The High Court’s 4–3 decision in Commissioner of Taxation v PepsiCo Inc; Stokely-Van Camp Inc 2025 HCA 30 (PepsiCo decision) is mandatory reading for any multinational group that sells products while licensing brand/intellectual property into Australia. The majority (Gordon, Edelman, Steward and Gleeson JJ) dismissed six linked appeals, confirming that neither PepsiCo Inc. (PepsiCo) nor Stokely-Van Camp Inc. (SVC) was liable for royalty withholding tax or the diverted profits tax (DPT) on payments made by Schweppes Australia (SAPL) for beverage concentrate.
The case concerned the tax treatment of payments made by SAPL, an Australian company, to PepsiCo and SVC, both US companies within the PepsiCo Group. PepsiCo and SVC owned global brands including Pepsi and Gatorade. SAPL entered into exclusive bottling agreements with PepsiCo and SVC, under which SAPL was appointed as the exclusive manufacturer, bottler, seller, and distributor of these branded beverages in Australia.
Under these agreements, SAPL was required to purchase beverage concentrate from a nominated member of the PepsiCo Group which was PepsiCo Beverage Singapore Pty Ltd (PBS), at agreed prices. The agreements also granted SAPL licences to use the relevant intellectual property (trade marks and other rights) necessary to manufacture and sell the branded drinks in Australia. No separate royalty was expressly paid for the use of the intellectual property; all payments were made to PBS for the concentrate.
PBS, in turn, purchased the concentrate from another PepsiCo Group company and transferred almost all the money received from SAPL to that company, retaining only a small margin. The payments from SAPL to PBS were recorded as income in PBS’s tax returns.
The Commissioner of Taxation contended that part of the payments made by SAPL to PBS for the concentrate should be characterised as royalties for the use of intellectual property and therefore subject to royalty withholding tax. Alternatively, the Commissioner argued that if no royalty withholding tax was payable, the arrangements were subject to the diverted profits tax (DPT), an anti-avoidance provision in Australia’s tax laws, on the basis that the structure was allegedly designed to avoid Australian tax.
Below is a summary of the key elements of the majority’s decision and key takeaways for multinational groups.
None of the concentrate price was a royalty
SAPL paid Pepsi-owned PBS for concentrate only.
The contractual price paid by SAPL to PBS for the concentrate was the price paid for goods sold and delivered and it was not disputed by the Commissioner that it was an arm's length price. In those circumstances, it could not be said that a part of the price paid for those goods was the payment of a royalty for the use of intellectual property applied to products partly made with those goods.
Irrespective of whether the payments by SAPL to PBS were royalties for tax purposes, the majority also found that they were not derived by, or paid or credited to, PepsiCo, which is a requirement for a liability for royalty withholding tax. This is because it was PBS – not PepsiCo or SVC – who was the seller under each concentrate contract. Without an antecedent monetary obligation from SAPL to the US entities, there could be no “payment by direction” and, therefore, no royalty withholding liability under section 128B.
The DPT failed because there was no tax benefit
The Commissioner argued that, but for the ‘scheme’, SAPL would have paid a royalty and PepsiCo would have been liable for withholding tax. The scheme identified by the Commissioner was the entry into exclusive bottling agreements (EBAs) under which SAPL bought concentrate and was licensed to use intellectual property but no royalty was paid for its use.
The Commissioner proposed two alternative postulates:
(a) That the EBAs might reasonably have been expected to provide for payments for all property and promises (not just concentrate).
(b) That the EBAs might have expressly provided for a royalty for the use of intellectual property.
The Commissioner contended that for the taxpayer to demonstrate that it did not obtain a tax benefit in connection with the scheme, it had to prove the existence of a reasonable alternative postulate in which it was not liable to pay royalty withholding tax, not simply demonstrate that the Commissioner’s alternative postulates were not reasonable. While the court held that it was not enough for the taxpayer to demonstrate that the Commissioner’s alternative postulate was unreasonable, it was also not the case that the taxpayer had to lead evidence of another reasonable postulate in which the taxpayer obtained no tax benefit.
A taxpayer would typically demonstrate the absence of a tax benefit by identifying a reasonable alternative postulate. However, in some cases, a taxpayer could demonstrate the absence of a tax benefit by establishing that there is no postulate that was a reasonable alternative to entering into or carrying out the scheme.
The majority found that the Commissioner’s alternative postulates were not reasonable because he misconceived the economic and commercial substance of the scheme. The commercial and economic substance of the scheme was that the agreed price was solely for concentrate. Any adjustments to the SAPL bottler, seller and distribution agreement and the PepsiCo EBA to provide for some part of that price to be also a royalty would involve entry into a fundamentally different arrangement.
Importantly, based on the ‘franchise-owned bottling operation’ business model adopted by the PepsiCo Group, PepsiCo showed that it was probable that no different arrangement might reasonably be expected to have been entered into. PepsiCo demonstrated that any postulate in which the payments for concentrate were seen as made in part for the grant of the right to use the PepsiCo intellectual property was not a reasonable expectation. As a result, the majority concluded that PepsiCo obtained no tax benefit.
Gageler CJ, Jagot and Beech-Jones JJ dissented, accepting that part of the concentrate price was consideration for intellectual property and that a DPT liability could arise if withholding tax did not.
Practical takeaways
The arrangements between PepsiCo, SVC and SAPL were arm’s length. The legal form reflected the economic and commercial substance of the arrangements and was consistent with PepsiCo’s global business model. Multinational groups should ensure that cross-border arrangements involving supply of goods and intellectual property are documented in a way that reflects the economic and commercial substance and that the pricing and terms can be supportable as arm’s length.
Intercompany agreements should also clearly specify what each payment is for, that is, goods, services or the use of intellectual property, and that allocations are commercially justifiable.
In relation to the DPT provisions, it is important to consider not just the legal form but also the commercial and economic substance of arrangements. Multinational groups should review their structures to ensure they do not trigger anti-avoidance or DPT rules.
The Australian Taxation Office (ATO) had not yet finalised Draft Taxation Ruling TR 2024/D1, which is about the characterisation of payments in respect of software and intellectual property rights, pending the decision of the High Court in PepsiCo Inc. v Commissioner of Taxation. For example, in the ruling, the ATO considers how to determine when a payment is consideration for one or more of the things contained in the royalty definition. This was a key question in the PepsiCo decision with the majority finding that although the licence for the PepsiCo intellectual property was a significant part of the architecture of the entire SAPL bottler, seller and distributor agreement, there was no basis for concluding that the PepsiCo intellectual property was given away for nothing. The consideration was the performance of the monetary and non-monetary undertakings by SAPL but not for the use of the PepsiCo intellectual property.
For further advice on the decision or its implications for your business, please contact a member of the Gilbert + Tobin tax team.