Choosing to use this will create a new derived dataset where the Incoming Data section is prefilled with the dataset this menu item was selected from. This is a sort of shortcut from having to Create New Dataset - Derived Dataset then having to Add Dataset. Both get you to the same place, but Creating a Dataset Based on This is faster and easier.
This is different from the menu option Copy Dataset Definition which copies all areas (Incoming Data, Joins, Transpose, New Fields, Filter, Aggregate, Finalize and QC) of a dataset. Creating a Dataset Based on This just prefills the Incoming Data area.