This dispute centers on Exclusive Bottling Agreements between PepsiCo, Inc., Stokely-Van Camp, Inc. (SVC), and Schweppes Australia Pty Ltd (SAPL), under which SAPL purchased beverage concentrates for purchase and sale in Australia. While the agreements implied a license to use PepsiCo’s intellectual property, they did not specify royalty payments. SAPL made payments to PepsiCo Beverage Singapore Pty Ltd (PBS), with no evidence of funds being transferred to PepsiCo or SVC in the US.
The Australian Taxation Office (ATO) issued tax settlement notices for the 2018 and 2019 fiscal years, arguing two points:
- The payments made included an implicit royalty, which would entail the application of royalty withholding tax under section 128B(2B) of the Income Tax Assessment Act 1936 (Cth).
- Alternatively, there was an undue tax benefit subject to Diverted Profits Tax (DPT) under section 177J of the same law.
PepsiCo and SVC challenged these determinations in the Federal Court of Australia, which initially ruled in favor of the ATO. In August 2025, the Supreme Court dismissed the ATO’s appeals, upholding the decision made by the Full Federal Court of Australia, which had previously overturned the initial ruling in favor of PepsiCo and SVC.
Supreme Court Decision: Key Grounds
The Supreme Court concluded, by a majority (4-3), that the payments made by SAPL were solely for the supply of concentrate without royalty components for using intellectual property. The interpretation was based on contractual analysis and contemporary evidence, such as invoices issued to SAPL, without alleging that concentrate prices were artificially inflated to conceal royalties. The Court also unanimously determined that SAPL did not engage in payments that were “paid or credited” or “derived” by PepsiCo or SVC in the US, since the actual beneficiary was PBS, an entity resident in Australia.
Consequently, there was no basis for applying royalty withholding tax under current legislation. As no withholding was needed, the alternative proposed by the ATO-the application of the Diverted Profits Tax (DPT)-was also rejected. The Court held that PepsiCo and SVC did not obtain an unlawful tax benefit under the parameters of section 177J of the ITAA 1936. The ruling also clarifies the treatment of “reasonable alternative assumptions” regarding DPT, specifying that a counterfactual scenario different from the actual facts is not always necessary if there is no viable scenario that excludes the tax benefit.
Practical and Legally Relevant Implications
The ruling affects international taxation, particularly the classification of payments in cross-border structures involving intellectual property and the application of royalty withholding tax. Likewise, it establishes more precise criteria for using DPT in related-party contexts, stressing that tax authorities consider the economic substance of agreements.
In this case, the Court recognized that the contract reflected genuine economic and commercial substance, given that SAPL undertook real commitments, such as the promotion and distribution of the products, which was valid consideration for the IP, without implying the existence of concealed royalties.
Relationship with Transfer Pricing
Although the Australia v. PepsiCo Inc. case was not directly resolved under traditional Transfer Pricing rules, its implications are highly relevant thereto. The litigation concerned the characterization of payments for using trademarks and intellectual property, considered by the Court as “royalties” subject to withholding, which is critical in Transfer Pricing, since:
- The correct classification of intra-group payments for intangibles is one of the most challenging issues in comparability analyses.
- The ruling highlights the necessity of accurately documenting licensing and distribution agreements according to OECD guidelines on intangibles.
- It is linked to the application of the Diverted Profits Tax, which introduces an additional tax risk element in cross-border related-party transactions.
- It sets a precedent for how tax authorities can recharacterize intra-group agreements when they find that the contractual terms do not reflect the economic substance.
Consequently, although this is not precisely a Transfer Pricing case, the approach taken by the Australian Court sets a precedent that multinationals should consider when designing and evaluating their Transfer Pricing policies for intangible transactions.
Conclusion
The ruling represents a landmark court decision for Australian tax law. The Supreme Court concluded that:
- There was no royalty in the payments for concentrate.
- There was no payment credited to non-resident entities.
- There was no obligation to apply DPT.
This result reinforces the importance of contractual interpretation, solid commercial evidence, and substance principles in defending cross-border structures involving intellectual property.
Source: TPCases