PepsiCo’s Australian Tax Win Is a Brief Multinational Respite

The Full Federal Court of Australia’s decision to absolve PepsiCo Inc. from its royalty withholding tax liability has cast doubt on the Australian Taxation Office’s position on “embedded royalties.”

While the ruling gives a reprieve to large multinationals operating and investing in the country, it likely won’t impact the ATO’s continued scrutiny of their tax arrangements as the regulator considers an appeal to the High Court.

A lower court’s decision in the case late last year made waves around the world by finding that Schweppes Australia Pty Ltd.’s payments for concentrate from PepsiCo Beverage Singapore Pty Ltd. included an embedded royalty for an exclusive license to use intellectual property granted to Schweppes by PepsiCo.

Justice Mark Moshinsky further found that PepsiCo should have charged an express royalty for the license, and that the arrangements would have run afoul of Australia’s diverted profits tax rules.

The Full Federal Court rejected these findings. On June 27, Justices Nye Perram and Ian Jackman jointly found that no amount of the payments could be characterized as a royalty paid to use PepsiCo’s IP under the license. Instead, Schweppes paid for the license by sustaining and promoting PepsiCo’s goodwill in Australia.

Moreover, Perram and Jackman found the payments couldn’t be characterized as income derived by PepsiCo because they were solely income of PepsiCo Beverage Singapore, so royalty withholding tax couldn’t apply.

The Federal Court also rejected the tax commissioner’s arguments that Australia’s diverted profits tax would apply. Though they agreed that PepsiCo may have had a principal purpose of avoiding tax, they found that the company had no reasonable alternative to the arrangement and therefore wasn’t liable for diverted profits tax.

In a dissent, Justice Craig Colvin said that while there was an embedded royalty, royalty withholding tax couldn’t apply because income wasn’t derived by PepsiCo. However, he found that diverted profits tax would apply because there was a reasonable alternative to PepsiCo.

This decision is the latest in a string of Federal Court judgments that have found for the taxpayer, respecting the underlying commercial drivers and agreements struck between arm’s-length parties. It’s a wake-up call to the ATO that it can’t imply a commercial arrangement is a sham without making the allegation directly.

The ruling should provide some much-needed respite for multinationals investing in Australia and those operating in other jurisdictions, where revenue authorities have been watching this case with keen interest. Tensions in cross-border deal making around warranty and indemnity protections should now ease.

It comes amid growing concern by foreign revenue authorities, including the US Treasury Department, about the ATO’s increasingly aggressive approach to cross-border arrangements.

Scott Levine, US Treasury’s deputy assistant secretary for international tax affairs, wrote to the Australian Treasury in early April, explaining his department’s position that the ATO’s views on software royalties conflict with the Australia-US tax treaty and OECD model tax convention commentary. He even added that US Treasury was “very disappointed” with the ATO.

The ATO will be considering its next move. Although the regulator’s arguments on royalty withholding tax were thoroughly rejected, this litigation has seen an equal number of Federal Court justices accept and reject the ATO’s arguments on diverted profits tax.

This leaves the ATO’s position in the balance, with 28 days to decide whether to apply for special leave to appeal to the High Court.

The latest PepsiCo decision is a speed bump for the ATO, but it doesn’t change the regulator’s goals. The ATO likely will continue to scrutinize arrangements involving large multinationals, with a range of weapons in its arsenal such as Australia’s transfer pricing framework and general anti-avoidance rules.

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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