Brazil: Brazilian Tax Review - December 2017

States vs. Municipalities: ICMS Agreement 106/2017 Enhances the Conflict over Digital Goods Taxation (including Streaming and Software)

There is an ongoing and significant conflict in Brazil between states and municipalities to decide who has the power to tax transactions involving digital goods, including streaming services and software, especially after the recent approval of ICMS Agreement 106/2017 by the states.

Regarding software, the dispute involves a historical position of the Brazilian Constitutional Court (STF) that standard software ("off-the shelf") distributed through retail stores is a good and, for this reason, should be subject to the Tax on the Circulation of Merchandise and Services (Imposto sobre Circulação de Mercadorias e Serviços), or ICMS, which is a state tax, whenever distributed in a physical medium (CD-ROMs etc.).

However, subsequently to the consolidation of the precedent, the Brazilian Congress passed Supplementary Law 106/2003, which lists software licensing as a service subject to the Service Tax (Imposto sobre Serviços), or ISS, which is a municipal tax. More recently, in 2010, and in a preliminary injunction, the STF allowed the ICMS to be collected even when the software is purchased through download, with no physical medium (even thought this case has not been finally decided yet).

As a result, even though in theory the ICMS and ISS taxes cannot be levied on the same transaction, based on the precedents, states are now charging ICMS on downloaded software under the argument that, despite its intangibility, it still could be deemed a good. The same rational applies to other digital goods.

With respect to streaming, similarly to software, the Brazilian Congress has recently passed Supplementary Law 157/2016, which lists streaming as a service for ISS purposes. Yet again, the states are ignoring this and considering this service to be subject to the ICMS.

Litigation will possibly be needed to resolve this dispute since it is likely both states and municipalities will continue levying the ICMS and ISS taxes on the same taxable events.

New Rules to Change Investment Fund Taxation in Brazil

On October 30, 2017, the Brazilian government published Provisional Measure 806/2017, which makes significant changes to the tax treatment of certain types of Brazilian investment funds, as described below.

Closed-End Funds ("Fundos de Investimento Fechados") – From May 2018, investors will be subject to automatic withholding income taxation on a semi-annual basis (every May and November). Currently, investors must pay income tax only on the redemption or amortization of their fund shares.

Private Equity Funds ("FIP") – From January of 2018, FIPs will be classified either as "investment entities" or as "non-investment entities," with the following tax consequences:

(i) "investment entities" – income earned as a result of the disposal of any of their investments will be automatically subject to the withholding income tax (if the gains exceed the paid-in capital of the FIP), regardless of distribution to the investors, i.e., the tax deferral will no longer be applicable; and

(ii) "non-investment entities" – will be subject to the same taxation applicable to Brazilian corporations. The income and capital gains that have not been distributed to the shareholders will be deemed distributed on January 2, 2018, for withholding income tax purposes.

The tax treatment of Real Estate Investment Funds ("FII"), Distressed Asset Funds ("FIDC") and Equity Investment Funds ("FIA") remains unchanged.

Brazil-Russia DTC Finally Comes into Force

The Double Taxation Convention signed with Russia was finally enacted by Presidential Decree 9,115/2017, becoming effective in Brazil on August 1, 2017. Even though the convention was signed back in 2004, it was only analyzed by the Brazilian Senate and sent for the Presidential approval in 2017.

CARF Holds that CIDE-Royalties Are Not Levied on Withholding Income Tax (IRRF) and Should Not Be Collected Before the Actual Remittance

In a recent decision, the CARF held that the Contribution on the Importation of Technology and Technical Services (CIDE-Royalties) levied on the remittances of royalties to non-residents, under the scope of a franchising agreement, must be collected upon the remuneration outflow to the beneficiary abroad. Thus, tax authorities cannot charge the contribution based solely on the liability accrued in the taxpayer's financial statements, if the remuneration has not yet been effectively paid.

Additionally, the calculation basis is the non-resident's remuneration, as set forth in the agreement. Therefore, the CIDE-Royalties' calculation basis must not include an occasional grossed-up withholding income tax.

Superior Court of Justice Considers Presumed ICMS Credits as Investments Subsidies for Federal Taxes Purposes

An important decision has recently been issued by the Superior Court of Justice (STJ), stating that presumed ICMS credits should be treated as an investment subsidy, which means they are not considered revenue for PIS, COFINS, Social Contribution on Net Profits (CSLL) and Income Tax (IRPJ) purposes. This decision is contrary to the Federal Revenue Office's position on this matter, which maintains they are subject to federal taxes.

In the same regard, the Brazilian Congress has overridden the presidential veto on this matter that was in the original text of the Supplementary Law 160/2017, which makes these amounts not subject to federal taxes in the future.

CARF Analyses IOF Taxation on Cash Pooling Arrangements

According to Law 9,779/99, the Financial Transaction Tax (Imposto sobre Operações Financeiras), or IOF, must be paid on loan agreements, including transactions conducted outside the financial system (i.e., entered into between non-financial private companies). However, it is not clear in the legislation if the cash pooling performed among related parties characterizes loan agreements or not.    

After analyzing a similar case, the Federal Tax Tribunal (CARF) held that cash pooling arrangements results in disposal of cash among the parties, which meets the definition of a loan agreement for IOF purposes. Therefore, the CARF decided that such arrangements must be taxed by IOF.

Brazilian IRS Requires Taxpayers to Register Remittances Abroad Related to Software Licensing as Royalties

The Brazilian IRS disclosed its position with respect to the obligation of taxpayers to register remittances for software licensing as royalties. This position was stated in Ruling 499/2017, issued in response to a request for a private letter ruling filed by an agent who has a distribution agreement with a license owner and was remitting payments for the rights to distribute a program in Brazil.

The IRS has deemed commercial rights as royalties for all purposes, which may affect its tax treatment in Brazil and forces taxpayers to collect the Withholding Tax (IRRF) and CIDE.

In addition, failure register the remittances on the SISCOSERV system would be subject to a fine on the amount remitted.

Interest Paid by Customers to Retailers Should Not be Considered Financial Revenue

The Superior Court of Justice (STJ) has ruled that the interest that customers pay to retail stores due to the acquisition of goods in installments cannot be deemed financial revenues and, thus, should be subject to regular Social Integration Program Tax (Programa de Integração Social), or PIS, and Social Security Financing Tax (Contribuição para o Financiamento da Seguridade Social), or COFINS, taxation at a 9.25% rate.

Financial earnings were not subject to PIS and COFINS until July 2015, when a Decree imposed a 4.65% rate. In view of that, according to the STJ's position, these earnings should now be fully subject to PIS and COFINS taxation at the regular 9.25% rate instead of the 4.65% applicable to financial revenue.

It is still possible to appeal to the Brazilian Constitutional Court (STF).

CARF Holds that Refund of Tax Credits obtained in judicial decisions Is Subject to Income Tax at Different Times

The Brazilian Federal Tax Tribunal (CARF) has analyzed the income tax incident on tax refunds gained through a judicial decision. In the specific case, the final judicial decision did not assess the amount to be refund but authorized the offset of the credits by the taxpayer before the end of the award calculation phase.

The Decision holds that tax refunds derived from judicial decisions must be included in taxable profit, for income tax purposes, on an accrual basis. In general, the revenue must be accrued within the final judicial decision, as long as the amount to be granted to the taxpayer is irrefutable, liquid and collectable.

However, if the judicial decision might be subject to enforcement or any incidental proceeding, the revenue must be accrued: (i) at the end of the enforcement/incidental proceeding; or (ii) insofar as the credits are offset by the taxpayer, if the judicial decision allows this previous compensation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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