Pepsi’s Australia Tax Case to Augur Multinationals’ Future Bills

Revenue collection agencies around the world, as well as executives at multinational companies, are watching PepsiCo Inc.’s appeal of its “embedded royalties” case in Australia with interest.

After the company’s loss to the Australian Taxation Office in November, the parties are returning to the Full Court of the Federal Court of Australia on May 8, where PepsiCo will seek to overturn a ruling over its “royalty-free” agreements with Schweppes Australia Pty Ltd.

If the decision is upheld, taxpayers and their advisers can expect the ATO to apply the decision expansively to attack other cross-border contracts with embedded royalty arrangements.

The decision is sector-agnostic and potentially applies to a range of industries including technology, pharmaceuticals, mining, manufacturing, and retail.

Another loss for PepsiCo also could embolden revenue authorities to take similarly aggressive positions on their royalty withholding tax provisions. That emboldening may have already started.

Amid the battle against 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. Just as swiftly, Coca-Cola filed an appeal with the Federal Court objecting to that assessment.

While that appeal is yet to be heard, court filings suggest that the ATO’s diverted profits tax assessment was issued on similar grounds as the PepsiCo case, which marked the first time those provisions were considered by a court.

Upcoming Arguments

Federal Court Justice Mark Kranz Moshinsky found PepsiCo liable for royalty withholding tax at a 5% rate related to portions of payments made under exclusive bottling agreements, which were held to be royalties. Even if the payments weren’t royalties, the court said Australia’s diverted profits tax would have applied at a rate of 40%.

PepsiCo had little choice but to appeal. Moshinsky’s finding that its business model was fundamentally “contrived” was a hammer blow for a company that operates a similar model in more than 100 jurisdictions around the world.

Appeals to the full Federal Court of Australia are limited to questions of law, not fact. In considering the ATO case against PepsiCo, Moshinsky dealt with the evidence thoroughly.

His conclusion about the amount of the royalty may not be disturbed on appeal. Instead, the battle lines will be drawn around the legal tests for the operation of the royalty withholding tax and diverted profits tax provisions.

PepsiCo likely will argue that royalty withholding tax rules focus on the relevant contractual terms and that, unlike transfer pricing and other anti-avoidance rules, the ATO can’t depart from those terms by referencing a broader commercial context. On that basis, PepsiCo would argue that no part of the payments for concentrate could be characterized as royalties.

PepsiCo also may take issue with a seeming incongruity in Moshinsky’s analysis that the payments were “derived by” and “paid to” PepsiCo, rather than an Australian subsidiary in the PepsiCo group called PepsiCo Beverage Singapore Pty Ltd. (PBS).

If Schweppes paid the amounts to PBS to purchase concentrate, and PBS included those amounts in its assessable income and was subject to Australian tax on that basis, how could it be that the same payment was in part “derived by” and “paid to” PepsiCo Inc as a royalty?

If the full court agrees with PepsiCo’s submissions on the royalties issue, the company also will need to successfully challenge any diverted profits tax liability. This would involve a close analysis of whether PepsiCo entered into the arrangements for a principal purpose of avoiding royalty withholding tax.

For PepsiCo to win, the company will need to convince the court on both the royalty issue and the diverted profits tax issue. If it succeeds on the royalty issue but not on the diverted profits tax issue on appeal, its tax bill will multiply eight-fold.

While the result will largely turn on the facts, the full court may provide further clarity on the previously untested diverted profits tax regime.

Through its justified trust compliance programs, the ATO may expect large multinational taxpayers to explain historic royalty withholding tax positions. The regulator also may rely on its suite of guidance products to “nudge” taxpayers into lower risk positions by suggesting they voluntarily recognize and assign a value to royalties in their contracts.

The ATO has already applied this “nudge” approach in its controversial draft ruling on royalties for software and intellectual property, much to the ire of US tech giants.

A loss for the ATO on appeal would take it back to the drawing board and give multinationals a reprieve.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Shaun Cartoon is tax partner at Arnold Bloch Leibler with focus on corporate, international, and employment taxes, mergers and acquisitions, corporate restructures, and employee share schemes.

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