Taxation of ISPs in Brazil by ICMS and ISS

Denis Borges Barbosa April 14, 1999.

a) On the taxation of ISP services by the Brazilian State tax ICMS

b) On the prognosis of a retroactive assessment of ICMS on ISPs

c) On the taxation of ISPs by ISS City tax

2) My conclusions – For the reasons below indicated, my conclusions are:

a) ICMS is not due on ISP activities, but is likely that the State authorities would be requesting for its payment from June 1998 on;

b) ISS is due on designated ISP activities.

3) On the facts of the case - ISP activities comprise a number of different services, among which the following must be mentioned:

a) Internet Connection Services rendered to all users, as defined in Ministry of Communications Norm 4/95, item 4.1[i], to wit:

i) Use of the equipment needed to implement the routing, storing and directing of information, and of the further software and hardware required for the ISP to implement the Internet protocols and manage the service;

ii) The employment of routines for connection (passwords, addresses and domains)

iii) Use of software by ISP, as e-mail, remote contact, FTP, access to data banks, etc.

iv) Use of data and information by ISP;

v) Use of other hardware by ISP

b) Special services related to dedicated services;

c) Web hosting and other domain services;

d) Technical support and assistance, including on-site installation services;

e) Site design and related services;

f) Advertising services rendered on behalf of third parties as displaying of banners, etc.

g) Other assorted services.

4) As far as we are aware:

a) No ICMS taxation is being imposed on ISP activity [ii].

b) Many providers are paying ISS to the various Cities, but some have been refusing to do so.

c) We are not aware of any court cases concerning the issue.

5) General Considerations - Business activities in Brazil are subject to a three tiered tax incidence, including the Federal, State and City levels. The relevant taxes for our analysis are the following:

a) ICMS or State Value added tax on merchandises, Electricity, Telecommunication and Transport services [iii].

b) ISS - Service Tax, due on the services listed in Federal Law and City Law, specifically excluding Electricity, Telecommunication and Transport services [iv].

2) The whole tax system is designed in the Federal Constitution. A specific National Law must also be in force to fix the tax basis and the tax payer of each abstract tax, or non retributive charge (imposto), as well as to precise the competing tax jurisdictions among the Union, States and Municipalities,

3) The General National Tax Law is the National Tax Code. However, other laws do act as National Laws as for instance, the National ISS Law [v] and the National ICMS Law [vi].

4) The basic fact under analysis - The basic fact concerning the issue under analysis is that ISP activity is a service, and both taxes concern to services. Therefore, our main task is to clarify whether any of those taxes is to be imposed on ISP services, and if so, which one.

5) ICMS is restricted to just some services[vii], including communication services; the Constitution says that the only tax that may be imposed on domestic operations concerning telecommunications is ICMS.

6) Therefore, if ICMS is actually to be imposed on ICPs, it is because it is a telecommunication service; and then, ISS can not be also imposed.

7) The ICMS tax - State VAT is imposed on various taxable events; this tax is basically imposed on physical merchandise, but also on the like taxable events related to Transport, Telecommunication and Electricity services.

8) ICMS is provided for in the Federal Constitution and in the specific National Law. However, many of its provisions, especially those of a procedural or exceptive nature, are provided by Interstate Tax Conventions [viii]. The Joint State Authorities meeting under the Federal coordination in the CONFAZ committee agree on such Conventions [ix]. In addition to that, each State has its own body of law, which is supposed to conform to the National Standards and Interstate Conventions.

9) As a value added tax, it is calculated in each operation taking into account the like tax already paid in regard to the same service or its inputs as result of prior operations of like nature. Therefore, the value of the tax previously paid in the various phases of the circulation of the service is offset to the value newly due, and just the difference is actually brought to the Government’s vaults.

10) Tax rates related to Telecommunication services do vary extensively from state to state. Minas Gerais current rate is 25%, whereas Rio de Janeiro current rate is 35% (up to June 30, 1999) [x].

11) The Telecommunication services - The 1988 Constitution itself does not clarify what are the telecommunication services upon which the ICMS is due [xi].

12) The National ICMS Law defines communication services as:

“the generation, the sending, the reception, the transmittal, the retransmittal, the repetition and the amplification of communication of any kind “ [xii].

13) I understand that this statutory definition is not clear enough to effectively bring ISP services within the scope of ICMS. The wording seems to indicate that the taxable service is actually the conventional telecommunication services, and not the value added ones [xiii]. Some authors precise, however that the National ICMS Law means that it is not only the communication itself but on the provision of “conditions under which the communication may occur”[xiv].

14) However, on June 1998, the Joint State Tax Authorities (CONFAZ) apparently decided to clarify such provision. Interstate ICMS Convention 69/98 included as within the taxable events of such tax (among other events),

"the use of supplementary services and additional facilities that optimize or render easier the communication process, whatever the denomination they may take" [xv]

15) However the obvious target of that Convention was the newly privatized Telecommunication Companies, the quoted clause encompasses a much broader range of activities as compared to the standard of the National Law. If this provision were held to be valid, I understand that there would be a clear risk that ISP activities would be included within ICMS taxable events [xvi].

16) It must be noted that the ensuing Interstate Convention no. 74/98 decided that Convention 69/98 would only be applicable to events following the latter's inception. This new Convention was however rejected by the State of Pernambuco, and therefore rendered inapplicable [xvii]. Convention 69/98 was therefore, at least in theory, applicable on a retroactive basis.

17) My understanding, however, is that

a) Convention 68/98 is not constitutional;

b) If Convention 69/98 were constitutional, it could only be applicable on a prospective basis, even though considering the rejection of Convention 74/98; and specifically

c) Convention 68/98 (and, furthermore, art. 2, III of the ICMS National Law) can not be applicable to any ISP services and, particularly, to those services classified as Internet Connection Services by Ministry of Communications Norm 4/95.

18) My contention as to the constitutional grounds is based on the following: or Convention 69/98 creates a new taxable event beyond the one specified in ICMS National Law, art. 1^st; or it just interpret or clarify such provision of the National Law.

19) Convention 69/98 could not create a new taxable event, as only National Laws could do so [xviii]. Under the 1988 Constitution, Interstate Conventions could only act in lieu of National Laws before a formal National Law was issued [xix]. The courts have been indeed stating - for the time being - that the Convention is unconstitutional on such grounds [xx].

20) On one hand, even if it were possible to create a new taxable event by a Convention, however, this creation could be only applicable to future events [xxi].

21) I understand that there is significant arguments to the sense that Convention 69/98 could not be applicable on a retroactive basis:

a) On one hand, even if Convention 69/98 was just clarifying the scope of the ICMS National Law, it could only be applicable on a prospective basis. [xxii] National Tax Code states that a change in the understanding of the Tax Administration (once a understanding has effectively been stated on a decision or the answer to a consultation) can only be applicable on future events [xxiii].

b) I think that it must be arguable that, by not previously stating in a Interstate Convention that “supplementary services and additional facilities” are included in the definition of “telecommunication services”, the Tax Administration had a understanding that they were not so. This understanding may be however subject to diverging views in the judiciary.

c) Thus, the rejection of Convention 74/98 would have not necessarily as effect the retroactivity of Convention 69/98.

22) The same considerations would be extended to any other eventual provision of law or other legislation specifically intended to submit to ICMS taxation the ISP activities. Retroactivity is not to be expected either as a new provision or as a new standard of application of an existing provision.

23) However, as I stated, I understand that Convention 68/98 (and, furthermore, art. 2^nd, III of the ICMS National Law) can not be applicable to ISP services. My understanding is that ISP is not a telecommunication service. This belief is supported by the specific legislation that in Brazil governs Internet Telecommunication Services [xxiv].

24) The applicable Internet Telecommunication rule is Ministry of Communications Norm 4/95[xxv]. It states that :

a) "Internet Connection Service" (SCI) is a generic name that designates an Additional Value service that allows Users and Information Service Providers to have Internet Access.

b) "Internet Service Connection Provider " (PSCI): entity that renders the Internet Connection Service.

25) The most relevant aspect of this Norm is that it defines the ISP activity as a " Additional Value service". The importance of this definition is that the General Telecommunication Law[xxvi] so states:

Article 61. Value added service is the activity that adds to the distinct and separate telecommunications service that supports it, new features related to the access, storage, presentation, handling or recovery of information.

Paragraph one. Value added service is not a telecommunications service, and the provider thereof is classified as user of the telecommunication service providing support thereto, with the rights and obligations inherent to this condition[xxvii].

Paragraph two. Access to the utilization of telecommunications service networks for rendering value added services is assured to interested parties, for which the Agency shall regulate the conditions as well as organize the relationship between same and the telecommunications service providers[xxviii].

26) Does that statement of the General Telecommunication Law governs the tax consequences of the classification of a service as a telecommunication service? The question is very relevant because the National Tax Code states in art. 109 that the general principles of private law do not dictate the tax consequences issuing therefrom[xxix].

27) However, the Code itself states also that once a definition from a non-tax law is adopted by the Constitution to define or circumscribe tax jurisdiction [xxx], this definition can not be changed by the tax laws. The definition of communication or telecommunication is utilized by the Constitution to design the jurisdiction of the States as to the taxation of services and therefore can not be changed in its nature by the tax laws.

28) Furthermore, Telecommunication services are regulated services, to be granted exclusively by Federal concession under art. 21, XI of the Constitution [xxxi]. Internet services are not regulated services as they are not deemed telecommunication services [xxxii]. Incidentally, the Supreme Court has decided that the former Federal Monopoly of telecommunication [xxxiii] was restricted only to transmittal of telecommunication signals [xxxiv].

29) In summary as to the issue of taxation by ICMS of telecommunication services:

a) ICMS State tax is only imposed on telecommunication services.

b) The Constitution and the National ICMS Law do not state clearly that Internet services are not telecommunication services.

c) Some States have expressed their intention of taxing ISP services even though to our information no ISP have been paying ICMS.

d) Interstate Convention 69/98, in force since June 29, 1998, broadened the National ICMS Law definition to include "the use of supplementary services and additional facilities that optimize or render easier the communication process, whatever the denomination they may take". This provision, if it were valid, could be held to include Internet services and introduce a risk that the States take it as applicable on a retroactive basis.

e) My understanding is that Convention 69/98 is not to be deemed applicable on a retroactive basis:

i) Under the Constitution, the Convention can not create a new tax event;

ii) Under the Constitution, new tax laws are not to be retroactive;

iii) Even if it were to be deemed a simple clarification of the text of the National Law, (and therefore not new) its effects under National Tax Code art. 146 would be probably held to be prospective.

f) The above analysis is restricted to the legal issues at stake and just takes in to consideration the most probable final result of the dispute with the States in the court system.

g) On a practical stand, it must be then considered that:

i) The States, by August 1998, have decided not to apply Convention 69/98 retroactively, and just Pernambuco backed off.

ii) However, the States are under very stringent financial conditions, and may be impelled to resort to every means to obtain revenues.

iii) If taxation were to be eventually required on ISP activities, it would cover most probably the period since June 1998, when the Convention 69/98 entered into force [xxxv].

h) Furthermore, my understanding is that ICMS is not to be applicable at all to the designated ISP activities listed in Ministry of Communications Norm 4/95:

i) The Constitutional provision designing the scope of the ICMS on telecommunication services is a jurisdictional standard as it indicates which services the States may tax, not to be taxed by the Cities;

ii) Jurisdictional provisions of the Constitution may assimilate the definitions of the non-tax laws, and such definitions must be followed by the tax laws;

iii) The General Telecommunication Law (as before its edition, the Minimum Telecommunication Law) says that Additional Value Services are not telecommunication services;

iv) Uniform Federal practice and the Ministry of Communications Norm 4/95 univocally state that designated ISP services are Additional Value Services;

v) Telecommunication services are under the Constitution regulated services, and the ISP designated activities were never deemed to be regulated services.

30) Again, the tax authorities would most probably disregard those legal considerations, although they are very relevant for a tax dispute brought into the courts. If an imposition is asserted, my estimate is that it would be (more probably than not) withheld by an injunction in a writ of mandamus, on the grounds of the definition of Internet Services as a Valued Added ones.

31) Therefore, my advice is that you should be prepared for the States imposing ICMS tax on IPS activities. However, if it were to be applicable on a retroactive basis, it would most probably be imposed from June 1998 on.

32) The ISS Tax - The Service Tax is imposed at the City Level. This tax is imposed on the gross values received as result of services rendered. This is not a value-added tax: except for very limited exceptions, there is no deduction from the tax basis for prior services rendered for the Company by third parties or for materials or other items used in the service.

33) When assessing the possibility to have a service taxed by ISS, the first question to answer is: are the services of the Company included in the taxable list?

34) The National ISS Law states the services listed, and the City Law also lists such services. As a rule, all City Laws add to the national list a general clause including "other services otherwise unlisted". Nevertheless, the courts have massively held that whenever the City list is not in conformity to the National List, there is an unconstitutional excess of taxation [xxxvi].

35) Thus, it is possible, albeit not probable, that a service, not taxable by ICMS, is also not taxable by ISS.

36) The tax rate may vary from service to service and from City to City, but as a general standard municipalities limit most of the services to a 5% level.

37) ISP services - As I noticed at the first page of this Memorandum, the ISP activities comprise a large scope of different services, including the Additional Value Services indicated in Norm 4/95. Some of them may be eventually argued to be Telecommunication Services, whereas other (as for instance, Web designing) most probably would not be so, notwithstanding the very broad wording of Convention 69/98.

38) Therefore, even in case ICMS taxation is held to be due on some ISP services, other would probably not be considered so. ISS taxation of at least a portion of ISP activities is a very clear possibility [xxxvii].

39) The National List and possibly all local lists do not include ISP activities as taxable events as such. As we stated, the local lists although used as a basis for taxation by the Cities, are only considered constitutional if they are in conformity with the National list; I shall return to this aspect below. Therefore, our first task is to classify (if possible) the various individual services within the National list.

40) The possible items that could relate to ISP activities are:

a) Data processing (items 24 and 22) – this is a very generic item, where many services related to computer activities may be included.

b) Broadcasting of texts, images and other publicity material, through any means whatsoever, except by newspapers, periodicals, radio and television. (item 86)

c) Lease of chattels (item 79)

d) Technical assistance (item 21)

e) Installation of equipment when same is provided by the user of the services (item 74)

41) The reasons for my choice of such items in the list are the following:

a) Data processing services is a very broad item, and its scope has been questioned before the various administrations and the courts. My understanding is that is a reasonable classification at least some for those Additional Value Services mentioned in Ministry of Communications Norm 4/95. The ISPs themselves seem to be in agreement with that idea as they describe their services as “timesharing of machines, added to consulting and software usage”[xxxviii].

b) If the service is considered in its effects, and not in the means it provides to users, it seems also reasonable to define it as “Broadcasting of texts, images and other publicity material”. This is particularly relevant for two specific activities:

i) Access to Internet WWW or other image, sound and text-based facilities.

ii) Actual display of publicity by means of banners or other similar means. In this case, the user of the service is the advertised entity [xxxix].

c) Leasing of space for web hosting seems to be an adequate classification under item 79 of the list. The Administrative Case Law has already settled in some Cities that licensing of Intellectual Property is leasing of chattels [xl], and therefore the idea that the paid use of immaterial chattels may be taxed. If use of address space were also a separate service, it would be possibly so classified.

d) Both the on line support and the eventual other service provided to the users could be classified as technical assistance or, sometimes, consulting (in this case, item 22).

e) In case that dedicated services or other clients require the actual installation of equipment or software, this service, if specified and onerous, and effected in equipment not supplied by the ISP is also to be classified as taxable under ISS.

42) Those considerations are intended to show why, to my understanding, the City Tax Authorities have reasonable chances of effectively classify some or most of the services as statutory tax events.

43) On the other hand, as already stated, some ISPs are not paying ISS, and compliance with the pertinent City Laws may result in significant competitive imbalance. Actually, the argument that the list does not provide for a specific ISP item may be compelling and the decision of not paying ISS is not entirely groundless.

44) However, to my understanding, the classification of ISP activities as above indicated is not to be taken as creation of a new taxable event by analogy [xli]. Much to the contrary, it follows adequately the trend adopted by the courts to accept as reasonable inclusions within the list of new services that are akin with the prior ones, without really exceeding the restrictive nature of the statutory schedule.

45) My recommendation in this context therefore is:

a) ISS is to be paid on the designated services;

b) In case competitivity or other factors advise the non-payment, adequate court or administrative procedures shall be followed to prevent tax auditors to impose penalties and request forcible payment of such tax.

46) We call your attention that, on concluding that ISS should be paid on ISP services, a series of other problems are raised, as for instance:

a) Taxation of services at the location where POPs are situated; this specific problem shall be analyzed in the context of each City Law, what may be specially complex in cases where the ISP keep a number of different POPs, some of them licensed as branches.