Private ruling: Early stage innovation company
Date of advice: 10 October 2019
Published: December 2019
Ruling period: Date xx XX 20XX to Date xx XX 20YY
Date scheme commenced: Date xx 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 ')? | A1: Yes

Relevant facts and circumstances: 1. Company A, is an Australian based unlisted public company, incorporated on x XX 20VV. 2. Company A's directors are Taxpayer A, Taxpayer B, Taxpayer C and Taxpayer D. 3. Company A is a standalone company with no subsidiaries. 4. For the financial year ending xx XX 20YY, Company A incurred and earned the following: · Total expenses of $xx · Total income of $yy 5. For the financial year ending xx XX 20XX, Company A incurred and earned the following: · Total expenses of $xx · Total income of $yy 6. For the financial year ending xx XX 20WW, Company A incurred and earned the following: · Total expenses of $xx · Total income of $yy 7. The source of income earned by Company A in the 20XX income year relates to a number of projects which Company A managed on behalf of third parties who were undertaking work for them. The purpose of that work was solely as research for Company A to gain an in-depth understanding first hand of the end-to-end work processes their platform is being designed to facilitate. It also provided essential insights on the collaboration pinch points and productivity road-blocks in the industry. 8. Company A is an unlisted public company and its equity interests are not listed for quotation in the official list of any stock exchange in Australia or a foreign country. 9. Company A is developing an Application ('App') which is a globally unique market network, by developing a cloud-based mobile-first digital ecosystem (the "Product') to greatly simplify and facilitate the particular industry and to give those business consumers complete end-to-end project visibility. 10. Through Company A's App, users will be able to manage and budget for a project, shop for materials and services, have products delivered and share information and experiences with other users. 11. There is no product currently available that addresses these multiple needs of users in this particular industry. 12. Company A's Product, housed in one app, and operable on any device, will deliver its customers a project management SaaS tool, an integrated retail marketplace and a social platform, within what is regarded as a globally unique first-of-its-kind market network. 13. Company A is developing their Product to address a number of discrete markets and is continuing to develop their Product. 14. Company A's Product has been identified as having an international addressable market. 15. Company A issued shares to investors at various dates in the 20YY income year. Information provided 16. 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 xx XX 20YY b. Responses to further questions provided 17. We have referred to the relevant information within these documents in applying the relevant tests to your circumstances. 18. You propose to issue new shares in Company A to various investors to assist in funding the continued development and commercialisation of the Product.

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 Further issues for you to consider | Not applicable.

Reasons for decision: Summary: All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated. Company A meets the eligibility requirements of an ESIC pursuant to subsection 360-40(1). | Detailed Reasoning - DETAILED REASONING: Qualifying Early Stage Innovation Company 19. 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': 20. 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): 21. 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). 22. 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. 23. 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): 24. 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): 25. 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): 26. 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: 27. 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: 28. 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): 29. 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. 30. 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. 31. 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: 32. 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..." 33. The innovation being developed by the company must either be new or significantly improved for an applicable addressable market.2 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. 34. 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. 35. 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." 36. 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. 37. 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. 2 Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016, paragraph 1.79. | Detailed Reasoning - High growth potential: 38. 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: 39. 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: 40. 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: 41. 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: 42. 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 xx XX 20YY. In particular, shares were issued by Company A to investors on various dates in the 20YY income year. Each issue date will be a test time for the requirements in subsection 360-40(1) ITAA 1997. | Detailed Reasoning - Current year: 43. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the current year will be the year ending xx XX 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 xx XX 20YY, 20XX and 20ZZ, and the income year before the current year will be the year ending xx XX 20XX (the 20XX income year). | Detailed Reasoning - Incorporation or Registration - paragraph 360-40(1)(a) ITAA 1997: 44. Company A was registered in the Australian Business Register (ABR) on x XX 20WW, which is within the last 6 income years, and across the last 3 of those years, Company A and its 100% subsidiaries incurred total expenses of $1 million or less, therefore the requirements of subparagraph 360-40(1)(a)(ii) are satisfied. | Detailed Reasoning - Total expenses - paragraph 360-40(1)(b) ITAA 1997: 45. 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. 46. Company A incurred total expenses of $xx for the 20XX income year. Consequently, subparagraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income - paragraph 360-40(1)(c) ITAA 1997: 47. 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 $yy or less in the 20XX income year, being the income year before the current year. 48. Company A earned $yy 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: 49. 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. 50. 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: 51. 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: 52. Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending xx XX 20YY. 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: 53. 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. 54. Company A is developing an Application ('App') a globally unique market network that can be operated on most devices, to greatly simplify and facilitate the project management of a particular industry, and to give users complete end-to-end project visibility. 55. Through Company A's App, users will be able to manage and budget for a project, shop for materials and services, have products delivered and share information and experiences with other users. 56. There is no product currently available that addresses these multiple needs of this particular industry. As a sector, this industry remains largely undisrupted by the digitalisation that has transformed many other large-scale industries. This is in part due to unique complexities of integrating multiple consumer needs, as well as the nature of the services and products themselves that are involved in the process. While the challenges are significant, the potential market available to a successful disruptor is huge. 57. Company A's Product, housed in one app, and operable on any device, will deliver its customers a project management SaaS tool, an integrated retail marketplace and a social platform, within what is regarded as a globally unique first-of-its-kind market network. 58. Company A's App is expected to help users achieve substantial productivity improvements, as well as material and significant improvements to safety, standards and quality and a commensurate lowering of claims, legal disputes and defects. 59. Company A will incorporate the above functionality in its proprietary app and supplement it with its own management SaaS tool, social platform and marketplace, all of which are being newly created by Company A's development team. 60. Based on analysis performed by Company A so far, it is estimated that this will result in a 20 to 25% bottom line boost to fundamental productivity. Revenue will be earned through a combination of customer subscriptions, fees for product delivery and product supplier subscription fees. 61. Product launch is currently scheduled to occur from September 20YY on a phased or module basis until March 20ZZ when the completed ecosystem will be fully operational. 62. The market for the product is substantial, with Australia being the first target. It is estimated that more than 2 million people in Australia alone spend around $xx annually in this industry. 63. Company A is genuinely focused on developing their Product, an App (a globally unique market network) for an applicable addressable market, so subparagraph 360-40(1)(e)(i) is satisfied for the period x XX 20XX to xx XX 20YY. | Detailed Reasoning - Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997: 64. 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. 65. Company A has identified multiple revenue sources associated with consumer and supplier users of their app. Extensive research has been undertaken over a 2 year period into, amongst other things, the prospective market, consumer and industry needs, competition and barriers to entry. 66. Work already undertaken to develop Company A's Product is as follows: · Market Research Study - both domestically and internationally · User Research Study - both domestically and internationally · Comparable and Competitive Product Research - both domestically and internationally · Market Dynamics Assessment Study · Product Specification · UX (User experience) testing, development and specification · UI (User Interface) design, specification, testing and development · User Testing (completed extensively with all discrete user groups, industry associations and with regulators) 67. 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: · User's SaaS iteration is in development with a beta release scheduled for late XX 20YY and with an MVP release anticipated in YY 20YY and revenue hoped to begin shortly thereafter and to scale. · Users SaaS tools are also in development with beta iterations due in XX 20YY respectively and MVPs in Q1 20ZZ, with revenues anticipated during Q1 20ZZ. · The marketplace piece of the business model is also in development and with a beta version expected during XX 20ZZ and with revenues expected to some level by end Q1 20ZZ. 68. Company A anticipates that the pathway to commercialisation (domestically in the first instance) will include launching modules between XX 20YY and XX 20ZZ. 69. Company A anticipate that the current programme of development will be completed in the 20ZZ financial year. 70. Company A is genuinely focussed on developing their Product, an App (a globally unique market network), for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period x XX 20XX to x XX 20YY. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997: 71. 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. 72. Company A has supplied revenue model/forecasts up to the financial year ending XX 20AA. For that year, Company A's model shows potential revenue scaling to $yy. This is primarily based on growth to: · xx premium subscribers, assuming growth of paid to unpaid subscribers to 1:5; · yy free Company A users; · zz Company A subscribers (growth of 1% of total national pool of users per month); 73. Company A has longer-term plans to add revenue streams through an increased range of offerings to customers, as well as strategies to increase spending per customer and foster customer loyalty. 74. There is genuine intention to launch the App beyond Australia, with identified key opportunities overseas. 75. Company A has demonstrated a high growth potential for their Product, an App (a globally unique market network), so subparagraph 360-40(1)(e)(ii) is satisfied for the period x XX 20XX to x XX 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. As an app-based ecosystem with a broad addressable market, Company A's offering is inherently scalable. New users can be signed up for minimal incremental cost, while providing increased revenue opportunities through, for example, subscription fees, product purchase and delivery commissions. 78. New users will initially be targeted and measured digitally, limiting marketing spend until there has been significant user uptake. As such, operating costs per user are expected to decline significantly with scale. 79. Notwithstanding the current gap in the industry, Company A's online marketplace will provide unprecedented opportunity for the business to scale up its operations on the back of this currently untapped market. 80. 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 x XX 20YY. | Detailed Reasoning - Broader than local market - subparagraph 360-40(1)(e)(iv) ITAA 1997: 81. 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. 82. Since commencing development, Company A have had the mindset of thinking globally. 83. Company A's initial market will be Australia-wide. From the outset, its customers need not be confined to a local market. The need being addressed is country-wide, with the app available on launch to anyone in Australia with a smartphone or computer. 84. From the outset, Company A is seeking partnerships with suppliers who will be able to supply and deliver products on a national basis. Once Company A has been able to demonstrate a level of take-up within Australia, opportunities to service other markets, will be reviewed in detail. 85. Company A's management considers that there is no reason in principle why its offerings should not be equally successful in a number of comparable overseas markets. 86. 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 x XX 20YY. | Detailed Reasoning - Competitive advantages - subparagraph 360-40(1)(e)(v) ITAA 1997: 87. 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. 88. Company A's business model focuses on providing a unique ecosystem that will address the needs of two different audiences. Each audience has quite distinct challenges and pain points that the ecosystem looks to address through its three-legged stool model. 89. Company A is creating a globally unique market network. It will allow consumers from both audiences to manage their projects, from budgeting to researching and buying products to coordinating deliveries and to do so visually on a smartphone. It will also allow sharing of information and progress. 90. The visual app-based tool, is a significant departure from currently available programs, few of which use an app and which are heavily reliant on spreadsheets. 91. Company A steps away from spreadsheets and uses a unique approach, making it far more intuitive and ultimately driving productivity improvements, as well as promoting better visibility and awareness for consumers by professionals effectively fostering better quality outcomes, better safety outcomes, reputational and cost outcomes. 92. In order to build the ecosystem, Company A must bring together multiple different existing technology solutions and incorporate them with its own proprietary software. There are significant challenges and complexities in doing so. Company A has undertaken extensive assessment of currently available tools on a global basis. 93. To date, there is no competitor who is close to providing an alternative holistic, consumer-friendly solution. All identified competitors instead operate in a single-focus category. Few software solutions are app-based and there is no comprehensive consumer-friendly tool available at all. 94. 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 x XX 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 x XX 20YY. | Detailed Reasoning - CONCLUSION: Company A meets the eligibility criteria of an ESIC under section 360-40 for the period x XX 20XX to x XX 20YY.