While the ruling sets out the ATO’s interpretation of the law, the draft Practical Compliance Guideline is arguably the more important document for many taxpayers because it provides a roadmap for understanding how the ATO intends to allocate its compliance resources. In simple terms, taxpayers can self-assess their arrangements into a risk zone ranging from white (lowest compliance risk) to red (highest compliance risk).

For CFOs, financial controllers, and technology businesses, the key question is often not whether software payments exist, but whether the ATO might consider part of those payments to be royalties that should be subject to royalty withholding tax. The new framework is intended to provide greater certainty around that issue.

Why has the ATO released this guidance?

The framework follows the High Court’s decision in PepsiCo and reflects the ATO’s view that economic substance and examining the totality of the arrangement may be relevant in identifying an embedded royalty, even where no royalty is expressly stated in the contract.

The guidance currently applies to software intermediation and distribution arrangements, with further schedules expected for other industries and transaction types.

Understanding the risk zones

Particular focus on restructures

The draft guidance includes a clear ATO warning on restructures.

The ATO may review changes to contractual or operating structures that reduce or eliminate Australian royalty withholding tax, even where the arrangement otherwise falls within a lower-risk zone. Transfer pricing, MAAL, DPT, and Part IVA may also be relevant.

Multinational groups undertaking software licensing or distribution restructures should therefore consider royalty withholding tax alongside transfer pricing.

Amber Zone example

A foreign software provider licenses ERP software to AU Software Co, an Australian related-party distributor, for supply to Australian customers. The agreement with the software owner grants AU Software Co the exclusive right to market and distribute the ERP software to Australian customers. However, it does not grant AU Software Co the right to make copies of, or modify, the ERP software. AU Software Co enters into customer contracts and receives payments from those customers, while the offshore supplier owns the software and provides the underlying platform and support. AU Software Co does not recognise any part of its payment to the offshore supplier as a royalty for Australian tax purposes.

On the facts in Example 8, the ATO would treat the arrangement as falling within the amber zone. The key risk indicators are that the Australian distributor is selling software-related products or services to Australian customers, the software and associated intellectual property are held offshore, and no Australian royalty has been recognised or subjected to royalty withholding tax.

The example illustrates that, where the relevant software rights and economic value sit offshore but Australian customer-facing activities are carried on locally, the ATO may expect taxpayers to undertake and document a more detailed royalty risk assessment.

By contrast, the risk assessment changes to the red zone where AU Software Co is also granted rights to make copies of, or modify, the ERP software. A red zone outcome may also arise where the software owner is located in a specified jurisdiction, or, generally speaking, is otherwise shielded from tax on the relevant income.

How SW can help

Businesses with cross-border software, SaaS, platform or technology distribution arrangements should review their existing arrangements against the framework. Even where no royalty has historically been recognised, the ATO expects taxpayers to be able to explain and support that position.

SW can assist in the following assessment:

• assessing where your arrangement is likely to sit within the ATO’s risk framework
• whether the undissected payments contain a royalty component
• whether sufficient documentation exists to support your position
• identifying whether practical steps are available to mitigate the relevant royalty withholding tax risk.

The release of TR 2026/2 and PCG 2026/D4 signals that software royalty arrangements will remain an area of significant ATO focus. Early assessment of risk positions and supporting documentation may help reduce the likelihood of future disputes and compliance costs.

The post What the ATO’s finalised software royalties ruling & draft guidance means for businesses appeared first on SW Accountants & Advisors.

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.

Contributors

Antony Cheung

Alan Tong

The post The Commissioner v PepsiCo: A turning point in intellectual property and royalty characterisation appeared first on SW Accountants & Advisors.

Whilst the important details of the framework have yet to be released (and remain the subject of an intended consultation process), the Albanese Government’s intention is to “to ensure multinationals pay their fair share of tax“.

The Government plans to do this via 4 major areas of reform or expansion:

1. implementation of BEPS 2.0
2. modification of thin capitalisation rules
3. restricting Intellectual Property deductions, and
4. expanding Tax Transparency measures, including requiring:
   • public release of Country-by-Country (“CbC”) information
   • a public registry of ultimate beneficial ownership of entities
   • mandatory reporting of “tax haven exposure”, and
   • transparency requirements for Australian government tenderers.

Adoption of BEPS 2.0

The ALP has confirmed its commitment to the timely implementation of the Base Erosion and Profit Shifting framework (BEPS 2.0) to follow through on Australia’s agreement to the global arrangement reached in October 2021 and membership of the OECD’s Inclusive Framework.

This will include the domestic implementation of what is known as a 2-Pillar solution, which includes:

• a global minimum effective minimum corporate tax rate set at 15% for multi-nationals, and
• a fairer distribution of profits by multinationals.

The new Government is clearly hoping that the introduction of these measures will increase Australia’s proportion of the tax take on many multinationals.

Thin capitalisation reform

The ALP is proposing to further limit interest deductions to bring Australia in line with the OECD recommended approach. In particular, the Government is proposing to limit interest deductions to 30% of EBITDA from 1 July 2023, while retaining the arm’s length and worldwide gearing debt tests.

The proposed reform is simple in statement but difficult in execution, and will likely have significant impact on a range of sectors that are traditionally highly leveraged and increase the compliance burden for many multinationals.

Thankfully, the ALP has stated that these reforms will only proceed after industry consultation, and we hope that due consideration is given to the broader implications of such a change.

Intellectual Property restrictions

The Government has seemingly sought to ‘borrow’ certain integrity measures from other tax systems such as the UK and US in seeking to deny tax deductions for the use of intellectual property when those payments are paid to a tax haven jurisdiction.

These measures are intended to only apply to Significant Global Entities (SGEs) and are intended to stop “treaty shopping”. The Government intends to introduce provisions that would deny such a payment unless it could be substantiated that the royalty payment was not for the dominant purpose of avoiding Australian tax.

There are many complexities evident with this proposal, not the least the interaction of these proposed rules with existing tax provisions such as Part IVA and Diverted Profits Tax.

Tax Transparency expansion

The remainder of the ALP’s reform agenda is focused on expanding requirements for multinationals to be transparent in their dealings.

These expansions focus on 4 areas:

Public reporting of CbC information

It is currently only mandatory to provide CbC Reporting information to the ATO. The ATO then shares that information with certain other global revenue authorities.

The ALP intends to require “large multinational firms” (presumably SGEs) to publicly disclose the CbC information.

Ultimate beneficial ownership information

The Government intends to create and maintain a public registry of ultimate beneficial ownership. Ultimate beneficial ownership is essentially the identity of who ultimately owns, controls, or receives profits from a company or other type of entity.

Implementation of a public register of such information will bring Australia in line with other G20 nations such as Canada, UK, and the US.

We expect that such a register would be limited in scope to large multinationals given the broader context of the reform agenda. However, limited information has been provided at this stage.

Mandatory reporting of “tax haven exposure”

Presumably tied to the implementation of BEPS 2.0, these changes will require multinationals operating in jurisdictions below the proposed global minimum 15% tax rate to disclosure a “material tax risk” to shareholders.

Tax transparency requirements for Australian Government tenderers

Lastly the ALP plan to implement a “Fair Go Procurement Framework” requiring companies tendering for Government contracts worth more than $200,000 to disclose their country of domicile for tax purposes.

ALP plan needs broad consultation

The ALP’s proposals clearly represent a significant pivot from policies in previous elections and have generally focused on ways of addressing tax avoidance by multinational corporations. Whilst they may provide some headaches and uncertainties for taxpayers, they are unlikely to unsettle Australian voters or mums and dads.

Nonetheless, the potential application of the reforms are significant and may impact many small and medium sized enterprises – as well as the SGEs. We welcome the opportunity for broad consultation to ensure that the plan achieves its objectives in an appropriate and measured way.

Contributors

Jae Debrincat

The post How will multinationals “pay their fair share” under the new Government? appeared first on SW Accountants & Advisors.