PepsiCo Case – Introduction
On June 26, 2024, in PepsiCo, Inc v Commissioner of Taxation [2024], the Full Federal Court delivered a critical decision regarding the tax treatment of payments made under two Exclusive Bottling Agreements (EBAs).
The Court ruled that these payments were not subject to Royalty Withholding Tax and, by majority, also decided that the Diverted Profits Tax (DPT) would not apply.
However, in a minority opinion, Justice Colvin asserted that DPT should apply.
The Full Federal Court’s decision overturned the earlier ruling by Justice Moshinsky on November 30, 2023, which had classified portions of the payments related to beverage concentrate sales as royalties subject to Royalty Withholding Tax.
Justice Moshinsky had also ruled that DPT could apply under alternative circumstances.
Background
PepsiCo, Inc. (PepsiCo) and Stokely-Van Camp, Inc (SVC), both US resident companies, had entered into EBAs with Schweppes Australia Pty Ltd (SAPL), an Australian company.
These agreements provided SAPL with beverage concentrate to produce finished beverages for retail in Australia, along with licenses for trademarks and intellectual property related to both carbonated and non-carbonated beverages.
The beverage concentrate was sold as a ‘kit’ containing various ingredients for blending and resale.
Key Observations
The Full Federal Court, comprising Judges Perram and Jackman (majority) and Colvin (minority), diverged significantly from the trial judge’s approach.
They focused on a detailed contractual interpretation of the EBAs, analyzing the central rights obtained by the parties, and referred to significant case precedents involving stamp duty and property/rights transfers.
The judges emphasized the importance of the ‘commercial and economic substance’ of the agreements over a simplistic contractual interpretation.
Given the divergence in views on critical tax issues such as ‘royalties’, ‘tax benefit’, and ‘principal purpose’ among the four Federal Court judges, it is anticipated that the Australian Tax Office (ATO) may seek leave to appeal to the High Court of Australia.
This case holds significant precedent value, particularly concerning DPT, and is closely monitored by sectors with valuable intellectual property, including Consumer Goods/Retail, Pharmaceuticals/Medical/Life Sciences, and Technology.
Majority Judges
Royalties & Royalty Withholding Tax
Perram and Jackman JJ ruled that the payments made by SAPL under the EBAs were solely for beverage concentrate and did not include any component that constituted a royalty for using PepsiCo/SVC’s intellectual property, such as trademarks.
They emphasized that the license rights granted to SAPL for using trademarks and other intellectual property benefitted both SAPL and PepsiCo/SVC by allowing SAPL to take advantage of the goodwill attached to these trademarks.
The judges noted that the contractual documents, including EBAs, purchase orders, and invoices, did not indicate that the payments were partly for the right to use trademarks.
They referred to the precedent set by International Business Machines Corporation v Commission of Taxation (2011) FCA335, supporting their reliance on the terms of the agreements.
The majority concluded that the payments were not royalties because the EBA stipulated that the license was royalty-free, at least under the SVC/EBA.
As no portion of the payments could be considered a royalty, there was no liability for Royalty Withholding Tax.
Diverted Profits Tax (DPT)
Regarding DPT, the Commissioner proposed two alternative postulates: first, that the EBA might reasonably have included payments for all property provided, including trademarks and IP rights; second, that the payments should have explicitly included a royalty for these rights.
However, the majority judges found these postulates unreasonable and concluded that the Commissioner’s arguments on DPT failed.
They noted that while the taxpayers might be seen to secure a ‘tax benefit’ under Section 177J, the Commissioner’s postulates were not reasonable alternatives.
Minority Judge
Royalties and Royalty Withholding Tax
Justice Colvin viewed the EBAs as appointing SAPL with the right to bottle, distribute, and sell branded beverages.
He argued that the trademarks were known to be valuable, and it would be commercially unreasonable to consider the EBAs as involving no consideration for these trademarks.
Therefore, he believed a portion of the payments should be classified as royalties.
However, Colvin J. agreed that because the Seller was nominated under the EBAs, the amounts paid were not derived by PepsiCo/SVC, and thus no Royalty Withholding Tax was applicable.
Diverted Profits Tax (DPT)
Justice Colvin also believed that the EBAs should have explicitly provided for the payment of royalties to PepsiCo/SVC, resulting in a ‘tax benefit’ with the principal purpose of achieving this benefit.
Hence, he concluded that DPT should apply.
PepsiCo Case – Conclusion
The Full Federal Court’s ruling has significant implications for the classification and tax treatment of payments under similar agreements.
The decision underscores the importance of detailed contractual analysis and the economic substance of transactions over simplistic interpretations.
While the majority ruling favored PepsiCo, the minority opinion highlighted potential areas of contention that could influence future tax assessments and legal interpretations.
Given the potential for an appeal to the High Court, this case may continue to shape the landscape of international tax law and intellectual property transactions in Australia.
Final thoughts
If you have any queries about the PepsiCo case, or other Australian tax matters, then please get in touch.