Draft Bill proposes a Digital Service Tax in Brazil

By Ramon Tomazela Santos (Partner, Mariz de Oliveira e Siqueira Campos Advogados)

The taxation of large technology companies has been at the center of the global debate in recent years, as their disruptive business models allows the exploitation of the market of a country without a physical presence. The underlying assumption surrounding the debate is that the application of current tax rules to companies operating in the digital economy has led to a misalignment between the place where profits are taxed and the place where value is created, due to the growing relevance of interaction and engagement with a user base for digital business.

In this context, the recent Bill 2,358/2020 presented by the Brazilian Congressman João da Silva Maia (PL-RN) proposes the introduction of Contribution for Intervention in the Economic Domain (“CIDE”) levied on the gross revenue derived from digital services provided by large technology companies (“CIDE-Digital”). The Bill’s justification mentions that, in the absence of a global consensus in relation to the taxation of the digital economy, countries may implement short-term measures, such as new tax on gross revenue. This was the path followed by several countries that introduced Digital Service Taxes (DST) on large technology companies, such as France, Italy, Austria, Hungary and other European Union countries.

The temporary nature attributed to the CIDE-Digital is a point that deserves specific attention, because when it comes to taxes, temporary measures may become definitive. A classic example in Brazil is the Provisional Contribution on Financial Transactions (“CPMF”). This tax levied on financial transactions was enacted as a temporary measure during Itamar Franco’s presidency to collect funds to public health, but ended up being renewed 4 times and remained effective for almost 11 years. In this respect, an important challenge for policymakers is that, from a tax policy standpoint, temporary taxes should not impose significant compliance and administrative costs, but the CIDE-Digital is likely to give rise to enforcement and tax compliance issues.

Since the CIDE is a contribution with a specific destination in the Brazilian tax system, the collection arising from the new tax will be destined to the National Fund for Scientific and Technological Development (FNDCT), with the purpose of financing innovation and scientific and technological development in Brazil.

According to the Bill, CIDE-Digital will be levied on gross revenue arising from (i) advertising offers on digital platforms to users in Brazil; (ii) provision of a digital platform that allows users to interact with each other, whether for selling goods or providing services directly between users, provided that one of them is located in Brazil; and (iii) transmission of data from users registered in Brazil, whether collected during the use of a digital platform or generated by the users themselves. For the purposes of the new tax, the user who accesses the digital platform on a device physically located in Brazil is considered to be located within the country.

The Bill defines digital platforms as internet or electronic applications that allow the electronic transfer of digital content or the interaction between users. The digital content includes any type of data delivered in a digital format, such as programs, applications, music, videos, texts, games, electronic files and akin.

The taxpayer is the foreign or Brazilian legal entity which earns gross revenue derived from such in-scope digital activities. The taxpayer will be liable to CIDE-Digital when the group’s global revenues exceeds 3 billion reais and local gross revenue in Brazil exceeds 100 million reais. Gross revenue in foreign currency will be converted into the U.S. dollar and then converted into reais using the official U.S. dollar exchange rate in force at the last business day of the previous year. The use of global gross revenue as a metric has been pointed out in the Bill’s justification as a mechanism to prevent revenue-splitting strategies. The CIDE-Digital must be paid until the last business day of March of the subsequent calendar year.

According to the Bill’s justification, CIDE-Digital will be levied only on large technology companies operating on an international scale. The new tax should not be placed on technology companies operating exclusively in Brazil, because this could discourage the emergence of national startup companies. The revenue threshold set forth in the Bill is high enough to avoid negative impacts on startup companies, whose gross revenues tend to remain low until they reach a certain stage of growth and development. However, the Bill’s justification does not present the reasoning behind the determination of the progressive rates chosen. Ideally, this new tax should only balance the tax burden, without overtaxing digital companies. The goal is to preserve neutrality and competition between companies operating in the digital economy and the traditional economy, without hampering economic development.

CIDE-Digital will be levied on the following progressive rates: (i) 1% on a portion of gross revenue up to 150 million reais; (ii) 3% on a portion of gross revenue that exceeds 150 million reais up to 300 million reais; (ii) 5% on a portion of gross revenue that exceeds 300 million reais. The total tax due corresponds to the sum of amounts through the application of the tax rates above.

The practice of adopting progressive rates departs from the international practice. According the Bill’s justification, the adoption of progressive rates intends to implement a fair tax regime, based on percentages that vary from 1% to 5% of the gross revenue. However, this argument fails to note that gross revenue, without deducting costs and expenses, does not reflect the actual profit margin. Thus, a flat rate on gross revenue adequately reflects the ability-to-pay and, consequently, tax fairness, because gross revenue is not an appropriate criterion to achieve vertical equity.

To conclude, the CIDE-Digital follows the growing proliferation of digital service taxes, which is expected to increase due to the pressing need for tax revenues, especially after the unprecedented decline in the global economy caused by COVID-19 pandemic. There are doubts as to whether this new tax is currently politically viable in Brazil, since it is not a Bill endorsed by the government. Nevertheless, even if the Bill goes ahead, there are technical details regarding the new tax that need to be clarified and improved during its debate at the Brazilian National Congress.