The beverage and food multinational sued the IRS in 2009, after the service sent the firm a bill alleging that millions were owed in unpaid tax.
The IRS claimed that payments sent from subsidiaries in Holland constituted debt interest on promissory notes handed out by PepsiCo in the US, and were thus subject to corporate income tax from 1998 to 2002 totaling circa. $200m.
PepsiCo Puerto Rico also owed circa. $165m for the same taxable period, the IRS claimed.
Race with Coca-Cola
Judge Joseph Goeke explained in a complex, 99-page ruling , that, prior to US Dutch tax treaty agreement changes in 1996, PepsiCo had developed ‘foreign partnerships’ controlled by Dutch Antillean subsidiaries, covering Poland, Germany, France, the Czech Republic, Spain, Slovakia, Hungary and China.
“By the mid-1990s PepsiCo recognized certain business opportunities were materializing in both new and existing international markets in which its primary competitor, Coca-Cola, was not the dominant soft drink brand,” Goeke wrote.
Specifically, PepsiCo saw opportunities in Eastern Europe after the Berlin Wall fell in 1989, while “once dormant” Asian markets were on the rise, Goeke added. But the firm needed to spend billions of dollars on capital investments to establish itself in these areas.
Goeke said that the tax regime changes led PepsiCo to transfer ownership of its foreign partnerships (above) from Dutch Antillean to Dutch holding companies in the late 1990s.
Thus, these partnerships passed to the contol of Dutch subsidiaries PepsiCo Global Investments (PGI) and PepsiCo Worldwide Investments (PWI), which were issued new promissory notes by PepsiCo in theUSto fund investments in these markets.
Goeke explained that PepsiCo developed ‘hybrid securities’ via “legitimate tax planning” that were classed as debt inHolland (under Dutch tax law) but equity for US Federal income tax purposes; the case turned on their classification in this respect.
PepsiCo successfully argued that it held an equity stake in its Dutch subsidiaries PGI and PWI, and payments made by them to its US base were thus non-taxable returns on capital expenditure in the said markets.
Speculative foreign investments
Goeke agreed, stating that the money had been lent for “speculative investments in undeveloped foreign markets”, where a lack of security regarding repayment and schedules to govern this were factors that struck out a debt-based relationship for the securities.
The judge concluded that the principle issue centered on the IRS assertion that the transactions in question evinced a clear intention to structure creditor-debtor arrangements.
PepsiCo Inc. and its affiliates disputed that characterization, he said, insisting instead that the advance agreements were legitimate equity instruments for Federal income tax purposes.
“We find [the] petitioners’ argument to be more persuasive,” Goeke wrote.
