Chapter 5: Tax Coordination between Regions in Brazil Role of the Courts

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Chapter 5: Tax Coordination between Regions in Brazil Role of the Courts

Authors
Lus Eduardo Schoueri and Mateus Calicchio Barbosa

5.1. Federal arrangements and tax jurisdiction allocation

It is hard to design the prototype of a federation. In a certain way, it can be done only ideally, as the federation will always be accommodated to the national reality, which varies in time and space. But there is a constant distinguishing feature in the modern and successful federations: financial autonomy. This was a concern of Alexander Hamilton, as can be read at the beginning of The Federalist no. 30: [1] Money is with propriety considered as the vital principle of the body politic; as that which sustains its life and motion, and enables it to perform its most essential functions. A complete power therefore to procure a regular and adequate supply of it, as far as the resources of the community will permit, may be regarded as an indispensable ingredient in every constitution. From a deficiency in this particular, one of two evils must ensue; either the people must be subjected to continual plunder as a substitute for a more eligible mode of supplying the public wants, or the government must sink into a fatal atrophy, and in a short course of time perish. The autonomy issue has two sides. One is the liberation of the central government from the states financial dependence, when the federation results from the political joining of previously independent states. The other occurs when a unitary state adopts the shape of a federation, which happens to be Brazils case. In this case, the political power granted to each state must be followed by the correspondent financial autonomy. This does not necessarily mean that each of the subdivisions of the federation should be granted the power to levy taxes based on its own competence: a common (federal) taxation would not jeopardize the idea of federation, provided each of the subdivisions is granted its financial resources independent from cooperation/will of other subdivisions. Generally, autonomy is also granted through taxes: several federations divide tax jurisdiction among their subdivisions. Therefore, the entire issue revolves around the attribution of tax jurisdiction to the union, states and municipalities, as the taxing power appears as the strongest, the most pervading of all the powers of government. [2] However, it must be said that while the attribution of tax jurisdiction to all subdivisions is quite common, an exclusive allocation of these taxes between the subdivisions is not. This allocation was even rejected by Hamilton, who wanted to see the Union strong, holding the powers that the previous Confederation lacked, on the grounds of the argument that the taxation could only be limited by the communitys resources and the public interest. Cumulative taxing powers, however, may cause economic and legal problems. From an economic perspective, tax policy might be jeopardized, since multiple taxes on the same basis may imply a lack of coordination among the tax authorities. For the taxpayer, there would always be a risk of an excessive burden, since each taxing power would not be likely to take into consideration the amounts already paid to other authorities for the same event (internal double taxation). Since all modern constitutions adopt the principle of ability to pay, it is also to be recommended that the constitution itself adopts mechanisms to avoid internal double taxation. This explains the decision for tax-exclusive tax allocation for each of the federal subdivisions adopted in several countries, including Brazil. Thus, the Brazilian federal system not only attributed tax jurisdiction to all of its subdivisions, but allocated the taxes between its three levels of government, attempting to avoid internal double taxation. It is important to say that allocation of tax jurisdiction includes the power to enact laws concerning such taxes. Therefore, the unions taxes are ruled by the unions laws; states taxes are ruled by statutes enacted by each single state and municipal taxes are ruled by statutes enacted by each of the more than 5,000 municipalities in Brazil. Due to the importance of the matter, allocation of taxes in Brazil was always provided for by the Constitution. In the history of Brazilian fiscal federalism, concerning allocation of taxing powers, three different phases can be identified, all of them reflecting the political federalism of the moment: centrifugal phase (first republican years, when the centralized monarchy was converted into a federal republic inspired by the US Constitution); centripetal phase (reflecting a centralized government which took place after 1930) and cooperation federalism (first steps taken during the military government, but deepened after Brazilian redemocratization). [3]

5.2. Tax jurisdiction allocation throughout Brazilian federal history

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Brazil has experienced different Constitutions throughout its history. Each text provided for a different tax allocation between the subdivisions. Although this phenomenon could be analysed since Brazil became a Republic in 1889, the present tax jurisdiction allocation has its origins in a 1965 Constitutional reform. As a matter of fact, the 1946 Constitution signalled the return of democracy, which would last for almost two decades, after 8 years under the New State (as Getulio Vargas dictatorship was known) and its 1937 Constitution. Thus, by the end of World War II and of the New State, circumstances were favourable to a decentralized federalism, where municipalities were granted an autonomy level that they never had before and where the union, state and municipal tax systems were almost disconnected. Regarding the municipalities autonomy, the Sub-commission on Revenue Allocation, in the words of its reporter, Aliomar Baleeiro, stated at the time: Without power to create new taxes, restricted to the few that the Constitution reserved to them, Municipalities decayed progressively to a penury stage that did not let them carry on their most essential administrative functions in the very interest of their respective citizens. Today, there is a true national will against this abuse. The numbers cold expression attests [to] this tragic reality which awaited the 1946 Constitution for the decisive remedy. [4] Nevertheless, in the 1946 tax system, taxes were distributed among federal subdivisions based on historical reasons and considering some juridical distinctions; this means that economically equivalent taxes were granted to different federal subdivisions, based on said juridical peculiarities. In brief, taxes were not conceived and distributed based on logical or economic concerns. As an outcome of the lack of economic rationality, for instance, the export tax was in the states jurisdiction, not in the unions, which made its use as an exchange policy instrument impossible. Another outcome was that the sales tax was cumulative and cascading, a fact that jeopardized the commerce of economic and industrial goods. The tax system centralization would only take place under the military regime, which enacted the 1965 18th Amendment to the 1946 Constitution. Since the federal government believed that it had a central role in the development of the country, soon after the military regime entered in force, the 18th Amendment to the Constitution was approved, whereby the entire tax system was revised and a tax classification based on economic criteria, in other words, concerned about the economic effects of the allocation, was adopted. Due to the peculiarities of a military regime, where Congress has a mere symbolic role, it was possible to achieve a tax system which was deemed to be rational, with taxes being allocated among federal, states and municipalities governments. Although this might be viewed as being a guarantee to local governments, it soon became clear that the federal level was granted a huge amount of resources, followed by the states. This centralized context allowed the enactment of the Brazilian Tax Code, which had been previously rejected on the grounds of the argument that a nationwide tax code would put the autonomy of states and municipalities at risk. The 1964 regime took a different approach: the federal government claimed to be the main responsible branch of government for the development of the country and a uniform tax policy seemed to be in compliance with such purpose. Professor Rubens Gomes de Sousa, who had drafted a bill for a Brazilian tax code, was called to be a reporter on the Tax Reform Special Commission. In his words, the main premise of the change to be made was: [A] conception of the tax system as integrated in the economic and juridical national level as a replacement for the current historical criterion, essentially political, of the co-existence of the three autonomous federal, state and municipal tax systems. (authors translation) However, considering Brazils social and political characteristics, he also recognized that it would not be an easy task, due to Brazils extreme political, human and social diversification. According to his opinion, the ideal of a national unity would have been easier in countries with less territory and more uniformity. The measures taken to achieve this integration were of negative and positive character. The negative measures were concerned with discriminatory state and municipal taxation, prohibiting limitations to interstate traffic of persons or goods through taxation or the establishment of distinctions between goods of any nature due to their origin or destination. Among the positive measures, in their turn, the most important was the acceptance by a state of credits accumulated by the sales tax levied in another states territory. Accordingly, the 1965 tax reform introduced in Brazil a non-cumulative sales tax. This is enough to show how audaciously the project was conceived. One should consider that at that time, value added taxes were very rare. The first comprehensive value added tax had just been introduced in France. However, due to the fact that the earlier sales tax was within the states jurisdiction, the 1965 tax reform decided to maintain the new noncumulative sales tax within that same jurisdiction, while services were taxed by municipalities. The 1965 18th Amendment tried to enact a national tax system, in the sense that federal, state and municipal taxes would have some coherence. This required a complete review of the existing taxes: nominal differences would no longer be relevant for tax allocation; more relevant would be to design a national tax system structure.

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It was a great step forward toward the rationalization of the system. The amendment synchronized it with Brazils progression to a market economy and the growing resource mobility.
[5]

As a matter of fact, the main idea of the 18th Amendment was to proceed to a rational analysis that would consider the nature of the tax and its relationship with each federal subdivision and its respective constitutional attributions; tax jurisdiction was divided among municipalities, states and the union and ideally the centralization of the national taxes in the unions jurisdiction would prevail and local taxes would be due locally. The state sales tax was the greatest exception to this, with consequences that are still being suffered today. One should mention that soon after the 18th Amendment, a new Constitution entered into force in Brazil, in 1967, but the tax system remained as it was designed in 1965. Notwithstanding the fact that the 1965 18th Amendment created a rational reform, based on serious work carried on by the Tax Reform Commission, it established a factual dependence relationship of the states and municipalities on the union, as the federal government would not satisfactorily share its revenues. Therefore, it was clear that this highly centralized system could not go on in a democratic regime. To this effect, the 1988 Constitution made adjustments in the tax system, trying to deal with the centralization matter. Nevertheless, the changes made in the tax system by the Constitution cannot be considered a reform, in terms of their extent, compared to the reform made by the 1965 18th Amendment: they were more like a substantial adjustment in the systems structure, with the improvement in the design of some taxes and their calculation basis. Article 151, III of the 1988 Constitution eliminated the union jurisdiction to provide for exemptions from state and municipal taxes, ending this federal interference in the other subdivisions taxes that had been established in the highly centralized context of the 1967 Constitution. Through a higher rate in the states and in the municipalities share fund, the Constitution allowed the other federal subdivisions to have a larger share in union revenues. Notwithstanding this, tax jurisdiction remained centralized in the unions hands, even with the removal of five taxes from its jurisdiction. The possibility given to the union to establish taxes that are different from those explicitly mentioned in the Constitution also remained, in the same way as in the 1967 Constitution. Some principles were added by the 1988 Constitution in order to assure the federal arrangement and the subdivisions autonomy: the principle of union tax uniformity (the tax established by the union must be uniform in the whole country, except for incentives promoting regional development policy) and the prohibition on exempting municipal or state taxes.

5.3. The complementary law

From the very beginning of the Brazilian Republic in 1889, it was realized that the Constitution could not be exhaustive. Therefore, laws needed to be enacted to fill in its general principles. At that time, the laws which aimed to complement the Constitution were not formally different from the others, with no different quorum required for their approval. However, from a material point of view, a kind of complementary law could be found in the first republican Constitution of 1981, which provided in article 34 that the National Congress should enact the organic laws for the complete execution of the Constitution. Such organic laws were seen by Brazilian scholar Ruy Barbosa as real complementary laws: But not all of the constitutional provisions are self-executing. Most of them, on the other hand, are not. The Constitution does not execute itself: it requires legislative action, in order to make its provisions effective. [6] Notwithstanding the fact that the 1937 and 1946 Constitutions did not expressly provide for laws that would complement them, a kind of complementary law, materially speaking, did not cease to exist. To think otherwise would be to assume that the constitutional wording, which is supposed to be generic, could cover all the legislative matters. [7] Until that time, complementary laws were considered formally equal to ordinary laws: as said, there was no different quorum needed for their approval. The 1961 3rd Amendment to the Constitution, which instituted a parliamentary government that would last until 1963, provided for a formal superior complementary law. Such law would find its hierarchical place above the ordinary laws and under the constitutional provisions. Moreover, a complementary law would require an absolute majority of the two Houses of the Congress to be approved. The laws to complement the Constitution were taken up again by the Tax Reform Commission designated by the President to elaborate the draft of the 18th Amendment to the Constitution, which would, as mentioned, substantially change the Brazilian tax system. The Commission prepared two drafts (A and B): the first, about legislative norms, provided for a complementary law with more rigidity than the ordinary laws. However, only the second draft was submitted to the Congress and the reform was approved without providing the complementary laws with the hierarchy level originally given to them.

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The Constitutions of 1967 and 1969 expressly provided for the complementary law. The current Constitution of 1988 also provides for it in article 59 (legislative process), requiring an absolute majority for its approval by the Congress, in the same way the 1961 3rd Amendment did.

5.4. The complementary law in tax matters

The Constitution of 1988 gave a specific role to the complementary law in the tax ambit. To this end, in article 146, the Constitution assigns three fundamental tasks to a complementary law dealing with tax.

5.4.1. Regulation of the states taxing powers

Accordingly, the complementary law must regulate the constitutional limitations to the states taxing powers. This role becomes particularly important when the constitutional provisions demand some clarification or complementation in order to be effective (which is the case with constitutional protection immunity against taxes for education and social assistance institutions, since such institutions must be defined by the complementary law to enjoy the benefit) or when constitutional principles regarding taxation (such as legality and equality) come into conflict.

5.4.2. Establishment of general tax norms

The complementary law may also establish general tax norms. Such norms ensure that the tax law will have a unity in the national ambit, despite the legislation enacted by the federal subdivisions. To this effect, the subdivisions must bow to the general tax norm provisions. Such a statement leads us to the question whether there is a hierarchy between the general tax norm, provided by the complementary law, and the specific tax norms enacted by the union, the states and the municipalities. The original understanding, according to which the complementary law would be above the ordinary law, can be seen through the words of the renowned Brazilian scholar Geraldo Ataliba: Under the constitutional laws, there are the complementary ones, followed immediately by the ordinary ones. The ideal hierarchy corresponds to this graduation. The main juridical consequence of this circumstance lies in the superiority of the complementary law over the ordinary one. [8] Nevertheless, this understanding has changed. There is no sense to the hierarchy between the complementary and the ordinary law, since they do not concern the same matters. To this end, one could only cogitate of the hierarchy between the referred laws in the case of antinomy, i.e. if both laws concern the same matter. However, the absence of a hierarchy between the complementary law and the ordinary law does not mean that the latter may contradict what was provided for by the complementary law in a general way. The very idea of a general norm implies that it must be followed by all the federal subdivisions. On the other hand, if the ordinary law provides for subject of its own jurisdiction, the complementary law which intends to regulate it must be disregarded, as it will be deviating from its jurisdiction. Accordingly, creating taxes is generally a matter of (federal, state or municipal) ordinary law. A complementary law would not be a valid instrument to create taxes. An interesting and educational figure which helps in the understanding of the relation between the norms provided by complementary law and those provided by ordinary law is the idea of the national law. Such an idea was put forward by Brazilian scholar Souto Maior Borges, who based his studies on the matter on the writings of Hans Kelsen. Accordingly, when analysing the federal state, Kelsen distinguished two legal systems: one which he deemed to be partial, the other which he considered total. To this end, there would be norms valid for the entire state (central norms), while there would be norms valid only for different parts of the state (local norms). The latter norms would constitute the partial local legal system, in opposition to the central norms which would integrate the partial central legal system. Thus, in addition to these two partial systems (the local and the central) there would be a third national or total legal system. Such an explanation leads to the understanding that not all legislation has the same range. Therefore, as an example, the legislation which provides for a federal subdivisions civil service is not relevant for another federal subdivision. This means the civil service legislation of the So Paulo State is not applicable to the civil service of the Rio de Janeiro State: So Paulos (partial) legal system must not be confused with Rio de Janeiros (partial) legal system. In the same way, the unions civil service legislation is only applicable to the federal civil servants, and does not concern the states civil servants, which are covered by each states partial legal system. As one may see, the unions partial legal system is different from the states partial legal system. Nevertheless, this circumstance does not prevent the existence of norms that are applicable to the whole legal system (total or national legal system). To this end, the Constitution must be complied with by the federal, state

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and municipal partial legal systems, since it belongs to the national legal system, and not to the partial. The same status can be granted to the complementary law, since it may also be integrated in the national legal system. The idea of the complementary law as a national law already existed by the time the Tax Code was enacted. In spite of being originally enacted as a federal law (since a complementary law did not formally exist at the time), the Tax Code is, from a material point of view, a complementary law, and, moreover, a national law. To this effect, the Special Commission in charge of the Codes draft stated: A peculiarity of the Brazilian Tax Code, which will distinguish it from all the others of the same nature, is its national character derived from its simultaneous applicability to the three levels of government that make up the Federation. In other words, the Commission decided that the Code, though attributed to the federal jurisdiction for an obvious reason of legislation hierarchy, will not be a federal law, but a national one. [9] Thus, notwithstanding the fact that one must not speak of a hierarchy between the complementary law and the ordinary law, since both provide for different subjects and belong to different legal systems, the partial legal systems (federal, state and municipal) must conform to the national legal system of which they are a part. Therefore, if the complementary law provides for a matter which belongs to the national legal system, then the ordinary law must bow to the provisions of the complementary law. Accordingly, from the role played by the complementary law as a source of general tax norms that are effective for the whole nation, one may consider the complementary law as the instrument, par excellence, whereby tax harmonization between the federal subdivisions is achieved. The Tax Code itself, which, as said, is a complementary law, is undeniable evidence of this: as a national law, rather than a federal one, its general provisions must be complied with by the legislation of all of the federal subdivisions. Another example of the tax harmonization played by the complementary law is the case of the state sales tax. To this end, the Constitution provides in article 155(2) XII: Article 155. The states and the Federal District shall have the competence to institute taxes on: [] II transactions relating to the circulation of goods and to the rendering of interstate and intermunicipal transportation services and services of communication, even when such transactions and renderings begin abroad; [] 2 the tax established in item II shall observe the following: [] XII a complementary law shall: a) b) c) d) define its taxpayers; provide for tax substitution; regulate the system of tax compensation; establish, for purposes of collection of the tax and definition of the responsible establishment, the location of the transactions concerning the circulation of goods and the rendering of services; e) exclude from levy of the tax, in export to other countries, services and other products other than those mentioned in item X, a); f) provide for the event of maintenance of a credit for services and goods remitted to another state and exported to another countries; g) regulate the manner in which, through deliberation by the States and the Federal District, tax exemptions, incentives and benefits shall be granted and revoked; h) define the fuels and lubricants on which this tax shall be levied only once, regardless of its purpose, in which case the provision of item X, b) shall not apply; i) stipulate the assessment basis so as to include the amount of the tax, also in the event of importation of goods, products or services from abroad (authors translation).

Therefore, one can see that the Constitution assigns to the complementary law numerous tasks regarding the state sales tax. Such assignments are fulfilled by Complementary Law no. 87 of 1996, which provides for said tax and all of the aspects mentioned by article 155(2) XII of the Constitution. Since it is a national law, Complementary Law no. 87 contains provisions which must be complied with by all the states, in the sense that all the states sales taxes must be harmonized according to the Complementary Law provisions. To this end, the state legislation which provides for each states sales tax may not deviate from the provisions of Complementary Law no. 87. If such law establishes as the taxpayer for purposes of the sales tax any person who performs, habitually or in a volume which has a commercial intention, operations relating to the

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circulation of goods and to the rendering of interstate and intermunicipal transportation services and services of communication, the state legislation may not provide otherwise.

5.4.3. Settling of tax jurisdiction conflicts

Regarding tax coordination, however, the most important role played by the complementary law in tax matters is to resolve jurisdiction conflicts between the federal subdivisions. As mentioned above, in Brazilian federalism, tax allocation was always provided for by the Constitution. The 1988 Constitution, in the same way the previous Constitutions did, adopted a tax system whereby each of the federal subdivisions is granted an exclusive tax jurisdiction. That is, the Constitution not only attributes tax jurisdiction to all of the federal subdivisions, but also distinguishes the taxes between them. Moreover, the tax jurisdiction granted to each subdivision may not be delegated: even if the jurisdiction is not exercised (i.e. a federal subdivision did not impose a tax which it would be authorized to do), another subdivision may not take advantage of the vacuum to impose a tax that is outside its jurisdiction. Notwithstanding the fact that the Constitution attributed tax jurisdiction to all the federal subdivisions and allocated the taxes between them, it did not necessarily intend to establish, itself, rigid limits for the jurisdictions. In this scenario, the complementary law has a fundamental role in drawing the definitive shape of each of the subdivisions jurisdiction. In some circumstances, the Constitution used concepts of private law when providing for the allocation of tax jurisdiction between the federal subdivisions. In such cases, there is no space left for questions about the limits of a subdivisions jurisdiction: the legislator may not redefine the private law concept, since a redefinition would imply a surpassing of the limits imposed by the Constitution. To this end, article 110 of the Tax Code provides: The tax law cannot [may not] change the definition, the content and the range of the institutes, concepts and forms of private law used, expressly or implicitly, by the Federal Constitution, the Constitutions of the States, or by the Organic Laws of the Federal District or Municipalities, to define or limit tax jurisdictions. (authors translation) However, when providing for the allocation of tax jurisdiction, the Constitution does not always use concepts. On many occasions, the various Constitutions used types while allocating the taxes between the federal subdivisions. Accordingly, while a concept allows an exact definition, precisely shaped, a type is a mere description, which has fluid contours. [10] The 1988 Constitution considered the taxes in the traditional profile they had in Brazilian tax system, i.e. the Constitution took the existing taxes and allocated them between the federal subdivisions. To this end, the expressions used in the Constitution to designate taxes may have fluid limits that may imply interpenetration and, possibly, give rise to jurisdiction conflicts between the federal subdivisions: such conflicts may take place vertically (those between the union, states and municipalities) or horizontally (conflicts between states or between municipalities). This is where the role of the complementary law as an instrument to settle jurisdiction conflicts starts. If the Constitution were to provide for the taxes as concepts, with hard and precise shapes, it would not have provided in article 146 I for the role of the complementary law in tax matters as a mechanism to solve jurisdiction conflicts, since such conflicts would not occur: each subdivision would have under its jurisdiction taxes with their range precisely defined by the Constitution, and no interpenetration with other subdivisions taxes would take place. Therefore, one can understand this role assigned by the Constitution to the complementary law in tax matters: it was necessary that the reality expressed in the constitutional text through types could be expressed by the complementary law in concepts. For instance, the Constitution allocates to the union the tax jurisdiction on rural property, while municipalities shall tax urban real estates. However, the Constitution itself does not clarify what urban or rural may mean. While some cases are obvious, there are some difficult situations. If one would imagine a ranch situated near to the city centre, is this a rural or a urban estate? One could claim it would be rural, due to its agricultural production, but it could also be considered urban, due to its location. This is a typical case where a complementary law is necessary, to define exactly what rural and urban real estate mean, preventing the natural fluidity of the types. Accordingly, the Tax Code (which is a complementary law) provides for the location of the real estate inside or outside the urban area as the criterion of discrimination. Due to the fluidity of the expression, the Code provides, in article 32, the requirements for a location to be identified as urban area (the presence, at least, of two of the public improvements mentioned in the article). Thus, if located in an urban area, as provided for by the Tax Code, real estate will be subject to the municipal tax on urban real estate, and not to the union tax on rural real estate. This is exactly the role of the complementary law in tax matters regarding jurisdiction conflicts: by setting the taxable event and the calculation basis of the taxes, it aids in the creation of precise definitions of the realities

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provided for by the Constitution. Then, what was provided for as a type by the Constitution will have a conceptual definition through the complementary law. In other words, notwithstanding the fact that the Constitution reflected economic reality from its own point of view, along with its inherent fluidity, it imposed on the complementary law the task of expressing the same reality through concepts, by means of the definition of the taxable event, the calculation basis and the taxpayer, or through the imposition of limits in case of conflict. Accordingly, the Constitution states in article 146 I and III (a) (authors translation): Article 146. The complementary law shall: I provide for jurisdiction conflicts, in tax matters, between the Union, the States, the Federal District and the Municipalities. [] III establish general norms in tax law matters, especially about: a) The definition of tax and its species, as well of, regarding the taxes mentioned in this Constitution, their respective taxable events, calculation bases and taxpayers. The residual jurisdiction of the Union is worth examining, since it shows the role of the complementary law in such a definition. The residual jurisdiction is the possibility of the union to institute taxes which were not expressly provided for by the Constitution. Such jurisdiction is provided for by article 154 I of the Constitution, as follows: Article 154. The Union may institute: I through complementary law, taxes which were not provided for in the previous Article, provided that they are non-cumulative and do not have taxable event and calculation basis characteristics of the ones mentioned in this Constitution. (authors translation) The decision of the Constitution to require a complementary law for the exercise of the residual tax jurisdiction by the union is considered a logical one, since it will only be exercised where there is no tax jurisdiction of the other federal subdivisions. If such jurisdiction is defined by the complementary law, the Constitution is correct in demanding an equivalent mechanism for the residual jurisdiction of the union. Thus, in summary, the allocation of tax among federal subdivisions is made by the Constitution. However, the complementary law is assigned the role of defining the limits of such jurisdiction and, by doing so, avoiding jurisdiction conflicts regarding taxes. Another example of the role of the complementary law concerning vertical tax jurisdiction conflicts is the case of the states sales tax and the municipalities tax on services. Accordingly, while sales of goods are within the states jurisdiction, municipalities were granted by the Constitution the right to tax services. Nevertheless, practice regarding such taxes reveals that a considerable part of the transactions regarding the rendering of services involve, to a greater or lesser degree, an operation concerning goods circulation. Thus, the question is: should such operation be taxed by the states sales tax or by the municipal tax on services? In other words, by means of an example: when a painter paints the walls of a house and supplies all the painting material, should he be subject to the municipal tax on services, since he is rendering a service, or should he be subject to the states sales tax, as he is providing goods (painting material)? The Constitution chose not to impose limits on each tax in such cases, leaving such issues for the complementary law to resolve. To this end, article 156 III of the Constitution states: Article 156. The Municipalities shall have the competence to institute taxes on: [] III services of any nature, not included in Art. 155, II, as they are defined in a complementary law (authors translation) The above-mentioned assignment is fulfilled by Complementary Law no. 116, which provides for a list of circumstances that correspond to services taxable by the municipal tax on services and, therefore, outside the states sales tax jurisdiction. If not for this provision, there would be innumerable cases of jurisdictional conflicts between the states sales tax and the municipal tax on services. The importance of the complementary law in the settling of tax jurisdiction conflicts is also evidenced in the case of the state tax on inheritance and donations. To this end, the Constitution provides: Article 155. The States and the Federal District shall have the competence to institute [impose] taxes on: I transfer by death and donation of any property or rights;

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[] 1 The tax established in item I: I regarding real property and the respective rights, is within the competence of the State where the property is located, or of the Federal District; II regarding movables, titles and credits, is within the competence of the Federal District or of the State where the probate or enrolment is processed, or where the donor is domiciled; (authors translation) One may observe that, regarding the taxation on the assignment of real property, there is no possibility left for tax jurisdiction conflict: the territory of which the real estate is located defines tax jurisdiction, and real estate cannot be located simultaneously in two different places. Nevertheless, the case of movables, titles and credits is quite different. If a movable is transferred by death, the Constitution provides for the competence of the state where the probate takes place, and there is no doubt about which state is entitled to levy the tax on the transfer, since the probate cannot legally occur in two places simultaneously. However, if the movable is transferred by gift, the Constitution provides for the competence of the state where the donor is domiciled. This circumstance may give rise to a tax jurisdiction conflict, as the latter may have his domicile in more than one state. Accordingly, Brazilian law provides for the possibility of a person having more than one domicile. To this end, article 71 of the Civil Code provides for that where a person has several residences in which he alternately resides, each of the residences may be considered his domicile. Therefore, each of the states where the donor has his/her domicile may consider itself competent to levy the tax on the donation of a movable asset. The above-mentioned article 146 I of the Constitution, which assigns to the complementary law the role of settling tax jurisdiction conflicts between the federal subdivisions, would make necessary the enactment of a complementary law dealing with the matter. Since such a law was not enacted, there is a serious potential tax jurisdiction conflict between the states regarding the donation of movable assets. The possibility of a tax jurisdiction conflict due to the lack of a complementary law settling the matter may be considered sufficient reason for the invalidity of the state legislation that adopts the constitutional criterion of the donors domicile to establish the competence to levy the tax on the donation of movable assets. To this end, the Supreme Court, when analysing the levy of taxes in addition to the federal income tax by the states, stated in Judgment no. 136.215: This Court judged the institution of the referred tax unconstitutional, in view of the non-existence of the previous enactment of complementary law, which is indispensable to settle tax jurisdiction conflicts between the States. (authors translation) Thus, emphasizing the importance of the role of the complementary law in settling tax jurisdiction conflicts between the federal subdivisions and, moreover, the role of the complementary law as an instrument for the tax harmonization between the federal subdivisions, the Supreme Court considered the potential jurisdictional conflict due to the absence of such a law as reason enough to deem the imposition of a tax as unconstitutional. From this circumstance one may see that the Supreme Court does not adopt positive measures of tax coordination, but rather leaves such measures to the legislator: when facing the situation of a tax jurisdiction conflict that was not provided for by a complementary law, the Court chose the understanding whereby no subdivision is entitled to tax until the conflict is solved by the complementary law.

5.5. The role of the courts

The role of the courts regarding the settling of tax jurisdiction conflicts between the federal subdivisions can be seen in the circumstances where the courts face the interpretation and application of the complementary laws, as well as in situations which expect the judiciary to hand down a final decision that will settle the conflict.

5.5.1. Horizontal tax jurisdiction conflicts

5.5.1.1. The tax on services
The case of the horizontal conflict between the municipalities concerning the municipal tax on services is evidence of the active role the courts may play in the tax coordination between the federal subdivisions. Before the enactment of Complementary Law no. 116 of 2003, jurisdictional conflicts arose between the municipalities whenever a service was rendered in a municipality by a provider whose establishment was located in another municipality. In such circumstances, each of the municipalities concerned considered itself competent to levy the tax on the said service.

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Accordingly, the tax on services was a tax that would be due in the place where the service was rendered. Before Complementary Law 116 was enacted, said service was ruled by Decree no. 406 from 1968, which stated in its article 12: Article 12. The place of the rendering of the service is considered: a) the place of the establishment rendering the service or, in its absence, the domicile of the provider; b) in the case of construction, the place where the rendering is performed. (authors translation) As one can see, the above-mentioned Decree stipulated that the only situation where the place of the service delivery would be where it was actually performed was the case of construction. Therefore, one can imagine that, in all other circumstances, the place of the service delivery would be where the providers establishment is located (or the domicile of the provider) and, consequently, this would be where the tax on service should be levied. Nevertheless, this was not the understanding adopted by the Superior Court of Justice. According to the Court, in the situation of a service rendered in a municipality by a provider whose establishment was located in another municipality, the tax on service would always be due in the municipality where the service was performed, despite the provision of article 12 of Law no. 406. To this end, Judgment no. 41.867-4 of the Superior Court of Justice stated: The relevant provision [Art. 12 Law no. 406] does not have an absolute meaning. Its understanding, as scholars teach, must be tempered. It is undeniable that, in tax allocation, the Law wants the tax on services to belong to the Municipality in whose territory the taxable event has taken place. It is, therefore, the place of the service delivery which indicates the Municipality competent to levy the tax. To think differently is nonsense, since it would allow a service delivered inside the borders of a Municipality to be allocated to another Municipality. (authors translation) Thus, in the Superior Court of Justices understanding, the service would be considered to be performed in the place where it was actually delivered, not only in the case of construction, as provided for by Decree no. 406, but rather in all circumstances. Therefore, the tax on a service would always be due to the municipality in whose territory the service was delivered if the provider had its establishment or domicile in another municipality, the latter would not be competent to levy the tax on the service rendered outside its borders. Such an understanding, in spite of having been adopted by the Superior Court of Justice, was clearly against the literal provisions of Law no. 406. This situation gave rise to a great uncertainty among taxpayers, since both the municipality of the providers establishment and the municipality where the service was delivered considered themselves competent to levy a tax on the same service. This uncertainty would only be removed in 2003 with the enactment of Complementary Law no. 116, which provided for the municipal tax on services. Aware of the conflict between Decree no. 406 and the Superior Court of Justices understanding, the above-mentioned Law enlarged the situations where the tax on services is owed to the municipality in whose territory the service is effectively performed and provided that, in the other situations, the respective tax should be levied by the municipality where the providers establishment is located. Nevertheless, article 4 of Complementary Law no. 116 provides that the providers establishment must be considered the place where the taxpayer performs the activity of rendering services, and configures an economic or professional unity. There is discussion whether or not such an establishment is the place of the actual carrying out of the service. Accordingly, on the occasion of Complementary Law no. 116, the Superior Court of Justice changed its understanding on the matter. Notwithstanding its previous judgments, when the Court established that the tax on services should always be due to the municipality where the service was actually delivered, it adopted the understanding whereby the tax must be levied by the municipality of the providers establishment, unless Complementary Law no. 116 provides otherwise. Such a position can be seen in Judgement no. 1.160.253: As one can see, the Municipality which is competent to levy the tax on services is the one where the service providers establishment is located. The latter is considered the place in which there is an economic or professional unit, i.e. where the activity is performed, independently of being formally considered the head or a branch of the legal entity. It means that the tax will not always be due in the place where the service is rendered. (authors translation) Another example of the Courts role in defining the subdivisions jurisdiction by means of the interpretation of the Constitution and of the complementary law is the case of the taxation of rental agreements of movables by the municipal tax on services. The Constitution provided for the municipal jurisdiction to tax services of any nature. Nevertheless, as article 155 III provides, only the services defined by complementary law are taxable by the municipalities. To this end,

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Complementary Law no. 56 of 1987 provides for a list of services which the municipalities were entitled to tax. Item no. 79 of this list included rental of movable assets, including leasing. However, the taxation of the rental of movable assets by the municipal tax on services was claimed to be unconstitutional by certain taxpayers. According to these taxpayers, in spite of the complementary law provision, the rental of movable assets could not be considered to be a service: notwithstanding the importance of the assignments of the complementary law in tax matters, it could not go beyond the constitutional provisions. If the Constitution provides for the municipal jurisdiction to tax services, the complementary law may not define as service something that is not: by doing so, the law would change the tax jurisdiction allocation provided by the Constitution. To this end, as we have mentioned above, article 110 of the Tax Code provides that the tax law may not change the definition, content and range of the institutes, concepts and forms of private law used, expressly or implicitly, by the Constitution. Accordingly, the Supreme Court held: [11] It is a provision of purely didactic value: it is implicit within the constitutional tax jurisdiction allocation. Without taking it strictly into account, the constitutional tax jurisdiction allocation would be chaotic, if not idle. (authors translation) When analysing the case of the movable assets rental, the Supreme Court held in Judgment no. 116.121-3: There is one undeniable fact: the Constitution, when granting tax jurisdiction to tax services of any nature to the Municipality, requires that the levy of the tax on services reach only acts and facts that can be legally characterized as services. (authors translation) Moreover, the Supreme Court held in the same Judgment: [T]he characterization of rental of movable assets as a service, for the purpose of the municipal taxation through the levy of the tax on services, means nothing but the inadmissible and arbitrary manipulation, by the complementary law, of the constitutional tax jurisdiction allocation, since the tax on services can only be levied on affirmative covenants, into which concept the rental agreement of movable assets does not fit. (authors translation) Thus, the Supreme Court declared unconstitutional the provision of Complementary Law no. 56 that granted the right to tax the rental of movable assets to the municipalities under their tax on services. A complementary law could not redefine concepts of private law (service) used by the Constitution, since it would lead to the redefinition of the tax jurisdiction allocation itself.

5.5.1.2. The sales tax on communication services

The current profile of the sales tax was laid down in the 1965 tax system reform. As mentioned, due to the fact that the earlier sales tax had been in the states jurisdiction, the 1965 18th Amendment to the Constitution decided to maintain the new non-cumulative sales tax within the same jurisdiction. One should say that retaining the states jurisdiction on a sales tax was most probably the biggest mistake of that reform: considering the political environment at that time (military regime, where Congress has no effective influence), this would have been a great opportunity to have a nationwide non-cumulative comprehensive sales tax. The fact of a tax with a national character which is not in the unions jurisdiction, but rather owed locally to each state, has consequences that are still being suffered today. One of these consequences is a harmful tax competition, since several states have attempted to attract investments through benefits in the sales tax. Tax jurisdiction conflicts can be considered another outcome of such circumstance, as one can see from the case of communication services when such services are provided through a phone card. Accordingly, in spite of being essentially a service, communication is taxed by the state sales tax, and not by the municipal tax on services. The attribution of the states to tax communication services through their sales tax was an innovation of the 1988 Constitution, since the previous 1967 Constitution (in article 21 VII) provided that such services should be taxed by the union, or by the municipalities when the communication had a strictly municipal character. To this end, the 1988 Constitution states in article 155 II: Article 155. The States and the Federal District shall have the competence to institute taxes on: [] II. transactions relating to the circulation of goods and to the rendering of interstate and intermunicipal transportation services and services of communication, even when such transactions and renderings begin abroad. (authors translation)

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Moreover, the Constitution assigns to the complementary law the role of establishing, for purposes of collection of the sales tax and definition of the responsible establishment, the location of the transactions concerning the circulation of goods and the rendering of services. Thus, the complementary law must provide for the criteria which will lead to the definition of the state that is entitled to levy the sales tax, avoiding a potential tax jurisdiction conflict. The above-mentioned assignment is accomplished by Complementary Law no. 87 from 1996. This Law provides, in articles 11 and 12: Article 11. The place of the operation or rendering, for purposes of the tax levy and the definition of the responsible establishment, is: [] III in the case of paid communication services: [] b) the establishment of the concession or permission-holding phone company which issues the coins, cards or similar items through which the service is paid. Article 12. The taxable event is considered to be realized at the moment: [] VII of the rendering of the paid communication services, done by any means, including the generation, emission, reception, transmission, retransmission, repetition and amplification of communication of any nature. [)] 1 in the hypothesis of item VII, when the service is rendered through payment in coins, cards, or similar items, the taxable event is deemed to have occurred in the State where such instruments were provided to the user. (authors translation) One may be aware of the phone card situation: such a card can be issued by a phone company in one state and then be sold to a reseller located in another state. The reseller may sell the card to the user, who can use it in a third state, or even use it partially in several states. Therefore, the question is: which state is entitled to levy the sales tax on the respective communication service? Such questions gave rise to a tax jurisdiction conflict between the states. Accordingly, by giving a certain interpretation to the wording of article 11 III (b) of Complementary Law no. 87, the state in whose territory the phone company that issued the phone card is established might consider itself competent to levy the sales tax on the communication service. Nevertheless, based on an interpretation of article 12 VII(1) of Complementary Law no. 87, the state where the reseller provides the phone card to the user might also consider itself competent to levy the sales tax on the respective operation, since it may be assumed to be the place where the communication service will be rendered. According to such an understanding, article 11 III (b) of Complementary Law no. 87 only defines the establishment of the phone company as being responsible for paying the tax debt, and does not define the moment of the levying of the tax. The question whether the sales tax is due to the state where the phone card is sold to its user or to the state where the establishment of the phone company which issued the phone card is located, or even to the state where the communication service is effectively performed, was submitted to the Superior Court of Justice. After an analysis of the situation, the Court adopted the view whereby the sales tax on the communication service is levied by the state in whose territory the establishment of the phone company that issued the phone card is situated. To this end, the Superior Court of Justice held in Judgment no. 1.119.517: In the case of communication services rendered through coins, cards or similar items, the tax is due to the State where the establishment of the company which provides such instruments is located. This means that, in a literal interpretation of the rule, it does not matter in which place the service is effectively performed, nor where the domicile of the respective user is located. (authors translation) The Court justified its position through practical arguments: The phone card may be acquired in a State and integrally used in another State. It is possible, also, that the same card is used in more than one State. In such terms, in the issue of cards, coins or similar, it is not possible to know which is the effective place of the communication service rendered, and this is why the legislator, aware of such difficulty, determined as spatial element of the operation the place of the establishment of the company which issues them, denying the place of effective rendering criterion. Therefore, the place where the card is used and places linked to the user were not, for sure, criteria adopted by Complementary Law no. 87 for the purpose of determining the place of the service rendered in this case. (authors translation)

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Thus, by the interpretation of the provisions of a complementary law, the Superior Court of Justice settled the jurisdictional conflict between the states regarding the sales tax levied on communication services when these are provided through phone cards. In the Courts understanding, the tax is only owed to the state where the establishment of the phone company that provides the phone card is located, since it would be extremely difficult to precisely indicate the place where the communication service actually took place.

5.5.2. Vertical tax jurisdiction conflicts

5.5.2.1. The tax on services on finance lease agreements
The case of the taxation of finance lease agreements gave rise to discussions about which federal subdivision should be entitled to tax the respective agreement. Should the finance lease be taxed by the municipal tax on services, the state sales tax or the federal tax on financial transactions? Accordingly, the finance lease agreement may be defined as the contract whereby the lessor purchases an asset selected by the lessee and rents it to the latter. The lessee, then, has the right to use the asset during the term of the agreement and must pay to the lessor the rentals for such use. At the end of the agreement, the lessee will have the option of acquiring ownership of the asset. One may consider the above-mentioned agreement essentially to be a financing. To this end, municipalities, by deeming the financing to be a service, intended to tax the finance lease agreement under the municipal tax on services. Actually, as mentioned, the Constitution provides the municipal jurisdiction to tax services, but does not provide for a concept of service. Complementary Law no. 116, which governs the municipal tax on services, provides in item 15.09 for the leasing agreement to be taxable under the tax on services. Nevertheless, taxpayers claimed there was no municipal jurisdiction to tax the finance lease agreements. For such purposes, taxpayers pointed to characteristics of the finance lease agreement which would argue against its characterization as a service. To this end, the taxpayers argued that the operations concerned in the respective agreement would lead to the acquisition of the asset by the lessee, something that would make the agreement very close to a sale, which would be taxed under the states sales tax. Moreover, a substantial part of the agreement would correspond to the letting of the asset at the lessee disposal, which would be very close to a rental agreement, and not to the rendering of a service. According to the taxpayers, even if one considers the principal characteristic of the finance lease agreement as financing, it should not be taxed under the municipal tax on services, but rather under the unions tax on financial transactions. State courts rejected the taxation of the finance lease agreements under the tax on services. In their understanding, the finance lease agreements could not be deemed as service deliveries, as the concept of service is constitutional and could not be changed by a complementary law. To this end, the State of Santa Catarina Court of Justice held: The finance leasing does not cover the rendering of services. Its nature cannot be changed by a legal provision. The law does not have the power to change the essence of things and facts. To define as a rendering of services what it is essentially not corresponds to a concealed form of cheating the constitutional limitation of the taxation (authors translation) The case was then submitted to the Supreme Court. In spite of the taxpayers arguments and of the state courts understanding, the Supreme Court deemed the levy of the municipal tax on services on the finance lease agreements to be constitutional. To this end, the Supreme Court held in its Judgment no. 547.245: In finance leasing, an autonomous agreement which is not a mixed one, the nucleus is the financing. And financing is a service, on which the municipal tax on services may be levied, the existence of a purchase in the case of the finance lease and the lease-back being irrelevant. (authors translation)

5.5.2.2. The taxation of software

The taxation of software has always given rise to questions about whether it should be taxed by the state sales tax or by the municipal tax on services. Due to its nature and its intangibility, it is not easy to immediately define the software as a good, which would be taxed under the sales tax. At the same time, one should be aware that numerous software is commercialized on a large scale with the very same configurations, which makes it quite difficult to deem it a service rather than a good. Accordingly, the Constitution provides for the taxation of goods by the sales tax and of services by the municipal tax on services, but does not provide for any concept covering both. Software, then, was potentially subject to the state sales tax and the municipal tax on services, in a traditional vertical tax jurisdiction conflict. When analysing the situation, the courts established the circumstances where the software should be taxed by the state sales tax, as well as cases where the software should be taxed by the municipal tax on service. In the

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first circumstances, the software would assume the character of a commercial good, while in the second the software would most correctly be defined as a service. Accordingly, in the courts understanding, software that is produced on a large scale and targeted to a wide range of consumers may be considered as a good such software is even bought by resellers and sold to the consumer in large stores and markets, and that is why it is called off the shelf. In such circumstances, the software may be taxed by the state sales tax. Nevertheless, there is software that is produced in a highly customized way. Since it is targeted to a specific user, it is produced according to its instructions and needs. In this situation, the software may be considered to be a service rendered to the costumer and, therefore, taxable under the municipal tax on services. To this end, the Supreme Court held in Judgment no. 176.626-3: Not having as object a good, but an intangible asset, the States effectively cannot levy the sales tax on the licensing or assignment of software rights: however, from this impossibility, it does not result that the circulation of copies or exemplars of the software produced in series and commercialized in the market known as off the shelf software is removed from the jurisdiction of the constitutional sales tax. (authors translation) Such an understanding was adopted before the enactment of Complementary Law no. 116 of 2003. Accordingly, this law, which, as mentioned, provides for the municipal tax on services, added in item 1.05 the licensing or assignment of software rights as a service taxable under the tax on services. Therefore, Complementary Law no. 116 defined as a service something that the Supreme Court had previously declared not to be the case. Thus, there is a question regarding the limits of the complementary law: it may not go beyond the constitutional provisions. Notwithstanding the fact that the complementary law must define the taxable event of taxes mentioned by the Constitution, it cannot define as a service something that does not fit into the constitutional category of service. By doing so, the complementary law would be changing the constitutional tax allocation itself. This circumstance is yet to be addressed by the Supreme Court.

5.6. Conclusion
Brazilian federalism attributed tax jurisdiction to all of its subdivisions and allocated the taxes between its three levels of government, attempting to avoid internal double taxation. The profile of the tax jurisdiction allocation has always been provided for by the Constitution. Nevertheless, the Constitution, when providing for the allocation of tax jurisdiction, used expressions which have fluid limits. Such circumstances could lead to confusion and give rise to horizontal or vertical tax jurisdiction conflicts between the federal subdivisions. By means of the fluidity of the constitutional definitions, more than one federal subdivision might consider itself entitled to levy tax on the same fact. In such circumstances, the Constitution earmarked a relevant role for the complementary law in tax matters: the settling of tax jurisdiction conflicts, whether they potentially happen horizontally or vertically. Therefore, the role of the courts in coordinating the taxes between the federal subdivisions may be seen in the cases where the judges interpret the Constitution along with the provisions of the complementary law. By establishing the range and the meaning of the provisions of the Constitution and of the complementary laws, the courts play a relevant role in defining the shape of each of the subdivisions tax jurisdiction. 1. 2. Alexander Hamilton, The Federalist p. 145 (Indianapolis: Liberty Fund, 2001). W.D. Guthrie, Lectures on the 14th Amendment to the Constitution of the United States p. 139 et seq. (Little, Brown and Co., 1898), cited in A.R. Sampaio Dria, Discriminao de Rendas Tributrias p. 12 (So Paulo: Jos Bushatsky, 1972). Sampaio Dria, id., p. 43. A. Baleeiro, Alguns andaimes da Constituio p. 20 et seq. at 23 (Rio de Janeiro: Livraria Principal, 1950), cited in Sampaio Dria, id., p. 104 (authors translation). Sampaio Dria, id., p. 162. R. Barbosa, Comentrios a Constituio Federal Brasileira: coligidos e ordenados por Homero Pires, vol. 2, p. 477 (So Paulo, Livraria Acadmica Saraiva & Cia, 1933) (authors translation). V. Nunes Leal, Leis complementares da Constituio, in Revista de Direito Administrativo 7 p. 381 (1947). G. Ataliba, Lei Complementar na Constituio p. 29 (So Paulo: Editora Revista dos Tribunais, 1971) (authors translation).

3. 4. 5. 6. 7. 8.

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9. 10. 11.

See Trabalhos da Comisso Especial do Cdigo Tributrio Nacional p. 8 (Rio de Janeiro: Ministrio da Fazenda, 1954) (authors translation). K-H. Strache, Das Denken in Standards Zugleich ein Beitrag zur Typologik p. 32 (Berlin: Duncker & Humblot, 1968). Supreme Court, Judgment No. 116.121-3.

Citation: J. Englisch et al., Horizontal Tax Coordination (M. Lang et al. eds., IBFD 2012), Online Books IBFD (accessed 2 Aug. 2013).

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