Edited version of private advice

Authorisation Number: 1051865437488

Date of advice: 20 July 2021

Ruling

Subject: Early stage innovation company eligibility

Question

Does the Company satisfy the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997) for the period 1 July YYYY to 30 June ZZZZ?

Summary

The Company satisfy the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997) for the period 1 July YYYY to 30 June ZZZZ.

This ruling applies for the following period:

Year ending 30 June ZZZZ

The scheme commences on:

1 July YYYY

Relevant facts and circumstances

The applicant ('the Company') is an Australian proprietary company which was incorporated in Australia and registered on the Australian Business Register during the year ended YYYY. Its equity interests are not listed for quotation in the official list of any stock exchange in Australia or overseas.

The Company has no subsidiaries and is not part of a consolidated group or planning to join a consolidated group.

The Company's directors are Individual A and Individual B.

The Company believes that it has an entrepreneurial management team and Advisory Committee with deep experience in banking, accounting, technology, startups and business.

The Company's registered office and principal place of business is in Australia.

The Company incurred total expenses of less than $1 million and derived total assessable income of less than $200,000 in the year ending 30 June YYYY, ie the year before the current year.

The Company is developing a data driven technology platform ('product') to provide a one-stop financial management and lending solution to specific sized business enterprises.

The Company believes that its product will, by capturing more data at source and enriching it with other third-party data sources, be optimally positioned to better service its customers and be able to extend into other aligned value propositions.

The product combines a smart business account with value-added accounting and tax related services.

The Company state its product will win back time for busy business owners, making it easier for them to stay in control of their financial destiny.

The Company believes that their integrated business banking solution will act as a financial operating system of a business, which will automate and simplify the bulk of financial administration tasks for their target business sector, saving time, increasing productivity, improving accuracy and help businesses grow and succeed through smarter access to data.

The Company believes that when fully developed, its product will be the only product on offer that provides all of the features and functions offered by its various competitors.

The Company's market analysis/comparison has identified that there has been significant demand for fintechs globally, and that like in other countries, the large Australian banks have underinvested in services for their target business segment, resulting in the service offering, from a digital point of view, within the Australian market to be lacking.

The Company state that their product is following a proven business model and is operating within similar market conditions to the likes of other companies who have all had success in other countries.

The Company believe that their product will occupy a unique position within the banking industry. The Company believe that whilst the various current financial services are competitive, none of the existing players are fundamentally solving the problem end-to-end.

The company believes that its product is the only product in the Australian market that, using its unique proprietary 'decision engine', will support businesses within its target segment during the various stages of their overall journey by integrating a comprehensive range of the related functions.

The Company states that it owns the IP that has been generated by activities being conducted for them in relation to their technology/product, but that it has not sought any formal patents or protections in relation to the IP.

The company state that the underlying architecture and specific coding of their unique proprietary 'decision engine' represents proprietary IP that cannot be easily replicated.

The Company believe that their product will enjoy first mover status for any product of a comparable type in the Australian market.

The Company identify their initial addressable market as a specific segment within the Australian business market and will initially target entities at a similar stage of development within specific industries. As part of the expansion phase of its business strategy the company will also conduct an analysis on potential international expansion opportunities and believes that there are logical options for expanding into other regions in the future.

Commercialisation strategy

To validate the market need and prove its concept, the Company has:

•         Signed agreements with banking and related partners

•         Acquired a significant number of businesses to its launch waitlist

•         Identified a clear target market and acquisition strategy

•         Successfully run online and social media marketing campaigns

In preparation for their product launch, the Company has:

•         Conducted significant development and testing of the product

•         Started user testing and demonstrations to its waitlist members

•         Recruited an experienced management team and advisors

•         Developed its website, content and brand.

To bring its product to market, the Company is partnering with a licenced financial institution which will allow it to offer a business account and full suite of complementary products and services.

By partnering, the Company can focus on its core proposition, delivering a world class financial management experience for businesses within its target market. The Company believe that this approach can take advantage of a very capital light business model with costs scaling in line with customer growth.

The Company believes that its partnership model ensures revenue and costs scale in line with growth, and that this sustainable approach means that thrive can focus on acquiring profitable customers without the upfront capital burden of obtaining its own financial services licences and infrastructure.

The Company states that its costs are minimal for the services it is able to offer its customers and this will allow the company to scale efficiently.

The Company forecasts that its 'cost-to-serve' will reduce and its revenue will increase as it scales.

Financial modelling undertaken by the Company, projects a substantial decreasing Cost-to-Income Ratio during the first years of its expansion phase commencing in the current financial year.

The Company is targeting a diversified business model which comprises of deriving revenue from a range of revenue streams.

Information provided

You have provided information in a number of documents in relation to the Company's product.

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

Shares in the Company were offered to investors in an offer that closed during the year ended 30 June ZZZZ.

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

All legislative references are to the ITAA 1997 unless otherwise stated.

Qualifying Early Stage Innovation Company

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'

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)

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).

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.

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

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

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)

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)

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

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.

'Principles-based test' - subparagraphs 360-40(1)(e)(i) to (v)

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.

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.

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

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]

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.

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.

The OECD Oslo Manual defines innovations as significant changes, with the intention of distinguishing significant changes from routine minor changes. However, it is important to recognise that an innovation can also consist of a series of smaller incremental changes that together constitute a significant change.[2]

In discussing services innovation activity, paragraph 111 of the OECD Oslo Manual states,

"Innovation activity in services also tends to be a continuous process, consisting of a series of incremental changes in products and processes. This may occasionally complicate the identification of innovations in services in terms of single events, i.e. as the implementation of a significant change in products, processes or other methods."

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."

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.

'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

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

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

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

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.

Foreign Company test - paragraph 360-40(1)(f)

At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001 (Cth).

The dictionary in section 9 of the Corporations Act 2001 (Cth) defines a foreign company to mean:

(a) a body corporate that is incorporated in an external Territory, or outside Australia and the external Territories, and is not:

(i) a corporation sole; or

(ii) an exempt public authority; or

(b) an unincorporated body that:

(i) is formed in an external Territory or outside Australia and the external Territories; and

(ii) under the law of its place of formation, may sue or be sued, or may hold property in the name of its secretary or of an officer of the body duly appointed for that purpose; and

(iii) does not have its head office or principal place of business in Australia.

APPLICATION TO YOUR CIRCUMSTANCES

Test time

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 YYYY, and on or before 30 June ZZZZ.

Current year

For the purposes of subsection 360-40(1), the current year will be the year ending 30 June ZZZZ (the ZZZZ 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 ZZZZ, YYYY and XXXX, and the income year before the current year will be the year ending 30 June YYYY (the YYYY income year).

Early stage test

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

The Company was registered on the Australian business Register (ABR) during the year ending 30 June YYYY, which is within the last 3 income years outlined above, therefore the requirements of subparagraph 360-40(1)(a)(i) are satisfied.

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

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 YYYY income year, being the year before the current income year.

The Company did not have any subsidiaries and incurred total expenses of less than $1 million in the YYYY income year. Consequently, paragraph 360-40(1)(b) is satisfied.

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

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 YYYY income year.

The Company did not have any subsidiaries and derived assessable income of less than $200,000 in the YYYY income year. Consequently, paragraph 360-40(1)(c) is satisfied.

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

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

The Company is not listed on any stock exchange in Australia or a foreign country at the test time. Consequently, subparagraph 360-40(1)(d) is satisfied.

Conclusion on early stage test

The Company satisfies the early stage test for the entire ZZZZ 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

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

Developing new or significantly improved innovations - subparagraph 360-40(1)(e)(i)

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.

The Company is developing a data driven technology platform ('product') that integrates banking, accounting and tax related services to provide a one-stop financial management and lending solution to specific sized business enterprises.

The Company believes that its product will, by capturing more data at source and enriching it with other third-party data sources, be optimally positioned to better service its customers and be able to extend into other aligned value propositions.

The product combines a smart business account with value-added accounting and tax related services.

The Company believe that their product will occupy a unique position within the banking industry. The Company believe that whilst the various current financial services are competitive, none of the existing players are fundamentally solving the problem end-to-end.

The company believes that its product is the only product in the Australian market that, using its unique proprietary 'decision engine', will support businesses within its target segment during the various stages of their overall journey by integrating a comprehensive range of related functions.

The Company is genuinely focussed on developing their product, which is a new or significantly improved innovation, so subparagraph 360-40(1)(e)(i) is satisfied for the period 1 July YYYY to 30 June ZZZZ.

Genuinely focussed on developing for commercialisation -

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

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

To validate the market need and prove its concept, the Company has:

•         Signed agreements with banking and related partners

•         Acquired a significant number of businesses to its launch waitlist

•         Identified a clear target market and acquisition strategy

•         Successfully run online and social media marketing campaigns

In preparation for their product launch, the Company has:

•         Conducted significant development and testing of the product

•         Started user testing and demonstrations to its waitlist members

•         Recruited an experienced management team and advisors

•         Developed its website, content and brand.

To bring its product to market, the Company is partnering with a licenced financial institution which will allow it to offer a business account and full suite of complementary products and services.

By partnering, the Company can focus on its core proposition, delivering a world class financial management experience for businesses within its target market. The Company believe that this approach can take advantage of a very capital light business model with costs scaling in line with customer growth.

The Company is genuinely focussed on developing their product for commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period 1 July YYYY to 30 June ZZZZ, or the date when their product has been fully developed and ready for client use, whichever occurs earlier. Once the product 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)

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

The Company's market analysis/comparison has identified that there has been significant demand for fintechs globally, and that like in other countries, the large Australian banks have underinvested in services for their target business segment, resulting in the service offering, from a digital point of view, within the Australian market to be lacking.

The Company state that their product is following a proven business model and is operating within similar market conditions to the likes of other companies who have all had success in other countries.

The Company believe that their product will occupy a unique position within the banking industry. In doing so, the Company can 'resegment' the market by offering a holistic financial management solution that addresses the fundamental shift in business owner needs. The Company believe that whilst the various current financial services are competitive, none of the existing players are fundamentally solving the problem end-to-end.

The Company identify their initial addressable market as a specific segment within the Australian business market and will initially target entities at a similar stage of development within specific industries. As part of the expansion phase of its business strategy the company will also conduct an analysis on potential international expansion opportunities and believes that there are logical options for expanding into other regions in the future.

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

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

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

To bring its product to market, the Company is partnering with a licenced financial institution which will allow it to offer a business account and full suite of complementary products and services (as discussed above).

By partnering, the Company can focus on its core proposition, delivering a world class financial management experience for businesses within its target market. The Company believe that this approach can take advantage of a very capital light business model with costs scaling in line with customer growth.

The Company believes that its partnership model ensures revenue and costs scale in line with growth, and that this sustainable approach means that thrive can focus on acquiring profitable customers without the upfront capital burden of obtaining its own financial services licences and infrastructure.

The Company states that its costs are minimal for the services it is able to offer its customers and this will allow the company to scale efficiently.

The Company forecasts that its 'cost-to-serve' will reduce and its revenue will increase as it scales.

Financial modelling undertaken by the Company, projects a substantial decreasing Cost-to-Income Ratio during the first years of its expansion phase commencing in the current financial year.

This leverage ensures that the Company has the potential to successfully scale up its business, generating increased revenue with a less than proportionate increase in operating costs, so subparagraph 360-40(1)(e)(iii) will be satisfied for the period 1 July YYYY to 30 June ZZZZ.

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

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

The company believe that their strategy of partnering with a licenced financial institution will facilitate their capability to rapidly gain traction within its identified addressable Australian market.

The Company identify their initial addressable market as a specific segment within the Australian business market and will initially target entities at a similar stage of development within specific industries.

As part of the expansion phase of its business strategy the company will also conduct an analysis on potential international expansion opportunities and believes that there are logical options for expanding into other regions in the future.

The Company has demonstrated that it has the capacity to address a broader than local market. Therefore, subparagraph 360-40(1)(e)(iv) will be satisfied for the period 1 July YYYY to 30 June ZZZZ.

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

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

As discussed above, the Company state that their product is following a proven business model and is operating within similar market conditions to the likes of other companies who have all had success in other countries.

The company believes that its product is the only product in the Australian market that, using its unique proprietary 'decision engine', will support businesses within its target segment during the various stages of their overall journey by integrating a comprehensive range of related functions.

The company state that the underlying architecture and specific coding of their unique proprietary 'decision engine' represents proprietary IP that cannot be easily replicated.

On these bases the Company believe that their product will enjoy first mover status for any product of a comparable type in the Australian market.

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 YYYY to 30 June ZZZZ.

Conclusion on principles test

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 YYYY until 30 June ZZZZ or the date when their product has been fully developed and is ready for sale, whichever occurs earlier.

Foreign Company Test - subparagraph 360-40(1)(f) ITAA 1997

As the Company was incorporated in Australia, it is not a Foreign Company and therefore paragraph 360-40(1)(f) is satisfied.

Conclusion

The Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July YYYY to 30 June ZZZZ or the date when their product has been fully developed and is ready for sale, whichever occurs earlier.

[1] See Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.76.

[2] OECD Oslo Manual, paragraph 124 and paragraph 151.