Private ruling: Early Stage Innovation Company
Date of advice: 14 September 2017
Published: January 2018
Ruling period: Year ending 30 June 2018
Date scheme commenced: 1 July 2017

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: 1. The Company was incorporated in Australia in the 2016 income year. Its equity interests are not listed for quotation in the official list of any stock exchange. 2. The Company has no subsidiaries and has expenses of less than $1 million in the previous income year, i.e. the year ended 30 June 2017. Its assessable income is less than $200,000 in the year ended 30 June 2017. 3. The Company will provide a platform, utilising a tool (being developed). This consolidated package is what provides a competitive advantage to The Company over its competitors. 4. Founded by individuals with vast experience in the relevant fields, The Company is focussed on providing the world’s largest platform. 5. The Company has identified its ultimate market as being the global market, with its initial target being Australia. 6. In addition to the above, you have highlighted the key differentiators of the platform as being: a. No other platform provides a package which combines all the features of The Company’s platform. 7. The Company’s focus is to expand to include international consumers when permitted in other jurisdictions. 8. You submitted that: b. There is increasing demand for the platform. c. A platform established overseas showed significant growth. 9. The cost of designing and developing the platform are significant in the early stages. However the platform has the ability to scale efficiently with minimal increase in costs. 10. The Company can access a global market and generate increased revenue with minimal increase in operating costs. Commercialisation strategy 11. The platform is currently in development, building on current systems/software with the first release scheduled for the second half of 2017. 12. The Company plans to lodge an innovation patent application with respect to the intellectual property regarding the platform. 13. According to the Business Plan, The Company has engaged with the relevant authorities and specialists to provide support on an ongoing basis. 14. According to the Business Plan and other information submitted, the following events are scheduled over the coming months: d. website launched. e. The first Expression of Interest (EOI) campaign to be launched. 15. Additional campaign types will be implemented in 2018. 16. You submitted that no one in the Australian market has experience operating such a platform. 17. The Company has access to an existing database of potential customers. 18. Firm commitment has been obtained from several customers that will use the platform. In addition The Company has several key partnership opportunities. 19. The Company is initially targeting the Australian market. They will pursue product sales through: f. Facebook Likes g. EOIs etc. 20. The product assists customers. Information provided 21. You have provided information in a number of documents and phone conversations in relation to your retail equity crowdfunding platform, including: h. your private ruling application i. our phone conversation j. supplementary information 22. We have referred to the relevant information within these documents and conversations in applying the relevant tests to your circumstances. 23. You propose to issue new shares in The Company to investors to assist in funding the continued development and commercialisation of the platform.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subdivision 360-A | Income Tax Assessment Act 1997 section 360-40

Reasons for decision: Detailed Reasoning - Qualifying Early Stage Innovation Company: 24. 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’: 25. 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): 26. 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). 27. 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. 28. 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): 29. 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): 30. 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): 31. 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: 32. 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 - ‘Principles-based test’ – subparagraphs 360-40(1)(e)(i) to (iv): 33. 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. 34. 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. 35. 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: 36. 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…” 37. 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. 38. 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. 39. 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. 40. 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.” 41. 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.” 42. 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. 43. ‘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: 44. 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. | Detailed Reasoning - Scalability: 45. The Company must be able to demonstrate that it has the potential to successfully scale up the business. The Company must have operating leverage, where as it increases its market share or enters into new markets, its existing revenues can be multiplied with a reduced or minimal increase in operating costs per unit. | Detailed Reasoning - Broader than local market: 46. 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: 47. 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 - Application to your circumstances: Test time 48. For the purposes of this ruling, the test time for determining if the Company is a qualifying ESIC will be a particular date during the income year ending 30 June 2018. Current year 49. For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 2018 (the 2018 income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last three income years will include the years ending 30 June 2018, 2017 and 2016, and the income year before the current year will be the year ending 30 June 2017 (the 2017 income year). | Detailed Reasoning - Early stage test: Incorporation or Registration – paragraph 360-40(1)(a) 50. As the Company was incorporated in the 2016 income year, which is within the last 3 income years, subparagraph 360-40(1)(a)(i) is satisfied. Total expenses – paragraph 360-40(1)(b) 51. As the Company had expenses less than $1 million in the prior income year, paragraph 360-40(1)(b) is satisfied. Assessable income – paragraph 360-40(1)(c) 52. As the Company’s’ assessable income for the prior income year was less than $200,000, paragraph 360-40(1)(c) is satisfied. No stock exchange listing – paragraph 360-40(1)(d) 53. As the Company is privately owned and is not listed on any stock exchange in Australia or a foreign country, subparagraph 360-40(1)(d) is satisfied. Conclusion on early stage test 54. The Company will satisfy the early stage test for the entire 2018 income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - Principles based test: Developing new or significantly improved innovations for commercialisation – subparagraph 360-40(1)(e)(i) 55. According to the Company, it will be developing the platform. Although it will initially be targeted at the Australian market, the platform has been identified as having a wider international addressable market. 56. Once developed the platform will bring together features that will make the Company’s platform unique in the market. 57. The Company will be the first to offer such a platform. 58. Looking at the Australian market what will be offered on the platform could be considered to be new or significantly improved. Genuinely focussed on developing for commercialisation – subparagraph 360-40(1)(e)(i) 59. The Company has taken the following steps in developing the platform: k. market research l. Utilising the expertise and experience of individuals. 60. This has led to the Company building upon current systems/software to provide a market leading platform utilising a tool (currently being developed). 61. The Company will pursue sales through : m. Facebook Likes n. EOIs Conclusion on subparagraph 360-40(1)(e)(i) 62. The Company is genuinely focussed on developing the platform for a commercial purpose. The platform will be a significantly improved product compared to existing products. 63. Therefore, subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 1 July 2017 until 30 June 2018 or the date when the platform has been fully developed, whichever occurs earliest. Once the platform 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. High growth potential – subparagraph 360-40(1)(e)(ii) 64. The Company is focused on becoming the world’s largest platform. 65. Statistics show there is a demand for the platform. 66. With access to a database, the Company can target users as potential customers of their platform. 67. Should the targeting strategies work, then there is a potential for high growth. 68. As the Company has demonstrated that the market for its platform has high growth potential, subparagraph 360-40(1)(e)(iii) has been satisfied. Scalability – subparagraph 360-40(1)(e)(iii) 69. The cost of designing and developing the platform are significant in the early stages. However the platform has the ability to scale efficiently. 70. As more people sign up to use the platform the development costs and maintenance costs will fall. 71. The reduction in unit costs demonstrates the Company’s potential to successfully scale up its business. Therefore, subparagraph 360-40(1)(e)(iii) will be satisfied. Broader than local market- subparagraph 360-40(1)(e)(iv) 72. The Company’s’ platform will be targeted at the Australian market which will expand to international consumers when permitted in the relevant jurisdictions. 73. The Company has demonstrated the platform has the potential to address a broader market than just the local market, including international markets. Therefore, subparagraph 360-40(1)(e)(iv) will be satisfied. Competitive advantages – subparagraph 360-40(1)(e)(v) 74. The Company has stated that their platform will have the following differentiating features which may give it a competitive advantage: o. No other platform provides a package which combines all the features of the Company’s platform. 75. Being the first of such platform the Company has the first mover advantage. 76. Through its investor and partner the Company has access to an already established customer base which may give rise to a high barrier of entry for a competitor wishing to compete with The Company platform. 77. The Company has demonstrated the potential for the platform to have competitive advantage therefore satisfying subparagraph 360-40(1)(e)(v). Conclusion on principles test 78. The Company satisfies the principles based test as it satisfies the requirements within subparagraphs 360-40(1)(e)(i)to (v) for the period commencing 1 July 2017 until 30 June 2018 or the date when the platform has been fully developed, whichever occurs earlier. Conclusion 79. The Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 2016 until the earlier of 30 June 2017 or the date when the platform has been fully developed and is ready for sale, whichever occurs earlier.