Australia: PepsiCo decision, petroleum taxation, and BEPS pillar two legislation

On June 26 2024, the Full Federal Court overturned the first-instance decision of the Federal Court and ruled in favour of the taxpayer, PepsiCo, Inc. (PepsiCo), in a landmark decision.

The court held, firstly, that payments made under two exclusive bottling agreements (EBAs) were not subject to royalty withholding tax (RWT) and, secondly (by majority), that diverted profits tax (DPT) would not apply (with Colvin J., in minority, holding that DPT should apply).

Under the two EBAs involving PepsiCo and Stokely-Van Camp, Inc., two US resident companies, Schweppes Australia Pty. Ltd., the sole distributor and bottler in Australia, was provided with beverage concentrate to produce finished beverages for retail sale in Australia, and an express or implied licence of trademarks and other intellectual property (including brands) covering carbonated soft drinks and non-carbonated beverages.

The approach of the three Federal Court judges (including Perram and Jackman J.J. in the majority) to the two key taxation issues – i.e., RWT and DPT – varies significantly from that of the trial judge, Moshinsky J., and, among other matters, focused intensely on a detailed contractual interpretation of the EBAs, the central rights sought and obtained by the parties, reference to significant stamp duty case precedent, “commercial and economic substance”, and a simplistic approach to contractual arrangements and reasonable alternative postulates.

Given the divergence in views on, and approaches to, the critical tax and related issues of the four Federal Court judges that have now opined on the PepsiCo scenario, and the critically important precedent of this case, particularly relating to DPT, the Australian Taxation Office (ATO) may seek leave to appeal to the High Court of Australia on this important decision.

This is a significant case in Australia given the ATO's focus on intangible arrangements and represents the first time the DPT has been considered in court. Furthermore, this decision and any further appeals will likely impact on the proposed penalty provision applicable to mischaracterised or undervalued royalty payments, to which RWT would apply, as announced in the May 2024 Federal Budget and applicable from July 1 2026.

As the then government stated in introducing the DPT in 2017, Australia is at the forefront of the international fight against tax avoidance.

This bill has passed both houses of Parliament and is now awaiting royal assent. The key measures in this bill are:

• Petroleum resource rent tax (PRRT)-specific anti-avoidance rules for the offshore resources sector – broadly, the legislation aims to strengthen these anti-avoidance rules and to more closely align the PRRT anti-avoidance rules with the income tax general anti-avoidance rule, including adopting the more specific ‘sole or dominant purpose’ test relating to a taxpayer securing a particular tax benefit in connection with a scheme. The amending legislation also adopts a more prescriptive approach to determining the ‘alternative postulate’ in relation to the relevant taxpayer’s potential alternative arrangements. These legislative amendments apply to any arrangement that was entered into on or after July 1 2023.

• Mining, quarrying, or prospecting rights (MQPRs) – these amendments provide for the following:

  • The reference to “exploration for petroleum” in the Petroleum Resource Rent Tax Assessment Act 1987 is limited to discovering petroleum, identifying the extent of discovered petroleum, or identifying the nature of discovered petroleum. That reference does not extend to determining the commercial viability, economic feasibility, or technical feasibility in relation to the recovery of petroleum or how to recover any petroleum – this amendment applies to all expenditure incurred from August 21 2013.

  • Limit when the ‘first use’ of an MQPR occurs, by specifying that first use starts when an activity that is authorised by the mining right is undertaken, and not just when the MQPR begins to be held.

  • Clarify that an income tax balancing adjustment does not occur in relation to a new MQPR in circumstances where the new MQPR is granted over an area that is the same or part of the area governed by an existing MQPR.

The amendments in the second and third limb above apply in respect of an MQPR that an entity started to hold after May 9 2023.

This bill has received royal assent and is now law. Briefly, this legislation, among other things, introduces a PRRT deductions cap that will take effect from July 1 2023. Broadly, if the cap applies to a taxpayer, the taxpayer will be deemed to have a taxable profit of 10% of the assessable receipts derived from the project in the relevant year of tax. This effectively limits deductible expenditure to 90% of the project’s assessable receipts in that tax year.

Amounts that cannot be deducted due to the cap can be carried forward, and can be uplifted at the government long-term bond rate. Projects will not be subject to the cap until seven years after the year of first production or July 1 2023, whichever is later.

The government has introduced a series of bills to the House of Representatives implementing the OECD's pillar two measures.

The bills propose to set a 15% global minimum tax and domestic minimum tax for all multinational enterprise groups with an annual global revenue of at least €750 million (approximately A$1.2 billion). The bills introduced are the:

• Taxation (Multinational – Global and Domestic Minimum Tax) Bill 2024, which implements the framework for the imposition of top-up tax for the income inclusion rule (IIR), the undertaxed profits rule (UTPR), and the domestic minimum tax (DMT) consistent with the GloBE Rules;

• Taxation (Multinational – Global and Domestic Minimum Tax) Imposition Bill 2024, which imposes top-up tax; namely, Australian DMT, Australian IIR tax, and Australian UTPR tax; and

• Treasury Laws Amendment (Multinational – Global and Domestic Minimum Tax) (Consequential) Bill 2024, which contains related miscellaneous provisions necessary for the administration of top-up tax.