Latvia Stalling in the EU Single Market: The State Revenue Service’s Failure to Uphold VAT Neutralit

One of the fundamental objectives of the European Union (hereinafter, the “EU”) is the commitment of its Member States, through common action, to ensure their economic and social progress by removing the barriers that divide Europe. One of the means of achieving this objective is the establishment of the EU Single Market, which encompasses the free movement of services and capital within the EU without internal frontiers. The EU Single Market, and the freedom of movement within it, is therefore one of the cornerstones that define the very nature of the EU.

A common value added tax (hereinafter, “VAT”) system has been established in the EU Single Market. The VAT system operating within the EU Single Market is characterised by the principle of neutrality, which essentially means that businesses must be able to deduct input VAT or, where deduction is not possible, reclaim the VAT, since VAT is ultimately borne by the final consumer.


For more than a decade, the Court of Justice of the European Union (hereinafter, the “CJEU”) has consistently provided Member States with guidance on this, in the author’s view, readily understandable VAT system designed to support the development of the EU Single Market. This follows from the Treaty on European Union, Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, and Council Directive 2008/9/EC of 12 February 2008 laying down detailed rules for the refund of value added tax, provided for in Directive 2006/112/EC, to taxable persons not established in the Member State of refund but established in another Member State. The titles of these instruments themselves explain their scope.

However, if the principle of VAT neutrality is so straightforward, the question arises: why have countless CJEU judgments addressed it, and what does it have to do with the State Revenue Service (hereinafter, the “SRS”) and Latvia?

Based on practical experience, my subjective view of the extensive body of CJEU case law is that, in most cases, no one is pleased to discover that money they have received and regarded as their own must be returned. It is therefore only human and natural to look for arguments that, objectively or subjectively, might justify keeping that money. If no objective grounds can be found, the correct course is to return it. If no objective grounds can be identified but there remains a strong reluctance to return the money, subjective arguments are put forward instead. The question is whether this satisfies the person entitled to the money. If it does not, legal remedies are available. These are my reflections on why the CJEU has repeatedly had to explain the principle of VAT neutrality to EU Member States: refunding VAT to an undertaking from another Member State indisputably reduces the budget of the Member State into which that VAT was originally paid.

As regards the SRS, the good news is that Latvia is not yet among the EU Member States that have been “named and shamed” in CJEU judgments reiterating the essence of the principle of VAT neutrality and of the EU Single Market, with its freedom of movement. At the same time, there is a substantial prospect that Latvia too may be mentioned in a CJEU ruling. An undertaking from another EU Member State (hereinafter, the “Client”) approached our tax specialists in connection with a project in Latvia involving preparatory work required to enable IT services to be provided at a property owned by a Latvian company. In order for the Client to provide its principal services, preparatory work had to be carried out. For this purpose, another Latvian company was engaged to perform the necessary work at the property. Since the place of supply of services connected with immovable property was Latvia, the Client was required to pay VAT when settling the Latvian company’s invoice. As the Client did not conduct business in Latvia of a kind that would require registration in the Latvian VAT register, it could not deduct the VAT paid in Latvia as input VAT. The Client therefore had to reclaim the VAT under the refund procedure for taxable persons from other Member States laid down in Section 113 of the Latvian VAT Law. This procedure was familiar to the Client, which is a well-known business providing IT services in other EU Member States as well. The Client was therefore greatly surprised when the VAT refund was refused on the ground that it should have understood that it was required to register a permanent establishment in the Republic of Latvia, which could then have been used to deduct the VAT.

Acting in the Client’s legal interests, BDO tax specialists sought to resolve the matter with the SRS by explaining the essence of the principle of VAT neutrality and why the SRS’s argument concerning the alleged need to register a permanent establishment was incorrect. The SRS nevertheless maintained its position, and the Client therefore decided to bring the matter before the courts.

It should be emphasised that the transactions were concluded with the Client, and the related VAT was paid by the Client, in 2022. The Client learned only in 2023 that the absence of a permanent establishment would be relied upon by the SRS as the basis for refusing the VAT refund.

I would reiterate the personal view expressed above as to why authorities comparable to the SRS have for more than ten years seemingly “failed to understand” the elementary nature of VAT neutrality. For example, where an undertaking has paid VAT in another EU Member State but cannot deduct that VAT as input VAT in that Member State, it must be entitled to reclaim it from the Member State in which it was paid. VAT is borne by the final consumer, and its burden cannot rest on a business. Consequently, if an undertaking from one EU Member State cannot deduct the amount, it must be entitled to reclaim it from the Member State in which the VAT was paid.
It should also be emphasised that Latvian case law already exists on this issue. In another case, even the Senate of the Supreme Court of the Republic of Latvia (hereinafter, the “Senate”) clearly explained to the SRS both the principle of VAT neutrality and the obligation to refund VAT where an undertaking from another EU Member State is unable to deduct it. Otherwise, free movement within the EU Single Market would be restricted, which is incompatible with the very nature of that market. Without even referring a question to the CJEU for a preliminary ruling, the Senate held that the reason advanced by the SRS for refusing the VAT refund—failure to register in the Latvian VAT register—was not, in itself, a lawful basis for denying the right to a VAT refund.

Nevertheless, although the SRS’s attention in the Client’s case was drawn to the existing Latvian case law, including the Senate’s judgment, the SRS attached legal significance to the assertion that the Client had been obliged to register a permanent establishment in Latvia. Latvian case law, meanwhile, had already rejected the SRS’s position that failure to register in the VAT register could serve as a basis for departing from the obligation to refund VAT. In effect, the SRS takes the position that Latvian case law, EU directives and the CJEU’s findings concerning the principle of VAT neutrality are not binding upon it.

From the standpoint of elementary logic, the Client cannot turn back the clock to the time when it entered into the transactions and paid for the services received in Latvia in connection with immovable property situated in Latvia. If the Client were now to register a permanent establishment artificially, following the SRS’s instructions, that establishment would have no right to deduct the VAT already paid by the Client. As noted above, the principle of VAT neutrality requires that VAT be either deducted or reclaimed. It must therefore be stressed that the SRS’s position results in a situation in which the Client can neither deduct the VAT nor reclaim it. In practical terms, the SRS’s position is that the economic burden of the VAT must be borne by the Client itself, while, from the SRS’s perspective, the VAT remains in the State budget.

The question therefore arises whether the SRS has devised something that had not already occurred to comparable authorities in other EU Member States that were subsequently criticised by the CJEU. Personally, I can identify nothing that the CJEU has not already considered. I leave the ultimate assessment to the reader. From the perspective of VAT neutrality, however, I see no difference between the SRS’s position that an undertaking must register in the VAT register—a position criticised by the Senate—and its position that a permanent establishment must be registered. In both cases, according to the SRS, there is no obligation to refund the VAT.

In defending the Client’s legal interests, one is left with the firm impression that the SRS is pursuing a practice aimed at increasing budget revenue while disregarding EU directives and the case law developed by the CJEU over many years. Such a practice is incompatible with the nature of the EU Single Market. What makes the situation particularly disheartening is that, in discussions, SRS officials gave the impression of being competent specialists who understood the hierarchy of legal rules, the scope of the applicable provisions and the principle of VAT neutrality, while informally invoking “policy” and suggesting that the matter should be taken up with the Ministry of Finance of the Republic of Latvia.


Clearly, refunding VAT to an undertaking from another EU Member State reduces the national budget, and this could hardly be expected to be the policy of the Ministry of Finance, which oversees the State budget. At the same time, if there truly is a policy aimed at increasing budget revenue, that “policy” cannot be pursued at the expense of the EU Single Market and the principle of free movement embodied within it. In other words, there can be no double standards: public authorities readily enjoy and actively make use of the right to receive EU support, yet are far less enthusiastic about the obligation to repay VAT due to undertakings from other Member States. In that respect, the authorities adopt the passivity typical of bureaucracy, and where a private party nevertheless insists on receiving the refund, litigation becomes necessary.

As noted above, the EU has not directly criticised the SRS. The Senate, however, in exercising judicial review over the actions of the executive branch—and thus over the SRS—identified fundamental problems and defects of understanding incompatible with the principle of VAT neutrality. Unfortunately, more than five years had passed before the Senate gave its ruling on the lawfulness of the SRS’s decision. In other words, more than five years elapsed between the date on which an undertaking from another EU Member State requested the refund of VAT and the date on which the Senate held that the SRS had acted unlawfully. Even on the most optimistic assessment, the SRS’s conduct in withholding for several years VAT due to an undertaking from another Member State was not, and cannot be regarded as, conduct promoting the free movement of services and capital without internal EU frontiers.

It appears that CJEU judgments recognising a right to compensation where EU Member States breach the principle of VAT neutrality are not a sufficiently effective deterrent to prevent authorities comparable to the SRS from searching for arguments that would allow them to withhold funds due to an undertaking from another Member State until the end of cumbersome court proceedings. In practical terms, these are attempts at national level to depart from the principle of VAT neutrality.

At the same time, there can be no doubt that such practices by public authorities—seeking to increase national budget revenue by disregarding the principle of VAT neutrality—are not and cannot be acceptable. This is especially so because legal proceedings aimed at demonstrating that the authorities have acted incorrectly require substantial resources and may continue for years, during which the company seeking the refund is deprived of funds that it could otherwise have used in its business operations. Authorities comparable to the SRS thereby create obstacles: internal EU borders plainly remain in place and impede free movement within the Union.

In any event, we are pleased that the Client did not acquiesce in manifest injustice, and we are honoured to have the opportunity to defend the Client’s legal interests in a case aimed at improving the functioning of the EU Single Market. In this context, one is left with the impression that the SRS is not troubled by CJEU case law or by the prospect of earning Latvia the distinction of being mentioned in a CJEU judgment that would yet again explain the essence of the EU, the EU Single Market, the principle of VAT neutrality, and the obligations assumed under the EU Treaties to remove internal barriers to the free movement of services within the EU Single Market.

Riga,
12 January 2024

Jānis Zaļais
Attorney-at-Law BDO Law

Updated on 15 July 2026 to include a link. For the continuation of the article, see Regional Court annuls SRS's refusal to refund cross-border VAT.