Why Is Sikkim Tax-Free? All You Need to Know

Sikkim, a small state in northeastern India, is renowned for its stunning landscapes, rich cultural heritage, and unique tax policies. Unlike other states in India, Sikkim enjoys a special tax exemption status that has piqued the curiosity of many.

To understand why Sikkim is tax-free, it's crucial to look at its historical context. This article delves into the reasons behind Sikkim's tax-free status, the historical context, and the legal framework.

Historical Background and Tax Exemption

Sikkim's journey to becoming a tax-free state is deeply rooted in its history. Before its integration into India, Sikkim was an independent kingdom ruled by the Namgyal dynasty. The kingdom's status changed significantly after Indian independence in 1947, leading to a treaty in 1950 that established Sikkim as an Indian protectorate while maintaining its internal autonomy. This agreement, known as the Indo-Sikkim Treaty of 1950, laid the groundwork for Sikkim's eventual merger with India.

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Why is Sikkim Tax Free? 

In 1975, following a referendum, Sikkim officially became the 22nd state of India. However, the terms of the merger were unique. Sikkim's tax-free status is also supported by special provisions under Article 371F of the Indian Constitution through the 36th Amendment Act, 1975. This article provides for the continuation of certain laws and privileges the state enjoys, including tax exemptions.

Initially, Sikkim followed its own income tax manual established in 1948. However, The 2008 Union Budget introduced Section 10 (26AAA) of the Income Tax Act, which aimed to offer income tax exemptions to Sikkimese individuals. 

2008 Tax Law Changes 

In 2008, significant changes were made to Sikkim's tax laws. The 2008 Union Budget introduced Section 10 (26AAA) of the Income Tax Act, which granted tax exemptions to the residents of Sikkim. This provision was designed to uphold the special status of Sikkimese individuals and exempt them from income tax on their earnings within the state or on dividends and interest from securities.

Key Provisions of Section 10 (26AAA):

Income Tax Exemption: Income accrued by Sikkimese individuals from sources within the state or through investments such as dividends and interest on securities was exempted from income tax.

SEBI Exemption: The Securities and Exchange Board of India (SEBI) also exempted Sikkim residents from the mandatory Permanent Account Number (PAN) requirement for investments in the Indian securities market and mutual funds.

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Supreme Court Verdict and Its Impact

The Exclusion of Certain Groups

Initially, Section 10 (26AAA) excluded certain individuals from the tax exemption. Specifically, the provision did not cover "old Indian settlers"—those who had permanently settled in Sikkim before its merger with India in 1975. This exclusion led to legal challenges and petitions from various groups.

In 2013, the Association of Old Settlers of Sikkim (AOSS) filed a petition challenging this exclusion. They argued that denying tax exemption to those who had been residing in Sikkim since before the merger, despite their Indian citizenship, was unjust and discriminatory.

Supreme Court Ruling

The Supreme Court of India responded to this petition by delivering a landmark verdict. The Court directed that the tax exemption provided under Section 10 (26AAA) should be extended to all Sikkimese people, including those who had settled in the state before the 1975 merger. This ruling was based on the principle that all Indian citizens domiciled in Sikkim before April 26, 1975, should be eligible for tax exemption.

Additionally, the Court struck down the exclusion of Sikkimese women who married non-Sikkimese men after April 1, 2008. This exclusion was deemed unconstitutional as it violated Articles 14, 15, and 21 of the Indian Constitution, which guarantees equality, non-discrimination, and the right to life.

Current Status and Benefits 

Following these legal developments, the tax-free status for Sikkimese individuals has been more clearly defined and universally applied. All residents of Sikkim, irrespective of their background or marital status, who meet the criteria set forth by the Supreme Court, benefit from income tax exemption on their earnings and investments.

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