Edited version of private advice

Authorisation Number: 1052152735761

Date of advice: 14 September 2023

Ruling

Subject: ESIC 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) for the year ending DD MM YYYY?

Answer

Yes.

This ruling applies for the following period:

Year ending ended DD MM YYYY

The scheme commenced on:

DD MM YYYY

Relevant facts and circumstances

Background facts

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

2.     Company A is not a foreign company pursuant to the Corporations Act 2001 (Cth).

3.     Company A had no subsidiaries during the period that the ruling application has been applied for and is not part of a consolidated group or planning to join a consolidated group.

4.     The current directors of Company A are Individual 1 and Individual 2.

5.     Company A's registered office is situated in Australia.

6.     Company A's principal place of business is situated in Australia.

7.     None of Company A's current or proposed shareholders are exempt, (under section 66A of the Corporations Act 2001)

8.     A number of Company A's shareholders are overseas entities.

9.     Company A's offering of shares required a disclosure under section 708 of the Corporations Act 2001 (Cth).

10.  Company A did not have any subsidiaries and incurred expenses of less than $1M in the income year ended DD MM YYYY (the year before the current year).

11.  Company A did not have any subsidiaries and did not generate any less than $200,000 in assessable income in the income year ended DD MM YYYY (the year before the current year).

Development of new or significantly improved innovations

Background research leading to innovation

12.  Company A is developing a new online platform ('the Platform') for Australia's businesses, which allows them to conduct direct transactions between businesses within its sector and provide complimentary services and subscriptions.

13.  Company A's initial addressable market are businesses within its sector in Australia, with the ultimate addressable market being businesses within its sector worldwide.

14.  Research sourced by Company A indicates that prior to the advent the Covid-19 pandemic revenue generated within its sector was expected to significantly increase within the short term. And that this trend has increased after the onset of Covid-19, with a survey of business buyers sourced by Company A showing an increased number of businesses transacting on online platforms within its sector during the pandemic.

15.  Additionally, market research conducted by Company A found online platforms within its sector providing a growing opportunity for small and medium sized businesses to utilize, and believe that with a large proportion of businesses within its sector falling within these categories Company A is strongly positioned to grow its platform, which is made for Australian businesses.

Service Innovation

16.  Through their online platform, computer automation and proprietary algorithms, Company A will digitally transform its sector by bringing together specialised participants from specific industries in a smart, simple and seamless way.

17.  The Platform helps participants to digitise their operational processes, allowing them to generate more income more whilst reducing costs.

18.  The company's Platform incorporates features that are not offered elsewhere in Australia.

19.  Company A is developing a tailored platform for its client businesses that are partners, and it plans to provide additional unique offerings in the future, which includes the provision of personalised experience per user through AI, software integrations and data & insights.

20.  Company A believes that these features represent service innovation for its addressable market.

Genuinely focussed on developing innovations for commercialisation

1.    Company A has been taking tangible steps that are directed towards the commercialisation of its product, such as:

•         conducting market research and developing a business plan

•         executing pilot programs

•         taking steps to protect intellectual property rights existing in the innovation, including Copyright, Trade Mark, and Employment and Collaboration agreements which include confidentiality and non-disclosure terms

•         investing in world exerts with significant experience in growing technology companies, and B2B platforms

•         investing in the best advisors in the business.

High growth potential

21.  The Company's initial addressable market are businesses within its sector in Australia, with its ultimate addressable market being businesses within its sector worldwide.

22.  Research sourced by Company A indicates a trend showing an increased number of businesses transacting and revenue being generated on online platforms within its sector.

23.  To enable this growth, the Company has developed an execution plan, whereby they will progressively target a variety of identified industries.

24.  Company A has already onboarded a number of users and received many positive testimonials, which signal customer satisfaction, retention, as well strong potential for the platform to grow for new users.

25.  Company A will be growing its userbase throughout Australia, as well as an overseas country. After testing the platform and analysing the performance of the Platform's rollout in the overseas country, Company A will expand its reach to other countries.

26.  Company A has an effective marketing strategy in place, led by its Chief Marketing Officer who has owned and run a successful marketing agency.

Scalability

27.  Although Company A will incur significant costs to develop the Platform, as its customer base grows, the cost per unit will reduce. Due to the nature of the software developed, it has operating leverage. It has the potential to successfully scale its business to supply to broad markets.

28.  As the Company expands its sales, it will be able to generate increased revenue with only a minimal increase in its operating costs.

29.  The Company has also developed a new technological tool that enables a viral effect and a significant growth of the Platform enabling the Company to effectively scale as expands its product offerings into other sectors.

30.  Company A has confidence in its ability to scale up the platform, under the leadership of the highly experienced experts within its leadership team.

31.  In addition to securing highly regarded technical and commercialisation experts, the Company has also raised significant funds from local and international strategic investors, to scale up its platform on the local and global markets.

Broader than local market

32.  Company A believe that it is capable of addressing a market that is broader than a local city, area or region, and it can adjust its business to supply to global markets.

33.  As previously stated, research sourced by Company A indicates a trend showing an increased number of businesses transacting and revenue being generated on online platforms within its sector.

34.  Company A is committed to its marketing and brand development strategy and has already allocated significant funds to its initial marketing costs to ensure successful and speedy growth.

35.  Furthermore, Company A has invested in world leading advertising and brand development experts with a breadth of experience in growing global technology platforms. Having invested in world leading business advisors Company A is equipped with invaluable connections with advertising agencies and distributors to drive a successful global campaign.

Competitive advantages

36.  Company has strong differential advantages by way of providing unique features, and benefits to businesses within its sector, which sets it apart from its competitors in its addressable market.

37.  Company A believes that these unique features will allow the Company to outperform its competitors. In addition, the Company has taken initial steps in developing the Platform and has also started to engage with businesses to be part of the Platform's network. Company A has already onboarded a number of companies to its platform. These companies have received many positive testimonials from their customers. Once the Australian experience is validated, the company will expand globally within a specific target region.

38.  The Company plans to provide additional unique offerings in the future, which includes the provision of personalised experience per user through AI, software integrations and data and insights.

39.  Company A's platform is rare, with no existing readily available substitute, and not capable of being imitated due to the nature of its IP protection, including copyright protections over the Platform's proprietary algorithms, data structures, and back and front end.

40.  The Company has conducted competitor analysis and discovered only a couple of remotely similar solutions, all with a different set of offerings or targeting a different addressable market.

41.  Other existing solutions are either manual or offline. Some larger global players do not personalise to specific regional needs and/or do not have inbuilt capabilities and innovations to cater to specific industries, a market gap that Company A's platform aims to fulfill.

42.  Company A's leadership team and advisors (both internal and external) are comprised of world experts with significant experience in growing technology companies and online platforms, which provides the Company with a further competitive advantage.

Information provided

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

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

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.

SUMMARY

Company A meets the criteria of an ESIC under subsection 360-40(1) of the ITAA 1997 for the income year ending DD MM YYYY.

DETAILED REASONING

Qualifying Early Stage Innovation Company

43.  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.

'EARLY STAGE TEST'

44.  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)

45.  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).

46.  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.

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

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

48.  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)

49.  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)

50.  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'

51.  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

52.  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)

53.  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.

54.  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.

55.  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 - subparagraph 360-40(1)(e)(i) ITAA 1997

56.  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]

57.  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.

58.  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.

59.      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]

60.      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."

61.      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."

62.  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.

63.  '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 - subparagraph 360-40(1)(e)(ii) ITAA 1997

64.  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 - subparagraph 360-40(1)(e)(iii) ITAA 1997

65.  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 - subparagraph 360-40(1)(e)(iv) ITAA 1997han local market

66.  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 - subparagraph 360-40(1)(e)(v) ITAA 1997

67.  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)

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

69.  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

70.  For the purposes of this ruling, the 'test time' for determining if Company A is a qualifying ESIC, will be upon the issue of qualifying shares on a particular date or dates on or after DD MM YYYY, and on or before DD MM YYYY.

Current year

71.  For the purposes of subsection 360-40(1), the current year will be the year ending DD MM YYYY (the YYYY income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last three income years will include the years ending DD MM YYYY, YYYY and YYYY, and the income year before the current year will be the year ending DD MM YYYY (the YYYY income year).

'EARLY STAGE TEST' - PARAGRAPHS 360-40(1)(a) - (d) ITAA 1997

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

72.  Company A was incorporated in Australia on DD MM YYYY, which is within the last three income years (the latest being the current year). Therefore, the requirements of subparagraph 360-40(1)(a)(i) are satisfied.

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

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

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

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

75.  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 YYYY income year.

76.  Company A did not have any subsidiaries and did not derive assessable income of $200,000 or more in the 2020 income year. Therefore, paragraph 360-40(1)(c) is satisfied.

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

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

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

CONCLUSION FOR EARLY STAGE TEST

78.  Company A satisfies the early stage test for the entire YYYY income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied.

'100 POINT TEST' - PARAGRAPH 360-40(1)(e) AND SECTION 360-45

79.  Company A has not provided sufficient evidence to substantiate that it would satisfy the 100-point test under section 360-45 for the year ending DD MM YYYY. Company A 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.

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

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

80.  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.

81.  Company A is developing a new online platform ('the Platform') for Australia's businesses, which allows them to conduct direct transactions between businesses within its sector and provide complimentary services and subscriptions.

82.  Through their online platform, computer automation and proprietary algorithms, Company A will digitally transform its sector by bringing together specialised participants from specific industries in a smart, simple and seamless way.

83.  Company A has provided details substantiating that it is developing a product that is either new or significantly improved for an applicable addressable market.

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

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

85.  Company A has been taking tangible steps that are directed towards the commercialisation of its product, such as:

•         conducting market research and developing a business plan

•         executing pilot programs

•         taking steps to protect intellectual property rights existing in the innovation, including Copyright, Trade Mark, and Employment and Collaboration agreements which include confidentiality and non-disclosure terms

•         investing in world exerts with significant experience in growing technology companies, and B2B platforms

•         investing in the best advisors in the business.

86.  Company A has provided details substantiating that that it is genuinely focussed on developing its innovation for commercial purpose in order to generate economic value and revenue for the company.

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

87.  Company A is genuinely focussed on developing their product, an online platform for Australia's businesses, which allows them to conduct direct transactions between businesses within its sector and provide complimentary services and subscriptions, for commercialisation. The product will be a significantly improved product compared to existing products in their addressable market.

88.  Therefore, subparagraph 360-40(1)(e)(i) is satisfied for the period DD MM YYYY to DD MM YYYY.

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

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

90.  Company A has provided details substantiating that it meets this requirement.

91.  Therefore, subsection 360-40(1)(e)(ii) is satisfied.

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

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

93.  Company A has provided details substantiating that it meets this requirement.

94.  Therefore, subsection 360-40(1)(e)(iii) is satisfied.

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

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

96.  Company A has provided details substantiating that it meets this requirement.

97.  Therefore, subsection 360-40(1)(e)(iv) is satisfied.

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

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

99.  Company A has provided details substantiating that it meets this requirement.

100.       Therefore, subsection 360-40(1)(e)(v) is satisfied.

Conclusion on principles based test

101.       Company A satisfies the principles based test as it satisfies the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period commencing DD MM YYYY until DD MM YYYY.

'FOREIGN COMPANT TEST' - subparagraph 360-40(1)(f) ITAA 1997

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

CONCLUSION

103.       Company A meets the eligibility criteria of an ESIC under section 360-40 of the ITAA 1997 for the period commencing DD MM YYYY to DD MM YYYY.

[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.