Private ruling: Early Stage Innovation Company eligibility
Date of advice: 29 August 2017
Published: December 2017
Ruling period: 1 July 2017 to 30 June 2017
Date scheme commenced: 1 July 2016

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, limited by shares, incorporated and registered in the Australian Business Register on DDMMYY 2. The Managing Director of Company A is B. 3. The Founding Directors of Company A are B and C. 4. Company A closed its pre-seed funding round in the 2017 year, with a number of ordinary shares by various independent investors. 5. For the financial year ending 30 June 2016, Company A has incurred and earned the following: a. Total expenses of $xx.xx b. Total income of $0.00 6. 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 business premise 7. Company A is a technology start-up business within the relevant industry. 8. Company A is developing a product (the Product), a ‘whole-of-market’ digital solution which brings together consumers and retailers in real time, cross bank and cross device. 9. The Product integrates a various interfaces, which allow customers to pay for their goods and services with funds through an interface. 10. Using the Product, customers will be able to pay for goods and services via the mobile app at integrated stores by utilising the product. 11. As an added feature, Company A is developing technology for secure identification purposes. 12. Company A is developing its intellectual property and has applied for a number of Patents – involving frameworks and methodologies. 13. Commercialisation of the Product’s mobile interface will take place with the following strategies: a. Company A will market their unique and identifiable brand identity into the Australian and worldwide markets. b. Company A will create customer focused campaigns with the dual purpose of educating the market on peer-to-peer and retailer payments with Company A as the latest payment option. 14. Company A’s app based interface has been identified as having an international addressable market. Information provided 15. You have provided a number of documents containing detailed information in relation to Company A, including: a. Private Binding Ruling (‘PBR’) Application, dated April 2017. b. An Investor Presentation c. Company A’s Financial Model d. Phase 1 of Business Plan e. Details of intellectual property applications f. Competitor analysis g. Commercialisation Strategy h. Links to Company A’s website, videos and online resources i. Profit and Loss statement and Balance sheet 16. 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: 17. Subsection 360-40(1) outlines the criteria required for a company to qualify as an Early Stage Innovation Company (ESIC) at a particular time in an income year. This time is referred to as the ‘test time’. The criteria are based on a series of tests to identify if the company is at an early stage of its development and it is developing new or significantly improved innovations to generate an economic return. ‘ The early stage test’ 18. 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): 19. 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). 20. 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. 21. 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): 22. 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): 23. 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): 24. 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: 25. 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: 26. 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): 27. 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. 28. 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. 29. 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: 30. 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…” 31. 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. 32. 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. 33. 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.” 34. 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. 35. 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: 36. 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: 37. 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: 38. 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: 39. 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: 40. 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 on three dates in the 2017 income year, so these are the ‘test times’ for which Company A must meet the ESIC requirements. | Detailed Reasoning - Current year: 41. Therefore, for the purposes of subsection 360-40(1) ITAA 1997 , the current year will be the year ending 30 June 2017 (the 2017 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 2017, 2016 and 2015. | Detailed Reasoning - Incorporation or Registration – paragraph 360-40(1)(a) ITAA 1997: 42. Company A was incorporated on DDMMYY, 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: 43. 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 2016 income year, being the income year before the current year. 44. Company A incurred expenses of $xx.xx in the 2016 income year. Consequently, paragraph 360-40(1)(b) is satisfied. | Detailed Reasoning - Assessable income – paragraph 360-40(1)(c) ITAA 1997: 45. 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. 46. Company A earned $0.00 assessable income in the 2016 income year. Consequently, paragraph 360-40(1)(c) is satisfied. | Detailed Reasoning - No Stock Exchange listing – paragraph 360-40(1)(d) ITAA 1997: 47. 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. 48. Company A was not listed on any Stock Exchange in Australia or a foreign country at any of the test times, so paragraph 360-40(1)(d) is satisfied. | Detailed Reasoning - CONCLUSION FOR EARLY STAGE TEST: 49. Company A satisfies the early stage test for the 2017 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: 50. Company A has not provided sufficient evidence of satisfying the 100 point test under section 360-45 for the year ending 30 June 2017. 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: 51. 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. 52. Company A is currently developing an app based interface, a technology product (the ‘Product’) which will be a significant shift away from the traditional banking model. 53. Company A’s Product will enable people to transact and interact for free and in real time. 54. Company A’s Product will allow consumers to pay for goods and services in relevant stores and venues via a patent pending technology. 55. Company A is also developing the first of its kind digital system in Australia, which will allow consumers to make payments for their goods and services if linked to their Company A digital interface (patent). 56. The shift to a mobile interface means consumers and brands can expect to seamlessly transact and interact anywhere and anytime. 57. Security is a major concern for consumers, and there is a strong need for secure methods of payment and ways to protect customer details and privacy. 58. Company A is developing and building the first network of its type in Australia via an app technology. 59. To further Company A’s edge in the market, Company A has built the first of its kind in Australia in partnership with Company B – a commercialised payment at relevant stores. 60. Company A’s Product offers consumers free peer-to-peer transactions. Company A’s revenue stream comes from merchants, whereby Company A charges a small merchant fee on a transaction by a Company A app user. 61. Company A Product also offers merchants the ability to communicate to their audience via a custom marketing platform based on a monthly fee. 62. Company A’s app based interface is the first of its kind technology in Australia. 63. Company A’s technology has 2 defining features: i. Feature 1 – Company A’s payment system identifies the customer in seconds in order to make a payment. ii. Feature 2 – Company A has developed a unique and new method to facilitate real time payments from a device. 64. The mobile app based interface being developed by Company A will be a ‘whole-of-market’ technology solution. 65. Such a product offering does not currently exist on the market in Australia or worldwide, so Company A is developing a product which is new, and is identified as having an international addressable market. Genuinely focussed on developing for commercialisation - subparagraph 360-40(1)(e)(i) ITAA 1997 66. 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. 67. Company A’s mobile interface was developed in a first phase release, and launched to the Apple App Store and Google Play Store. 68. Company A has been working for many months on developing the secure features, and has worked with a manufacturer to help build a prototype for this product. 69. The prototype product is live and in testing. Company A is now exploring with several major companies on how this technology can be introduced for consumers. 70. The Security System is built and live. Company A is in talks with several partners to potentially work together to commercialise the product within their ecosystem. 71. Company A is still in the early stages of development. To become a fully developed product, Company A will need to go live within its first commercial project successfully, and have a full suite of developed features completed. Steps required to become fully developed are: a. Prototype the product with client led requirements, spec out and develop prototype for testing b. Roll out first phase c. Roll out of new features, upgrades, testing, R&D d. Finalise development to complete Company A’s product fully developed 72. The Product will be a new product compared to any mobile systems currently used in the Australian or worldwide market. Company A is genuinely focussed on developing the Product, a mobile interface, for a commercial purpose, so subparagraph 360-40(1)(e)(i) is satisfied for the period 1 July 2016 to 30 June 2017. | Detailed Reasoning - High growth potential - subparagraph 360-40(1)(e)(ii) ITAA 1997: 73. 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. 74. Company A’s app is currently available on the Australian Apple and Google Play app stores, making this platform accessible throughout Australia. Company A has plans for global expansion of the app when its retail solutions are marketed globally. 75. The unlimited potential reach of the app presents an uncapped growth potential of Company A’s technologies into new international markets. While the retail solutions have only recently been launched in Australia, the company is already in discussions with major national and international retailers and organisations, in regards to adopting both the in-store and online technologies. The uptake of its technologies within these companies will instantly give Company A access to a valuable and large international user-base. 76. Company A is well geared to expand its reach immediately with funding in place to acquire new talent and execute further marketing as required. In addition, Company A’s product development team is constantly innovating and developing additional new technologies that provide further growth potential for the company. 77. Company A is broadly targeting a specific generation comprised of 9.8 million Australians. This demographic makes up 45% percent of Australia’s total population of 22 million, or the country’s second-largest generation after Generation X. The sheer size of this market makes them, by default, the next great engine of the Australian consumer economy. 78. Within this generation, Company A are specifically targeting a specific generation who have a higher propensity to embrace or adopt (use or acquire) new technology. In order to assess their addressable market size, they have drawn upon Company C Research using their technology adoption segmentation model of the Australian population focusing on the Early Adopter and Early Majority (Professional Technology Mainstream and Digital Life) segments. This segmentation model is based on the Everett Rogers’ Technology Innovation model and makes use of psychographic and socio-economic data collected by Company C. 79. Company A has demonstrated a high growth potential for the Product, a mobile interface, so subparagraph 360-40(1)(e)(ii) is satisfied. | Detailed Reasoning - Scalability - subparagraph 360-40(1)(e)(iii) ITAA 1997: 80. 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. 81. The core of the Product is the mobile interface which utilises software and a technology framework to provide an effective and reliable service. 82. Company A has partnered with several major clients. Should a successful trial and implementation take place, Company A will be able to scale with these clients to grow across their portfolio. Some of these clients are international; with Company A having new client prospects in overseas cities and countries. however Company A is solely focussed on commercialising in Australia first. 83. Company A is currently operating very lean, and is able to sell their product at approximately $yy.yy per annum with a setup fee. 84. Company A will start to break even with 12 implementations. This will allow Company A to rapidly scale the product. 85. Once the interface and technology has been fully developed and tested with target consumers, Company A will be able to market and increase sales to customers. 86. Once Company A completes and launches a successful mobile interface, 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 the Product interface being completed. 87. Company A was founded with the goal of rapid scale up and, as such, has the right investor network, people, resources and technology in place to allow for this. The team continues to grow, as the company further innovates and develops additional solutions for commercialisation. Every member of the team brings their own unique experience and qualifications. 88. Company A’s investors each have a network of national and international business contacts which can be leveraged to reach new markets, and the founding team has extensive experience in growing start-ups into successful organisations. 89. Company A’s two-sided market network drives growth and demand for its products, whereby app users enjoy the convenience of using Company A’s technology and prefer merchants to offer this option, while merchants want to provide their customers with the easiest way to pay. The growth on one side of the network will affect growth on the other, thus, improving the company’s revenue. 90. The hardware required to operate the solutions can be developed with economies of scale. The merchant technology can be easily duplicated making on-boarding easy and effective and cost effective. 91. This 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: 92. 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. 93. The mobile interface which Company A are developing, is being designed to be used as both a national and global service, to access consumers worldwide. 94. Company A are looking at potential expansion of the product to a data centre in an overseas country which is another Company D project. 95. While Product Z is presently available in Australia, consumers still need an overseas credit card to make it work. Company A is focussing heavily on exclusive contracts with specific clients, a market that Product Z does not have much market share in, or a view to target. 96. 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: 97. 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. 98. Company A has identified a number of competitive advantages it has due a number of differentiating features. 99. Another competitor edge which Company A has is its ability to rapidly develop technology through a team that is highly experienced, and their software developers fall into the top 1% in the world. 100. Company A has a significant competitive edge in securing exclusive partners to promote the technology, and this allows Company A to achieve rapid scale. Company A is addressing a key market that other players have not yet identified. 101. 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 1 July 2016 until 30 June 2017. | Detailed Reasoning - CONCLUSION: Company A meets the eligibility criteria of an ESIC under section 360-40 for the period commencing 1 July 2016 until 30 June 2017. Specifically, Company A met the eligibility criteria and was considered an ESIC at each of the relevant test times. | Detailed Reasoning - Other references (non ATO view): Explanatory Memorandum to the Tax Laws Amendment (Tax Incentives for Innovation) Bill 2016

REASONS FOR DECISION: All legislative references are to the Income Tax Assessment Act 1997 ( ITAA 1997 ) unless otherwise stated. | Tax incentives for Early Stage Investors