Australia: Judgment on embedded royalties and application of DPT publicly released (Federal Court decision)

Taxpayer was liable for withholding tax on embedded royalties

Taxpayer was liable for withholding tax on embedded royalties

The Federal Court on 6 December 2023 publicly released its judgment in PepsiCo, Inc v. Commissioner in which it held that the taxpayer was liable for withholding tax on embedded royalties and opined that if the taxpayer were not liable for royalty withholding tax, the diverted profits tax (DPT) would apply. Read TaxNewsFlash

Key points from the judgment include:

  • In characterizing payments made under an agreement, the terms of the agreement must be considered in “their business and commercial context.” To that end, the manner in which payments are described by the parties to a transaction is not determinative of whether they are consideration for the relevant items. Payments may be consideration for the use of, or right to use, trademarks and other intellectual property (IP), even if the payments are not labelled a “royalty,” or when the contract describes the use of relevant intangible assets as “royalty-free.”
  • Courts may aggregate transactions involving multiple parties and agreements in considering the character of a payment and whether an entity may be “beneficially entitled” to an amount of income or have received an amount of income because of a direction to pay another entity.
  • The perceived value of a brand (which may be a subjective assessment) may impact the characterization of an arrangement. In addition, a valuation methodology may rely on comparable license agreements, even if it does not strictly constitute a transfer pricing comparable uncontrolled price (CUP) method.
  • The quantification of an embedded royalty may ultimately turn on the evidence of experts. 



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