Private ruling: Early Stage Innovation Company
Date of advice: 17 August 2018
Published: October 2018
Ruling period: x xx 20XX to y yy 20YY
Date scheme commenced: x xx 20XX

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 1997 ’)? | A1: Yes | Q2: Are Investors entitled to a tax offset and modified capital gains treatment for shares in Company A, pursuant to Subdivision 360-A of the ITAA 1997 ? | A2: We are unable to answer this question as it does not relate to the tax affairs of Company A. Please refer to additional information we have provided for prospective investors.

Relevant facts and circumstances: 1. Company A is a proprietary company incorporated and registered in the Australian Business Register on zz zz 20ZZ. 2. Company A’s Directors are Taxpayer B and Taxpayer C. 3. For the financial year ending xx xx 20XX, Company A has incurred and earned the following: a. Total expenses of $x b. Total income of $y 4. 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. 5. Company A is developing an online system (the ‘Product’), which will significantly improve the business process. 6. The Product enables candidates to nominate their preferences across the applicable business market and combines with the traditional profile creation. 7. The Product allows shortlisting of preferences, where users are matched based on the preferences. 8. The Product determines the ‘fit’ between the users, based on their assessment. Users appear in shortlists as both a code and a percentage suitability score. 9. By utilising Company A’s Product, users will save up to 3x the cost of a standard process and will be able to place users 4x faster than traditional methods. 10. Company A is continuing to develop the Product. Company A predicts that there is still approximately x,000 hours of development left to be completed before the Product is fully developed and ready for general release, however this is dependent on developer resources. 11. Company A ‘s Product has been identified as having an international addressable market. 12. Research and a very high volume of business development meetings indicate high demand for an alternative to the inefficient and expensive traditional process. 13. The scalability potential of the platform is global with no more than the usual challenges of global deployment. 14. Company A has identified competitive advantages over its competitors. Information provided 15. 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 x xx 20XX b. Responses to further information as requested by the ATO c. Responses to numerous emails 16. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances. 17. 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: 18. 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’: 19. 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): 20. 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). 21. 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. 22. 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): 23. 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): 24. 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): 25. 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: 26. 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: 27. 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): 28. 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. 29. 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. 30. 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: 31. 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…” 32. 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. 33. 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. 34. 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.” 35. 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. 36. 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: 37. 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: 38. 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: 39. 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: 40. 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: 41. 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 x xx 20XX, and on or before y yy 20YY. | Detailed Reasoning - Current year: 42. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the current year will be the year ending y yy 20YY (the 20YY income year). For clarity, in relation to particular requirements within subsection 360-40(1), the last 3 income years will include the years ending y yy 20YY, 20XX and 20ZZ, and the income year before the current year will be the year ending x xx 20XX (the 20XX income year). | Detailed Reasoning - Incorporation or Registration – paragraph 360-40(1)(a) ITAA 1997: 43. Company A was incorporated on x zz 20ZZ, 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) ITAA 1997: 44. 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 20XX income year, being the income year before the current year. 45. Company A incurred expenses of $x in the 20XX income year. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income – paragraph 360-40(1)(c) ITAA 1997: 46. 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 20XX income year, being the income year before the current year. 47. Company A did not earn any assessable income in the 20XX income year. Consequently, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No Stock Exchange listing – paragraph 360-40(1)(d) ITAA 1997: 48. 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. 49. 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: 50. Company A satisfies the early stage test for the 20YY 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: 51. 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: 52. 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. 53. Company A is currently developing an online system (the ‘Product’), which will significantly improve the business process. 54. The Product enables users to nominate their preferences across the market. 55. The Product allows shortlisting, where users are matched based on preferences – considering a number of parameters. 56. The Product determines the ‘fit’ between users, based on their assessment. Users appear in shortlists as both a code and a percentage suitability score. 57. Company A has developed the market leading analysis to create a better understanding for users on whether the new process undertaken will be a good fit - something which is currently opaque to users. 58. Company A sits in a unique position to improve this understanding as they provide a private service - users are not known to each other until later in the process - so they are able to establish true and trusted relationships with users. This will allow Company A to collect and interpret real and meaningful data. 59. By utilising Company A's Product, employers will save up to 3x the cost of the standard process and will be able to place users 4x faster than traditional methods. 60. Company A’s Product will allow users to meet their goals more readily, as they can find more users much faster than with traditional methods. 61. Company A’s Product is a significantly improved product within the addressable market. 62. Between y 20YY and x 20XX, development work has continued on the Product, including market research, concept development, custom builds of database architecture, user interface builds, site testing, MVP launches, user acquisition and digital marketing. 63. Since x 20XX, development is continuing on the Product. Company A has begun talking to users, introducing the platform and introducing their services as a platform first. 64. Company A are monitoring the user journey through Analytics, trying to improve the middle of the funnel by changing the process the user inputs their details. At present Company A has acquired over x,000 user emails, with users having varying levels of completion. 65. Company A has chat enabled on the site to converse with users as they move through the process. Company A are in the sales process, having acquired x companies using their services to place users in their preferred process so far. 66. Company A is developing a significantly improved Product, an online system for an applicable addressable market. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997 67. 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. 68. 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. 69. Company A is genuinely focussed on developing their Product for a commercial purpose, so subparagraph 360-40(1)(e)(i) will be satisfied for the period x xx 20XX to y yy 20YY or the date when the Product has been fully developed, whichever occurs earliest. Once the Product has been fully developed, Company A 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: 70. 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. 71. Company A has extremely high growth potential as the platform is easily and infinitely scalable to a global audience. 72. Their target industry is not an industry under any threat of replacement and the majority of the cost is in the platform itself. 73. As the company grows, Company A will take on more cities and more industries which will only involve an incremental increase in account managers and platform developers. 74. Research and a very high volume of business development meetings indicate high demand for an alternative to the inefficient and expensive traditional process. 75. Company A has demonstrated a high growth potential for their Product, so subparagraph 360-40(1)(e)(ii) is satisfied for the period x xx 20XX to y yy 20YY. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997: 76. 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. 77. The scalability potential of the platform is global with no more than the usual challenges of global deployment. 78. The company is a <.com> address which translates well to a global audience. 79. The company has engaged multiple mentors with a view to investment and will utilise their professional networks when growth justifies it. 80. Company A will scale industry by industry, postcode by postcode, employing industry experts as advisors as they move into each new sector. 81. 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 x xx 20XX to y yy 20YY. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997: 82. 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. 83. Company A will reach significant numbers of user registrations and site traffic from overseas. Although Company A has not spent any marketing dollars in these regions, they have indications that word is spreading and there is an interest in those regions for the innovative solution which Company A provides. 84. As an online platform, Company A has a potential global market, which will be able to expand when commercially sensible to do so. 85. 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 x xx 20XX to y yy 20YY. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v) ITAA 1997: 86. 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. 87. Company A has identified x key competitive advantages over its competitors: i. The relationship in matching is based on user preferences - providing us a customer centricity and breaking a path dependency that exists in the market. ii. The method of match gives Company A a first mover advantage and puts it logically as the first port of call in a search - by having a free search process. iii. The Product is typically three times cheaper than the other outsourced method that can actively find users. This is due to removing the expensive elements of the process. iv. Company A will be in the best position to develop true intelligence in fit, as it is establishing credibility and trust with both users. Company A will store private data from both users to help both parties create more productive environments. Company A has a unique advantage to do this. v. Company A can establish partnerships with industry associations looking to provide services to their members. For example, a professional association, who is wishing to provide a service to its' members to help them find better services, can outsource the board to us as a white label service. vi. Because of the depth of data, Company A can provide a pathway tool (currently in development). This pathway allows people, particularly those with less experience, to see what users say about different processes. vii. The dashboard Company A provides, combining all the data mentioned previously, enables Company A to give the user unrivalled, live and real feedback on their position within the marketplace. 88. Company A has demonstrated that it has competitive advantages over its competitors, so subparagraph 360-40(1)(e)(v) is satisfied for the period x xx 20XX to y yy 20YY. | 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 x xx 20XX to y yy 20YY or the date when the Product has been fully developed, whichever occurs earliest.. | Detailed Reasoning - CONCLUSION: Company A meets the eligibility criteria of an ESIC under section 360-40 for the period x xx 20XX to y yy 20YY or the date when the Product has been fully developed, whichever occurs earliest.

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