Originally published in the January 24 edition of World Tax Daily (Copyrights Tax Analysts – www.taxanalysts.com)
Brazil’s Superior Court of Justice (Superior Tribunal de Justiça, or STJ) recently dealt a blow to Brazilian franchisers when it ruled that franchise income earned/received as of January 1, 2004, is no longer free from the municipal service tax (ISS).
The decision was delivered in Special Appeal 873440, and a summary was published in the official gazette of December 3, 2007. The case involved a postal service franchisee, Flores Carlesso e Carlesso Ltda., who filed a lawsuit in 2002 to claim that franchise payments due to Brazil’s postal service were not subject to ISS.
In the judgment, the STJ accepted the taxpayer’s arguments, but only those concerning franchise payments made before the entry into force of the 2003 ISS general statute, Complementary Law 116/2003, effective January 1, 2004. In the decision, the court followed the well-established case law in which ISS was not due on franchise payments. But it expressly stated that the case law applied exclusively until Complementary Law 116/2003 became effective — that is, the court rejected the application of the case law for franchise payments after the Complementary Law (January 1, 2004).
Since the enactment of Complementary Law 116/2003, the franchise industry has worked to confirm the ISS exemption for franchise payments after 2003. The Brazilian Franchise Association (ABF) has retained two constitutional law scholars to deliver legal opinions on the existing unconstitutionality of the levy. Those legal opinions have been distributed to the ABF associates who have challenged the new tax in court.
The main argument against the ISS on franchise payments is that income arising from franchise agreements cannot be characterized as mere service income, but rather as that from a group of different activities, some of which may or may not be considered as taxable services. That argument has prevailed until Complementary Law 116/2003, as prior laws did not expressly contemplate franchise as a taxable service.
Franchisers also used a Supreme Court precedent in a different case to sustain the non-levy of ISS. That case (Extraordinary Appeal 11.612-1-SP) involved the exclusion of equipment rentals from ISS taxation. The Supreme Court held that ISS can be imposed only on activities in which one party has an obligation to do something for another party, and that an obligation to give something to someone cannot be a service. Franchisers argue that a franchise agreement encompasses obligations to do something for, and obligations to give something to, someone, which should exclude ISS taxation. That argument, however, was rejected by the recent STJ decision.
To make the situation worse, a Supreme Court decision in June 2007 (Appeal AI-AgR 583632) ruled that the controversy involving franchise agreements and ISS are not under the Supreme Court’s jurisdiction, but rather the STJ’s, because it deals with nonconstitutional matters. With such a precedent, the chances of bringing the matter to the Supreme Court and having the STJ’s recent decision reversed are low, though not entirely impossible.
David Roberto R. Soares da Silva