“Compulsory” rental agreement concluded by operation of law is subject to VAT and exemptions must be interpreted strictly (Pilsētas zemes dienests, C-598/20, order of 1.12.2021)

The case involved land owned by entity A. There was a building on the land. Entity B was the owner of the building. Under Latvian law, a „compulsory” rental relationship was established ex lege between these entities.

One of these parties argued that this „forced” rent should be exempt from VAT by virtue of articles 135.1.l and 135.2 of the VAT directive. According to these provisions member states shall exempt the leasing or letting of immovable property. Member States may apply exclusions to the scope of the exemption referred to in the above provisions.

The Court disagreed with the party’s approach. It considered that:

• Such “compulsory” letting is an activity subject to VAT;
• As to whether such rent should be exempt – the terms used in constructing the exemptions should be interpreted strictly;
• Provisions excluding these exemptions should be interpreted broadly;
• Provision 135.2 constitutes exclusion from exemption and should therefore be interpreted broadly.