STF rules that ISS should be levied over software transactions
On 18th February 2021, the Brazilian Supreme Court (“STF”) ended a dispute of many years and ruled that Municipal Service Tax (“ISS”) is the correct tax to be levied on software transactions, especially in respect of software licensing and use assignment transactions.
The understanding handed down more than two decades ago, in the sense that State Value Added Tax (“ICMS”) should be applied to off-the-shelf software and that ISS on customizable software was outdated and did not follow the technological innovations incurred in the sector.
While States considered that such transactions were subject to ICMS (usually levied at rates ranging between 5% and 18%) in view of the interpretation that it was an intangible good, Municipalities and taxpayers, in general, argued that ISS should be levied on such transactions (with rates ranging between 2% and 5%) due to the lack of transfer of ownership and inclusion of such transactions in services depicted in Supplementary Law No. 116/2003, which lists services subject to ISS.
Such decision changed the prevailing case law regarding the matter and impacts IT companies all over the country, since they had been waiting for a final decision to be rendered to have legal certainty on how to conduct their activities. Pursuant to the fact that the applicable tax was still under dispute, companies filed lawsuits seeking that the Judiciary define the correct tax to be applied to in their transactions, while others simply chose to collect a specific tax (or even neither of them) exposing themselves to the risk of potential tax assessments by the authorities.
On 24th February 2021, the STF ruled on the modulation of the effects of the decision in relation to potential charges by States and Municipalities for past transactions, as well as the recovery of amounts unduly paid by taxpayers. On such occasion, eight different solutions were established by the STF. In short, Municipalities will only be authorized to charge retroactively the cases in which no tax has been collected. Additionally, taxpayers may only apply for a refund of the ICMS amount to States in the cases where the payment of both taxes has been effected.
Under this new scenario, IT companies will no longer need to enrol with the State Tax Authority at the time of their incorporation, a requirement that had been triggered automatically by the State Authority at that stage, and which also required the need for physical and segregated premises (which was not always possible or available at the time of the company’s incorporation, particularly when the company was a subsidiary of a foreign IT company). Therefore, the judgment will not only produce a lower tax burden for the technology sector, but will also bring less complexity to the company’s operations, whether in relation to the calculation of the tax itself (since the ISS offers less complexity in ancillary obligations when compared to those pertaining to ICMS) or even in relation to the bureaucracy imposed on companies that wish to start their activities in Brazil in this sector.