[2010] UKFTT 174

TC00479

Appeal number: TC/2009/12588

Income tax, Schedule D - deduction - expenditure on letting premises - whether on repairs or improvements

FIRST-TIER TRIBUNAL

TAX 

	CHRISTOPHER WILLS	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

		TRIBUNAL: 	S.M.G.RADFORD (TRIBUNAL JUDGE)							J.ROBINSON (MEMBER)		

Sitting in public at Southampton Appeals Service, Southampton, S01 2SH on 23 March 2010

Mr. R. Green Wilkinson of C.W. Fellowes Ltd for the Appellant

Mr. M. Riordan for the Respondents

© CROWN COPYRIGHT 2010

DECISION

The Appeal
1.	The Appellant appealed against the HMRC’s decision that a sum of £43,665 claimed for repairs to an outbuilding attached to one of the Appellant’s rental properties in tax year 2005/2006 should be disallowed and that tax of £17,399.23 was payable for that year.
Background and Facts
2.	The Appellant has income from property lettings. On 30 January 2007 the Appellant submitted his tax return for 2005/2006 which included rental income of  £133,910.  The total deductions claimed from the rental income were £130,863 of which £119,002 was claimed for repairs and renewals.
3.	One of the properties let was The Old Rectory which the Appellant had owned for some 30 years and which consists of a house, an outbuilding, garden and grounds. A significant amount of work was carried out on the outbuilding.
4.	In the tax year 2005/2006 the total cost of the work incurred on the outbuilding was £106,707.  In the accounts capital expenditure was shown as £63,042 and the cost of the repairs claimed was £43,665.
5.	Following an enquiry into the 2005/2006 tax return HMRC decided that the amount claimed for repairs was not an allowable expense but was capital expenditure and thus not allowed.
6.	In 2004 the Appellant approached Grahame Thomas Design Ltd, a firm of architects to advise him regarding necessary repair work to the outbuilding.
7.	The outbuilding which is a listed building was used in a variety of ways.  Prior to the repair work the outbuilding had been used for storage, as a games’ room and generally as additional living space although there was a period of a few years when a car was sometimes garaged in the building.  It had become extremely run down and in view of its state of disrepair was becoming dangerous.
8.	Mr Grahame Thomas of the architects appeared as a witness for the Appellant.  He confirmed that the outbuilding was in a poor state of repair to the extent that it was becoming dangerous.  As the building was listed there was no option other than to undertake a substantial repair scheme. He was concerned that the roof could collapse if there was a heavy fall of snow, the point work had perished, the brickwork had been affected by frost, some of the timbers were rotten and had wet rot, there was no felt under the tiles, the slates had slipped, there was no damp course and an internal partition was required to keep any timber away from moisture and the rafters, doors and windows were in an appalling state of repair. 
9.	Mr Thomas confirmed that his remit was to provide a proposed repair scheme and to obtain the necessary listed building consent. He produced to the Tribunal his plans for the repair of the outbuilding, before the repair and after the repair photographs of the outbuilding and the letters from the Basingstoke and Deane Borough Council setting out the requirements for listed building consent which was obtained on 1 August 2005.
10.	Mr. Thomas explained that in undertaking this repair scheme it made sense to bring the interior a little more up to date.  200 years ago there would not have been any thought of heating and it therefore made sense to include heating, electric power points and water supply.  Although it made sense to include these while carrying out the work, there were no basins, toilets, kitchen or anything that would allow this space to be anything more than additional living space ancillary to the main house.
11.	Mr. Green Wilkinson explained that effectively the difference after the repairs was that there was now dry storage all year instead of, as was previously, damp storage.  Since the repairs the outbuilding has been used as games room and studio as well as for storage.  Mr. Green Wilkinson explained that this was not hugely different to the previous use of storage, games room and, at one time, garaging. In giving evidence Mr. Thomas confirmed that when he inspected the outbuilding a table tennis table and train set were in place there. 
12.	Mr. Green Wilkinson explained that the work was principally a repair scheme involving shoring up the structure, grouting, pointing, decorating and replacing windows, doors and roof, keeping exactly to the previous external design apart from a change to the size of a door.
13.	Mr Green Wilkinson explained that when the claim was made for the repair costs it had been based on an agreed split between repairs and renewal for VAT purposes.  He now believed however that the repair claim should have included such items as structural works because these were only undertaken in order to shore up the building to ensure that it didn’t collapse.  The work was driven by an urgent need to repair and any improvements were incidental. It just made sense to carry them out at the same time.  In any event the outbuilding was more likely to remain in good repair and suitable for storage use into the future if it was kept heated and had a damp proof course.
14.	HMRC submitted that the work undertaken and claimed as repairs was part of a wider capital scheme of work to convert the outbuilding into additional living space.  HMRC further submitted that all the expense should be treated as capital expenditure and that none of the cost qualified as an allowable deduction against the letting income when calculating the taxable profits.
15.	On 15 January 2008 a notice of enquiry under section 9A Taxes Management Act was sent to the Appellant advising him of HMRC’s intention to enquire into his tax return for 2005/2006 and the Appellant’s representative, C.W. Fellowes Ltd, provided a schedule of the costs for the work on the outbuilding at The Old Rectory.
16.	On 13 May 2009 HMRC issued a notice closing the enquiry into the 2005/2006 tax return which showed an increase of tax due £18,937.18 as a result of the amount claimed for repairs on the outbuilding being disallowed.
17.	On 19 May 2009 the Appellant appealed against the tax amendment and requested a review of the decision.  On 3 June 2009 HMRC confirmed its view of the matter but amended the amount of additional tax due to £17,399.23 because of an error.  A review conclusion letter was sent to Mr Wills upholding the decision and concluding that: 
(a)	Previously the outbuilding had only been used for storage but had now been converted to a different use requiring substantial capital expenditure in order to do so.
(b)	If the costs had been to put the outbuilding back into good repair and had it continued to be used for storage then the expenditure might well have been allowable as repairs in calculating the taxable profits from lettings.
(c)	However plans and photographs (before and after the work) show its different re-use.
(d)	The outbuilding is a separate building and an entirety in itself.

Authorities

18.	Section 34(2) of the Income and Tax (Trading and Other Income) Act 2005 (“ITTOIA”) provides that where expenses are incurred for more than one purpose, it is not prohibited to deduct any identifiable part or proportion of the expense which is incurred wholly and exclusively for the purposes of the trade.  Mr Green Wilkinson for the Appellant submitted that as the repair elements of the work on the outbuilding were wholly and exclusively for the purposes of the trade and could be identified as separate elements to the improvements made, he believed that this part of the expenditure could be deducted from the rental income.
19.	In Conn v Robins Bros Ltd (1966) 43TC 266 the respondent company carried on a family retail business held on a tenants repairing lease for 21 years.  Part of the premises was 400 years old and was scheduled as an ancient monument so that the exterior could not be altered except for purposes of preservation.  It became clear that substantial expenditure on the property was needed and the company spent £3,817 on repairs and alterations of which £1,081 was admitted to be capital expenditure.  The balance of £2,736 was spent, inter alia, on replacing the slate roof with one of corrugated asbestos; inserting steel joists at first floor level and building new walls above; replacing oak flooring with concrete in the main shop; replacing the shop front; eliminating a bow window; and replacing certain timbers with steel joists encased in oak.  No additional space was created but the inside appearance of the ground floor was somewhat changed.
20.	In this case the Crown contended that the expenditure was not of a revenue nature and assessed the respondent company to income tax but the General Commissioners found that the expenditure was on essential repairs and not on improvements.  In the High Court of Justice it was held that the Commissioners decision was justified.
21.	Mr. Green Wilkinson contended that the case was very similar to his and quoted from the case:
“No doubt in the course of carrying out these works, certain structural alterations were made, as one would expect with any extensive repair of a building over 400 years old, (when repairs were being carried out at a time when building techniques have completely altered).”
In the Appellant’s case a building which was approximately 200 years old had extensive repairs carried out in order to make the building safe and structurally sound.  Although the materials and methods to do this were kept close to the traditional building methods wherever possible, similarly to Conn v Robins Bros Ltd, a modern approach was used in terms of the designs used to make this historic building safe.
22.	HMRC contended that the circumstances in the Appellant’s case were different to Conn v Robins Bros Ltd case.  Firstly the work on the outbuilding went on beyond reinstating it to its former condition and secondly unlike in the Robins case the Appellant’s lettings business would have continued as before whether or not the work had been done on the building.
23.	In the case of Lurcott v Wakely and Others (1911) 1KB Buckley LJ said:
“Repair is restoration by renewal or replacement of subsidiary parts of the whole.  Renewal as distinguished from repair, is reconstruction of the entirety, meaning by the entirety not necessarily the whole, but substantially the whole matter under discussions… it follows that the question of repair is in every case one of degree, and the test is whether the act be done is one which in substance is the renewal or replacement of defective parts or the renewal or replacement of substantially the whole.” 
24.	In William P Lawrie v CIR [1952] 34TC20 Lord Carmont said:
“Any sum claimed by the taxpayer as having been actually spent on repair can be analysed by the Inspector or by the Commissioners, with a view to determining whether or not it is a repair or renewal, but once it its determined that the matter is a renewal the whole of the sum must be treated as capital outlay and it is not allowable to split up the cost of the renewal so determined with a view to showing that a certain part of it should be debited to income because that amount would have been expended if the necessary work had been done as a repair, because that course would be going back on the decision that has already been arrived at, viz., that the work done should be charged as a renewal.
25.	HMRC Manuals at PIM 2020 (page 114 subtitled “Capital work and revenue repairs at the same time”) confirm that where work is undertaken that includes both repairs and improvements, deduction will be allowed for the repairs element.  Under the subtitle “Extensive alterations to a property” it is specified that the actual cost of normal revenue repairs to a part of the old building which is preserved in the rebuilt structure is allowable as an ordinary revenue business expense.
26.	The Appellant contended that HMRC might seek to claim that they were not bound by the HMRC Manual.  However the Appellant contended that in the very recently decided Gaines- Cooper case it was stated by the Court of Appeal that:
“The Court recognised that the Revenue could be bound to honour statements made to the public as to how a taxpayer would be treated”.
Appellant’s submissions
27.	On behalf of the Appellant it was submitted by Mr. Green Wikinson that the case of Lurcott v Wakely and Others involved the replacing of a wall in poor repair and consequently dangerous.  The wall was replaced and it was decided that the cost was a repair.  This helped the Appellant’s case in that the outbuilding was in poor condition however it was not rebuilt.  The decision in this case however suggested that there was a test as to whether this was a renewal or replacement of defective parts of the entirety.  HMRC is focussing on the definition of entirety.  This is because they claim that the entirety that is being repaired is the outbuilding.
28.	Mr. Green Wilkinson contended that since the outbuilding provided ancillary living space to the main house and since some £24,000 was also spent on repairing the main house, the entirety was the whole of the let property at The Old Rectory.
29.	On behalf of the Appellant it was submitted that the case of William P Lawrie v CIR was very different from the Appellant’s case.  In that case the roof was in need of repair but instead they extended the building and raised the level of the roof before adding a new roof of a different design.  The repairs were not required due to the improvements which took place instead and notional repair costs were claimed by the taxpayer which were calculated based on the original area of the old roof compared to the increased area of the new roof.  The view that notional repairs cannot be claimed was upheld by the Judge in this case.
30.	Mr Green Wilkinson submitted that in the Appellant’s case the repairs were not notional; they were actually carried out with no increase to the dimensions of the building.  The cost of the repairs that took place on the outbuilding were clearly distinguishable from the works which were additions to the building and capital in nature such as electrical and heating installations.  He contended that the Revenue Manual at PIM2020 was intended to clarify just this issue.
31.	HMRC had claimed that since the work on the outbuilding it had been used as additional accommodation.  Mr Green Wilkinson submitted that the word accommodation was wrong because its appropriate definition in accordance with the Oxford Dictionary is “lodging or board and lodging” and he did not believe the outbuilding had ever been either of those.
32.	HMRC had also called it “additional living space”.  Mr Green Wilkinson expected that the main use would be for storage in accordance with the architect’s plans which were produced to the Tribunal, although some improvements have been made to allow occasional use for other purposes.  It had never been possible to live in the outbuilding either before or after the work, because it lacked all the basic needs for living there such as kitchen facilities and sanitation.  The outbuilding, both before and after the work was carried out, was in use as an extension to the main house, never more, never less than just ancillary use.
33.	HMRC might claim that the works carried out had improved the value of the property and rental income so must as a whole be an improvement for income tax purposes.  Mr Green Wilkinson submitted that this did not follow.  If the outside or inside of a property is in a poor state of repair and it is repaired and redecorated, it will always substantially improve the looks of a property as in this case and will probably increase the value.
34.	As far as the rent for The Old Rectory is concerned this was £2,450 per month before the work was carried out and continued at this rate until 5 April 2007.  A new tenancy began in June 2007 with a rental rate of £2,600 per month, an increase of only 6% over the three year term which is no more than inflationary.
35.	In conclusion Mr Green Wilkinson submitted that the work the Appellant undertook to the outbuilding was driven by the dangerous state of the building.  The motive was one of repair.  If the Appellant had repaired the building first and then subsequently completed the improvements, there would have been no challenge by HMRC as to the deductibility of the repair costs but it would not have made logical business sense.  It was surely fair and reasonable for the Appellant to be able to obtain deduction for the repair works within the works that were undertaken.  This was confirmed by the Respondents own manual at PIM2020 and was backed up by the case of Conn v Robins Bros Ltd.
HMRC’s submissions
36.	HMRC submitted that the work undertaken and claimed as repairs was part of a wider capital scheme to convert the outbuilding into additional living space.  
37.	HMRC contended that the circumstances in the Appellant’s case were different to the case of Conn v Robins Bros Ltd because the work was necessary so that the company could continue to carry on its business there and following the repairs the building was put back into a similar state.  In the Appellant’s case the work on the outbuilding went beyond reinstating it to its former condition and the Appellant’s lettings business would have continued as before whether or not the work was done on the outbuilding.  If the outbuilding was in a dangerous state then the Appellant could have fenced it off from the main house.
38.	HMRC contended that similarly to the case of William P Lawrie v CIR the Appellant had taken the opportunity to improve the asset instead of simply repairing it.
39.	Although there was no change of use for planning approval purposes, the scale of the work on the outbuilding went beyond repairing what was there before and the character of the outbuilding had changed.  The consequence of this was that the whole cost of the works should be treated as capital in nature and therefore not allowable as a deduction from the profits of the trade under Section 33 of ITTOIA.
Findings
40.	The Tribunal examined the photographs produced and confirmed that the outbuilding was previously in a dangerous state.
41.	Having examined the architect’s plans and report, the Tribunal found that the disputed work undertaken was one of essential repair.
42.	The Tribunal found that there was no evidence to support HMRC’s contention that after the building work there was a change of use of the outbuilding from games room and storage to additional accommodation or living space. The potential letting income from The Old Rectory had not increased any more than was caused by inflation.
43.	The Tribunal found that HMRC’s contention that the outbuilding could have been fenced off was not practical as the photographs produced to the Tribunal showed that the outbuilding was precariously close to the main house and as such would be dangerous to the tenants thereby rendering the main house inhabitable. In any event it would surely have reduced the property’s rental potential.
Decision
44.	The Tribunal decided that the Appellant should be able to obtain deduction for the repair costs claimed and that in addition the costs for the structural works which were undertaken to ensure that the outbuilding did not collapse should be allowed.
45.	The Tribunal decided that their decision was supported by the HMRC Manual at PIM 2020 and by the case of Conn v Robins Bros Ltd. The Tribunal agreed with the contention for the Appellant that the case of Lurcott v Wakely and Others dealt with a matter where there was a replacement of the whole structure which did not apply here; and that similarly the case of William P Lawrie v CIR did not apply because in that matter the taxpayer had claimed for notional repairs rather than repairs which had actually been carried out.
46.	The Appeal is allowed.
47.	This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.   The application must be received by this Tribunal not later than 56 days after this decision is sent to that party.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

TRIBUNAL JUDGE S.M.G RADFORD

RELEASE DATE: 16 April 2010