A blow for victory was struck for small time landlords when HM Revenue & Customs were forced to back down over their challenge of tax deductions for repairs that were part of a refurbishment project.

The ruling, which told the Revenue to revisit their own rule book, confirmed a landlord’s right to offset the cost of legitimate repairs against rental income, even where they are part of a major refurbishment or rebuilding project.

But experts are warning this is the tip of the iceberg from an increasingly aggressive HMRC, which is turning to litigation, even where the taxpayer is odds on favourite to win.

In the case, which came before the first tier tax tribunal recently, HM Revenue and Customs were given a rap on the knuckles and reminded to follow their own guidelines in future.

The case was brought by Mr Wills, the landlord of a property comprising a house, an outbuilding and grounds which he let out to tenants. The outbuilding was used as a games room or for storage but had fallen into disrepair and was becoming dangerous. In 2004, the landlord obtained consent to repair the outbuilding, which was listed, and to install heating, power points and running water.

The total cost of the work came to £106,707, and accepting that the bulk represented improvements to the outbuilding, the landlord claimed £43,665 as a deduction from rent received for the cost of repairs. But the Revenue threw out the claim, saying that the work had changed the character of the outbuilding and represented a capital scheme for improvement and additional living space.

In a scene worthy of Yes Minister, the Revenue even suggested that the outbuilding could have been fenced off as an alternative way to deal with the dangerous state.

When Mr Wills appealed to the Tribunal, he supported his claim to deduct the cost of repairs from rent by pointing out that it was strictly in accordance with HM Revenue’s practice manual. This says that where work is carried out that includes both repairs and improvements, deductions will be allowed for the repair element, even where the work includes an element of rebuilding.

The Tribunal agreed with Mr Wills, saying that the work he claimed was essential repair, and that there was nothing to suggest that a change of use was intended. They even went so far as to find that Mr Wills was entitled to an additional deduction for structural work carried out to ensure that the outbuilding did not collapse.

Said tax/property specialist James Sherratt, of Romford-based lawyers Mullis & Peake LLP: “The case shows two things. Firstly, the revenue has been forced to go away and read its own rulebook. They must be bound by their own manuals, which are a statement to the public setting out how taxpayers will be treated.

“It also shows a trend on the part of HMRC over the last few years to act more aggressively towards taxpayers and to litigate even if the chance of success is slim.

“Perhaps the Coalition Government’s crusade against waste will extend to stopping the Revenue’s enthusiasm for embarking on hazardous litigation at public expense.”

ENDS

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