What has been described as "a state-endorsed assault on the rural economy and small business sector" has been hit after a B&B owner secured a victory against HM Revenue & Customs.
The ruling centred around HMRC which brought the case against a farmer's wife running a rural B&B that nearly forced her to close down her business.
The government department attempted to charge VAT on the rural diversification activities of Danielle Forster who, along with her husband and son, were partners in a VAT-registered farming business.
Mrs Forster has run bed and breakfast business from the family's Essex farmhouse since the 1970s. She is a sleeping partner in the wholly separate farm business and the B&B has always traded below the VAT-registration threshold.
But following an inspection by an HMRC officer, as part of the government's 'rural diversification project', Mrs Forster's business was compelled to be 'aggregated' with the farm. Tax experts CCH, which represented the Forsters, said the action threatened to put an end to the business as the entrepreneur risked losing 20% of her income by paying VAT and knew it would be uncompetitive to hike her prices.
The British VAT code rules were designed to avoid 'business-splitting', whereby a business trading slightly above the threshold would separate their activities so that each business remained below the tax trigger point. This means that a non-VAT registered business can charge 20% - or achieve much higher margins - than its VAT registered competitors.
Glyn Edwards, CCH's VAT litigation specialist, argued that HMRC's officer had reached an unreasonable decision and exaggerated the importance of alleged financial links between the partnership and Mrs Forster's business while ignoring the fact that the two were separate.
Glyn Edwards said: "This judgement will make it much easier to resist HMRC's attempts to target small stand-alone businesses run by, in this case, a farming family member.
"Since this decision we have already seen HMRC retreat in another similar case in the farming sector which had been the subject of a long dispute.
"HMRC should never had taken the case this far and defend what proved to be indefensible. It also shows that HMRC can push small businesses to tribunals even when it is unlikely to win."
Responding to the case, a spokesperson for HMRC said: "This is not a ground breaking ruling but is one isolated Tribunal decision relating to a specific set of circumstances.
"HMRC applies the rules fairly and consistently in all cases where we believe that a single business has been artificially separated to ensure that the right amount of VAT is paid on all taxable supplies.
"HMRC makes decisions based on the facts related to each specific case and where a customer disagrees with that decision they can take it to a Tribunal for independent review. Because of our statutory duty of confidentiality, we cannot discuss individual taxpayer affairs."
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