Full Federal Court decision in PepsiCo falls flat for the ATO

The PepsiCo case is one of the more significant tax cases in recent times, and touches on a number of important considerations for multinationals. It explores what constitutes an embedded royalty for tax purposes, the concept of consideration for the use of intangible assets and the application of Australia’s Diverted Profits Tax anti-avoidance provisions.

Summary of key takeaways

• The Full Federal Court found in favour of PepsiCo, meaning that PepsiCo is not subject to either Royalty Withholding Tax or Diverted Profits Tax in respect of certain cross-border intellectual property licencing arrangements involving unrelated Australian third parties. The decision will be of high relevance to Australian taxpayers and multinational groups with similar third party commercial arrangements.
  
  
• The taxation treatment of intellectual property arrangements continues to be a focus area of the Australian Taxation Office (ATO) – and is subject to ongoing change, contrasting opinion, differing interpretation and uncertainty.
  
  
• Taxpayers should remain vigilant and proactively review relevant arrangements. In particular, they should reflect on the ATO’s willingness to consider the application of the Diverted Profits Tax anti-avoidance provisions in circumstances where payments for intellectual property may be viewed as containing royalty components.
  
  
• Such review should include an objective assessment of the terms of any contracts and legal agreements that record relevant arrangements. Contemporaneous documentation and evidence that support the commercial nature of relevant arrangements should also be reviewed, including any associated economic analysis, and the basis on which that analysis has been undertaken.
  
  
• The statements made by the majority of the Full Federal Court regarding how the 2013 amendments to Part IVA operate in determining or identifying a tax benefit will also be relevant to the application of Part IVA more generally (subject to any High Court decision if special leave to appeal is sought and granted).
  
  
• The decision represents a potentially unfavourable outcome for the Commissioner that could have broader application. This is particularly relevant in the context of announcements in this year’s Federal Budget regarding the application of penalties for mischaracterised or undervalued royalty payments, to which Royalty Withholding Tax would otherwise apply.

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