage Innovation Company

Tax incentives for Early Stage Investors

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