By Chetan Soni

Abstract

Through this article, I will be bringing to light the special tax regime followed in the Indian state of Sikkim, and present how the central government can attempt to combat the potential for fraud due to Sikkim’s special tax status.

Sikkim, an erstwhile kingdom, was merged into India on condition its old laws and special status as envisaged in Article 371(f) of the Constitution remain intact. Thus, the state followed its own Sikkim Income Tax Manual 1948, which governed the tax laws for Sikkimese residents. Under it, no Sikkimese resident was supposed to pay taxes to the Centre, with the exact clause from the Act stating-

“Any income, which accrues or arises to a Sikkimese individual from any source in the State of Sikkim or by way of dividend or interest on securities, shall not be included in the total income of such individual.”

The application of the provision thus exempts any person who qualifies the definition of a Sikkimese resident from the ambit of the Indian Income tax provisions. Consequently, a Sikkimese resident does not require a pan card, or file an income tax return to the Indian government coffers.

Sikkim’s tax laws were attempted to be repealed due to the Gift Scam of the 1980s. The same saw an exploitation of the privileged position granted to Sikkim. That is, the local people had to merely file affidavits in court, legalised by an advocate’s signature on a one-rupee revenue stamp. The same stated that the black money – laundered and handed over to them by non-sikkimese residents – was earned in the state and they now intended to gift it to their friends in other states. A key precursor to its success was that the Sikkim Income Tax Manual of 1948, did not permit a Sikkimese being questioned on the source of his income. In light of this the Center attempted to bring Sikkimese people within the tax net, while making good the losses suffered by the Sikkim State as a result of the revenue lost. However, the same was later repealed in the face of diplomatic pressure. Another attempt was made in 2008, but the Union Budget exempted the State by inserting Section 10 (26AAA) to the Income Tax Act, 1961.

Thus, any income generated within the State of Sikkim by a Sikkimese resident could not be taxed by the Centre, and rather, could only be governed by Sikkim’s own laws. In 2023, the Supreme Court upheld the distinction and granted exemption to all Sikkimese people, including all such Indians/citizens, who had settled in Sikkim prior to the merger of Sikkim with India on 26.04.1975. Hence, the exemption extends to any and all such settlers in the nation prior to the merger.

Additionally, companies incorporated in Sikkim under the Registration of Companies (Sikkim) Act, 1961, and not the Companies Act, 1956, are exempt from the Income Tax Act, 1961. So as to prevent any financial disadvantage, in 2008, SEBI exempted Sikkimese residents from needing a Permanent Account Number (PAN) to invest in Indian securities markets and mutual funds. The State Bank of Sikkim (SBS) too does not fall under the direct purview of the Reserve Bank of India (RBI), allowing for the deposit of any amount into the bank accounts of the users without any KYC requirements. A culmination of these factors, based on lack of identification- indicatively has the potential to evolve into tax evasion.

An instance of the same materialized in April 2022, when the Multi Commodity Exchange Traders of Sikkim saw a multi-fold increase in volume as their presence grew from nil to 5.5% within a couple of years, constituting $6 billion of the total volume of $110 billion. Tax experts attributed such a rise to the exemption granted to Sikkimese residents, from the mandatory requirement of a PAN, which allows them to maintain financial autonomy.

The Indian state has been aware of the potential for fraudulence on the part of Indian residents, wherein it has previously attempted ‘recovery of tax’ while simultaneously trying to prevent the creation of shell companies with name-sake Sikkimese promoters, being incorporated in the North Eastern state for the sole purpose of tax evasion. This was done through the scheme of the Sikkim (Collection of Taxes and Prevention of Evasion of Payment of Taxes) Act, 1987. An application of the statute was viewed in the Delhi High Court’s judgement in Commissioner of Income Tax- Delhi v. Mansarovar Commercial P. Ltd. & Ors., later upheld by the Supreme Court, wherein the respondents had incorporated a company in Sikkim, but were accused of functioning and being managed through their Chartered Accountants in Delhi. The subsequent investigation revealed books of accounts, signed blank cheques, vouchers and other income documents of the assesses. Indicative of the fact, that the Assessee companies were in fact being managed and controlled from within Delhi, and not Sikkim. Hence, the court noted that the accused were “intentionally trying to take advantage of the prevailing laws at Sikkim by routing money through Sikkim and ploughing back in India.”

At the time of demonetization in 2016, the RBI viewed increased activity, and deposits in the State Bank of Sikkim attempted to crack down upon them. However, attempts to curb the same by blocking 52,000 accounts in the State Bank led to the then Union Home Minister publicly standing with SBS, and highlighting the protection granted to them under Article 371 F. An advisory was issued by the Sikkim Government cautioning Sikkimese individuals to not allow non-sikkimese people to deposit money into their accounts, as the same is illegal. Further, the Income Tax department reached out and attempted to make KYC mandatory for those depositing more than INR 50,000.

More recent instances of fraudulence were seen in 2022, when the commodities market in Sikkim blew up. In addition to the peculiar tax status provided for Sikkim based corporations, it is pertinent to note the impact of the Stamp Act, 1899. The stamp duty is a tax that is levied while issuing, selling or transferring the stocks, debentures, currency derivatives, and commodity instruments. The tax is collected for providing a stamped contract note to each trader at the end of the day. Further, the Indian Stamp Act of 1899, to create uniformity was extended to all states in 2019, however, it was later held not to be applicable on Sikkim, allowing Sikkim to attract traders. Thus, the laxity of PAN requirements, the peculiar status awarded to these corporations come in handy for Sikkim based commodity market traders, who face no urgency of tax filings leading to them enjoying a tax haven like status in Sikkim.

Thus, as a consequence of the various relaxations and loopholes allowed by the centre with regards to Sikkimese residents, there erupts a significant cause for concern with regards to the tax avoidance by residents of India through a use of these loopholes.

Conclusion and Suggestions:

While the Sikkim (Registration of Companies) Act, 1961, has been statutorily repealed by the Companies Act, 2013, it has not led to an automatic repeal of Sikkim’s special status. The definition of an Indian company still cannot cover companies incorporated under the erstwhile act, and neither can companies incorporated in Sikkim be automatically brought under the Income Tax Act’s purview. That is, such companies were determined to be taxed as an Association of Persons, as was held by the Income Tax Appellate Tribunal, Kolkata in Himal Enterprise Pvt. Ltd v. Income Tax Officer, Ward- Gangtok, Sikkim. Thus, in effect, successfully navigating the Indian tax net, on the back of a Sikkimese promoter to a favourable tax structure. However, as was mentioned before, a certain proactiveness was shown by the executive authorities in applying a test similar to the Place of Effective Management (POEM) to determine whether the income was in fact being generated within Sikkim for Sikkimese people can be effectively put in place. 

An ex-RBI governor stated- “We were persuading the government to bring it under Reserve Bank’s purview, but these arrangements are all relating to diplomatic terms and we (the regulator) are not privy to that,” R Gandhi, former deputy governor at RBI. The lack of regulation allows for them to maintain Swiss bank sort of secrecy, coupled with lax Know-your-customer rules allows for a lucrative opportunity to tax fraudsters. CAG audits on the same have shown non-compliance with banking regulations, along with multiple violations during the Demonetization period, and huge amounts being withdrawn.

In order to tackle the issue of tax evasion, it is important to inspect large flows of money from Sikkimese accounts to Indian accounts. This will help identify individuals and businesses that may be engaging in illegal activities, such as hiding assets or underreporting income. It is also important to verify the position of traders and their trading activities through the use of novel methods. By doing so, it will be possible to detect any potential tax evasion and take necessary action. In addition to these measures, cooperation from all parties involved is crucial. This includes revealing information and making sure that the Sikkimese Banking System (SBS) cooperates fully in identifying any potential tax evasion. By working together, it will be possible to ensure that tax laws are being followed and that all taxpayers are fulfilling their obligations. Ultimately, this will help to maintain the integrity of the tax system and ensure that everyone is paying their fair share.

About the author

The Author is a 5th Year BA-LLB Student from Jindal Global Law School. He is interested in the intersection between law and economics, and how intrinsically this interaction impacts the daily lives of the common man. In his free time you can catch him discussing the implication of the country’s macroeconomic policies, or weirdly engrossed in a debate of whether the present Indian cricket team is the greatest ever!

Image Source: https://wealth18.com/tax-haven-within-india/