Revenue collection agencies globally, along with executives of multinational corporations, are following with keen interest PepsiCo Inc.’s appeal of its “embedded royalties” case in Australia. This follows the company’s loss to the Australian Taxation Office in November. The case returns to the Full Court of the Federal Court of Australia on May 8 where it seeks to overturn a ruling about its “royalty-free” agreements with Schweppes Australia Pty Ltd.
If the decision is upheld, it could set a precedent that taxes cross-border contracts with embedded royalty arrangements, irrespective of sector. This move could apply to a broad spectrum of industries, including technology, pharmaceuticals, mining, manufacturing, and retail. It also hints at a more assertive stance from revenue authorities on their royalty withholding tax provisions.
This turn of events already seems to be influencing related cases. Amid the ongoing battle with PepsiCo, the Commissioner of Taxation issued Coca-Cola Co. a diverted profits tax assessment of AU$173.8 million ($115 million)for the 2018-2019 income years, an assessment promptly appealed by Coca-Cola. This suggests the ATO’s diverted profits tax assessment was predicated on similar grounds as the PepsiCo case, marking the first time these provisions were considered by a court.
Federal Court Justice Mark Kranz Moshinsky found PepsiCo liable for royalty withholding tax at a 5% rate tied to payments made under exclusive bottling agreements, which were designated as royalties. However, PepsiCo’s arguments in its forthcoming appeal will aim to challenge these legal definitions around royalty withholding tax and diverted profits tax provisions.
Regarding royalties, PepsiCo is expected to argue that the relevant contractual terms dictate the royalty withholding tax rules, rather than a broader commercial context, as the ATO suggests. Further argument may be centered on the discrepancies in Moshinsky’s analysis of “payments derived by” and “paid to” different entities in the PepsiCo group. If successful on the grounds of royalties, PepsiCo will then seek to dispute any liabilities from the diverted profits tax through a detailed study of the company’s intent to evade withholding tax.
Though the verdict of the case will primarily be contingent on the facts, it could provide a better understanding of the untested diverted profits tax regime. Consequently, the ATO may then request multinational corporations to provide historical context for their royalty withholding tax positions via its “justified trust” compliance programs. In addition, the ATO may suggest to taxpayers to voluntarily recognize royalties in their contracts with a technique it used in its debatable draft ruling pertaining to royalties for software and intellectual property.
If the ATO loses this appeal, it could imply a temporary relief for multinationals and potentially require the tax authority to rethink its strategy.
Shaun Cartoon, tax partner at Arnold Bloch Leibler, provided this analysis. His practice focuses on corporate, international, and employment taxes, mergers and acquisitions, corporate restructures, and employee share schemes.