Advanced Taxation (UK) · Corporation tax: the use of exemptions and reliefs in deferring and minimising corporation tax liabilities

Choice of Business Structure and Extraction of Profits for ACCA ATX

Updated 11 October 2026 · Fact-checked

Choice of business structure compares trading as a sole trader or partner with trading through a company. You compare income tax, NIC, CGT and corporation tax on the profits, then on how they are extracted as salary, dividends or benefits. Compute the total tax and net cash for each option, then recommend one.

Understand Choice of Business Structure and Extraction of Profits

A sole trader is taxed on the profits of the business, whether or not he takes the cash out. He pays income tax and Class 4 NIC on those profits. A company is a separate person. It pays corporation tax on its profits. The owner is taxed again only when profit reaches him as salary, dividends, benefits or a gain on sale.

So the real question is the total tax on one pound of profit. For a company, add corporation tax, then the personal tax on the extraction route. Salary is deductible for the company but suffers income tax and NIC (employee and employer). Dividends are not deductible, but have no NIC. This is why a mix of a modest salary and the rest as dividends is a common starting point. Check it with numbers each time.

Timing matters too. Profit left in the company is taxed only at corporation tax rates. Tax on extraction can be deferred. The company rate depends on profit level, because marginal relief applies between the lower and upper limits. Remember associated companies and short accounting periods change those limits.

On incorporation, the owner transfers the business to the company. The transfer is a disposal for CGT. Incorporation relief applies automatically where the whole business is transferred as a going concern with all its assets (other than cash) in exchange wholly or partly for shares. The gain is deferred by reducing the base cost of the shares. Gift holdover is an alternative for assets that are not part of a full transfer for shares. Business asset disposal relief (BADR) is the third option. You can elect that incorporation relief does not apply, pay tax now at the BADR rate, and keep a higher base cost in the shares.

Finally look at the wider picture: losses (a sole trader can use early losses against other income, a company cannot pass them to the owner), pensions, stamp duty, VAT, IHT, cash flow and the owner's wishes. A good answer states assumptions, shows the numbers and gives a reasoned recommendation.

Key rules to remember

Corporation tax rates: Small profits rate 19% (profits up to £50,000); main rate 25% (profits over £250,000); Limits are for a single company with no associates and a 12-month period. Divide the limits by 1 + number of associates, and time-apportion for short periods.
Marginal relief: (Upper limit − Augmented profits) × 3/200 × Taxable total profits ÷ Augmented profits; Deduct from corporation tax at 25%. Applies where augmented profits fall between £50,000 and £250,000. Augmented profits include dividends received from non-group companies.
Dividend tax rates: Basic 8.75%; higher 33.75%; additional 39.35%. Dividend nil rate band £500; The £500 band is taxed at 0% but still uses up part of the basic or higher rate band. Dividends are taxed as the top slice of income.
Income tax normal rates: Basic 20% (£1–£37,700); higher 40% (£37,701–£125,140); additional 45% (over £125,140); Use for salary, trading profit and benefits. Take the personal allowance, NIC rates and thresholds from the tax tables you are given.
CGT rates and annual exempt amount: Lower rate 18%; higher rate 24%; annual exempt amount £3,000; The rate depends on how much of the basic rate band is left after taxable income.
BADR: Gains taxed at 14% up to a lifetime limit of £1,000,000; Gains above the limit are taxed at the normal CGT rates. Check the qualifying conditions in the question, including the ownership period.
Incorporation relief: base cost of shares: Base cost of shares = Market value of shares received − Gain deferred; If part of the consideration is cash or loan, only the proportion of the gain matching the shares is deferred: Gain × Shares ÷ Total consideration.
Cost of employing through salary: Company cost = Salary + employer NIC; the company gets corporation tax relief on both; Dividends carry no NIC and no corporation tax relief. Use the NIC rates provided in the exam.

How to solve Choice of Business Structure and Extraction of Profits questions

Use this order for any question that asks you to compare structures or ways of taking profit out.

1Read the requirement and the client's objectives. Note whether they want maximum cash now, deferral, or an exit plan.
2List the facts you need: expected profits, other income, existing use of the basic rate band, losses, assets to transfer, and the ownership history.
3Set out each option in a clear layout: sole trader, then company with each extraction route. Use the same profit figure for each.
4Compute tax for each option. For the company: corporation tax (check associates, period length and marginal relief), then personal income tax, NIC on salary, and dividend tax. Apply rates only from the tax tables.
5Deal with the one-off effects: incorporation CGT, choice between incorporation relief, gift holdover and BADR, stamp duty land tax or stamp duty if relevant, and capital allowances.
6Compare the net cash and the total tax for each option. Say which is higher and why.
7Add non-tax and longer-term points: limited liability, losses, pensions, IHT, cash flow, administration and the risk of HMRC challenge.
8Finish with a clear recommendation and state any assumptions you made.

Quickest way: One-pound-of-profit comparison

When to use it: When time is short and you must show the better route in a few lines of numbers.

Take the profit before owner's pay. Work out the company tax on it, including marginal relief if profit is between the limits.
Test the all-dividend route: net profit less dividend tax at the right rate, remembering the £500 nil rate band.
Test the salary route: cost of salary including employer NIC, less corporation tax saved, less employee income tax and NIC.
Compare net cash for each route against the sole trader result (income tax plus Class 4 NIC on the whole profit).
Write one sentence on the difference, then list two non-numerical points.

Common mistakes in Choice of Business Structure and Extraction of Profits

Ignoring corporation tax and comparing only personal taxes
Students focus on the owner's tax and forget the company is taxed first.
Fix: Always start with profit, deduct corporation tax, then apply personal tax on the extracted amount.
Using the wrong corporation tax rate with no marginal relief
Students apply 19% or 25% automatically.
Fix: Check profits against the £50,000 and £250,000 limits, adjusted for associates and short periods. Apply the marginal relief formula between them.
Forgetting that incorporation relief is automatic
Students think a claim is needed, as for gift holdover.
Fix: State that it applies automatically when conditions are met. To avoid it, an election is needed, for example to use BADR.
Applying BADR without checking conditions or the lifetime limit
BADR is treated as a free reduction in the rate.
Fix: Check the business, the ownership period and the £1,000,000 limit. Remember the 14% rate in the tables.
Treating dividends as deductible or NIC-free salary
Confusion about which costs are deductible for the company.
Fix: Salary and employer NIC are deductible; dividends are not. Dividends bear no NIC but do bear dividend tax.
Giving numbers without a recommendation or professional judgement
Students run out of time after the calculations.
Fix: Keep two minutes for a recommendation, assumptions and non-tax factors. Professional skills marks need these.

Worked examples

Example 1

Ravi's company has profits of £60,000 for a 12-month period before any owner pay. It has no associated companies. Ravi is a higher rate taxpayer with other income of £50,000 and no other dividends. All the post-tax profit will be paid to him as a dividend. Compute the corporation tax, Ravi's dividend tax and the total tax.

Show the solution

Corporation tax at 25%: £60,000 × 25% = £15,000.
Profit is between £50,000 and £250,000, so marginal relief applies: (£250,000 − £60,000) × 3/200 × (£60,000 ÷ £60,000) = £190,000 × 0.015 = £2,850.
Corporation tax = £15,000 − £2,850 = £12,150.
Profit after tax available for dividend = £60,000 − £12,150 = £47,850.
Total income = £50,000 + £47,850 = £97,850, which is below £125,140, so the dividend is taxed at the higher rate of 33.75%, with the first £500 at 0% under the dividend nil rate band.
Dividend tax = (£47,850 − £500) × 33.75% = £47,350 × 33.75% = £15,980.63, rounded to £15,981.
Total tax = £12,150 + £15,981 = £28,131. Ravi keeps £47,850 − £15,981 = £31,869 net.

Answer: Corporation tax £12,150; dividend tax £15,981; total tax £28,131; Ravi's net cash £31,869. There is no NIC on the dividend.

Example 2

Meera has traded as a sole trader for several years. She transfers the whole business to a new company as a going concern, including all its assets except cash, in exchange for shares only. The shares are worth £450,000. The only chargeable gain is £400,000 on goodwill. Assume she has no other gains, her annual exempt amount is available and BADR conditions are met. Explain the CGT position on incorporation and compute the tax if she elects to disapply incorporation relief.

Show the solution

The transfer is a disposal for CGT. The conditions for incorporation relief are met: whole business, going concern, all assets other than cash, consideration wholly in shares.
Incorporation relief therefore applies automatically. All of the £400,000 gain is deferred, as the consideration is wholly shares.
Base cost of the shares = £450,000 − £400,000 = £50,000. The deferred gain is brought into charge when she sells the shares.
If she elects that incorporation relief does not apply, the gain of £400,000 is taxed now. BADR can apply, with the gain within the £1,000,000 lifetime limit.
Annual exempt amount: £400,000 − £3,000 = £397,000 chargeable.
Tax at 14% = £397,000 × 14% = £55,580.
With the election the base cost of the shares is the full £450,000, so a later sale will give a lower gain. Compare paying £55,580 now with deferring and relying on BADR later.

Answer: With no election, there is no CGT on incorporation and the shares have a base cost of £50,000. If she elects out of incorporation relief and BADR applies, the CGT is £55,580 and the base cost of the shares is £450,000.

Exam tips

Show the numbers for each option side by side. A short table in your answer script keeps marks easy to find, even though you should not use tables on this page.
Check for associated companies and short periods before you pick the corporation tax rate. Examiners often plant these.
If the question says 'advise', give a recommendation and mention at least two non-tax factors for the professional skills marks.
Use only the rates and bands in the tax tables. Do not quote NIC or allowances from memory.
Always state assumptions, such as whether the owner has other income or has already used the dividend nil rate band.

Practice questions from Corporation tax: the use of exemptions and reliefs in deferring and minimising corporation tax liabilities

Choice of Business Structure and Extraction of Profits: frequently asked questions

Is it better to take salary or dividends from my own company?

There is no single answer. Salary is deductible for the company but attracts NIC and income tax. Dividends are not deductible but have no NIC. In the exam, compute the net cash for each route and compare, using the rates given.

Is incorporation relief automatic in ATX-UK?

Yes, where the whole business is transferred as a going concern with all its assets (other than cash) in exchange wholly or partly for shares. You can elect that it does not apply, usually to use BADR. If the consideration includes cash, only part of the gain is deferred.

What is the BADR rate and limit in the ATX-UK tax tables?

The tax tables show a rate of 14% and a lifetime limit of £1,000,000 for business asset disposal relief. Gains above the limit are taxed at the normal CGT rates of 18% or 24%.

What is the main tax difference between a sole trader and a limited company?

A sole trader pays income tax and Class 4 NIC on all profits as they arise. A company pays corporation tax, and the owner pays further tax only when profits are extracted or the shares are sold. The company route also gives limited liability but adds compliance.