The special constitutional status of the islands was originally founded on the ancient viking tradition from the 9th century AD (all free men convened at the Althing, later called Løgting, in the capital Tórshavn), and from the latter half of the 12th century on – when attached to the medieval Norwegian Kingdom – they further developed their own culture, language and other social institutions, while at the same time adapting constitutionally to the surrounding political contexts of coming and going empires reaching out from the Scandinavian heartlands.

Originally  part of Norway
Norway and Denmark joined in a double monarchy in the late 14th century. When Norway in 1814 was cessioned to the King of Sweden, Norway’s westernmost territories, among them the Faroe Islands, remained under the sovereignty of the Danish Monarch. Not least due to the large geographical distance to Norway and Denmark, the Faroes always maintained a special jurisdiction along with their distinct language and culture, guarded by the ancient Løgting. Since the split from Norway, the Faroe Islands have accommodated to, but not fully integrated into, the modern state of Denmark.

Home Rule 

Constitutionally, Faroese relations to the Danish State were in 1948 defined in the Home Rule legislation. This legislation divides the administrative and legislative areas into two groups; joint affairs under Danish State authority, and special Faroese affairs under Faroese Home Rule, administration and legislation.
The Faroe Islands have, for example, their own independent area regarding Customs and Excise, Taxation and Administration.
 
The great degree of Faroese autonomy may be best illustrated by the fact that the Faroes are not members of the EU, nor EFTA (and thereby not of the EEA either).
 
Full legislative and administrative competence in areas subject to Faroese authority are for instance:
Agriculture
Education
Environmental affairs
Import and export control
Industrial affairs
Labour market
Living marine resources, e.g. fisheries’ regulation
Mineral resources of the subsoil and seabed
Physical planning
Search and Rescue service
Social services
Taxation and Customs
Telecommunications
Transport
 
Health affairs and parts of the Social affairs are still joint affairs, though, the actual administration in these areas have been taken over by Faroese Home Rule authority.

Some areas are Danish 

Judicial, Defence and Foreign Affairs are among those affairs that cannot be taken over by the Faroese Government according to the Home Rule Act. Nevertheless there are now ongoing negotiations between Faroese and Danish government representatives with the aim to clarify, whether the Faroese Government can
take over judicial affairs as well, provided a legal basis can be found for such a profound change.

The penal system, civil law - including personal, family and inheritance laws, company, banking and insurance legislation - is covered by corresponding Danish legislation. It is main practice that Danish legislation only takes effect in the Faroe Islands after ratification by the Faroese Parliament (Føroya Løgting), but this is not a guaranteed right.

Legislation in force in the Faroes is therefore not always identical to Danish legislation for similar issues.

Finances 

Areas designated as special Faroese affairs are fully financed by the Faroes themselves. The National Budget for 2006, amounted to approximately DKK 3.9 billion, and the total budget for all the Municipalities amounted to approximately DKK 1.09 billion.

The Danish Government is responsible for all expenses relating to purely state affairs, such as the Police and Court system. Expenditure for joint affairs is divided between the Danish and Faroese authorities. Most of the Danish State subsidy to the Faroe Islands is issued as a block grant.

The block grant has since 2003 been a fixed amount of DKK 615.5 bill. per year, (this amount is included in the aforementioned Budget of DKK 3.9 billion). The main source of revenue for the Faroese Government is income tax and VAT.

For the Municipalities, the main source of revenue is income tax alone. There is no property tax. The Faroe Islands are not liable for tax to the Danish Treasury.