PepsiCo’s landmark win in the High Court: a turning point for the Australian anti-avoidance and transfer pricing rules for embedded intangible arrangements?
In brief
PwC Australia represented PepsiCo, Inc. And Stokely-Van Camp, Inc. (collectively, ‘PepsiCo’) in Commissioner of Taxation v PepsiCo, Inc. all the way from the issue of diverted profits tax (DPT) assessments to the High Court of Australia, in which PepsiCo was wholly successful.
This was the first case to address the DPT regime in the Australian tax law, and, also whether there was an embedded royalty that attracted royalty withholding tax (RWHT) in third party PepsiCo bottling contracts.
This case sets an important benchmark for how the Australian tax law applies to intangibles and the proper construction of the Australian general anti-avoidance rules. This is a subject of considerable interest to taxpayers, particularly given the Commissioner’s focus on the characterisation of payments made by software distributors for RWHT purposes.
In detail
PwC’s tax controversy and dispute resolution team represented PepsiCo in its precedential litigation in the High Court. The issues in dispute were the application of the RWHT provisions and the potential application of the DPT in Part IVA of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936).
Background
The PepsiCo group of companies operated a global beverage business.
PepsiCo and its relevant subsidiaries are US-resident companies that own intellectual property (IP) relating to the Pepsi, Mountain Dew and Gatorade brands.
In 2009, PepsiCo amended and restated its existing exclusive bottling appointment (EBAs) with its Australian bottler to bottle, market and distribute carbonated and non-carbonated beverages. Other agreements were entered into in connection with marketing and advertising activities to be performed by the bottler in respect of the PepsiCo brand. Importantly, the Australian bottler was unrelated to the PepsiCo group.
Under the EBAs:
PepsiCo agreed to sell, or cause a related entity to sell, beverage concentrate to the bottler; the concentrate was to be mixed by the bottler with other ingredients in accordance with formulas, specifications and other information provided by the PepsiCo group to produce finished beverages for retail sale in Australia, and
PepsiCo granted the bottler the right to use in Australia its IP to enable the bottler to manufacture, bottle, sell and distribute the finished beverages in branded PepsiCo group packaging.
The bottler was authorised to use PepsiCo’s IP in connection with the manufacture and distribution of branded PepsiCo beverages, subject to compliance with PepsiCo’s strict conditions as to how the IP was to be used.
The bottler purchased beverage concentrate from an appointed seller, an Australian subsidiary of the PepsiCo group, PepsiCo Beverage Singapore (PBS).
The relevant transactions that occurred in the 2018 and 2019 years were as follows:
PBS purchased concentrate from a PepsiCo entity which manufactured the concentrate
the bottler sent purchase orders to PBS to purchase concentrate
PBS issued invoices to the bottler for the sale of concentrate, and
the concentrate was delivered to the bottler to perform the bottling function pursuant to the EBAs.
The proceedings were brought in two forms, the first was under the Judiciary Act 1903 (Cth) with the taxpayer seeking declaratory relief to the effect that PepsiCo was not liable to pay royalty withholding tax, the second was four proceedings under the Taxation Administration Act 1953 (Cth) in relation to the DPT assessments made by the Commissioner in relation to the relevant years. The proceedings were heard together, and evidence in one proceeding was taken to be evidence in the other proceedings.
At first instance, in a decision delivered on 30 November 2023, Moshinsky J found for the Commissioner in respect of both the RWHT issue, and, in the alternative, in respect of the DPT matter as well.
Upon appeal to the Full Federal Court, the majority of the Full Federal Court found for the taxpayers in respect of both matters. The Commissioner appealed the Full Federal Court’s decision to the High Court, with the matters heard on 2 and 3 April 2025.
Issues
The questions before the High Court were:
first, whether the amounts paid by the bottler attracted the imposition of RWHT under section 128B of the ITAA 1936. PepsiCo was liable to pay RWHT if both:
- the payments were royalties – that is, if the payments were partially in 'consideration for' the license provided to the bottler under the EBAs to use PepsiCo’s IP, and
- if the payments were royalties, the payments were derived by PepsiCo (a non-resident), and
second, whether PepsiCo was liable to pay DPT pursuant to section 177P of the ITAA 1936 because the principal purpose of the entry into the EBAs was to avoid the incidence of RWHT and to reduce PepsiCo’s US tax liabilities.
The matter was heard by the full seven court panel of the High Court of Australia. The High Court unanimously decided the RWHT issue in PepsiCo’s favour. While 3 justices determined that the amounts paid by the bottler was a royalty, all 7 justices held that PepsiCo had not derived the purported royalty income. The DPT issue was decided in PepsiCo’s favour in a close 4-3 decision.
The High Court’s findings are summarised below.
RWHT issue
Broadly, royalties from Australia that are derived by and paid to a US-resident attracts an Australian withholding tax rate of 5%.
Whilst the treaty definition of royalty was also considered at first instance, neither party contended that there was any relevant distinction between the treaty definition and the domestic definition of royalty in section 6(1) of the ITAA, and accordingly, the High Court’s reasons focused on whether payments made by the third party bottler were within the meaning of the domestic definition of a ‘royalty’.
The bottler’s payments were not in 'consideration for' the use of PepsiCo’s IP
The Commissioner’s position was that the payments made by the bottler to PBS were a 'royalty' within the meaning of section 6(1) of the ITAA 1936 because the payments were to be viewed as partially in consideration for the right to use PepsiCo’s IP. The Commissioner reasoned that PepsiCo could not have licensed its valuable IP to the bottler for 'nothing'. The majority rejected the proposition that the IP was licensed for 'nothing'.
The EBA was characterised as an 'umbrella agreement' that governed the parties’ future dealings, including future concentrate sales. The consideration that PepsiCo received for providing an IP license was a promise by the bottler to perform contractual obligations including to build the PepsiCo brand in Australia.
No payment was made to PepsiCo for the sale of concentrate. Rather, the amounts paid by the bottler discharged the monetary obligations it owed to PBS under each invoice it received for purchase orders of concentrate. The majority treated each invoice as its own contract which effected the transfer of concentrate from vendor to purchaser. The Commissioner did not dispute that the price of concentrate was an arm’s length price and so the majority did not disturb the arrangements entered into by unrelated third parties.
Key takeaway
The principle emerging from the High Court is that attention should be directed to precisely identifying what is being paid for under agreements where IP rights are contemplated or being exchanged. However, this must be balanced against the backdrop of PepsiCo’s unique facts which concerned an arrangement with an unrelated third party acting at arm’s length for the use of IP and other property.
To the extent that IP and other property can be separated, then this may assist in demonstrating that certain payments bear a direct and proximate nexus with non-IP property such that the payments are not characterised as a 'royalty'.
However, there will be cases where identifying the specific nature of consideration received under a contract may be more difficult to separate. This question was a finely balanced one throughout the course of PepsiCo’s proceedings at the High Court and in earlier proceedings with a slight majority of 6-5 justices agreeing with PepsiCo’s position that the character of the payments made by the bottler were not a royalty.
The Commissioner did not assert that the arrangements were not at arm’s length and did not seek to apply the transfer pricing provisions. This may be an important distinction to consider for other taxpayers when they are evaluating the character of payments made from Australia, including for payments of intangible assets.
The bottler’s payments did not represent income in PepsiCo’s hands
The Commissioner’s case was that the amounts paid by the bottler to PBS were constructively derived by PepsiCo on the basis the proper legal construction of the EBAs should instead lead to the conclusion that PepsiCo directed its income, being the payments for concentrate, to PBS. The Commissioner did not contend that an agency or trustee relationship existed on the part of PepsiCo and PBS, nor did he assert that the transactions for the sale of concentrate by PBS to the bottler were a sham.
PepsiCo’s position was that the bottler owed the purchase price for the concentrate to PBS and not to PepsiCo, the bottler owed no monetary obligation to PepsiCo for the sale of concentrate, and that PepsiCo did not derive any income from the sale of concentrate by PBS to the bottler.
The High Court disagreed with the Commissioner’s interpretation of the EBAs. The court found that no monetary obligation was owed by the bottler to PepsiCo in respect of the concentrate because PepsiCo did not have legal title to the concentrate and there was no antecedent monetary obligation owed by the bottler to PepsiCo. The payments made by the bottler caused legal title to the concentrate to be transferred to the bottler by the Australian tax-resident entity (i.e. PBS).
Key takeaway
The Commissioner was unsuccessful in asserting that there was an antecedent monetary obligation owed by the bottler to PepsiCo under the EBAs, and that the payments made by the bottler were in discharge of that obligation. The Commissioner contended that the payments made to the Australian tax-resident entity (i.e. PBS) was done at the direction of PepsiCo.
The payment to an Australian tax-resident entity (i.e. PBS) was a factual matter that is, likely, unique to PepsiCo’s case.
DPT issue
DPT sits within the framework of the Australian General Anti-Avoidance Rules in Part IVA. Importantly, these rules are excluded from the operation of Australian tax treaties.
DPT was introduced in the Australian taw law in 2017, with a projection that the new rules would raise $200m of additional revenue by the end of the 2020 income year. The DPT rules were enacted to complement Australia’s transfer pricing and anti-avoidance rules by:
ensuring the tax paid by significant global entities (SGEs) properly reflects the economic substance of their activities in Australia
preventing the diversion of profits offshore through contrived arrangements, and
encouraging significant global entities to provide sufficient information to the Commissioner to allow for the timely resolution of tax disputes.
If the DPT rules apply to an arrangement, the Australian tax law will impose tax on the amount of diverted profit at a rate of 40%.
A primary object of the DPT was to prevent SGEs from reducing the amount of Australian tax they pay by diverting profits offshore through contrived arrangements between related parties.
PepsiCo’s litigation, which concerned the characterisation of payments from a third party bottler, was the first time that the Australian DPT rules have been subject to judicial consideration.
In order for PepsiCo to have been liable to pay DPT, PepsiCo’s entry into the EBAs must have:
produced a DPT tax benefit in PepsiCo’s hands within the meaning of section 177CB—i.e. the non-incidence of RWHT and a reduction in US tax liabilities, and
after considering the eleven objective factors, it needed to be concluded that the scheme was entered into for a principal purpose to obtain such a DPT tax benefit within the meaning of section 177J.
'It is what it is' - what must a taxpayer do to demonstrate that it did not obtain a tax benefit?
A taxpayer obtains a tax benefit in connection with the scheme if a 'reasonable' alternative hypothetical transaction exists which produces a higher taxing outcome. A 'reasonable' alternative is one that achieves the same commercial objectives as the scheme undertaken (ignoring differences in tax outcomes).
In PepsiCo’s case, the Commissioner put forward two alternative hypothetical EBAs that could have been effected through a 'minor textual change' that would have produced a tax benefit, being:
that it was reasonable for the EBAs to express that the payments by the bottler were for all the consideration provided to the bottler (including the IP license), and
that it was reasonable for the EBAs to express that the payments by the bottler for concentrate to include a royalty for the IP license.
A taxpayer bears the burden of proving that a DPT assessment is excessive.
The question that arose in this case was what does a taxpayer need to do to demonstrate that there was no tax benefit? In this regard:
the Commissioner submitted that PepsiCo can only prove there was no tax benefit by demonstrating that a reasonable alternative bottling arrangement existed that also did not result in a tax benefit, and
PepsiCo’s position was the alternative postulates were not a reasonable expectation of events, and further, there were no reasonable alternative arrangement to the EBAs as they were entered into.
The majority in the High Court agreed with PepsiCo. The Commissioner’s alternative postulates were determined to not reflect the economic and commercial substance of the EBAs - which was to enable value creation of the PepsiCo brands in Australia and the licensing of the IP was essential for the bottler to perform that obligation for the benefit of PepsiCo. The majority also dismissed that the Commissioner’s alternatives could be achieved through a 'minor textual change' to the EBAs—this would have resulted in the parties entering into a fundamentally different arrangement.
It is noted that the three justices in minority who concluded that the character of the payments made by the bottler to PBS were a royalty (but not income that was derived by PepsiCo) also concluded that a reasonable alternative to the scheme existed because there was considerable scope for variation in the EBAs, including pricing terms.
This case is distinct from the position accepted by the Court in RCI Pty Limited v Commissioner of Taxation [2011] FCAFC 104 that absent a scheme, a taxpayer would 'do nothing'. Rather, the PepsiCo case is a situation where 'it is what it is', because the scheme was the only way that the commercial objectives could be achieved.
Key takeaway
Although PepsiCo was able to discharge its burden of proof that it did not obtain a tax benefit in connection with its entry into the EBAs, the High Court indicated that this was an unusual case.
PepsiCo’s case was unusual in the sense that the facts concerned an arrangement where independent third parties struck a bargain that the majority did not disturb.
In a general anti-avoidance rules inquiry, the Commissioner is likely to continue to ask that taxpayers (and in particular those who have entered into an arrangement with related parties) to point to its own reasonable alternative that produces the same outcome as that of the scheme. After all, it is the taxpayer’s burden to prove that any tax assessments served on it are excessive. In this context it is critical that taxpayers collate contemporaneous evidence to substantiate the commercial and economic objectives that are sought to be achieved under an arrangement – including identifying comparable arrangements (in a transfer pricing context). However, PepsiCo is useful precedent in demonstrating that the post-RCI amendments do impose an obligation that any identified alternative postulate must reflect the substance of the scheme that was actually entered into or carried out.
Principal purpose?
The High Court proceedings were the first instance where 'purpose' in the context of DPT in section 177J was considered outside obiter. This is because PepsiCo cross-appealed against the Full Federal Court’s conclusion (in obiter) that the EBAs were entered into for a RHWT avoidance purpose. The majority in the High Court took a different view from the Full Federal Court.
The majority acknowledged that it would be 'unthinkable' if taxpayers did not take into account tax outcomes in negotiating a transaction. In this regard, Gordon, Edelman, Steward and Gleeson JJ explained at [229]:
‘...It would be unthinkable to suppose that sophisticated commercial operators did not take tax outcomes into consideration in negotiating the form of a transaction. As this Court observed in Federal Commissioner of Taxation v Spotless Services Ltd, “tax laws are one part of the legal order within which commerce is fostered and protected”. But taking tax outcomes into account does not necessarily justify an application of Pt IVA of the ITAA 1936, or, indeed, the imposition of DPT. The choice of leasing rather than buying business premises, as described by Gleeson CJ and McHugh J in Federal Commissioner of Taxation v Hart, illustrates that reality.’
The probative matters that gave rise to the majority’s conclusion that the EBAs were not entered into for a tax avoidance purpose was that:
it was a product of an arm’s length negotiation between experienced and large commercial enterprises;
the EBAs produced a price payable for concentrate that was not disproportionately high; and
the EBAs followed broadly a pre-existing and commercial way of PepsiCo 'doing business'—the absence of charging a royalty under the EBAs was consistent with bottling arrangements that PepsiCo entered into with unrelated parties in other jurisdictions.
In assessing the eleven objective factors that the tax law directs consideration be had to ascertain a party’s purpose for participating in an arrangement, the majority concluded that the manner and the form and substance of the EBAs did not reveal an intention to avoid the incidence of RWHT. Although the balance of the factors assumed lesser importance, the majority also concluded that all the factors in subsection 177D(2) (and 177J(2) save for the last) ‘strongly’ supported the conclusion that the principal purpose for PepsiCo’s entry into the EBAs was not for a tax avoidance purpose.
Key takeaway
The application of the general anti-avoidance rules is a complex and fact-rich issue. Whether or not those rules apply to an arrangement will vary according to each case’s factual matrix.
It does not necessarily follow that the circumstances in PepsiCo’s case that pointed away from a tax avoidance purpose will then point in the same direction for other arrangements entered into by other taxpayers – particularly if those arrangements involve non-arm’s length parties.
What’s next?
Implications to the Commissioner’s guidance on the use of intangibles
In January 2024, the Commissioner issued a draft tax ruling (TR 2024/D1) which sets out the circumstances in which payments made under a software arrangement will attract the imposition of RWHT. This draft has been updated from an earlier draft that was published in 2021 (TR 2021/D4).
At a high-level, where there is a payment for 'several things' (at least one of which is a right to use copyright or other IP), the Commissioner’s current position is that the payment must be a royalty to at least some extent and an apportionment exercise may need to be carried out. TR 2024/D1 includes nearly 30 paragraphs that consider the interpretation of the words 'consideration' and 'for' which may need to be reconsidered having regard to the majority's detailed guidance as to the appropriate interpretation of those words (including as a phrase) in the context of the royalty withholding tax provisions.
In a statement on 12 August 2025, the ATO indicated that they are considering the impact of PepsiCo upon the guidance that has been provided in TR 2024/D1.
Implications for other industries
The Court’s guidance in determining whether a payment is a royalty within the meaning of subsection 6(1) of the ITAA 1936 and the options available for a taxpayer to assert that it did not obtain a tax benefit in connection with an arrangement under section 177CB of the ITAA 1936 may be instructive to a broad range of industries dealing in the licensing of intangibles such as software, copyright rights, consumer goods and manufacturing.
However, given the number of related party licensing arrangements in the market, we expect transfer pricing principles to feature heavily in the resolution of these issues moving forward—particularly as IP and other items of property have become interlocked over time.
Potential application of the transfer pricing provisions
The Australian transfer pricing provisions in Subdivision 815-B of the Income Tax Assessment Act 1997 (ITAA 1997) can be applied where a taxpayer gets a transfer pricing benefit from non-arm’s length dealings. Specifically, a reduction in the withholding tax that might otherwise have been payable can be a transfer pricing benefit. The transfer pricing provisions were not considered in the PepsiCo decision where EBAs and supply of concentrate was with an unrelated bottler in circumstances which were accepted as arm’s length.
This raises a question about the level of comfort that taxpayers might be able to obtain from the PepsiCo decision in circumstances where contractual arrangements are between related parties. Subdivision 815-B of the ITAA 1997 specifically requires that the conditions that actually occurred between the parties can be disregarded and or replaced if one of those conditions would not have occurred at arm’s length. Does this therefore give the Commissioner the ability to ‘unbundle’ the intercompany agreement and ‘reconstruct’ terms with those that might have occurred at arm’s length? Equally, is the way in which taxpayers characterise their intercompany arrangements consistent with the substance of the commercial arrangements that they have entered into?
To date, there has been no Australian Court decision in respect of the operation of Subdivision 815-B of the ITAA 1997 which has specific reconstruction provisions and was introduced in 2014. There has been a number of significant transfer pricing cases in recent years in which the question of how broadly conditions can be interpreted has been considered in the context of the precedent transfer pricing provisions. The implications of the judgements will need to be considered in light of the decision of the High Court in PepsiCo.
The question of whether withholding tax can be imposed on the income of the non-resident recipient by applying the transfer pricing provisions is rarely addressed in the context of transfer pricing documentation, which ordinarily focusses on the profit outcome of the Australian related party making the payment. Taxpayers will need to consider whether they should separately document and analyse the application of the Australian transfer pricing consequences from the perspective of the non-resident to support any position adopted in relation to withholding tax.
PwC is uniquely placed to share its insights and observations with you after having represented PepsiCo throughout the litigation process into the High Court, and based on our market leading multi-disciplinary tax, legal and transfer pricing practice.
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