Alfred Henry Lionel Leach, C.J.
1. The case for the income-tax authorities set out in the reference by the Commissioner of Income-tax cannot be accepted. The facts are very simple. In the year 1936-37 one Muhammad Ibrahim was the agent of the Standard Oil Company in Trichinopoly. There were two agencies for the Burmah Shell Company in that district, on(r) being conducted by Ramakrishna Chettiar and the other by G. Srinivasalu Naidu respectively. They had agencies in other places in South India and there was an agreement between them that Ramakrishna was to have the profits of the business done in the town of Trichinopoly. There was a further arrangement between Ibrahim and Ramakrishna. This was to the effect that they were to carry on business jointly without competition between themselves and to divide the profits made by them in the ratio of 48 :52. The Income-tax Officer attempted to assess these three persons as a firm, but they objected and their objection prevailed. The consequence was that for that year they were assessed separately.
2. Ramakrishna and Srinivasalu quarrelled in the course of that year and Eamakrishna filed a suit for the dissolution of his, partnership with Srinivasalu. On the 1st May, 1938, Ibrahim and Srinivasalu commenced to trade jointly as a firm and on the 7th February, 1939 a formal deed of partnership was drawn up with effect from the 1st May, 1938. The firm was then registered tinder Section 26 (a) of the Income-tax Act.
3. For the, year 1938-39 the firm returned a loss of Rs. 7,014? in respect of the year 1937-38. The firm was not, however, liable to assessment in respect of that year because it had not carried on business in the year of account. The Income-tax Officer appears to have treated the firm as being the successor to the businesses carried on by the two partners and Ramakrishna. The firm did not object to the course adopted by the Income-tax Officer, presumably because of the alleged loss in the year of account. The Income-tax Officer, however, refused to accept the figure of Rs. 7,014. He added back certain; sums which appeared in the books and had been carried forward from the books kept by Ibrahim. There were large sums entered in the?suspense account in Ibrahim's books and the Income-tax Officer considered that these represented secret profits made when Ibrahim, Ramakrishna and Srinivasalu were carrying on business, not in partnership, but in conjunction with one another. These sums had received the attention of the Income-tax Officer when he was assessing Ibrahim in 1937-38. He considered the whole question then and came to the conclusion that Rs. 20,000 .of the sums entered in the suspense account represented secret profits. He assessed Ibrahim accordingly.
4. When it came to assessing the firm of Ibrahim and Srinivasalu in 1938-39 the Income-tax Officer was not satisfied that the secret profits amounted only to Rs. 20,000 and he formed the opinion that Rs. 26,699 of the moneys then appearing in the suspense account also represented secret profits. It was on this basis that he made his assessment. Objection was taken on the ground that the question of secret profits had been considered and decided in the previous year when Ibrahim was assessed and that the Income-tax Officer was not entitled to re-open the matter.
5. This reference concerns the sum of Rs. 26,699. The Appellate Assistant Commissioner accepted the decision of the Income-tax Officer, as did the Commissioner who refused to state a case to this Court under Section 66 (2). Ibrahim and Srinivasalu then applied to this Court for an order directing the Commissioner to state a case under Section 66 (3). The Court directed that this should be done and framed the question as follows:
In including the sum of Rs. 26,699 in the amount of the taxable income for the year of assessment 1938-39 were the income-tax authorities acting in accordance with law?
It is obvious that the income-tax authorities were not acting in accordance with law. Even assuming that there was justification for assessing the firm under Section 26 (2), the Income-tax Officer could not include in the assessment profits, secret or otherwise, which had been earned before the year of account and the sum of Rs. 26,699 had been earned before the year of account. This sum appeared in Ibrahim's books for the year 1936-37 and was included in the balance of the year 1937-38. It is true that the objection now stated was not taken by the assessees and that they were content to base their case on the fact that the secret profits question had been investigated and decided in the previous year. At the same time the Income-tax authorities are not entitled to include in the assessment a sum of money which the law does not allow to be included. There Was no action taken under Section 34 with a view to collect tax on income which had escaped taxation. The decision was merely to treat the Rs. 26,699 as profits earned by the firm in the year of account, which was certainly not the case.
6. The question will be answered in the negative and the Commissioner will pay the assessees' costs, Rs. 250.