Multinationals – Time to review your intangibles?

The PepsiCo Case

On 30 November 2023, Moshinsky J handed down the landmark decision. The case concerned PepsiCo’s “royalty-free” exclusive bottling agreements (EBAs) with Schweppes Australia Pty Ltd (SAPL). Per the EBAs, PepsiCo and another USA company, SVC, granted SAPL the right to use in Australia trademarks and other IP in the manufacture, bottling, sale and distribution of beverages in PepsiCo Group packaging. Pepsi Co and SVC agreed to sell the concentrate to SAPL through a related Australian entity, PBS.

SAPL was authorised to mix the concentrate with ingredients in accordance with formulas, specifications and other information provided by the PepsiCo Group to produce finished beverages for retail sale in Australia. SAPL paid the Australian company, PBS, and PBS transferred almost all of the money to a Pepsi Company in Singapore.

The Federal Court ruled that PepsiCo was liable for royalty withholding tax (at a 5% rate) in relation to portions of payments made under the EBAs which were held to be royalties and, in the alternative, diverted profits tax (DPT) would apply at a rate of 40%, i.e. if the payments were not royalties.

Some notable points from the case include:

• The EBAs did not expressly provide for the payment of a royalty for the right to use IP. SAPL had no licensing agreement with PepsiCo that required it to pay for PepsiCo’s IP.
  
  
• The court found that portions of the payment to PBS were a royalty – however it is important to note that these payments were for purchases of concentrate (i.e. stock purchases by SAPL) from an Australian company.
  
  
• The PepsiCo case illustrates that while the legal form of an intercompany agreement is important, the ATO (and Federal Court in the case of PepsiCo) will look beyond the terms to the commercial substance of the arrangements in determining whether a royalty exists. 

What can multinationals learn from the PepsiCo case?

The ATO’s increasing focus on intangibles, and in particular the concept of “embedded royalties”, has caused concern internationally as the approach adopted in Australia may not align with internationally recognised OECD principles.  Despite these concerns, the PepsiCo decision is a victory for the ATO and will likely spur on its efforts to continue its consideration of cross-border intangible arrangements. The fact that the PepsiCo decision is being appealed is unlikely to stop the current efforts by the ATO on intangible assets.

The Government is also stepping up its efforts to tackle this “leakage” from Australia. On 14 May 2024 the Treasurer announced in the 2023-24 Federal Budget that it will introduce a new provision from 1 July 2026 that applies a penalty to taxpayers who are part of a group with more than $1 billion in global turnover annually that are found to have mischaracterised or undervalued royalty payments, to which royalty withholding tax would otherwise apply. No further details around this measure were provided, however as the rate of royalty withholding tax on payments to the US is only 5%, it is likely that this measure is directed towards cases of "embedded royalties" and is intended to increase the financial impost of arrangements similar to those considered in PepsiCo where a portion of a payment for goods or services is found to be a royalty.

The message to multinationals operating in Australia is clear – if you have not started already, now is the time to review the use of your intangibles in Australia.