The recent PepsiCo vs Commissioner of Taxation case is one of the most significant developments in Australian tax law in recent years. It addresses two critical issues, royalty withholding tax (RWHT) and Diverted Profits Tax (DPT), in the context of complex arrangements involving intellectual property (IP) and independent third-party bottling agreements.
The High Court’s decision provides valuable guidance for multinational businesses on how payments connected to the use of intangibles should be characterised and taxed in Australia.
Background of the PepsiCo Tax Case in Australia
The PepsiCo group runs a global beverage business. Several US-resident subsidiaries own key intellectual property (IP) for brands such as Pepsi, Mountain Dew, and Gatorade.
In 2009, PepsiCo updated its exclusive bottling agreements (EBAs) with an independent Australian bottler. These allowed the bottler to make, market, and distribute PepsiCo drinks in Australia, while separate agreements covered marketing and advertising. The bottler was not part of the PepsiCo group.
Under the EBAs:
- PepsiCo, or a related entity, supplied concentrate to the bottler, who mixed it with other ingredients to produce finished beverages for sale in Australia.
- PepsiCo granted the bottler rights to use its IP and packaging, with strict controls on how the IP could be used.
The bottler bought concentrate from PepsiCo Beverage Singapore (PBS). For the 2018 and 2019 years: PBS acquired concentrate from another PepsiCo entity, processed orders from the bottler, issued invoices, and shipped the concentrate for local production.
Two sets of proceedings followed:
- Under the Judiciary Act 1903 (Cth), PepsiCo sought a declaration that it was not liable for royalty withholding tax (RWHT).
- Under the Taxation Administration Act 1953 (Cth), it challenged Diverted Profits Tax (DPT) assessments.
On 30 November 2023, Justice Moshinsky found for the Commissioner on both issues. The Full Federal Court later ruled for the taxpayers, but the Commissioner appealed. The PepsiCo vs Commissioner of Taxation matter was heard in the High Court on 2–3 April 2025, raising important questions on use of intangibles and Australia’s DPT rules.
Key Issues Before the High Court
The PepsiCo vs Commissioner of Taxation appeal raised two main questions:
- Royalty Withholding Tax (RWHT):
- Whether the payments made by the Australian bottler under the EBAs were “royalties” under section 128B of the Income Tax Assessment Act 1936 (ITAA 1936).
- If so, whether those royalties were “derived” by PepsiCo, a non-resident, and therefore subject to RWHT.
- Diverted Profits Tax (DPT):
- Whether PepsiCo was liable for DPT under section 177P of the ITAA 1936, on the basis that the EBAs were primarily designed to avoid RWHT and reduce PepsiCo’s US tax obligations.
The case was heard by a full seven-judge panel of the High Court of Australia.
The High Court unanimously ruled in PepsiCo’s favour on the RWHT issue. While three justices found that the payments were royalties, all seven agreed that PepsiCo had not “derived” the income.
The DPT question was resolved by a narrow 4–3 majority, again in PepsiCo’s favour, concluding that the principal purpose of entering into the EBAs was not tax avoidance.
Royalty Withholding Tax (RWHT) Issue
Under Australia’s tax law, royalties paid to a US-resident are generally subject to a 5% withholding tax. In this case, the High Court focused on whether the payments made by the Australian bottler were “royalties” under section 6(1) of the ITAA 1936.
Were the bottler’s payments for IP use?
The Commissioner argued that part of the bottler’s payments to PepsiCo Beverage Singapore (PBS) were effectively for the right to use PepsiCo’s IP, since valuable IP could not have been licensed “for nothing.”
The High Court disagreed. It treated the exclusive bottling agreement (EBA) as an umbrella contract governing future dealings, where PepsiCo’s consideration for licensing IP included the bottler’s promise to build the PepsiCo brand in Australia, not monetary payments. Each invoice for concentrate was treated as a separate arm’s length sale between PBS and the bottler, with no royalty component.
Key takeaway: When agreements involve both tangible goods and intangible rights, it is crucial to identify precisely what each payment is for. Where IP rights and other property can be separated payments for goods may not be treated as royalties.
Did PepsiCo “derive” the income?
The Commissioner also argued that, even if PBS received the payments, they should be treated as income “derived” by PepsiCo.
The High Court rejected this. The bottler owed payment only to PBS, not PepsiCo. PepsiCo held no legal title to the concentrate, and no antecedent obligation existed between the bottler and PepsiCo. The payments simply discharged the bottler’s debt to PBS, an Australian tax-resident entity.
Key takeaway: The Court confirmed that PepsiCo did not derive the amounts paid to PBS, further supporting that RWHT did not apply. This finding is closely tied to PepsiCo’s unique facts, particularly the presence of an unrelated, arm’s length bottler and a separate Australian-resident seller.
Diverted Profits Tax (DPT) Issue
Australia’s Diverted Profits Tax (DPT), introduced in 2017, sits within the country’s General Anti-Avoidance Rules (Part IVA) and operates outside tax treaties. It was designed to:
- Ensure tax paid by significant global entities (SGEs) reflects their real economic activities in Australia.
- Prevent profits being shifted offshore through artificial arrangements.
- Encourage SGEs to provide sufficient information to the ATO to resolve disputes efficiently.
If the rules apply, tax is imposed at 40% on the diverted profit.
The PepsiCo tax case was the first judicial test of the DPT. For PepsiCo to be liable, two conditions needed to be met:
- Entry into the EBAs had to produce a DPT tax benefit: namely avoiding RWHT and reducing US tax liabilities.
- It had to be concluded, after considering statutory factors, that the EBAs were entered into for a principal purpose of gaining that benefit.
Competing views on “reasonable alternatives”
The Commissioner argued that a reasonable alternative arrangement could have been made, with minor wording changes to the EBAs, that would have treated bottler payments as including a royalty, resulting in more tax.
PepsiCo argued that no reasonable alternative existed. The EBAs reflected genuine commercial arrangements necessary to build the PepsiCo brand in Australia with an independent bottler, and the Commissioner’s alternatives did not reflect the real economic substance of the agreements.
The High Court agreed with PepsiCo in a 4–3 decision. The majority found the Commissioner’s alternatives would have created a fundamentally different deal, not a simple textual change. The licensing of IP was essential to achieving the commercial objectives, and the arrangement was not a contrived tax-avoidance scheme.
Three justices in the minority, however, considered there was scope to vary the EBAs and therefore saw a reasonable alternative that would have triggered DPT.
Key takeaway
The PepsiCo vs Commissioner of Taxation ruling confirms that for DPT to apply, any “reasonable alternative” must genuinely reflect the substance of the actual commercial arrangement. PepsiCo succeeded because its EBAs involved unrelated third parties acting at arm’s length, and the High Court accepted that “it is what it is”, there was no other realistic way to achieve the same commercial objectives.
However, the Court also signaled that this was an unusual case. Taxpayers, especially those with related-party arrangements, still bear the burden of proving that no reasonable, higher-tax alternative exists. Detailed, contemporaneous evidence of commercial and economic purpose remains essential to defend against DPT assessments.
Implications for the Use of Intangibles
Commissioner’s Guidance
In January 2024, the Commissioner released Draft Tax Ruling TR 2024/D1, outlining when payments under software arrangements may attract royalty withholding tax (RWHT). The ruling updates an earlier 2021 draft (TR 2021/D4).
Under the current position, if a payment covers “several things” with at least one being a right to use copyright or other IP, then the payment is treated as a royalty to some extent, requiring an apportionment.
Following the PepsiCo tax case, the High Court’s analysis of the words “consideration for” in the context of royalties may require the Commissioner to revisit this position. On 12 August 2025, the ATO confirmed it is reviewing the impact of the PepsiCo vs Commissioner of Taxation decision on TR 2024/D1.
Broader Industry Impact
The Court’s guidance on identifying royalties and testing for DPT liability may influence a wide range of sectors that deal with IP licensing including software, copyright, consumer products, and manufacturing.
However, because many arrangements involve related parties, transfer pricing principles are likely to play a central role in future disputes. As intangible property and other assets become increasingly intertwined, accurately characterizing payments will remain a complex but critical task for multinationals.
The PepsiCo tax case highlights how carefully structured commercial arrangements, even those involving valuable IP, can withstand scrutiny when they reflect genuine economic substance.
While the decision favoured PepsiCo, it also underscores that each arrangement must be analysed in its own commercial and legal context. For global businesses, this case is a timely reminder to review agreements involving IP, licensing, and cross-border payments to ensure they are properly documented, arm’s length, and capable of being defended under both RWHT and DPT frameworks.