Pleadings in PepsiCo filed in the High Court
Both parties have now filed their primary pleadings in the High Court
The story so far
Last Thursday PepsiCo filed its pleadings in response in the High Court appeal. We are expecting a hearing in the first half of the calendar year, with a judgement following fairly quickly. That ATO has said that the draft software royalty ruling, TR2024/D1 will only be finalised after the judgement is issued.
Both parties have now filed submissions which outline their case. The Commissioner has appealed, having lost in the Full Federal Court with two judges out of three finding in PepsiCo’s favour. That the amounts paid for concentrate did not include a royalty and
that Australia’s DPT rules did not “deem” part of the payment to be a royalty.
The Commissioners pleadings
On appeal the parties essentially continue to press the key arguments they ran in the Federal Court.
The Commissioner focusses on the State stamp duty cases, which examine the nature of “consideration”. And says that they mean that the totality of the dealings between all of the parties result in the payment for concentrate including an amount for use, by the bottler/distributor of intellectual property rights. This is so even though the rights are from another party and are expressed to be “royalty free” or for no explicit consideration. He says “consideration” should be given a very wide meaning.
The State duty decisions (which are also High Court decisions) are looking at “consideration” from quite a different perspective, however.
In those, the property being transferred under a contract was clear, but the consideration under the agreement was ambiguous. The court included in consideration the value of all the promises made under the agreement (Lend Lease), matters expressly described as consideration on proper reading of the contract (Dick Smith, Davis) together with anything else which on all the facts should be considered consideration (Archibald Howie).
In PepsiCo the EBA agreement (bottling agreement) is clear on both the property (concentrate) and the consideration. The existence of a separate agreement providing access to IP rights is mentioned but does not expressly form part of the concentrate transaction. The Commissioner, however, says this mention is enough to bring it under analysis.
In relation to DPT, the Commissioner reiterates that the tax scheme was the failure to specifically provide for a royalty in the parties dealings. He says that this could have been done by simply including a royalty clause in the purchase of concentrate agreement, or by reducing the concentrate price and separately paying a royalty to the US. He says that the failure to provide any consideration for trade mark use is not commercial.
Taxpayers now have a clear picture of the Commissioner’s approach across all three courts. The High Court decision in this matter will still be significantly dependent on the facts. Whatever is decided it
will not provide a perfect precedent for other taxpayers.
It is possible, however, to review existing arrangements and determine the likelihood of a dispute. It is also possible to identify whether the issues before the High Court might lead to clarification of the treatment of any aspects of your existing arrangements.
This is especially likely to be the case for arrangements where intangibles such as trade marks are used by an Australian distribution subsidiary “royalty free”.
The taxpayer’s pleadings
The taxpayer sets out a case which argues that the nature of the rights to use IP given to the distributor are severely controlled in such a way that significant benefits accrue to the licensor (through processes which ensure the value of any increase in goodwill accrues to the licensor). And that this amounts to sufficient “consideration”, so that it is wrong to say there was no consideration for their use. In addition, the “head agreement” should be read as providing that the consideration included the non-monetary promise to buy concentrate from a nominated seller. No part of the concentrate price itself should be allocated to these rights.
It is interesting that the taxpayer does not appear to have specifically led evidence at the first instance about the actual costs of the concentrate and profitability of the seller (as proof no part was attributable to IP), or that it is common for distributors to receive royalty free IP use in arm’s length cases, or that the terms around use of IP ensure all economic value accruing to the licensor is sufficient consideration.
The second issue necessary for a withholding tax liability is the question of whether the part of the price said to be a royalty was “derived” by the licensors. It was decided in the taxpayer’s favour by the full court. No amount was directly paid by the licensee to the licensors. The commissioner continues to argue that only the licensors were entitled to sue for all the amounts under the arrangements and therefore if an amount was a royalty, it was their entitlement.
On DPT the Full Federal Court found that the Commissioner’s “alternate postulate” that, but for the scheme to avoid a royalty the agreements would have specified a royalty, was not successful.
For several reasons, including that the taxpayer persuaded them that the “alternate postulate” proposed by the Commissioner was simply not reasonable. This continues to be the focus of the pleadings in the High Court. The Commissioner says that his alternate postulate (a clause in the agreement would have to be amended to split the price, or a separate royalty agreement would have been executed) is simple and reasonable on the facts. The taxpayer points to a long- established principle that our avoidance rules are focussed on “contrived” arrangements and that a taxpayer should not be forced into a minor but artificial change. Particularly when the reality of that change is that in fact there would be significant other commercial changes required. For instance, if the agreed price was partly allocated to royalty, there would be consequential considerations such as changes to the profitability of the seller of the concentrate.
Whatever the decision of the court, the Commissioner is likely to continue to pursue these issues.
In another recent matter, his staff gave evidence that there are a significant number of cross border cases with “royalty” disputes of various sorts.