PepsiCo, Inc v Commissioner of Taxation
[2024] FCAFC 86
•26 June 2024
FEDERAL COURT OF AUSTRALIA
PepsiCo, Inc v Commissioner of Taxation [2024] FCAFC 86
Appeal from: PepsiCo, Inc v Commissioner of Taxation [2023] FCA 1490 File numbers: VID 27 of 2024
VID 28 of 2024
VID 74 of 2024
VID 75 of 2024
VID 76 of 2024
VID 77 of 2024Judgment of: PERRAM, COLVIN AND JACKMAN JJ Date of judgment: 26 June 2024 Catchwords: TAXATION – royalty withholding tax – where non-resident taxpayers entered into exclusive bottling agreements (‘EBAs’) with an Australian company (‘Bottler’) for the bottling and sale of beverages in Australia – where EBAs provided for sale of concentrate by the taxpayers or their nominated seller to the Bottler – where EBAs included a licence of the taxpayers’ trademarks and other intellectual property but did not provide for a royalty – whether the taxpayers were liable to pay royalty withholding tax on part of the payments made by the Bottler under the EBAs – whether payments made by the Bottler were consideration for the right to use intellectual property – consideration of Davis Investments Pty Ltd v Commissioner of Stamp Duties (NSW) (1958) 100 CLR 392, Chief Commissioner of State Revenue (NSW) v Dick Smith Electronics Holdings Pty Ltd [2005] HCA 3; 221 CLR 496 and Commissioner of State Revenue (Vic) v Lend Lease Development Pty Ltd [2014] HCA 51; 254 CLR 142 – whether payments made by the Bottler were income derived by the taxpayers
TAXATION – diverted profits tax – consideration of s 177J of Income Tax Assessment Act 1936 (Cth) – whether the taxpayers obtained a tax benefit in connection with a scheme – commercial and economic substance of the scheme and alternative postulates – results or consequences for the taxpayers of the scheme and alternative postulates – whether such postulates were reasonable alternatives to the scheme – whether the taxpayers entered into or carried out the scheme for a principal purpose of obtaining a tax benefit and reducing foreign tax liabilities
Legislation: Acts Interpretation Act 1901 (Cth) ss 15AB(1)(b)(i), 15AB(2)(e)
Diverted Profits Tax Act 2017 (Cth)
Income Tax Assessment Act 1936 (Cth) ss 6(1), 26(f) (repealed), 128B(2B), 177C(1)(a), 177C(1)(bc), 177C(1)(g), 177CB(1)(e), 177CB(3), 177CB(4)(a)(i), 177CB(4)(a)(ii), 177CB(4)(b), 177CB(5), 177D(1)(b), 177D(2), 177J(1)(a), 177J(1)(b)(i), 177J(2)(a), 177J(2)(b), 177J(2)(c), 177J(2)(d), 177N(a), 177P(1)(a), 177P(2)(a), 255(1), 256 (repealed)
Income Tax Assessment Act 1997 (Cth) Div 815
International Taxation Agreements Act 1953 (Cth) s 17A(1)
Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act 2013 (Cth)
Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013 (Cth)
Taxation Administration Act 1953 (Cth) s 14ZZO(b)(i), Part IVC
Taxation Laws Amendment Act (No 5) 1992 (Cth)
Trade Marks Act 1995 (Cth) ss 8, 20, 58, 88(2)(a), 92, 122(1)(e)
Treasury Laws Amendment (Combating Multinational Tax Avoidance) Act 2017 (Cth)
Cases cited: ABB Australia Pty Ltd v Federal Commissioner of Taxation [2007] FCA 1063; 162 FCR 189
Archibald Howie Pty Ltd v Commissioner of Stamp Duties (NSW) (1948) 77 CLR 143
Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation (1965) 114 CLR 314
Chevron Australia Holdings Pty Ltd v Commissioner of Taxation [2017] FCAFC 62; 251 FCR 40
Chief Commissioner of State Revenue (NSW) v Dick Smith Electronics Holdings Pty Ltd [2005] HCA 3; 221 CLR 496
Commissioner of State Revenue (Vic) v Lend Lease Development Pty Ltd [2014] HCA 51; 254 CLR 142
Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3; 115 ATR 316
Commissioner of Taxation v Hart [2004] HCA 26; 217 CLR 216
Commissioner of Taxation v Peabody (1994) 181 CLR 359
Commissioner of Taxation v Sleight [2004] FCAFC 94; 136 FCR 211
Commissioner of Taxation v SNF (Australia) Pty Ltd [2011] FCAFC 74; 193 FCR 149
Commissioner of Taxes (SA) v The Executor Trustee and Agency Company of South Australia Limited (1938) 63 CLR 108
Davis Investments Pty Ltd v Commissioner of Stamp Duties (NSW) (1958) 100 CLR 392
Dunn v Shapowloff (1978) 2 NSWLR 235
Electricity Generation Corporation v Woodside Energy Ltd [2014] HCA 7; 251 CLR 640
Freedom Foods Pty Ltd v Blue Diamond Growers [2021] FCAFC 86; 286 FCR 437
International Business Machines Corporation v Commissioner of Taxation [2011] FCA 335; 91 IPR 120
Minerva Financial Group Pty Ltd v Commissioner of Taxation [2024] FCAFC 28
Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd [2015] HCA 37; (2015) 256 CLR 104
PepsiCo v Commissioner of Taxation [2023] FCA 1490
Project Blue Sky Inc v Australian Broadcasting Authority [1998] HCA 28; 194 CLR 355
RCI Pty Ltd v Commissioner of Taxation [2011] FCAFC 104; 84 ATR 785
Roufeil as Trustee for the Bankrupt Estate of Tarrant v Tarrant Enterprises Pty Ltd as Trustee for the MRT Family Trust [2023] FCAFC 142; 299 FCR 204
Goode RM, Payment Obligations in Commercial and Financial Transactions (Sweet & Maxwell, 1983)
Division: General Division Registry: Victoria National Practice Area: Taxation Number of paragraphs: 220 Date of hearing: 8-10 May 2024 VID 27 of 2024 and VID 28 of 2024: Counsel for the Appellants: Mr EF Wheelahan KC with Ms CM Pierce Solicitor for the Appellants: PricewaterhouseCoopers Counsel for the Respondents: Ms K Deards SC with Ms T Phillips and Mr D Lewis Solicitor for the Respondents: MinterEllison VID 74 of 2024, VID 75 of 2024, VID 76 of 2024 and VID 77 of 2024: Counsel for the Appellants: Ms K Deards SC with Ms T Phillips and Mr D Lewis Solicitor for the Appellants: MinterEllison Counsel for the Respondents: Mr EF Wheelahan KC with Ms CM Pierce Solicitor for the Respondents: PricewaterhouseCoopers ORDERS
VID 27 of 2024 BETWEEN: PEPSICO, INC
Appellant
AND: COMMISSIONER OF TAXATION
Respondent
VID 28 of 2024 BETWEEN: STOKELY-VAN CAMP, INC
Appellant
AND: COMMISSIONER OF TAXATION
Respondent
VID 74 of 2024
VID 75 of 2024BETWEEN: COMMISSIONER OF TAXATION
Appellant
AND: PEPSICO, INC
Respondent
VID 76 of 2024
VID 77 of 2024BETWEEN: COMMISSIONER OF TAXATION
Appellant
AND: STOKELY-VAN CAMP, INC
Respondent
ORDER MADE BY:
PERRAM, COLVIN AND JACKMAN JJ
DATE OF ORDER:
26 JUNE 2024
THE COURT ORDERS THAT:
1.The parties provide a short minute of order to give effect to these reasons within 14 days.
Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.
REASONS FOR JUDGMENT
PERRAM AND JACKMAN JJ:
INTRODUCTION
The questions in these appeals are whether PepsiCo, Inc (‘PepsiCo’) and Stokely-Van Camp, Inc (‘SVC’) (together ‘PepsiCo/SVC’) are liable to pay royalty withholding tax under s 128B(2B) of the Income Tax Assessment Act 1936 (Cth) (‘ITAA 1936’) and, if they are not, whether they are instead liable to pay diverted profits tax under s 177J of Part IVA of that Act. Section 177J was inserted into Part IVA by the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Act 2017 (Cth) and this litigation is the first occasion on which its operation has been considered. The detail of the facts and the relevant provisions are comprehensively set out in the reasons of the trial judge: PepsiCo v Commissioner of Taxation [2023] FCA 1490 (‘TJ’).
In broad outline, Schweppes Australia Pty Ltd was the sole distributor and bottler in Australia of the famous beverages Pepsi, Mountain Dew and Gatorade in the relevant income years ending 30 June 2018 and 30 June 2019. It is convenient to refer to Schweppes as the Bottler. It purchased concentrate to make the beverages from PepsiCo Bottling Singapore Pty Ltd (‘the Seller’) under a series of purchase orders totalling around $240 million. The Seller was an Australian company although it maintained its offices at the Alfa Centre in Singapore. It was the Seller’s responsibility to deliver the concentrate to the Bottler’s plant in Western Sydney. The invoices issued by the Seller were, on their face, calculated by reference to specified rates for concentrate although they were broken down into the several different components which together comprised the concentrate (such as syrups and acidulants). In addition to those charges, the Bottler agreed to pay the freight, insurance and handling charges the Seller incurred in supplying the Bottler with the concentrate and it also agreed to be responsible for any customs duties or goods and services tax the Seller became liable to on the importation and supply of the concentrate (PepsiCo EBA cl 4(c) / SVC EBA cll 7.2(b), 7.3(b) and 14). The Bottler paid the amounts invoiced by the Seller into the Seller’s bank account.
The Seller is a member of the PepsiCo group of companies, the ultimate parent of which is PepsiCo. The rates charged by the Seller to the Bottler were, however, not fixed purely by arrangement between them. Rather, the rates were dictated by other contractual arrangements the Bottler had with PepsiCo. The payments made by the Bottler to the Seller for the Pepsi and Mountain Dew concentrates were contemplated to be made under an exclusive bottling agreement between, inter alia, PepsiCo and the Bottler (‘PepsiCo EBA’). On the other hand, the payments made by the Bottler to the Seller for the Gatorade concentrate were made under a separate exclusive bottling agreement between SVC and the Bottler (‘SVC EBA’). Like the Seller, SVC is a member of the PepsiCo group. Gatorade was dealt with under this separate EBA for reasons which are historical and which reflect the acquisition by PepsiCo of the SVC group of companies at an earlier juncture. Both EBAs were dated 3 April 2009. PepsiCo and SVC are resident in the United States of America.
The EBAs determined the price at which the concentrates were to be purchased. They left some flexibility as to the identity of the party which would eventually sell the concentrates to the Bottler by permitting, but not requiring, the nomination of an entity within the PepsiCo group as the seller (PepsiCo EBA cl 4(a) / SVC EBA cll 7.1(a) and 7.3(a)). The EBAs also included a grant by PepsiCo/SVC to the Bottler of the right to use the trade marks and other intellectual property associated with each beverage such as bottle and can designs. In the case of the PepsiCo EBA, it is uncontroversial that this licence was implied by law because the EBA bound the Bottler to distribute the beverages it made from the concentrates as Pepsi and Mountain Dew (cl 3(a)). In the case of the SVC EBA, however, a licence was granted in express terms (cl 4.1).
Neither EBA made any provision for the payment by the Bottler of a royalty for its use of the trade marks. Further, as already noted, whilst both EBAs contemplated that PepsiCo/SVC might themselves supply the Bottler with the relevant concentrates each also entitled them to appoint some other related entity to do so. This right was exercised by PepsiCo/SVC early in the life of the EBAs when they appointed another member of the PepsiCo group to be the seller of the concentrate. This company was Pepsi-Cola International, Cork, a company incorporated in Ireland. At the end of 2015 PepsiCo and SVC again exercised this right by replacing the Irish company with the current Singapore-based Seller. Thereafter, the Seller sold the concentrates to the Bottler in return for which the Bottler transferred sums of money to the Seller in apparent payment of invoices issued by it. The invoiced amounts were consistent with PepsiCo/SVC’s obligations under the EBAs to sell the concentrates at fixed unit prices (PepsiCo EBA cll 4(a)-(b) / SVC EBA cll 7.2 and 7.3(b)-(c)). This is unsurprising since, in the event that PepsiCo/SVC nominated another seller, they had promised the Bottler under the relevant EBA to cause the nominated seller to comply with what would have been their obligations under the EBA had they themselves remained as the seller (PepsiCo EBA cl 22(b) / SVC EBA cl 15.2).
The Commissioner’s two cases relate to the question of whether the payments made by the Bottler to the Seller for concentrate in fact included a royalty component for the licence to use the trade marks and other intellectual property associated with the beverages. His primary case is: (a) that the provisions of the EBAs, properly construed, show that the payments made by the Bottler to the Seller were, in part, in consideration for the use of the trade marks and other intellectual property; and (b) that the facts show that these royalties were income which was derived by PepsiCo/SVC. If the first of these contentions be correct then it will entail that the payments made by the Bottler to the Seller were in part ‘as consideration for’ the right to use the trade marks and other intellectual property as that phrase is used in the definition of ‘royalty’ in s 6(1) of the ITAA 1936. If so, the relevant part of the payments will satisfy that definition and to that extent the payments will be royalties. If the second contention is also made good then it will mean that those royalties will be ‘income derived’ by a non-resident within the meaning of s 128B(2B) and as such exigible to royalty withholding tax under that provision (recalling that PepsiCo and SVC are resident in the United States). In this case, royalty withholding tax is levied at the rate of 5%. This results from the operation of s 17A(1) of the International Taxation Agreements Act 1953 (Cth) which limits the rate at which royalty withholding tax is imposed to any limit specified in a double taxation treaty. The double taxation treaty between the United States and Australia presently imposes a limit of 5% on royalty withholding taxes.
The Commissioner’s secondary case takes as its point of embarkation the failure of his primary case so that on this alternative case it is a given that, on the proper construction of the EBAs, the amounts the Bottler paid to the Seller did not include a royalty for the use of the trade marks or other intellectual property. The Commissioner then alleges that by entering into EBAs on terms which did not include such a royalty, PepsiCo/SVC had entered upon a scheme which was subsequently carried into effect and which, speaking loosely for now, conferred upon them two tax benefits. The first tax benefit was that PepsiCo/SVC were not exigible to royalty withholding tax in Australia since there was no royalty upon which s 128(2B) could operate. The second tax benefit arose from the fact that no royalty could be brought to tax under the laws of the United States since there was no royalty upon which those foreign tax laws could operate either. The Commissioner then alleges that PepsiCo/SVC entered into these schemes with ‘a principal purpose’ of obtaining these tax benefits wherefor they are liable under s 177J of the ITAA 1936 to deferred profits tax at the rate of 35% (the awkward language of ‘a principal purpose’ being that of s 177J rather than that of the Commissioner or his advisers).
The trial judge upheld the Commissioner’s first case and therefore dismissed the second. His Honour did, however, indicate that had he not upheld the Commissioner’s first case then he would have upheld his second. This was because on that hypothesis the terms of the EBAs would be ‘contrived, in that payments that are ostensibly for concentrate alone are in substance for both concentrate and the licence of valuable intellectual property’: TJ [465]. PepsiCo/SVC appeal from the orders dismissing the first case whilst the Commissioner, in case that appeal is allowed, appeals from the orders dismissing the second.
ROYALTY WITHHOLDING TAX
In summary, we conclude that the payments made by the Bottler to the Seller were for concentrate alone and did not include any component which was a royalty for the use of PepsiCo/SVC’s intellectual property. The payments were in no part made in ‘consideration for’ the use of that intellectual property and they did not therefore include a ‘royalty’ within the definition of that term in s 6(1) of the ITAA 1936. Further, the payments were received by the Seller on its own account and they cannot be said to have been paid to PepsiCo/SVC. The Commissioner’s attempts to bring PepsiCo/SVC to tax under s 128B(2B) therefore fails for two interrelated reasons: there was no ‘royalty’ as required by s 128B(2B)(b) and the payments made to the Seller by the Bottler cannot constitute ‘income derived’ by PepsiCo/SVC within the meaning of s 128(2B)(a). Our reasons for these conclusions are as follows:
Were the payments made by the Bottler to the Seller in part ‘consideration for’ the right to use intellectual property so that they were a royalty for the purposes of s 128B(2B)(b)?
In the context of stamp duties, it is established that the consideration for a conveyance or transfer of property is ‘the money or value passing which moves the conveyance or transfer’: Archibald Howie Pty Ltd v Commissioner of Stamp Duties (NSW) (1948) 77 CLR 143 (‘Archibald Howie’) at 152 per Dixon J (Rich J agreeing at 150). This question is to be answered by looking to what was received by the transferring party so as to move the transfers to the receiving party as stipulated in the relevant agreement: Chief Commissioner of State Revenue (NSW) v Dick Smith Electronics Holdings Pty Ltd [2005] HCA 3; 221 CLR 496 (‘Dick Smith’) at 518 [72] per Gummow, Kirby and Hayne JJ; Commissioner of State Revenue (Vic) v Lend Lease Development Pty Ltd [2014] HCA 51; 254 CLR 142 (‘Lend Lease’) at 159 [49] per French CJ, Hayne, Kiefel, Bell and Keane JJ. Consequently, to determine whether the payments made by the Bottler to the Seller were in part paid as consideration for the right to use the trade marks and other intellectual property, attention is to be confined to the terms of the contractual documents which, in this case, include at least the EBAs. It is unnecessary to determine whether the Seller and the Bottler entered into separate contracts for the sale of the concentrates (evidenced by the purchase orders placed by the Bottler and the invoices issued by the Seller). Even if there were separate contracts, they were on terms dictated by the EBAs and, as between PepsiCo/SVC and the Bottler, the nature of the payments made by the Bottler could not be altered merely because PepsiCo/SVC exercised their option to nominate another entity to sell the concentrates rather than do so themselves.
The EBAs provided that the concentrate was to be sold to the Bottler by PepsiCo/SVC or their nominee at the price nominated in the EBAs (PepsiCo EBA cll 4(a)-(b) / SVC EBA cll 7.2 and 7.3(b)-(c)). It is established that where parties to a conveyance have agreed the purchase price for a transfer on sale then the consideration for the transfer is that agreed price: Davis Investments Pty Ltd v Commissioner of Stamp Duties (NSW) (1958) 100 CLR 392 (‘Davis’) at 408-409 per Dixon CJ.
The first question then is whether the EBAs fixed a price for the sale of concentrate. The answer to this question is dictated by the proper construction of the EBAs as contracts; that is to say, it is an orthodox exercise in contractual interpretation. In International Business Machines Corporation v Commissioner of Taxation [2011] FCA 335; 91 IPR 120 at 125 [19], Bennett J held that the question of whether payments are consideration for the right to use intellectual property rights, and therefore a ‘royalty’, for the purpose of s 128B of the ITAA 1936 is determined by the construction of the relevant agreement. Senior Counsel for both parties in the present case agreed that that was correct.
Construction of the EBAs
On their face, the price fixing provisions of the EBAs contemplated future sales of concentrate either by PepsiCo/SVC or their nominee at the unit rates specified therein. (A unit is an amount of concentrate sufficient to make one litre of beverage.) The EBAs themselves were neither contracts for the sale of goods (under which title passed immediately) nor agreements to sell goods (under which title passed subsequently on some event such as delivery). Rather, they contained provisions which contemplated future sales the price for which would be determined, once quantities were specified, by reference to the unit rates provided for in the EBAs. Until such time as an actual amount of concentrate was ordered, so that an actual price could be determined, the provisions lay dormant in that sense. Nevertheless, as a matter of ordinary language they suggested the presence of an agreement to enter upon future sales of concentrate at specified prices subject only to the question of quantity. The ordinary meaning of the language used by the parties therefore suggests that what was to be paid by the Bottler to PepsiCo/SVC or their nominated seller was a price being paid for the concentrate and therefore ‘as consideration for’ the sale of the concentrate.
The Commissioner submits that the EBAs should not be construed in this fashion. His construction of these provisions is that they provide for a mechanism by which the amounts to be paid by the Bottler can be calculated but that those amounts should not be seen as being just the price paid for the concentrate. Rather, he submits, they should be seen as including a component for the price for the concentrate together with a component for the Bottler’s contractual entitlement to use the relevant trade marks and other intellectual property. There were two reasons for this. First, whilst the provisions did refer to the unit rate as the price for the concentrate they did not go so far as to say that that price was being paid only in consideration for the concentrate. It remained possible, on this view, that the price was being paid for other promises received by the Bottler under the EBAs and, in particular, that part of it was being paid for the right to use the trade marks and other intellectual property.
Secondly, if that approach were not taken to these provisions, it would entail that the right granted to the Bottler to use the relevant trade marks and intellectual property would have been given in effect for nothing. The brands associated with these beverages included some of the most valuable brands in the global beverage market (including the famous Pepsi brands) and it was unlikely that PepsiCo/SVC were giving away something so valuable for nothing.
The EBAs are commercial contracts. It is not in dispute that the meaning of their terms ‘is to be determined by what a reasonable businessperson would have understood those terms to mean’; or that its ascertainment will require ‘consideration of the language used by the parties, the surrounding circumstances known to them and the commercial purpose or objects to be secured by the contract’: Electricity Generation Corporation v Woodside Energy Ltd [2014] HCA 7; 251 CLR 640 at 656-657 [35] per French CJ, Hayne, Crennan and Kiefel JJ.
We do not agree with the Commissioner’s submission that the licence to the Bottler for the use of the trade marks and other intellectual property was otherwise being granted for nothing. The licence rights did not exist in isolation. Rather, they were intertwined with the Bottler’s obligations to distribute the beverages in Australia under the Pepsi, Mountain Dew and Gatorade trade marks using PepsiCo/SVC’s can and bottle designs and to do so under the strict quality control of PepsiCo/SVC and in accordance with its detailed stipulations about how the trade marks were to be used.
The Commissioner’s submission proceeds on the overly simplistic assumption that the grant of the licence right to the Bottler was only of benefit to the Bottler. In fact, it was also a benefit to PepsiCo/SVC. Further, the Commissioner’s submission leaves out of account the significant restrictions placed upon the Bottler’s entitlement to use the trade marks and other intellectual property.
In relation to the benefits which the licences conferred on the Bottler, the Bottler obtained the right to use the trade marks to distribute and sell beverages in Australia. The benefit consisted of the right to take advantage of the goodwill attaching to those marks which belonged to PepsiCo/SVC. The licence did not operate as an assignment of the goodwill from PepsiCo/SVC to the Bottler. On the contrary, the goodwill at all times remained with PepsiCo/SVC. The licence was not like the grant of a right to do the acts comprised in a copyright or the grant of a right to make products under a patent. Unlike those species of intellectual property rights, the licensor of a registered trade mark typically (although perhaps not invariably) maintains a commercial interest in the licensed mark through its continuing goodwill, and that was clearly the case with PepsiCo/SVC: c.f. ss 58, 88(2)(a) and 92 of the Trade Marks Act 1995 (Cth). Thus the grant of the licence was also a significant benefit to PepsiCo/SVC. By means of the efforts of the Bottler to distribute the beverages under the trade marks in Australia their goodwill was maintained. To see the trade mark licence as simply a contractual grant of a right solely for the benefit of the grantee is significantly to misunderstand the nature of the rights involved. The correct view, if benefits are to be the lens, is that PepsiCo/SVC obtained the benefit of having their goodwill sustained and enhanced and the Bottler obtained the benefit of being able to exploit Pepsico/SVC’s goodwill to its own advantage. Whether these benefits were ultimately in favour of PepsiCo/SVC or the Bottler is unclear and likely in any event to be a close function of market dynamics. For example, in a new market it is quite possible that PepsiCo/SVC obtained more by way of benefit in having its brands established than the Bottler would obtain from utilising relatively weak brands. In a more mature market, the converse might be true. Nevertheless, if benefit were to be the metric it would be these offsetting benefits which would be a surer guide to the value of the trade mark licence.
In fact, however, benefit is not the entire picture. Whilst the Bottler may have obtained the benefit to which we have just referred (and leaving out of account the countervailing benefit obtained by PepsiCo/SVC), any such benefit was accompanied by significant restrictions. Unlike a copyright or patent licence, the Bottler was not permitted to use the trade marks for any purpose it liked. It could not for example sell its own cola under the Pepsi brand but was instead bound to use the trade marks only for the purpose of distributing PepsiCo/SVC’s highly particular beverages (PepsiCo EBA cl 7 / SVC EBA cll 4.1-4.3). Further, it had no latitude in how it made these beverages but was instead hemmed about by the contractual necessity that it make the beverages in the very precise way dictated by the EBAs (PepsiCo EBA cll 6-7 / SVC EBA cll 5.1-5.2). In short, it could use the trade marks but only for the purpose of selling the beverages, the nature of which was entirely controlled by PepsiCo/SVC. Further, it bound itself under the EBAs to permit PepsiCo/SVC to ensure that what was being sold was in fact the beverages. Rights of inspection, reporting and testing were conferred on PepsiCo/SVC so that they could be assured of that fact (PepsiCo EBA cll 13-16 / SVC EBA cl 12). Moreover, the Bottler’s right to use the trade marks was circumscribed by a requirement that the manner in which the trade marks were used was likewise under the control of PepsiCo/SVC (PepsiCo cl 5(b) / SVC EBA cl 5.2(b)). The Bottler could not embark on its own interpretation of the brand strategy.
Thus a complete view of the licence granted by PepsiCo/SVC to the Bottler is one which acknowledges: (a) the benefits obtained by the Bottler in being permitted to use the goodwill attaching to the trade marks; (b) the restrictions both as to product and marketing imposed on the Bottler in its utilisation of that goodwill; (c) the burdens placed upon the Bottler in complying with testing and inspection regimes; and (d) the benefits obtained by PepsiCo/SVC in having the Bottler sustain and promote their goodwill in Australia. Once that is appreciated, the Commissioner’s submission that PepsiCo/SVC were giving away the right to use the trade marks for nothing unless some element of the concentrate price was seen as embedding some value for it, must be rejected.
For completeness, it is necessary to note a remark made by the Full Court of this Court in Freedom Foods Pty Ltd v Blue Diamond Growers [2021] FCAFC 86; 286 FCR 437 (‘Freedom Foods’). That case concerned a local licence to use the ‘Almond Breeze’ trade marks and associated intellectual property for the distribution of almond milk products. The question in the case was whether a licence agreement was subject to a regulation which governed franchising agreements. The licensor supplied a product known as ‘almond base’ to the licensee from which a range of almond milk products were then manufactured. The only fee which was payable under the agreement by the licensee to the licensor was for the supply of the almond base. One question in the case was whether the fees paid to the licensee were on a genuine wholesale basis which was one of the criteria for determining whether what was present was a franchising arrangement (c.f. Franchising Code of Conduct cl 5(d)(v)). In obiter, the Court expressed its agreement with the primary judge’s conclusion that the fee paid was not on a genuine wholesale basis because it included an element for the licence of the trade marks. At [66] the Court said this:
It may be inferred that the price that Blue Diamond was to charge Freedom Foods for the Almond Base was to include remuneration for the value of the brands (the value of which was to be further enhanced by the ongoing marketing expenditure to be incurred by Blue Diamond) or that there was no charge for the value of that intellectual property. The latter is such an unlikely commercial position that, in the absence of the Court being taken to evidence to the contrary, it may be inferred that the Almond Base price included remuneration not just for the supply of the Almond Base. The primary judge was correct in reaching that conclusion.
It is not obvious from the report of the decision whether the licensee submitted that the right to distribute almond milk products under the ‘Almond Breeze’ trade marks was of commercial benefit to the licensor, or whether attention was given to the restrictions and burdens imposed on the licensee in relation to the quality of the almond milk products or the manner in which the trade marks were used. Thus, we would not read [66] of Freedom Foods as determining the answer to the current issue. To the extent that the Full Court may have suggested that these other benefits and burdens were to be ignored in determining whether a licence was royalty free we would, however, respectfully differ from that view.
This leaves the Commissioner’s submission that the sale clauses of the EBAs did not specify that the price paid was the consideration for the purchase of the concentrate. There is nothing in this point. The ordinary reading of a provision that says that an item is to be sold for a price is that the price is the consideration for the purchase. If it could be said that the grant of the licences had been for nothing (which it cannot), a question may then have arisen as to whether the sale clauses of the EBAs might be construed in the manner suggested by the Commissioner. There may be cases where it is apparent that a price set under a contract for the transfer of property does include a component which, on the proper construction of the contract, must include an element for some other transfer under the contract. Reconciling the sale provisions with these other elements will present a conventional exercise in contractual interpretation and will turn on the language used by the parties. However, since it is not shown that the licences in this case were given in exchange for nil value no occasion arises to embark upon such an exercise. For completeness, the Commissioner did not submit, and we have no need to consider, that the price charged for concentrate was disproportionately high.
It follows that on their proper construction, the EBAs fixed a price for future sales of concentrate alone which did not include a component for the licence to use the trade marks and other intellectual property.
Consideration of Davis, Dick Smith and Lend Lease
That conclusion is not, however, the end of the matter. In Davis at 408 Dixon CJ said that where parties to a conveyance have agreed the purchase price for a transfer on sale then the consideration for the transfer is that agreed price. However, the Commissioner submitted that that principle was qualified by the subsequent decisions of the High Court in Dick Smith and Lend Lease. It was submitted that those decisions established that the consideration for a transfer of property could be something different to that which the parties had agreed it to be.
It has of course long been accepted where the transfer involved is not one connected to a sale of identified property that one may look at the broader context in determining the consideration for the transfer. Justice Dixon’s own judgment in Archibald Howie is an example of that kind of case. There Dixon J thought that the consideration for the transfer of shares needed to bring to account a reduction of capital which occurred at the same time. But in that case there was no sale of the shares and all the events which had occurred had taken place under the auspices of the articles of association and a resolution of the board. A similar problem arose in Davis but in that case there was an agreement which specified the price at which the shares were to be sold. Chief Justice Dixon distinguished his own decision in Archibald Howie on this basis at 408 (‘But here, for their own purposes the parties have given the transaction the form of a sale at a price.’). He then said at 408-409:
To go beyond the price may be to prefer realism to formal expression, but it means going to the circumstances warranting the parties in fixing the price they chose and that is not necessarily the same thing as consideration. It cannot be denied that it is an attractive view that the consideration in money or money’s worth “upon” which the transfers would be made consists of all the essential elements involved as it does the effectuation of pre-existing rights. But, notwithstanding some hesitation, I have reached the conclusion that, in the circumstances of the present case, it is the price which must for the purposes of stamp duty be regarded as the consideration upon which the transfers would be made.
Reasoning to substantially the same effect was given by McTiernan J (at 409-410) and Taylor J (at 419-421). By contrast, the dissenting judgment of Kitto J (at 414-415, with whom Webb J agreed) focused on ‘the consideration which really passes, and not, if there be a distinction between them, the consideration appearing from the instrument’. Apart from the fact that it is the majority view which is binding, it is common ground between the parties, as indicated above, that the particular issue arising in the context of s 128B of the ITAA 1936 is determined by the construction of the relevant agreement, which is consistent with the majority in Davis.
In both Dick Smith and Lend Lease the Court, on the facts of the cases before it, was willing to do what Dixon CJ was not willing to do and ‘prefer realism to formal expression’.
In Dick Smith the consideration which moved the transfer by the vendors to the purchaser of the shares was the performance by the purchaser of the several promises recorded in the agreement. The result of the performance by it of those several promises was that the vendors received in total the sum of $114,131,649. The majority reasoned (at 519 [75]) that ‘it was only in return for that total sum (paid by the various steps and in the various forms required by the Agreement) that the Vendors were willing to transfer to the Purchaser the bundle of rights which their shareholding in the Company represented’.
Similar reasoning underpins the Court’s conclusions in Lend Lease. That case concerned the redevelopment of the Docklands area in Melbourne by Lend Lease. The land was owned by VicUrban. The redevelopment was to occur in stages under the auspices of a development agreement. Clause 4.7 of the development agreement obliged Lend Lease to pay VicUrban sums of money at different stages of the redevelopment. The payments listed in cl 4.7 included payments made under ancillary agreements for the sale of land. But cl 4.7 included other payments which Lend Lease would make to VicUrban and these payments both antedated and post-dated the contracts for the sale of the land. For example, Lend Lease was to pay VicUrban sums of money in respect of costs incurred by VicUrban in remediating a gasworks site and developing certain infrastructure.
Citing Dick Smith, the Court reasoned that the consideration which moved the transfers to Lend Lease of each of the various parcels of land was the performance by Lend Lease of the several promises recorded in the development agreement in consequence of which VicUrban would receive the total of the several amounts set out in cl 4.7. Thus, as the Court observed at 159-160 [50], it ‘was only in return for the promised payment of that total sum, by the various steps recorded in the applicable agreement, that VicUrban was willing to transfer to Lend Lease the Land comprised in the relevant Stage’. For that reason, the consideration for the transfers of the land was not just the amounts which were specified as the sale prices of the parcels of land but instead the whole of the amounts which Lend Lease was bound to pay VicUrban under the development agreement.
In neither Dick Smith nor Lend Lease was Davis overruled. The challenge for an intermediate court of appeal is therefore to identify what Dick Smith and Lend Lease hold in light of the fact that this Court remains bound to apply Dixon CJ’s statement in Davis that the consideration for the transfer of property effected under an agreement for its sale is the price the parties have agreed for that sale. We conclude that Dick Smith and Lend Lease apply when:
(a)the parties to an agreement have agreed that an item of property or the conferral of a right is in return for a nominated price;
(b)the agreement provides for the transfer of other items of property or the performance of other obligations for value;
(c)on its proper construction the agreement shows that the transfer of the property in (a) can only be in return for all of the value in (a) and (b).
Thus in Dick Smith the Court said this (at 519 [75]):
The consideration which moved the transfer by the Vendors to the Purchaser of the Shares which they owned in the Company was the performance by the Purchaser of the several promises recorded in the Agreement in consequence of which the Vendors received the sum of $114,139,649. It was only in return for that total sum (paid by the various steps and in the various forms required by the Agreement) that the Vendors were willing to transfer to the Purchaser the bundle of rights which their shareholding in the Company represented.
And in Lend Lease the pivotal conclusion was at 159-160 [50]:
In these cases, the consideration which moved the transfer by VicUrban to Lend Lease of each Stage was the performance, by Lend Lease, of the several promises recorded in the 2001 DA (or that agreement as later varied and supplemented), in consequence of which VicUrban would receive the total of the several amounts set out in the applicable agreement. It was only in return for the promised payment of that total sum, by the various steps recorded in the applicable agreement, that VicUrban was willing to transfer to Lend Lease the Land comprising the relevant Stage.
In this case, we do not think that the concentrate prices in the EBAs are of this kind. The price paid for concentrate was not part of what moved the right of the Bottler to use the trade marks and other intellectual property. The right to use trade marks and other intellectual property was not the central property disposition or transaction which they contemplated. Rather, the central bargain under the EBAs was the establishment of an exclusive arrangement to distribute PepsiCo/SVC’s beverages in Australia. What the purchaser in Dick Smith ultimately wished to acquire were the shares in the company. What Lend Lease ultimately wished to acquire (and then sell) was the land at Docklands. In this case, what the Bottler ultimately wanted to acquire was not the right to use trade mark and other intellectual property rights but rather the right to distribute famous beverages in Australia. Of course, the right to use trade marks and intellectual property was a necessary element in the transaction. But what the parties were centrally seeking to achieve was not a contract for the licensing of trade marks and intellectual property. It was a distribution arrangement of which the licensing of intellectual property was merely a part.
In that circumstance, the outcome is governed by Davis, and Dick Smith and Lend Lease are not apposite. It follows that the consideration for the purchase of the concentrate was the price the parties stipulated for it in the EBAs. As such, the payments made by the Bottler to the Seller did not include an element which was a royalty for the use of the trade marks (since the payments were not in consideration for the right to use the trade marks).
In the case of the SVC EBA this conclusion is underscored by the fact that it provided that the licence was to be royalty free (cl 4.1). This confirms the conclusion we have reached but is not necessary for that conclusion.
Were the payments income derived by PepsiCo/SVC?
That conclusion renders it strictly unnecessary to consider whether the amounts received by the Seller from the Bottler could be income which was derived by PepsiCo/SVC. On appeal the Commissioner was clear that he did not contend that the Seller was the agent for PepsiCo/SVC and he eschewed any suggestion that the moneys received by the Seller from the Bottler were held on trust by it for PepsiCo/SVC. His case was instead that the moneys had been paid to PepsiCo/SVC because there had been a payment by direction.
We do not accept this submission. It is well established that a direction by a creditor to a debtor to pay a third party constitutes a payment to the creditor. The authorities are, with respect, usefully collected by Jackman J (with whom Derrington and Abraham JJ agreed) in Roufeil as Trustee for the Bankrupt Estate of Tarrant v Tarrant Enterprises Pty Ltd as Trustee for the MRT Family Trust [2023] FCAFC 142; 299 FCR 204 at 212-214 [27]-[35]. Nevertheless, it is also recognised that there can be no payment by direction unless there is an antecedent monetary obligation owed by the Bottler to PepsiCo/SVC: ABB Australia Pty Ltd v Federal Commissioner of Taxation [2007] FCA 1063; 162 FCR 189 at 226 [166] per Lindgren J; Goode RM, Payment Obligations in Commercial and Financial Transactions (Sweet & Maxwell, 1983) at p 11.
The Commissioner submits that this monetary obligation arose from the EBAs. We do not see how this can be correct. The EBAs contemplated either a sale by PepsiCo/SVC or their nominee. Where a related entity was nominated as the seller the EBAs were clear that it was that related entity and not PepsiCo/SVC that would be selling the concentrate. It is true that PepsiCo/SVC remained contractually bound to the Bottler to ensure that the related entity did, in fact, sell the concentrate. It is also true that they assumed a contractual responsibility to the Bottler to ensure that that which the Seller delivered was in accordance with what would have been PepsiCo/SVC’s obligations had they been the seller (PepsiCo EBA cl 22(b) / SVC EBA cll 7.1(c) and 7.3(d)). Thus, if the concentrate delivered was not of merchantable quality then the Bottler could sue PepsiCo/SVC directly. However, these matters cannot have the effect of making PepsiCo/SVC the vendor of the concentrate when the parties were explicit that the vendor was to be the nominated related entity.
During argument, the Commissioner accepted that there had been a sale of the concentrate by the Seller to the Bottler. He nevertheless maintained that there was a sale by PepsiCo/SVC. But PepsiCo/SVC had neither possession of nor title to the concentrate and they did not deliver the concentrate either actually or constructively.
The only way that PepsiCo/SVC could have sold the concentrate to the Bottler was if they had by some means become a party to the sale by the Seller to the Bottler. But, as we have noted, the Commissioner eschewed a case that the Seller was PepsiCo/SVC’s agent for the purpose of the sale. As such, we do not accept that there can have been a sale by PepsiCo/SVC. And, if there was no sale of concentrate by PepsiCo/SVC it cannot be the case that the Bottler was ever obliged to pay them for something they were not selling. It follows that the EBAs did not give rise to any monetary obligation on the part of the Bottler to PepsiCo/SVC to pay them for the sale of concentrate by the Seller.
Since there was no antecedent monetary obligation, it is not possible that by paying the Seller the Bottler was paying PepsiCo/SVC. It is not necessary to determine in that circumstance whether the nominated direction to pay was in fact an effective direction to pay. Here the Commissioner submitted that the direction to pay from PepsiCo/SVC was constituted by the formal notices given to the Bottler in December 2015 that henceforth the seller of the concentrate would be the Seller and the subsequent provision by PepsiCo/SVC of the Seller’s bank account details. It is not necessary to determine whether such notices could be directions to pay. However, on their face these notices do not appear to be directions to pay but rather directions under the EBA to buy concentrate from another entity.
In any event, the payments made by the Bottler to the Seller were not income derived by PepsiCo/SVC. The payments did not ‘come home’ to PepsiCo/SVC in the sense described by Dixon J in Commissioner of Taxes (SA) v The Executor Trustee and Agency Company of South Australia Limited (1938) 63 CLR 108 at 155 and by the Court in Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation (1965) 114 CLR 314 at 318. It is not necessary to determine what the answer to this question would have been if we had concluded that the payments made by the Bottler did, in fact, include a royalty for the use of the trade marks and other intellectual property. It is possible, although we draw no firm conclusions, that the royalty component of the payments might have been seen as belonging to PepsiCo/SVC. In that case, the receipt by the Seller of the royalty component might have given rise to some species of agency or trust as between PepsiCo/SVC and the Seller. It is not necessary to pursue this further, however, since the Commissioner did not advance his case on such a basis.
Conclusions on royalty withholding tax
The payments made by the Bottler to the Seller did not include any element for the licence to use the trade marks or other intellectual property and hence were not royalties within the meaning of s 6(1) of the ITAA 1936. They were also not income derived by PepsiCo/SVC for the purposes of s 128B(2B). PepsiCo/SVC are not liable to pay royalty withholding tax on the payments made by the Bottler to the Seller.
PART IVA
Introductory remarks
The trial judge concluded that royalty withholding tax was exigible because the EBAs provided for the payment of a royalty for the use of the trade marks and other intellectual property. The Commissioner’s alternative case under Part IVA was that PepsiCo/SVC had entered into schemes which provided for the sale of concentrate but without the charging of any royalty for the right to use the intellectual property. On the trial judge’s findings those schemes were not made out on the facts since the payments for concentrate had in fact been payments for both concentrate and the right to use the intellectual property. Consequently, he dismissed the Commissioner’s alternative case under Part IVA. In light of our conclusion that the payments did not include a royalty component his Honour’s conclusion that Part IVA could not apply was in error.
His Honour gave extensive reasons, in the alternative, for his conclusion that if the payments did not include a royalty component then Part IVA would have applied. These reasons, however, are not his Honour’s dispositive reasons for dismissing the Part IVA case. Demonstration of error in his Honour’s alternative reasons is not material to the orders his Honour in fact made. They are therefore not directly relevant to the exercise of this Court’s appellate jurisdiction although, as will be seen, they do have an indirect relevance. In any event, it falls to this Court to determine for itself whether Part IVA applies to the schemes alleged by the Commissioner.
We should nevertheless record that we consider that his Honour’s treatment of the case under Part IVA was heavily and perhaps understandably influenced by the factual findings he made in the royalty withholding tax case about the quantum of the royalties which had been paid (an issue of quantification his Honour was obliged to confront once he had concluded that the payments did in fact include such a royalty). There was valuation evidence before his Honour from Mr Malackowski (for the Commissioner) and Ms Wright (for PepsiCo). The trial judge felt that Mr Malackowski had ‘considerably more experience’ in valuing intellectual property rights than Ms Wright did: TJ [272]. His Honour ultimately accepted Mr Malackowski’s evidence that the appropriate royalty was 5.88% subject to a small downward adjustment: TJ [404]. However, both Mr Malackowski’s and Ms Wright’s opinions were expressly premised on an assumption that the concentrate price did include a royalty. The trial judge recorded the fact of this assumption at TJ [268].
As will be seen, the Commissioner’s scheme case likewise assumed that the concentrate price included a royalty component. This was the same assumption that Mr Malackowski and Ms Wright had been asked to and did make. As we will explain, the difficulty which arises is that there was no evidence before the Court that this assumption was correct. Put another way, Mr Malackowski’s valuation evidence determined what the value of the licence granted under the EBAs was but there was no corresponding evidence which showed that that value was being recovered through the concentrate price. Evidence of that kind would have required a detailed analysis of the economics of the EBAs and its relationship with the concentrate price. The Commissioner’s scheme case lacked evidence of this kind.
Whilst this is by no means the same kind of issue which would arise in a transfer pricing case under Division 815 of the Income Tax Assessment Act 1997 (Cth) (if only because PepsiCo and the Bottler were plainly operating at arm’s length), the inquiry is similar to the extent that it involves a determination that a price charged for one thing in substance includes an economic transfer of value for something else. Such transactions may be varied. They include a transfer within a multinational group of losses from a higher taxation jurisdiction to a lower taxation jurisdiction by means of the pricing of intra-group product sales (Commissioner of Taxation v SNF (Australia) Pty Ltd [2011] FCAFC 74; 193 FCR 149) or equivalently the cost of intra-group financing arrangements: Chevron Australia Holdings Pty Ltd v Commissioner of Taxation [2017] FCAFC 62; 251 FCR 40. In this case, the Commissioner’s scheme case begs the question of why the concentrate price should be understood as including a royalty. Establishing that the licence of the intellectual property was valuable is only half of the necessary inquiry. The missing other half involves the concentrate price and all of the other burdens and benefits flowing from the EBAs.
The schemes
The schemes for PepsiCo and SVC are relevantly identical and attention may be confined to the scheme alleged in the case of PepsiCo. Unless necessary, this section of the reasons will eschew further reference to SVC. The schemes relied on by the Commissioner are identified in his amended appeal statements in the diverted profits tax proceedings. The PepsiCo scheme is set out at [67.1] of the amended appeal statement and was reproduced by the trial judge at TJ [32].
67.[The] Commissioner contends that PepsiCo entered into a scheme comprising some or all of the following (the Scheme):
67.1.effective from 3 April 2009, PepsiCo entered into the [PepsiCo] EBA with SAPL whereby:
(a)SAPL was appointed as the sole and exclusive licensee to bottle, sell and distribute trademarked PepsiCo Group carbonated soft drink beverages. (The beverage brands the subject of the [PepsiCo] EBA, apart from the Seven Up brands, are referred to below as the Pepsi Beverages);
(b)SAPL agreed to purchase concentrate for the manufacture of the Pepsi Beverages from PepsiCo or one of its appointed subsidiaries; and
(c)SAPL obtained, under the [PepsiCo] EBA and/or the agreements referred to within it, including the Co-op A&M Agreements:
i.the use of, or rights to use, certain intellectual property owned by PepsiCo in the bottling, sale and distribution of the Pepsi Beverages;
ii.technical, industrial or commercial knowledge or information in relation to the Pepsi Beverages; and/or
iii.assistance ancillary to and furnished as a means of enabling the application or enjoyment of such intellectual property or knowledge or information.
(d)no royalty was paid for the items set out at (c) above.
The term ‘scheme’ is defined in the ITAA 1936 but there is no dispute that the Commissioner’s scheme satisfies that definition. It will be noted that the scheme relied upon by the Commissioner does not in any way depend on the prices at which the concentrate was to be sold. An immediate problem flowing from that is that the scheme relied upon operates regardless of the concentrate price and, in particular, even where that price does not reflect the value which Mr Malackowski placed upon the intellectual property licence. As in a transfer pricing case, it is not possible to conduct the kind of inquiry implicit in the Commissioner’s scheme case without detailed analysis of the pricing under the EBA.
The issues
There are two statutory issues between the parties. The first concerns whether PepsiCo obtained a tax benefit in relation to that scheme. The second is whether it did so for a principal purpose that included a purpose of obtaining a tax benefit and of reducing its liability to tax under the law of the United States.
These questions arise in an elaborate statutory context. The central provision is s 177J of the ITAA 1936. It is one of the anti-avoidance provisions contained in Part IVA. It deals with, but does not impose, a ‘diverted profits’ tax. We will return to the text of s 177J but, for present purposes, it is to be noted that the opening words of s 177J(1) are ‘This Part also applies to a scheme…if…’ which are then followed by various provisions which are conditions precedent to the satisfaction of that conditional statement. The word ‘also’ refers to the fact that other provisions in Part IVA, not presently germane, may also lead to the conclusion that Part IVA applies to a scheme (e.g. ss 177D-177F). The end point of a successful invocation by the Commissioner of s 177J(1) is a conclusion that Part IVA applies to a scheme.
The legal relevance of a conclusion that Part IVA applies to the scheme emerges from ss 177N(a) and 177P(1)(a). Relevantly they provide:
177N Diverted profits tax – consequences
If this Part applies to a scheme because of section 177J:
(a)section 177P applies to the relevant taxpayer mentioned in section 177J;
…
177P Diverted profits tax – liability
(1)The relevant taxpayer is liable to pay tax at the rate declared by the Parliament on:
(a)if this Part applies to a scheme in respect of the relevant taxpayer for the year of income mentioned in paragraph 177J(1)(a), in relation to one DPT tax benefit—the DPT base amount for that DPT tax benefit;
…
Note: The tax is imposed by the Diverted Profits Tax Act 2017 and the rate of the tax is set out in that Act.
(2) The DPT base amount for a DPT tax benefit is:
(a)if the DPT tax benefit is a tax benefit mentioned in paragraph 177C(1)(a), (b), (ba) or (bc)—the amount of the DPT tax benefit
As will be seen, the tax benefit involved in this case is the tax benefit mentioned in s 177C(1)(bc). Thus the effect of s 177P(2)(a) is to make the DPT base amount the tax benefit mentioned in s 177C(1)(bc). As the note suggests, the rate of the tax is set by the Diverted Profits Tax Act 2017 (Cth) at 40%. Thus if s 177J(1) results in the conclusion that Part IVA applies, tax will be applied at that rate to the amount of the tax benefit identified in s 177C(1)(bc). Section 177C(1) is a definition provision which defines the concept of ‘the obtaining by a taxpayer of a tax benefit in relation to a scheme’ across a multitude of circumstances including those dealing with withholding taxes such as the royalty withholding tax imposed by s 128B(2B). Where the tax involved is a withholding tax, the relevant definition is supplied by the provision to which reference has been made above, s 177C(1)(bc). Relevantly s 177C(1)(bc) provides:
(1)Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:
…
(bc)the taxpayer not being liable to pay withholding tax on an amount where the taxpayer either would have, or might reasonably be expected to have, been liable to pay withholding tax on the amount if the scheme had not been entered into or carried out
There are two limbs to this definition turning respectively on what (but for the scheme) would have happened or what (but for the scheme) might reasonably be expected to have happened. On appeal, the Commissioner sought to rely on the second limb only so that the inquiry in this Court is not into what would have happened but for the scheme but rather what might reasonably be expected to have happened but for the scheme. The trial judge in his alternative reasons in relation to Part IVA explained why the first ‘would’ limb could not apply and both parties to the appeal proceeded on the basis that his Honour’s conclusion about this was correct. The appeal is to be approached therefore on the basis that it is the second limb which is to be applied. The dichotomy inherent in the two limbs of s 177C(1)(bc) persists in subsequent provisions reflecting their different inquiries. We will only deal with those provisions insofar as they relate to the second limb given the way the parties have approached the appeal.
Returning then to s 177C(1), the provision next goes on to specify the amount of that tax benefit in s 177C(1)(g):
(1)and, for the purposes of this Part, the amount of the tax benefit shall be taken to be:
…
(g)in a case to which paragraph (bc) applies—the amount referred to in that paragraph
As a definition provision, s 177C(1)(bc) contains no statement of any legal rule. However, as we have pointed out, s 177P(1)(a) imposes the diverted profits tax at 40% on the amount of the tax benefit mentioned in s 177C(1)(bc) which by s 177C(1)(g) is the amount referred to in s 177C(1)(bc). There is only one amount referred to in s 177C(1)(bc) and, on the way the Commissioner puts his case, it is the amount upon which the taxpayer might reasonably be supposed to have been liable to pay royalty withholding tax but for the scheme. The amount referred to in s 177C(1)(bc) and brought to tax under ss 177P(1) and (2)(a) is therefore the amount of the royalty which did not come into existence because of the scheme. It is not the amount of royalty withholding tax that would have been due on that royalty. Referring to this as a tax benefit is conceptually confusing but, as will be seen, the provisions operate harmoniously, if somewhat counterintuitively, to ensure an outcome which is rational, if perhaps poorly expressed.
At this point it is useful to set out s 177J(1)(a), the first of the contested subsections of s 177J(1):
(1)This Part also applies to a scheme, in relation to a tax benefit (the DPT tax benefit) if:
(a)a taxpayer (a relevant taxpayer) has obtained, or would but for section 177F obtain, the DPT tax benefit in connection with the scheme, in a year of income
As already noted, the tax benefit is not the amount of royalty withholding tax to which PepsiCo did not become liable but rather the amount of the royalty which it did not receive. If that concept alone were reintroduced directly back into the question posed by s 177J(1)(a) then the provision appears not to operate since, by definition, PepsiCo did not obtain the royalty and hence did not obtain that tax benefit. However, the concept used by s 177J(1)(a) is not the idea of a tax benefit in isolation, but rather the concept defined in s 177C(1)(bc); namely, the obtaining of a tax benefit in connection with a scheme. As will be recalled from the discussion above, that definition makes clear that PepsiCo will be taken to have obtained a tax benefit in connection with the scheme if it was not liable to pay royalty withholding tax where, but for the scheme, it might reasonably be expected to have been liable to pay that tax. This is the more appropriate definition to apply in s 177J(1)(a) since the application of the other renders the provision pointless. Neither party suggested to the contrary.
Thus the first question posed in s 177J(1)(a) will be answered in the affirmative if the definition in s 177C(1)(bc) is satisfied. On the way the Commissioner puts the case, that question is to be answered in the manner dictated by ss 177CB(1)(e), (3), (4) and (5). They provide:
(1)This section applies to deciding, under section 177C, whether any of the following (tax effects) would have occurred, or might reasonably be expected to have occurred, if a scheme had not been entered into or carried out:
…
(e) the taxpayer being liable to pay withholding tax on an amount;
…
(3)A decision that a tax effect might reasonably be expected to have occurred if the scheme had not been entered into or carried out must be based on a postulate that is a reasonable alternative to entering into or carrying out the scheme.
(4) In determining for the purposes of subsection (3) whether a postulate is such a reasonable alternative:
(a) have particular regard to:
(i)the substance of the scheme; and
(ii) any result or consequence for the taxpayer that is or would be achieved by the scheme (other than a result in relation to the operation of this Act); but
(b)disregard any result in relation to the operation of this Act that would be achieved by the postulate for any person (whether or not a party to the scheme).
(5) Subsection (4) applies in relation to the scheme as if references in that subsection to the operation of this Act included references to the operation of any foreign law relating to taxation:
(a) if this Part applies to the scheme because of section 177DA or 177J; or
(b) for the purposes of determining whether this Part applies to the scheme because of section 177DA or 177J.
The definition in s 177C(1)(bc) will be satisfied only if there is a postulate that is a reasonable alternative to the scheme. If there is no such postulate then a decision may not be made that the tax effect might reasonably be expected to have occurred in the absence of the scheme (recalling that the tax effect in this case is, by s 177CB(1)(e), the liability of PepsiCo to pay royalty withholding tax in the absence of the scheme). In determining the answer to that question the Court is to disregard any taxation consequences under the ITAA 1936 and any taxation consequences arising under foreign law: ss 177CB(4) and (5).
In determining whether the postulate is reasonable the Court is to have ‘particular regard’ to the matters in s 177CB(4)(a). Two implications flow from this. First, it is an indication of statutory intent in relation to weight; that is to say, the considerations are not merely relevant but particularly so. Secondly, the fact that the considerations in s 177CB(4)(a) are particularly relevant implicitly demonstrates that the matters which can be taken into account are not limited by s 177CB(4) although tax consequences are excluded by ss 177CB(4)(b) and (5).
The Commissioner puts forward two postulates which he says satisfy s 177CB(3). The trial judge set these out at TJ [430]:
(a)the relevant EBA would or might reasonably be expected to have expressed the payments to be made by SAPL to be for all of the property provided by (and promises made by) the PepsiCo Group entities (rather than for concentrate only); or
(b)the relevant EBA would or might reasonably be expected to have expressly provided for the payments to be made by SAPL to include a royalty for the use of, or the right to use, the relevant trademarks and other intellectual property (whether or not the amount of the royalty was specified).
Whilst the Commissioner identifies two postulates which he says are reasonable alternatives to the entry into or carrying out by PepsiCo of the scheme, the question in this Court is not whether the postulates he suggests are unreasonable. In review proceedings of the present kind, it is the taxpayer which bears the burden of proving that the assessments are excessive: s 14ZZO(b)(i) of the Taxation Administration Act 1953 (Cth). Proving that the Commissioner’s postulates are unreasonable does not in itself discharge that burden. It remains the burden of the taxpayer to show on all of the evidence that the tax benefit would not reasonably be expected to have been obtained if the schemes had not been entered into: Commissioner of Taxation v Guardian AIT Pty Ltd ATF Australian Investment Trust [2023] FCAFC 3; 115 ATR 316 (‘Guardian AIT’) at 351 [156]-[157] per Hespe J (Perry and Derrington JJ agreeing at [1] and [2]); RCI Pty Ltd v Commissioner of Taxation [2011] FCAFC 104; 84 ATR 785 at 842-843 [128]-[131] per Edmonds, Gilmour and Logan JJ.
What this means in practice in a proceeding such as the present is that PepsiCo must show that there is no reasonable postulate for the purposes of s 177CB(3). Naturally this will include demonstrating that the Commissioner’s postulates are not reasonable but PepsiCo must also demonstrate on the evidence that there is no other reasonable postulate.
As to the Commissioner’s two postulates, the first was that the EBAs might reasonably be expected to have expressed the payments made by the Bottler to be for all of the property provided by (and promises made by) the PepsiCo group entities (rather than for the concentrate alone). The second was that the EBAs might reasonably be expected to have expressly provided that the payments made by the Bottler to the Seller would include a royalty for the use of the trade marks and other intellectual property.
Notable features of these postulates include the fact that they eschew either identifying the actual price of the concentrate or advancing an element from which it might be inferred that the concentrate price reflected the value of the intellectual property licence. That may perhaps reflect the fact that there was no evidence before the trial judge from which such a conclusion could have been drawn.
To determine whether either of these postulates is reasonable, one must begin therefore with the particularly relevant matters in s 177CB(4)(a). The first of these is the substance of the scheme. Here PepsiCo submitted that the postulates represented a departure from the scheme (s 177CB(4)(a)(i)) and do not achieve the same commercial results or consequences as the schemes: s 177CB(4)(a)(ii).
The substance of the scheme: s 177CB(4)(a)(i)
It is not immediately obvious from the language of s 177CB(4)(a)(i) what the substance of a scheme might be. It could mean the legal substance of a scheme but it could equally mean its commercial and economic substance. In that sense the word ‘substance’ is ‘ambiguous’ within the meaning of s 15AB(1)(b)(i) of the Acts Interpretation Act 1901 (Cth). Consequently, resort to material not forming part of the ITAA 1936 is authorised by that provision. The permissible materials include, by s 15AB(2)(e), any explanatory memorandum that was laid before or furnished to the members of either House by a Minister when the provision was enacted. Section 177CB(4) was inserted into the ITAA 1936 by the Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act 2013 (Cth).
The Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013 (Cth) was introduced into Parliament by the then Treasurer who circulated an explanatory memorandum to its members. That memorandum observed at [1.103] that the reference to the substance of the scheme ‘requires a consideration of its commercial and economic substance as distinct from its legal shape or form’. In that regard, the diverted profits tax provisions were evidently intended to continue the approach taken to questions of substance in the context of other similar scheme provisions in Part IVA: see e.g. Commissioner of Taxation v Sleight [2004] FCAFC 94; 136 FCR 211 at 233 [81] per Hill J and Commissioner of Taxation v Hart [2004] HCA 26; 217 CLR 216 (‘Hart’) at 245 [71] per Gummow and Hayne JJ. The substance of the scheme emerges therefore from a consideration of its commercial and economic substance.
Apart from having particular regard to it, s 177CB(4)(a)(i) provides little guidance on what the Court is to do with the substance of the scheme once identified. However, the explanatory memorandum goes on to observe at [1.106] that for a postulate to constitute a reasonable alternative it ‘should correspond to the substance of the scheme’.
In this case, the Court must therefore assess the commercial and economic substance of the scheme and the commercial and economic substance of each postulate and reach a conclusion as to whether they correspond. It is necessary therefore to assess the commercial and economic substance of the scheme, on the one hand, and that of the first and the second postulates, on the other.
The commercial and economic substance of the scheme
PepsiCo submitted that the commercial and economic substance of the EBAs was that the price paid by the Bottler was for the concentrate. As it was put in argument, the price was not bifurcated and any such bifurcation would require a valuation of the relevant items. The Commissioner contended that the commercial and economic substance of the scheme was that the amount of money paid by the Bottler was for the concentrate and for the licence granted to the Bottler to use the trade marks and other intellectual property; that is to say, the commercial and economic substance of the scheme was that the payments for concentrate included a royalty for the use of the trade marks and other intellectual property.
There is nothing in the terms of the scheme from which this may be inferred and there is no evidence which could support the Commissioner’s submission.
As to the scheme, it is useful to recall its relevant components. Paragraph 67.1(a) of the Commissioner’s amended appeal statement states that the Bottler was appointed as the ‘sole and exclusive licensee to bottle, sell and distribute trademarked PepsiCo Group carbonated soft drinks’. Paragraph 67.1(c) states that the Bottler obtained, inter alia, the right to use the intellectual property owned by PepsiCo in the bottling, sale and distribution of PepsiCo beverages. Paragraph 67.1(d) states that no royalty was paid for the grant of those rights.
The scheme does not include any elements to the effect that:
(a)the grant of the licence to use the intellectual property had an economic value from PepsiCo’s perspective having regard to all of the terms of the EBA; and
(b)the concentrate price included that value.
As to the evidence, both Mr Malackowski and Ms Wright proceeded on an assumption that the concentrate price included a royalty. Their evidence did not, however, establish the correctness of that assumption. Whilst Mr Malackowski placed a value on the licence there was nothing in the evidence which could sustain a conclusion that the price charged for the concentrate included that value and, indeed, neither expert was invited to consider that question. To reach the conclusion that the concentrate price included a royalty it would be necessary to analyse the economics of the EBA, including the cost to PepsiCo of manufacturing the concentrate and the other benefits and burdens flowing to it under the EBA, and to have shown in light of those matters that the price paid by the Bottler necessarily included the value of the licence. Such an exercise was not undertaken. There was therefore no evidence which would have sustained a scheme including elements (a) and (b).
Consequently, neither the scheme advanced by the Commissioner nor any of the evidence provides material from which it may be inferred that the commercial and economic substance of the scheme was that the concentrate price included a royalty for the licence of the intellectual property.
In that circumstance, there is no basis upon which we could conclude that the price for concentrate in the scheme included a royalty component. The commercial and economic substance of the scheme was that the price agreed for concentrate was for concentrate.
We do not say that a case could not be imagined in which a concentrate price did, as a matter of commercial and economic substance, include a royalty. However, we do not see how this can be done without engaging in an analysis of the economics of the EBA. These economic questions are likely to be influenced not only by the value of the intellectual property involved but also by the other benefits and burdens flowing from the relevant EBA. As we have explained when dealing with the royalty withholding tax issue, it is not the case that PepsiCo derived no benefit from the grant of the licence to use the intellectual property. The determination of the extent of benefits of that kind is likely to involve at least an examination of the extent of the goodwill attaching to the relevant marks and PepsiCo’s market share in Australia in relation to the brands in question. Given the complexity of the bargain expressed in the EBA, there may well be many other relevant considerations.
The commercial and economic substance of the first postulate
Under the first postulate the relevant EBA is expressed so that the payments by the Bottler are for all of the property provided by (and promises made by) the PepsiCo group entities. It may be assumed in favour of the Commissioner that the grant of the licence to use the trade marks and other intellectual property was either property or a promise (although this may perhaps be doubted as a matter of intellectual property law since the licence operates as an authorisation for the purposes of the Trade Marks Act 1995 (Cth) so as to provide a defence to an action for infringement: see ss 8, 20 and 122(1)(e)).
The commercial and economic substance of the first postulate is that payment made by the Bottler for the concentrate would also be for the use of the trade marks and other intellectual property together with all of the other property and promises conferred on the Bottler under the EBAs.
Consequently, the commercial and economic substance of the scheme and the first postulate are quite different and do not correspond.
The commercial and economic substance of the second postulate
The second postulate differs from the first in that it provides that the payments by the Bottler include a royalty for the use of the trade marks. The second postulate does not require that the amount of the royalty be specified. The commercial and economic substance of the second postulate is that the payments made by the Bottler would be for concentrate and the rights to use the trade marks and other intellectual property. Again, this does not correspond to the commercial and economic substance of the scheme.
Any result or consequence for PepsiCo that is or would be achieved by the scheme (other than as a result of the ITAA 1936 or the operation of foreign law): ss 177CB(4)(a)(ii) and (5)
The difference between a result and a consequence is not self-evident. The 2013 explanatory memorandum does not contain any material throwing light on the difference. It ought not lightly be concluded that these two words are synonyms (Project Blue Sky Inc v Australian Broadcasting Authority [1998] HCA 28; 194 CLR 355 at 382 [71] per McHugh, Gummow, Kirby and Hayne JJ) as one should assume that Parliament intended from its use of different words that there was some difference. No occasion arises in this appeal, however, to consider what that difference might be.
As a matter of ordinary language ‘result or consequence’ would include all financial and non-financial results or consequences. This understanding of the meaning of ‘result and consequence’ in s 177CB(4)(a)(ii) means that the Court should consider any consequence or result for the taxpayer (apart from tax consequences or results). Again, it is necessary to consider the scheme and the two postulates separately.
The scheme
The result for PepsiCo of the scheme is that the Bottler pays an amount of money for concentrate. The scheme does not identify any particular price.
The first postulate
The result for PepsiCo of the first postulate is that the Bottler pays an amount of money but this time for concentrate and all of the other property and promises under the EBAs. Again, the postulate does not fix on any price but it may be assumed, as it was by the trial judge, that the price under the postulate is the same as the price under the scheme. Making that assumption, the amount of money received by PepsiCo under the first postulate is the same amount of money as it received under the scheme.
The second postulate
Making the same assumption, the result for PepsiCo of the second postulate is that the Bottler pays the same amount but this time for the concentrate and as a royalty for the right to use the intellectual property.
Whether first or second postulate are reasonable alternatives to the scheme
The fact that the substance of the scheme and the postulates do not correspond is indicative that the postulates are not reasonable alternatives to the scheme. On the other hand, the fact that the results and consequences for PepsiCo under the scheme and the postulates are the same tends to a conclusion that the postulates are reasonable alternatives.
The question posed by s 177CB(3) requires the Court to assess whether entry into either of the postulates is a reasonable alternative to entering into and giving effect to the scheme. It is not clear from s 177CB(3) how the reasonableness of the postulate as an alternative is to be gauged. The 2013 explanatory memorandum at [1.86]-[1.87] throws some light on this issue:
The amendment makes it clear that when postulating what might reasonably be expected to have occurred in the absence of a scheme, it is not enough to simply assume the non-existence of the scheme — the postulate must represent a reasonable alternative to the scheme, in the sense that it could reasonably take the place of the scheme.
Such a postulate will necessarily require speculation about the state of affairs that would have existed if the scheme had not been entered into or carried out. This may include speculation about the way in which connected transactions would have been modified if they had had to accommodate the absence of the scheme.
This clarifies that the inquiry is into what might reasonably be expected to have occurred in the absence of the scheme. Thus a postulate will be a reasonable alternative to the scheme if it may reasonably be expected that, but for the scheme, the taxpayer would have entered into or carried out the postulate. This is an exercise in prediction. This case is concerned with the concept of obtaining a tax benefit in connection with a scheme under s 177C(1)(bc) but the more general operation of that concept appears from s 177C(1)(a) which provides that a reference to the obtaining of a tax benefit in connection with a scheme shall be read as a reference to:
an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out
It will be observed that this provision also calls for an assessment of what might reasonably be expected to have occurred in the absence of a scheme and uses the same language of ‘might reasonably be expected’ as s 177CB(3). Of that concept the High Court observed in Commissioner of Taxation v Peabody (1994) 181 CLR 359 (‘Peabody’) at 385:
A reasonable expectation requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable [citing Dunn v Shapowloff (1978) 2 NSWLR 235 at 249 per Mahoney JA].
This is the approach which ought to be taken to s 177CB(3). In effect, the role of the postulate under s 177CB(3) is similar in kind to the prediction referred to in Peabody. In assessing the reasonableness of the postulate one must therefore ask whether it is reasonable to think that, but for the scheme, the taxpayer would have entered upon and carried into effect the postulate.
For present purposes it may be noted that the analysis in Archibald Howie was undertaken by focussing upon the legal nature of the transaction revealed by a proper construction of the agreement and analysing the nature of the consideration actually moving the transaction. Properly analysed the transaction was not the return of the amount of money that had been subscribed by the shareholder but was the discharge of the whole of the right which the shareholder had to receive a share in the assets held by the company in proportion to the shareholding. As applied to the present circumstances, such an approach requires an evaluation as to whether the transaction recorded in the EBAs which gave rise to the obligation to pay the agreed price per unit of concentrate was such that the monetary consideration actually moving the transaction included a royalty for the use of the trade marks. On the approach in Archibald Howie the answer to that question requires a proper characterisation of the transaction undertaken by reference to the terms of the EBAs construed in the context of relevant surrounding circumstances.
Next there are the three High Court cases referred to in the joint reasons, namely Davis, Dick Smith and Lend Lease.
In Davis the High Court was concerned with the application of stamp duty provisions where 57 shares held by a company were transferred to its holding company. As explained by Dixon CJ (at 405):
… the transaction is expressed as a sale and purchase of the shares in the other companies at prices which are in fact par, that is to say at £1 each. But the value of the fifty-seven shares is not £57: it is £54,382 … What the transfer meant to the holding company was a change of the form of property containing this value. That is to say, by the transfers that company would become the immediate owner of the shares which theretofore were the property of the company whose share capital it held.
The issue for the High Court in Davis concerned what was the consideration for the transfers for the purposes of stamp duty (not what the consideration was for). If the consideration was equal to the full value (by reason that the holding company did not accrete any additional value through the transaction) then the stamp duty was low. However, if the consideration for the transfer was the price of £57 then the stamp duty was considerable. Dixon CJ described the relevant inquiry as being ‘whether the consideration for the transfers if and when executed would be what is nominated in the agreement as the price or would be the full value’: at 406. As to the answer to that question, his Honour said (at 406-407):
Neither the nature nor the effect of the transaction is open to much question. The matter is really one of ‘characterisation’. Must the price be characterised as the consideration or is it proper to characterise the further elements in the transaction which determine or govern its real effect the consideration? Assuming, as I think we should, that the transfer of the shares would not deprive the transferor company of assets representing paid-up share capital, the shares to be transferred must contain, in point of value, either accumulated trading profits or some accretion to capital over and above the equivalent of the paid-up share capital of the company. Such a ‘fund’, whether real or notional, would be ‘distributable’. In any case to sell and transfer these shares to the only shareholder of the company at a price which must amount to a nominal or book price effects a ‘distribution’ of the trading or capital profit contained in or represented by the shares. It places in the shareholder’s hands the trading or capital profit contained in or represented by the shares.
His Honour went on to analyse the nature of the transaction effected by the parties. The earlier decision in Archibald Howie was distinguished on the basis that it ‘dealt with a transfer made wholly in pursuance of a resolution and order for the reduction of capital … [as] a method of effectuating the rights of shareholders’ and that was the full extent of the transaction. As to the case at hand, his Honour reasoned that the transaction having been cast as a sale and purchase of shares it could not be recast as a means of effectuating the rights in the shares. As the nature of the dealing was a sale and purchase of shares, the consideration was the price as fixed by the parties for the sale and purchase. Therefore, it was £57.
The reasoning in Davis reveals that the conclusion was reached because the legal nature of the agreement reached was one in which shares were to be transferred for a price. Applied to the present case, reasoning of that kind would only lead to the conclusion that the amounts paid in the present case were not paid as consideration for the trade marks if the EBAs were confined to expressing the terms of supply of concentrate to PepsiCo. They are not. As has been explained, the EBAs provide for much more. Therefore, Davis does not assist in resolving a case like the present where the agreement has other dimensions, save that (like Archibald Howie) it places an emphasis upon understanding the precise character of the commercial dealing effected by the terms in which the agreement is expressed.
In Dick Smith, the issue again concerned the consideration for the purposes of a dutiable transaction which involved the transfer of shares. The shares were transferred under an agreement which defined the purchase price as a specified amount ‘minus the Dividend Amount’. The ‘Dividend Amount’ was to be all retained earnings which the company was able to pay to shareholders before settlement on the purchase of the shares. Clause 5 of the agreement provided for the sales of the shares for the purchase price as defined. As to that provision, the majority (Gummow, Kirby and Hayne JJ) said at [54]:
It would be a misstatement of the operation of the Agreement, and of the transaction for which it provided, to refer simply to cl 5 and the statement therein that the Purchaser will purchase the Shares for the Purchase Price, for the conclusion that it was the receipt by the Vendors of that payment alone which supplied the monetary consideration actuating or moving the transfer of the Shares by the Vendors to the Purchaser. It is necessary to look further into the provisions of the Agreement.
(emphasis added)
The relevant statutory provision levied duty on the ‘dutiable property’ by reference to the greater of ‘the consideration (if any) for the dutiable transaction’ and ‘the unencumbered value of the dutiable property’.
Their Honours began at [71] by referring to Archibald Howie and Davis as authority for the proposition that the reference to ‘consideration’ was not to be read ‘as requiring identification of the consideration sufficient to support a contract’. Rather, it should receive its wider conveyancing meaning as ‘the money or value passing which moves the conveyance or transfer’ (quoting from Dixon J in Archibald Howie). They explained that the reference to ‘consideration for’ the transaction looks to ‘what was received by the Vendors so as to move the transfers to the Purchaser as stipulated in the Agreement’: at [72].
Regard to the terms of the agreement led the majority to conclude that the consideration which moved the transfer was the whole of the purchase price as agreed (not the amount, net of the dividend, the payment of which was required to be funded by the Purchaser by loan to the company): at [75].
In the present case the issue is of a different character. There is no dispute between the parties that the extent of the monetary consideration which was to ‘move’ under the terms of the EBAs was the agreed price per unit of concentrate. The issue concerns what moved that consideration. Was the amount of that consideration, when paid, just for the concentrate or was it paid, in part, for a licence to use the trade marks? The resolution of that question, in the manner in which the case was presented by the parties, turns upon the proper construction of the EBAs and the fact that they were performed by making payments to a Related Entity as Seller. It requires a conclusion to be reached as to whether, in those circumstances, the amount paid as the ‘price’ was only for concentrate and did not include any component for use of the trade marks.
In Lend Lease the High Court was again concerned with a dutiable transaction. In the Court’s reasons in that case it was emphasised that: ‘The search is for “what was received by the [vendor] so as to move the transfers to the [purchaser] as stipulated in the Agreement”’: at [51]. It concluded that the consideration for the land transfers that were in issue included promises of payment in the development agreement in performance of which those sales were effected and was not confined to the consideration expressed for the transfer. It was that additional consideration ‘which moved each transfer’: at [62]. The High Court reached that conclusion on the basis that the land sale contracts were made pursuant to a ‘single, integrated and indivisible’ transaction as recorded in the development agreement: at [50]-[53].
For present purposes, I would draw two propositions from these authorities when it comes to determining the monetary consideration for a transaction or dealing recorded by agreement based upon its proper construction, namely:
(1)it is first necessary to discern from the whole of the terms of the agreement the nature of the transaction or dealing that is provided for by the agreement; and
(2)the monetary consideration is that which is actuating or moving the whole of that dealing or transaction.
Turning then to the present circumstances, the amounts that are required to be paid are specified as a price per unit of concentrate. There is an obligation on the part of the Bottler to buy its requirements of concentrate only from PepsiCo (or, as has been explained, a Related Entity). However, regard to the whole of the terms of the EBAs makes plain that it is not an agreement to supply concentrate. The nature of the transaction or dealing recorded in the agreement is one in which PepsiCo appoints the Bottler to bottle, distribute and sell branded beverages. It deals with the extent of the territory for that activity. By the EBAs, the Bottler secures the licence to be able to sell branded products to its customers. The only payment that it makes for that right is the per unit price for concentrate specified in the EBA.
Importantly, the trade marks are known to the parties to be strong and valuable. That is to say they have considerable existing goodwill. If the amount that is required to be paid under the EBAs is for the concentrate alone then the right to distribute the branded products is being afforded without any part of the monetary consideration being attributable to the licence to use the valuable brands of PepsiCo. That is a commercially unreasonable view of the terms of the EBAs considered as a whole.
Finally, the operative provision of the EBAs pursuant to which the concentrate is sold and bought is a provision that binds PepsiCo on the one hand and the Bottler on the other. True it is that it allows for the Seller to be either PepsiCo or a Related Entity nominated by PepsiCo as the party who will perform that obligation and receive the amounts to be paid, but there is no agreement by the Bottler with the Related Entity recorded in the EBAs. If the Bottler ceased buying concentrate during the term, it is PepsiCo that would have a claim. Similarly, if there was a failure to pay for concentrate, the terms of the EBA meant that PepsiCo could sue to require payment to be made because failure to pay the Related Entity would be a breach of the term of the EBA by which the Bottler agreed with PepsiCo to buy the concentrate. It may be that the Related Entity could also claim on the basis of terms voluntarily agreed as between the Bottler and the Related Entity (or on some restitutionary basis in the absence of such an agreement). However, when it comes to considering who is entitled to performance of the promise to pay the specified prices in the EBAs, it is PepsiCo that is entitled to performance of that provision.
In those circumstances, regard to the whole of the terms of the EBAs reveals that the prices to be paid under the terms of the EBAs are not simply consideration for the concentrate. Rather they are also consideration moving in favour of PepsiCo for the right to use the valuable brands that are conferred by the terms of the EBAs. They are properly construed as agreements to bottle, sell and distribute branded products, not as agreements for the supply of concentrate. It follows in my view that the amounts provided for by the EBAs as the prices for units of concentrate were partly amounts in consideration for the use of the trade marks which the Bottler was licensed to use.
The fact that the EBAs included a provision by which PepsiCo as the Seller could nominate a Related Entity to be the Seller does not alter the commercial character of the EBAs that is evident from a consideration of the whole of the terms of the agreements. Nor does the fact that in the manner in which the EBAs were performed a Related Entity was nominated as the Seller and the amounts provided for by the terms of the EBAs came to be paid to the Related Entity. Rather, the part of the price specified for concentrate, remained consideration for the use of the trade marks. Which is not to say that, when received by the Related Entity, it was received by that party as a royalty. The price as agreed between PepsiCo and the Bottler in the EBA could be in consideration (as to part) for the right to use the trade marks, but when an amount calculated in the same manner is paid to the nominated Related Entity as the supplier of the concentrate it could be in consideration for the concentrate. Nor is it to say that when received by the Related Entity in return for the supply of the concentrate that the monies in the hands of the Related Entity included an amount received for and on behalf of PepsiCo. As explained in the joint reasons, the Commissioner’s case was silent as to any aspect of that kind. However, it does mean that part of the amount which was to be paid to the Related Entity as a consequence of the Related Entity being nominated by PepsiCo as the Seller for the purposes of performance of the obligation to sell concentrate under the terms of the EBA, was still an amount of money that was agreed to be paid by the Bottler partly in consideration for the use of the trade marks.
In Freedom Foods Pty Ltd v Blue Diamond Growers [2021] FCAFC 86; (2021) 286 FCR 437, I was a member of a Full Court (with Allsop CJ and Anastassiou J) that reached a similar conclusion in respect of a different agreement for different statutory purposes. The issue in that case was whether an agreement was a franchise agreement for certain regulatory purposes. The agreement in that case was an agreement by which Freedom Foods was licensed by Blue Diamond Growers to manufacture and sell almond milk products using a name and trade marks owned by Blue Diamond Growers. The only payment to be made by Freedom Foods was for the almond base which was to be used to manufacture the products to be sold under the licensed names. There was no separate licence fee for the use of the name and trade marks.
Amongst other things, in order for the licence agreement to be a franchise agreement for the purposes of the regulation it had to provide for Blue Diamond Growers to grant the right to Freedom Foods to carry on the business of offering, supplying or distributing goods or services in Australia under a Blue Diamond Growers system or marketing plan.
In considering what was provided for by the agreement for the purposes of reaching a conclusion as to whether the above requirement was met, the following conclusion was reached as to the significance of the fact that the only price to be paid was a price for almond base supplied by Blue Diamond Growers to Freedom Foods (at [66]):
It may be inferred that the price that Blue Diamond was to charge Freedom Foods for the Almond Base was to include remuneration for the value of the brands (the value of which was to be further enhanced by the ongoing marketing expenditure to be incurred by Blue Diamond) or that there was no charge for the value of that intellectual property. The latter is such an unlikely commercial position that, in the absence of the Court being taken to evidence to the contrary, it may be inferred that the Almond Base price included remuneration not just for the supply of the Almond Base.
The above reasoning was undertaken in a very different context and provides no authority as to how to approach the present statutory task. Nevertheless, it does provide an example of a different factual circumstance in which the adopted method for calculation of the monetary consideration to be paid under an agreement (per unit of product sold) does not mean that the consideration is being paid solely for that product.
Does the ‘exclusive royalty-free licence’ language in the EBA with SVC lead to a different conclusion concerning the royalty?
For reasons I have given, the fact that the EBA with SVC provided expressly that the grant of the right to use the trade marks was of ‘an exclusive royalty-free licence to use’ cannot determine what the monetary consideration provided for by the EBA was ‘for’. The provisions of the EBA with SVC are otherwise not materially different (for present purposes) from the provisions of the EBA with PepsiCo. To label the grant of the right to use the trade marks as being given ‘royalty-free’ could do no more than say that there was no monetary consideration beyond that which was provided for elsewhere in the EBA, namely in the form of a price per unit of concentrate. There remained the question whether any part of that amount when paid was paid ‘as consideration for’ the use of the trade marks. For reasons that have been given, that amount was, in part, consideration for the use of the trade marks and was therefore a royalty to that extent.
Whether the amounts paid constituted income derived by PepsiCo and SVC?
As has been explained, in order for a liability to withholding tax to be imposed, the amount derived by a non-resident that consists of a royalty must also be income of PepsiCo or SVC as the case may be.
The trial judge concluded that the relevant portions of the amounts paid by the Bottler to the Related Entity were income derived by PepsiCo and SVC and were amounts to which they were beneficially entitled. His Honour said that this conclusion ‘follows as a matter of contract from the fact that PepsiCo and SVC were the parties to the EBAs and [the Bottler’s] payment obligations under the EBAs were owed to them’: at TJ[255]. Respectfully, I do not accept that to be the case. As has been explained, if a Related Entity was nominated the Seller (as was the case) then the obligation to buy the concentrate from PepsiCo or SVC (as the case may be) became an obligation to buy from the Related Entity. Admittedly it was the case that the party entitled to enforce performance in that way remained PepsiCo or SVC. But the obligation became one which required the Bottler to buy from the Related Entity (and to make payment of the price per unit to that Related Entity). In effect, the nomination of the Related Entity as the Seller directed the benefit of the payment required by the EBAs to the Related Entity. Once the nomination was made, all of the amounts to be paid upon supply of the concentrate were owed to the Related Entity as the Seller. This position is reinforced by regard to the manner in which the supply of concentrate was actually effected by the Australian subsidiary as the Seller.
Therefore, it was not the case that the amounts that were paid by the Bottler to the Related Entity were ‘owed’ to PepsiCo or SVC (as the case may be).
Respectfully, I agree with Perram and Jackman JJ for the reasons they give that the payments made by the Bottler received by the Related Entity did not result in the derivation of income by PepsiCo or SVC (as the case may be).
Conclusion as to withholding tax appeal
It follows from the conclusion as to derivation of income that PepsiCo and SVC have demonstrated that the trial judge was in error in concluding that the terms of s 128B(2B) were met in the circumstances of the present case. Their appeals must be upheld.
The diverted profits tax appeal
The relevant statutory provisions are carefully considered in the joint reasons of Perram and Jackman JJ. For the reasons there given, if I am wrong in my view that the amounts paid by the Bottler consisted of a royalty because they were paid as consideration for the use of the trade marks then, with respect, I agree that for the reasons expressed in the joint reasons, that the diverted profits appeal must fail.
However, there remains the issue whether the diverted profits tax appeal can and should be upheld on the basis of the conclusions I have reached to the effect that the EBAs provided for the payment of amounts that were, in part, as consideration for the use of the trade marks. On the conclusion I have reached, it is the mechanism by which the Related Entity could be nominated as the Seller (and be the party to whom payment would be made) that means that there is no income in the form of a royalty that may be the subject of a withholding tax liability on the part of PepsiCo or SVC (as the case may be). Therefore, on the conclusions I have reached in the context of the withholding tax appeal, different questions arise to those considered in the joint reasons.
The possibility that the scheme case may arise for consideration in the circumstances I have found was raised in the course of oral argument. Counsel for PepsiCo and SVC accepted that the scheme case would still need to be considered in such circumstances.
The schemes as alleged by the Commissioner are set out in the joint reasons. They allege, in effect, that by entering into the EBAs, PepsiCo and SVC appointed the Bottler to bottle, sell and distribute branded beverages on terms that required the purchase of concentrate and conferred the right to use the trade marks, but that they did so in circumstances where ‘no royalty was paid’ for the licence to use the trade marks.
As to the relevant tax benefit that is required for the scheme provisions to apply and the operation of those provisions, I agree with the analysis in the joint reasons.
Much of the case advanced for PepsiCo (or SVC) as to why the trial judge was in error in finding (on the assumption that there was no withholding tax liability) that the diverted profits tax provisions applied involved submissions as to why the payment of monetary consideration by way of royalty for the licence to use the trade marks was not essential to the commercial character of the dealings with the Bottler. However, those submissions presumed a finding to the effect that in the EBAs there was no amount included in the price per unit of concentrate that was for the licence to use the trade marks. For reasons that have been given, I do not accept that premise. Therefore, in my respectful view, the application of the scheme provisions fall to be considered in respect of a transaction which includes an amount which is consideration for the use of the trade marks.
On the conclusion that I have reached concerning the royalty question, the EBAs resulted in a tax benefit because, if the EBAs had not been entered into, then a reasonable postulate was that the EBAs would have provided for the royalty to be paid to PepsiCo or SVC (as the case may be) as the holder of the rights to the trade mark.
The second of the reasonable alternatives advanced by the Commissioner as the basis for the contention that tax effects would have occurred if the scheme had not been entered into, was that the EBAs would have, or might reasonably be expected to have, expressly provided for the payments to be made by the Bottler to include a royalty for the use of the trade marks. Given that the claim made was that there was a diverted profits tax liability that would support the assessments that had been issued to PepsiCo and SVC, the postulate advanced by the Commissioner must refer to an express provision for a royalty to be paid to PepsiCo or SVC (as the case may be).
It follows that the reasonable postulate that I have described is consistent with the second of the alternatives advanced by the Commissioner. In any event, as the joint reasons explain, it is the burden of PepsiCo and SVC to prove that there was no reasonable alternative to entering into the scheme and for the reasons I have given they have not done so.
Therefore, it is necessary to consider the principal purpose of PepsiCo and SVC (as the case may be) in entering into and carrying out the scheme in order to determine whether the requirements of s 177J(1)(b) are met. As to the requirements to be met, I agree with the analysis in the joint reasons. Their Honours have undertaken their analysis of purpose on the basis of an assumption which equates to my findings. On that basis their Honours would have concluded that the requisite purpose would have been established. Respectfully, I agree with their analysis.
Conclusion as to diverted profits tax appeals
For those reasons, I would uphold the Commissioner’s appeals.
Conclusion
For those reasons, I would join in the orders allowing the appeals by PepsiCo and SVC. However, I would allow the Commissioner’s appeals. I would have heard from the parties on the question of costs, but as I am in a minority the appropriate order as to costs is properly determined by Perram and Jackman JJ.
I certify that the preceding eighty-five (85) numbered paragraphs are a true copy of the Reasons for Judgment of the Honourable Justice Colvin. Associate:
Dated: 26 June 2024
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