Taxation and Technology: Recent Developments on Cloud Computing in Brazil

For some time now increasing technological development has caused uncertainty in the application of the Law.  This is because technology and the new business models it makes possible develop at a much faster rate than the slow legislative process.  The problem is even worse in the tax area because of the Brazilian Constitution’s rigidity in regard to taxes, taxpayers’ uncertainty when faced with a lack of clear (and up-to-date) legislation and the tax authorities’ voracity in levying taxes.
 
In this context, this article will highlight certain recent positions the tax authorities have taken regarding cloud computing transactions.
 
“Cloud computing” consists of offering services over the Internet that involve data processing, software use and data storage, among other things, that do not require consumers’ to know the physical location and configuration of the system providing the services.  Users hire the service, frequently from computers with limited memory capacity (“thin” computers) precisely because the service operates software and files remotely (there is no need to download) and without a specific, predetermined physical location (files and software can be shifted according to the service provider’s needs).
 
Cloud computing transactions are not subject to a specific tax treatment.  This leads to difficulties in attempting to place certain contracts within the legislative framework.  The problem is especially acute when trying to determine whether certain activities qualify as services subject to the municipal Service Tax (Imposto sobre Serviços), or ISS,or to the taxes on the payment of money abroad to hire technical services (Withholding Tax (Imposto de Renda Retido na Fonte), or IRRF, Intervention in the Economic Domain Tax (Contribuição de Intervenção no Domínio Econômico), or CIDE-technology, and Social Integration Program Tax (Programa de Integração Social), or PIS-import/Social Security Financing Tax (Contribuição para o Financiamento da Seguridade Social), or COFINS-import, as well as the ISS-import).
 
Although most cloud computing agreements are complex and contain various, interrelated obligations, three main types are currently used: Infrastructure as a Service (IaaS), Platform as a Service (PaaS) and Software as a Service (SaaS).  Each of these transactions involves controversial issues regarding which taxes are due.
 
IaaS is the use of computer infrastructure as a service, with the server providing storage capacity according to the customer’s needs.  The main activity for this type of transaction is digital data storage, which is generally charged for on the basis of the amount actually used.  Although it is treated as a service by the market, this activity is not included in the list of services under Supplementary Law 116/2003, which contains an exhaustive list of services for the purpose of the municipalService Tax (ISS).  In any case, the fact that it is not listed as a service under Supplementary Law 116/2003 does not mean the activity cannot be considered a service for other tax purposes; it only means it cannot be taxed under the municipal ISS tax.
 
One method for conducting IaaS transactions is through hiring third-party data centres.  This can be done through a simple equipment lease, when there is no third-party involvement in the use of the equipment, or through the provision of the service of maintaining and managing files, which requires third-party activity.  This type of contract has been the subject of controversy at Brazilian Federal Revenue, which is the agency responsible for administering the Brazilian federal tax system.  Brazilian Federal Revenue has gone so far as to issue conflicting opinions regarding whether contracting with nonresident data centers is subject to the IRRF, CIDE-technology and PIS/COFINS-import taxes on funds paid abroad.
 
After the controversy, Brazilian Federal Revenue settled the question for its internal purposes by deciding that the amounts paid, credited, delivered or sent by someone resident or domiciled in Brazil to a company domiciled abroad due to remote-access data processing and storage infrastructure being made available, identified as a data center, are considered payment for the provision of services and not payment resulting from a lease agreement for chattel property (which would not be taxable).  Brazilian Federal Revenue has therefore decided that the amounts described above are subject to the IRRF (15%), CIDE-technology (10%) and PIS/COFINS-import (9.25%).  There was no decision regarding the ISS (subject to a rate from 2% to 5%, depending on the case) since the ISS falls under the jurisdiction of Brazilian municipalities and not Brazilian Federal Revenue, which is a federal agency and cannot issue an opinion on the matter.
 
Another common type of operation within the cloud, SaaS is a method through which software is made available by the contractor over the Internet, with the software and related information hosted in the cloud.  It does not involve a download to the user’s computer.  Rather, the user accesses the software remotely and pays the cloud service provider for the time it is used (by subscription or pay-per-use).
 
As with IaaS, SaaS agreements lead to a series of tax issues.  The leading issue is whether these transactions fit within the list in Supplementary Law 116/03, item 1.05 of which includes “software licensing or assignment of use rights.” The question arises because, unlike traditional transactions for acquiring off-the-shelf software, the user in this case does not acquire a physical media or download the software – the software always remains in the cloud.  The user therefore does not acquire a definitive software use right, but rather only a temporary and uncertain right to use it. 
 
However, the municipality of São Paulo has recently stated its position that SaaS transactions are subject to the ISS tax even if there is no definitive acquisition of a software use right, strictly speaking.  Although the municipal tax authorities have not given a detailed explanation of the issue, since the Brazilian software law (from 1998) provides that a contract for the use of computer software is classified as a “licensing agreement”, it would be difficult to convince the tax authorities otherwise.  Alternative resolutions would be for the courts to declare including the item on the list of transactions subject to the ISS tax on licensing unconstitutional (there are lawsuits in this regard currently being heard but no definitive judgment has yet been entered) or for the software law itself to be updated by the legislature.
 
Finally, PaaS contracts consist of the use of a computing platform in conjunction with a solutions package, which is generally focused on developing, testing and delivering software for cloud computing.  This is a quintessentially complex service that involves data processing, data storage and software licensing, in addition to software testing and development.  These activities are generally included in a single, indivisible agreement, characterising them as merely means to achieve the main service that is contracted for (PaaS).  Therefore, even though data processing and licensing are included on the list of services subject to the ISS tax under Supplementary Law 116/03, the prevalence of a complex service that is not included on the list should stop the ISS tax from being levied on this activity.
 
However, since ISS tax legislation provides for the tax being levied on “data processing and the like,” the municipality of São Paulo has taken the position that PaaS transactions are similar to agreements for data processing and should therefore be subject to the municipal ISS tax.  This position is highly questionable but unlikely to be changed.
 
It is important to stress that a bill is currently before the Brazilian Congress that would make major changes to the current ISS tax structure, including placing a number of services related to cloud computing on the list of services subject to the ISS tax. 
 
Brazilian Federal Revenue has not yet taken a position on whether SaaS and PaaS transactions are subject to federal taxes on funds sent abroad.  However, it is probable that they will receive tax treatment similar to that of IaaS.
 
Maurício Barros is a director at Gaia Silva Gaede Advogados in São Paulo and is in charge of the indirect taxation and customs areas at the Firm.  He holds a Ph.D in Tax Law from the University of São Paulo (USP) and a Master Degree (M.Sc) from the Catholic University of São Paulo (PUC/SP).  He is also Visiting Professor at Universidade Presbiteriana Mackenzie and Fundação Getúlio Vargas (FGV) and a Judge of the São Paulo State Taxes and Fees Court (Tribunal de Impostos e Taxas).  Maurício has authored many articles on taxation for specialised reviews and books in Brazil and abroad.
 
Contact Details:
Gaia, Silva Gaede & Associados – Sociedade de Advogados
Rua da Quitanda, 126, Centro, São Paulo/SP
Posto Code 01012-010 – Brazil
e-mail: mauricio.barros@gsga.com.br
Tel.: +55 11 3797-7400