Private ruling: ESIC Principles Based Test
Date of advice: 30 March 2017
Published: August 2017
Ruling period: 1 July 20YY to 30 June 20ZZ
Date scheme commenced: 20VV

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: No.

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. 1. The Company was incorporated in in 20VV. Its equity interests are not listed for quotation in the official list of any stock exchange. 2. The Company has no subsidiaries and is in its X year of existence. 3. The Company had income of less than $200,000 in the 20YY year. 4. The Company had expenses of less than $1,000,000 over the 20XX - 20ZZ years. 5. The Company has developed a funding rewards based platform. 6. The platform is built with readily available software for operating, hosting and payments. 7. The platform launched in 20WW. It allows for All or Nothing and Flexible campaigns to run. Payments are transferred immediately in Flexible campaigns. 8. The Company is initially targeted at the Australian market. 9. The Company is also looking to expand into other countries and have created an overseas landing page and adapted the content for this market. 10. Improvements to the funding platform since 20WW has included: ● The introduction of a new payment gateway ● The introduction of a multi-currency capability on the platform ● The introduction of a CRM system ● Registration of the logo as a trade-mark with IP Australia ● The brand registered with an internet search facility searchable by selected key search terms 11. The Company has 3 separate revenue streams: ● Campaign Fees - Where The Company creates and operates its own funding platforms revenue will be generated a % of funds raised through the platforms. For this platform the standard fee arrangement is X% of the funds raised. ● Platform Creation Fees - Where The Company develops and creates funding businesses a revenue stream will comprise of both the consulting fee for developing the platform and the business model and in certain cases a % of the revenue that is driven through the platform. ● Expert Referral Fees - As well as creating and developing the business The Company continues to build a network of funding consultants and a community of campaign builders with a range of skills. The Company takes a % of the fees charged by consultants that it introduces Commercialisation strategy 12. The majority of the build and development has been undertaken with the platform being operational. 13. Market research has been done on competitors with specific solutions being offered. This has lead The Company to the conclusion there is no other funding platform that exists in the form of theirs at commercialisation stage. 14. Developers were sourced to undertake design and testing on the platform to enable The Company to test new features being developed and make the platform available to other developers and testers to continue refining our solution. 15. In the last month further development has been undertaken to streamline and automate the customer relationship management and the sales process. An efficient system of integrating marketing, sales, and operational data as well as platform dashboards for managing transactions and campaigns now exists. 16. Current work includes advanced automation for the campaign creation build process, minor platform improvements and promotion and marketing of the product to global audiences. 17. The introduction and development of the multi-currency capability has provided the platform with the ability to operate in various overseas markets. 18. The payment mechanism enables the creators of flexible campaigns to take their share of pledges immediately as opposed to waiting for a specified period of time after the deadline date or the reaching of the monetary target. 19. The platform financial model generates income by a X% fee charge to funds raised through the platform by campaign creators. Information provided 20. You have provided information in a number of documents in relation to 'The Innovation', including: a. your private ruling application. b. supplementary information provided. 21. 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

Reasons for decision: Detailed Reasoning - Qualifying Early Stage Innovation Company: 22. 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': 23. 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): 24. 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). 25. 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. 26. 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): 27. 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): 28. 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): 29. 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: 30. 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: 31. 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): 32. 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. 33. 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. 34. 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: 35. 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…” 36. 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. 37. 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. 38. 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. 39. 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.” 40. 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.” 41. 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. 42. '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: 43. 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: 44. 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: 45. 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: 46. 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 47. 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 20ZZ. Current year 48. For the purposes of subsection 360-40(1), the current year will be the year ending 30 June 20ZZ (the 20ZZ 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 20ZZ, 20YY and 20XX, and the income year before the current year will be the year ended 30 June 20YY (the 20YY income year). | Detailed Reasoning - Early stage test: Incorporation or Registration - paragraph 360-40(1)(a) 49. As The Company was incorporated in 20VV, which is within the last six income years and across the last three of those income years the company incurred total expenses of less than $1 million subparagraph 360-40(a)(ii) is satisfied. Total expenses - paragraph 360-40(1)(b) 50. As The Company reported expenses of less than $1,000,000 in the 20YY year paragraph 360-40(1)(b) is satisfied. Assessable income - paragraph 360-40(1)(c) 51. As The Company had earnings of $X in the 20YY year paragraphs 360-40(1)(c) is satisfied. No stock exchange listing - paragraph 360-40(1)(d) 52. As The Company is an unlisted public company which is not listed on any stock exchange in Australia or a foreign country, subparagraph 360-40(1)(a)(d) is satisfied. Conclusion on early stage test 53. The Company will satisfy the early stage test for the entire 20ZZ income year, as each of the requirements within paragraphs 360-40(1)(a) to (d) have been satisfied. | Detailed Reasoning - 100 point test: 54. The Company has not provided any evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 20ZZ. For The Company to be a qualifying ESIC it will need to satisfy the principles-based test. | Detailed Reasoning - Principles based test: Developing new or significantly improved innovations for commercialisation - subparagraph 360-40(1)(e)(i) 55. The funding reward based programme has been developed and operating since 20WW 56. You have advised the following key achievements ● The platform went live in 20WW; ● An introduction of a new payment gateway provider in 20YY; ● The introduction of a multi-currency capability on the platform in 20YY; and ● The introduction of a CRM system that better tracks and drives customer engagement in 20ZZ. 57. You have advised there are some minor automation component upgrades to the platform which will enable the platform to operate with less manual input that the Company plans to implement by 20ZZ. 58. The Company has already hosted numerous fundraising campaigns with over 2/3rds of these being finalised. Some of these campaigns ended between 1-2 years ago. 59. The platform was fully developed and commercialised since 20WW. The Company has run campaigns since 20WW. However, as expected with all platforms minor upgrades will be undertaken to improve the operations of the platform, this in itself is not innovative. 60. You advise that the platform is innovative and offering a more efficient, cost effective and customisable solution that is unseen in the funding landscape. 61. You have achieved this through the use and adaptation of readily available products. For a product to be significantly improved the improvements must be significant in nature and customising existing products would not be considered significant. 62. Hence, The Company has not developed new or has made significant improvements for commercialisation, hence subparagraph 360-40((1)(e)(i) is not satisfied. High growth potential - subparagraph 360-40(1(e)(ii) 63. The platform is a funding rewards based programme aimed at small and medium businesses, including start-up companies. In Australia there are roughly 2.1 million small and medium sized businesses that The Company could target to use their site. 64. The Company has already provided solutions to businesses located across Australia. The breadth of types of businesses and the range of locations indicate the high growth potential through the ability to expand the use of this mobile platform. 65. The Company will continue to refine the platform and are aiming advertising at start-up companies in Australia. The Company is also looking to expand the platform in a foreign country and have had an overseas Head of Operations join the team and the content is being adapted for the overseas market. The Company has demonstrated the business relating to their platform has a high growth potential within a broad addressable market. 66. The introduction and development of the multi-currency capability has provided the platform with the ability to operate in various overseas markets. 67. Therefore, subparagraph 360-40(1)(e)(ii) will be satisfied. Scalability - subparagraph 360-40(1)(e)(iii) 68. As the platform is an internet based platform, with multi-currency payment functionality it does have the potential to successfully scale up its business. The platform generates income by taking a X% fee of the funds raised through the platform. The platform utilises Web Services so that the platform capability and database can be easily scaled as demand grows. As more businesses come on board the platform will make more money, without increasing costs. 69. The majority of the monthly costs are relatively fixed subject to any platform development work and enhancements The Company chooses to implement. Soon the operating costs will be reduced as the key platform's underlying architecture is finalised and will operate with reduced manual input thus increasing its commercial viability. Promotion costs are within your control and do not vary with volume. 70. Therefore, subparagraph 360-40(1)(e)(iii) will be satisfied. Broader than local market- subparagraph 360-40(1)(e)(iv) 71. The Company is initially targeted at the Australian market to provide a solution to Australian entrepreneurs. Different types of customers have used the solution to date. The breadth of types of businesses and the range of locations indicate the high growth potential through the ability to expand the use of this mobile platform. 72. Steps have been undertaken as part of the business expansion strategy where the overseas market has been identified as part of a two-stage expansion plan, firstly for the expansion of the platform and secondly for The Company as a niche platform developer. 73. An overseas 74. Head of Operations has joined the team has started discussions with local universities, government bodies and start-up conferences to position the platform as the funding to help start-ups get going and businesses grow without giving equity away and diluting the founder shareholders. 75. The Company have created an overseas landing page and adapted the content for this market. 76. In 20YY The Company implemented a payment system that had multi-currency capability so that anyone in multiple overseas countries could create a funding account on the platform. 77. The Company has the potential to address a broader market than just the local market, including international markets. 78. Therefore, subparagraph 360-40(1)(e)(iv) will be satisfied. Competitive advantages - subparagraph 360-40(1)(e)(v) 79. Your analysis shows there are many other funding platforms already in existence. Of the X funding sites you analysed all competitors offer Flexible and All or Nothing Campaigns like You. All competitors charge X% plus transaction costs or 0%. 80. You have stated your significant advantage over your competitors is that creators of campaigns receive their share of funds as soon as pledges are made. However on further analysis another platform also offers Flexible and All or Nothing Campaigns with immediate funds available to campaign creators. 81. The Company also uses readily available programmes. These programmes are available for anyone to use and adapt. 82. You have stated Funding has made significant advances in technology and through the use of social media which has led to funding becoming a global phenomenon. As such The Company has not demonstrated it has a competitive advantage over other competitors in the funding space and therefore do not satisfy subparagraph 360-40(1)(e)(v). Conclusion on principles test 83. The use of funding websites has been around for many years and there are many sites offering very similar platforms with the same campaign type, fee structure and fund transfer time. 84. The Company's platform has been developed and implemented and has similar advantages to other funding platforms they do not satisfy the principles based test namely not satisfying the commercialisation competitive advantage requirements. As such it does not satisfy all of the requirements within subparagraphs 360-40(1)(e)(i) to (v) for the period commencing 1 July 20YY until 30 June 20ZZ. Conclusion 85. The Company does not meet the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 20YY until 30 June 20ZZ.