PepsiCo — High Court dismisses Commissioner's appeals on embedded royalties and Diverted Profits Tax

The High Court of Australia has dismissed the Tax Commissioner’s (“the Commissioner”) appeals in FCT v PepsiCo, Inc [2025] HCA 30¹ (“PepsiCo”).

It was ruled that payments made by Schweppes Australia Pty Ltd to PepsiCo’s Australian subsidiary, PepsiCo Beverage Singapore Pty Ltd for concentrate did not constitute royalties, and that PepsiCo and Stokely‑Van Camp were not liable for royalty withholding tax or diverted profits tax for the 2018 and 2019 income years.

At a glance

• The High Court dismissed (with costs) all six appeals by the Commissioner against the Full Federal Court decision.
• The majority (4–3) held that payments by PepsiCo, Inc’s bottler Schweppes Australia Pty Ltd to PepsiCo Beverage Singapore Pty Ltd for concentrate did not include a royalty under s 6(1) ITAA 1936; they were consideration for goods only.
• The High Court held unanimously that even if a royalty existed, it was not “paid or credited to” nor “derived by” PepsiCo, Inc or Stokely Van Camp, Inc under s 128B(2B), and as such no royalty withholding liability would apply.
• On Diverted Profits Tax (DPT), the majority (4-3) concluded that the Commissioner failed to establish a reasonable alternative postulate by which PepsiCo, Inc or Stokely Van Camp would, or might reasonably be expected to, have been liable to royalty withholding tax.

Why this matters?

• Contract architecture governs characterisation: This judgment reinforces that contractual architecture and actual cash‑flow mechanics govern tax characterisation. Where a supply of goods co‑exists with an intellectual‑property licence in an integrated distribution model, courts will test whether the price for goods truly functions as consideration for goods alone, and whether the licence is supported by other reciprocal obligations rather than a hidden or “embedded” royalty. If documentation, invoicing, title and risk all align with goods‑only consideration, a re‑characterisation into a royalty becomes far harder to sustain. 
  
  
• Royalty Withholding Tax requires a nexus: The decision clarifies the withholding‑tax nexus: even if a royalty might be argued in principle, liability under s 128B(2B) requires that the amount be paid or credited to, or derived by, the non‑resident. Interposing a resident seller that alone invoices and receives payment can break that nexus where there is no antecedent debt owed to the foreign IP owner and no agency or trust. 
  
  
• DPT is not a ‘backup plan’: The case shows that DPT is not a catch‑all. The Commissioner must anchor any counterfactual in a reasonable alternative consistent with the transaction’s commercial substance. Where the taxpayer evidences an arm’s‑length industry model, the DPT “tax benefit” limb may fail at the first step.
  
  
• TR 2024/D1: The ATO has indicated that following the High Court’s decision in the PepsiCo appeal, it will review and, if necessary, update its draft ruling on royalties and software/IP arrangements TR 2024/D1. Businesses should expect continued scrutiny of “embedded royalty” theories, but the Court has now set high thresholds for both the royalty withholding tax nexus and the DPT counterfactual. Proactively preparing and maintaining contemporaneous evidence will be essential to managing risk.

Practical takeaways for taxpayers

• Review existing agreements and supporting documentation to ensure the consideration split is explicit: Make clear what is paid for goods/services versus any IP licence, and, where a royalty‑free licence is intended, state this expressly and tie non‑monetary obligations (brand‑building, quality, exclusivity, compliance) to the licence rather than the unit price.
  
  
• Trace and reconcile end‑to‑end cash flows with legal form: Confirm who sells, invoices, holds title/risk and is paid, and keep records showing the money flow matches the contracting parties. If no royalty withholding tax outcome is intended, ensure there is no antecedent monetary obligation to the foreign IP owner and maintain arm’s‑length pricing evidence for the goods/services.
  
  
• Arm’s length pricing still matters: While the Court did not reprice concentrate here, evidence that the goods price is arm’s length and not disproportionate helped defeat the embedded royalty thesis.

Please contact your Grant Thornton tax or transfer pricing advisor if you wish to discuss this matter further.

¹ FCT v PepsiCo, Inc [2025] HCA 30 

Article contributed to by Lachlan Mackey - Transfer Pricing

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