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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.
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.
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.
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.
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.
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.
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.
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.
If you have any queries about the PepsiCo case, or other Australian tax matters, then please get in touch.
A landmark ruling by the US Supreme Court has significantly curtailed the authority of federal agencies, including the Internal Revenue Service (IRS), to interpret the laws they enforce.
The decision in the case of Loper Bright v Raimondo overturns the Chevron doctrine, a 40-year-old principle that required courts to defer to federal agencies on the interpretation of ambiguous laws passed by Congress.
For decades, the IRS relied on the Chevron doctrine to defend its tax regulations in litigation.
This doctrine compelled federal courts to defer to a federal agency’s reasonable interpretation of an ambiguous statute.
This effectively limited the opportunities for taxpayers and tax practitioners to contest some of the muddier aspects of Internal Revenue Code.
The Supreme Court declared that Chevron is incompatible with the Administrative Procedure Act’s mandate for courts to resolve legal questions using their judgment.
Going forward, the Courts will rely on their discretion in cases involving ambiguous statutes rather than deferring to agency interpretations. That said, they may still consider an agency’s interpretation if it is long-standing or well-reasoned.
The implications of the Loper ruling are still unfolding, but experts anticipate an increase in litigation.
Additionally, the IRS will likely face constraints in issuing tax guidance and rules, as the process to establish these as settled law becomes more protracted.
The ruling may also invigorate pending legal challenges to potentially overreaching federal agency actions.
However, the Supreme Court’s decision in Loper does not retroactively invalidate cases decided under the Chevron deference doctrine over the past 40 years. Statutory precedent will still apply to those cases. “We do not call into question prior cases that relied on the Chevron framework,” the Court stated. “The holdings of those cases that specific agency actions are lawful remain subject to statutory stare decisis despite our change in interpretive methodology.”
This ruling marks a significant shift in the balance of power between federal agencies and the courts, with potentially far-reaching consequences for regulatory practices and the enforcement of federal laws.
If you have any queries about this article on Loper Bright v Raimondo, or any other US tax matters, then please get in touch.
In a recent ruling, the Israeli court addressed claims by the Netanya tax assessor regarding the restructuring of Shalam Packaging Products Group.
The assessor argued that the group’s restructuring was conducted solely to reduce tax liabilities by offsetting business losses against a capital gain from insurance payouts following a fire at one of their plants.
Shalam Packaging Products (1998) Ltd, the parent company, manufactures and markets plastic packaging products.
It owns several subsidiaries, including Shalam Packaging Solutions Ltd., which operated an industrial plant in Yakum.
The parent company acquired 100% of the subsidiary’s shares between 2008 and 2013, during which the subsidiary incurred business losses totaling about ILS 54 million.
In January 2014, the parent company filed a notice of restructuring with the tax assessor, transferring assets to the subsidiary under Section 104A of the Income Tax Ordinance, in exchange for shares allotted to the parent company.
Subsequently, the subsidiary transferred operations from its Yakum plant to the parent company’s plant in Caesarea.
In June 2014, a fire at the Caesarea plant led to insurance payouts totaling ILS 155 million.
The group reported capital gains from these payouts and offset significant business losses against this income.
However, the tax assessor claimed the restructuring was a scheme to improperly reduce tax liabilities, labeling it as an artificial transaction.
The assessor issued a tax assessment charge, disallowing the loss offset.
The assessor also contested the classification of ILS 49 million in capital notes from the subsidiary’s previous owner, Kibbutz Yakum, as perpetual notes.
The assessor argued these were regular liabilities and should be treated as such for tax purposes, requiring the income from debt forgiveness to be offset against the business loss.
The court ruled in favor of Shalam Packaging Products Group, rejecting the tax assessor’s claims on several grounds:
This ruling underscores the importance of commercial substance in tax planning and restructuring activities.
It confirms that tax authorities must consider the genuine business purposes behind transactions, rather than solely focusing on potential tax benefits.
The decision provides clarity on how business losses can be offset against capital gains and reinforces the distinction between legitimate tax planning and artificial transactions.
If you have any queries on this article about this New Israeli Court Ruling on Artificial Transactions, or tax matters in Israel more generally, then please get in touch.
Debentures are a common method for companies to raise debt, but there remains ambiguity regarding the taxation of certain income earned from them.
One such issue is the taxation of the premium received on the redemption of debentures. This ambiguity arises because a taxable transfer under the Income-tax Act, 1961 (IT Act) includes the relinquishment of an asset or the extinguishment of any rights therein.
Taxpayers argue that redemption premiums should be taxed as capital gains since they are payments received upon the extinguishment of a capital asset (i.e., debentures).
However, the term ‘interest’ is broadly defined to include any income earned from borrowed money or incurred debt. Consequently, it may be argued that redemption premiums, being income from a debt instrument, should be taxed as interest income.
Recently, the Mumbai Income Tax Appellate Tribunal (ITAT) in Khushaal C. Thackersey v. Assistant Commissioner of Income-tax adjudicated on this issue, holding that the premium received upon redemption of Non-Convertible Debentures (NCDs) is not capital gains but interest, taxable under the head “income from other sources.”
In this case, the taxpayer, an Indian tax resident, purchased NCDs issued by an Indian company from nationalized banks.
These NCDs offered a 0% interest rate but were redeemable at a premium. Upon maturity, the taxpayer received the face value plus the premium from the company.
The taxpayer computed long-term capital gains by subtracting the cost of acquisition from the maturity proceeds, aiming to benefit from the favorable 20% tax rate (plus surcharge and cess) available for long-term capital gains, compared to interest, which is taxed at rates up to 30% (plus surcharge and cess).
The taxpayer also attempted to claim an exemption on the capital gains earned.
Upon assessment, the tax officer determined that the gain received on redemption of NCDs was interest income, assessable under “income from other sources,” and recomputed the tax liability.
This decision was upheld by the first appellate authority under the IT Act.
The taxpayer appealed to the Mumbai ITAT.
The taxpayer argued that debentures are ‘capital assets’ and their extinguishment constitutes a taxable transfer under the IT Act.
The taxpayer cited precedents where redemption of preference shares and capital investment bonds were considered “transfers” under the IT Act, qualifying for capital gains treatment.
Additionally, the taxpayer referenced Section 50AA, which deems gains from transfer, redemption, or maturity of Market Linked Debentures (MLD) taxable as capital gains, indicating that redemption of debentures constitutes a taxable transfer.
The tax authorities countered that NCDs are debt instruments, and the premium received on redemption is interest income.
They relied on Bennett Coleman & Co. Ltd, where it was held that premium received on redemption of debentures is taxable under “income from other sources.”
The tax authorities also referred to Circular 2/2005, which clarifies that the difference between redemption price and purchase cost of deep discount bonds by intermediate purchasers is taxable as interest or business income.
The Mumbai ITAT ruled in favor of the tax authorities, holding that the premium on redemption of debentures is taxable as interest income. The ITAT observed that the discount on deep discount bonds (DDBs) is similar to the premium paid on the redemption of NCDs, as both are debt instruments, and the discount/premium is determined by applying a specific interest rate.
The ITAT noted that for Market Linked Debentures (MLDs), the interest rate is not determined at issuance, but the return depends on the performance of an underlying market index or instrument, making MLDs materially different from NCDs. Hence, no support could be drawn from Section 50AA in the taxpayer’s argument.
The ITAT further distinguished between debentures and preference shares/capital investment bonds, noting that the latter carry additional rights, such as the right to receive surplus on liquidation, which are absent in debentures. Thus, the cases cited by the taxpayer regarding taxable transfers involving an ‘extinguishment’ were deemed not applicable to the present facts.
The ITAT concluded that the redemption of NCDs at face value by the issuer does not give rise to capital gains but merely constitutes the realization of money advanced by a creditor. Consequently, any premium received is considered interest income.
This ITAT judgment upholds the principle that the premium received on the redemption of NCDs is generally taxable as interest under the head ‘income from other sources.’
However, it is important to note that the judgment dealt with a specific scenario where NCDs were issued at 0% interest in lieu of an outstanding debt obligation.
Other scenarios, such as a buyback of interest-bearing NCDs before maturity, could be treated differently. In such cases, if the investor relinquishes the right to receive future interest for a one-time payment, it might be considered an ‘extinguishment of rights,’ potentially triggering capital gains tax implications.
Therefore, it is crucial to analyze the impact of this ruling based on the specific facts and relevant tax principles of each case.
The ITAT judgment in the Khushaal C. Thackersey case provides valuable clarity on the tax treatment of premium received on NCDs, ruling it as interest income rather than capital gains.
However, the applicability of the principles highlighted will need to be tested against the complexities of individual cases.
If you have any queries on this article on the taxation of premium on redemption of debentures, or Indian tax matters in general, then please get in touch.
Businesses that engage self-employed contractors, consultants, and freelancers should now reassess their commercial arrangements to ensure they meet the requirements for tax and employment purposes.
In May 2024, the Irish Revenue Commissioners released a guidance note detailing the factors to be considered in determining employment status for tax purposes. This guidance, while focused on tax law, also impacts employment and social welfare considerations.
The European Parliament adopted the Platform Work Directive on April 24, 2024, introducing a presumption of employment for certain workers in platform work activities.
This legislative change underscores the ongoing importance of accurately determining employment status in both the gig economy and broader business contexts.
The new guidance follows a landmark decision by the Irish Supreme Court in October 2023, in The Revenue Commissioners v. Karshan (Midlands) Limited t/a Domino’s Pizza [2023] IESC 24.
We have covered this case previously on Tax Natives.
This case involved delivery drivers and fundamentally altered the analysis of employment contracts to determine whether an individual is an employee or self-employed.
The ruling has significant implications for businesses engaging individuals for personal services, whether as independent contractors, consultants, or freelancers.
The Supreme Court established five key tests to determine employment status, which the Revenue Commissioners’ guidance now elaborates on with practical examples from various sectors, including construction, IT, and professional services.
This test examines if there is an agreed rate for services provided, whether hourly, daily, or linked to specific deliverables. The nature and arrangement of any payment are crucial factors.
This test differentiates between individuals providing services personally and those who can delegate the work to others.
The level of control the contractor has over how the work is performed is a fundamental factor. The presence of control is also critical under the Platform Directive for determining employment status.
After passing the first three tests, all facts and circumstances of the relationship must be considered, including:
The specific wording of relevant statutory regimes or legislation must be considered, as different laws may confer different rights.
For example, being taxed under the PAYE system does not automatically grant employment rights.
The Supreme Court’s decision and the Revenue guidance note clarify that transferring between taxing regimes for a tax benefit does not constitute abusive tax avoidance. Structuring one’s affairs to fall within a particular regime is considered legitimate.
Businesses must now proactively review their commercial arrangements with self-employed workers. The guidance note provides detailed examples to help businesses apply these tests in various scenarios.
The Supreme Court ruling specifically addresses the Taxes Consolidation Act 1997 and does not automatically apply to other areas of law. The Revenue Commissioners emphasize ongoing engagement with government departments responsible for employment and social welfare status to ensure consistent application across different legal contexts.
The Supreme Court case and the Revenue Commissioners’ new guidance significantly impact how businesses should classify their self-employed contractors.
Businesses are advised to review and possibly restructure their current arrangements to ensure compliance with the updated requirements for tax and employment purposes.
If you have any queries about this article the Guidance Issued on Employment Status, or Irish tax matters in general, then please get in touch.
In a landmark decision on 8 March, the Full Federal Court (FFC) sided with the taxpayer, Minerva Financial Group Pty Ltd, against the Commissioner of Taxation, clarifying the application of general anti-avoidance rules within Part IVA of the Income Tax Assessment Act 1936.
This ruling underscores the nuanced interpretation of Part IVA, particularly concerning discretionary distributions by trustees, and marks a significant victory for taxpayers navigating the complexities of tax law.
The court’s decision offers several crucial insights into Part IVA’s operation:
Taxpayers are reminded of the importance of documenting the reasons behind their arrangements. While Part IVA’s test is objective, understanding the context can help determine the dominant purpose.
It’s essential to consider all eight factors outlined in section 177D(2) collectively, rather than in isolation, to ascertain a scheme’s dominant purpose.
Part IVA does not merely assess if a different course of action would have been taken without the tax benefit, emphasizing that a dominant purpose of obtaining a tax benefit must involve more substantive evidence.
Transactions within a commonly owned group, even if they involve intra-group loan account entries instead of cash transfers, are not inherently indicative of a scheme’s dominant purpose to secure a tax benefit.
The FFC’s ruling further clarified the legality of certain structures and practices:
The case centered around the Liberty group’s restructuring into corporate and trust silos, aimed at optimizing for an IPO.
This restructure led to significant profits being distributed in a way that incurred a lower withholding tax rate, prompting the Commissioner to apply Part IVA, suggesting these distributions were primarily for tax avoidance.
The FFC meticulously dissected the application of Part IVA, focusing on the intent behind the distributions and the structure of the Liberty group.
The court’s analysis, particularly on how the scheme was executed and the financial implications for the involved entities, led to a conclusion that favored the taxpayer.
The decision stresses that the presence of a tax benefit alone is insufficient to prove a dominant purpose of tax avoidance.
This ruling is a pivotal moment for taxpayers and legal practitioners, offering clarity on Part IVA’s interpretation and its application to complex financial structures and distributions.
It serves as a reminder of the critical balance between tax planning and avoidance, reinforcing the need for a comprehensive evaluation of arrangements under the lens of tax law.
The victory of Minerva Financial Group in this case not only provides a roadmap for similar cases but also reassures taxpayers that legitimate business arrangements, even those resulting in tax benefits, can withstand scrutiny under Australia’s general anti-avoidance rules.
If you have any queries about the Minerva case, or any other Australian tax matter, then please get in touch.
In a significant ruling, the Upper Tribunal (UT) has upheld a penalty against Kevin John Pitt for failing to take corrective action in response to a follower notice (FN) issued by HM Revenue and Customs (HMRC).
The case, referred to as K Pitt v HMRC [2024] UKUT 21 (TCC), serves as a critical reminder of the stringent requirements imposed by HMRC concerning tax compliance.
HMRC issued a follower notice to Mr. Pitt in 2016, based on the judicial ruling in Audley v HMRC [2011] UKFTT.
The FN identified that the tax avoidance arrangements Mr. Pitt had entered into, which involved the acquisition and disposal of loan notes and claimed a loss of £694,684, were similar to those previously ruled on.
HMRC contended that these arrangements did not warrant the claimed tax relief of £278,557.60.
When Mr. Pitt failed to amend his tax returns in line with the FN, HMRC subsequently imposed a penalty amounting to £83,547. This penalty was calculated based on a percentage of the tax advantage that had been incorrectly claimed.
Mr. Pitt challenged both the closure notice that denied his loss relief claim and the penalty at the First-tier Tribunal (FTT), but was unsuccessful.
He then escalated the challenge concerning the penalty to the UT, arguing that the FTT had erred by comparing evaluative conclusions and inferences rather than the primary facts of the Audley case.
The UT dismissed the appeal, affirming that the legislative intent required an analysis that extends beyond mere primary facts to include evaluative conclusions and inferences.
This approach aligns with the Ramsay principle, which advocates for a realistic view of facts in light of the legislative purpose.
The UT clarified that reconstituted facts, when construed purposively and realistically, are indeed facts and must be treated as such in the assessment of follower notices.
This ruling underscores the effectiveness and reach of the FN regime beyond just mass-marketed tax avoidance schemes.
It highlights the necessity for taxpayers to adhere strictly to the directives specified in FNs, especially when prior judicial rulings clearly delineate the bounds of permissible tax relief claims.
The decision of the UT provides crucial insights into the interpretation and application of laws related to follower notices and corrective actions.
While FNs have been controversial since their introduction about ten years ago, the UT’s detailed narrative and analysis offer valuable guidance for taxpayers who might find themselves subject to such notices.
The ongoing legal narrative around FNs and the responsibilities they place on taxpayers continue to evolve, and this decision is a pivotal addition to the existing body of case law.
Taxpayers and tax professionals alike should note the implications of this ruling, as it not only affirms the breadth of the FN regime but also reinforces the need for compliance with its requirements.
If you have any queries about this article on Upper Tribunal Upholds Follower Notice Penalty, or UK tax matters more generally, then please get in touch.