In a recent judgment on May 4, 2023 (C-516/21), the European Court examined a case involving the rental of a building with permanently installed equipment and machinery. The judgment provides clarity on whether this rental should be considered as a single supply for VAT purposes.
From 2010 to 2014, Person Y leased a barn specifically designed for raising turkeys. The facility was equipped with permanently installed machinery and equipment, such as an industrial spiral conveyor for feeding the birds, and a heating, ventilation, and lighting system that was adjustable based on the turkeys' growth stages. The lease agreement stipulated that Y would receive a single fee for providing both the building and the equipment and machinery.
Person Y argued that the entire lease should be exempt from VAT, while the German tax authorities believed that the rental of the equipment and machinery was subject to VAT. Nevertheless, the Finanzgericht (Tax Court of First Instance, Germany) ruled in favor of a full exemption for the lease. Dissatisfied with this decision, the tax authorities appealed to the Bundesfinanzhof (highest federal court in tax matters, Germany), which served as the referring court.
The rental of permanently installed equipment and machinery is subject to mandatory taxation under Article 135(2)(c) of the VAT Directive. In principle, the rental of a building is exempt from VAT based on Article 135(1)(l) of the VAT Directive.
The referring court is uncertain whether the compulsory VAT applies to the rental of equipment and machinery when they are closely linked to an exempt service, such as leasing a building, and requests the court to provide the necessary clarification.
The European Court refers to its previous case law, such as the Henriksen case, which states that the rental of parking spaces is not excluded from the VAT exemption for the rental of immovable property if both rental transactions form a single economic transaction.
As a result, there is no obligation to divide a single economic transaction into separate services, contrary to the German tax authorities' claim.
The German tax authorities base their argument for taxing the rental of permanently installed equipment and machinery on the principle that the exemptions of the VAT Directive must be interpreted strictly.
However, the European Court maintains that different services forming one economic transaction must follow the same VAT regime to prevent artificial splitting and distortion of the VAT system. Therefore, the principal service (the rental of a building) and the ancillary service (the rental of fixed equipment and machinery) should be exempted as a whole since they form a single economic supply. This means that the rental of permanently installed equipment and machinery need not be taxed separately if they form a single economic supply together with the rental of a building.
In conclusion, the Court determines that the principal service, namely the rental of the building, combined with the rental of the permanently installed equipment and machinery, should be exempted from VAT as a whole.
Impact for Practice
In Belgium, when a landlord of a property commits to providing so-called ancillary services to the tenant, the transaction is generally fully exempt from tax. However, ancillary services can be subject to tax when provided by the landlord themselves to the tenant and a separate price has been agreed upon (Circular no. 4/1973 of 12.01.1973, paragraphs 95 and 96). One may question whether this optional VAT levy is compatible with EU case law. In practice, landlords are often still required to split the price into a taxable and an exempt part for VAT purposes when dealing with a furnished property. Cases like the "Y" case demonstrate that this is actually incorrect.
The "ancillary component follows principal supply" principle remains difficult to apply in practice, often leading to case-by-case assessments. However, this does not mean that a transaction must be split because it consists of one (or more) taxable components. When the "principal matter" (property rental) is exempt, the "ancillary matter" (furnishing of the building) also follows that VAT treatment. This discussion may sound familiar, as it was recently discussed in the context of applying reduced VAT rates, where the same debate applies. Guidance or group lessons in a fitness center generally also follow the VAT treatment of the access or use of that center (6%).
It remains essential to exercise caution in practice…