Why residents of Sikkim are exempted from paying Income Tax? EXPLAINED

Sikkim Tax-Free: Sikkim, a small yet stunning state in northeastern India, is renowned for its breathtaking landscapes and vibrant cultural heritage, as well as its unique tax policies. Unlike most Indian states, Sikkim benefits from a special tax exemption status. This status, established under its own tax laws in 1948, makes it an intriguing case. Once a kingdom, Sikkim joined India in 1975 as the country’s 22nd state. To explore why Sikkim enjoys this tax-free status, delve into its historical and legal context. 

Discussions about Sikkim's tax-free status have gained traction on social media, with many users highlighting this unique privilege, which is not shared by any other state in India. This has sparked significant interest and debate online. A social media user Aditya Singhania in a post on X said, "Forget Dubai! Someone get me a resident's status for Sikkim. Kitne mai milega bhai?"

Why is Sikkim tax-free?

Sikkim's journey to becoming a tax-free state is deeply rooted in its history. Before its merger with India, Sikkim was an independent kingdom under the Namgyal dynasty. Following India's independence in 1947, the Indo-Sikkim Treaty of 1950 established Sikkim as an Indian protectorate with internal autonomy, setting the stage for its eventual merger with India. In 1975, Sikkim became the 22nd state of India through a referendum, with unique terms including its tax-free status supported by Article 371F of the Indian Constitution and the 36th Amendment Act of 1975. 

Initially governed by the Sikkim Income Tax Manual of 1948, this local tax framework was repealed by the 2008 Union Budget, which introduced Section 10 (26AAA) of the Income Tax Act. This section provides tax exemptions for Sikkimese residents on all forms of income, including earnings from interest, dividends, and other sources, thereby cementing Sikkim's distinctive tax-free status within India.

Changes in tax law in 2008

In 2008, the Union Budget repealed the Sikkim Tax Act and introduced Section 10(26AAA) of the Income Tax Act to exempt Sikkim's residents from paying income tax, thus maintaining the state's special status under Article 371(f). However, in 2013, the Association of Old Settlers of Sikkim (AOSS) petitioned against the exclusion of "old Indian settlers" who had settled in Sikkim before its merger with India in 1975. The Supreme Court responded by ordering an amendment to Section 10(26AAA) to include all Indian citizens residing in Sikkim up to April 26, 1975, thereby extending the tax exemption to these individuals as well.

Key Provisions of Section 10 (26AAA)

• Income Tax Exemption: Residents of Sikkim are exempt from paying income tax on their earnings. This includes salary, business income, and other forms of income.
• SEBI Exemption: The market regulator SEBI has exempted Sikkim residents from the mandatory PAN requirement for investing in the Indian securities market and mutual funds.

Specific conditions for this exemption are:

• The individual must be a resident of Sikkim.
• The exemption applies to income earned in Sikkim and not to income earned outside the state.
• A Sikkimese woman who marries a non-Sikkimese man may lose her tax exemption status. This condition was upheld by the Supreme Court in a 2008 ruling, which clarified that marriage to a non-Sikkimese could impact her eligibility for the tax benefits granted to Sikkimese residents.

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