Private ruling: Early Stage Innovation Company
Date of advice: 17 February 2020
Published: March 2020
Ruling period: Year ended 30 June 2020
Date scheme commenced: 1 July 2019

Ruling: Q1: For the year ending 30 June 2020 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 registered on the Australian Business Register in the 2019 income year. 2. The Company has no subsidiaries and is not listed on any stock exchange. 3. The Company did not incur any expenditure or derive any assessable income for the year ended 30 June 2019. 4. The Company is developing a platform utilising artificial intelligence (AI) and leverages analytics. 5. The platform is a 'do-it-yourself' platform where all users will manage the product themselves. 6. A large amount of unique intellectual property (IP) has been developed by the Company in FY20. 7. The platform will be using technology from Google, allowing the Company to get to market quickly. Systems already in development include a website and a Beta version of the platform. 8. The Company is creating a tool that does not exist in the market today and will be creating technology, systems and algorithms that deliver strategic answers to the user. 9. No similar product or platform currently exists. There are competitors working on some parts of the platform but the whole process does not exist elsewhere. The complete set of features that the Company offers cannot be found elsewhere in the market. There are platforms that offer parts of the process but no other platform offers end to end capability like he Company's platform. 10. The product will be offered on a subscription basis or on a project basis. 11. The Company will own the IP and will be able to use the IP commercially. No relationship with any developer exists that could restrict the Company's ability to use the IP commercially. 12. Once the technology and AI is developed, the human interface will be limited and the product is able to be scaled without a proportional increase in costs. 13. The Company is currently in discussions with a number of clients who want to participate in its Client Pilot Program. 14. Systems already in development include a website and a Beta version of the platform which will utilise algorithms and conversational AI to provide businesses with a powerful platform to connect with their customers. 15. The platform has initial setup costs, however it provides the opportunity for significant scale. 16. The main markets into which the Company is looking to expand, after Australia and New Zealand, are Country A and Country B. Both markets have large qualitative research spends. Information provided 17. You have provided information in a number of documents including: a. Your private ruling application. b. Business Growth Grant Application Form. c. Financial modelling 18. 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 360-40 Income Tax Assessment Act 1997 section 360-45 Summary The Company meets the eligibility requirements of an ESIC under subsection 360-40(1). 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. 'The early stage test' 2. The early stage test requirements are outlined in detail within paragraphs 360-40(1)(a) to (d). 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 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. 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. 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. 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. 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. The Company has applied for this ruling on the basis that it meets the principles-based test. 'Principles-based test' - subparagraphs 360-40(1)(e)(i) to (v) 10. 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. 11. 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. 12. 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. Developing new or significantly improved innovations for commercialisation 13. 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..." 14. 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. 15. 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. 16. The OECD Oslo Manual defines innovations as significant changes, with the intention of distinguishing significant changes from routine minor changes. An innovation can also consist of a series of smaller incremental changes that together constitute a significant change. 17. 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. 18. The EM does not define the meaning of the term 'genuinely focussed' within the context of subparagraph 360-40(1)(e)(i). Genuine is defined in the online Macquarie Dictionary as " Being truly such; real; authentic ." Focus is defined as " 3. a central point, as of attraction, attention, or activity. ... 8. to concentrate; to focus one's attention. " In essence, the phrase "genuinely focussed" is looking to what the company is truly concentrating and focussing their attention on or, put another way, what is the real central point of the company's activities. 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. 20. 'Commercialisation' is discussed further at paragraph 1.81 in the EM which states "Commercialisation encompasses a spectrum of activities including those leading to the sale of new or significantly improved product, process or service as well as activities involving the implementation of a new, or significantly improved, process or method, where the process or method directly leads to the generation of economic value for the company." High growth potential 21. 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. Scalability 22. 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. Broader than local market 23. 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 24. 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. Application to your circumstances Test time 25. 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 2020. Current year 26. For the purposes of subsection 360-40(1), the current year will be the year ended 30 June 2020 (the 2020 income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last three income years will include the years ended 30 June 2020, 2019 and 2018, and the income year before the current year will be the year ended 30 June 2019 (the 2019 income year). Early stage test Incorporation or Registration - paragraph 360-40(1)(a) 27. As the Company was incorporated in the 2019 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) 28. As the Company had no expenses in the prior income year, paragraph 360-40(1)(b) is satisfied. Assessable income - paragraph 360-40(1)(c) 29. As the Company had no assessable income for the prior income year, paragraph 360-40(1)(c) is satisfied. No stock exchange listing - paragraph 360-40(1)(d) 30. 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 31. The Company will satisfy the early stage test for the entire 2020 income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. Principles based test Developing new or significantly improved innovations - subparagraph 360-40(1)(e)(i) 32. The Company is a company that is developing a platform anchored in AI and leverages analytics. The platform utilises AI, machine learning and algorithms to find themes and trends. 33. The platform allows the user to manage the product themselves. 34. The platform being created by the Company does not exist in the market today. The company will be creating technology, systems and algorithms that deliver strategic answers to the user. Although there are competitors working on some parts of the platform, the whole process does not exist elsewhere. That is, the complete set of features that the Company offers cannot be found elsewhere in the market. There are platforms that offer parts of the process but not the end to end capability of the Company's platform. Consequently, the platform is considered an innovation. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) 35. During the 2020 income year the Company has done the following: · developed a tried and tested processes; · created and published many pieces of thought leadership; and · created and developed two models. 36. The Company intends using technology from Google, allowing the Company to get to market quickly. Systems already in development include a website and a Beta version of the platform which will utilise algorithms and AI to provide businesses with a powerful platform to connect with their customers. 37. Based on the above, the Company is genuinely focussed on developing the innovation for commercial purposes. Therefore, subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 1 July 2019 until 30 June 2020 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 platform for commercialisation and subparagraph 360-40((1)(e)(i) will no longer be satisfied. Conclusion on subparagraph 360-40(1)(e)(i) 38. The Company is genuinely focussed on developing its platform for a commercial purpose. This platform will include features that are not currently available as an end to end process in the market and is clearly an innovation. 39. Therefore subparagraph 360-40(1)(e)(i) will be satisfied for the time period from 1 July 2019 until 30 June 2020 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 platform for commercialisation and subparagraph 360-40((1)(e)(i) will no longer be satisfied. High growth potential - subparagraph 360-40(1)(e)(ii) 40. According to Ibis World (2018-2019 data in Australia), the annual research spend by enterprise is $3.1 billion. Of this amount, 21.6% (approximately $670 million) relates to qualitative research services. 41. The use of the Company's product will allow large corporate entities to retain some of this expenditure in-house and use the platform to explore those ideas that haven't previously been explored due to lack of resources. 42. The Company is currently in discussions with a number of clients who want to participate in its Client Pilot Program. 43. With the potential to access large corporate entities, combined with ongoing negotiations with possible clients, the Company can reasonably demonstrate that a high growth potential exists. Subparagraph 360-40(1)(e)(ii) is satisfied. Scalability - subparagraph 360-40(1)(e)(iii) 44. As the Company is developing a cloud based tool it is not impacted by factors such as manufacturing capability or size of premises. Ongoing costs would not be expected to increase in a linear fashion alongside its increase in market penetration. As the number of users increases, the Company's growth can be leveraged against already developed information technology. 45. Indeed, once the technology and AI is developed and applied to formulate its outcomes, the human interface will be limited and the product is able to be scaled without a proportional increase in costs. All users will manage the product themselves and as the product scales, human involvement becomes limited. 46. As a software platform, the Company can demonstrate the 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) 47. As stated previously, the annual research spend by enterprise is $3.1 billion. Of this amount, 21.6% (approximately $670 million) relates to qualitative research services. 48. The Company's business plan includes the globalisation of the business. The main markets targeted are Country A and Country B markets, both have large qualitative research spends. 49. The market for the Company's investment operating system is broader than the local market. Subparagraph 360-40(1)(e)(iv) is satisfied. Competitive advantages - subparagraph 360-40(1)(e)(v) 50. The Company will own the IP developed and will be able to use it commercially. 51. The Company can provide lower cost for businesses than using an agency. 52. The Company will enjoy the benefit of first-mover advantage insofar as the platform being created by the Company does not exist in the market today. That is, the complete set of features offered cannot be found elsewhere in the market. There are platforms that offer parts of the process but not the end to end capability of the Company's platform. 53. These factors demonstrate the potential for the Company's platform to have competitive advantages, satisfying subparagraph 360-40(1)(e)(v). Conclusion on principles test 54. 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 2019 until 30 June 2020 or the date when the platform has been fully developed and is fully commercialised, whichever occurs earlier. Conclusion 55. The Company meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 2019 until 30 June 2020 or the date when the platform has been fully developed and is fully commercialised, whichever occurs earlier.