PepsiCo prevails in High Court, but how long will refreshment last?

The High Court of Australia has issued its highly anticipated judgment in the case of Commissioner of Taxation v PepsiCo Inc [2025] HCA 30 (PepsiCo), with a 4:3 majority dismissing the appeal of the Commissioner of Taxation (Commissioner).

The decision brings welcome clarification to the royalty characterisation of payments made offshore for intellectual property (IP) rights, especially in light of recent Australian Taxation Office (ATO) guidance.

It also provides useful precedent on the scope and application of the diverted profits tax (DPT), as well as the application of other anti-avoidance rules in the tax legislation, including the general anti-avoidance rules in Part IVA of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936).

Observations

ATO guidance and regulatory landscape

• Impact on Draft TR 2024/D1: In light of the outcome, the Commissioner will likely be required to review the expansive and controversial approach to the characterisation of payments as “royalties” that is outlined in Draft TR 2024/D1, Income tax: royalties – character of payments in respect of software and intellectual property rights. The ATO observed as much in Draft PCG 2025/D4 (published last week – see KWM Insight here) and may alter its position to align with the Court’s decision. The extent to which the ATO will revise its views remains to be seen. By way of example, the Draft TR 2024/D1:
  • provides “[t]hat ‘consideration’ does not have its technical meaning on contract law” (at [16]). This may now contrast with the majority’s analysis of Dick Smith and Lend Lease;[1]
  • adopts a narrow interpretation of paragraph 14.4 of the OECD Commentary on Article 12 (concerning circumstances in which payments for the rights to distribute copies of a program will not constitute a royalty), partly based on the ATO’s view that such payments may still be royalties on the basis that they are “consideration for” the use of, or the right to use, copyright (at [64]-[70]); and
  • notes circumstances where IP rights granted may be inseparable from a “practical and business point of view”, from any other things for which the consideration is paid (at [18]; Scenario 1). This re-emphasises the majority’s approach in construing the commercial arrangements under consideration in PepsiCo.
• Importance of comprehensive, well documented commercial arrangements: It is unlikely the decision will cause the ATO to reverse from its highly proactive focus on reviewing and enforcing compliance with the tax laws in connection with the intangibles arrangements of multinationals, particularly in the technology space. However, the decision is important as it highlights the significance of having comprehensive, well documented and appropriately legally structured arrangements for the use of offshore intangible assets in being able to properly defend the positions that have been adopted.
• Complexity and clarifications in tax law: Two practical observations can be made about PepsiCo, Inc’s (PepsiCo) narrow win. First, the application of our tax laws is complex. Especially in the current context of tax reform and productivity, steps should be taken towards a simpler and easier to interpret tax system that can be applied efficiently. This includes minimising the number of grey areas of tax law where even judges disagree on the outcome (five out of eleven justices who gave judgments in the PepsiCo appeals found that the payments were in part a royalty and that DPT applied). Second, while the decision is a loss for the ATO, PSLA 2009/9 states that a key objective for the ATO when conducting litigation is to achieve law clarification for the community and the Government.

Royalty withholding tax and commercial arrangements involving intellectual property rights

• Consideration for IP rights: Critically, the findings of the High Court majority in the PepsiCo decision underscore the position that payments made pursuant to agreements involving the grant of IP rights from the payee to the payor will constitute a “royalty” only if, on a proper construction of the parties’ overall commercial arrangements, the payment is “consideration for” the grant of the relevant IP rights, as distinct from consideration for some other valuable promise (such as the provision of goods or services, or the conferral of some other right or benefit). The majority recognised that in the context of certain commercial arrangements (in this case, exclusive bottling and distribution arrangements between the parties), consideration for the grant of IP rights may be non-monetary, and may be constituted by the performance of other obligations and undertakings by the licensee. It should be noted, however, that relevant to the majority’s decision was the finding that the amount paid by the licensee to the licensor was an arm’s length price, or a fair price, for the goods sold and delivered under the relevant agreements.
• Meaning of “consideration for” in the context of royalties: As part of the royalty characterisation dispute, the Commissioner had relied on the authority of two stamp duty cases: Dick Smith and Lend Lease, to contend that it was necessary for the Court to look beyond the construction of the agreement to the whole of the arrangement and commercial dealing between the parties. This included the value of the trade mark and other intellectual property rights of PepsiCo (PepsiCo IP) and the pricing model adopted in other jurisdictions for other products, in order to characterise the consideration. The majority held that neither case supported the Commissioner’s contention as they each turned upon an application of a State Duties Act to their particular facts, and did not look outside the terms of the arrangements and the transactions involved. This finding is particularly important in the context of Draft TR 2024/D1, in which the Commissioner relies in part on Dick Smith and another stamp duty case, Archibald Howie,[2] as supporting the proposition that the word “consideration” incorporates a wider notion than consideration in a contractual sense (refer to [77] – [80] of Draft TR 2024/D1).
• No derivation of income: The High Court was unanimous in that income was not derived by PepsiCo. The Court’s views had regard to the specific transaction structure of bottling arrangements. More “traditional” arrangements (including in software and other industries) may not necessarily separate the vendor of the goods in question (concentrate in this example) with the IP owner. Put differently, the derivation argument that succeeded in PepsiCo may not exist in other structures.
• Mutual benefit arrangements: One explanation of the key difference on the royalty issue between the majority and minority might be that while the minority observed that the sales in Australia of PepsiCo products would increase the value of the global brand, that brand did not belong to the 3rd party bottler and the increase would be for the benefit of the PepsiCo company which owned the brand. As the majority observed, the payments for the concentrate did not move the transfer of the PepsiCo IP to the bottler.
• When a “use” of IP arises: Left undecided by the High Court is when a “use” of intellectual property relevantly arises. While the High Court’s decision considered whether the impugned payments were “consideration for” the PepsiCo IP, there was limited consideration as to whether there was, at law, any “use” of IP as a threshold matter. This may leave open the ATO’s expansive and controversial approach to this issue as set out in Draft TR 2024/D1, and which has been moderated recently in accordance with Draft PCG 2025/D4 and the ATO’s identification of “low risk” software payments. Particularly in the technology space, this may be a continuing issue to watch.

Diverted profits tax

• Application of DPT: The decision is the first High Court decision to consider the DPT regime. It has highlighted the inherent difficulties of applying the DPT provisions to a situation in which arm’s length consideration is paid by a third party for goods or services.
• Principal purpose test and permissibility of tax planning: The decision provides some much-needed clarity on the scope and reach of the DPT provisions, in particular with respect to the principal purpose test. The majority makes clear that it is expected that “sophisticated commercial operators” will undertake tax planning when structuring a transaction, and that this alone will not cause the taxpayer to fail the purpose test, despite this test having a lower threshold than the “sole or dominant purpose” test in section 177D of the ITAA 1936. In circumstances where taxpayers have entered into a commercial arrangement that is the product of arm’s length negotiations, and which reflects a “pre-existing and entirely commercial way of doing business”, the fact they have taken tax considerations into account should not be fatal. Given these comments were made in the context of the lower “principal purpose” test, this should give taxpayers comfort that ordinary tax planning (without more) would be even less likely to fail the more traditional “dominant purpose” test found in Part IVA of the ITAA 1936 (see [228] – [230]).
• Onus of proof: The decision reaffirms an important principle concerning the onus on the taxpayer in anti-avoidance cases in relation to the alternative postulate, i.e. a taxpayer may demonstrate the absence of a tax benefit by establishing that there is no postulate that is a reasonable alternative to entering into or carrying out the scheme. This reaffirms the position previously set out in Federal Commissioner of Taxation v Trail Bros Steel & Plastics Pty Ltd, RCI Pty Ltd v Federal Commissioner of Taxation, and more recently in Federal Commissioner of Taxation v Guardian AIT Pty Ltd.[3]

Background

In July 2024 the Full Court of the Federal Court of Australia (Perram, Colvin and Jackman JJ) handed down its judgment in PepsiCo, Inc v Commissioner of Taxation FCAFC 86. A full summary of that decision and the facts of the dispute can be found in our previous Insight Article. In summary, the Full Court overturned the decision of the primary judge and:

• held that payments made by Schweppes Australia Pty Ltd (SAPL or the Bottler) to PepsiCo Beverage Singapore Pty Ltd (PBS or the Seller) under exclusive bottling agreements (EBAs) were consideration solely for the purchase of concentrate and did not include any royalty component for the grant of the PepsiCo IP under the EBAs;
• concluded that, because the payments were received by a nominated related-party seller and did not “come home” to PepsiCo or Stokely-Van Camp, Inc (SVC) (together, the PepsiCo Parties), no “income derived” by those US entities arose and the royalty withholding tax (WHT) provisions in section 128B of the ITAA 1936 were not enlivened; and
• dismissed the Commissioner’s cross-appeal under the diverted profits tax (DPT) provisions in Part IVA of the ITAA 1936 on the footing that, absent reliable evidence that any part of the concentrate price in fact embodied a royalty, there was no reasonable counterfactual capable of giving rise to a tax benefit.

In parallel with the litigation, the ATO has continued to advance an expansive “substance over form” approach to cross-border payments for software and intellectual property rights:

• Draft TR 2024/D1 – Draft Taxation Ruling TR 2024/D1, Income tax: royalties – character of payments in respect of software and intellectual property rights – sets out the Commissioner’s view that a wide range of payments made under software distribution, cloud and other intangibles arrangements are royalties, even where the contracts label them otherwise.
• Draft PCG 2025/D4 – Draft Practical Compliance Guideline PCG 2025/D4, Low-risk payments relating to software arrangements – ATO compliance approach, outlines the risk assessment framework the ATO proposes to apply in deciding whether to review particular software payments for royalty risk. The Guideline confines the “white/green zones” (no review) to tightly defined fact patterns and foreshadows active compliance activity for arrangements outside those zones.

Given the tension between the views of the ATO under Draft TR 2024/D1 and the majority decision in the Federal Court, the decision of the High Court has been highly anticipated.

Summary of decision

Royalty withholding tax

Diverted profits tax

Majority decision

The majority, comprised of Gordon, Edelman, Steward and Gleeson JJ, dismissed each of the Commissioner’s appeals.

Royalty withholding tax

The majority concluded that the payments made by the Bottler to the Seller were not brought to tax under s 128B(2B) of the ITAA 1936 because there was no "royalty" as required by s 128B(2B)(b) and the payments made by the Bottler to the Seller were not "income ... derived by" PepsiCo within the meaning of s 128B(2B)(a).

The proper construction of the agreements between the Bottler, PepsiCo, and SVC was critical to the analysis. The majority emphasised that in considering whether the payments made by the Bottler to the Seller constituted a “royalty”, it was necessary to determine whether those payments were made “in consideration for” the use of the PepsiCo IP. This required an examination of whether the right to use the PepsiCo IP was part of the parties’ comprehensive commercial arrangements, which was constituted by a “complex exchange of valuable promises” (at [166]), and under which the grant of the right to use PepsiCo IP formed just one part.

The majority found that, here, the right to use the PepsiCo IP was an essential element of this comprehensive commercial arrangement and this element obliged the Bottler, to build the PepsiCo Parties’ brand and strengthen the PepsiCo IP. This was of real value to the PepsiCo Parties. As stated at [123]:

As these reasons will show, although SAPL did obtain a licence to use the PepsiCo Intellectual Property, no part of the price for the concentrate was payment for that licence. But SAPL did not obtain the licence for nothing. The right to use the PepsiCo Intellectual Property was part of a comprehensive commercial arrangement, an essential element of which obliged SAPL to build PepsiCo's and SVC's brands and strengthen the PepsiCo Intellectual Property. The more successful SAPL was, the more valuable the PepsiCo Intellectual Property became. SAPL's agreement to build the brands was of real value to PepsiCo and SVC. It was not "nothing". The Commissioner was wrong to assert that part of the arm's length price paid by SAPL to PBS for concentrate had to be treated as payment from SAPL to PepsiCo or SVC for the right of SAPL to use the PepsiCo Intellectual Property. There is no legal or economic reason to make that leap in logic. To do so would involve assigning part of the fair price paid for goods to a different commercial bargain.

In its terms, the commercial arrangement in place was held to be comprised of a composite agreement recorded in three separate agreements which were to be read together:

• the PepsiCo EBA;
• a Performance Agreement regarding the operations of the Bottler had been entered into between Pepsi-Cola International, Cork, a subsidiary of PepsiCo, and the Bottler (Performance Agreement); and
• a representative annual Co-operative Advertising and Marketing Agreement between the Seller and the Bottler (2017 Annual Co-op A&M Agreement),

together, the SAPL Bottler, Seller and Distributor Agreement.

In the case of SVC, the SVC EBA contained obligations “… in not dissimilar terms to those found in the Performance Agreement and the 2017 Annual Co-op A&M Agreement” (at [125]). On this basis the majority’s reasons are principally set out by reference to the arrangements with PepsiCo, but applied equally to SVC unless otherwise noted.

SAPL Bottler, Seller and Distributor Agreement

The majority held that the specific contractual rights and obligations of the parties to the SAPL Bottler, Seller and Distributor Agreement were to be construed objectively, by reference to the language used, circumstances addressed and commercial purpose or objects to be secured.[4]

On this basis the majority construed the SAPL Bottler, Seller and Distributor Agreement not as an agreement for the sale of goods or an agreement to sell goods in the future, but as an agreement that the Bottler would manufacture, bottle, sell and distribute the beverages, and one which was mutually beneficial to both local bottlers and PepsiCo. This included, for example, the Bottler being able to leverage the PepsiCo Group's “innovation and marketing capabilities” while PepsiCo was able to receive the benefit of the Bottler’s “local investment in bottling and distribution equipment and capabilities” (at [147]). To facilitate those functions, the PepsiCo Parties licensed the Bottler to use the PepsiCo IP (impliedly in the case of PepsiCo, and expressly in the case of SVC); and separately, the contracts between the Bottler and the Seller for the sale and purchase of concentrate were negotiated at arm's length and imposed a 0.05% margin.

The majority also noted that under the SAPL Bottler, Seller and Distributor Agreement, the Seller had historically returned and reported those amounts paid by the Bottler to the Seller for concentrate as profit derived in Australia; and the Seller had returned and reported Australian income tax accordingly.

Payments were not “consideration for” intellectual property rights

Although the offshore PepsiCo Parties granted a licence to the Bottler to use the PepsiCo IP as a local bottler, the onshore payments made by the Bottler to the Seller were held to be only for the concentrate and nothing else. Therefore, the payments did not include any component which was a “royalty” for the use of the PepsiCo IP. The payments from the Bottler, as local bottler, to the Seller, as nominated local seller, were held not to have been made "as consideration for" the use of the PepsiCo IP and therefore did not constitute or include a "royalty" within the definition of that term under s 6(1) of the ITAA 1936.

It was not suggested by the majority that there was no consideration for the grant of rights to the PepsiCo IP. Rather, in reaching their conclusion, their Honours held that the phrase "consideration for" in the definition of "royalty" in s 6(1) of the ITAA 1936 extended to the "basis", "purpose", or "condition" for a transaction by which one party confers a benefit upon another. The “consideration” for the use by the Bottler of the PepsiCo IP in this sense was the performance of the monetary and non-monetary undertakings by the Bottler under the SAPL Bottler, Seller and Distributor Agreement, which itself constituted a “complex exchange of valuable promises” (at [166]). By way of example, the Bottler was required to:

• follow all instructions and directions of the Seller for preparing and bottling beverages, including maintaining properly and adequately equipped and staffed bottling plants and conforming to standards dictated by PepsiCo in respect of the bottling of beverages;
• only use the concentrate purchased from the Seller and the packaging specified by PepsiCo;
• sell beverages only in agreed packages as specified by PepsiCo;
• use reasonable endeavours to maximise sales of beverages;
• fully meet and increase the demand and share of the market for beverages throughout the territory; and
• cooperate in PepsiCo’s cooperative advertising and sales promotion programs and campaigns.

The agreement to sell concentrate under clause 4(a) of the PepsiCo EBA was therefore only one exchange of promises amongst many. In the words of the majority, that clause reflected “… a bargain made, within the context of the broader exchange of promises contained in the SAPL Bottler, Seller and Distributor Agreement, as to what the prices for concentrate would be and no more” (at [166]). Further, it was critical to the majority’s reasoning that the Commissioner did not contend that the prices for concentrate were “incorrect or had been inflated to hide some secret royalty outlay” (at [167]); and similarly none of the invoices issued by the Seller to the Bottler “were inflated or had embedded in them some form of royalty” (at [168]).

The majority further made clear that the High Court’s previous decisions in Dick Smith and Lend Lease, which applied a broader meaning of the word “consideration” in the conveyancing context rather than in the standard contractual context, should not be improperly extended to apply to the royalty WHT provisions. The majority clarified that each of these cases should be read in their proper statutory context, and with each turning upon the application of particular provisions contained in State duties legislation to particular facts.

On this issue, the majority concluded that the price paid by the Bottler to the Seller for the concentrate therefore did not move the transfer of the PepsiCo IP to the Bottler, and was instead simply the price paid “for goods sold and delivered”. Finally, in expressing their conclusion, it should be noted that the majority held as follows (emphasis added) (at [174]):

The contractual price paid by SAPL to PBS for the concentrate was the price paid for goods sold and delivered [i.e. concentrate]. The Commissioner did not dispute that it was an arm’s length price, or a fair price, or that it was not disproportionately high. When the price paid for goods has those characteristics, it cannot be said that a part of the price paid for those goods is payment of a royalty for the use of intellectual property [i.e. trade marks] applied to products [i.e. bottled drinks] partly made with those goods [i.e. concentrate].

The PepsiCo decision effectively dispenses with the argument that a payment made under an agreement which entails the grant of intellectual property rights as a necessary or important part must constitute a “royalty”, without further regard to the full terms of the commercial bargain between the parties.

Income was not “derived by” and “paid or credited to” PepsiCo

The majority further found that, in any event, on the facts of the case, the payments received by the Seller could not be said to have been paid or credited to, or derived by PepsiCo, within the meaning of s 128A(2) of the ITAA 1936.

The Commissioner’s contention was that the Bottler’s liability to make payments was owed at all times to PepsiCo and that when the payments were made by the Bottler to the Seller, those payments were made at the direction of PepsiCo. It was however accepted by the Commissioner that, in order for a payment to be made under direction there must be an antecedent obligation between PepsiCo and the Bottler.

The Court held that, in considering the terms of the relevant agreements, there was no such antecedent monetary obligation. This was because, once PepsiCo nominated a seller, the Bottler was under an obligation to buy from that entity. It did not matter that the Seller was not a party to the SAPL Bottler, Seller and Distributor Agreement; at no point after the nomination would PepsiCo have title to the concentrate, and no monetary obligation was owed by the Bottler to PepsiCo for or in respect of the concentrate. This argument was supported by the fact that, where the Bottler failed to pay for the concentrate supplied by the Seller, it was the Seller as the contracting party that had an action for debt under those sale transactions. Under the PepsiCo EBA, PepsiCo only had an action for specific performance.

In this respect the Court noted that while the income was not derived by PepsiCo, as a matter of fact, the payments by the Bottler to the Seller for the sale of concentrate were income derived by the Bottler in Australia, and were already being assessed accordingly for Australian income tax purposes.

Diverted profits tax

Identification of scheme and alternative postulates

In relation to DPT, the Commissioner's identified scheme was, in substance, entry by PepsiCo into the PepsiCo EBA with the Bottler on terms where the Bottler bought concentrate and was licensed to use the PepsiCo IP but paid no royalty for the use of the PepsiCo IP (the Scheme) (at [195]).

The Commissioner's case identified two alternative postulates as counterfactuals to the Scheme, being:

1. that that the PepsiCo EBA would or might reasonably be expected to have expressed the payments by the Bottler to be for all the property and promises provided and made by the PepsiCo Group entities rather than for concentrate only; or
2. that that the PepsiCo EBA would or might reasonably be expected to have expressly provided for the payment by the Bottler for the concentrate to include a royalty for the provision to the Bottler of the PepsiCo IP.

On either alternative, the Commissioner contended that a royalty would or might reasonably be expected to have been paid by the Bottler to PepsiCo or to another entity on PepsiCo's behalf, or as PepsiCo directed. PepsiCo contended that neither postulate was reasonable within the meaning of s 177CB(3). On this basis, there were two issues to be dealt with by the majority:

1. Tax benefit: whether PepsiCo obtained a “tax benefit” in connection with the Scheme for the purposes of s 177J(1)(a) of the ITAA 1936; and
2. Principal purpose: if so, whether it would be concluded, having regard to the matters in s 177J(2), that the person, or one of the persons, who entered into or carried out the Scheme or any part of the Scheme did so for the principal purpose of enabling PepsiCo to obtain a tax benefit in connection with the Scheme.

Tax benefit

In the result, the majority upheld the Full Court’s decisions that PepsiCo did not obtain a tax benefit. In doing so, the majority clarified several key principles relating to the proper application of the DPT regime and other related anti-avoidance rules.

Proper use of alternative postulates

In relation to establishing whether there is a “tax benefit” as a matter of objective fact, and the inquiry contemplated under Part IVA of comparing the scheme and an alternative postulate, the majority stated at the outset that “Courts must be careful to avoid the false dichotomy between a rational commercial decision and obtaining a tax benefit” (at [204]).

Onus

The majority then proceeded to consider the onus of proof in determining whether or not a tax benefit had been obtained. Critically at [211]-[212], and having regard to the statutory test in s 177CB(3):

• The majority affirmed the general principles that: 1) “a taxpayer who merely demonstrates that the postulate relied upon by the Commissioner is unreasonable does not demonstrate that it has not obtained a tax benefit” (at [211]); and 2) “a taxpayer may more usually demonstrate the absence of a tax benefit by identifying, on the evidence, a postulate or counterfactual which shows what it might reasonably be expected to have done, had it not entered into or carried out a relevant scheme” (at [212]).
• The majority went on to clarify that s 177CB(3) also permits a taxpayer, albeit in “unusual” cases, to “demonstrate the absence of a tax benefit by establishing that there is no postulate that is a reasonable alternative to entering into or carrying out the scheme” (at [212]).

Alternative postulates were not reasonable

Having clarified the proper evidentiary onus contemplated under Part IVA, the taxpayers were able to demonstrate that the Commissioner’s alternative postulates were not reasonable, and that in their circumstances there was no postulate that was a reasonable alternative to entering into and carrying out the Scheme.

In particular, the following “critical facts” enabled PepsiCo to demonstrate that there were no other reasonable alternative postulates and therefore no relevant tax effect (at [219] – [220]):

1. The substance of the Scheme (as properly construed and characterised) included that the price paid for concentrate was for concentrate and nothing else.
2. The Scheme was a product of arm's length dealings between unrelated parties.
3. The absence of a royalty was market standard and a substantive element of the business model which was adopted by the PepsiCo Group, being the "franchise-owned bottling operation" or "FOBO" model which commenced in the early 1900s. This model requires joint investment by both PepsiCo and the bottler to develop, manufacture, bottle and distribute the beverages and to engage in marketing to promote sales - features which were carefully reflected in the terms of the SAPL Bottler, Seller and Distributor Agreement and which benefited both PepsiCo and the Bottler.

Based on those facts, PepsiCo was able to show that it was probable that no different arrangement might reasonably be expected to have been entered into. In the words of the majority: “ … the only postulate here that might have exhibited the same substance and achieved the same results as that found in the Scheme was the SAPL Bottler, Seller and Distributor Agreement” (at [224]). On this basis the majority held that PepsiCo did not obtain a tax benefit in connection with the Scheme for the purposes of s 177J(1)(a) of the ITAA 1936.

Principal purpose

Given the majority’s conclusion that no tax benefit arose, it was not considered necessary to address the question of principal purpose. However, the majority provided the following observations in relation to an issue raised in PepsiCo’s Notice of Contention:

• Section 177D(2)(a): As to the manner in which the Scheme was entered into or carried out: the majority affirmed the trial judge’s observations that “it would not be safe to assume that tax considerations did not have a role to play” in the Scheme (at [228]). Indeed, the majority stated that “it would be unthinkable to suppose that sophisticated commercial operators did not take tax outcomes into consideration in negotiating the form of a transaction” (at [229]). However, simply taking tax outcomes into account does not necessarily justify an application of Pt IVA of the ITAA 1936, or, indeed, the imposition of DPT.
• Section 177D(2)(b): As to the form and substance of the Scheme: the majority held that the Commissioner's argument could not succeed because it misstated the true economic and commercial substance of the Scheme. In reality, because the price agreed for concentrate was for concentrate and nothing else, the form and substance of the Scheme were the same.
• Section 177D(2) (Other matters): the majority observed that a range of other factors in relation to the Scheme would support the conclusion that PepsiCo did not have a principal purpose of enabling it to obtain a tax benefit. This included that:
  • it was the product of an arm's length negotiation between experienced and large commercial enterprises;
  • it produced a price payable for concentrate that was not disproportionately high and which was paid to an Australian resident taxpayer;
  • it was broadly a pre-existing and entirely commercial way of doing business (the “FOBO” model);
  • the royalty WHT said to have been avoided represented about 1% of the total payments made by the Bottler - a negligible sum for such large commercial enterprises; and
  • it was not suggested that the timing of when the composite SAPL Bottler, Seller and Distributor Agreement was entered into was affected by considerations about withholding tax.

Minority decision

Gageler CJ, Jagot and Beech-Jones JJ, in the minority, agreed with the conclusions reached by Colvin J in his Full Court dissent in respect of each of the three key issues on appeal.

Specifically, the minority found that:

1. Royalty withholding tax: at least some part of the amount paid by the Bottler to Seller for concentrate constituted a “royalty” amount;
2. Income “derived by” PepsiCo: despite this, the PepsiCo Parties were not liable to pay royalty withholding tax because they did not “derive income” from the amounts paid by the Bottler; and
3. Diverted Profits Tax: this being the case, the Commissioner’s DPT appeal would have been upheld on the basis that both the tax benefit and principal purpose requirements were met.

Royalty withholding tax

Central to the minority’s decision on the first issue was:

1. the characterisation of the EBAs as an “interlocking and indivisible” set of promises and rights (at [48]);
2. that the “EBAs would be pointless without the intellectual property licences and other interlocking promises” (at [50]); and
3. the proposition that the use of IP was a “necessary element” of the right to distribute the beverages (at [58]).

Further, on the minority’s analysis of the relevant case law, their Honours considered the division of a transaction into its central and ancillary objects as entirely inapposite to the statutory definition of a “royalty” which involves “any amount paid or credited, however described or computed” (at [42]-[43]).

The only possible conclusion in the minority’s view was that part of the payments made by the Bottler were for the use of the PepsiCo IP. In their Honours' opinion, the Full Court majority necessarily erred in dissecting the transactions so that the payment specified attached only to the concentrate and the other value exchanged attached to other aspects of the agreements. In effect, characterising the price payable as consideration only for the sale of concentrate “subdivides the indivisible” (at [49]). Accordingly, the minority found that: “once it is accepted that within the contractual scheme SAPL's payment for the concentrate in part moved the grant of the intellectual property licences, the answer that the payment included a royalty component is unavoidable” (at [52]).

The High Court minority further engaged with (and in fact accepted) the Full Court majority’s construction of the EBAs as involving not only the benefits to the Bottler in being permitted to use the goodwill attaching to the trade marks, but also the restrictions and burdens imposed on the Bottler in utilising that goodwill, together with the benefits to the PepsiCo Parties in having the Bottler promote their goodwill in Australia. However, their Honours considered this simply served to underscore the “single, integrated and indivisible” nature of the transaction (at [56]).

On the second issue of derivation, the minority agreed with the majority and held that neither PepsiCo nor SVC derived income from the payment of a royalty.

Diverted profits tax

By way of comparison to the majority, the minority judgment applied the DPT provisions as follows.

Identification of scheme and alternative postulates

Consistent with the majority, the minority accepted that the relevant "scheme" was the entry into the EBA, understood as “an agreement under which each of [the PepsiCo Parties] granted to SAPL an exclusive licence to use intellectual property rights of substantial value without requiring payment of a royalty for the licence” (at [85]).

Tax benefit

In contrast to the majority, the minority found that a “tax benefit” did arise.

This was because a reasonable alternative postulate (being an effective refinement of the Commissioner’s second postulate) was that the EBAs would have provided for a royalty to be paid to the PepsiCo Parties as the holders of the rights to the trade marks and other intellectual property rights. This, in the minority’s view, was consistent with the commercial and economic essence of the schemes as it was expressly provided for in the EBAs.

In obiter, their Honours further rejected the proposition that if a scheme omitted a royalty payment that a reasonable alternative postulate must also omit a royalty payment. The minority stated that “[i]f that were so, the DPT provisions would never operate” (at [97]).

Further and in contrast to the majority, the minority did not consider it necessary to resolve the appeal issues as to onus (at [75]) (i.e. concerning whether a taxpayer may discharge their onus of proof under s 177C(1)(bc) by proving that there was no reasonable alternative to a scheme).

Principal purpose

In considering whether the requisite principal purpose of obtaining a tax benefit was met, the minority found no error in the primary judge’s reasoning and adopted a critical view of the evidence, describing the evidence adduced by the PepsiCo Parties in relation to s 177J(2) as “somewhat vague and over-generalised evidence” (at [101]).

In the result, the minority affirmed the reasoning of the primary judge that the considerations in s 177J(2) weighed in favour of the principal purpose condition being satisfied (at [101]-[108]). In particular, the minority stated (at [108]):

It is the commercial and economic substance of the schemes, in which the parties to the EBAs have executed an indivisible transaction involving interlocking promises including the sale of concentrate and the grant of the intellectual property licences along with other promises of value, which drives the outcome. Within that indivisible transaction, there is no doubt that the intellectual property licences are of fundamental importance and substantial value. The evidence exposes that, without them, SAPL would have no interest in buying the concentrate and, indeed, PepsiCo and SVC would not sell SAPL the concentrate to enable it to market the drinks under different brands. The entire object of the EBAs was to enable and to maximise the sale in Australia of the drinks as branded under the globally famous trade marks. This objective character of the transactions drives the conclusion that SAPL's promise in respect of the purchase of and payment for concentrate, to some extent, included consideration for the intellectual property licences.