Private ruling: Early Stage Innovation Company eligibility.
Date of advice: 18 August 2017
Published: December 2017
Ruling period: 1 January 201B to 30 June 201B
Date scheme commenced: 1 July 201A

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 ? | A1: Yes

Relevant facts and circumstances: Background 1. Company A is a proprietary company incorporated and registered in the Australian Business Register in early 201B. 2. The Director of Company A is B, the founder and former CEO of an online marketplace company that connects customers and businesses. 3. Company A has issued ordinary shares to various shareholders since its registration in early 201B. 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. Description of Company A’s business premise 5. Company A is a business within a global industry. 6. Company A is developing a service to bring together vendors on products and services in a market – by consolidating products to a one-stop shop website. 7. Company A anticipates that development of the service will continue into the 201B/CC year. 8. Commercialisation of the service will take place in 2 parts: i. Company A will market their product directly to consumers via acquisitions, search engine marketing (paid and organic), content marketing, video marketing and influencer outreach. ii. Company A have the potential to licence their platform to existing agents for a fee or percentage commission per sale which they make off the platform. 9. Company A‘s one-stop shop service would represent a global aggregator of products for a worldwide market. 10. Company A‘s service has been identified as having an international addressable market. 11. Using Company A’s website, customers are able to search databases to find their ideal product and service, based on ratings, price, discounts and description. 12. Global customers purchase and pay for their products via Company A‘s service. Funds received are transferred to the respective third party vendors, less the agreed fees of z% which are paid to Company A. Information provided 13. You have provided a number of documents containing detailed information in relation to Company A, including: a. Private Binding Ruling (‘PBR’) Application, dated mid 201B. b. Appendix A – A Memorandum to Company A’s Director, dated mid 201B c. A listing of shares issued to Shareholders d. A spreadsheet detailing forecast revenue and costs e. Responses to further information as requested by the ATO 14. 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: Detailed Reasoning - Qualifying Early Stage Innovation Company: 15. 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’: 16. 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): 17. 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). 18. 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. 19. 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): 20. To meet the requirement in paragraph 360-40(1)(b), the company and its 100% subsidiaries must have incurred total expense 21. s of $1 million or less in the income year before the current year. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c): 22. To meet the requirement in paragraph 360-40(1)(c), the company and its 100% subsidiaries must have derived total assessable income of $200,000 or less in the income year before the current year. | Detailed Reasoning - No stock exchange listing - paragraph 360-40(1)(d): 23. To meet the requirement in paragraph 360-40(1)(d), the company must not be listed on any stock exchange in Australia or a foreign country. | Detailed Reasoning - Innovation tests: 24. If the company satisfies the early stage test, the company must also satisfy one of two innovation tests: the objective (100 point) test or the principles-based test. | Detailed Reasoning - ‘100 point test’ – paragraph 360-40(1)(e) and section 360-45: 25. To satisfy the 100 point test the company must obtain at least 100 points by meeting the innovation criteria in the table within section 360-45. The criteria are tested at a time immediately after the relevant shares are issued. If a company satisfies this test it does not need to satisfy the principles-based test. | Detailed Reasoning - ‘Principles-based test’ – subparagraphs 360-40(1)(e)(i) to (iv): 26. To satisfy the principles-based test, the company must meet five requirements in paragraph 360-40(1)(e). This is tested at a time immediately after the relevant new shares are issued to the investor. 27. The company can demonstrate that it meets each requirement through existing documentation such as a business plan, commercialisation strategy, competition analysis or other company documents. The company must be able to show that tangible steps have been or will be taken in relation to each of the requirements. 28. The five requirements of the principles-based test, as outlined in paragraph 360-40(1)(e) are: i. the company must be genuinely focussed on developing for commercialisation one or more new or significantly improved products, processes, services or marketing or organisational methods ii. the business relating to that innovation must have a high growth potential iii. the company must demonstrate that it has the potential to be able to successfully scale up the business relating to the innovation iv. the company must demonstrate that it has the potential to be able to address a broader than local market, including global markets, through that business, and v. the company must demonstrate that it has the potential to be able to have competitive advantages for that business. | Detailed Reasoning - Developing new or significantly improved innovations for commercialisation: 29. For the purposes of Subdivision 360-A, the Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016 (‘EM’) provides the following at paragraph 1.76 in relation to the definition of innovation: “Implicit in the definition of innovation is the requirement that the company is developing a new or significantly improved type of innovation such as a product, process, service, marketing or organisational method. This list of various types of innovations provides flexibility for innovation companies and is adaptable to current and future innovations. The Oslo Manual, published by the Organisation for Economic Co-operation and Development (OECD) provides a description of these different types of innovations…” 30. The innovation being developed by the company must either be new or significantly improved for an applicable addressable market. The company’s addressable market is the revenue opportunity or market demand arising from the innovation or the related business. The addressable market must be objective and realistic. 31. Improvements must be significant in nature to meet this requirement. Significant is defined in the online Macquarie Dictionary as “ important; of consequence .” Customising existing products or minor changes resulting from software updates, pricing strategies or seasonal changes are examples of improvements that would not be considered significant. 32. The OECD Oslo Manual, in relation to defining innovative services, states at paragraph 161 that “innovations in services can include significant improvements in how they are provided (for example, in terms of their efficiency or speed), the addition of new functions or characteristics to existing services, or the introduction of entirely new services.” 33. The company must be genuinely focussed on developing the innovation for a commercial purpose in order to generate economic value and revenue for the company. This requirement draws the distinction between simply having an idea and commercialising an idea. 34. For a company to qualify as an ESIC under the principles based test, the company must be “genuinely focussed on developing for commercialisation” their innovation. That is, the central activities of the company must be truly concentrated on developing their innovation for a commercial purpose. ‘Commercialisation’ includes a range of activities that involve the implementation or sale of a new or significantly improved innovation that will directly lead to the generation of economic value for the company. | Detailed Reasoning - High growth potential: 35. The company must be able to demonstrate that the business relating to the innovation has a high growth potential within a broad addressable market. This refers to the company’s ability to rapidly expand its business. Companies that are limited to supplying local customers will not meet this requirement. | Detailed Reasoning - Scalability: 36. The company must be able to demonstrate that it has the potential to successfully scale up the business relating to the innovation. The company must have operating leverage, where as it increases its market share or enters into new markets, its existing revenues can be multiplied with a reduced or minimal increase in operating costs. | Detailed Reasoning - Broader than local market: 37. The company must be able to demonstrate that it has the potential to address a market that is broader than a local city, area or region. The company does not need to have a serviceable market at a national, multinational or global scale at the test time. However, it does need to show that the business is capable of addressing a market that is broader than a local market and that the business can be adapted to a broader scale in the future. | Detailed Reasoning - Competitive advantages: 38. The company must be able to demonstrate that it has the potential to have competitive advantages, such as a cost or differential advantage over its competitors which are sustainable for the business as it expands. The company can analyse what competitors in the market offer, and consider whether the company has a differentiating advantage that would allow it to outperform these competitors. | Detailed Reasoning - TEST TIME: 39. For the purposes of this ruling, the ‘test time’ for determining if Company A is a qualifying ESIC, is the time immediately after any shares are issued to investors. Company A shares were issued mid 201B and mid 201B, so these are the ‘test times’ for which Company A must meet the ESIC requirements. | Detailed Reasoning - Current year: 40. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the current year will be the year ending 30 June 201B (the 201B 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 201B, 201A and 201D. | Detailed Reasoning - Incorporation or Registration – paragraph 360-40(1)(a) ITAA 1997: 41. Company A was incorporated early 201B, 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: 42. In applying the requirements of paragraph 360-40(1)(b), Company A and any of its 100% subsidiaries must have incurred total expenses of $1 million or less in the 201A income year, being the income year before the current year. 43. Company A did not exist in the 201A income year, so did not incur any expenses. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income – paragraph 360-40(1)(c) ITAA 1997: 44. In applying the requirements of paragraph 360-40(1)(c), Company A and any of its 100% subsidiaries must have derived total assessable income of $200,000 or less in the income year before the current year. 45. Company A did not exist in the 201A income year, so did not earn any assessable income. Consequently, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No Stock Exchange listing – paragraph 360-40(1)(d) ITAA 1997: 46. In applying the requirements of paragraph 360-40(1)(d), Company A must not be listed on any Stock Exchange in Australia or a foreign country at the test time. 47. Company A was not listed on any Stock Exchange in Australia or a foreign country at either test time, so paragraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: 48. Company A satisfies the early stage test for the 201B income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - THE ‘100 POINT TEST’ – paragraph 360-40(1)(e) and section 360-45: 49. Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 201B. For Company A to be a qualifying ESIC, it will need to satisfy the principles-based test. | Detailed Reasoning - Developing new or significantly improved innovations for commercialisation – subparagraph 360-40(1)(e)(i) ITAA 1997: 50. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be developing an innovation which is either new or significantly improved for an applicable addressable market. 51. Company A is currently developing an online service to bring together third-party vendors on all products and services in a market – by consolidating products to a one-stop shop website. 52. Company A’s service will provide a service for allowing consumers to book products and to receive instant, live pricing and confirmation. 53. The booking process as it currently stands is that a consumer submits a form to a third party agent with information. 54. Presently, the agent manually looks up the product either via an internal portal, manual spreadsheet or phone/email to various providers to verify availability and price. These manual processes are often hit and miss and may take approximately 20-30 minutes per query. The response times may be up to 1-2 business days, which is unacceptable to many consumers, who may be looking for instant confirmation and pricing. These processes also make it difficult for consumers to compare products, as often this would mean a lot of back and forth with the agent, and prices are often subject to change. 55. Two of the largest product providers in Australia currently adopt this approach. The largest product provider in X also uses this same approach. 56. Company A’s service utilises a novel database feature. This database is currently being populated with statistical data from more than 200,000 providers to suggest to consumers which product would suit their preferences best, based on a number of criteria. 57. Compared to its major competitors in Australia, and in X, Company A’s service features have been documented. 58. Current response times for consumer inquiries in the global market are anywhere between three hours to two or three business days, and services are only available during business hours. 59. Company A is currently developing technology that will completely revolutionise the product space. Company A’s service will integrate directly with more than 100 providers across Australia and the world to provide users with live package pricing, availability, ratings and comparison information. 60. Company A has X developers working fulltime, integrating the different platforms of various suppliers – some of the major platforms are currently being integrated. 61. Company A’s service will allow users to book their product with accurate pricing and to receive instant confirmation of their booking. 62. Such a product offering does not currently exist on the market in Australia or worldwide, so Company A is developing a service which is new, and is identified as having an international addressable market. | Detailed Reasoning - Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997: 63. In applying the requirements of subparagraph 360-40(1)(e)(i), Company A must be genuinely focused on developing an innovation for a commercial purpose in order to generate economic value and revenue for the company. 64. Company A has taken the following steps in developing their service: a. They have engaged X full time software developers to their permanent staff to work on the development of their Service b. Engaged a Chief Technology Officer and Co-Founder who was previously the lead developer at an online marketplace company that connects customers and businesses, and has more than twelve years of experience in software development c. Building the platform on software with the most current technology available., d. Almost completed their system integration with Z different suppliers who are all running on separate systems and backend code – this will be an ongoing task.. e. They have commenced populating a database with more than 20,000 suppliers– with statistical data. 65. Company A are also in the process of developing the front-end experience. This will be critical to the product’s success, as Company A needs to ensure that all users of the website and app can access any information they need seamlessly during their booking experience. 66. Company A have already engaged with the majority of suppliers and providers. They are currently negotiating contracts with suppliers in Australia and overseas. 67. Company A understands from both their suppliers and competitors, that the average product is expensive, and that the majority of suppliers are willing to pay more than 10% commission for any inventory which Company A sells. 68. Company A anticipates completing negotiations and having signed contracts with all their overseas suppliers well ahead of late 201B. 69. Company A anticipates completing negotiations and having signed contracts with all their Australian suppliers well ahead of early 201C. 70. Commercialisation will take place in 2 parts: i. Company A will market their product directly to consumers via acquisitions, search engine marketing (paid and organic), content marketing, video marketing and influencer outreach. ii. Company A have the potential to licence their platform to existing travel agents for a fee or percentage commission per sale which they make off the platform. 71. Company A’s service will be a new product compared to any product access system currently used in the Australian or worldwide market. Company A is genuinely focused on developing their service, an online marketplace, for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period early 201B to mid 201B. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997: 72. 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. 73. Company A’s service will appeal to consumers looking for certain products, within the Australian market, based on the following: a. The current market is not organised to provide easy and reliable website access between products and potential customers, resulting in difficulties and delays when customers book their products. b. Company A’s service is unique in that it allows customers to search databases to find their ideal product and service, based on ratings, price, discounts and description. c. Company A’s service is a one-stop shop website which represents a global aggregator of products worldwide, allowing customers to search possible products in a global context. 74. Company A has projected revenue sales for the next three years to grow considerably. 75. Company A has demonstrated a high growth potential for their service, an online marketplace, so subparagraph 360-40(1)(e)(ii) is satisfied. | 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 core of Company A’s service is the web based portal which uses software and a technology framework to provide an effective and reliable service which provides a one-stop shop web based product booking system for consumers for all their requirements. 78. Company A are progressing with building the software which is the most current technology available, but also extremely popular with a view to being able to then hire more developers and grow the size/bandwidth of the platform as the product begins to scale. 79. Company A is working on completing their backend system integration with Z different suppliers who are all running on separate systems and backend code – this will be an ongoing task. 80. Once the software and technology has been fully designed and tested with target customers, Company A will be able to market and increase sales to customers. 81. Once Company A completes and launches a successful web based portal, they will then be able to scale the business, by expanding their sales and generating increased revenue with only a minimal increase in their operating costs, due to their service interface being completed. 82. Company A are able to scale up their business through: a. Global Reach: Company A will have global reach through the internet. Company A currently has more than 400,000 unique sessions globally via their wholly owned website. Company A are confident that they will be able to grow this web traffic. b. Technology: Company A has the capability to identify ideal products with live pricing and comparisons. Company A will scale this to capture all product bases in the world. c. Advisory Network: Given the founders are all technology entrepreneurs, the founding team have access to a strong network of board level advisors, investors, and venture capital offers. 83. Company A will be able to leverage off their technology web based platform and algorithms to identify the ideal product for their audience and offer live pricing for every aspect of their service. 84. This operating leverage ensures that Company A has the potential to successfully scale up its business, so subparagraph 360-40(1)(e)(iii) is satisfied. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997: 85. 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. 86. Company A’s service is a web based portal system which they are developing and has been designed to be used as both a national and global service, including Australia and the world. 87. Company A expects to complete integration with major worldwide platforms by late 201B, after which they will have access to roughly 70% of all available inventory. Company A will continue working to integrate over 100 individual suppliers across Australia and the world. 88. In their projections, Company A anticipate to have access to approximately 90-95% of all available inventories by mid 201C. 89. 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. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v) ITAA 1997: 90. 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. 91. Company A has identified a number of competitive advantages it has in the product market: i. The Service will have live pricing and availability display and ii. The built in database 92. Company A’s database has 2 main functions which are not currently available in the global market. 93. Company A’s current competitors are all ‘traditional’ agents. Due to the nature of these products and their complexity, agents currently receive an enquiry via email and then reply to the customer either that day or the next business day. Company A’s ability to provide this information in a much shorter timeframe gives it a competitive advantage. 94. Company A has demonstrated that it has competitive advantages over its competitors, so subparagraph 360-40(1)(e)(v) is satisfied. | 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 commencing early 201B until mid 201B. | Detailed Reasoning - CONCLUSION: Company A meets the eligibility criteria of an ESIC under section 360-40 for the period commencing early 201B until the earlier of mid 201B or the date when their service has been fully developed and is ready for client use, whichever occurs earlier.