Private ruling: ESIC eligibility
Date of advice: 12 June 2019
Published: August 2019
Ruling period: Date X to Date Y
Date scheme commenced: Date X

Ruling: Q1: 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')? | A1: Yes

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. 1. Company A is a proprietary company incorporated in State X on Date X. Company A is the head company of a consolidated group. 2. Company A's directors are Director A and Director B. 3. For the financial year ending Date X, Company A has incurred and earned the following: a. Total expenses of $X b. Total income of $X 4. Company B is a wholly owned subsidiary of Company A. Company A is developing the Product (software), but Company B will be the eventual trading company and access the technology by a license fee or similar. 5. For the financial year ending Date X, Company B has incurred and earned the following: a. Total expenses of $Y b. Total income of $Y 6. Company A's equity interests are not listed for quotation in the official list of any stock exchange, either in Australia or a foreign country. 7. Company A is developing a unique digital platform ('Product') using two unique features. 8. Company A has a number of standard software systems that it continues to develop. These software systems can be customised to provide solutions specific to a customer's needs. 9. Company A's software solutions are different from anything else currently offered in the market because of the software's ability to take proactive steps in relation to business development. 10. An additional point to note is the unique use of both features, which make the software, developed by Company A, cutting edge. Company A has not been able to find a competitor that has developed anything similar. 11. Company A is developing their digital platform to address a number of discrete markets and is continuing to develop their Product. 12. Company A's Product has been identified as having an international addressable market. Information provided 13. You have provided a number of documents containing detailed information in relation to Company A's Product, including: a. Private Binding Ruling ('PBR') Application, dated Date X b. Response to further questions provided - Company presentation document 14. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances. 15. You propose to issue new shares in Company A to various investors to assist in funding the continued development and commercialisation of the 'Product'. Assumption(s) Not applicable.

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: Company A meets the eligibility requirements of an ESIC pursuant to subsection 360-40(1). | Detailed Reasoning - Qualifying Early Stage Innovation Company: 16. 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': 17. 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): 18. 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 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). 19. 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. 20. 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): 21. 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): 22. 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): 23. 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: 24. 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: 25. 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): 26. 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. 27. 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. 28. 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: 29. 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..." 30. 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. 31. 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. 32. 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." 33. 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. 34. 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: 35. 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: 36. 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: 37. 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: 38. 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: 39. 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 Date X, and on or before Date Y. | Detailed Reasoning - Current year: 40. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the current year will be the year ending Date Y (the Y income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last 3 income years will include the years ending Date Y, Date X and Date W, and the income year before the current year will be the year ending Date X (the X income year). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a) ITAA 1997: 41. Company A was registered in the Australian Business Register (ABR) on Date X, which is within the 3 income years outlined above, therefore the requirements of subparagraph 360-40(1)(a)(iii) are satisfied. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b) ITAA 1997: 42. 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 X income year, being the income year before the current year. 43. Company A did not incur any expenses and its subsidiary Company B incurred $X in expenses in the X income year. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c) ITAA 1997: 44. 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 X income year, being the income year before the current year. 45. Neither Company A nor its subsidiary Company B earned any assessable income in the X income year. Consequently, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No Stock Exchange listing - paragraph 360-40(1)(d) ITAA 1997: 46. In applying the requirements of paragraph 360-40(1)(d), Company A must not be listed on any Stock Exchange in Australia or a foreign country at the test time. 47. Company A is 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: 48. Company A satisfies the early stage test for the Y 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: 49. Company A 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 - Developing new or significantly improved innovations for applicable addressable market - subparagraph 360-40(1)(e)(i) ITAA 1997: 50. 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. 51. Company A is developing a unique digital platform ('Product') using two unique features. 52. Company A has a number of standard software systems that it continues to develop. These software systems can be customised to provide solutions specific to a customer's needs. 53. Company A's software solutions are different from anything else currently offered in the market because of the software's ability to take proactive steps in relation to business development. 54. An additional point to note is the unique use of both features, which make the software, developed by Company A, cutting edge. Company A has not been able to find a competitor that has developed anything similar. 55. Company A is developing their digital platform to address a number of discrete markets and is continuing to develop their Product. 56. The addressable market for the Product is international. There is significant potential for international expansion. The technology being developed is not country specific and could be utilised across multiple industries, countries and continents. 57. Company A consider their Product is new within the addressable market, both in terms of existing market elements and processes that the product uniquely stitches together, plus elements that are entirely new to market. 58. Company A is genuinely focussed on developing their Product, a unique digital platform for an applicable addressable market, so subparagraph 360-40(1)(e)(i) is satisfied for the period Date X to Date Y. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997 59. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be genuinely focussed on developing an innovation for a commercial purpose in order to generate economic value and revenue for the company. 60. Work already undertaken to develop Company A's Product is as follows: a) Developed an initial install of the digital platform b) Built initial framework c) Built a tool to handle 'unknown transitions' d) Developed a campaign of a series of solutions for a client to a large number of potential responders. e) Developed tools and performed load testing f) Created a System As A Service (SAAS) approach g) There are a number of steps which are required to be completed into the future, before the Product is considered to be fully developed for commercialisation: h) The platform will need to evolve in performance and scalability, which will involve the creation of new tests and monitoring solutions to reach peak performance. 61. Company A anticipates that the current programme of development will be completed in the Z financial year. 62. Company A is genuinely focussed on developing their Product, a unique digital platform, for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period Date X to Date Y. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997: 63. In applying the requirements of subparagraph 360-40(1)(e)(ii), Company A must be able to demonstrate that it has the potential for high growth within a broad addressable market. 64. Company A has extremely high growth potential as the Product is easily and infinitely scalable to a global audience. 65. The ability for Company A to customise and tailor the solution offered means that their software solutions cut across different industries and are therefore industry agnostic. 66. The ability for Company A to customise and tailor the solution offered also means that their software solutions can be country agnostic, because they could be updated for any language. 67. Company A's Product may be scaled across multiple countries and continents. Whilst minor regulatory tweaks may be required, Company A believes the principles remain the same across different markets/industries and countries. 68. Given the product is software it can be scaled very quickly. This high growth potential is clear from the following early activities of the company: · Demonstrations that have been completed by the company at trade fairs and pilots completed for potential customers. · Discussions with potential future customers that are interested in how the technology works and what it can offer. 69. Company A has demonstrated a high growth potential for their Product, a unique digital platform, so subparagraph 360-40(1)(e)(ii) is satisfied for the period Date X to Date Y. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997: 70. In applying the requirements of subparagraph 360-40(1)(e)(iii), Company A must be able to demonstrate that it has the potential to successfully scale up the business. 71. The Executive team has proven experience with successfully scaling up technology companies, and the company has had discussions and provided demonstrations to a number of businesses worldwide. 72. Company A has significant strategic points of difference to their competitors in the market. Company A has many live opportunities and they have the resources needed to close and capitalise on these opportunities. 73. This leverage ensures that Company A has the potential to successfully scale up its business, so subparagraph 360-40(1)(e)(iii) is satisfied for the period Date X to Date Y. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997: 74. In applying the requirements of subparagraph 360-40(1)(e)(iv), Company A must be able to demonstrate that it has the potential to be able to address a broader than local market, including global markets. 75. Since commencing development, Company A have had the mindset of thinking globally. From a product perspective, they are global ready now. 76. Company A has demonstrated that it has the capacity to address a broader than local market, so subparagraph 360-40(1)(e)(iv) is satisfied for the period Date X to Date Y. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v) ITAA 1997: 77. In applying the requirements of subparagraph 360-40(1)(e)(v), Company A must demonstrate that it has potential to be able to have competitive advantage for that business. 78. The software solution developed is at the forefront of new technology, and means their software is more advanced and has a competitive advantage when compared to other software solutions in this area. 79. In addition to the above, the executive team have expertise and experience with the different software options that could be used to build Company A's software products. 80. Company A's solution can be executed cross channel, thereby empowering Company A against their competitors. 81. Company A has demonstrated that it has competitive advantages over its competitors, so subparagraph 360-40(1)(e)(v) is satisfied for the period Date X to Date Y. | Detailed Reasoning - Conclusion for Principles Based Test: Company A satisfies the principles based test as it has satisfied the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period Date X to Date Y. | Detailed Reasoning - Conclusion: Company A meets the eligibility criteria of an ESIC under section 360-40 for the period Date X to Date Y.

Reasons for decision: All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.