Originally published in the June 4 edition of World Tax Daily (Copyrights Tax Analysts)
Brazil’s Supreme Court (Supremo Tribunal Federal, or STF) on May 26, by a majority vote, delivered an important preliminary decision on the application of the state VAT (ICMS) to software, ruling that ICMS may be applied to sales of off-the-shelf software and software licensing (including downloadable software).
The decision was delivered upon preliminary review of a request in Direct Action of Unconstitutionality (Ação Direta de Inconstitucionalidade, or ADIn) No. 1945, filed in January 1999 by the Brazilian Democratic Movement Party (PMDB), to suspend the legal effects of state law 7,098/1998, enacted by the state of Mato Grosso. The action requested an injunction to suspend the effects of article 2 of the law, which establishes the levy of ICMS on any transaction (sale) of a computer program, including those via electronic transfers (download).
When the action was filed in 1999, STF Justice Octávio Galotti (now retired) delivered a preliminary opinion that the court partially accept PMDB’s arguments to suspend the state law. Justice Galotti held that ICMS should not apply to downloadable software or software licensing but that off-the-shelf software, produced in large scale, should be treated as any other tangible good and fully subject to ICMS.
In 2006, STF Justice Nelson Jobim (also retired) delivered an opinion that ICMS should apply to any software produced in large scale, whether tangible or intangible — including software licensing and downloadable software. This opinion also regarded the injunction requested by PMDB, not the merits of the case.
At the May 26 session, the STF finally ruled on PMDB’s injunction request to suspend the state VAT on software. STF Justices Ricardo Lewandowski, Marco Aurélio, and Celso de Mello agreed with Justice Galotti that ICMS on intangible software should be suspended, while Justices Gilmar Mendes, Dias Toffoli, Eros Grau, Ayres Britto, and Cezar Peluso agreed with Justice Jobim that ICMS should be fully applicable to software.
The practical effect of the decision is that state law 7,098/1998 continues to be as fully effective and enforceable as it has been for the last 12 years. The STF justices made it clear that the decision was a preliminary review of the subject, even though 11 years have passed since ADIn 1945 was filed. The court will now begin a more thorough review of the subject in preparation of its final ruling.
Outlook
Because of the STF’s composition, its position could change when it reviews the merits of the case. Two current STF justices, Carmen Lúcia and Ellen Gracie, did not vote on the issue because they replaced Justices Jobim and Galotti, respectively, after the latter delivered their opinions. However, justices Lúcia and Gracie will participate in the debate over the case when the court delivers its final decision. Also, Justice Grau, who agreed to full application of ICMS to software, has announced his retirement later this year, meaning he will barely participate in the final debate on the issue.
Nevertheless, the STF preliminary decision may affect state tax policy toward software taxation. While many states already subject software to full ICMS taxation, some states, such as São Paulo, charge ICMS only on the software’s media carrier (for example, a CD); the entire intangible value is free from ICMS taxation. Also in São Paulo, downloadable software with no media carrier is not subject to ICMS. The policy, however, may change based on the STF preliminary decision.
David Roberto R. Soares da Silva