Back to Taxes Committee publications

Leonardo Homsy
Mattos Filho, Veiga Filho, Marrey Jr e Quiroga Advogados, Rio de Janeiro
leonardo.homsy@mattosfilho.com.br

Luiz Valente Loureiro
Mattos Filho, Veiga Filho, Marrey Jr e Quiroga Advogados, Rio de Janeiro
luiz.loureiro@mattosfilho.com.br

[1]

 

Digital economy and the international playing field

Continuous transformation caused by information and communications technology has made technology cheaper, more powerful and widely accessible around the globe, affecting the way business is conducted and how people interact with each other. Such disruptive movement is known as the digital economy. The digital economy is one of the most relevant topics on the agenda of international policy and law-makers, media outlets and civil society, as it keeps evolving at a fast pace and is increasingly becoming part of our daily routine.

The ranking made by Forbes of 'The World’s Most Valuable Brands' in 2019 illustrates this importance, with the first five companies in the top ten being from the technology industry (Apple, Google, Microsoft, Amazon and Facebook).^[2] These companies represent not only the way in which people interact with each other or have access to useful information but also a new way of doing business, which no longer relies on physical presence (bricks-and-mortar stores), but rather on intangibles and the massive collection and use of personal data from users, enabling business models that reach customers in different jurisdictions with limited or no physical presence in the corresponding jurisdictions, as well as different end-users at the same time, which may not be located in the same jurisdiction. Our daily routine provides different examples of this phenomenon, including the booking of hotels, online marketplaces and social networks, all of which are heavily reliant on intangibles and users' data.

Considering that the current international tax system was originally designed in the 1920s, when conducting business was essentially reliant on the idea of selling tangible goods and providing services through a physical presence, the digital economy is putting a strain on the existing system, which is no longer able to ensure a fair allocation of taxing rights between residence and market jurisdictions.

The taxation of major multinational entities (MNEs) has become largely elective, as they can be physically located in a low-tax jurisdiction (residence jurisdiction), while the entire process to create value and obtain revenue (eg, through intangibles, data and users) is spread across other market jurisdictions.

Although the impact of the digital economy has been perceived more in recent years, and has been strengthened amid all the economic and social transformations caused by the outbreak of Covid-19, which is making the digital universe more relevant than ever, the concern regarding the suitability of the international tax system to a digital way of doing business is not new.

In 1996, when the New York University (NYU) School of Law welcomed the first students to its International Tax Law Program, Professor Charles I Kingson was the first to speak at the Tillinghast Lecture, which would become a traditional lecture marking the beginning of the academic year of the programme.

Due to the large explosion of e-commerce and intangibles, the topic chosen by Kingson was 'Taxing the Future'. On that opportunity, Kingson affirmed that 'the world on which we based our tax rules and – more important – our tax thinking – is largely gone'.^[3]

The Organisation for Economic Co-operation and Development (OECD)/Group of Twenty (G20) acknowledged this disruptive process and contemplated the tax challenges of the digital economy as Action 1 of the Action Plan on Base Erosion and Profit Shifting (BEPS).

With the release of Action 1 – 2015 Final Report, the OECD/G20 explored many of the challenges caused by the digital economy, including those related to the ability of MNEs to create value in market jurisdictions regardless of any physical presence, and the lack of ability of the international tax system: (1) to establish a 'nexus' between MNEs and market jurisdictions, allocating taxing rights to such jurisdictions in cases in which MNEs do not have a physical presence but still create value and obtain revenue through a digital presence; and (2) to properly allocate profit to market jurisdictions, ensuring a fair division of tax revenue.

Reflecting the importance of achieving a multilateral consensus, the OECD/G20 released other reports between March 2018 and January 2020, evidencing the progress achieved and detailing the next steps towards a consensus-based solution.

The OECD/G20 is now working under a two-pillar approach.

Under Pillar One, the core issue is the reallocation of taxing rights between residence and market jurisdictions, and proposing a new nexus based on the significant/sustained engagement of MNEs with market jurisdictions (eg, considering the revenue obtained in certain digital services and businesses rather than a physical presence),^[4] as well as determining where tax should be paid and the portion of profit that should be taxed in each jurisdiction.

Under Pillar Two, the OECD/G20 is working on a global anti-base erosion ('GloBE') mechanism, to mitigate the shifting of profits to low or tax-free jurisdictions and ensure that MNEs pay a minimum level of tax.

If the importance of addressing the challenges of the digital economy is undeniable, the challenges of reaching a consensus-based solution are also clear. Although the OECD/G20 is working to provide a solution by the end of 2020, many countries are adopting unilateral measures by creating digital services taxes (DST).

The United Kingdom, France, Italy and Spain, for example, introduced DSTs that apply to revenue derived from activities such as online search engines, social media platforms, online marketplaces, online advertising and transfer of data. The collection of such taxes may take place in late 2020 or early 2021.^[5]

As the implementation of unilateral measures is extremely harmful, resulting in a complexity of legal systems, lack of legal certainty, negative impact on investment and innovation, and ultimately increasing the risk of double taxation, the expectation is that such taxes may not be collected at all if the OECD/G20 reaches a multilateral solution by the end of 2020.

Alongside such harmful effects, the unilateral implementation of DSTs is on the radar of the United States, global headquarters of the main MNEs of the digital economy. While its commercial pressure originally targeted specific cases (mainly the French DST, threatening to tax cheese, wine and other French products), on 2 June 2020, the US launched an investigation into countries that implemented or are considering implementing a DST (including Brazil and its CIDE-Digital).^[6]

The Brazilian playing field and the Bill of Law No 2,358/2020 (CIDE-Digital)^[7]

The Brazilian tax system is known as one of the most complex in the world, being grounded on different taxing powers for federal, state and municipal authorities, with taxing powers and taxes applicable to the purchase of assets differing significantly from those applicable to the provision of services.

An example of this difference is that, in addition to the federal jurisdiction, services are generally under the taxing powers of municipalities, while the purchase of goods is generally under the taxing powers of states (applicable tax rates also change).

Such complexity is a long-standing issue in Brazil, and has become a major trending topic since 2019, when different proposals for tax reform started to be discussed in more depth.

A common goal of such proposals is the simplification of taxation on consumption, merging different taxes into one tax on goods and services (a Brazilian VAT). Alongside all the benefits that such unification may cause, it may be particularly relevant for the challenges caused by the digital economy.

Due to the inherent characteristics of the Brazilian tax system, taxpayers still must deal with many challenges regarding taxation that applies to certain digital businesses, and whether they should be subject to state taxation (Tax on Circulation of Goods and Communication Services – Imposto sobre Circulação de Mercadorias e Serviços or ICMS) or municipal taxation (Tax on Services – Imposto sobre Serviços or ISS). To mention a few, the taxation that applies to online advertising, cloud computing and downloads of software is highly controversial.

Although the challenges of the digital economy go way beyond the solutions that potentially result from a Brazilian VAT, it may still result in significant legal certainty to taxpayers.

With the outbreak of Covid-19, discussions concerning tax reform were put on hold, with the focus now on measures to control the virus and mitigate economic damage.

However, on 4 May 2020, a congressman presented the Bill of Law No 2,358, proposing the introduction of a tax on certain digital services (CIDE-Digital). CIDE-Digital would have the following characteristics.

Scope

The scope is gross revenue arising from: (1) the placing of advertising in a digital platform for users located in Brazil; (2) availability of a digital platform that allows users to interact for the purpose of selling goods or providing services between themselves, as long as one of them is located in Brazil; and (3) transmission of the data of users located in Brazil, collected during the use of a digital platform or generated by users. A user is in Brazil when it accesses a digital platform through a device physically located in Brazil, determined through its Internet Protocol (IP) address.

Taxpayer

The taxpayer is an entity domiciled in Brazil or abroad, which earns revenue from in-scope activities and is part of an economic group that earned, in the previous calendar year: (1) global gross revenue higher than or equivalent to BRL 3bn and, cumulatively; (2) gross revenue higher than BRL 100m in Brazil.

Tax basis

The tax basis is the total value of gross revenue from in-scope activities earned during the calendar year. In the case in which gross revenue arising from the placing of advertising in a digital platform encompasses advertising placed to users located in other countries, the tax basis would include gross revenue proportionate to the advertising placed to users located in Brazil. A similar mechanism would apply to gross revenue arising from the transmission of data.

Tax rate

The tax rate is progressive, one per cent, three per cent and five per cent, observing specific revenue thresholds.

Payment

Payment is the last day of March of the calendar year following the triggering event.

The legislative intent, which is a document that details the reasons why CIDE-Digital would be important to Brazil, mentions that the taxation of revenue earned by major players in the digital economy is a great concern of the OECD/G20, and that while such organisations do not reach a multilateral consensus, 'Brazil cannot stay out of the movement' already started by many countries (mentioning specifically the proposal of the European Union, later dropped for the benefit of a consensus-based solution by the OECD/G20, and the Italian and French DSTs).

The legislative intent acknowledges that a multilateral solution is the ideal solution, affirming that whenever the moment comes, Brazil should adhere to it and extinguish CIDE-Digital.

As already detailed, international discussions regarding the taxation of the digital economy started a long time ago, with the consensus that a multilateral solution should address this topic.

Although Brazil is not a member of the OECD, a multilateral consensus may certainly guide other countries in establishing their own legislation on the matter, in a fashion that is aligned with international standards. This might be particularly relevant to the aspirations of Brazil in joining the OECD.

If it is right to affirm that the intention of addressing this matter in Brazil is extremely important, especially if it has the purpose of keeping Brazil aligned with the discussions carried out at an international level, the creation of CIDE-Digital at this moment might not be the best way forward.

Brazilian taxpayers already deal with a high tax burden applicable on revenue, encompassing corporate income tax at a total rate of 34 per cent and social contributions on gross revenue at a combined rate of 9.25 per cent (not to mention other state and municipal taxes).

The importation of services and intangibles are subject to gross taxation that may reach nearly 50 per cent, encompassing multiple taxes and contributions.

It is unquestionable that Brazil needs to put in place tax reform to simplify its tax system. Therefore, the adoption of any measure regarding the taxation of the digital economy should be discussed in the context of tax reform and respecting a consensus-based solution achieved by the OECD/G20. A different approach may end up adding more taxes and complexity to a system that is already extremely complex and burdensome to taxpayers.

Apart from the unfavourable environment, there are other elements that cause concern. The Bill of Law follows the EU proposal to a great level, but unlike the European proposal, does not address the matter with the necessary level of technical detail and sophistication, which could trigger debate regarding its constitutionality, enforceability, determination of the tax basis and compatibility with tax treaties.

Finally, the indication that CIDE-Digital should be a 'temporary' tax is an argument that raises distrust among Brazilians, as Brazil dealt with the 'Temporary Contribution on Financial Transactions'^[8] from 1997 to 2007; a temporary contribution that lasted ten years.

The aspects mentioned above are just of few of many others that should be considered as a starting point, and which indicate that the Bill of Law No 2,358/2020 and its CIDE-Digital should be discussed in the context of tax reform, and ideally, considering a consensus-based solution reached at the level of the OECD/G20.

 

Notes

 

Back to Taxes Committee publications