TMI Blog2007 (2) TMI 627X X X X Extracts X X X X X X X X Extracts X X X X ..... and expenses is an important exercise under Accounting. Depreciation is a part of this exercise. DERC was not entitled to derive the rate from the fair life of the asset, particularly, when the consequence was to reduce the ARP substantially. In conclusion, we reiterate that in the present case because of inflation, we have to go by the Cost of Replacement instead of Historical Cost. However, we state that our judgment is confined to the facts of the present case alone and the reasoning given hereinabove is in the context of the period of 5 years. This judgment should not be construed to apply for all times. It is confined to the transition period only. This civil appeal preferred by DERC stands dismissed - C.A. 2733 OF 2006 - - - Dated:- 15-2-2007 - Dr. Arijit Pasayat and S. H. Kapadia, JJ. JUDGMENT This is an appeal by special leave concerning tariff fixation by Delhi Electricity Reforms Commission ('DERC' for short). In this appeal, a short point which arises for consideration is : whether on the facts and circumstances of the case DERC was right in reducing the rate of depreciation from 6.69% to 3.75%. The facts giving rise to this civil appeal a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stated that for revising the tariffs in 2001- 02, DVB has already filed a tariff application with DERC in which DVB has proposed Tariff Setting Principles through which the tariffs of 2001-02 would get adjusted in 2002-03, 2003-2004, 2004-05 and 2005-06. In para 5.10 of the RFQ document, GoNCTD stated that it was committed to the power sector reforms in Delhi; that this was its commitment which stood reflected in various steps undertaken by it, namely, creation of DERC, appointment of financial advisors for unbundling and for privatization, enactment of DERA, approval to the structure of unbundled DVB on 6.1.01 and commencement of the process of inviting RFQ bids through the issuance of RFQ document. At this stage, it may be noted that DERC was created in March 1999. However, vide para 5.10 of the RFQ document, GoNCTD indicated that by passing DERA its role was restricted to provide directions on policy matters in the process of electricity tariff determination. In the context of future tariffs, the RFQ document further clarified that the order to be passed by DERC on the tariff application of DVB for the year 2001-02 would be made available to the bidders before the last date of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .01, that for want of details regarding asset-composition at the beginning of financial year 2001-02, it approved the WADR of 6.83% for computing the depreciation. At this stage it may be noted that on unbundling, the WADR stood reduced to 6.69% for the financial year 2001-02. The said depreciation was chargeable to ARR of DVB. It was quantified at Rs.232 crores for the financial year 2000-01 and at Rs.262 crores for the financial year 2001-02. On 20.11.01 GoNCTD notified the Transfer Scheme under Section 15, 16 and 60 of DERA setting out rules for transfer and vesting of assets, liabilities and obligations of DVB in the three DISCOMs herein. Under the said Scheme DVB was unbundled, the Opening Balance Sheet of each of the three DISCOMs gave the value of the Gross Fixed Asset ('GFA' for short) as also the value of Net Fixed Asset ('NFA' for short) for tariff purposes. The Transfer Scheme was brought into force with effect from 1.7.02. On 22.11.01 GoNCTD issued Request for Proposal document ('RFP document' for short). The said document was accompanied by the Policy Directions issued to the prospective bidders referring to the transition period of 5 year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l/May 2002. Bids were similarly made by M/s. BSES for purchase of 51% equity in the other Distribution Companies owned by GoNCTD. For the sake of convenience we are stating the facts concerning the bids submitted by M/s. Tata Power Company Limited in the context of purchase of 51% equity in the North North-West Delhi Distribution Company. On 29.5.02, GoNCTD accepted the bid of M/s. Tata Power Company Ltd. based on the loss reduction profile, RFP documents etc. Accordingly, M/s. Tata Power Company Ltd. was invited to sign Share Acquisition Agreement by GoNCTD. This was on 31.5.2002. On 1.7.02, the Transfer Scheme was brought into force by GoNCTD. The majority share-holding (51%) and management control of the three Distribution Companies owned by GoNCTD stood transferred to the successful private bidders. M/s. Tata Power Company Ltd. was one of the three DISCOMs. After privatization of Distribution Companies on 1.7.02, the Electricity Act, 2003 was brought into force on and from 10.6.2003. Section 185 of the said 2003 Act saved DERA by stating that all directives issued before the commencement of 2003 Act under DERA shall stand expressly saved. Vide Tariff Order dated ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dated 22.2.2002 applicable for two months ending 31.3.02. It was further held that depreciation is the source of debt repayment for a Utility and since no loan repayment was due during the financial years 2002-03 and 2003-04, DERC had accepted the request of NDPL and two others to treat depreciation as a source of funding to partly fund Capital Expenditure. It was further held by DERC that depreciation is a non-cash expenditure and since there was no loan repayment in the financial year 2002-03 and financial year 2003-04, the allowed depreciation rate of 3.75% will not affect the DISCOMs' operations, cash-flow/returns as all legitimate expenses were duly covered in the determination of ARR. It was further held that DERA empowered DERC to depart from the Principles mentioned in Schedule VI of the said 1948 Act, during the process of tariff determination, by providing in writing the reasons for such variations. It was held that since there were serious deficiencies in the Fixed Asset Register ('FAR' for short), DERC took the decision to reduce the rate of depreciation from 6.69% to 3.75% in accordance with the power entrusted to DERC vide Section 28(3) of DERA. It was fur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ATE also allowed another appeal filed by NDPL challenging the Tariff Order dated 9.6.04 concerning creation of Regulatory Asset(s) by DERC. On 23.8.06 Civil Appeal No.2733 of 2006 filed by DERC came for hearing when the following interim order was passed: After hearing learned counsel for the parties at some length, we feel it would be appropriate for the Appellate Tribunal to consider the conclusions of the Commission as if they were good and sufficient for the purpose of making a departure from the Schedule VI rates. The basic issue involved in this appeal is whether the Appellate Tribunal was justified in its view that the Commission had not indicated any reason for deviating from Schedule VI rates. This direction is being given because the Commission was of the view that no reasons have been indicated. Without expressing any final opinion, we direct the Tribunal to examine whether the conclusions of the Commission are supportable in facts and in law. Let the parties appear before the Appellate Tribunal without further notice on 5th September, 2006 so that the Appellate Tribunal can fix a confirmed date of hearing or take up the matter on that very day. The Appellate Tri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for loan repayment. According to the impugned order passed by ATE this reasoning was erroneous since depreciation under Schedule VI was admissible even in cases where the DISCOM has not taken any loan in the relevant financial year. According to the impugned order, depreciation is an item of deduction in respect of an outgoing which is notional, and which is a part of profit as also part of the asset(s) charged. According to ATE, depreciation does not generate cash, it simply allocates the original cost of an asset to the period in which the asset is used. According to ATE, depreciation is an item of Allowable Expenditure and if the rate of depreciation is reduced from 6.69% to 3.75% the same will disable the DISCOMs from funding replacement of one or the other of the equipments/machinery which becomes obsolete, adversely affecting the distribution system. According to ATE, the DERC has erred in holding that depreciation is meant to be utilized for meeting working capital requirement, loan repayment, capital investment etc. According to ATE, depreciation under Schedule VI is an item of authorized expenditure. According to ATE, DERC was wrong in holding that depreciation stood built ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll as MOP Notifications. Further, according to ATE, the rate of depreciation in term of MOP Notification works out at an average of 6.69%. According to ATE, even the BST Order issued by DERC proceeds on the basis that depreciation is admissible at a rate for an identical equipment and, therefore, there was no reason to treat the DISCOMs herein differently. According to ATE, the Policy Directions of GoNCTD did not indicate depreciation at the rate of 6.69% but while passing the BST Tariff Order dated 22.2.02, DERC had granted depreciation at the same rate of 6.69%. According to ATE, the BST Tariff Order dated 22.2.02 constituted a parameter for the DISCOMs herein for the transition period of 5 years. According to ATE, 16% return on equity was guaranteed. This was not in dispute. However, according to ATE, 16% of the return on equity can be arrived at only if Allowable Expenditure is made admissible. Lastly, according to ATE, depreciation has been allowed by DERC at the rate of 6.69% to TRANSCO and GENCO and, therefore, there was no reason to treat the DISCOMs herein differently. According to ATE, MOP Notification dated 29.3.94 enabled the DISCOMs herein to claim the accelerated rate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch rate was not admissible as there was no question of debt redemption during the aforestated years. According to learned counsel, MOP Notifications granted higher rate of depreciation depending on the loan repayment and since in the present case there was no liability of loan repayment for the DISCOMs during the above years, they were not entitled to the higher rate of depreciation of 6.69%. According to learned counsel, reliance placed by DISCOMs on the MOP Notifications was erroneous since the said Notifications are based on the concept of AAD which is limited to the actual loan liability in a given year. In the circumstances, according to learned counsel, DERC was right in holding that DISCOMs were not entitled to the depreciation expenditure at the rate of 6.69%. According to learned counsel, the MOP Notifications show that higher depreciation was admissible in the regulatory mechanism because at the relevant time the Utility had undertaken loan repayment liabilities which did not exist for the financial years 2002-03, 2003-04 and 2004-05. Mr. Dholakia, learned counsel for DERC, next contended that the Policy Directions issued by GoNCTD on 22.11.01 promised as assured retur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rily based on fair life of the assets, the rate whereof can vary depending upon the object sought to be achieved, for example, under I.T. Act, depreciation is a tool for tax incentive and capital formation. Similarly, depreciation is often prescribed on different basis, in the case of energy saving devices, pollution control equipments etc. Depreciation calculated under the Companies Act is intended to arrive at the true and fair value of the assets of the company in order to keep the shareholders, creditors and investors well informed. Learned counsel urged that in Electricity Accounting, DERC is entitled to adopt a fair rate of depreciation based on fair life of the assets so that the consumer is not overburdened. In the present case, it was urged that on the date of transfer all the accumulated losses were taken over by GoNCTD; that the DISCOMs herein were aware that the existing tariffs would not be enough to recover the cost of units input in the immediate future as there were substantial AT C losses; to recover the cost of units input, DISCOMs were aware that the tariff would have to be increased to a higher level which was not practical and for the above reasons GoNCTD offer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion in the Official Gazette, lay down from time to time. In other words, it was incumbent on the licensee to provide for depreciation in accordance with the principles as the Central Government may by notification lay down, from time to time. Reliance, in this connection, was placed on the first MOP Notification dated 23.1.92 in which depreciation was prescribed in accordance with the straight-line method ( SLM for short). In the notification there was a column which indicated the fair life of the assets. However, a Note was added to the said Notification making it clear that the rate of depreciation shall not be determined on the basis of the fair life of the assets. The said Note read as under: NOTE: The reference to the straight line method in this notification is intended to differentiate the same from the reducing balance method and not for derivation of rates from the fair life of the asset and the residual value In other words, the rate of depreciation prescribed by the Central Government had no linkage with the fair life of the assets. Therefore, where accounts were required to be drawn up under the Sixth Schedule, it was incumbent on the DERC to provide rates of d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cy Directions dated 22.11.01 issued by GoNCTD. In this context, it was pointed out that Policy Directions dated 22.11.01 and BST Order dated 22.2.02 had fixed the rate of 16% ROE after providing for all expenses including depreciation. They had also fixed an incentive for reduction in AT C losses. All these aspects were taken into account while fixing the transition period of 5 years. The BST was fixed for 5 years and, therefore, it was not open to DERC to reduce the rate of depreciation and thereby frustrate the reforms and the period of 5 years. It was further pointed out that one of the important problems which had dogged the privatization process was that the particulars of the assets were not known and, therefore, DERC had adopted WADR allowable on the assets in question. The rate of depreciation and the rate of return on equity were significant features of the Transfer Scheme. It was submitted that if DERC is allowed to reduce the rate then such tinkering would frustrate the reforms. It was further pointed out that in order to ensure ARR to be met through the tariff, DERC was required to provide the basis on which the return on equity was to be computed. It was contended on b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... advanced on behalf of DERC was to be accepted, namely, higher depreciation for higher loan it would lead to disaster. If a DISCOM borrows money from the market then, according to DERC, it can recover the cost of borrowing from the consumer. Such reasoning would impose on the consumer twofold liabilities - firstly, the interest burden in such an event could be passed on to the consumer as a cost and secondly, the redemption of the loan would result in accelerated depreciation in tariff. Therefore, according to NDPL, DERC had erred in holding that NDPL was not entitled to depreciation rate of 6.69% as it had not borrowed moneys from the marker during the relevant years. According to learned counsel for NDPL there was no linkage between depreciation and loan repayment since depreciation is a charge on the income to be kept aside for asset replacement. Depreciation is admissible so that the cost of the asset can be recovered by reducing the distributable profit and the money so retained in the business (distributable profit minus cash profit) can be used for replacement of asset. According to NDPL, the above MOP Notification dated 23.1.92 (as amended) contemplated different rates of d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amme. Under that programme the anticipated date for issue of the Tariff Order for 2001-02 was 2.4.01 while the date fixed for receiving RFQ bids was fixed as on 16.4.01. Similarly, the receipt of RFP bids was by 30.8.01. Therefore, according to learned counsel, the bid documents clearly indicated that the bidders had to file their bids after perusing the Tariff Order for 2001-02. Learned counsel submitted that, therefore, the bids for privatization were specifically invited on the clear basis that during the transition period the tariff of the DISCOMs would be fixed in accordance with the Principles set out in the BST Order to be issued by DERC pursuant to the Policy Directions dated 22.11.01. Learned counsel, therefore, submitted that the DISCOMs acted and alterd their position on the basis of the tariffs mentioned in the BST Order read with the Policy Directions which were not only binding on DISCOMs and GENCO but also on DERC, therefore, DERC was not entitled to depart from the BST Order during the transition period on any ground whatsoever. In this connection, learned counsel placed reliance on the order dated 21.7.06 of ATE in the case of BYPL and BRPL concerning Regulatory As ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of accounting different from those set out in the BST Order. In the circumstances, learned counsel submitted that the Policy Directions gave three assurances to the investors, namely, ROE of 16%, incentive for overachievement in bringing down the AT C losses and recovery of expenses permissible in terms of the financial principles set out in the Sixth Schedule to the said 1948 Act. Learned counsel for BYPL and BRPL adopted the contentions advanced on behalf of NDPL. Learned counsel, however, submitted that if any items of allowable expenditure are disallowed, the consequence would be that the return earned by the DISCOMs will stand significantly reduced from 16% and this would be in breach of Policy Directions as well as the solemn assurances given to investors at the time of inviting the bids. If the rate of depreciation allowed is reduced from 6.69% to 3.75%, the result would be that the difference between the amount denied by DERC, on account of reduction in the depreciation rate and the amount granted as ROE, will show that instead of earning the assured 16% ROE, the actual return earned by the DISCOMs herein may not be 0.5%. Therefore, the variations from the Principles set ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of matching is a concept according to which expenses are recognized in the Statement of Profit and Loss on the basis of direct connection between the costs incurred and the earning of specific items of income. Depreciation helps this concept of matching. The Full Cost Method ('FCM' for short) is a method of matching income (revenue) and expenses. This method proceeds on the basis that a proper matching of income and expenses can take place only if total costs are depreciated on a pro rata basis. The FCM, therefore, avoids distortion of reported earnings. It is in this context that one has to keep in mind the difference between distributable profits and the cash profits. Depreciation reduces the distributable profit without reducing the cash profit. The difference between the two is a sum which the company has to retain to meet the cost of replacement in future. We may clarify that depreciation is ordinarily not a source of fund under Commercial Accounting, however, as held by this Court in the case of Ahmedabad Miscellaneous Industrial Workers' Union v. Ahmedabad Electricity Co., Ltd. - AIR 1962 SC 1255, in the context of the Electricity Supply Act, depreciation enabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... artered Accountants in England and Wales, in its recommendations made in 1949 under the heading Rising price levels in relation to accounts has pointed out that the gap between historical and replacement costs might be too big to be bridged by a provision made for replacement spread over a period of years either by way of supplementing the depreciation charges or by setting up in lieu of depreciation a provision for renewals based on estimated replacement costs. It is therefore suggested that in revising the formula the claims for rehabilitation should be fixed at a reasonable amount and industry should be required to find the balance from other sources and if necessary from its share in the available surplus. 34. The theory that the whole of the rehabilitation charges need not come out of the trading profits of the industry does not appear to be generally accepted. As has been observed by Paula himself, In the past the accepted principle has been that the main object of providing for the depreciation of wasting assets is to recoup the original capital invested in the purchase of such assets. As part of the capital of the concern has been invested in the purchas ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... industry is as much for the benefit of the employer as for that of labour; and so reasonable provision made in that behalf must be regarded as justified. The above discussion indicates the reasoning behind the higher rate being prescribed in the MOP Notifications of 1992 and 1994. The above discussion indicates reasons for not linking the rates of depreciation to the fair life of the asset(s) under the above Notifications. The above discussion emphasizes the substitution of the concept of Historical Cost by the concept of the Replacement Cost on account of the inflation in the economy. As stated above, our economy is essentially even today cost push economy. India has achieved GDP rate of 8 to 9%. To sustain that rate we need the rate of savings at 30 to 35%. Infrastructure including electricity is one of the problems faced by our economy. Electricity - generation, distribution and transmission - is a Capital Intensive Industry. The MOP Notifications have referred to the life of the asset(s) in the Electricity Industry at 25 years. However, the Note appended to the Notification of 1992 clarifies that the Utility shall not derive the rate of depreciation from the fair life of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... our economy. DERA was enacted keeping in mind the concept of public-private enterprise. It was enacted to encourage such Joint Ventures. Under Section 12, DERC was required to be guided by Directions in matters of Policy involving public interest as the Government may issue from time to time. Government was the final Authority regarding such Directions. Section 28 of DERA came under Part VII which dealt with fixation of tariffs. Under Section 28, the licensee was required to observe the methodologies specified by the Commission (DERC) from time to time in the matter of calculating the expected revenue from charges which the licensee was permitted to recover under the terms of its licences. Under Section 28(2), DERC was entitled to prescribe the terms and conditions for the determination of the licensee's revenues and tariffs in such manner as DERC considers appropriate. However, Section 28(2) was subject to a proviso which stated that the DERC shall be guided in the matter of determination of revenues for the licensees by the financial principles mentioned in the Sixth Schedule to the said 1948 Act read with Sections 57 and 57A of the said Act. This was one of the parameters me ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 10.55 (years), if one goes by the said MOP Notification then the ARP comes to 13.45 years (90% value of asset divided by 6.69%, rate of depreciation). On the other hand, if one goes by the same value divided by 3.75% rate of depreciation then the ARP comes to 24 years. Similarly, on account of the reduction in the rate of depreciation from 6.69% to 3.75%, the overall actual return from the package becomes illusory. For example, for the financial year 2004-05, DERC approved 16% ROE amounting to Rs.61.69 crores. However, for the same financial year on account of fall in the rate of depreciation from 6.69% to 3.75%, DERC has disallowed depreciation to the tune of Rs.60.57 crores (Rs.106.19 crores minus Rs.45.62 crores). In other words, what is given by one hand is taken away by the other. In other words, the return on the total package becomes illusory if the rate of depreciation is reduced from 6.69% to 3.75%. The certainty for 5 years is also obliterated for reducing the rate of depreciation. This violation also infringes the doctrine of Legitimate Expectation of the DISCOMs to get lawful and reasonable recovery of expenditure. DERC was expected to fix the rate in the context of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rom the life of an asset. It is for this reason that the Note was appended to the said Notification stating that the life of the asset shall not constitute the basis for fixing the rate of depreciation. In view of the above Note, we are of the view that DERC was not entitled to derive the rate from the fair life of the asset, particularly, when the consequence was to reduce the ARP substantially. In conclusion, we reiterate that in the present case because of inflation, we have to go by the Cost of Replacement instead of Historical Cost. However, we state that our judgment is confined to the facts of the present case alone and the reasoning given hereinabove is in the context of the period of 5 years. This judgment should not be construed to apply for all times. It is confined to the transition period only. Before concluding, we may state that the basic object of providing depreciation is to allocate the amount of depreciation of an asset over its useful life and not actual life so as to exhibit a true and fair view of the financial statements of an enterprise. Useful life is a period over which a depreciable asset is expected to be used. Useful life of an asset in a capital int ..... X X X X Extracts X X X X X X X X Extracts X X X X
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