ATO’s Decision Impact Statement on PepsiCo: not exactly sparkling?

The Australian Taxation Office (ATO) has released its Decision Impact Statement in response to the High Court’s decision in PepsiCo. The Decision Impact Statement is, in many respects, as expected – the Commissioner of Taxation (Commissioner) seeks to limit the implications of the decision to the specific facts of the case. Notwithstanding that the taxpayers prevailed before the High Court, the Commissioner appears emboldened by aspects of the decision, particularly in relation to the ATO’s previous hypotheses regarding embedded royalties and the characterisation of payments involving intellectual property. Taxpayers and their advisers may therefore have some confirmation of the Commissioner’s views. 

This article examines the key aspects of the DIS and the Commissioner’s stated views.

On 19 March 2026, the Commissioner released his Decision Impact Statement (DIS) on the High Court’s decision in Commissioner of Taxation v PepsiCo Inc [2025] HCA 30 (PepsiCo). The DIS sets out the Commissioner’s views on the implications of PepsiCo, in which the High Court dismissed the Commissioner’s appeals and confirmed that the taxpayers, PepsiCo, Inc. and Stokely-Van Camp, Inc., were not liable for royalty withholding tax or diverted profits tax (DPT). 

The Commissioner has published a lengthy statement explaining his response to PepsiCo. As expected, the effect of the DIS is largely to seek to confine the scope of the Court’s reasons in PepsiCo to that case’s specific facts and circumstances.

PepsiCo was easily the most highly-anticipated tax judgment of 2025. In rejecting the Commissioner’s arguments that the relevant taxpayers were liable to royalty withholding tax or, in the alternative, that DPT applied, their Honours traversed at length several key topics related to those taxes (and anti-avoidance provisions in general):

• the relevant principles of contractual construction; 

• what constitutes consideration for the use of intangible assets;

• embedded payments of royalty; 

• whether amounts have been ‘paid to’ or ‘derived by’ a taxpayer; 

• tax benefits; and 

• alternative postulates. 

For this reason we have previously published a detailed analysis of the ongoing implications of the judgment.

The Commissioner has taken a somewhat narrower view in the DIS regarding several important aspects of the High Court’s reasons. In particular, the DIS appears to affirm the Commissioner’s previous positions regarding the existence of embedded royalties and applicable principles of contractual construction. Further, its treatment of the High Court’s discussions of DPT and the derivation of income warrant closer scrutiny. However, there may be an implicit acceptance that embedded royalties (at least more generally) apply to related party transactions.

Background to the PepsiCo litigation

We have previously published several detailed articles and analyses of the PepsiCo litigation at each stage:

• Full Federal Court decision in PepsiCo falls flat for the ATO

• Commissioner orders one last round in PepsiCo

• PepsiCo and Oracle cases: reassessing royalties in Australian tax

• PepsiCo case comes to an end: High Court calls last drinks and closes the bar

• Commissioner of Taxation v PepsiCo, Inc: a guide to the ongoing implications

Those publications detail the background in more depth. This included the factual history to the dispute, and the relevant conclusions reached by the various decisions of the Federal Court, prior to the High Court’s consideration of PepsiCo.

In brief though, the taxpayers, PepsiCo, Inc. and Stokely-Van Camp, Inc., are US-resident companies that own intellectual property for global drink brands like Pepsi, Mountain Dew and Gatorade. They each entered into exclusive bottling agreements (EBAs) with an Australian-resident manufacturer of soft drinks, Schweppes Australia Pty Ltd (the Bottler).

Under the EBAs, the taxpayers were required to sell (or cause a nominated subsidiary to sell) to the Bottler concentrate from which the branded drinks could be made. The Bottler was also granted exclusive licences to exploit intellectual property rights so that it could become the exclusive manufacturer, bottler, seller and distributor of those branded drinks in Australia. Further, the Bottler was required to purchase a specified minimum amount of concentrate from the taxpayers or their nominated subsidiaries at a set price.

Ultimately, the taxpayers each nominated PepsiCo Beverage Singapore Pty Ltd (Seller) as the seller of the concentrate, and the Bottler purchased concentrate from the Seller at agreed prices.

Having reviewed this arrangement, the Commissioner believed that part of the payments from the Bottler to the Seller for the concentrate was in fact for the use of or right to use the taxpayers’ intellectual property in respect of the branded drinks. He therefore concluded that the payments included an ‘embedded royalty’. This would mean that the taxpayers, who were said to derive income from this royalty, were liable to pay royalty withholding tax on their derived royalty income.

In the event that the taxpayers were not liable because they could not be said to have ‘derived’ royalty income, the Commissioner argued in the alternative that they were subject to DPT because they entered into a scheme for a principal purpose of obtaining a tax benefit (i.e. not being liable to pay royalty withholding tax), and reducing their liability to tax under a foreign law in connection with that scheme.

The Commissioner thereafter issued royalty withholding notices and DPT assessments on these bases. In this regard, the arguments of the Commissioner in PepsiCo as summarised above closely replicated the concerns previously expressed by the Commissioner in Taxpayer Alert TA 2018/2, which sought to address the perceived mischaracterisation of activities or payments in connection with intangible assets.

The taxpayers eventually commenced proceedings in the Federal Court, where the primary judge (Moshinsky J) found in favour of the Commissioner with respect to both the liability to pay royalty withholding tax and, in the alternative, DPT (PepsiCo Inc v Commissioner of Taxation [2023] FCA 1490). On appeal, the majority of the Full Court of the Federal Court (Perram and Jackman JJ) overturned the primary judge’s orders, holding that there was no royalty, no income derived by the taxpayers, and no tax benefit for the purposes of DPT (PepsiCo Inc v Commissioner of Taxation [2024] FCAFC 86). Colvin J dissented as to the existence of royalty and application of DPT, but agreed with the majority that there was no income derived by the taxpayers.

A majority of the High Court in PepsiCo (Gordon, Edelman, Steward and Gleeson JJ) found in favour of the taxpayers and dismissed the Commissioner’s appeals from the Full Court. Their Honours found that the payments made by the Bottler did not comprise an embedded royalty for use of the intellectual property: 

• the payments did not move the transfer of the intellectual property; and 

• the payments were not consideration for the use of that intellectual property. 

Further, no part of those payments was ‘derived by’ or ‘paid or credited to’ the taxpayers, with the result that they could not in any event be liable to royalty withholding tax. 

In respect of DPT, the majority found that the taxpayers obtained no tax benefit, and that (even if there had been) the principal purpose of the entry into and carrying out the relevant scheme was not to obtain such a benefit.

The minority (Gageler CJ, Jagot and Beech-Jones JJ) agreed with the majority that there was no income derived by the taxpayers. However, they found that there had been a payment of royalty, and that the circumstances were such as to give rise to a liability to DPT. Their Honours would have allowed the appeals against the Full Court on that basis.

The Commissioner’s DIS: royalty withholding tax

Was there a royalty?

Consideration

The DIS first notes that all Justices of the High Court adopted a broad approach to determining the meaning of the words ‘consideration for’ in the definition of ‘royalty’ in section 6(1) of the Income Tax Assessment Act 1936 (Cth). In this context, the word ‘consideration’ refers to the ‘moving’ or ‘material cause’ for a payment – a meaning broader than the concept of consideration in contract law. The Court’s endorsement of this approach provides a welcome resolution to this issue, which has until now been subject to some debate.

The ‘totality’ of the bargain

The Commissioner also stresses the importance of ‘correctly identifying the “agreement” that is to be analysed for whether there is a royalty’, noting that this agreement may be comprised of multiple documents. This point is uncontroversial.

However, the Commissioner stated that he will ‘continue to seek to obtain documents and information necessary to understand the nature of the arrangements… [including] copies of contracts, details of dealings between the relevant parties and details of the negotiations which informed those contracts and dealings’. This appears to reflect the Commissioner’s comments in Draft Taxation Ruling TR 2024/D1; namely, that characterisation of a payment requires ‘regard to matters beyond the boundaries of any contract giving rise to the payment… having regard to the circumstances surrounding the payment, including the commercial relations between the parties…’. 

It is here that the DIS, and the approach that the Commissioner endorses, may raise questions.

The majority of the High Court in PepsiCo stressed that although the relevant primary agreement was a ‘composite agreement recorded in three agreements, to be read together’, the orthodox principles of contractual construction apply. That is, the composite agreement was to be construed objectively, by reference to the language used, circumstances addressed and commercial purpose of objects to be secured. This was a critical feature of the majority’s decision. In objectively construing the nature of the arrangements between the parties, the majority also found that the composite agreement did not effect the sale of concentrate, which was the subject of a second and separate contractual relationship between the Bottler and the Seller. Importantly, the minority of the High Court also endorsed an orthodox approach to the interpretation and construction of relevant contractual arrangements, notwithstanding that they arrived at a different interpretational conclusion.

In undertaking their objective construction, the majority expressly rejected the proposition that the caselaw cited by the Commissioner supported the need to look beyond the construction of the agreement to the whole of the arrangement, stating that the relevant cases did not look outside the terms of the arrangements and the transactions involved. Nor were the subjective purposes of the parties relevant to the objective construction process. It is questionable whether the Commissioner’s position in the DIS, and his indicated willingness to seek to look beyond the terms of agreements, signals an acceptance of the Court’s objective approach.

That being said, one might justify the Commissioner’s restated approach on the basis that evidence of surrounding circumstances can be used to assist in the interpretation of a contract where its language is ambiguous, noting the intermediate appellate court authority for the proposition that ambiguity in this context is a conclusion rather than a precondition to the use of that material (see, Cherry v Steele-Park (2017) 96 NSWLR 548 and Mainteck Services Pty Ltd v Stein Heurtey SA (2014) 89 NSWLR 633). This justification could only be maintained insofar as the Commissioner seeks to limit its recourse to such material to that extent. This is another reason why it is imperative that parties should always prioritise clear and precise language when drafting their commercial agreements.

Embedded royalty

The DIS notes that the decision in PepsiCo does not contradict the Commissioner’s position that payments of royalty may be ‘embedded’ in payments that on their face appear to be of a different character, such as a payment for goods or services. The Commissioner also notes that the labelling of payments is not determinative, and that the decision in PepsiCo does not establish a broad proposition that the characterisation of payments under contracts, being either related-party or arm’s-length contracts, is not open to challenge. The approach of all Justices to the question would appear consistent with this being the position: their Honours approached the issue of characterisation by reference to the specific commercial arrangements before them.

The Commissioner’s comments after this statement that “[w]e continue to monitor the arrangements of related parties closely” is significant. It acknowledges that issues of embedded royalty are more likely to arise in respect of related-party transactions. More broadly, however, and notwithstanding the statement that the characterisation of payments under related-party or arm’s-length contracts can be challenged, it may suggest a shift of the Commissioner’s scrutiny away from arm’s-length arrangements. This may be considered appropriate in view of the High Court’s decision. However, it does not lead to the conclusion that arm’s-length parties, or related parties acting at arm’s length, should not continue to pay due care, attention and diligence to the drafting and documenting of relevant commercial arrangements.

The DIS also references the importance the majority placed on the Commissioner’s failure to argue that the pricing of the payments by the Bottler for concentrate were incorrect or had been inflated. In the DIS, the Commissioner said he must seek to obtain pricing evidence in future cases, including in relation to the value of intellectual property rights and other property being exchanged. While such evidence may assist the Commissioner, it should not distract from the central issue as to whether the parties had objectively agreed to make payments, part of which was to be consideration for the right to use intellectual property.

The existence of evidence demonstrating that the price paid for certain goods or services, for example, exceeded market value, and that any intellectual property rights obtained also had some market value in excess of their price, may suggest but does not invariably lead to a conclusion that the parties objectively agreed to make an embedded payment of royalty. This may be so even in circumstances where the price for the goods or services exceeds the market value thereof, and is commensurate with the shortfall in price paid (if at all) for any intellectual property rights.

Was that royalty ‘paid or derived’?

Although recognising that the High Court unanimously found that any royalty was not paid to or derived by the taxpayers because the Bottler had no ‘antecedent obligation’ to make payments to the taxpayers, the DIS stresses that this was a conclusion based on the facts as found by the Court. The Commissioner states that he does not ‘expect a scenario where a royalty is present but that royalty is not being paid to or at the direction of the provider of the relevant IP to be common’. Were this scenario to occur again, the Commissioner records that he would seek to ‘understand the commercial context and rationale for the arrangement’.

One would expect the issue of whether a royalty was ‘paid to or derived by’ a particular person to turn on the facts of a particular case. In the DIS, however, the Commissioner appears to express doubt as to the likelihood of such an arrangement. Yet this is in a context where all ten judges on the PepsiCo appeals (three in the Full Court of the Federal Court, seven in the High Court) agreed that the payments by the Bottler were not ‘paid to or derived by’ the taxpayers.

To the extent doubt is directed to non-resident holders of intellectual property rights that have changed their affairs after PepsiCo, such doubt may be reasonably warranted. It is possible, however, that similar arrangements were entered into prior to PepsiCo, possessing similar features and characteristics, and that there were numerous commercial reasons for doing so. As stated, all such matters should be determined on their own facts.

The Commissioner’s DIS: diverted profits tax

Was there a tax benefit?

The DIS states the majority’s finding that there was no tax benefit was based on ‘critical facts, unique’ to the appeals before the High Court, including: 

• that there was no royalty component to the payments; 

• that the scheme arose from dealings between unrelated parties; and 

• that the scheme was the implementation of long-standing ‘market standard’ business models. 

The Commissioner therefore repeats that he does not expect that ‘this set of “unique” and “critical” facts will be common to other cases’, and that the majority’s analysis accordingly has limited implications for the application of DPT or Part IVA in other cases.

In relation to the statement that such cases will not be common, a question arises as to how well that sits with the preceding reference to the taxpayers’ arrangements in PepsiCo as reflecting the implementation of a ‘long-standing “market standard” business model’. More importantly, however, the DIS’s attempt to understate the ongoing relevance of PepsiCo on anti-avoidance matters overlooks the more general statements of principle that found favour with the High Court. Some of these are referenced in the sections below.

Onus

The DIS highlights some significant statements by the majority in PepsiCo with respect to the role of onus in Part IVA matters. It is well established that the taxpayer bears the onus in such matters of proving that they have not obtained a tax benefit in connection with a scheme. The majority provides important guidance, however, as to how that onus can be discharged. It appears that questions of discharge rather than onus will be the focus of future Part IVA matters.

As to how a taxpayer is to discharge this onus, the DIS records that it is insufficient for the taxpayer merely to demonstrate that the Commissioner’s alternative postulates are unreasonable. More is required. In PepsiCo, the Commissioner had argued that the taxpayers needed to prove the existence of a reasonable alternative postulate in which they were not liable to pay royalty withholding tax. The majority accepted that a taxpayer may ‘more usually’ demonstrate the absence of a tax benefit by identifying a reasonable alternative postulate to such effect. However, their Honours rejected the Commissioner’s argument that this was the sole means of discharging the onus: the taxpayer may also 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’ (emphasis added).

The Commissioner acknowledges the majority’s clarification of this position, but highlights the majority’s statement that discharging the onus by proving the absence of a reasonable alternative postulate will be ‘unusual’. It must be stressed that the majority’s statements on the topic of onus will have ongoing and general relevance in future Part IVA cases (and the Commissioner said as much in its submissions supporting a grant of special leave), and that taxpayers will invariably at least consider the argument that there is no reasonable alternative postulate to entering into or carrying out the scheme in question. In this regard, the preparation and documentation of contemporaneous evidence supporting such a position, and demonstrating a contrary position where reasonable alternatives are present, is also of critical importance.

The possibility of multiple alternative postulates

The DIS cites a passing reference in the majority’s reasons as raising the possibility that there can be more than one alternative postulate that is reasonable. As the Commissioner observes, there appears to be some tension between this possibility and the Full Court of the Federal Court’s recent decision in Commissioner of Taxation v Hicks [2025] FCAFC 171 (which is explored in ATO loss in the Full Federal Court on section 45B and Part IVA: different name, same story). It is possible that this tension would make the High Court more likely to grant the Commissioner special leave to appeal from that decision. A definite resolution to this issue by the High Court would be welcome.

The DIS also raises the possibility that, in a scenario where there are two or more reasonable alternative postulates, not all of those postulates may result in identifying a tax benefit. The Commissioner’s position is that the taxpayer cannot discharge their onus just by demonstrating that one reasonable alternative postulate (or, presumably by extension, multiple but not all such postulates) does not result in the obtaining of a tax benefit. No doubt taxpayers and their advisers would be grateful for a more fulsome exploration of the issue, as may occur in any High Court appeal of the Hicks decision.

Substance of a scheme

The DIS also considers the majority’s finding that there was a significant misalignment in economic substance between the actual scheme and postulates advanced by the Commissioner in PepsiCo, which recognised the payment of an embedded royalty. It followed that the Commissioner’s postulates were found not to be reasonable alternatives.

Responding to these findings, the Commissioner first emphasises that the majority’s conclusion was found on the ‘unique facts of the case that no part of the payment was a royalty’, and that this absence of a royalty was part of the scheme’s substance. Viewed more generally, the Commissioner also notes that the effect of the majority judgment is not to require postulates to ‘reproduce entirely or replicate the “substance” or “consequences” of the scheme’ in order to be reasonable alternatives. The Commissioner states that such a requirement would ‘neuter Part IVA’ as postulates replicating a scheme’s substance and consequences would also replicate that scheme’s tax effects, rendering it impossible to identify any tax benefits.

However, the majority expressly stated that ‘for a postulate to be a reasonable alternative it “should correspond to the substance of the scheme”’ (emphasis added). Likewise, in refuting the existence of an alternative reasonable postulate in which a royalty was paid, the majority stated that ‘the only postulate here that might have exhibited the same substance and achieved the same results as that found in the Scheme’ was an arrangement similar to that present in PepsiCo; namely, an arrangement that also did not include the existence of a royalty.

The majority did not go so far as to require exact replication. However, the DIS does not engage with the considerable degree of similarity that their Honours did find was necessary. A seemingly minor move away from the substance of a scheme may radically change an arrangement’s nature. An obvious example is in the scenario in PepsiCo itself, where adjusting the agreements such that the payment for concentrate was in part a royalty was found by the majority to involve the entry into a ‘fundamentally different arrangement’.

Was there a requisite principal purpose?

The DIS states that, in view of their Honours’ findings with respect to the absence of a tax benefit, the majority’s comments on the scheme purpose element to DPT liability were made in obiter and admittedly ‘unnecessary’ to resolve the dispute. The Commissioner said that the majority’s ‘(limited) observations on scheme purpose have reduced relevance where parties are not arm’s-length parties acting at arm’s length or where the scheme gives rise to a tax benefit’.

The majority’s comments on scheme purpose are rightly classified as obiter remarks. However, there is force in their Honour’s observations that should not be minimised. For example, one key observation made by the majority was that merely taking tax incomes into account does not necessarily justify an application of Part IVA or the imposition of DPT.

Further, a consideration of the manner in which the scheme was entered into or carried out did not support the conclusion that the taxpayers had a principal purpose of enabling them to obtain a tax benefit. This was demonstrated by the three most significant features of the entry into and carrying out of the scheme in PepsiCo: 

• the scheme was the product of an arm’s length negotiation between experienced and large commercial enterprises; 

• the scheme involved a price payable for concentrate that was not disproportionately high and which was paid to an Australian resident taxpayer (the Seller); and 

• the scheme broadly followed a pre-existing and commercial way of doing business.

Additionally, in view of the finding that the price agreed for concentrate was solely for that concentrate and did not comprise an embedded royalty, the form of the scheme was found to be on all fours with its substance. This was a factor strongly favouring the position that the scheme was not entered into for a principal purpose of enabling the taxpayers to obtain a tax benefit.

These and other factors substantially weighed in the taxpayers’ favour that there was no requisite principal purpose of seeking to obtain a tax benefit in entering into the scheme. At least some of these factors may apply to similar effect in similar arrangements, and so should not lightly be overlooked.

The impact of the Commissioner’s DIS

As stated, the Commissioner’s DIS broadly appears to confine the High Court’s decision in PepsiCo to its facts and to limit the general implications that may flow from it. The Commissioner also affirms a number of positions that were anticipated, including the ongoing relevance of embedded royalties and the characterisation of payments involving intellectual property.

In addition to publishing the DIS, the ATO are also currently reviewing the broader impact of the decision on Law Administration Practice Statement PS LA 2005/24 Application of General Anti-Avoidance Rules, and Draft Taxation Ruling TR 2024/D1 Income tax: royalties – character of payments in respect of software and intellectual property rights. The amendments made to those publications (if any, noting the observations above regarding the statements of principle relevant to the objective interpretation and construction of contracts) are likely to be consistent with the Commissioner’s position as expressed in the DIS.

Further, given the Commissioner has expressed the DIS to be open to comment until 1 May 2026, it remains to be seen when these publications may be updated.

It cannot be denied that PepsiCo is a landmark case of high importance with respect to royalty withholding tax, DPT, and Part IVA generally. While the Commissioner may seek to limit its reach, the statements of principle now confirmed by the High Court should be considered to extend and remain relevant to broader commercial arrangements, involving withholding tax and potential anti-avoidance implications, going forward.