Australia’s significant tax victory over PepsiCo is likely to have serious repercussions for multinational enterprises (MNEs) operating within the country as it could lead to increased examination of embedded royalties emerging from the use of intellectual property (IP), as well as potential shifts in the interpretation of tax treaties.
The Federal Court of Australia on Nov. 30 ruled in favor of the Australian Taxation Office (ATO) in its tax dispute with PepsiCo Inc. This was the first instance in which a court considered Australia’s diverted profits tax since its inception in 2017. The case hinged around Pepsi US’s exclusive bottling agreement contracts with Schweppes, a third-party entity owned by Asahi Group Holdings Ltd, and whether certain payments included a royalty for the use of IP.
Despite the contract stating otherwise, the court ruled that a royalty existed based on the substantial nature of the arrangements. The judge pinpointed the court’s ruling on the contrast between the legal form of the contract, entailing no royalty, versus its commercial substance, where the use of IP was essential to the business outcomes for the parties involved.
The ATO’s scrutiny of the embedded royalty issue is expected to persist. MNEs, especially those in IP-intensive sectors such as life sciences, technology, and retail, will need to reassess their arrangements to ascertain if an embedded royalty surfaces from IP use in Australia. The judgment provides guidance on what approach may be accepted. With no statutory limitation period for Australian withholding tax, substantial exposure may arise for taxpayers who don’t comply.
Australia’s diverted profits tax applies to arrangements predominantly aimed at obtaining certain tax benefits, such as evading withholding tax. The court agreed with the ATO’s argument that, if not for tax purposes, the payment would have been expressed in the contract as made for all the rights that Schweppes acquired or at least expressly for the IP, not just for the concentrate.
The ATO may have other diverted profits tax cases to examine, including the Coca-Cola Co.’s Federal Court proceedings. Australia’s diverted profits tax is located within its anti-avoidance provisions, superseding tax treaties. Therefore, no treaty relief is accessible for taxpayers subject to the tax.
If PepsiCo decides to challenge the ruling, an appeal to the full Federal Court must be filed within 28 days of the court’s final orders. However, a resolution before the end of 2025 seems unlikely.
For a more in-depth analysis and context of the court’s ruling, refer to the full article.