Edited version of private advice

Authorisation Number: 1052246663672

Date of advice: 3 May 2024

Ruling

Subject: Early stage innovation company eligibility

Question:

Does Company X meet 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 DD MM YYYY to DD MM YYYY?

Answer:

Yes.

This ruling applies for the following periods:

DD MM YYYY to DD MM YYYY

The Scheme commences on:

DD MM YYYY

RELEVANT FACTS AND CIRCUMSTANCES

Early Stage Test

Company Z is an Australian proprietary company incorporated in ZZZ on DD MM YYYY.

For the financial year ending DD MM YYYY, Company Z incurred and earned the following:

•         total expenses of $xxx

•         total income of $yyy

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

Background Facts

Company Z has a wholly owned subsidiary, Company X, that is an operating company for the business.

Company Z has changed its company name to Company X.

Company X's directors are AAA and BBB.

Company X's registered office and principal place of business is situated at ZZZ.

Company X is not a foreign company within the meaning of the Corporations Act 2001 (Cth).

The 'test time' for determining if Company X 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. Shares have been issued by Company X to a number of investors on DD MM YYYY to raise capital.

Product Development

Company X is developing an online platform, allowing for particular businesses, Australian end consumers of particular products and financiers to liaise and transact with each other in an online environment.

Company X's online platform intends to streamline interactions between those businesses and end consumers of particular products and financiers.

The current process is heavily driven by manual handlings of brokers in the form of emails or phone calls with multiple layers of brokering between businesses and end consumers. Particular brokers and end consumers often experience a significant delay in connecting with these businesses, as the process is largely dependent on the manpower of particular brokers.

A number of steps are required for each party involved in a single transaction, including (without limitation) enquiring, obtaining quotes, generating purchase orders and delivery of product, and each step takes considerable time based on the current logistics in the industry.

Company X plans to overcome the above-mentioned challenges by integrating its platform with various stakeholders.

Company X's online platform aims to be a 'one-stop' shop for the users where they can browse, order and pay for the products they need.

A significant commercial value is realised for both businesses and domestic end consumers when the platform is developed to achieve the intended integration. Company X also expects that the online platform will significantly reduce response times for each party as it automates the process, such that end consumers would not be dependent on others to initiate the transaction.

The online platform is almost at the stage of a Minimum Viable Product ('MVP'), which provides enough features to attract early users. The founder of Company X has the clientele whom he has acted for as a broker, and the platform will be introduced to his clientele, as early users, to receive customer feedback and evaluate user experience before making it available to a wider client base.

Whilst the platform is nearing MVP stage, significant works on the back-end software architecture have already been completed to ensure a smooth transition into the full-scale production.

Product Development Stages

Prior development

Company X is strategically developing their product through a multi-faceted approach initiated in the fourth quarter of YYYY. The founder began by engaging with previous contacts in the industry, including importers and three overseas businesses, to introduce and gather feedback on the online trading platform concept.

The founder and a business partner had undertaken focussed research on technology platforms for x months prior to the incorporation of Company X. Negotiations with an experienced full-stack developer began in MM YYYY.

Research on suitable platform architecture and product-market fit followed shortly thereafter, conducted by the developer, the founder and business partners. The formal development of the MVP began in MM YYYY and concluded in MM YYYY. Subsequently, the developer initiated the transition of the platform towards a more commercially robust, client-focused product.

This early engagement led to a group of these contacts agreeing to become test demonstration clients for the MVP website. Development of the MVP commenced in MM YYYY, with demonstrations to these prospective clients starting around MM YYYY. These demonstrations have been crucial in identifying new features and refining existing ones based on client feedback, indicating an iterative development process focussed on user needs.

Current development

To further advance the platform's commercial readiness, Company X is collaborating with a third-party digital products development company. Company X is aiming to enhance product testing, improve UI/UX design, develop a landing page and assist with ad-hoc front-end development work.

The scope of work is being negotiated. This partnership signifies an effort to leverage external expertise to accelerate the commercialisation process. Concurrently, internal product testing is being conducted by an industry supply chain specialist, ensuring the platform's functionality and market fit.

Approval from the overseas businesses (as key suppliers) has been secured to feature their products, with plans to integrate their systems for streamlined operations. Outreach is expanding to additional industry contacts, confirming a strong market interest.

Although current focus remains on refining the platform's automated capabilities for scalability, future plans include expanding marketing efforts and potentially hiring a sales team post-YYYY, once operational smoothness is ensured.

Future development

Development and improvement work is expected to be ongoing for some time. The launch of a feature light but commercially viable product that will be offered to select customers, is scheduled for MM or MM YYYY.

Around this time, to speed up the pace of new feature development, Company X will either hire additional developers and/or expand the scope of outsourced work with the third-party digital products company with whom they are negotiating.

Company X's aim will be to invite more customers to the platform throughout the remaining quarters of YYYY. A public launch its anticipated sometime in YYYY.

Commercialisation Strategy

Company X is currently collaborating with particular businesses and early users to develop a brokering model for its revenue streams.

The first revenue stream exploits the current trend of brokering between particular businesses and end consumers in the online environment, facilitating the faster-paced transactions.

The second model involves Company X acting as a trader, earning a margin from the price differential between the wholesale price from particular businesses and the selling price to the end consumers. The last stream extends the second model by offering trade finance to those who have robust credit ratings and are approved under Company X credit application terms. This will allow returns to be generated on trade finance, in addition to deriving revenue from a margin from the price differential.

The second and third streams require initial investor capital. This will be funded by the founder and initial investors. Company X intends to offer all three revenue streams to the early users based on their needs.

Due to the substantial dollar value of average transactions in the particular industry, the business is projected to generate $x million of monthly revenue during the first xx months.

As the scale of the business increases, Company X will require finance from external financiers to support the provision of trade finance to customers. Company X has initiated discussions with potential financiers in this regard.

In the meantime, trade finance will be funded by the founder and initial investors. Once external financiers become involved, Company X anticipates generating commission from transactions between financiers and end consumers.

High Growth Potential

The online platform will initially be offered to a select group of businesses and end consumers. The targeted users include businesses overseas, as well as domestic end consumers.

The online platform will streamline commercial interactions between overseas businesses and domestic end consumers.

Once the online platform has been successfully launched and thoroughly tested with the early users and modified as necessary to make it widely attractive to the industry, Company X has plans to expand its business into broader global markets, given that the software has minimal barriers to entry into different regions.

Scale up the Business

Once Company X establishes the early users of its online platform, it is expected that the customer base will grow rapidly, with minimal increase in operating costs, due to the existing critical infrastructure being established to accommodate multiple users.

Company X intends to leverage the trade relationships between particular businesses and their customer base to expand its own customer base.

After targeting initial businesses in the selected region, Company X intends to expand its serviceability to a broader network of businesses and end consumers globally.

Revenue is projected to meet or exceed A$xx million annually when the platform is utilised by the intended number of users.

Broader than Local Market

Company X's online platform has the potential to address global distribution markets. The heavily manual process in the particular industry is prevalent globally and the fact that the platform can readily be adapted without a geographical limitation, ensures that the serviceable market should continue to grow.

Company X is initially focusing on the product 'XYZ', where the founder of the company has substantial prior experience in dealings with these particular businesses. In the future, Company X plans to expand its product offering into more diversified products.

Expanding across the Australian imported market will require hiring sales personnel and implementing advertising strategies. The founder possesses extensive industry contacts, which will be leveraged for direct marketing efforts once the platform is deemed ready.

Global expansion offers two main strategies: 1) forming partnerships, and 2) leveraging contacts. The partnership strategy entails collaborating with seasoned sales professionals or executives in target countries. The contact method capitalises on existing relationships with businesses that serve multiple countries, including Australia, albeit as one of their smaller markets.

Competitive Advantages

Company X's online platform has a competitive advantage in the particular industry as there is no known competitor who has developed a similar product in the market.

Due to the significant amount of expertise, capital, time and deep relationships with busineses required to develop a similar platform, Company X is of the view that it would be very difficult for a potential competitor to replicate its combination or online platform, product offerings and relationships to build an equivalent customer base and scalable business.

Compared to the current process with prevailing high fixed costs for wages, rent and marketing, Company X's online platform is expected to derive significant cost savings.

Company X is developing their Product to address a number of discrete markets and is continuing to develop their Product.

Information provided

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

•         Private Binding Ruling ('PBR') Application, dated DD MM YYYY

•         response to further questions provided DD MM YYYY

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

Company X has issued shares to various investors to assist in funding the continued development and commercialisation of their Product. Shares have been issued by Company X to a number of investors on DD MM YYYYto raise capital.

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

CONCLUSION

Company X meets the eligibility criteria of an ESIC under section 360-40 for the period DD MM YYYY to DD MM YYYY or the date when their Product has been fully developed and is ready for client use, whichever occurs earlier.