Brazil’s Supreme Court takes up taxation of software downloads

By Francisco Lisboa Moreira &  Rachel Mira Lagos, Bocater Advogados, Brazil

Brazil’s Supreme Court is expected to soon clarify the taxation of activities related to the digital economy and the services connected to the world wide web.

A majority of the 11 justices on Brazil’s Supreme Court have concluded in two cases that a software download should be considered services rather than a sale of goods for tax purposes. However, on November 11, newly appointed Justice Nunes Marques asked for a review of the cases, which stayed the judgment.

While the dispute concerns the appropriateness of ISS and ICMS levies, which are Brazilian sales taxes, the Supreme Court’s guidance is expected to provide clarity regarding indirect taxes that may be levied on such activities. 

Indirect Tax treatment of Software

Brazil’s Supreme Court has not analyzed software licensing and its taxation since the mid-’90s.

The prevailing jurisprudence has concluded that a software sale, when sold as a bundle, is a sale of a tangible good, treated as merchandise and, as such, is subject to the Imposto Sobre Circulação de Mercadorias e Serviços (ICMS). The ICMS is a tax on the transfer of goods levied by Brazil’s 27 States and the Federal District,  and operates in a way that resembles a VAT.

We must remember that in the past, software was sold on a physical support (CD or DVD), and the sale of a good, the CD or DVD, attracted the levy of the ICMS.  

Technology has changed dramatically over time, though, not only from the standpoint of software, which was previously only sold with physical support, like a floppy disk or a CD-ROM, but also the technologies offered, like continuous updates and changes in licensing forms (lifetime or provisory).  

ADI No. 1945

On April 17, the Brazilian Supreme Court began considering (virtual chamber) direct action of unconstitutionality (Ação Direta de Inconstitucionalidade or ADI) No. 1945, brought in 1999 by the political party PMDB.

ADI No. 1945 challenges the Brazilian state of Mato Grosso’s law n. 7.098/98, which imposes the ICMS levy on software operations, even if performed by a data download.

The case had been included in the Supreme Court’s trial list three times but was removed for various reasons. Many believe the case was delayed so the Court could render a comprehensive decision that included other forms of software sales, including hosting and streaming.  

After trial, Justices Carmén Lucia (Rapporteur) and Edson Fachin voted to basically continue the ICMS levy.

Supreme Court president Justice Dias Toffoli then asked for a review of the decision. Justice Toffoli was the Rapporteur for another case, ADI No. 5659, filed by the National Service Confederation, which challenged a similar law imposing the ICMS levy on software by the Brazilian state of Minas Gerais.  

On November 4, the Supreme Court continued the judgment, now together, of ADI No.1945 and ADI No. 5659. Justice Toffoli then voted in support of the levy of Brazil’s service tax (ISS) on licensing or right to use of software programs.

For him, software licensing or the right to use software, either standard or customized, should be placed in item 1.05 of the service list attached to the Complementary law 116/03, regardless of whether the transfer of use takes place via download or through cloud access.  

Software as a service

In Justice Toffoli’s view, software is a service that results from human effort (an obligation to perform something), which derives from intellectual efforts. Also, there are other services usually provided for the user, such as help desk, instruction manuals, technological and other functions foreseen in the licensing contract. He concluded this decision should be applied prospectively only.

The following Justices agreed: Alexandre de Moraes, Luís Roberto Barroso, Rosa Weber, and Ricardo Lewandowski. Justice Marco Aurélio also agreed but was against applying the decision on a prospective basis only.  

Later, Justices Edson Fachin and Gilmar Mendes, and Carmen Lúcia ruled that the ICMS levy on goods/merchandise should apply to standard software (or off-the-shelf).

In their view, when the intellectual creation is produced in a series, and there is a mercantile activity, the ICMS and not the ISS should prevail. Software should not be considered a good if a developer is engaged to produce it on demand (personalized software), though.

After the votes of nine justices, six favoring the service tax on licensing or granting of the right to use software programs, and three favoring the ICMS levy on sales of goods, Justice Luiz Fux, the new president of the Supreme Court, announced his decision following Justice Toffoli.

Then, on November 11, newly-appointed Justice Nunes Marques asked for a review, which stayed the judgment once again.

Other cases

While the taxation of software remained unresolved, the states returned to charging ICMS on sales. This time, tax was imposed on the licensing itself, whether or not a physical good was included, with or without a transfer of ownership, creating a conflict between states and municipalities.  

Besides these two lawsuits, there are apparently three other lawsuits pending analysis in the Supreme Court addressing the taxation of software transactions: ADI No. 5576, filed by CNS and challenging Decree 61.791/16 of São Paulo state; ADI No. 5958, filed by the Brazilian Association of Information Technology and Communication – BRASSCOM, which challenges the ICMS state Agreement 106/17; and, finally, the extraordinary appeal 688.223, interposed by TIM, which challenges the ISS on licensing and right to use of customized software. 

The finalization of this Supreme Court judgment may soon provide Brazilian taxpayers with a conceptual coherence of activities that relate to the digital economy and the services connected to the world wide web, not only with reference to the effects on the ISS and ICMS levies but also from other taxes that may be levied on such activities.