The Australian Taxation Office (ATO) has had a significant win in a recent case in the Federal Court of Australia involving international beverage giant Pepsi Co.

The decision, PepsiCo, Inc. v Commissioner of Taxation, considered royalty withholding tax and, for the first time, diverted profits tax, in the context of a cross-border intragroup arrangement involving intellectual property.

The case is important for Australian businesses with offshore operations given such businesses will often have cross-border intragroup arrangements in place, with such arrangements likely to be closely monitored by the ATO from an Australian income tax perspective following this decision.

What happened

While the facts of the case are complex, they have been summarised in very broad terms below.

• An arrangement was entered into between various Pepsi Group Australia entities (PG Aus) and various Pepsi Group offshore entities in Singapore and America (PG Offshore) which broadly provided for:
  • the supply of certain beverage concentrate by PG Offshore to PG Aus to be used as part of the Australian beverage business;
  • the beverage concentrate to be on-supplied on an intra-group basis within the PG Aus group for a specified on-supply amount (less an applicable margin) (Relevant Amounts); and;
  • the Relevant Amounts to ultimately make its way from PG Aus to PG Offshore (Arrangement).

• The ATO submitted that:
  • the payment of the Relevant Amounts by PG Aus to PG Offshore should be characterised as a 'royalty' for the use of the corresponding intellectual property and trade marks related to the beverage concentrate; and
  • the Relevant Amounts should be subject to Australian 'royalty withholding tax' (RWT) or in the alternative the 'diverted profits tax' (DPT) regime should apply to the Arrangement (i.e. in general terms RWT is payable on certain royalty payments made by an Australian tax resident to an offshore entity and the DPT is a broad regime which applies a 40 per cent penalty to multinationals with annual global incomes of at least A$1 billion who shift profits overseas).

• The Federal Court found in favour of the ATO and determined that the payment of the Relevant Amounts from PG Aus to PG Offshore were "consideration for the use of, or the right to use, the relevant trademarks and other intellectual property" of PG Offshore.
• Consequently, the Federal Court determined that the Relevant Amounts should have been subject to RWT – and that even if RWT did not apply, the DPT regime would have applied.

Why it's significant

This decision is significant because it was the first time that a DPT related dispute has been determined by an Australian court. Importantly, the DPT contains far reaching provisions and gives the ATO certain specific powers which extend beyond those typically found in the RWT and Australian transfer pricing regime.

The ATO's success in the case will no doubt embolden the ATO in respect of its current strategy related to targeting similar arrangements of which the ATO has stated it has been targeting "arrangements where royalty withholding tax has not been paid because payments have been mischaracterised, particularly payments for the use of intangible assets, such as trade marks". 

Consequently following this decision, we anticipate that the ATO will continue to:

• closely review any related party arrangements that multinationals have in place between its Australian group entities and its offshore group entities (particularly arrangements relating to the use of intangible assets such as intellectual property and trademarks); and
• apply the RWT and DPT provisions (together with other related provisions such as under the transfer pricing regime) as applicable as part of its Australian tax review of such arrangements.

Having said that, the decision may be appealed so there could be a little more to play out on this matter.

Further, the ATO is currently involved in a similar dispute with The Coca Cola Company and it will be interesting to see how that matter progresses.

Way forward

Corporate entities with cross-border operations inside and outside Australia should:

• review any intra-group cross border supply arrangements in place between Australian entities and offshore group entities (Cross-Border Arrangements);
• consider the potential implications of the decision in respect of such Cross-Border Arrangements;
• retain relevant evidence to support the current Australian income tax position in respect of the Cross-Border Arrangements; and
• seek professional tax advice as applicable.

When reviewing such arrangements, particular regard should be had to Cross-Border Arrangements relating to the use of intangible assets such as intellectual property and trademarks.

Further, it may be worth considering whether there would be utility in any early engagement with the ATO in respect of its Cross-Border Arrangements noting that we would anticipate that the ATO will continue to increase its compliance review activity in this area following the decision.

For more information or assistance, please contact our Tax team.