Private ruling: Tax incentives for early stage investors
Date of advice: 22 December 2021
Published: March 2022
Ruling period: Year ended 30 June zzzz
Date scheme commenced: 1 July yyyy

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

Relevant facts and circumstances: The Company was incorporated in Australia during the year ended 30 June zzzz. The Company is not listed for quotation on any stock exchange in Australia or overseas. The Company has one fully owned subsidiary incorporated in the United States of America. The Directors of the company are Taxpayer A, Taxpayer B and Taxpayer C. The Company's registered office and place of business is in Australia. The Company had total expenses of less than $1 million and derived total assessable income of less than $200,000 in the year ending June yyyy i.e. the year before the current year. The Company's goal is to provide a solution for employers that addresses both their staff management and real-estate management through providing an employee experience platform, enabling individualised hybrid work, embedded culture and collaboration within a sophisticated workplace relations management program. The Company's product is deliverable through a mobile application, computer web-based service, or embedded into commonly used professional messaging applications such as Microsoft Teams or Slack. The company has stated that the product makes an exceedingly complex and laborious process easy and intuitive. Furthermore, due to the impact of the COVID-19 pandemic and a large number of office employees working from home, there is a global need for practices which make employees feel engaged and communicate the culture of the company to them at home. Through the Company's product, employees are able to: • Select work preferences • View colleagues' availabilities and locations • Schedule and book resources • Browse and book events • Drive team coordination Further, employers are able to: • Plan and manage staff and real-estate • Measure key performance indicators and benchmark in real time • Securely maintain corporate directory and human resource information systems • Prepare and manage emergencies • Optimise evolving policies • Engage employees through targeted events and activities Apart from the founders, the Company has a substantial technology team for its start-up, enabling it to deploy the first beta test and gain valuable insights from large corporate clients which form part of the company's addressable market. The Company has submitted that the existing solutions available to the addressable market of the company only address parts of the problem of staff and real-estate management for employers. The Company is confident that their product is not merely a solution to the staff and real-estate problems that have occurred through the COVID-19 pandemic. The company has submitted that their product will support employers in their future of staff and real-estate management, no matter it's form. The ownership of any background intellectual property (IP) will be retained as all the rights associated to and for any prototypes are exclusively licenced to the Company. This provides additional opportunities for commercialisation in the future. International IP protection is also included in the future plans of the company. As the company's product is still not available publicly, it has not yet lodged its patent applications. However, the Company has submitted that the company will lodge IP license patents, licenses or trademarks in the due course. The Company has received early acceptance from IP Australia, which means that the company has passed the first of the two stages of the registration process in Australia. Two additional stages for complete acceptance are remaining. The IP that currently exists is in the form of software code is stored in a secure online repository provided by an external party. Further, the Company also manages its own IP at data centres that are equipped with both physical and network security. When data is stored with a third-party storage provider, it is encrypted. Due to the Company's product which provides services for both property and staff management, it has competitors in both sectors. The company has submitted that the Company's product will provide equally high-quality services in both property and staff management for both employees and employers, and that sets them apart from all other competitors. Commercialisation Strategy In the ideation stage of the Company, over 6 months of market research was conducted on the viability of the company and its product Initial release occurred in May zzzz with the first design partner release occurring in October zzzz. This release complemented the close of the initial investment round and precedes the private demo of the 'Pro' version of the product in late zzzz. The completion of the primary feature set of the Company's product and its public release is anticipated by mid-2022. The Company has beta tested their product with a number of large corporate customers across different locations and sectors. The company has submitted that with the benefits of funding, the company will expand their team up to approximately 35 in Australia and the USA in the next 12 months. Further, the company has submitted that an advisory board comprising of the Company's prominent investors and executives and founders from leading companies is currently being formed. The company has a three stage go-to market plan for their commercialisation. The first stage begins with carrying out the 'standard' cloud which enables small to medium enterprises to use the Company's product. The Company will dedicate marketing automation efforts and investments for this stage. The intention of this stage is to transition standard users to the Pro or Enterprise version as quickly as possible. The second stage is for the 'Pro' version be available publicly to customers. At this stage of the commercialisation, the Pro version of the product would be sold directly to business decision makers such as HR, real-estate or IT executives. To support the provision of this version of the product, the Company will invest in a dedicated sales function, supported by PR and marketing initiatives. The third and final stage of the commercialisation strategy is the release of the 'Enterprise' solution. The same sales and marketing strategies as the second stage will be deployed, however the intention of this stage is to rely more heavily on the channel model owing to the longer sales cycles. Based on initial customer feedback during beta testing, the company foresees that a number of smaller organisations requesting the Enterprise feature as well. Therefore, the company may consider including a tiered Pro version of the products to bridge the gap between the two plans. The Company's earliest addressable market will be east-coast based technology enabled businesses in Australia. The company has submitted that their product has a potential for a global market, through targeting businesses of different sizes globally. Information provided You have provided a number of documents containing detailed information in relation to the Company's product and operations. 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

Reasons for decision: Summary: All legislative references are to the ITAA 1997 unless indicated otherwise. | Detailed Reasoning - Qualifying Early Stage Innovation Company: Subsection 360-40(1) outlines the criteria required for a company to qualify as an Early Stage Innovation Company (ESIC) at a particular time in an income year. This time is referred to as the test time. The criteria are based on a series of tests to identify if the company is at an early stage of its development and it is developing new or significantly improved innovations to generate an economic return. | Detailed Reasoning - 'THE EARLY STAGE TEST': The early stage test requirements are outlined in detail within paragraphs 360-40(1)(a) to (d) of the ITAA 1997. | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a) ITAA 1997: 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 6 income years (the latest being the current year), and across the last 3 of those income years before the current year it and its *100% subsidiaries (if any) 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). iv. 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. v. 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) ITAA 1997: 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) ITAA 1997: 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) ITAA 1997: 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': 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 ITAA 1997: 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 (V) ITAA 1997: To satisfy the principles-based test, the company must meet five requirements in paragraph 360-40(1)(e). This is tested at a time immediately after the relevant new shares are issued to the investor. The company can demonstrate that it meets each requirement through existing documentation such as a business plan, commercialisation strategy, competition analysis or other company documents. The company must be able to show that tangible steps have been or will be taken in relation to each of the requirements. The five requirements of the principles-based test, as outlined in paragraph 360-40(1)(e) are: i. the company must be genuinely focused on developing one or more new or significantly improved innovations for commercialisation ii. the business relating to that innovation must have a high growth potential iii. the company must demonstrate that it has the potential to be able to successfully scale up the business relating to the innovation iv. the company must demonstrate that it has the potential to be able to address a broader than local market, including global markets, through that business, and v. the company must demonstrate that it has the potential to be able to have competitive advantages for that business. | Detailed Reasoning - Developing new or significantly improved innovations for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997: For the purposes of Subdivision 360-A, the Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 ('EM') provides the following at paragraph 1.76 in relation to the definition of innovation: "Implicit in the definition of innovation is the requirement that the company is developing a new or significantly improved type of innovation such as a product, process, service, marketing or organisational method. This list of various types of innovations provides flexibility for innovation companies and is adaptable to current and future innovations. The Oslo Manual, published by the Organisation for Economic Co-operation and Development (OECD) provides a description of these different types of innovations..." [1] The innovation being developed by the company must either be new or significantly improved for an applicable addressable market. The company's addressable market is the revenue opportunity or market demand arising from the innovation or the related business. The addressable market must be objective and realistic. Improvements must be significant in nature to meet this requirement. Customising existing products or minor changes resulting from software updates, pricing strategies or seasonal changes are examples of improvements that would not be considered significant. The OECD Oslo Manual defines innovations as significant changes, with the intention of distinguishing significant changes from routine minor changes. However, it is important to recognise that an innovation can also consist of a series of smaller incremental changes that together constitute a significant change. [2] In discussing services innovation activity, paragraph 111 of the OECD Oslo Manual states, "Innovation activity in services also tends to be a continuous process, consisting of a series of incremental changes in products and processes. This may occasionally complicate the identification of innovations in services in terms of single events, i.e. as the implementation of a significant change in products, processes or other methods." The OECD Oslo Manual, in relation to defining innovative services, states at paragraph 161 that "innovations in services can include significant improvements in how they are provided (for example, in terms of their efficiency or speed), the addition of new functions or characteristics to existing services, or the introduction of entirely new services." The company must be genuinely focused on developing the innovation for a commercial purpose in order to generate economic value and revenue for the company. This requirement draws the distinction between simply having an idea and commercialising an idea. 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. High growth potential - subparagraph 360-40(1)(e)(ii ) ITAA 1997 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 The company must be able to demonstrate that it has the potential to successfully scale up the business. The company must have operating leverage, whereas 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. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997: 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 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 - Foreign Company test - paragraph 360-40(1)(f) ITAA 1997: At the test time, the company must not be a foreign company within the meaning of the Corporations Act 2001. The dictionary in section 9 of the Corporations Act 2001 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. | Detailed Reasoning - TEST TIME: For the purposes of this ruling, the 'test time' for determining if the Company is a qualifying ESIC, will be upon the issue of qualifying shares on a particular date or dates on or after 1 July yyyy, and on or before 30 June zzzz. | Detailed Reasoning - Current year: 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): The Company was registered in the Australian Business Register (ABR) in the financial year ended on 30 June zzzz, which is within the 3 income years outlined above, therefore the requirements of subparagraph 360-40(1)(a)(i) are satisfied. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b): In applying the requirements of paragraph 360-40(1)(b), The Company and any of its 100% subsidiaries must have incurred total expenses of $1 million or less in the yyyy income year, being the income year before the current year. The Company did not have any subsidiaries, and incurred expenses of less than $1 million in the yyyy income year. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c): In applying the requirements of paragraph 360-40(1)(c), The Company and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the yyyy income year, being the income year before the current year. The Company did not have any subsidiaries, and derived assessable income of less than $200,000 in the yyyy income year. Consequently, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No stock exchange listing - paragraph 360-40(1)(d): 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. The Company is not listed on any Stock Exchange in Australia or a foreign country at the test time, consequently paragraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION ON EARLY STAGE TEST: 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: The Company has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June zzzz. The Company is electing to seek eligibility by satisfying the Principles based Innovation test under section 360-40(1)(e)(i)-(v), in order to be issued with a Private Binding Ruling. | Detailed Reasoning - Developing new or significantly improved innovations - subparagraph 360-40(1)(e)(i) ITAA 1997: In applying the requirements of subparagraph 360-40(1)(e)(i), The Company must be developing an innovation which is either new or significantly improved for an applicable addressable market. The Company is developing software/technology designed to provide both employers and employees with an all-encompassing platform to stay engaged, get organised and manage productivity. The technology will be offered to a range of client groups including small businesses or teams within larger organisations, corporations, or large organisations. The Company is developing a product which is deliverable through a mobile application, computer web-based service, or imbedded into commonly used professional messaging applications such as Microsoft Teams or Slack. The Company believes that its technology ultimately combines the tools of staff management and real-estate management for both employees and employers, combining the services that organisations typically use multiple different products for. The Company's market analysis/comparison has identified that there are several other providers which have products aimed at productivity management, or real-estate management for organisations. However, the company believes that there is no other product on the market which combines both staff productivity and real-estate management services for both employees and employers. The Company also believes that even though their initial addressable market is large organisations located on the east-coast of Australia, they have the potential to provide their product globally, and to organisations with a range of numbers of employees. The Company is genuinely focussed on developing their product, a productivity management software, which is a new or significantly improved innovation, so subparagraph 360-40(1)(e)(i) is satisfied for the period 1 July yyyy to 30 June zzzz, or the date when their product has been fully developed and is ready for client use, whichever occurs earlier. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997 In applying the requirements of subparagraph 360-40(1)(e)(i), The Company must be genuinely focussed on developing an innovation for a commercial purpose in order to generate economic value and revenue for the company. The Company commenced development on the product in Jan zzzz after the registration of the company. The company has submitted that prior to the formation of the company, over 6 months of market research was undertaken by the founders of the company. The Company's product has been beta tested by a number of customers from different sectors. The company's software is predicted to be available to the public in the current financial year. The Company's plan after the public release of its product is to provide the three different tiers of its product to different organisations within the Australian addressable market. The company's aspirations after the end of its initial commercialisation plan include an Initial Public Offering on the Australian Stock Exchange within the next 24 months, depending on the market opportunity and busines performance. There is also the possibility of a trade sale, particularly from major IT organisations as it is expected that the the Company's technology and processes would appeal greatly to any number of large technological corporations. The Company is genuinely focussed on developing their product, for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period 1 July yyyy to 30 June zzzz. or the date when their product has been fully developed and is ready for client use, whichever occurs earlier. Once the product has been fully developed, The Company will no longer be 'developing' the product for commercialisation and subparagraph 360-40((1)(e)(i) will no longer be satisfied. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997: In applying the requirements of subparagraph 360-40(1)(e)(ii), The Company must be able to demonstrate that it has high growth potential within a broad addressable market. The Company believes that it has extremely high growth potential due to the inherently advantaged software element of its product offering, and the fact that its product is easily and infinitely scalable to a global audience. As previously stated, the company identifies its initial addressable market is companies located in the eastern states of Australia. However, as its product is a productivity and real-estate management software aimed at serving both employees and employers, the company has identified its addressable market as being both the Australian and international/global market. While it is impossible to know the size of the potential market, it is noted that all businesses who have any number of employees in running their business can benefit from The Company's product. The ability for The Company to customise and tailor their product offering to the size of the business or the type of business conducted by the business means that their product cut across different industries and are therefore industry agnostic. The Company has demonstrated a high growth potential for their product, so subparagraph 360-40(1)(e)(ii) is satisfied for the period 1 July yyyy to 30 June zzzz. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997: 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. The company states that it has ample capacity to scale up the business due to the inherently advantaged and customisable software element of its product offering. The company has forecast that they will begin producing an income in the current financial year, and ultimately producing a positive net revenue in the year after the current financial year. The Company has already beta tested their product with several companies across different sectors and have received positive feedback and treatment towards its product. The company believes that this shows positive treatment by the general addressable market. The Company has the potential to successfully scale up its business, generating increased revenue and a larger market share, so subparagraph 360-40(1)(e)(iii) is 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: 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. As stated above, The Company is developing their product to address the needs of a range of businesses which are employers including small businesses or teams within large corporations, corporations and large organisations, and is continuing to develop their product offering. The company identifies its initial addressable market is Australian, specifically companies based in the eastern states of Australia. However, as its product is software designed to provide an efficient productivity and real-estate management tool to its customers, the company has identified its addressable market as being both the Australian and international/global market. The early success in commercialisation is still considered internally as 'the beta version', with ongoing development and additions to the tech team helping to ensure that the business can continue to develop its offering and grow its capacity to service multiple customer channels. As stated above, the company is about to commence the process of applying for IP rights protection internationally, to ensure that The Company's IP is secured, prior to the company exploring commercialising internationally. The Company has demonstrated that it has the capacity to address a broader than local market, including international and global markets. Therefore, subparagraph 360-40(1)(e)(iv) is satisfied for the period 1 July yyyy to 30 June zzzz. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v) ITAA 1997: 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. The Company's market analysis/comparison has identified that there are several other providers which have products aimed at productivity management, or real-estate management for organisations. However, the company believes that there is no other product on the market which combines both staff productivity and real-estate management services for employees and employers. The company believes that its product is the only product currently offered that provides a large number of features for employees and employers. The Company has demonstrated that it has competitive advantages, so subparagraph 360-40(1)(e)(v) is satisfied for the period 1 July yyyy to 30 June zzzz. | Detailed Reasoning - CONCLUSION FOR PRINCIPLES BASED TEST: 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, or the date when their product has been fully developed and is ready for client use, whichever occurs earlier. | Detailed Reasoning - Foreign Company Test - subparagraph 360-40(1)(f) ITAA 1997: As the Company was incorporated in Australia, it is not a Foreign Company and therefore paragraph 360-40(1)(f) is satisfied. | Detailed Reasoning - CONCLUSION: The Company meets the eligibility criteria of an ESIC under section 360-40 for the period 1 July yyyy to 30 June zzzz, or the date when their product has been fully developed and is ready for client use, whichever occurs earlier. [1] 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.