Assignment III (LSG 311)

Pro. Freshta Zuhal Rahman

M. Iqbal Sekandari
To provide the best advice—from a tax perspective—to Ms. Rahman, we define sole
proprietorship and Limited Liability Company (LLC). First, a sole proprietorship is an
unincorporated business that has only one owner who is liable to pay personal income tax on
profits she earned. The owner is also personally liable for all the debts of the company. On the
other hand, a Limited Liability Company is a legal person “in which the partners (shareholders)
are not individually liable for debts of the company but each partner has liability limited to their
shares of capital in the company,” says Article 31 of Afghan Tax Law. Although we suggest that
Ms. Rahman forms an LLC instead of establishing a sole proprietorship, she must be mindful of
certain disadvantages of the former and advantages of the latter.
First and foremost, in an LLC, shareholders are not personally liable for all the debts and losses
of the company. They are distinct from the company and are separate entities while the owner of
the sole proprietorship is personally liable for losses and debts of the company. Thus, Ms.
Rahman will not liable for the losses and debts of the company which she establishes.
Additionally, a sole proprietorship is subject to progressive taxation in which the tax on its
income increases when the company’s profit increases. According to Afghan Tax Law, a sole
proprietorship business pays 20% tax plus a fixed amount when its income exceeds 100,000
AFN. LLCs, however, are subject to 20% flat tax regardless of the increase/decrease in their
incomes. Also, LLCs are required to withhold 20% tax on dividends distributed to their
shareholders from their earnings which means LLCs are taxed twice. However, according to
Article 58 of Afghan Tax Law, which asserts that “all natural or legal profit and nonprofit
[entities]… employing two or more employees in any month of a year shall be required to
withhold taxes”, both sole proprietorship and Limited Liability Company are required to
withhold tax.
Since a sole proprietorship business is a separate legal entity for tax purposes, it is not required to
pay business receipts tax while providing goods and services in exchange for consideration
unless its revenue is 750,000 AFN or more per quarter in a year. The LLCs are required to pay
business receipts tax regardless of the amount of their revenue in a quarter per year. In addition,
LLCs can carry forward their losses for many years (an unregistered business is allowed to
recover its loss for three subsequent years). A sole proprietorship, on the other hand, cannot
recover its losses by deducting the losses from the profit of the subsequent years, which is a
major disadvantage compared to an LCC. Although the recovery of the losses is an advantage for
LLCs, it makes the procedure of taxation complicated. Similarly, a Limited Liability Company is
required to withhold tax from paying dividends to shareholders and file the withholding tax
separate from tax on income which is another layer of complexity on the taxation of LLCs.
Nonetheless, a sole proprietorship has a simple business structure in which the owner is liable to
file his/her personal income tax during the tax year without going through the intricate process of
taxation which belongs to LLCs. Furthermore, a sole proprietorship will pay less additional tax
compared to LLCs if it fails to prepare and maintain records of the transaction. For example,
Article 101 of Afghan Tax Law asserts that “A person who, without reasonable cause, fails to
prepare and maintain records required by the provisions of this Law or fails to provide the
officers of the Ministry of Finance access to the records shall pay additional income tax of 5,000
AFN if the person is a natural person or 20,000 AFN if the person is a legal person”. There is a
similar difference in additional taxation of sole proprietorship and Limited Liability Companies
where the tax return is not filed.
Lastly, because a sole proprietorship is regarded as a natural person from a tax perspective, it can
benefit from fixed taxes if it is a resident of Afghanistan. For example, Articles 73 and 74 posit
that “fixed tax shall be applied to natural persons who are residents of Afghanistan” if they “have
income which is neither exempt nor subject to withholding” and their “total gross annual
income… is less than 3,000,000 AFN for a tax year”. Therefore, Ms. Rahman should be mindful
of the issue.

Reference
Income Tax Law of Afghanistan
Income Tax Law Manual of Afghanistan