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Taxation (UK) · The use of exemptions and reliefs in deferring and minimising income tax liabilities

Tax Planning for Business Owners and Inheritance Tax Reliefs

Updated 11 October 2026 · Fact-checked

Tax planning for business owners means choosing the legal form, pay mix and timing that cut total tax lawfully. You compare income tax, NIC and corporation tax for self-employment versus a company, salary versus dividends, then use business asset disposal relief at 14% and inheritance tax nil rate bands. Always compute both options.

Understand Tax Planning for Business Owners and Inheritance Tax Reliefs

Tax planning is the lawful use of rates, allowances, exemptions and reliefs to reduce or defer tax. It is not evasion, and it must not be artificial avoidance. In TX-UK you are asked to compare options and recommend one, with figures.

The first choice is the form of business. A sole trader pays income tax and Class 4 NIC on all profits, whether drawn or not. A company pays corporation tax on its profits (small profits rate 19%, main rate 25%, with marginal relief between £50,000 and £250,000). The owner is then taxed only on what the company pays out. Incorporating can defer personal tax and give flexibility, but extraction brings a second layer of tax.

The second choice is how to extract profit. Salary is deductible for the company, but it attracts employee NIC (8% from £12,571 to £50,270, then 2%) and employer NIC (15% above £5,000, less any employment allowance of £10,500 if available). Dividends are not deductible for corporation tax and carry no NIC. Dividends are taxed at 8·75% (basic), 33·75% (higher) and 39·35% (additional), with a £500 dividend nil rate band. The usual answer is a modest salary plus dividends, but you must check the numbers for the facts given.

The third area is exit and death. When an owner sells a qualifying business or shares, business asset disposal relief (BADR) taxes the gain at 14% instead of 18% or 24%, up to a £1,000,000 lifetime limit. Conditions in outline: the asset is the whole or part of a trading business, or shares in the individual's personal trading company (broadly 5% of ordinary shares and voting rights, and the individual is an officer or employee), and the qualifying period is at least two years before disposal. Check the conditions in the question.

For inheritance tax, the nil rate band (£325,000) and residence nil rate band (£175,000, for a home passing to direct descendants) reduce the tax on death. Unused bands of a deceased spouse can be transferred. Lifetime gifts use exemptions, potentially exempt transfers and taper relief to cut the 40% death rate.

Key rules to remember

BADR tax
Tax (BADR gains only) = (Qualifying gain − annual exempt amount) × 14%
Use this layout only where BADR gains are the only gains. Where BADR gains are mixed with other gains, set the £3,000 annual exempt amount against gains taxed at 24% first, then 18%, and against BADR gains last. Lifetime limit £1,000,000 of qualifying gains. Gains above the limit are taxed at 18% or 24%.
CGT rates without BADR
18% lower rate; 24% higher rate
Applies to gains within the basic rate band and above it respectively, after taxable income is considered.
Dividend tax rates
8·75% basic; 33·75% higher; 39·35% additional; first £500 at nil rate
The nil rate band still uses up part of the tax band.
Employee Class 1 NIC
Nil to £12,570; 8% from £12,571 to £50,270; 2% above
Not payable on dividends.
Employer Class 1 NIC
15% × (salary − £5,000); employment allowance £10,500
Employer NIC is a deductible expense for the company. The employment allowance of £10,500 can only be claimed if the company is eligible. It is not available to a company where the director is the only employee, so check who else is employed and any other facts in the question before deducting it.
Class 4 NIC (sole trader)
Nil to £12,570; 6% from £12,571 to £50,270; 2% above
Charged on profits, not drawings.
Corporation tax rates
19% small profits (up to £50,000); 25% main (over £250,000)
Marginal relief = (£250,000 − augmented profits) × 3/200 × taxable total profits ÷ augmented profits. The £50,000 and £250,000 limits are divided by (1 + the number of associated companies) and are reduced proportionally for accounting periods shorter than 12 months.
IHT rates
Death 40%; lifetime 20% on excess over the nil rate band
Nil rate band £325,000; residence nil rate band £175,000.
Taper relief on death tax for lifetime gifts
More than 3 but less than 4 years 20%; more than 4 but less than 5 years 40%; more than 5 but less than 6 years 60%; more than 6 but less than 7 years 80% reduction
Reduces the tax, not the value. No relief if death is within 3 years of the gift. Check the exact number of years, as the boundaries matter. It only helps where the gift exceeds the available nil rate band.

How to solve Tax Planning for Business Owners and Inheritance Tax Reliefs questions

Use this method for any planning question, whether it compares business forms, pay mixes or disposals.

  1. 1Read the requirement and list the options being compared, plus the owner's other income and tax status.
  2. 2Identify which tax each option triggers: income tax, NIC, corporation tax, CGT or IHT.
  3. 3Compute each option separately, in a clear layout, using only the rates in the tax tables.
  4. 4Include all layers: company tax, employer NIC, employee NIC and personal tax on extraction.
  5. 5Check reliefs and conditions, such as BADR qualifying period, ownership percentage and the £1,000,000 limit.
  6. 6Compare the totals and state the saving in pounds.
  7. 7Add short non-tax or timing points, such as cash flow, payment dates and the risk of HMRC challenge, if marks are available.
  8. 8Finish with a clear recommendation.

Quickest way: Total tax cost comparison

When to use it: Use this in Section C questions asking which option is better, when time is short.

  1. Write a two-column table of the options in your answer.
  2. Compute only the figures that differ between the options and ignore anything identical.
  3. Put each tax on its own line, then total.
  4. Subtract the totals and write 'Option X saves £Y'.
  5. Add one sentence on a relevant condition, such as the BADR two-year rule.

Common mistakes in Tax Planning for Business Owners and Inheritance Tax Reliefs

  • Treating dividends as deductible for corporation tax.

    Salary is deductible, so students assume all extraction is.

    Fix: Dividends are paid from post-tax profit. Only salary and employer NIC reduce company profit.

  • Forgetting employer NIC when comparing salary and dividends.

    Students focus on the director's personal tax.

    Fix: Always calculate 15% above £5,000, deduct the employment allowance only if eligible, and treat the cost as company expense.

  • Applying BADR without checking conditions.

    The 14% rate is memorised but the conditions are not.

    Fix: Check trading status, the two-year period, officer or employee status and the 5% holding, then check the £1,000,000 lifetime limit.

  • Using the annual exempt amount twice or on the wrong gain.

    Students forget it is a single amount per individual.

    Fix: Deduct £3,000 once. Where gains are taxed at different rates, set it against gains taxed at the highest rate first: 24% gains, then 18% gains, then BADR gains at 14%. If BADR gains are the only gains, deduct it from them.

  • Applying taper relief to the value of the gift.

    The word 'relief' suggests reducing the gift.

    Fix: Work out the death tax first, then reduce that tax by the taper percentage. Check that the gift exceeds the available nil rate band.

  • Using the residence nil rate band when no home passes to direct descendants.

    Students add £175,000 automatically.

    Fix: Only use it for a home (or its replacement) left to children or other direct descendants, and cap it at the home's value.

Worked examples

Example 1

Mia sells all her shares in her personal trading company, where she has been a director and 100% shareholder for six years. The chargeable gain is £400,000. She has no other gains or losses and is a higher rate taxpayer. Calculate the CGT payable with BADR and the saving compared with no BADR.

Show the solution
  1. The conditions are met: personal trading company, officer, more than two years, and the gain is within the £1,000,000 lifetime limit.
  2. Deduct the annual exempt amount: £400,000 − £3,000 = £397,000.
  3. Tax with BADR: £397,000 × 14% = £55,580.
  4. Tax without BADR as a higher rate taxpayer: £397,000 × 24% = £95,280.
  5. Saving: £95,280 − £55,580 = £39,700.

Answer: CGT with BADR is £55,580. BADR saves £39,700.

Example 2

Harold dies owning an estate of £1,100,000, including a home worth £400,000 left to his children. His wife died earlier (after 8 July 2015) and left everything to him, so her nil rate band and residence nil rate band were unused. Harold made no lifetime gifts. Calculate the inheritance tax payable on death. Assume the estate is below the level at which the residence nil rate band is withdrawn.

Show the solution
  1. Nil rate band: £325,000 own + £325,000 transferred = £650,000.
  2. Residence nil rate band: £175,000 own + £175,000 transferred = £350,000. The home passes to his children and is worth £400,000, so the £350,000 is below the home's value and is not restricted.
  3. Total bands: £650,000 + £350,000 = £1,000,000.
  4. Taxable amount: £1,100,000 − £1,000,000 = £100,000.
  5. Tax at the death rate: £100,000 × 40% = £40,000.

Answer: Inheritance tax payable on death is £40,000.

Exam tips

  • Use only the rates and limits in the tax rates and allowances document supplied in the exam, and quote the figures you use.
  • In planning questions, show the numbers for each option before the recommendation. A conclusion without figures scores poorly.
  • For BADR, write the conditions in a sentence and apply them to the facts, including dates.
  • In objective tests, check whether the question asks for tax saved or tax payable, and whether the amount is before or after the annual exempt amount.
  • For IHT, always list the order: lifetime gifts in the last seven years, then the death estate, then bands used.

Practice questions from The use of exemptions and reliefs in deferring and minimising income tax liabilities

Tax Planning for Business Owners and Inheritance Tax Reliefs in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Tax Planning for Business Owners and Inheritance Tax Reliefs: frequently asked questions

Is salary or dividends better for a director in TX-UK?

It depends on the figures. Salary is deductible but carries NIC, while dividends carry no NIC but are not deductible. Compute total tax for both on the facts given and compare.

What is the BADR rate and limit in the exam?

The rate is 14% and the lifetime limit is £1,000,000 of qualifying gains. Gains above the limit are taxed at the normal CGT rates of 18% or 24%.

Does incorporating always save tax?

No. It can defer personal tax and use the 19% small profits rate, but extracting profit brings a second layer of tax. Whether it saves tax depends on how much profit is drawn out.

How does the residence nil rate band work?

It is £175,000 and applies when a home passes to direct descendants on death. It is limited to the value of the home, and an unused amount can be transferred to a surviving spouse.