Commissioner granted special leave by the High Court to appeal the PepsiCo case

The Commissioner of Taxation (the Commissioner) has been granted leave to appeal the decision of the Full Federal Court (FFC) for the case of PepsiCo, Inc v Commissioner of Taxation [2024] FCAFC 86 (PepsiCo case).

The case involved two key issues:

1. Whether certain payments made by the Australian bottler of Pepsi and other beverages, were subject to royalty withholding tax; and 
2. In the event that the payments were not royalties and therefore not subject to royalty withholding tax, whether the diverted profits tax measures in Part IVA of the Income Tax Assessment Act 1936 applied. 

The FFC decision was that neither of the above issues were proven. Therefore, the payments made by the Australian bottler were not subject to royalty withholding tax, and also, the diverted profits tax provisions were not applicable.

The High Court granting the Commissioner special leave to appeal the FFC’s decision casts further uncertainty for multinationals making cross-border payments. It also reinforces the importance of undertaking careful commercial analysis in relation to the character of cross-border related party arrangements, and whether some of the payments made pursuant to those arrangements may be characterised as royalties for Australian royalty withholding tax purposes.

For more details on the PepsiCo case, see our previous technical update: PepsiCo wins in Full Federal Court

Ramifications for other Royalty Withholding tax issues

The decision of the High Court to allow the Commissioner special leave to appeal the FFC’s June decision reinforces some of the uncertainty for taxpayers and advisers alike in relation to embedded royalties and related arrangements. 

Further, the ATO have indicated that they will defer on finalisation of TR 2024/D1 Income tax: royalties – character of payments in respect of software and intellectual property rights until the outcome of the proceedings in the High Court is released. The ATO have noted that the views reflected in TR 2024/D1 remain their current views relating to software arrangements but also note that deferring finalisation until completion of any High Court proceedings will allow for incorporation of any court findings relevant and applicable to software arrangements into the ruling prior to finalisation. An updated draft is expected to be released in late 2025. 

The ATO have also flagged that taxpayers should continue to consider its views as articulated in Taxpayer Alert TA 2018/2 Mischaracterisation of activities or payments in connection with intangible assets, covering the ATO’s concerns regarding mischaracterisation of payments connected with intangible assets.

Taxpayers with potentially impacted arrangements should seek professional advice in order to ascertain the risk profile attached to their arrangements. Additionally, taxpayers should review their arrangements and agreements considering in detail, the commercial character of the arrangement and whether any intellectual property elements are present, such that consideration as to whether there may be an embedded royalty may be warranted.

Administrative penalties may apply in circumstances where statements are made to the Commissioner or an entity exercising powers or performing functions under an income tax law where the treatment of such law is not reasonably arguable. A position is generally reasonably arguable if it would be concluded in the circumstances, that the position argued for is as likely to be correct as incorrect, or is more likely to be correct than incorrect. Given that embedded royalties are currently a focus area for the ATO, taxpayers are encouraged, where practical, to ensure that reasonable steps are taken to ensure that any positions adopted treating payments as not including a royalty element are reasonably arguable, including obtaining advice and/or documenting the tax position taken.

If you would like to further understand whether your group’s cross-border arrangements may have features that may suggest there is an embedded royalty, or you would like further information regarding this issue, reach out to our corporate tax team.