The Commissioner v PepsiCo: A turning point in intellectual property and royalty characterisation
26/08/2025
The High Court has handed down its long-awaited decision in Commissioner of Taxation v PepsiCo, Inc [2025] HCA 30 (PepsiCo), with a 4–3 majority finding in favour of the Taxpayer in the protracted ‘embedded’ royalty dispute with the Commissioner.
The High Court has, by a 4-3 majority, dismissed the Commissioner’s appeal ruled in favour of the taxpayer.
The majority held that payments for the concentrate were not to any extent for the use of intellectual property (IP). Accordingly, there was no ‘embedded royalty,’ and PepsiCo and Stokely-Van Camp (SVC) had not obtained a tax benefit. Therefore, they were not liable for diverted profits tax (DPT).
Notably, the full Bench agreed that no royalty withholding tax (RWHT) arose as payments were not derived by PepsiCo or SVC.
This outcome followed PepsiCo’s successful appeal in June 2024 when the Full Federal Court overturned the primary Judge’s decision. A summary of the background and earlier judgements is discussed in our previous article.
Due to the High Court decision, the ATO is considering any broader impact the decision may have on the reasoning set out in Draft Tax Ruling 2024/D1. However, this loss will unlikely deter the ATO from reviewing multinationals of their intangible / distribution arrangements.
High Court decision
The High Court majority held that:
Payments were for concentrate only
On the proper construction of the exclusive bottling agreements (EBA), the payments made by SAPL to PBS were for concentrate only, not for trademarks or intellectual property. The High Court gave significant weight to the agreement being entered into between two arm’s length parties. This significantly determined the nature of the transactions and the relevant tax laws. The arm’s length nature of the agreement established that the transactions were conducted on commercial terms, influencing the High Court’s decision on the liability for royalty withholding tax and diverted profits tax.
No royalty withholding tax liability
Even if the payments included a royalty component, such amounts were not income derived by, and were not paid to, PepsiCo or SVC. As payments were made to PBS (an Australian resident) rather than to the US entities, the conditions for RWHT under section 128B of the ITAA 1936 were not satisfied. This aspect of the decision was unanimous across the full bench.
ATO’s argument rejected
The Commissioner argued that unless part of the concentrate price was treated as a royalty, SAPL would have obtained the right to use PepsiCo’s intellectual property for free. The majority rejected this reasoning as the more successful SAPL was in selling Pepsi-branded products, the more valuable the PepsiCo IP became. From a commercial aspect, this was not “nothing,” and there was no legal or economic basis to reallocate part of the concentrate price to a separate royalty component.
No diverted profits tax exposure
On DPT, the majority found the Commissioner’s proposed counterfactuals (e.g. stripping out the royalty-free licence provisions) were not commercially realistic, especially given PepsiCo’s longstanding franchise arrangements since the early 1900s. Furthermore, the arrangements did not meet the principal purpose test under section 177J of the ITAA 1936. Apart from a potential US tax saving, the Commissioner’s case lacked commercial support. The amount of royalty WHT allegedly avoided was negligible for such large multinational businesses.
Key implications for multinational groups
Close result
The High Court decision was delivered by a 4–3 majority, following a 2–1 split in the Full Federal Court and a single judge (in the Commissioner’s favour). This narrow margin at all levels of Courts underscores that the outcome was not definitive and future cases with different facts could be decided differently.
- Entity separation – A key factor was that the entity owning the IP (PepsiCo/SVC) and the entity selling the concentrate (PBS) were different. The outcome may be different if the entity owns both the IP and service / good provided.
Similarly, the majority emphasised the unique and arm’s length nature of the arrangement, suggesting limited relevance of the decision in related-party transactions. - ATO Draft Rulings – The ATO is considering the broader impact of the decision on public guidance and software arrangements, including TR 2024/D1 and PCG 2025/D4. We offer that the following considerations may be relevant:
- Placing more focus on the contractual substance, as the High Court determined that fair market payments should not be divided into notional royalties without a clear contractual basis.
- Evaluating different levels of risk zones based on the nature of the parties involved, whether they are related or third parties.
- Characterisation of royalty – The High Court reinforced that payments under integrated commercial arrangements will not be treated as royalties unless the agreement clearly allocates part of the consideration to IP use. Simply including ‘right to use’ does not imply a royalty unless there is evidence of ‘inflation’.
- Counterfactuals – The Court emphasised that the ATO’s alternative postulates must be commercially realistic and reasonable, considering the business model of a taxpayer. From the taxpayer’s perspective, the ‘do nothing’ counterfactual is still possible but heavily depends on the facts.
- Practical takeaway – Multinationals relying on supply/licensing models should still ensure that their documentation and pricing reflect genuine commercial arrangements. While the decision favours taxpayers, it shows the ATO’s readiness to challenge structures through RWHT and DPT, making strong transfer pricing and intercompany agreement support crucial.
How SW can help
Our experts can assist with advising how this outcome affects your existing and prospective cross-border arrangements. We can also engage with the ATO to deal with potential disputes.
Reach out to your SW advisor for support from our Corporate Tax team.
