Brazil software taxation
- Nov 28, 2017 | Richard Asquith
Software Taxation in Brazil - New Tax War among States and Municipalities promises to raise a lot of issues to taxpayers in 2018
The understanding that had been pacified by the Supreme Court's jurisprudence (RE 176.626-3) on the software tax rule fell at the end of 2017. This change is generating legal uncertainty for all companies in the technology sector located in São Paulo, both those that market so-called shelf software as well as those that provide SaaS (software as s service).
States and Municipalities had been subscribing to the Supreme Court's understanding that shelf software should be taxed exclusively by the ICMS (State taxation) and on-demand software, software development and SaaS should be taxed exclusively by the ISS (City taxation).
However, at the end of 2015, CONFAZ (organization that represents all 27 States) published the ICMS Decision No. 181, establishing the competence of States to tax, through the ICMS, the operations involving software. The definition of software is very broad and includes programs, electronic games, applications, data storage, including standard software whether it has been or can be adapted. It is also independent of how it is made available, on-premises, SaaS or including operations carried out through electronic data transfer. According to this Decision, States would be allowed to grant a reduction in the ICMS tax base, so that the tax burden corresponds to the percentage of at least 5% (five percent) of the value of the operation. Prior to this decision, software was taxed by the city tax ISS which is capped at 5%.
In compliance with the provisions of said Decision, the State of São Paulo published the Decree nº 61.791 and Normative Decision nº CAT 04/2017, ratifying their understanding in order to confirm that there is an ICMS assessment in operations with software as defined above regardless of how they are distributed on a large scale physically in a store or on as a digital medium through download or streaming ("in the cloud") considering either case to be software distribution. In this way, the State of São Paulo has established that any type of software, regardless of the way it is marketed, is subject to ICMS.
On the other hand, in 2017, the Municipality of São Paulo (note that the State and City by the same name are distinct tax authorities) also adopted a bold strategy and published Normative Opinion SF nº 01/2017, aiming to establish their interpretation that the legislation establishes ISS taxation rules on computer programs applies to all businesses segments operating within the municipal boundaries. According to the São Paulo Municipality, the licensing or assignment of the right to use computer programs, by means of physical deployment or by electronic transfer of data (software download), or when installed on an external server (Software as a Service - SaaS), is subject to the ISS taxation. In addition, it has been maintained that the framework dealt with in the aforementioned normative opinion does not depend on the software having been programmed or adapted to meet the specific needs of the borrower ("software to order") or to be standardized ("shelf software" or "off the shelf"). That is, the City also understands that all types of software will be taxed by the ISS. The idea of the City Hall was to standardize the interpretation of the ISS assessment on software and establish legal certainty to the taxpayers, but ended up going much further and causing legal uncertainty. Therefore, tax chaos is set in the technology sector in São Paulo. Besides the conflict established among States and Municipalities, the Municipality of São Paulo also determined that in relation to SaaS taxation, the framework of the service in sub-item 1.05 of the municipal list of services, whose rate is 2%, does not affect the setting of part of its contracting in the subitems 1.03 (Data processing and similar) and 1.07 (Technical support in computer science, including installation, configuration and maintenance of computer programs and databases), whose ISS rates are 5% and 3%, respectively. This means that all taxpayers who have SaaS-related activities and who are setting up their services solely and exclusively as "software licensing", subject to a 2% rate, may suffer City inquiries and tax assessments in order to collect the difference of 2% to 3% and 5% on part of the contracted services, plus the penalties. It is important to mention that the City of São Paulo, the largest city in Brazil, has been a leader in setting standards, proactively enforcing rules and regulations and creating new compliance requirements. These actions are very often adopted by other cities across the country. This dispute between the State of São Paulo and its state capital can soon spread and involve several states and many of the 5270 cities in Brazil. Faced with this complex scenario, we recommend that all companies in the Brazilian technology sector, located in São Paulo, analyze the impacts of these new determination on their activities, adjusting what is necessary to minimize fiscal risks and prevent the increase in their tax burden.