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...is the amount of points that the word “tax” will gain a player in the game of Scrabble but get it wrong and it could cost you a lot more than that.

The direct tax treatment of dilapidations is not straight forward. In the recent decision of James Allan Thornton vs The Commissioners for Her Majesty’s Revenue & Customs [2016] UKFTT 767 (TC) the Court was asked to consider whether a payment in respect of dilapidations was an income or capital receipt.


Mr Thornton was the landlord of a block of 18 flats known as Jordan House, Nairn. The tenant was Albyn Housing Society Limited. The lease was on a standard FRI basis.

Whilst the lease was continuing the tenant decided that the flats were not fit for habitation and the parties commenced discussions for the surrender of the lease.

Initially the parties discussed a figure of £300,000 to reflect dilapidations and rent. Eventually the parties agreed a settlement of £250,000 by way of surrender premium. The surrender premium was not attributed to any particular item. The parties recorded the payment as being "...in full and final settlement in relation to all issues associated with the lease of Jordan House to Albyn Housing Society Limited”.

Following the surrender Mr Thornton used the funds to repair the flats. The cost of the repairs and improvements to the flats exceeded the £250,000 received from the tenant.

The Hearing

HMRC argued that the surrender premium should have been treated as an income receipt because it covered the loss of rental income.

Mr Thornton argued that the surrender premium should be treated as a capital receipt as it had been used to repair the property.


The tribunal concluded that no part of the payment was attributable to rental because it found that the true amount of dilapidations amounted to more than £250,000.

Practical Considerations

Whilst the decision is fact specific it highlights the need for parties to seek early advice on the tax treatment of settlements. It also highlights the need to correctly document of what the payment is in respect. This is particularly important in surrender documents where due consideration should be given to separating the surrender premium into separate distinct figures for rent and dilapidations.

Winter 2016

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