Originally published in the June 24 edition of World Tax Daily (Copyrights Tax Analysts)
Brazilian franchisers may have gained a new opportunity to try to reverse the Superior Court of Justice’s (STJ) 2007 ruling that from 2004 onward, franchise income would be subject to the municipal service tax (ISS). In a recent decision, Supreme Court Justice Marco Aurélio argued that franchise income is not characterized as service income and therefore should not be subject to ISS.
Decision 651255, published in the judiciary’s official gazette on May 26, was issued in acceptance of an appeal before the Supreme Court by Rio de Janeiro franchiser Spoleto Franchising Ltda.
The decision is important to the franchise sector, which includes many multinational companies, particularly in light of the STJ’s ruling in Special Appeal 87344 that franchise income received as of January 1, 2004, would no longer be exempted from ISS. The court cited the enactment of Complementary Law 116/2003 (the ISS Act), which lists franchising activities as taxable services.1
The situation was made even worse for franchisers when the Supreme Court in June 2007 ruled that the issue was not under its jurisdiction, but rather the STJ’s, because it dealt with nonconstitutional matters.
In the new ruling, Aurelio said Brazil’s Constitution is the ultimate legal basis for ISS; therefore the issue is a constitutional matter that should be reviewed by the Supreme Court.
He said the Franchise Act (Law 8,955/1994) does not imply that franchise agreements encompass services. According to article 2 of the Franchise Act, franchise agreements include the rights of use of trademarks or patents associated with the exclusive or semiexclusive distribution rights of products or services. They can also include access rights to technology and the implementation and management of a business developed or owned by the franchiser, which is compensated without creating an employment relationship. Nothing in that definition appeared to characterize a service (subject to ISS) in the preliminary review, Aurelio said.
His rationale is in line with the arguments that historically have been used by the franchise sector to fight the ISS on franchise income. The main argument is that income arising from franchise agreements cannot be characterized as mere service income, but rather, as income from a group of different activities, some of which may or may not be considered as taxable services.
Because Aurelio agreed to review the application of ISS on franchise income from a constitutional perspective, the Supreme Court could eventually overturn the STJ’s 2007 ruling. The bad news is that the Supreme Court does not have a deadline to deliver a decision in the case.
FOOTNOTE
1 Previously, franchise income was not listed as an ISS taxable activity and Brazilian courts had repeatedly ruled that such income should not be subject to the tax.
END OF FOOTNOTE
David Roberto R. Soares da Silva