15 August, 2025
The High Court has, by majority, dismissed the Commissioner’s appeal against the Full Federal Court (FFC) decision in the PepsiCo case. On 13 August 2025, in Commissioner of Taxation v PepsiCo Inc | High Court of Australia, the High Court majority judgement confirmed the FFC decision by deciding payments made by the Australian bottler of Pepsi and other beverages, were not subject to royalty withholding tax and PepsiCo was also not subject to Diverted Profits Tax (DPT).
This decision confirms no part of the payment by the Australian bottler, Schweppes Australia Pty Ltd (Schweppes) to PepsiCo Beverage Singapore Pty Ltd (PBS) (an Australian resident) was to be attributed to a royalty for the use of Intellectual Property (IP) owned by PepsiCo Inc and Stokely-Van Camp Inc, a subsidiary of PepsiCo (together referred to as PepsiCo) and therefore not subject to royalty withholding tax nor DPT.
The High Court decision had four judges in the majority and three judges dissenting. In essence there were three questions dealt with in this case:
The majority decision answered no to all these questions and the minority answered yes to the first and third questions and no to the second question; the reasons are summarised below.
All references are to the Income Tax Assessment Act 1936 unless otherwise stated.
Although Schweppes did obtain a licence to use the PepsiCo IP, the majority decision held that no part of the price paid for the concentrate was a payment for that licence. However, that does not mean Schweppes did not have to do anything to obtain the licence. Under the agreement with PepsiCo, Schweppes was obliged to build PepsiCo's brands and strengthen the PepsiCo IP, which the majority considered was sufficient consideration for the use of the IP. However, the majority judgement did not comment on what was the equivalent monetary value of either the use of the IP or of building the PepsiCo brands and strengthening the IP, which was a factor considered in the Minority judgment holding that DPT applied.
The majority judgment made the following comments in relation to the concentrate purchased by Schweppes in support of the judgment:
The majority judgment also commented that the fact that Schweppes increased the value of the PepsiCo IP by using the concentrate in the beverages that it sold to its customers does not mean any part of the amount paid for concentrate was to, or for the benefit of, PepsiCo for the use of the PepsiCo IP.
In summary, the minority judgement held that there was a royalty paid on the basis that:
In order to determine whether royalty withholding tax applies to the payments made by Schweppes to PBS, section 128B(2B) requires the payments to be income derived by a non-resident (i.e. PepsiCo). However, the payments were made to PBS, which is a resident of Australia. Both the majority and minority judgments held that no part of the relevant payments were "derived by", or "paid or credited" to, PepsiCo, and therefore section 128B(2B) would not apply.
Under the agreements between Schweppes and PepsiCo it required a payment from Schweppes to PepsiCo for the concentrate. However, under the agreements, PepsiCo had the right to nominate another entity to be the seller of the concentrate. PepsiCo nominated PBS to be the seller in relation to the agreements with Schweppes. It was held that the title to the concentrate that Schweppes acquired from PBS was never with PepsiCo. There was also no indication that the payments were received by PBS as an agent for PepsiCo.
On this basis, The High Court was unanimous that PepsiCo did not derive any of Schweppes payment for the concentrate. Therefore, all the judges in The High Court decision agreed that there was no royalty withholding tax to be paid on the payments by Schweppes to PBS. This means the minority judgment, holding that there was a royalty, is irrelevant to this case, as there is no withholding tax payable (but may be relevant in considerations for other royalty situations).
The DPT is part of the General Anti-tax avoidance provisions in Part IVA and if applicable can result in tax at 40 per cent of the profits diverted away from Australia. In summary, for DPT to apply, there must be a scheme entered into with a principal purpose of enabling a significant Global Entity (SGE) to obtain a tax benefit by diverting profits offshore through contrived arrangements between related parties.
In order to conclude that a tax benefit has been obtained, The Commissioner must identify reasonable alternatives where no tax benefit would be obtained. The alternative postulates provided by the Commissioner must be reasonable as per section 177CB(3). The Commissioner identified two alternative postulates that he contended indicated that there was a scheme to obtain a tax benefit by PepsiCo. In summary, these two alternative postulates propose that the agreements between PepsiCo and Schweppes could have been expressed such that either:
Under both, it was contended that a royalty would have been paid by Schweppes to PepsiCo or to another entity on PepsiCo's behalf, or as PepsiCo directed.
The majority judgment agreed with the Commissioner that it was the taxpayer’s onus to prove the Commissioner’s assessments are incorrect and that proving that the Commissioner’s alternative postulates are unreasonable does not of itself discharge this burden. However, the majority judgment agreed with the decision in the Full Federal Court that the taxpayer could discharge the onus by showing that no reasonable postulate existed and “If none exist, no relevant ‘tax effect’ can be demonstrated”.
The majority judgment held that the Commissioner’s two alternative postulates were not reasonable, as the alternative postulates should correspond to the substance of the scheme. The commercial and economic substance of the scheme was that the price agreed for the concentrate was only for the concentrate. If some part of the payment was to be for a royalty, it would involve entry into a fundamentally different arrangement.
The majority judgment concluded that PepsiCo was able to demonstrate that there were no other reasonable alternative postulates and therefore PepsiCo did not obtain a tax benefit.
The majority judgment dealing with DPT provides some further insight for broader Part IVA considerations. In particular, in relation to the taxpayer’s onus of proof when the Commissioner has proposed unreasonable alternative postulates, it appears the majority judgment opens up wider arguments that an assessment issued by the Commissioner based on Part IVA is not correct where the Commissioner’s alternative postulate could be seen as unreasonable. This would be particularly relevant where under the circumstances of the taxpayer, it would not be practicable or commercially realistic for the taxpayer to carry out the arrangement as posited by the Commissioner in his alternative postulates.
The minority judgment pointed to its reasoning above for concluding the payment by Schweppes to PBS included a royalty component. However, as the payment was not made to PepsiCo it was not subject to royalty withholding tax, which opened up the consideration of whether DPT applied.
The minority judgment found that PepsiCo failed to discharge its burden of proof that the assessments were incorrect because they did not negate the Commissioner’s reasonable alternative postulate that, had the scheme not been entered into, the EBAs would have named PepsiCo as the sellers and the payments would have included royalties. The minority judgment held that this postulate does align with the commercial and economic substance of the agreements and supports the conclusion that a tax benefit was obtained under section 177C(1)(bc) in relation to avoidance of withholding tax.
The minority judgment also held that the scheme had a principal purpose of avoiding royalty withholding tax and US tax, noting that the PepsiCo failed to provide detailed evidence explaining the pricing structure of the agreements, which pointed to tax considerations playing a role.
While there are some comments in this case that may have some relevance to royalty withholding tax for software distributers and Draft TR 2024/D1, it is possible the ATO will distinguish this case on the basis the facts are very different. We are also awaiting the outcome in the Oracle dispute, which is dealing with software acquired by Oracle from an Irish associate and therefore is likely to have more relevance to software distributers and TR 2024/D1.
However, in Draft PCG 2025/D4 the ATO have indicated that they were waiting for the outcome of the PepsiCo case before finalising TR 2024/D1 and PCG 2025/D4. It will be interesting to see how the ATO applies The High Court decision in finalising their guidance.
This case has passed through three levels of the Courts with a total of 11 judges, six judges finding for the taxpayer and five judges finding for the Commissioner. Although the taxpayer won in the end, the complexity of the structure of the arrangements and the split decisions along the way, indicate that the ATO will still be looking closely at arrangements that could be seen as involving embedded royalties. Taxpayers should ensure they carefully document the positions taken and identify the reasonably arguable positions that have been taken to support the tax position of their arrangements.
It is also possible Treasury may consider the limitation to DPT that the PepsiCo case has identified, particularly the restriction on what was considered a tax benefit, and they may consider amending the legislation so that it can be utilised as anticipated. However, it is expected Treasury will need to consider the current US position on such matters and the current tariff negotiations in play.
4 July, 2024
PepsiCo has successfully appealed to the Full Federal Court (FFC), which has held that payments made by the Australian bottler of Pepsi and other beverages, were not subject to Royalty Withholding Tax (the first issue) and was also not subject to Diverted Profits Tax (the second issue).
On 26 June 2024, in PepsiCo, Inc v Commissioner of Taxation [2024] FCAFC 86, the FFC reversed the Federal Court single judge decision by unanimously deciding on the first issue that payments made by the Australian bottler, Schweppes Australia Pty Ltd (Schweppes), to the seller of beverage concentrate, PepsiCo Bottling Singapore Pty Ltd (PBS) (an Australian company) were not subject to Royalty Withholding Tax.
On the second issue, two out of the three FFC judges concluded that if the payments were not royalties, the diverted profits (DPT) tax would not apply in these circumstances. This is the first occasion that the operation of the Diverted Profits Tax provisions in s177J of Part IVA ITAA 1936 has been judicially considered. The DPT applies to significant global entities (those with annual global income of $1b or more) operating in Australia where, based on information available to the Commissioner, it is reasonable to conclude that, under a scheme to obtain tax benefits, profits have been artificially diverted from Australia. Generally, DPT imposes a 40 per cent penalty tax on profits transferred offshore through related party transactions.
Schweppes was the sole distributor and bottler in Australia of beverages: Pepsi, Mountain Dew and Gatorade. It purchased concentrate to make the beverages from PBS, an Australian subsidiary of the PepsiCo group.
The payments were made under two ‘Exclusive Bottling Agreements’ (EBAs) that determined the price at which the beverage concentrates were to be purchased. The EBAs also included a grant, by two US members of the PepsiCo group (PepsiCo, Inc and Stokely-Van Camp, Inc (SVC)) to Schweppes, for the right to use the trademarks and other intellectual property associated with each beverage. Although PepsiCo and SVC were parties to their respective EBAs, neither EBA made any provision for the payment by Schweppes of a royalty for its use of the intellectual property. Under the EBAs, the payments for supply of the concentrate were made by the Schweppes to PBS, an Australian subsidiary of Pepsi Co, which on paid it (less a small profit margin) to the producer of the concentrate in Singapore (another subsidiary of PepsiCo). There was no indication that the producer on paid any of the payment to PepsiCo, Inc or SVC, the owners of the trademarks and other intellectual property.
In the first instance, the Federal Court held that the payments by Schweppes were, to some extent, consideration for the right to use the trademarks and other intellectual property, and thus ‘royalties’ for the purposes of s128B of the ITAA 1936 and the US Double Tax Convention. Although the payment from Schweppes was to an Australian subsidiary of PepsiCo, the Federal Court held the payments were attributable to the royalties for use of trademarks and other intellectual property. It was also held that the payments were also income derived by PepsiCo Inc and SVC and taken to be paid to them because they were parties to the EBAs. Accordingly, PepsiCo, Inc and SVC were liable to pay Royalty Withholding Tax (RWT) in respect of the part of the payment by Schweppes characterised as ‘royalties’ (i.e. RWT was payable on 5.88 per cent of Schweppes Australia's net revenue from sales of licensed products during the relevant years).
The Federal Court also held that if PepsiCo and SVC were not liable to pay RWT, they would have been liable to pay DPT on the basis they had entered into a scheme with the ‘principal purpose’ of obtaining tax benefits (including the non-payment of RWT) for the purposes of s177J.
The Majority of the FFC, two of three judges, concluded that the payments made by Schweppes to the Seller were for concentrate alone and did not include any component that was a royalty for the use of PepsiCo/SVC’s intellectual property. The payments were in no part made in ‘consideration for’ the use of that intellectual property and they did not therefore include a ‘royalty’ within the definition of that term in s6(1) of the ITAA 1936. Further, all three of the FFC court judges concluded that even if the payments were attributable to ‘a royalty’, the payments were received by the Seller (the Australian subsidiary of PepsiCo) on its own account and they cannot be said to have been paid to PepsiCo/SVC. Therefore, they were not income derived by PepsiCo/SVC for the purposes of s128B(2B). Hence, the FFC unanimously held that PepsiCo/SVC were not liable to pay Royalty Withholding Tax on the payments made by Schweppes to the Seller.
By a majority, the Court concluded that PepsiCo and SVC were not liable to pay DPT. In coming to this conclusion, the majority judges considered but rejected the two alternative postulates (below) put forward by the Commissioner, as not being ‘reasonable alternatives’:
Further the majority FFC considered that the only postulates which could bring the payments to tax were ones in which the payments for concentrate could be seen as being made in part for the grant of the rights to use PepsiCo and SVC's intellectual property. However, based on the Court’s findings, they determined there was no postulate which was a reasonable alternative to the scheme actually carried out. Therefore, PepsiCo and SVC did not obtain a tax benefit "in connection with a scheme" for the purposes of s177J.
On this point the minority judge disagreed with the majority decision, finding that PepsiCo and SVC would have been subject to DPT. The minority judge taking the view that the EBAs resulted in a tax benefit because, if the EBAs had not been entered into, a reasonable postulate was that the EBAs would have provided for the royalty to be paid to PepsiCo or SVC as the holder of the rights to the trademark. This view being consistent with the second of the reasonable alternatives advanced by the Commissioner.
The result of the FFC decision may have some implications for other Australian entities that have entered into agreements with foreign entities to use intellectual property where the agreements do not provide for the payment for the use of the intellectual property. It may also have implications for the Australian Taxation Office (ATO) in finalising its views in draft taxation ruling TR 2024/D1 on the character of payments in respect of software and intellectual property rights. Many of the comments in TR 2024/D1 are reliant on the ATO finding that there are embedded royalties in agreements that do not provide for payments for the use of copyright or other intellectual property. The FFC decision discounted this concept of embedded royalties, therefore the ATO may have to reconsider its position in TR 2024/D1.
As part of the 2024-25 Federal Budget, the Federal Government have announced its intention to introduce penalties for SGEs that are found to have mischaracterised or undervalued royalty payments to which royalty withholding tax would otherwise apply. This new additional penalty will apply from 1 July 2026. The PepsiCo decision will likely impact how the Government drafts its proposed penalty provision.
Due to the significance of both Federal and FFC decisions, it is anticipated the Commissioner will request special leave to appeal to the High Court. Therefore, it may not be all over just yet.
Should you have any questions regarding how this Full Court decision may impact your organisation, please contact your BDO tax adviser for further guidance and visit our tax services page to see how we can help.
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