Alternative ways to the same outcome

Most planning questions at ATX come down to one idea: there is more than one way to get where the client wants to go, and each way carries a different tax bill. An owner can take money out of a company as salary or as dividends; a business can be run by a sole trader or through a company; a parent can give an asset away now or leave it in a will. ATX's study guide asks you to calculate the receipts from a transaction net of tax, compare the alternatives and advise on the most tax-efficient one. This lesson works through three classic comparisons, with full computations. All figures come from the ATX tax tables, which the exam gives you, and the tax year is 2025/26.

The method

1. Fix the outcome. Decide what you are comparing: cash in the owner's hands, total tax paid, or value reaching the family.
2. Follow the money through every taxpayer. A company and its shareholder are two taxpayers; so are a donor and a donee. Leave nobody out.
3. Use the same facts for each route. Same profit, same values, same dates. If you assume something, assume it for all routes and say so.
4. Compare, then look beyond the numbers. Timing, risk (will the donor survive seven years?) and non-tax factors can outweigh a small saving.

What drives each comparison

Salary or dividends. Salary is deductible for corporation tax, but carries employer's NIC at 15% above £5,000 a year and employee NIC at 8% (2% above £50,270), and is taxed at 20%, 40% or 45%. The employment allowance of £10,500 cannot be claimed where a director is the company's only employee (not in the tables: learn it). A dividend comes out of profit after corporation tax (19%, 25%, or an effective 26.5% in the marginal relief band between £50,000 and £250,000), carries no NIC, and is taxed at 8.75%, 33.75% or 39.35% after the £500 dividend nil rate band. A salary up to the personal allowance is usually efficient, because it is deductible and free of income tax.

Sole trader or company. A sole trader pays income tax and class 4 NIC on all the profit as it arises, whether drawn or not. A company pays corporation tax on its profit, and the owner pays tax only on what is paid out. So the company's advantage depends on how much profit can be left in it.

Lifetime gift or gift on death. A lifetime gift is a disposal at market value for capital gains tax, unless a relief applies, and a PET for inheritance tax, which becomes exempt after seven years and fixes the value at the date of the gift. An asset left on death bears no capital gains tax, and the heir takes it at probate value, but the estate pays inheritance tax at 40% above the nil rate bands.

Worked example

Comparison 1: salary or dividends for an owner-manager

Femi owns all the shares in Femi Ltd, which has a profit of £60,000 before paying him anything, a 12-month accounting period and no related companies. He is its only employee and has no other income. He wants all the profit paid out to him. Because he is a director and the only employee, the company cannot claim the employment allowance.

Workings:

• All salary. The salary S is the most the company can pay with its NIC: S + 15% × (S − 5,000) = 60,000, so S = £52,826 and employer's NIC is £7,174. Income tax: taxable income 40,256 (52,826 − 12,570); 37,700 × 20% = 7,540 plus 2,556 × 40% = 1,022, total £8,562. Employee NIC: 37,700 × 8% = 3,016 plus 2,556 × 2% = 51, total £3,067.
• Salary and dividend. Employer's NIC on the salary: (12,570 − 5,000) × 15% = £1,136. The salary uses Femi's personal allowance and is below the employee NIC threshold. Dividend tax: 500 × 0%, then 36,998 × 8.75% = £3,237, all within the basic rate band.

The salary and dividend route leaves Femi £5,634 better off. Salary saves corporation tax but costs NIC on both sides; a dividend bears corporation tax but no NIC and lower income tax rates. A salary of only £5,000 (no employer's NIC) is worse here, leaving him £46,016, because the extra company profit (£55,000 in total) takes the company into the marginal relief band, where the profit above £50,000 is taxed at an effective 26.5%.

Non-tax points belong in the answer too. Salary counts as relevant earnings for personal pension contributions and dividends do not; dividends can only be paid out of distributable profits; and an employer pension contribution is cheaper still if Femi does not need the cash now, because it is deductible for the company and free of income tax and NIC within his annual allowance.

Comparison 2: sole trader or company

Halima expects a trading profit of £80,000 a year. Should she stay a sole trader or trade through a company she owns, paying herself a salary of £12,570 and dividends? She is the only employee and has no other income.

Workings:

• Sole trader. Income tax on 67,430 (80,000 − 12,570): 37,700 × 20% = 7,540 plus 29,730 × 40% = 11,892, total £19,432. Class 4: 37,700 × 6% = 2,262 plus 29,730 × 2% = 595, total £2,857.
• Corporation tax. Taxable total profits are 66,294 (80,000 − 12,570 − 1,136), within the marginal relief band: 66,294 × 25% = 16,574, less marginal relief of (250,000 − 66,294) × 3/200 = 2,756, giving £13,818.
• All paid out. The dividend is £52,476 (66,294 − 13,818). Income tax: 500 × 0%, 37,200 × 8.75% = 3,255, and 14,776 × 33.75% = 4,987, total £8,242.
• Profit kept. The £25,000 dividend bears 500 × 0% and 24,500 × 8.75% = £2,144.

At this level of profit, paying everything out through a company costs £907 more than trading as a sole trader, because, at the margin, corporation tax at an effective 26.5% followed by dividend tax at 33.75% takes more than income tax at 40% plus class 4 NIC at 2%. The company wins when profit can stay in it. If the £27,476 kept is later paid out within the basic rate band at 8.75% (£2,404), the company route still saves about £2,800 overall; if it can only be paid out at 33.75%, the sole trader route wins. A company also brings limited liability, but higher running costs and public accounts.

Comparison 3: a lifetime gift or a gift on death

Ada, aged 68, has never married. She owns quoted shares worth £300,000 (cost £180,000), which are not business property, and other assets of £800,000, with no residence. Her income uses all of her basic rate band, and she has made no lifetime gifts. Everything will go to her son. Should she give him the shares now or leave them in her will? Assume values do not change.

If Ada survives seven years, the gift saves £103,152. If she dies within three years, it costs £14,448: the PET is within the nil rate band, so it bears no tax itself, but it uses £294,000 of the band the estate would have had, and the capital gains tax is a cost that keeping the shares avoids (death brings no capital gains tax). Death between three and seven years gives the same answer, because taper relief reduces only tax on the gift itself, and there is none. Two more points tip the balance towards giving:

• Growth. Any growth in the shares after the gift is outside Ada's estate. If they were worth £400,000 at her death, the gift would save a further £40,000 even if she died within seven years.
• Choice of asset. Giving cash, or business assets that qualify for gift relief and business property relief, avoids the capital gains tax altogether.

Common mistakes

• Comparing the company's tax on one route with the owner's tax on another, instead of following the money through every taxpayer on each route.
• Forgetting employer's NIC on salary, or giving the employment allowance to a company whose only employee is a director.
• Paying a dividend out of pre-tax profit: dividends come out of profit after corporation tax.
• Assuming taper relief helps a PET that is within the nil rate band.
• Ignoring the capital gains tax on a lifetime gift, and the fact that death removes it.
• Changing an assumption between routes, such as the profit or the value of the asset.

Exam technique

Put the alternatives side by side in columns with the same rows, so the marker can follow each tax across the routes. Show workings for each figure below the table, briefly, as above. Then state the difference in one sentence and recommend, adding the main risk or non-tax factor: "If Ada expects to live for seven years, she should give the shares now; if her health is poor, she should keep them." State your assumptions once, for example that values do not change.

Study with AI

I am studying ACCA Advanced Taxation (ATX-UK), Finance Act 2025, syllabus area B2.
Give me a 2025/26 scenario where I must compare two ways of reaching the same goal,
for example salary against dividends for an owner-manager, a sole trade against a
company, or a lifetime gift against a gift on death. Wait for my side-by-side
computation of the net cash or value under each route, then check every line using
the ATX tax tables and tell me whether my recommendation follows from the numbers.

AI assistants can make arithmetic slips, forget employer's NIC or marginal relief, and use out-of-date rates: check every answer against these notes and the ATX tax tables before you rely on it.

Lecturer's note: The question is never "which route has less tax?" but "which route leaves the client with more of what they want?" Sometimes the answer is the route with more tax now, because it removes a larger tax later (a gift that survives seven years), or because the client values cash today over money locked in a company. Say what you are measuring before you measure it, and your recommendation will follow.

Key points

• Compare routes by following the money through every taxpayer involved, on the same facts, and measure the net cash or value that reaches the client.
• A small salary plus dividends usually beats all-salary extraction because dividends carry no NIC, but marginal relief and the employment allowance rules can shift the best salary.
• With full extraction, a company can cost more than a sole trade; it wins where profits can be kept in the company and paid out later at lower rates.
• A lifetime gift saves inheritance tax only if the donor survives seven years, but freezes the value given and may cost capital gains tax now; death removes capital gains tax.
• Recommend clearly, and state the assumptions and the main risk behind the recommendation.

Quick check

1. A director is the only employee of his company and is paid a salary of £12,570. What employer's NIC does the company pay?
2. A company with profits of £40,000 pays all its post-tax profit to its owner as a dividend. The owner's other income is a salary of £50,000. How much of the dividend does the owner keep after tax?
3. In Comparison 3, if Ada gives the shares and dies five years later, does taper relief reduce the tax?

Answers

1. (£12,570 − £5,000) × 15% = £1,136. The employment allowance is not available where a director is the sole employee.
2. Corporation tax is £40,000 × 19% = £7,600, so the dividend is £32,400. The owner's salary leaves only £270 of the basic rate band (37,700 − 37,430), so after the £500 nil rate band the remaining £31,900 is taxed at 33.75% = £10,766. The owner keeps £21,634.
3. No. The PET of £294,000 is within the nil rate band, so no tax arises on it for taper relief to reduce. The cost of dying within seven years falls on the estate, through the nil rate band the gift uses.