The recent High Court of Australia decision in Commissioner of Taxation v PepsiCo Inc represents one of the most significant transfer pricing victories for multinational enterprises in recent years. This landmark case, which concluded in August 2025 with a narrow 4-3 majority decision favouring PepsiCo, provides crucial insights into how Australian courts will approach embedded royalties, transfer pricing documentation, and anti-avoidance measures.
Is the PepsiCo v ATO case a Transfer Pricing case?
The PepsiCo v Australian Taxation Office (ATO) case is considered a transfer pricing case, though with significant nuances, primarily because the underlying dispute revolved around applying the arm's length principle to determine if the payments by Schweppes Australia Pty Ltd (SAPL) to PepsiCo Beverage Singapore Pty Ltd (PBS) included an undeclared royalty.
While SAPL and PepsiCo group entities are unrelated parties, the core issue mirrors a typical transfer pricing dispute where tax authorities scrutinise how much a related-party transaction should have been priced to reflect a market-rate transaction. In this case, the ATO essentially applied transfer pricing logic to an arm's-length arrangement.
How the case relates to transfer pricing
- Arm's length principle at its core: The central argument from the ATO was that a portion of the payment for beverage concentrate should be reclassified as a royalty for using PepsiCo's valuable intellectual property (IP), such as trademarks and formulas. An arm's length transaction would have typically involved a separate royalty payment for the use of this IP.
- Use of transfer pricing methods: The Federal Court originally sided with the ATO, applying the Comparable Uncontrolled Price (CUP) method to determine the appropriate royalty rate. This is a standard transfer pricing methodology used to compare a transaction's price to comparable transactions between unrelated parties.
- Focus on substance over form: The ATO's position was a classic transfer pricing strategy of looking past the explicit contractual terms (which stated payments were for concentrate only) to examine the economic substance of the arrangement. They argued that the payments effectively included an "embedded royalty".
Why the case is distinct from a typical transfer pricing case
Despite the transfer pricing elements, the case had several distinct features that ultimately led the High Court to rule in favour of PepsiCo:
- Unrelated parties: A typical transfer pricing case involves transactions between legally related parties. The High Court, in contrast, emphasised that the PepsiCo-Schweppes arrangement was an arm's-length negotiation between large, unrelated commercial enterprises. The arm's length nature of the deal significantly influenced the majority's reasoning.
- Commercial and economic substance: The High Court majority found that the commercial and economic substance of the deal was exactly as the contracts stated: the price was for concentrate and nothing else. The ATO's alternative view - that a portion of the payment was an implicit royalty - was considered unreasonable.
- Reliance on general anti-avoidance rules: When its royalty withholding tax argument failed, the ATO's alternative position was based on Australia's general anti-avoidance rules, specifically the Diverted Profits Tax (DPT). This move highlights that the ATO was not solely relying on traditional transfer pricing provisions but was using broader anti-avoidance measures.
Case Background and Key Players
The dispute centred on exclusive bottling agreements (EBAs) between PepsiCo group entities and SAPL, covering the distribution of iconic brands including Pepsi, Mountain Dew, and Gatorade in Australia. SAPL and the PepsiCo group entities are unrelated parties. The arrangement involved PepsiCo Inc. as the US parent company, its subsidiary Stokely-Van Camp Inc. (also US-based), PBS as the regional hub, and SAPL as the Australian bottler and distributor.
The ATO challenged this arrangement, arguing that payments made by SAPL to PBS for beverage concentrate contained embedded royalties for the use of PepsiCo's valuable intellectual property, including trademarks, brand value, and manufacturing know-how.
The ATO challenged this arrangement, arguing that payments made by SAPL to PBS for beverage concentrate contained embedded royalties for the use of PepsiCo's valuable intellectual property, including trademarks, brand value, and manufacturing know-how.
The Journey Through Three Court Levels
The case's progression through Australia's court system demonstrates the complexity and contentiousness of modern transfer pricing disputes. The timeline reveals a fascinating evolution of judicial thinking on embedded royalties:
- 2009-2019: The Foundation Years
The original exclusive bottling agreements were signed in 2009, establishing the commercial framework that would later come under scrutiny. During the 2018 - 2019 assessment periods, the ATO began its examination of the arrangements, focusing on whether the payments reflected purely commercial transactions or contained hidden royalty components.
- November 2023: Federal Court Victory for ATO
Justice Moshinsky's first-instance decision marked a significant win for the ATO, finding that the payments did indeed contain embedded royalties. The court applied the Comparable Uncontrolled Price (CUP) method and determined a royalty rate of 5.88% of net revenue, representing approximately AUD 3.6 million in additional tax liability for the relevant periods.
- July 2024: Full Federal Court Reversal
In a unanimous decision, the Full Federal Court overturned the initial ruling, finding in favour of PepsiCo. Justices Perram, Colvin, and Jackman rejected the embedded royalty concept in this specific case, determining that the payments were solely for concentrate supply and did not constitute royalties subject to withholding tax.
- August 2025: High Court Confirmation
The High Court's 4-3 majority decision definitively resolved the dispute in PepsiCo's favour, dismissing the ATO's appeal and confirming that no embedded royalties existed in these arrangements.
Contrasting Legal Positions
The case highlighted fundamental disagreements about how to characterise cross-border payments involving intellectual property.
The ATO's position was built on several key arguments. They contended that the payments inherently included embedded royalties for IP use, applying the CUP method to establish a 5.88% royalty rate on net revenue. Their alternative argument invoked DPT provisions, suggesting the arrangements were primarily designed for tax avoidance purposes rather than legitimate commercial objectives.
PepsiCo's defense centred on commercial reality and contractual clarity. They argued that payments were exclusively for concentrate supply with no separate IP licensing arrangement. The pricing was arm's length and reflected legitimate business operations with clear commercial rationale, not tax avoidance schemes.
The ATO's position was built on several key arguments. They contended that the payments inherently included embedded royalties for IP use, applying the CUP method to establish a 5.88% royalty rate on net revenue. Their alternative argument invoked DPT provisions, suggesting the arrangements were primarily designed for tax avoidance purposes rather than legitimate commercial objectives.
PepsiCo's defense centred on commercial reality and contractual clarity. They argued that payments were exclusively for concentrate supply with no separate IP licensing arrangement. The pricing was arm's length and reflected legitimate business operations with clear commercial rationale, not tax avoidance schemes.
The Corporate Structure and Transaction Analysis
Understanding the corporate structure was crucial to the case outcome. PepsiCo Inc., as the US parent, owned the valuable intellectual property rights. Through its subsidiary structure, including the Singapore-based PBS entity, concentrate was supplied to SAPL under commercial terms. The key question was whether these payments implicitly included consideration for trademark usage and brand value, or whether they represented pure product supply transactions.
The courts ultimately concluded that the contractual arrangements clearly characterised the payments as being for goods rather than intellectual property rights. Importantly, the Commissioner had not argued that the concentrate prices were inflated to hide secret royalty payments, which strengthened PepsiCo's position.
Understanding the corporate structure was crucial to the case outcome. PepsiCo Inc., as the US parent, owned the valuable intellectual property rights. Through its subsidiary structure, including the Singapore-based PBS entity, concentrate was supplied to SAPL under commercial terms. The key question was whether these payments implicitly included consideration for trademark usage and brand value, or whether they represented pure product supply transactions.
The courts ultimately concluded that the contractual arrangements clearly characterised the payments as being for goods rather than intellectual property rights. Importantly, the Commissioner had not argued that the concentrate prices were inflated to hide secret royalty payments, which strengthened PepsiCo's position.
The courts ultimately concluded that the contractual arrangements clearly characterised the payments as being for goods rather than intellectual property rights. Importantly, the Commissioner had not argued that the concentrate prices were inflated to hide secret royalty payments, which strengthened PepsiCo's position.
Understanding the corporate structure was crucial to the case outcome. PepsiCo Inc., as the US parent, owned the valuable intellectual property rights. Through its subsidiary structure, including the Singapore-based PBS entity, concentrate was supplied to SAPL under commercial terms. The key question was whether these payments implicitly included consideration for trademark usage and brand value, or whether they represented pure product supply transactions.
The courts ultimately concluded that the contractual arrangements clearly characterised the payments as being for goods rather than intellectual property rights. Importantly, the Commissioner had not argued that the concentrate prices were inflated to hide secret royalty payments, which strengthened PepsiCo's position.
Critical Takeaways for Transfer Pricing Practice
- Contractual Clarity Remains Paramount: The decision emphasises the critical importance of clear contractual terms that explicitly separate payments for goods from intellectual property usage. Practitioners should ensure that agreements definitively state what each payment covers to avoid recharacterisation risks.
- Commercial Substance Over Form: Courts will examine the true commercial rationale behind international structures. Companies must maintain robust documentation of non-tax business reasons for their arrangements, ensuring that actual operations align with contractual agreements and transfer pricing policies.
- Transfer Pricing Documentation Standards: The case reinforces the need for sophisticated transfer pricing documentation supported by appropriate methodologies. While the ATO's application of the CUP method was ultimately unsuccessful, the approach demonstrates the importance of having defensible transfer pricing policies backed by comparable data and expert analysis.
- Embedded Royalties Remain a Live Issue: Despite PepsiCo's victory, the concept of embedded royalties has not been eliminated. The decision is highly fact-specific, and the narrow 4-3 High Court split indicates this remains contentious territory. Similar arrangements with different facts could yield different outcomes.
Future Enforcement Outlook
The ATO's response to this defeat will likely shape future enforcement strategies. Despite the loss, tax authorities retain significant resources and political mandate to pursue multinational tax compliance. The decision may prompt more aggressive early intervention and more sophisticated arguments in future cases.
Multinational enterprises should expect continued scrutiny of cross-border arrangements involving intellectual property. The ATO will likely focus on arrangements with weaker documentation, less clear commercial rationale, or more obvious tax-motivated structures.
Multinational enterprises should expect continued scrutiny of cross-border arrangements involving intellectual property. The ATO will likely focus on arrangements with weaker documentation, less clear commercial rationale, or more obvious tax-motivated structures.
Note: The views and opinions expressed in this article are those of BDO and do not necessarily reflect the official policy or position of any other organisation, company, or individual.