Intercompany transactions, agreements under ‘heightened scrutiny’, companies warned
Recent court cases highlight the ATO’s focus on Australian businesses performing distribution activities on behalf of offshore affiliates, warns Grant Thornton.
A decision handed down by the Federal Court in late November concerning PepsiCo, Inc. v Commissioner of Taxation demonstrates the ATO’s targeted focus on multinational tax avoidance and in particular, the setup of corporate arrangements to avoid withholding tax payments, says accounting firm Grant Thornton.
PepsiCo has now filed a notice of appeal to the Full Federal Court in relation to the decision in which the Court found that PepsiCo was liable for royalty withholding tax and, in the alternative, diverted profits tax would apply.
In a statement issued shortly after the judgement, the ATO noted this was the first time a Court had considered the diverted profits tax – a new tool to ensure multinationals pay the right amount of tax.
Justice Mohinsky found that a component of the payments ‘taken to be’ received by PepsiCo and its subsidiary Stokely-Van Camp (SVC) in the US from Schweppes Australia Pty Ltd (SAPL) for concentrate should have been characterised as royalties, Grant Thornton explained.
“The US entities were therefore found to owe the Australian Taxation Office (ATO) approximately AUD 3.6m in royalty withholding tax for the 2018 and 2019 financial years. If the royalty withholding tax provisions were deemed not to apply, the Court found that the Diverted Profits Tax (DPT) provisions would have applied in the alternate,” Grant Thornton’s tax and transfer specialists explained in a recent article.
“In what was the first DPT case in Australia since its introduction in 2017, this outcome would have resulted in PepsiCo owing the ATO approximately 28.9 million in DPT for the 2018 and 2019 financial years.”
In this particular case, PepsiCo. Inc as the brand owner for carbonated soft drinks such as Pepsi and Mountain Dew, and SVC as the brand owner for non-carbonated soft drinks such as Gatorade, entered into Exclusive Bottling Agreements with SAPL, an Australian third party.
“The EBAs enabled SAPL to manufacture finished beverages by mixing concentrate with other ingredients using confidential formulas and specifications provided by PepsiCo Group. In addition, the EBAs authorised SAPL to bottle and package the beverages in PepsiCo-branded packaging prior to sale,” said Grant Thornton.
“The concentrate needed by SAPL to perform its manufacturing activities was produced by Concentrate Manufacturing (Singapore) Pty Ltd (CMPL) in Singapore. The concentrate was sold by CMPL to a nominated seller, namely PepsiCo Beverage Singapore Pty Ltd (PBS) in Australia, who on-sold the concentrate to SAPL. Over the course of 2018 and 2019, SAPL made AUD $240 million in payments to PBS for the concentrate, which PBS returned to CMPL, after retaining a small margin.”
Under the terms of the EBAs, the pricing for the concentrate was explicit but the rights to use trademarks were implied or expressly described as ‘royalty-free’ and no price was attached to the use of these rights.
The Court agreed with the Commissioner’s argument that royalties were ‘embedded’ within the payments made by SAPL for the concentrate, as SAPL would not have been able to manufacture, package, and sell the beverages without consideration for the use of, or the right to use, the relevant trademarks and other intellectual property.
“It was considered inconceivable that PepsiCo was willing to license its brand to a third party for no compensation, particularly given the global strength of its brand which increased its value. This contention was supported by evidence that similar agreements for the sale of PepsiCo concentrate involved a licence of the brand,” explained Grant Thornton.
Grant Thornton said despite payments being made from SAPL to PBS, the Court found that the payments were income ‘derived by’ and deemed to have been ‘paid to’ PepsiCo and SVC.
“Similarly, it was also concluded that PepsiCo and SVC were ‘beneficially entitled’ to those amounts. This was on the basis that PepsiCo and SVC were the parties to the respective EBAs and were entitled to receive payment for the concentrate,” it said.
It was concluded by the Court that the nomination of PBS as a seller merely constituted a direction of payment for SAPL to pay PBS rather than PepsiCo and SVC.
“The Court contended that, had the royalty withholding tax provisions not applied, the diverted profits tax provisions would have instead been relevant as PepsiCo and SVC contrived the arrangement in question to obtain a tax benefit, and one of the principal purposes for entering into the scheme was to obtain a tax benefit,” Grant Thornton said.
With the ATO now involved in a similar dispute with The Coca-Cola Company and Coca-Cola Amatil, its Australian subsidiary after issuing The Coca-Cola Company with a $173.8m penalty notice for 2018 and 2019, Grant Thornton said companies should be aware the ATO is increasing its activities in this area.
In the case involving The Coca-Cola Company and Coca-Cola Amatil, Grant Thornton said the ATO claimed that Coca-Cola Amatil did not pay The Coca-Cola Company for the use of IP, thereby avoiding royalty withholding tax liabilities resulting in diverted profit benefits, the accounting firm said.
“Both PepsiCo and the ongoing Coca-Cola dispute illustrate that while the legal form of an intercompany agreement is important, the ATO and Federal Court in the case of PepsiCo, will look beyond the terms to the commercial substance of the arrangements in determining whether a royalty exists,” it said.
“Australian taxpayers with distribution arrangements should expect heightened scrutiny on embedded royalties arising from IP exploitation. In addition, certain taxpayers may be open to significant exposure given there is no statutory limitation period for Australian withholding tax or the DPT.”
Grant Thornton said companies performing distribution activities should be mindful of the outcomes of these disputes and consider how the ATO’s guidance regarding embedded royalties in Taxpayer Alert TA 2018/2, may apply to their existing arrangements.
It also said companies should conduct a review of intercompany transactions and associated legal agreements, to consider whether there are express or implied rights to use IP and if the legal and economic substance of the transactions align.
