Brazil: A Possible New Future for Digital Taxation

Addressing the taxation of goods and services in Brazil has been a challenge for several decades, especially in view of the substantially different tax treatment of each one. One of the main challenges in this regard results from the fact that Brazil splits the taxation of goods and services mainly between the State VAT (ICMS) – levied on transactions with goods – and the Municipal Service Tax (ISS) – levied on other services listed in the law.

Such controversies have taken even greater proportion in connection with the taxation on the digital economy, as Brazilian laws are not clear as regards the nature of the digital goods that are marketed (be they goods or services).

In the late 1990s, the Brazilian Federal Supreme Court (STF) analysed two cases regarding the taxation of software, understanding that: (a) the licensing of the rights to use a software between its owner (licensor) and the licensee is not a transaction with goods subject to the ICMS; and (b) the sales of physical copies of standard software in stores are transactions with goods subject to the ICMS. Also, it was acknowledged that it is possible to request the development of a software from scratch (tailor-made), which could typify a service.

Based on these decisions, the lower courts and federal and state tax authorities have construed an interpretation in which: the marketing of standard software is considered as a transaction of goods subject to the ICMS, regardless of whether they are delivered by physical means or by download; and the development of a software by order is considered as a service subject to the ISS. However, municipalities never agreed upon such interpretation, as the licensing of the rights to use software is legally considered as service subject to the ISS, thus charging this tax on any transaction with software.

In October 2020, the STF has begun judging Direct Actions of Unconstitutionality (ADI) 1945 and 5659, in which it evaluates the constitutionality of state law on the levy of the ICMS on transactions with software delivered by means of download. The majority of STF Justices has voted against the levy of the ICMS on software licensing agreements, pending the opinion of one Justice.

Based on this judgement, it is possible to predict a substantial change in the current case law and tax authorities’ approach towards software taxation, under which – regardless of the type of software and its form of delivery – it cannot be considered as a transaction with goods. As a result, there will be legal grounds to construe that transactions with software are considered as a service for tax purposes. Hence, the conflict between the levy of the ICMS and ISS is most likely resolved in favour of the municipalities.

Aside from the revolution regarding the generally accepted tax treatment of software, a revision of the approach of the federal tax authorities – which accept that transactions with standard software should be taxed as transactions with goods – can be expected. Such revision might substantially increase the tax burden on the import of software by download because, on the one hand, as bodyless goods, transactions were generally not subject to customs taxation and, on the other hand, as a service, it will be subject to a heavy tax burden.

With the expected conclusion of the STF judgement in 2021, a new year will most likely bring a new future for the taxation of software in Brazil.

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