Private ruling: Income tax: tax incentive for early stage investors
Date of advice: 29 May 2020
Published: July 2020
Ruling period: Year ending 30 June ZZZZ
Date scheme commenced: Year ending 30 June ZZZZ

Ruling: Q1: Does the Company meet the criteria of an Early Stage Innovation Company (ESIC) under subsection 360-40(1) ofthe Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: 1. The Company is an Australian based proprietary company, incorporated in Australia and registered in the Australian Business Register during the year ending 30 June ZZZZ. 2. The Company's director is Individual A. 3. The Company has no subsidiaries and is not part of a consolidated group, or planning to join a consolidated group. 4. For the financial year ending 30 June YYYY, the Company incurred and earned the following: a. Total expenses of $0.00 b. Total income of $0.00 5. The Company is a proprietary company and its equity interests are not listed for quotation in the official list of any stock exchange in Australia or a foreign country. 6. The Company's goal is to develop a technology (the Product), which is an AI-powered system that will allow users to radically improve their productivity and efficiency, and aggregators to provide a better experience to their clients. 7. The Company's management team currently consists of: Individual B - Founder and Chief Executive Officer (CEO) Individual B has extensive banking experience as a consultant, and is the Ex-CEO and founder of a successful finance company. Individual C - Chief Technical Officer (CTO) Individual C is a technology leader with extensive experience in domains, including the financial technology industry. They are currently the CEO of an Australian-owned company providing IT services and software product development. 8. The Company is based out of the office of an innovation hub / impact network. 9. The Company states that all of the intellectual property (IP) associated with the Product's technology was developed and is owned by the Company, and that the IP is still in development. 10. The Company does not have any registered patents or trademarks in place for the technology/product. 11. The Company are planning to register with AusIndustry and claim R&D offsets. 12. The Company have highlighted the key differentiators and competitive advantages of the Product compared with competitor products in the market. 13. The Company state that other key unique value propositions for their system/platform include: · Deep Tech/IP - Using data, the Product will be building proprietary statistical models to drive a better experience for the users and improve efficiencies. The statistical models built by the Product over time will not be easily replicable. · The Company will also open up the marketplace through an open API for other service providers to partner with us and integrate within our platform. All applications for the marketplace will be checked and authorised to ensure they are adding value to its clients. These will feature platforms in other verticals relevant for a user's client base. 14. The Company's target market is a specific industry. 15. The Company has identified its addressable market as being both the Australian and the international/global market. Its business strategy is initially to prove the technology/system and establish a market in Australia before expanding into international markets. 16. In addition to Australia, the Company is looking to enter a major international market during the next few years in partnership with leading network. The Company aims to capture 3.5% of the Australian market share within 12 months of the full launch of the Product, and 9% of the Australian market share within 24 months of the full launch by partnering with two enterprise clients that they are currently in discussions with. Commercialisation Strategy 17. The Company's product is still in development, with the first phase of development due to be completed within the current year. The Company are developing the Product with the assistance of an Australian a software company with a shareholding in the Company. 18. A prototype of the Product has been developed. The Company plan to launch the Product in Australia by the end of June ZZZZ. 19. The Company's commercialisation strategy is to start as a low-end disruptor addressing simpler requirements for an under-served part of the market, and then move upmarket over time as the disruption becomes more mainstream and the offering becomes more mature. The Company state that the Company's founder and CEO, through his previous startup company successfully built a strong disruptor brand in a related market. 20. The Company are in discussions with partners to cross-sell additional services. It is anticipated that these partners will also promote the Company's product to their existing clients. 21. The Company is also in discussions with a major comparison website to instantly connect their visitors with a local client using the Product through APIs powered by the Product. The Company believe that combined with a strong network of advisors and mentors, as well as having received a solid validation from the industry and investors already, show the Company's potential for high growth and success with the current product, as well as its future features. 22. The Company state that it already has a good working relationship with a leading network that could assist the Company in fast tracking expansion in its initial international target market. The Company also state that it has also received investment funding from an internationally based venture capital fund to help the Company scale its operations in two other international markets. 23. The Company plans to derive revenue from the technology by offering a paid subscription service. 24. The Company contend that their business model as B2B Software as a Subscription is easily scalable, as once the internal development team is onboarded, their external costs are extremely minimal, capped at hosting data, security and operational expenses. They state that with minimal hosting and server costs, their costs will increase at a minimal amount compared to the rising recurring revenue from those using the platform and storing their data. Information provided 25. You have provided information in a number of documents containing detailed information in relation to the Company's product. 26. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances. 27. The Company has issued shares during the year ending 30 June ZZZZ, but do not intend to issue more shares in this period. You have not issued shares during any other period, but are intending to issue more shares in a subsequent period. 28. You propose to issue new shares in the Company to various investors to assist in funding the continued development and commercialisation of the Product's technology.

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: Summary: The Company meets the eligibility requirements of an Early Stage Development Company (ESIC) pursuant to subsection 360-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997). | Detailed Reasoning - Qualifying Early Stage Innovation Company: 1. Subsection 360-40(1) outlines the criteria required for a company to qualify as an Early Stage Innovation Company (ESIC) at a particular time in an income year. This time is referred to as the 'test time'. The criteria are based on a series of tests to identify if the company is at an early stage of its development and it is developing new or significantly improved innovations to generate an economic return. | Detailed Reasoning - 'THE EARLY STAGE TEST': 2. The early stage test requirements are outlined in detail within paragraphs 360-40(1)(a) to (d). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a): 3. To meet the requirement in paragraph 360-40(1)(a), at a particular time (the test time) in an income year (the current year) the company must have been either: i. incorporated in Australia within the last three income years (the latest being the current year); or ii. incorporated in Australia within the last six income years (the latest being the current year), and across the last three of those income years 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). 4. The term 'current year' is defined in subsection 360-40(1) with reference to the 'test time'; the 'current year' being the income year in which the company issues shares to the investor. 5. A company that does not meet any of these conditions will not qualify as an ESIC. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b): 6. To meet the requirement in paragraph 360-40(1)(b), the company and its 100% subsidiaries must have incurred total expenses of $1 million or less in the income year before the current year. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c): 7. To meet the requirement in paragraph 360-40(1)(c), the company and its 100% subsidiaries must have derived total assessable income of $200,000 or less in the income year before the current year. | Detailed Reasoning - No stock exchange listing - paragraph 360-40(1)(d): 8. To meet the requirement in paragraph 360-40(1)(d), the company must not be listed on any stock exchange in Australia or a foreign country. | Detailed Reasoning - INNOVATION TESTS: 9. If the company satisfies the early stage test, the company must also satisfy one of two innovation tests: the objective (100 point) test or the principles-based test. | Detailed Reasoning - '100 POINT TEST' - PARAGRAPH 360-40(1)(E) AND SECTION 360-45: 10. To satisfy the 100 point test the company must obtain at least 100 points by meeting the innovation criteria in the table within section 360-45. The criteria are tested at a time immediately after the relevant shares are issued. If a company satisfies this test it does not need to satisfy the principles-based test. | Detailed Reasoning - 'PRINCIPLES-BASED TEST' - SUBPARAGRAPHS 360-40(1)(E)(I) TO (IV): 11. To satisfy the principles-based test, the company must meet five requirements in paragraph 360-40(1)(e). This is tested at a time immediately after the relevant new shares are issued to the investor. 12. The company can demonstrate that it meets each requirement through existing documentation such as a business plan, commercialisation strategy, competition analysis or other company documents. The company must be able to show that tangible steps have been or will be taken in relation to each of the requirements. 13. The five requirements of the principles-based test, as outlined in paragraph 360-40(1)(e) are: i. the company must be genuinely focussed on developing for commercialisation one or more new or significantly improved products, processes, services or marketing or organisational methods ii. the business relating to that innovation must have a high growth potential iii. the company must demonstrate that it has the potential to be able to successfully scale up the business relating to the innovation iv. the company must demonstrate that it has the potential to be able to address a broader than local market, including global markets, through that business, and v. the company must demonstrate that it has the potential to be able to have competitive advantages for that business. | Detailed Reasoning - Developing new or significantly improved innovations for commercialisation: 14. For the purposes of Subdivision 360-A, the Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 ('EM') provides the following at paragraph 1.76 in relation to the definition of innovation: "Implicit in the definition of innovation is the requirement that the company is developing a new or significantly improved type of innovation such as a product, process, service, marketing or organisational method. This list of various types of innovations provides flexibility for innovation companies and is adaptable to current and future innovations. The Oslo Manual, published by the Organisation for Economic Co-operation and Development (OECD) provides a description of these different types of innovations..." 15. The innovation being developed by the company must either be new or significantly improved for an applicable addressable market. [1] The company's addressable market is the revenue opportunity or market demand arising from the innovation or the related business. The addressable market must be objective and realistic. 16. Improvements must be significant in nature to meet this requirement. Significant is defined in the online Macquarie Dictionary as " important; of consequence ." Customising existing products or minor changes resulting from software updates, pricing strategies or seasonal changes are examples of improvements that would not be considered significant. 17. The OECD Oslo Manual, in relation to defining innovative services, states at paragraph 161 that "innovations in services can include significant improvements in how they are provided (for example, in terms of their efficiency or speed), the addition of new functions or characteristics to existing services, or the introduction of entirely new services." 18. The company must be genuinely focussed on developing the innovation for a commercial purpose in order to generate economic value and revenue for the company. This requirement draws the distinction between simply having an idea and commercialising an idea. 19. For a company to qualify as an ESIC under the principles based test, the company must be "genuinely focussed on developing for commercialisation" their innovation. That is, the central activities of the company must be truly concentrated on developing their innovation for a commercial purpose. 'Commercialisation' includes a range of activities that involve the implementation or sale of a new or significantly improved innovation that will directly lead to the generation of economic value for the company. | Detailed Reasoning - High growth potential: 20. The company must be able to demonstrate that the business relating to the innovation has a high growth potential within a broad addressable market. This refers to the company's ability to rapidly expand its business. Companies that are limited to supplying local customers will not meet this requirement. | Detailed Reasoning - Scalability: 21. The company must be able to demonstrate that it has the potential to successfully scale up the business relating to the innovation. The company must have operating leverage, where as it increases its market share or enters into new markets, its existing revenues can be multiplied with a reduced or minimal increase in operating costs. | Detailed Reasoning - Broader than local market: 22. The company must be able to demonstrate that it has the potential to address a market that is broader than a local city, area or region. The company does not need to have a serviceable market at a national, multinational or global scale at the test time. However, it does need to show that the business is capable of addressing a market that is broader than a local market and that the business can be adapted to a broader scale in the future. | Detailed Reasoning - Competitive advantages: 23. The company must be able to demonstrate that it has the potential to have competitive advantages, such as a cost or differential advantage over its competitors which are sustainable for the business as it expands. The company can analyse what competitors in the market offer, and consider whether the company has a differentiating advantage that would allow it to outperform these competitors. | Detailed Reasoning - TEST TIME: 24. For the purposes of this ruling, the 'test time' for determining if the Company is a qualifying ESIC, will be upon the issue of qualifying shares on a particular date or dates on or after 1 July YYYY, and on or before 30 June ZZZZ. | Detailed Reasoning - Current year: 25. Therefore, for the purposes of subsection 360-40(1) ITAA 1997, 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 3 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). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a) ITAA 1997: 26. As the Company was registered in the Australian Business Register (ABR) during the ZZZZ income year, which is within the 3 income years outlined above, and has no subsidiaries, the requirements of subparagraph 360-40(1)(a)(iii) are satisfied. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b) ITAA 1997: 27. In applying the requirements of paragraph 360-40(1)(b), the Company and any of its 100% subsidiaries must have incurred total expenses of $1 million or less in the YYYY income year, being the income year before the current year. 28. The Company did not incur any expenses in the YYYY income year, and did not have any subsidiaries. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c) ITAA 1997: 29. In applying the requirements of paragraph 360-40(1)(c), the Company and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the YYYY income year, being the income year before the current year. 30. The Company did not earn any assessable income in the YYYY income year, and did not have any subsidiaries. Consequently, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No Stock Exchange listing - paragraph 360-40(1)(d) ITAA 1997: 31. In applying the requirements of paragraph 360-40(1)(d), the Company must not be listed on any Stock Exchange in Australia or a foreign country at the test time. 32. The Company was not listed on any Stock Exchange in Australia or a foreign country at the test time, so paragraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: 33. The Company satisfies the early stage test for the ZZZZ income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - THE '100 POINT TEST' - PARAGRAPH 360-40(1)(E) AND SECTION 360-45: 34. 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 are electing to seek eligibility by satisfying the principles-based innovation test under section 360-40(1)(e)(i)-(v), in order to be issued with a Private Binding Ruling. | Detailed Reasoning - Genuinely focussed on developing one or more new or significantly improved innovations for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997: New or significantly improved products, processes, services or organisation methods - subparagraph 360-40(1)(e)(i) 35. In applying the requirements of subparagraph 360-40(1)(e)(i), the Company must be developing an innovation which is either new or significantly improved for an applicable addressable market. 36. The Company's goal is to develop a technology (the Product), which is an AI-powered system that will allow users to radically improve their productivity and efficiency, and aggregators to provide a better experience to their clients. 37. The Company's target market is a specific industry. 38. The Company has identified its addressable market as being both the Australian and the international/global market. Its business strategy is initially to prove the technology/system and establish a market in Australia, before expanding into specific international markets. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997 39. In applying the requirements of subparagraph 360-40(1)(e)(i), the Company must be genuinely focused on developing an innovation for a commercial purpose in order to generate economic value and revenue for the company. 40. The Company's product is still in development, with the first phase of development due to be completed within the current year. The Company are developing the Product with the assistance of an Australian software company with a shareholding in the Company. 41. A prototype of the Product has been developed. The Company plan to launch the product in Australia by the end of June ZZZZ. 42. The Company's commercialisation strategy is to start as a low-end disruptor addressing simpler requirements for an under-served part of the market, and then move upmarket over time as the disruption becomes more mainstream and the offering becomes more mature. The Company state that the Company's founder and CEO, through his previous startup company, successfully built a strong disruptor brand in a related industry. 43. The Company are in discussions with partners to cross-sell additional services. It is anticipated that these partners will also promote the Company's product to their existing clients. 44. The Company is also in discussions with a major comparison website to instantly connect their visitors with a local client using the Product through APIs powered by the Product. The Company believe that combined with a strong network of advisors and mentors, as well as having received a solid validation from the industry and investors already, show the Company's potential for high growth and success with the current product, as well as its future features. 45. The Company plans to derive revenue from the technology by offering a paid subscription service. 46. The Company applied for an Australian State funded Minimum Viable Product (MVP) grant which was approved in the year ending 30 June ZZZZ. | Detailed Reasoning - Conclusion on subparagraph 360-40(1)(e)(i): 47. The Company is genuinely focused on developing their technology for a commercial purpose, and their Product will be a significantly improved product compared to existing products in their target markets. 48. Therefore, subparagraph 360-40(1)(e)(i) will be satisfied for the period 1 July YYYY until 30 June ZZZZ, or the date when the Product has been fully developed. 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 be no longer be satisfied. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997: 49. In applying the requirements of subparagraph 360-40(1)(e)(ii), the Company must be able to demonstrate that it has the potential for high growth within a broad addressable market. 50. The Company's research indicates that there is currently a very substantial client base in Australia who would benefit from the capabilities that they believe that their Product can provide. 51. The Company believe that with increased compliance within their industry, reduction in commission rates and increased competition from on-line competitors, their clients are demanding productivity applications to help them manage their clients and provide a better digital experience while meeting their compliance obligations. 52. The Company has developed a detailed commercial plan. The plan addresses its revenue model, customer acquisition strategy, a detailed analysis of their competition, channel manager to marketplace, a detailed SaaS offering plan, clear product roadmap and a clear capital raise strategy. 53. The Company has demonstrated a high growth potential for their process/product, therefore subparagraph 360-40(1)(e)(ii) will be satisfied for the period 1 July YYYY to 30 June ZZZZ. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997: 54. In applying the requirements of subparagraph 360-40(1)(e)(iii), the Company must be able to demonstrate that it has the potential to successfully scale up the business. 55. The Company contend that their business model as B2B Software as a Subscription is easily scalable, as once the internal development team is onboarded, their external costs will be extremely minimal, capped at hosting data, security and operational expenses. They state that with minimal hosting and server costs, their costs will increase at a minimal amount compared to the rising recurring revenue from those using the platform and storing their data. 56. The Company's key financial forecasts predict an expected positive trend resulting in a profit within three years of the Product's launch. 57. The Company has demonstrated that it has the operating leverage potential to successfully scale up its business, therefore subparagraph 360-40(1)(e)(iii) will be satisfied for the period 1 July YYYY to 30 June ZZZZ. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997: 58. In applying the requirements of subparagraph 360-40(1)(e)(iv), the Company must be able to demonstrate that it has the potential to be able to address a broader than local market, including global markets. 59. While choosing to launch the product in Australia, the Company has scoped out the potential for versions for two international markets, and aim to take the framework developed and apply this to markets globally. Already having begun conversations with overseas markets, the Company is extremely confident of the platform's ability to address a global market, with multiple countries and regions being able to use the product and its advanced features to make users within their client base more productive. 60. In addition to Australia, the Company is looking to enter a major international market during the next few years in partnership with a leading network. The Company aims to capture 3.5% of the Australian market share within 12 months of the full launch of the Product, and 9% of the Australian market share within 24 months of the full launch by partnering with two enterprise clients that they are currently in discussions with. 61. Once the Company has captured 10% of the Australian market share, the Company plans to expand into the major international market through its partnership with the leading network, which is currently being explored. 62. The Company state that it already has a good working relationship with the leading network that could assist the Company in fast tracking expansion in its initial international target market. The Company also state that it has also received investment funding from an internationally based venture capital fund to help the Company scale its operations in two other international markets. 63. 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. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v) ITAA 1997: 64. In applying the requirements of subparagraph 360-40(1)(e)(v), the Company must demonstrate that it has potential to be able to have competitive advantages for that business. 65. The Company have highlighted the key differentiators and competitive advantages of their Product compared with competitor products in the market. 66. The Company state that other key unique value propositions for their Product's system/platform include: · Deep Tech/IP - Using data, the Product will be building proprietary statistical models to drive a better experience for the users and improve efficiencies. The statistical models built by the Product over time will not be easily replicable. · The Company will also open up the marketplace through an open API for other service providers to partner with us and integrate within our platform. All applications for the marketplace will be checked and authorised to ensure they are adding value to their clients. These will feature platforms in other verticals relevant for its user's client base. 67. The Company has demonstrated that it has competitive advantages over its competitors, therefore subparagraph 360-40(1)(e)(v) will be satisfied for the period 1 July YYYY to 30 June ZZZZ. | Detailed Reasoning - CONCLUSION FOR PRINCIPLES BASED TEST: 68. The Company satisfies the principles based test as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period 1 July YYYY to 30 June ZZZZ. | Detailed Reasoning - CONCLUSION: 69. The Company meets the eligibility criteria of an Early Stage Innovation Company (ESIC) under section 360-40 of the Income Tax Assessment Act 1997 (ITAA 1997) for the period 1 July YYYY to 30 June ZZZZ. | Detailed Reasoning - Other references (non ATO view): Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016

REASONS FOR DECISION: All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.