The document discusses the differences between a sole proprietorship and a Limited Liability Company (LLC) from a tax perspective to advise Ms. Rahman on the best business structure. A sole proprietorship has unlimited personal liability for debts and taxes, whereas LLC owners have liability limited to their investment. LLCs are subject to a flat 20% tax, while sole proprietorships pay progressive taxes over 100,000 AFN in income. LLCs can carry losses forward for many years, while sole proprietorships cannot recover losses from prior years. However, sole proprietorships have a simpler tax filing process than LLCs.
The document discusses the differences between a sole proprietorship and a Limited Liability Company (LLC) from a tax perspective to advise Ms. Rahman on the best business structure. A sole proprietorship has unlimited personal liability for debts and taxes, whereas LLC owners have liability limited to their investment. LLCs are subject to a flat 20% tax, while sole proprietorships pay progressive taxes over 100,000 AFN in income. LLCs can carry losses forward for many years, while sole proprietorships cannot recover losses from prior years. However, sole proprietorships have a simpler tax filing process than LLCs.
The document discusses the differences between a sole proprietorship and a Limited Liability Company (LLC) from a tax perspective to advise Ms. Rahman on the best business structure. A sole proprietorship has unlimited personal liability for debts and taxes, whereas LLC owners have liability limited to their investment. LLCs are subject to a flat 20% tax, while sole proprietorships pay progressive taxes over 100,000 AFN in income. LLCs can carry losses forward for many years, while sole proprietorships cannot recover losses from prior years. However, sole proprietorships have a simpler tax filing process than LLCs.
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