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While PepsiCo ultimately succeeded, the ATO has made it clear that the decision does not materially change its approach to embedded royalties, intellectual property (IP) arrangements or diverted profits tax (DPT).
On 19 March 2026, the ATO issued its Decision Impact Statement on the PepsiCo judgement.
From the ATO’s perspective, the key takeaways are that:
Ultimately, the ATO will continue to:
Further, the ATO expressed its view that the facts of the PepsiCo case are unique, and the precedential implications of the judgment are limited for taxpayers.
To place the ATO’s Decision Impact Statement in context, the key procedural milestones in the PepsiCo case are set out below:
The High Court majority characterised the relevant payments as ‘consideration’ for concentrate alone, meaning that no royalty existed and royalty withholding tax did not apply.
In reaching this position, the majority referenced stamp duty cases and adopted a broad approach to determining the meaning of the words ‘consideration for’ in the definition of ‘royalty’ in section 6(1) of the Income Tax Assessment Act 1936 (Cth).
In this context, the word ‘consideration’ refers to the ‘moving’ or ‘material cause’ for a payment – a meaning broader than the concept of consideration in contract law.
The ATO also highlights that the High Court did not endorse any ‘central bargain’ or ‘central transaction’ test for royalty characterisation.
The ATO noted that a royalty may be found to exist, irrespective of the label attached to it by the parties to the arrangement. Parties calling an amount a payment for goods or services as ‘royalty-free’ was not sufficient to confirm the characterisation of that payment.
The ATO stresses the importance of correctly identifying the ‘agreement’ that is to be analysed, which may comprise of multiple documents.
Following the Court’s endorsement that the relevant arrangement can extend beyond a single contract, the ATO has stated that it will continue to look beyond a single contract or ‘agreement’ to understand the nature of the arrangement between parties where there is an IP dealing.
This may include inspecting internal documents, details of negotiations which formed the basis of the contracts, and multiple contracts where these exist to determine the broader context of the arrangements.
In addition to the above, the ATO confirmed its view that even where rights to use IP have been ‘embedded’ into amounts marked as consideration for something that is not IP (such as a good or a service), a royalty could be found. The ATO commented that it would “continue to monitor the arrangements of related parties closely”.
This will include the ATO seeking evidence on the arm’s length values of IP rights supplied under an agreement, as well as other properties that have been exchanged. The ATO states that in future cases, it will seek to understand and test the economic fundamentals of arrangements that involve the provision of IP with no royalty.
The High Court found there was no antecedent obligation for payments to be made to PepsiCo. This meant that even if the payments contained a royalty component, no constructive payment was made to PepsiCo for the use of IP.
As the High Court’s conclusions appear to depend entirely on the precise structure, flow, and character of the payments in PepsiCo’s particular distribution arrangements, the ATO made it clear that their view is the precedential effect of PepsiCo is limited and different payment structures may give rise to royalties or DPT. The ATO goes on to state that they would seek to ‘understand the commercial context and rationale for the arrangement’ where this scenario was to occur again.
On appeal, the absence of a royalty was one factor in the Commissioner’s DPT position failing. The Commissioner was also unable to establish the ‘tax benefit’ or ‘insufficient economic substance’ tests.
However, the ATO has stated that the DPT outcome was ultimately based on “critical facts, unique to these appeals”. These unique facts included:
On this basis, the ATO has warned taxpayers that they believe the PepsiCo judgment has limited implications for the application of DPT or the general anti-avoidance provisions in other cases.
While PepsiCo succeeded after a two-year legal battle, the ATO has come out strong in its view that the facts of the case were unique, and the general implications of the judgement are therefore limited for other taxpayers. Further, the ATO has reaffirmed its interest in the proper characterisation of payments involving IP and embedded royalties, especially arrangements between related parties.
Taxpayers should therefore re-examine their IP arrangements holistically and document the commercial rationale and substance of such arrangements, so there is sufficient evidence to support the characterisation or nature of intercompany payments involving the rights to use IP.
The ATO expressed in the Decision Impact Statement that they are also currently reviewing the broader impact of the decision on Law Administration Practice Statement PS LA 2005/24 Application of General Anti-Avoidance Rules, and Draft Taxation Ruling TR 2024/D1 Income tax: royalties – character of payments in respect of software and intellectual property rights. There is no further guidance on when those documents will be updated and finalised, which remains a source of uncertainty for taxpayers.
If you’d like to discuss how the High Court’s dismissal of the Commissioner’s appeals in the PepsiCo case and the ATO’s Decision Impact Statement may affect your business, please reach out to our team of specialists today.
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