PepsiCo v Australia: Implications for Royalty Withholding Tax and Diverted Profits Tax

Case Information:

• Court: Federal Court of Australia
• Case No: VID 27 of 2024, VID 28 of 2024, VID 74 of 2024, VID 75 of 2024, VID 76 of 2024, VID 77 of 2024
• Applicant: PepsiCo, Inc and Stokely-Van Camp, Inc
• Defendant: Commissioner of Taxation
• Judgment Date: 26 June 2024

Judgment Summary

The case of PepsiCo, Inc v Commissioner of Taxation involves the Federal Court of Australia addressing the issue of whether PepsiCo and Stokely-Van Camp (SVC) are liable to pay royalty withholding tax under section 128B(2B) of the Income TaxIncome Tax is a direct levy imposed by governments on the income generated by individuals, corporations, and other entities within a specific jurisdiction. It serves as a major source of revenue for governments and funds various public expenditures, such as infrastructure projects, healthcare, education, national security, and welfare programs. The tax is generally calculated as a percentage of the taxable...Tax AssessmentA tax assessment is a formal determination made by a tax authority to calculate the amount of tax an individual or entity owes. It is a comprehensive evaluation based on financial records, declared income, expenses, deductions, and any applicable tax laws or regulations. Tax assessments may arise from routine self-assessments by taxpayers, or they may be conducted by revenue authorities... Act 1936 (Cth) (ITAA 1936). If not, the court also considered whether they are liable for diverted profits taxDiverted Profits Tax (DPT) is a tax measure designed to counteract aggressive tax avoidance by multinational enterprises (MNEs). It aims to address arrangements where profits are artificially shifted to jurisdictions with lower tax rates or where transactions lack genuine economic substance. Introduced initially by the United Kingdom in 2015, DPT is sometimes informally called the "Google Tax" due to its... under section 177J of the same Act. This judgment marks the first time section 177J has been considered in litigation.

The key issues were whether payments made by the Bottler to a related entity under exclusive bottling agreements (EBAs) included royalties for the use of trademarks and whether these payments were income derived by PepsiCo, thus subject to royalty withholding tax.

Key Points of the Judgment:

Background:

PepsiCo and SVC had entered into exclusive bottling agreements (EBAs) with Schweppes Australia Pty Ltd (the Bottler), which was responsible for bottling and distributing Pepsi, Mountain Dew, and Gatorade in Australia. The EBAs involved the sale of concentrate to the Bottler and included the use of PepsiCo’s trademarks and other intellectual propertyIntellectual Property (IP) refers to creations of the mind, including inventions, literary and artistic works, symbols, names, images, and designs used in commerce. It grants creators exclusive legal rights to use and exploit their work, ensuring protection against unauthorised use or reproduction. These rights are critical in fostering innovation and creativity while providing economic value to individuals and organisations. IP... without explicitly charging a royalty. The Commissioner of Taxation contended that part of the payments made by the Bottler under the EBAs should be considered as royalties, thus subjecting them to royalty withholding tax.

Core Dispute:

The primary dispute was whether the payments made by the Bottler included royalties for the use of PepsiCo’s intellectual propertyIntellectual Property (IP) refers to creations of the mind, including inventions, literary and artistic works, symbols, names, images, and designs used in commerce. It grants creators exclusive legal rights to use and exploit their work, ensuring protection against unauthorised use or reproduction. These rights are critical in fostering innovation and creativity while providing economic value to individuals and organisations. IP..., which would make them subject to royalty withholding tax. If the payments did not constitute royalties, the court needed to determine if the arrangements were a scheme designed to avoid paying taxes, thus invoking the diverted profits taxDiverted Profits Tax (DPT) is a tax measure designed to counteract aggressive tax avoidance by multinational enterprises (MNEs). It aims to address arrangements where profits are artificially shifted to jurisdictions with lower tax rates or where transactions lack genuine economic substance. Introduced initially by the United Kingdom in 2015, DPT is sometimes informally called the "Google Tax" due to its... provisions.

Court Findings:

1. Royalty Withholding Tax: The court concluded that the payments made by the Bottler to PepsiCo and SVC were for the concentrate alone and did not include any component as royalties for the use of intellectual propertyIntellectual Property (IP) refers to creations of the mind, including inventions, literary and artistic works, symbols, names, images, and designs used in commerce. It grants creators exclusive legal rights to use and exploit their work, ensuring protection against unauthorised use or reproduction. These rights are critical in fostering innovation and creativity while providing economic value to individuals and organisations. IP.... This conclusion was based on the proper construction of the EBAs and the manner in which they were performed.
2. Diverted Profits TaxDiverted Profits Tax (DPT) is a tax measure designed to counteract aggressive tax avoidance by multinational enterprises (MNEs). It aims to address arrangements where profits are artificially shifted to jurisdictions with lower tax rates or where transactions lack genuine economic substance. Introduced initially by the United Kingdom in 2015, DPT is sometimes informally called the "Google Tax" due to its...: The court also considered whether the arrangements constituted a scheme to avoid tax, thus falling under the diverted profits taxDiverted Profits Tax (DPT) is a tax measure designed to counteract aggressive tax avoidance by multinational enterprises (MNEs). It aims to address arrangements where profits are artificially shifted to jurisdictions with lower tax rates or where transactions lack genuine economic substance. Introduced initially by the United Kingdom in 2015, DPT is sometimes informally called the "Google Tax" due to its... provisions. The court found that there were no reasonable alternatives to the scheme presented by the Commissioner, and therefore, PepsiCo did not obtain a tax benefit that would invoke section 177J.

Outcome:

PepsiCo and SVC’s appeals in the royalty withholding tax proceedings were allowed, setting aside the notices of assessment for royalty withholding tax. The Commissioner’s appeals in the Part IVA proceedings were dismissed. PepsiCo and SVC were awarded costs for both sets of appeals.

Transfer Pricing Method Used:

The judgment does not explicitly outline a specific transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... method the parties use. However, the dispute centres around the characterization of payments under the EBAs, examining whether they included royalties for intellectual propertyIntellectual Property (IP) refers to creations of the mind, including inventions, literary and artistic works, symbols, names, images, and designs used in commerce. It grants creators exclusive legal rights to use and exploit their work, ensuring protection against unauthorised use or reproduction. These rights are critical in fostering innovation and creativity while providing economic value to individuals and organisations. IP....

Major Issues or Areas of Contention

• Characterization of Payments: Whether the payments were for the concentrate alone or included a component for using trademarks.
• Income Derivation: Whether the payments made to the related entity constituted income from PepsiCo.
• Application of Diverted Profits TaxDiverted Profits Tax (DPT) is a tax measure designed to counteract aggressive tax avoidance by multinational enterprises (MNEs). It aims to address arrangements where profits are artificially shifted to jurisdictions with lower tax rates or where transactions lack genuine economic substance. Introduced initially by the United Kingdom in 2015, DPT is sometimes informally called the "Google Tax" due to its...: Whether the scheme was designed to avoid tax and thus subject to diverted profits taxDiverted Profits Tax (DPT) is a tax measure designed to counteract aggressive tax avoidance by multinational enterprises (MNEs). It aims to address arrangements where profits are artificially shifted to jurisdictions with lower tax rates or where transactions lack genuine economic substance. Introduced initially by the United Kingdom in 2015, DPT is sometimes informally called the "Google Tax" due to its....

Decision Analysis:

The decision was not entirely unexpected, given the complexity of determining whether payments included royalties. However, the case’s significance lies in its interpretation of the diverted profits taxDiverted Profits Tax (DPT) is a tax measure designed to counteract aggressive tax avoidance by multinational enterprises (MNEs). It aims to address arrangements where profits are artificially shifted to jurisdictions with lower tax rates or where transactions lack genuine economic substance. Introduced initially by the United Kingdom in 2015, DPT is sometimes informally called the "Google Tax" due to its... provisions under section 177J, marking a precedent in Australian tax lawTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public....

Significance for Multinationals and Revenue Services:

This decision has profound implications for multinationals and revenue services. It clarifies the application of royalty withholding tax and the diverted profits taxDiverted Profits Tax (DPT) is a tax measure designed to counteract aggressive tax avoidance by multinational enterprises (MNEs). It aims to address arrangements where profits are artificially shifted to jurisdictions with lower tax rates or where transactions lack genuine economic substance. Introduced initially by the United Kingdom in 2015, DPT is sometimes informally called the "Google Tax" due to its... provisions, emphasizing the need for clear and precise structuring of international transactions and agreements. Multinationals must ensure that their EBAs and similar agreements are meticulously drafted to avoid unintended tax liabilities.

Value of Transfer Pricing Expertise

Transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... expertise is crucial in structuring intercompany transactionsIntra-Group Transactions are interactions between entities within the same multinational enterprise (MNE). Such transactions form the backbone of related-party dealings and are essential in managing global operations and aligning business objectives across jurisdictions. Understanding intra-group transactions is critical in international tax and transfer pricing, as they directly impact a company's tax obligations, profitability, and compliance standing. Tax professionals, accountants, lawyers,... to ensure compliance with tax regulationsTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public... and to defend against tax authorityTax authorities are fundamental institutions within government frameworks, overseeing tax assessment, collection, and administration. Their operations ensure that tax laws are enforced and public funds are collected efficiently. This article delves into tax authorities' purpose, responsibilities, and structure, offering insights into their essential role in supporting government functions and economic stability. What is a Tax Authority? A tax authority is... challenges. Proper transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... documentation and economic analysis can prevent disputes and potential tax liabilities.

Preventative Measures

To avoid or better manage cases like this, companies should:

• Implement a proper tax risk managementTax risk management is a structured process used by organizations, particularly multinational enterprises (MNEs), to identify, assess, and mitigate potential risks that arise in relation to tax compliance, reporting, and planning. It plays a crucial role in ensuring that a company’s tax obligations are managed in a way that minimizes risk exposure while maximizing efficiency and strategic value. process.
• Establish a tax steering committee to oversee tax planningTax planning is the process of organising and structuring one’s financial affairs in a manner that legally minimises tax liabilities while ensuring compliance with relevant tax laws. The primary objective of tax planning is to reduce the amount of taxes paid, optimise the use of available tax benefits, and preserve wealth. It can be applied at various levels, including personal... and compliance.
• Ensure clear and precise documentation of intercompany agreementsIntercompany Agreements (ICAs) are legally binding contracts between two or more entities within the same corporate group. These agreements outline the terms and conditions of transactions such as the sale of goods, provision of services, use of intellectual property, or intercompany financing. ICAs are crucial for managing transfer pricing compliance, mitigating tax risk, and demonstrating that intercompany transactions are conducted... and the nature of payments.
• Conduct regular transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... reviews and economic analyses to support the characterization of payments.

In Summary

The Federal Court of Australia’s judgment in PepsiCo, Inc v Commissioner of Taxation provides critical insights into the characterization of payments under intercompany agreementsIntercompany Agreements (ICAs) are legally binding contracts between two or more entities within the same corporate group. These agreements outline the terms and conditions of transactions such as the sale of goods, provision of services, use of intellectual property, or intercompany financing. ICAs are crucial for managing transfer pricing compliance, mitigating tax risk, and demonstrating that intercompany transactions are conducted... and the application of tax lawsTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public.... It emphasizes the importance of detailed documentation and economic analysis in defending against tax authorityTax authorities are fundamental institutions within government frameworks, overseeing tax assessment, collection, and administration. Their operations ensure that tax laws are enforced and public funds are collected efficiently. This article delves into tax authorities' purpose, responsibilities, and structure, offering insights into their essential role in supporting government functions and economic stability. What is a Tax Authority? A tax authority is... challenges and highlights the value of transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... expertise in managing tax risksTax Risk refers to the uncertainty surrounding the potential financial or reputational impact of tax-related decisions and events on a business or individual. This risk arises due to various factors, such as complex tax regulations, inconsistent tax authority interpretations, or evolving international tax laws. Effective tax risk management involves identifying, assessing, and mitigating potential tax-related threats to prevent financial penalties,....