The High Court decision in Commissioner of Taxation v PepsiCo, Inc [2025] HCA 30 is redolent of first year fumbling in Contract 101 attempting to decipher: What does the contract do?
The decision illustrates that the correct interpretation of the interlocking rights and obligations of a contract is paramount. Once the bargain between the parties is accurately characterised, the tax consequences naturally flow.
This note does not seek to provide detailed analysis of the tax law implications of the decision and the current ATO Commissioner guidance that will need to be refined in light of the decision.
While the application of royalty withholding tax and the examination of the Diverted Profits Tax to multinationals is more exciting to tax fanatics than a Sydney Sweeney marketing campaign, the purpose of this brief note is to highlight the key theme that is applicable across the profession.
Nature of the dispute
The essence of the dispute is that an Australian company named Schweppes Australia Pty Ltd (Schweppes) agreed to purchase concentrate from companies within the US PepsiCo, Inc group of companies (Pepsi) which owned the brands for “Pepsi”, “Mountain Dew” and “Gatorade”.
The contracts provided for the Pepsi companies (or a nominee party) to sell the concentrate to Schweppes to manufacture the branded drinks. The suite of contracts also provided for Pepsi to grant exclusive licences to Schweppes to exploit the intellectual property of Pepsi so that Schweppes could be the exclusive manufacturer, bottler, seller and distributer of the branded drinks in Australia.
The case turned on whether the price paid for the concentrate included a royalty component for the use of Pepsi’s intellectual property. There was no explicit payment allocated to the use of Pepsi’s intellectual property. Rather, the Commissioner argued that the price was embedded within the concentrate price.
The outcome was driven by the characterisation of the contracts and determining what the Schweppes consideration was for. Essentially, the Commissioner sought to deconstruct the price paid for the concentrate in order to impose royalty withholding tax on intellectual property granted to Schweppes. Alternatively, the Commissioner advanced an anti-avoidance argument stipulating that the principal purpose of the arrangement was for Pepsi to obtain a tax benefit.
What is consideration for?
The outcome was finely balanced in a 4-3 decision for Pepsi. The majority emphasised that the entire contractual arrangement had to be evaluated to determine the multiplicity of promises and undertakings exchanged between the parties. The majority found that Schweppes had provided non-monetary consideration for the use of Pepsi’s intellectual property as part of the broader commercial framework between the parties. It was a mutually beneficial arrangement.
The minority emphasised the “single, integrated and indivisible” nature of the transaction, and found that within the contractual framework the Schweppes payments for the concentrate moved the grant of intellectual property licences. As such, payments with a royalty component could be identified.
Separately, the High Court was unanimous in finding that Pepsi did not derive income for royalty withholding tax purposes given the nomination of rights to a subsidiary entity under the contract architecture. The final lever available to the Commissioner was the anti-avoidance argument.
A taxpayer bears the onus of proof in tax cases. Pepsi discharged its onus by demonstrating that there was no “reasonable alternative postulate” which aligned with the commercial substance of the arrangement. Therefore, Pepsi did not obtain a tax benefit in the majority view.
It certainly assisted Pepsi’s case that an arms length price was paid for the concentrate, and the composite contractual framework was well documented and followed a standard practice implemented by Pepsi globally (a fun acronym called the “FOBO” model: Franchise-Owned Bottling Operation).
Key learning
Know thyself. Know thycontract. Know thyclient industry.
