On 13 August 2025, the High Court of Australia delivered its eagerly awaited decision in Commissioner of Taxation v PepsiCo, Inc [2025] HCA 20 (PepsiCo Case).

By a 4:3 majority decision (Gordon, Edelman, Steward and Gleeson JJ), the High Court dismissed the appeal of the Commissioner of Taxation (Commissioner) from the decision of the Full Federal Court in PepsiCo, Inc v Commissioner of Taxation [2025] FCAFC 86, providing welcome guidance in respect of the application of the royalty withholding tax (RWHT) and Diverted Profits Tax (DPT) provisions.

The majority and minority judgments of the High Court, and earlier decisions, highlight the difficulties in applying complex aspects of the taxation laws consistently.

HWLE is highly experienced in assisting clients to review and structure cross-border arrangements, determine how payments should be characterised, substantiate the position adopted with comprehensive evidence, and manage any potential or actual scrutiny by the Commissioner in an audit or review.

Key takeaways

Taxpayers should be prepared for sustained scrutiny by the Commissioner in respect of the pricing and taxation of intangible arrangements.

The Commissioner has dedicated significant resources to compliance activities focused on intangible arrangements, anti-avoidance considerations, and the mischaracterisation of royalty payments. It is expected that the Commissioner will continue to apply the RWHT and DPT provisions under an expansive ‘substance over form’ approach to cross-border intangible arrangements, in an attempt to bring the (purported) economic gains from such arrangements into Australia’s tax net.

While the High Court’s decision in the PepsiCo Case provides some clarity, it remains to be seen how the Commissioner will seek to apply, or confine, its application to the facts of the case. Importantly, the outcome will likely require the Commissioner to reconsider the expansive approach as to the characterisation of royalties outlined in Draft Taxation Ruling 2024/D1, Income Tax: royalties — character of payments in respect of software and intellectual property rights, as well as the recently released Draft Practical Compliance Guideline PCG 2025/D4, Low-risk payments relating to software arrangements – ATO compliance approach.

Regardless of how the Commissioner ultimately responds, the approach taken by the majority in the PepsiCo Case provides important guidance about how taxpayers should prevent and manage the risk of scrutiny:

1. Proactively review contractual terms: taxpayers must review the terms of relevant agreements to ensure they objectively reflect the economic and commercial substance of the underlying arrangements. This is particularly critical in cases involving the licensing or transfer of intellectual property rights or intangible assets.
2. Determine the flow of payments and obligations: taxpayers must carefully review how each party’s interests and obligations are structured within an arrangement, to determine whether a payment to a vendor may be considered as income derived by or credited to the owner of underlying intellectual property assets.
3. Maintain comprehensive and contemporaneous documentation: taxpayers should keep detailed qualitative and quantitative evidence to demonstrate the commercial rationale in respect of the entering into and carrying out of a relevant arrangement more broadly.
4. Clearly characterise the nature of payments: the majority decision emphasised that a payment will constitute a royalty only when a proper construction of the overall arrangement indicates the monetary or non-monetary consideration was provided for the grant of IP rights, as distinct from any other right or benefit derived. Although the majority of the Court formed the view that the Commissioner took an oversimplified approach to the construction of the relevant agreements, taxpayers should ideally ensure that contracts explicitly describe whether payments are for goods, services, or intellectual property, particularly where bundled transactions may be involved.
5. Engage in permissible tax planning: taxpayers must have regard to their commercial interests in structuring or carrying out an arrangement, but the fact that sophisticated businesses have regard to tax considerations does not, without more, indicate a principal purpose of tax avoidance under the DPT.
6. Discharge the onus of proof in anti-avoidance cases: the majority decision affirms that the taxpayer has the onus of establishing the Commissioner’s alternative postulate is unreasonable, and may demonstrate the absence of a tax benefit on the basis that there is no reasonable alternative to entering into or carrying out the scheme undertaken when having regard to its substance.

Background

Broadly, the relevant arrangements considered by the High Court were as follows in the relevant years, being the income years ended 30 June 2018 and 30 June 2019:

• PepsiCo, Inc. and its US subsidiary, Stokely-Van Camp, Inc., (PepsiCo) entered into Exclusive Bottling Agreements (together with other relevant distribution agreements) (EBAs) to appoint Schweppes Australia Pty Ltd (SAPL) as the sole distributor and bottler of PepsiCo branded beverages in Australia;
• to manufacture the PepsiCo branded beverages, PepsiCo undertook that it, or its nominee, was to sell concentrate to SAPL. PepsiCo nominated PepsiCo Bottling Singapore Pty Ltd (PBSPL), a PepsiCo subsidiary incorporated in Australia, as the seller of the concentrate to SAPL;
• the EBAs specified a formula which calculated the consideration payable by SAPL to PBSPL per unit of concentrate required (EBA Payments); and
• under the EBAs, SAPL was also granted a licence to use PepsiCo trademarks and other intellectual property (PepsiCo IP) to undertake its distribution and bottling functions, although no amount was expressly payable as consideration for this right.

The Commissioner imposed tax on PepsiCo with respect to a portion of the EBA Payments, on the following two alternative bases:

• by recharacterising a portion of the EBA Payments as a royalty for the use of PepsiCo IP, and assessing RWHT pursuant to section 128B of the Income Tax Assessment Act 1936 (ITAA 1936) and Article 12 of the Australia-US treaty; and
• by asserting that the principal purpose of entering into the arrangement by PepsiCo was contrived to avoid RWHT, and subjecting PepsiCo to the application of the DPT under sections 177J and 177P of the ITAA 1936.

The High Court’s decision

On a proper construction of the EBAs, the majority held that the payments made by SAPL to PBSPL were exclusively for concentrate and did not include a royalty component for the right in the PepsiCo IP.

The majority further held that PepsiCo did not enter into a scheme conferring a tax benefit by reason of not being liable to pay RWHT.

Royalty withholding tax

On an objective analysis of the agreements, the majority held that no component of the payment from SAPL to PBSPL included a royalty for the use of the PepsiCo IP. Accordingly, PepsiCo did not derive income from the payment of a royalty as referred to in section 128B(2B) of the ITAA 1936.

Consideration for use of PepsiCo IP

The High Court agreed with the majority of the Full Federal Court by undertaking an objective analysis of the EBAs by reference to the language used, circumstances addressed, and commercial purposes or objects secured by the parties.

The majority conceived the EBAs as a complex exchange of valuable promises, and rejected the Commissioner’s assertion that the licence to use the PepsiCo IP was provided under the EBAs ‘for nothing’ or for nil consideration. Rather, the PepsiCo IP licence rights were part of a comprehensive commercial arrangement of monetary and non-monetary undertakings which obliged SAPL to strengthen and promote the goodwill in the PepsiCo brand in Australia, and the success of which generated real economic value for PepsiCo.

In arriving at its conclusion, the majority also distinguished the High Court’s decisions in the State Duties Act cases of Dick Smith and Lend Lease. The Commissioner relied on those cases to contend that the meaning of ‘consideration’ required the Court to look outside the terms of the EBAs and beyond the dealings between the parties. The majority rejected this contention, and clarified that the word ‘consideration’ was applied in those cases to a duty, rather than a standard contractual context, and should not be improperly extended to apply to characterise consideration under the WHT provisions.

Derived by PepsiCo

Irrespective of whether part of the EBA Payments represented a royalty, both the majority and minority of the High Court held that no payment by SAPL was ‘derived by’ or ‘paid or credited’ to PepsiCo.

The Court rejected the contention by the Commissioner that SAPL’s liability for payment of the concentrate under the EBAs was to PepsiCo, such that there existed a direction by PepsiCo to make payment to PBSPL within the meaning of section 128A(2) of the ITAA 1936. Under the proper construction of the EBAs, the High Court held that there was no preexisting monetary obligation owed by SAPL to PepsiCo for the concentrate. Payments were received by PBSPL on its own account as the seller nominated by PepsiCo and with the title to the concentrate sold, such that the income received was not derived by PepsiCo.

Diverted profits tax

The majority held that no liability under the DPT provisions arose, as PepsiCo did not obtain a tax benefit in connection with a scheme within the meaning of section 177J of the ITAA 1936.

Tax benefit

The majority found that PepsiCo obtained no tax benefit as a result of the proper construction of the EBAs. In doing so, the majority provided much-needed guidance around the perceived ambiguity regarding the way in which the ‘alternative postulate’ counterfactual is to be determined and applied.

The majority rejected each of the two alternative postulates advanced by the Commissioner under section 177CB of the ITAA 1936, in identifying that PepsiCo entered into EBAs on terms which would not give rise to the payment of a royalty for the use of the PepsiCo IP (Scheme). These two alternative postulates to the Scheme were that EBAs might reasonably be expected to have, either:

• expressed the payments to be made by SAPL to be for all the property provided by, and promises made by, PepsiCo, rather than concentrate only; or
• expressly provided that the payments by SAPL for the concentrate included a royalty for the provision of the PepsiCo IP.

The majority considered neither postulate to be reasonable alternatives to the Scheme based on an objective analysis, as they did not align with the economic and commercial substance of the arrangement entered into and carried out between the parties. In agreeing with the reasoning of the Full Federal Court, the majority held the substance of any ‘scheme’ was that ‘the price agreed for concentrate was for concentrate’. This view was supported by three critical factors observed by the majority:

• first, objective evidence indicated the price paid was for concentrate and nothing else;
• second, the Scheme was the product of an arm’s length dealing between unrelated parties; and
• third, the absence of a royalty was a PepsiCo and market standard which preceded the EBAs.

The majority rejected the Commissioner’s construction of the onus cast upon PepsiCo by section 14ZZO of the Taxation Administration Act 1953 (Cth) to overcome the Commissioner’s counterfactual. Rather than a need to prove the existence of an alternative postulate in which it was not liable to pay RHWT, the majority held that a taxpayer may usually discharge its onus by identifying a postulate that demonstrates what it might reasonably be expected to have done absent any scheme. In unusual cases, establishing that there is no postulate that is a reasonable alternative to entering into the scheme may also be sufficient, which the majority found was made out by PepsiCo.

Principle purpose

The majority also held that the Scheme was not entered into for the principal purpose of enabling PepsiCo to obtain a tax benefit as required by section 177J(1)(b)(i) of the ITAA 1936, rejecting the findings of the majority Full Federal Court decision.

In arriving at its conclusion, the majority reiterated the findings in previous High Court decisions, such as FCT v Spotless and FCT v Hart, to observe that having regard to tax outcomes when entering into a scheme does not necessarily justify an application of Part IVA or, indeed, the imposition of DPT.

The majority further found that the Commissioner’s argument could not succeed because it misstated the true economic and commercial substance of the Scheme. As the price agreed for the concentrate was only for concentrate, the form and substance of the Scheme were the same.

The majority further observed a range of other commercial considerations which informed the basis that PepsiCo entered into the EBAs, including that they were negotiated between arm’s length and sophisticated enterprises, reflected a not disproportionate price payable for concentrate, and reflected a pre-existing and commercial business model of PepsiCo.

This article was written by Timothy Stokes, Partner, and Samuel Romano, Senior Associate.