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CASE NO.: Appeal (civil)  2733 of 2006

PETITIONER: Delhi Electricity Regulatory Commission

RESPONDENT: BSES Yamuna Power Limited & Others

DATE OF JUDGMENT: 15/02/2007

BENCH: Dr. Arijit Pasayat & S. H. Kapadia

JUDGMENT: J U D G M E N T

KAPADIA, J.

       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 are as follows.         On 23.1.92 Ministry of Power (’MOP’ for short) issued  a notification (which was published in Official Gazette on  31.1.92) stating that a licensee shall provide for  depreciation in its Annual Statement of Accounts  commencing on 1.4.92 as per straight-line method in  respect of asset(s), indicated in column no.1, at the rates  indicated in the columns of Schedule VI to the Electricity  (Supply) Act, 1948 which vests the power to stipulate the  principles for depreciation in the said Ministry.  A note was  appended to the said Notification under which it was stated  that the reference to the straight-line method in the said  Notification was intended to differentiate the same from the  concept of reducing balance method and not to derive rates  from the fair life of the asset(s).

       On 29.3.94, in continuation of the above Notification,  MOP amended the Schedule.  A bare reading of the said  amendment indicates absence of linkage between the fair  life of an asset and the rate of depreciation.           On 23.11.2000 the Delhi Electricity Reforms Act, 2000  (’DERA’ for short) was enacted by the State Legislature to  establish DERC and to restructure the electricity industry  in Delhi.

       On 6.1.2001 the Government of National Capital  Territory of Delhi (’GoNCTD’ for short) decided to unbundle  Delhi Vidhyut Power (’DVB’ for short), its undertaking and  assets, and vest the same in six successor companies  including three distribution companies (’DISCOMs’ for  short).  These three DISCOMs are \026 North Delhi Power  Limited (’NDPL’ for short), BSES Yamuna Power Limited  (’BYPL’ for short) and BSES Rajdhani Power Limited (’BRPL’  for short).  On 15.2.2001 GoNCTD issued the Request for  Qualification document (’RFQ’ for short) to the prospective

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bidders.  It indicated the period of transition and stated  that tariff principles were being worked out by DERC so  that the investors could plan their investments.  That,  transition period was to be of 5 years.  A tariff order would  be made available to the bidders before the last date of  submission of their Statement of Qualifications.  Under  RFQ document a chapter titled "Investment Highlights" was  incorporated (see: Chapter 5).  Under para 5.9 of the RFQ  document, DVB referred to Tariff Setting Principles for  2002-03, 2003-2004, 2004-05 and 2005-06.  In the said  para it is further 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 submission of Statement of  Qualification (’SOQ’ for short) so that the bidders would  have a clear idea of the tariff level for the next five years.   This was, in order to enable the bidders to prepare an  appropriate business strategy [See: para 3.3.6.2].  In para  9.7 of the RFQ document, the Tariff Setting Principles were  set out.  Vide para 9.7, the Tariff Principles were  summarized in the form of a formula which referred to tariff  in any year as equal to tariff in the financial year 2001-02  plus sum total of all expenses such as power purchase  cost, salary, O&M, administration and general expenses,  interest on debt, return on equity minus increase in  revenue due to reduction in T&D losses divided by  estimated units sold in a year.  Vide para 9.7, it was  clarified that under the formula, the tariffs stipulated by  DERC for the financial year 2001-02 was to get adjusted in  the financial years 2002-03, 2003-04, 2004-2005 and  2005-06.  Vide para 9.7, it was further stated that the  above Tariff Setting Principles have been proposed to  provide certainty to the tariff determination process.  Under  para 9.7.2 of the RFQ document, it was further stipulated  that the order of DERC on the tariff proposal of DVB for the  financial year 2001-02 shall be made available by 2.4.01 so  that the pre-qualified bidders could submit their financial  bids for the proposed DISCOMs.

       On 23.5.01, DERC issued its Retail Supply Tariff  Order on the Annual Revenue Requirement (’ARR’ for short)  for the financial year 2001-02 and the Tariff Determination  Principles for the financial years 2002-2003 till 2005-06.   This Tariff Order computed the ARR of DVB for the ensuing  year 2001-02.  As can be seen from the Tariff Order, DVB  had computed the ARR for financial year 2001-02 at  Rs.5514 crores.  DVB suggested to DERC for framing Tariff

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Setting Principles in order to develop a long-term business  strategy so that tariff levels could be indicated for the next  five years [See: para 1.6.6].  Under the said order, DERC  computed the depreciation expenditure for DVB in relation  to distribution of asset(s) at 6.83%.  Before DERC, DVB had  submitted Annual Accounts for the financial year 1998-99  based on Weighted Average Depreciation Rate (’WADR’ for  short) which was proposed at 6.83% based on the said  Notifications issued by MOP.  On these projections, DERC  held vide Tariff Order dated 23.5.01, 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  years.  It also referred to the Tariff Principles framed by  DERC in order to enable the bidders to develop their  business plans and in order to enable the bidders to make  their bids.

       On 22.11.01, GoNCTD after considering the views  expressed by DERC issued Policy Directions under Section  12 of DERA for restructuring of the Electricity Industry and  privatization of Distribution Companies.  In the Policy  Directions, GoNCTD clarified that the Directions have been  issued in public interest to enable restructuring of DVB  and to privatize the business of distribution.  It was further  clarified that the transition period shall be of 5 years (2002  till 2007) to attract private participation in respect of AT&C  loss reduction, tariff structure including return on equity of  16% and 50% additional revenue arising from AT&C loss  reduction with inbuilt incentive to DISCOMs.  Under the  Policy Directions, GoNCTD assured the bidders that a BST  Order shall be issued by DERC to facilitate investors to  have a full idea of various elements in tariff fixation, before  bidding.  Vide para 19 of the Policy Directions, it was  clarified that DERC shall be bound by Policy Directions on  and from 22.11.01 till end of financial year 2006-07.

       Accordingly on 22.2.2002, DERC issued the BST  Order on a Joint Petition filed by GoNCTD owned  Distribution Companies (that is before privatization) and  Delhi Power Supply Company Ltd.  This BST Order, issued  by DERC, approved Bulk Supply Tariff to be charged by  Delhi Power Supply Company Ltd. to the said DISCOMs, on  the basis of the paying capacity of the Distribution  Companies.  The said BST Order issued by DERC also

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approved the Opening Levels of AT&C losses for each  Distribution Company.   It also approved the Tariff  Determination Principles for the period of 5 years (2002 to  2007).  As stated above, this BST Order was issued before  bidding giving certainty to the bidders regarding Tariff  Entitlement for the transition period.  Based on this order,  the bidders were expected to bid.  They were expected to  bid on the basis of annual reduction of AT&C losses over a  5 year period.

       Accordingly, M/s. Tata Power Company Limited  submitted its bid for purchase of 51% equity in the North  North-West Delhi Distribution Company Limited on the  basis of reduction of AT&C losses which they were to  achieve yearwise over a 5 year period (transition period).   This was in April/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 26.6.03 DERC reduced the rate  of depreciation from 6.69% to 3.75%.

On 25.7.03 North Delhi Power Ltd. (’NDPL’ for short), a  joint venture of M/s. Tata Power Company Ltd., filed a  Review Petition before DERC which was dismissed on  25.11.03.  The Review Petition was made by NDPL seeking  to challenge the reduction in the rate of depreciation.  While  rejecting the Review Petition it was held by DERC that  depreciation is a charge to the Profit and Loss Account and  it represents a measure of loss in value of an asset arising  from use, efflux of time and market changes.  It was further  held that from a regulatory perspective, depreciation is a  small amount of the original cost of the capital asset(s),  built into the tariff computation every year with a view to  provide the Utility a source of funding to repay instalments  of debt capital.  It was further held that since the asset is  used over its operational life, depreciation is a percentage  charged over the fair life of the asset(s).  It was further held  that in the BST Order dated 22.2.2002 the rate of  depreciation was based on WADR since the details of the  asset(s) at the beginning of the financial year 2001-02 were

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not available and, therefore, at that time DERC had taken  the view that instead of rejecting the computation of ARR,  submitted by DVB, it was better to give directions to DVB to  update their data so that in future it could file proper  computation concerning ARR.  It was further held that the  erstwhile DVB was required to file ARR by 31.12.01 for the  financial year 2002-03 which they failed to do so and  instead the three Distribution Companies filed a Joint  Petition for determination of the Opening Levels of AT&C  losses and also for determination of BST in order to enable  the privatization process to be proceeded further in  accordance with the Policy Directions issued by GoNCTD,  that accordingly on 22.2.02 DERC had issued a BST Order  on the Opening Levels of AT&C losses and the BST  applicable to the DISCOMs and, therefore, according to  DERC, there was no change in the principles of tariff  fixation as regards treatment of expenses and revenue.   According to DERC, the basic principles underlying the  approval of various items in ARR remained unchanged  across the first Retail Supply Tariff Order (’RST Order’ for  short) dated 23.5.01 applicable for the financial year 2001- 2002 and the BST Order 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 further held that the decision taken  by DERC was in public interest since the higher rate of  depreciation of 6.69% would cast a heavy burden on the  consumers.  It was further held that the depreciation  expenditure at the rate of 3.75% allowed by DERC was in  accordance with the statutory provisions of DERA, the  Policy Directions of the GoNCTD and the Regulatory  Practices.  It was further held that it was the duty of DERC  to allow adequate and prudent expenses which fall within  the regulation on annual basis.  Accordingly, the Review  Petition of NDPL came to be dismissed as per the order of  DERC on 25.11.03.

Thereafter on 19.12.03 NDPL filed its petition for  determination of ARR for financial year 2004-05 and for  determination of Retail Supply Tariff in terms of Section 28  of DERA.  Vide Tariff Order dated 9.6.04 DERC denied to  NDPL the assured return on equity at 16% as well as  depreciation expenditure at the rate of 6.69%.

Vide Review Petition dated 8.7.04, NDPL requested  DERC to revise its Tariff Order dated 9.6.04.

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On 23.7.04 NDPL preferred Writ Petition No.15175 of  2004 before this Court.  That petition was disposed of on  9.8.05 upon constitution of Appellate Tribunal for  Electricity (’ATE’ for short).

The above Review Petition dated 8.7.04 was dismissed  by DERC on 29.10.04.

Aggrieved by the above decision of DERC, NDPL  preferred Writ Petition No.140 of 2005 in the Delhi High  Court challenging the legality and validity of the impugned  Tariff Order dated 9.6.04 in respect of creation of  Regulatory Asset(s) whereby 53% of the operating expenses  of NDPL was deferred without providing a schedule of  recovery/amortization.  However, in the meantime in view of  the constitution of the ATE, NDPL filed its statutory appeal  before the Tribunal (that is ATE).  ATE allowed the appeal of  NDPL on the question of depreciation vide Order dated  24.5.06 which has been challenged by DERC in this civil  appeal.  By the said order dated 24.5.06 ATE held that  DERC has not given any reasons for deviating from the  Principles mentioned in Schedule VI to the said 1948 Act.   By the said order, ATE further held that DISCOMs were  entitled to 16% ROE, which is accepted as final by DERC.

As stated above, aggrieved by the decision of ATE  dated 24.5.06, DERC filed the present Civil Appeal No.2733  of 2006 before this Court limited to the question of  depreciation.

On 21.7.06 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 Tribunal shall decide the matter after taking  into consideration all contentions raised or to be raised by  the parties. However, we make it clear that we have not  expressed any opinion on the merits of the case. The  exercise to be undertaken by the Appellate Tribunal shall  be only on the question of depreciation.

       It is clarified that order dated 13th June, 2006, we  had permitted the process of determination to be  continued by the appellant as directed by the Appellate  Tribunal (by mistake recorded as High Court). The final

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decision may be taken, but the same shall be open to  challenge by the affected parties. This matter shall be  placed for further hearing after a period of six weeks.

       It is, however, made clear that we have not given  any interim protection for any period other than the  period to which the present appeal relates to.

The determination made by the Appellate  Authority shall be indicated to the parties."

As per direction of this Court dated 23.8.06, ATE  recorded it findings on the rate of depreciation vide its order  dated 29.9.06 (hereinafter referred to "the impugned order").   By the impugned order, it was held that depreciation is not  a source of fund, it is a process of Allocation of Cost and  that funds are generated by sales and not by depreciation,  which is an expenditure incurred in terms of Schedule VI.   At the same time, ATE observed in its impugned order that  in certain cases companies did follow Depreciation Fund  Method for replacement of asset(s).  According to ATE,  Section 28 (3) of DERA was an enabling provision which  empowered DERC to depart from the factors specified in  Schedule VI while determining the revenues subject to  DERC recording reasons thereof; that in respect of  depreciation DERC has suggested deviation but there was  total non-application of mind on the part of DERC since the  reasons given by DERC for fixing the rate of depreciation at  3.75% were legally not sustainable.  According to ATE,  depreciation is a process of cost allocation.  It is not a  process of valuation.  It is not a cash-flow.  It is not a  source of funds.  Therefore, DERC, according to ATE, was  wrong in assuming that depreciation was built into the tariff  as a source of fund to repay the debt capital.  As stated  above, DERC had taken the view that since NDPL had not  borrowed any loan during the relevant financial years, there  was no liability on NDPL 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 into tariff  computation to provide source of funding to repay debt  capital, loan repayment and to meet working capital  requirement.  By the impugned order, ATE further held that  DERC had proceeded on an erroneous reasoning, namely,  that the average fair life of lines and cables in the  distribution system was 25 years and, therefore, the

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average depreciation worked out to 3.75%.  By the  impugned order, ATE came to the conclusion that the above  reasoning of DERC was erroneous since DERC had misread  the MOP Notification of 1992, referred to above, which  categorically stated that the straight-line method was not  for derivation of rates from the fair life of the asset(s).   Therefore, according to ATE, it was not open to DERC to  derive the rate of depreciation at the rate of 3.75% from the  fair life of the equipment as is sought to be done by DERC.   According to ATE, the MOP Notification dated 29.3.94 had  allowed depreciation at the rates mentioned therein on a  straight-line method as an authorized expenditure which  had no linkage with the fair life of the asset(s).  According to  ATE, NDPL was entitled to depreciation in terms of MOP  notification dated 29.3.94, Policy Directions dated 22.11.01  and BST Order dated 22.2.02 and, therefore, there was no  reason to reduce the rate of depreciation from 6.69%  claimed by the DISCOMs herein as an allowable  expenditure in terms of Schedule VI of the said 1948 Act.   The said Policy Directions issued by GoNCTD under Section  12 of DERA to DERC, according to ATE, were binding on the  DISCOMs which DERC failed to notice.  According to the  impugned order, DERC had accepted the WADR proposed  for Generation Company in terms of MOP Notification dated  29.3.94.  This rate was approved by DERC when DVB was  in picture.  Therefore, there was no reason to reduce the  rate of depreciation for DISCOMs herein on privatization.   According to ATE, DERC on 22.2.2002 had issued BST  Order which covered Tariff Elements, namely, depreciation,  taxes and return on equity.  The investors submitted their  bids on the basis of representations contained in the Policy  Directions dated 22.11.01, BST Order dated 22.2.02 and  the tariff structure mentioned in MOP Notification dated  29.3.94.  Therefore, according to ATE, the method adopted  by DERC to calculate depreciation on the basis of the fair  life was contrary to the above-mentioned BST Order and  Policy Directions as well 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 of depreciation so that the Utility  can meet Higher Capital Expenditure and Higher  Operational Expenditure requirements.  Thus, by the  impugned order dated 29.9.06 ATE confirmed and  reiterated in detail its earlier order (dated 24.5.06) in favour  of the DISCOMs herein holding that the rate of depreciation  fixed by DERC at 3.75% was erroneous and that the denial  of depreciation to the Utility at 6.69% was not sustainable

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either in law or in facts.  Accordingly, the appeal filed by the  DISCOMs herein stood allowed by ATE.  Hence this civil  appeal by DERC.

Mr. S.K. Dholakia, learned senior counsel appearing  for DERC, submitted that under Section 28 of DERA, DERC  had to fix tariff taking into account the interests of the  DISCOMs and the consumers.  Under Section 28, according  to learned counsel, DERC is required to follow the Principles  of Schedule VI of the said 1948 Act but it also has the  power to deviate from the said Principles for reasons to be  recorded by DERC.  In this connection, it was pointed out  that in exercise of the powers under Section 28, DERC had  fixed the rate of depreciation at 3.75% having regard to the  fair life of the assets.  According to learned counsel, DERC  was right in rejecting the claim of 6.69% on the ground that  the said rate could be considered only if there was a debt  redemption involved.  Learned counsel further submitted  that GoNCTD had never promised 6.69% as rate of  depreciation in the RFQ, RFP or in the Policy Directions.  In  this connection, it was urged that allowing higher  depreciation at the rate of 6.69% would increase the tariff  level imposing a burden of almost Rs.300 crores on the  consumers for the financial years 2002-03, 2003-04 and  2004-05.  Learned Counsel further submitted that the  reliance placed by DISCOMs on MOP Notifications of 1992  and 1994 were totally misplaced.  They were issued under  the said 1948 Act which stood repealed by DERA to the  extent of inconsistency and that Section 28 of DERA  empowered DERC to deviate from the principles mentioned  in Schedule VI to the said 1948 Act.  Moreover, according to  learned counsel, even under the MOP Notifications there  was a concept of Advance Against Depreciation ("AAD" for  short) provided there existed actual loan liability in a given  year.  Therefore, in the present case, according to learned  counsel, DERC was right in rejecting the claim of 6.69% on  the ground that such 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 return of 16% on equity and  certain incentive on the Utility attaining overachievement  beyond the level specified in the Policy Directions in respect  of AT&C losses.  No other promise was made by GoNCTD.   It was urged that depreciation is a non-cash expense,  therefore, DERC could permit only reasonable depreciation

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which in the present case was 3.75%.  It was urged that in  the above Policy Directions dated 22.11.01 there was no  promise that the rate of depreciation will remain constant  for all five years.  As regards the BST Order dated 22.2.02  on which reliance has been placed by DISCOMs herein,  learned counsel submitted that the said BST Order was  valid only for two months of February and March 2002 and,  therefore, there was no promise under the said BST Order  regarding fixation of the rate of depreciation for 5 years.  It  was further pointed out that in the said BST Order dated  22.2.02 there were certain variables which included items of  expenditure which varied from year to year, one such item  was depreciation.  Accordingly, the Chart on Expenses  allowed by DERC for NDPL show different amounts (in  crores) allowed as depreciation expenses in the financial  years 2001-02 (two months), 2002-03 (9 months), 2003-04  and 2004-05.  This Chart, according to learned counsel,  shows that it was open to DERC to allow depreciation as an  item of expense on annual basis.

At this stage, it may pointed out that in the course of  hearing before us, learned counsel for NDPL submitted a  Chart suggesting that the denial of depreciation at 6.69%  resulted in reduction of rate of return on equity.  In this  connection, learned counsel pointed out that the Chart  submitted by NDPL was erroneous.  He pointed out that the  disallowed depreciation mentioned in the Chart was  reduced from the total allowed ROE for the financial year  2004-05.  He pointed out that in respect of the financial  year 2004-05, DERC had calculated 16% ROE and  accordingly had allowed Rs.61.69 crores as 16% ROE.   However, in addition to the said sum of Rs.61.69 crores,  DERC had also granted to NDPL a sum of Rs.45.62 crores  as depreciation.  The total sum was, therefore, Rs.117.31  crores and, therefore, NDPL was wrong in saying that its  return on equity got adversely affected on account of lower  rate of depreciation.

On the concept of depreciation, learned counsel urged,  relying on certain textbooks, that depreciation is ordinarily  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 offered to the  DISCOMs herein assured 16% return on equity.   Accordingly, DISCOMs were required to reduce the AT&C  losses.  Higher the recovery from consumers meant higher  revenue to the DISCOMs and lower the tariff.  Learned

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Counsel submitted that the DISCOMs herein were fully  aware of the above aspects when they came into business  with an obligation to reduce the said losses to assured  levels as per Policy Directions and, therefore, the rate of  depreciation had no relevance to AT&C losses and to 16%  ROE.  Learned counsel submitted that it was never the case  of DISCOMs that the rate of depreciation had any  connection with AT&C losses.  According to learned  counsel, DERC had exercised its power under the statute in  going for a departure from Schedule VI to the said 1948 Act.   Therefore, according to DERC, DISCOMs herein were  entitled to depreciation in the above years derived from the  fair life of the assets since during the said years there was  no debt redemption involved.

Mr. Harish N. Salve, learned senior counsel appearing  on behalf of NDPL, submitted that under Section 28(2) & (3)  of DERA, DERC was required to adhere to the financial  principles and their obligations provided in Schedule VI to  the said 1948 Act and if DERC wants to depart from those  principles it has to record reasons in writing.  Learned  counsel submitted that the said reasons to depart and the  flexibility of DERC to depart are both subject to provisions  of DERA including Section 12(3) read with statutory Policy  Directions dated 22.11.01 as reaffirmed by Parliament in  Section 185(2)(e) of the Electricity Act, 2003.  In this  connection, our attention was also invited to para XVII of  the Sixth Schedule to the said 1948 Act which gives the  definition of the word "clear profit".  The definition shows  that clear profit has to be arrived at after deducting the  outgoings.  The word "clear profit" is defined in sub-para  (2)(b) of para XVII to mean the difference between the  amount of income and expenditure.  The word "expenditure"  in sub-para (2) of para XVII refers to depreciation,  computed as hereinbefore set out [See: clause (x)].  Our  attention was also invited to para VI of the Sixth Schedule  which, inter alia, states that the licensee shall provide each  year for depreciation such sum calculated in accordance  with the principles as the Central Government may, after  consulting the Authority, by notification 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 depreciation as per the above

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MOP Notification and it was not open to DERC to  recalculate the rates on the basis of the fair life of the  assets.  Therefore, it was urged on behalf of NDPL that  when they made a bid for buying 51% equity after  unbundling in April/May 2002, it was on the basis of the  representations held out to the investors as contained in  MOP Notification dated 23.1.92, BST Order dated 22.2.02  and the Policy Directions dated 22.11.01.

Mr. Salve, learned counsel for NDPL, next submitted  that the only reason given by DERC to depart from the  Sixth Schedule was that the fair life of the assets was 25  years and since NDPL was not required to redeem the debt  as it had not borrowed during the aforestated years DERC  was entitled to derive the rate of depreciation at 3.75%  having regard to the fair life of the asset(s) (25 years).   According to learned counsel, the above reasoning of DERC  was contrary not only to the representations made to the  investors but it was also contrary to the Note appended to  MOP Notification dated 23.1.92 which stated that the rate of  depreciation shall not be derived from the fair life of the  asset.  Therefore, according to the learned counsel, DERC  had departed from the Sixth Schedule which was untenable  and per se illegal.

In the alternative, Mr. Salve submitted that even if  DERC was entitled to depart from MOP Notification dated  23.1.92 and BST Order dated 22.2.02, the impugned order  of DERC cannot constitute a good order under Section 28(3)  of DERA as it results in total dismembering of the total 5  year transition mechanism, it renders 16% ROE illusory  and it extends the replacement period for assets from 13.45  years to almost 24 years.  Learned counsel submitted that  the limited issue in the present case is: whether DERC is  empowered to flout para 17 of the Policy Directions dated   22.11.01 read with para 3.6.2 of the BST Order dated  22.2.02 by changing the depreciation rate from 6.69% to  3.75% without any justifiable reason after having induced  private investment on that premise.  Section 12, according  to learned counsel, makes Policy Directions binding upon  DERC.  The Transfer Scheme had indicated policy for  privatization under Section 14 to 16 of DERA.  The said  Scheme recognized the need for the Government to draw up  the scheme for privatization.  Therefore, in tariff fixation  DERC was required to comply with the Policy 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

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computed.  It was contended on behalf of NDPL that ROE  and the rate of depreciation were significant features of the  scheme and if the rate of depreciation is reduced from  6.69% to 3.75% then the entire package/privatization  process would fail.  In this connection, it is pointed out that  under the order of the DERC the net return equal to 16% on  ROE in the ARR cannot be computed by reducing the  allowable expenses since that would render the return of  16% nugatory.  It is pointed out, in this connection, that the  net returns available to the ARR under the orders of DERC  was Rs.61 crores approximately (equal to 16% of ARR); that  the amount of depreciation allowed has been reduced by  60% and if the net return is calculated on the principles  applicable to the BST Tariff then the said return would  stand reduced to less than 0.5%.  Therefore, even assuming  for the sake of argument that DERC was entitled to deviate  from the Sixth Schedule, the impugned exercise undertaken  by DERC leads to unjustifiable reasons.  Learned counsel  submitted that DERC was wrong in holding that  determination of the principles for tariff entitlements for  next 5 years was not the key factor in the privatization  process.

Learned counsel for NDPL next contended that the  reasons given by DERC for departing from the Sixth  Schedule was specious, untenable and erroneous.  In this  connection, it was urged that depreciation is not a "source  of funds".  The source is always the "sale price" of goods.   Depreciation is a non-cash charge.  It reduces the  distributable profit without reducing the cash profit.  The  difference between the distributable profit and cash profit is  a sum which the company has to retain.  Depreciation in a  sense is a source of funds for future investments.  However,  it is not a "sources of funds" for the current year.  The Sixth  Schedule makes it clear that depreciation is an expenditure  properly incurred.  Learned counsel for NDPL pointed out  that DERC had erroneously assumed that the rate of 6.69%  was some sort of higher depreciation.  It is further pointed  out that the figure of 25 years is taken by DERC from the  MOP Notification which itself clarifies that the said figure is  not to be taken into account for determining the rate of  depreciation.  It is submitted that DERC cannot assume the  power to alter the depreciation rate as per financial needs of  the Utility of the DISCOMs.  It is submitted that if the  argument 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)

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contemplated different rates of depreciation having no  linkage with the fair life of the asset because MOP wanted  faster replacement of the assets.  It is submitted that DERC  has failed to appreciate this aspect.  It is submitted that by  increasing the period of replacement DERC has taken a  retrograde step.  It has acted contrary to Section 12 of  DERA.  In the circumstances, learned counsel submitted  that we should not interfere with the impugned order of  ATE dated 29.9.06 by which ATE has held that the rate of  depreciation cannot be reduced from 6.69% to 3.75%. Mr. S. Ganesh, learned senior counsel appearing on  behalf of BYPL and BRPL, submitted that during the  transition period, 2002-07, the tariffs of the aforestated to  DISCOMs had to be fixed strictly in conformity with the BST  Order dated 22.2.02.  According to learned counsel, the said  order dated 22.2.02 had laid down Normative Principles for  tariff fixation.  It was submitted that the said BST Order  followed the MOP Notifications dated 23.1.92 and 29.3.94  by which WADR of 6.69% was admissible.  During the said  transition period it was not permissible for DERC to depart  or deviate on any ground from the above MOP Notifications  concerning rate of depreciation.  In the alternative, learned  counsel submitted that in the present case the rate has  been reduced only on the basis of the estimated useful life  of the assets which in law cannot be considered to a good or  cogent ground or reason for departing from the MOP rates,  particularly, when the said ground or reason is expressly  prohibited by the MOP Notification of 1992 which lays down  that the rates shall not be recomputed on the basis of the  fair life of the assets.  It was submitted that such a  departure from the MOP rates violated Section 28 of DERA  read with Section 185 of the Electricity Act, 2003.

Relying on the doctrine of legitimate expectation,  learned counsel submitted that Policy Directions were  issued by GoNCTD (Delhi Government) for facilitating the  privatization of the electricity distribution undertakings in  Delhi.  The Policy Directions were issued with the object of  inducing investors to bid for taking over the distribution  entities.  The bidders were invited to submit their bids on  the basis of tariff mentioned in the BST Order dated  22.2.02.  In this connection, our attention was invited by  learned counsel to the RFQ document dated 15.2.01.  This  document gave the entire programme.  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 Assets.  This order

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of ATE has been accepted by DERC.  It was held by ATE  that the Policy Directions dated 22.11.01 were binding on  DERC.  In that matter the issue which arose for  determination was: whether it was lawful for DERC to direct  the DISCOMs herein to create a Regulatory Asset by  capitalizing some of its revenue expenditure and by carrying  the same forward so that the expenditure would not be  covered by the tariff admissible to the DISCOMs during the  tariff period.  It was held by ATE that the Policy Directions  were binding and that the order passed by DERC was  contrary to such directions and, therefore, the impugned  order passed by DERC was illegal and bad in law.  This  order of ATE, concerning the statutory binding effect of the  Policy Directions, has been accepted by DERC.  It has not  been challenged.  It has become final.  Learned counsel,  therefore, submitted that it was not open to DERC to raise  any contrary or inconsistent regarding the binding effect of  Policy Directions.  Moreover, it was pointed out that even in  the past DERC has followed the MOP Notification in its  Tariff Order dated 23.5.01 for financial year 2000-01.  This  was even without FAR register.  Learned counsel pointed  out that the MOP Notification was also followed by DERC in  the BST Order dated 22.2.02.  In the said BST Order, there  was no reference made for the depreciation rate to be  computed on the basis of useful life of the assets, as has  been done in the impugned order of DERC in the present  case.  Therefore, according to learned counsel, the  departure from the BST Order was unjustifiable as  Normative Principles set out in the BST Order had to be  followed till 31.3.07, in terms of the Policy Directions dated  22.11.01.  Learned counsel submitted that the BST Order  and the Policy Directions were intended to be relied upon by  the investors for determining varies elements of the tariff so  that they could assess their financial position before filing  their bids.  Learned counsel urged that if the impugned  order of DERC was allowed to stand then the very object of  having a BST Order for 5 years and inviting investors to buy  51% equity on that basis would stand completely frustrated.   Hence, the said representations held out to the investors  binds the DERC for the transition period and it does not  allow DERC to deviate from the representations made by  GoNCTD on any ground including principles 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 out

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in the BST order would result in obliteration of the entire  basis of privatization.  It was submitted that the DISCOMs  herein were obliged to reduce AT&C losses by 17% over a  period of 5 years and in lieu of this promise they were  entitled to retain 50% of the additional revenue resulting  from such better performance on part of the respondent  DISCOMs.  This was also a part of Policy Directions.  In the  circumstances, it is not open to DERC to deviate from the  Principles mentioned in the BST Order.

Learned counsel for the respondent DISCOMs lastly  submitted that for allowing revenue requirement, DERC was  duty-bound to follow the guiding Principles laid down in the  Sixth Schedule to the said 1948 Act which provides for  depreciation each year vide Section VI(a) of the Sixth  Schedule.  Such sum is required to be calculated in  accordance with the principles set out in the MOP  Notifications.  The schedule given for calculation of the  rates of depreciation refers to the assets existing in the  books of accounts and the amount of depreciation is  determined as a percentage of such value.  This procedure  is followed by most of the State Electricity Regulatory  Commissions in India.  Therefore, according to learned  counsel, it was not open to DERC to deviate from the MOP  Notifications and the Principles mentioned therein.                              

For the following reasons, there is no merit in this civil  appeal.  Firstly, accounting for costs differs according to the  object and the purpose for which the exercise is  undertaken.  Depreciation is Allocation of Costs so as to  charge a fair proportion of the depreciable amount in each  accounting period during the expected useful life of the  asset(s).  Depreciation includes amortization of assets  whose useful life is pre-determined.  It includes depletion of  resources through the process of use.  Depreciation in  Commercial Accounting differs from depreciation in Tax  Accounting.  In this case, we are concerned with Electricity  Accounting.  An asset is recognized in the Balance Sheet  when one expects economic benefits associated with it to  flow in future over a period of years.  Accordingly, the asset  has a cost or value that can be measured.  Matching of  revenue and expenses is an important exercise under  Accounting.  Depreciation is a part of this exercise.  The  Allocated Cost of a given year has to match with the  expected revenue for that year.  The concept 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,

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depreciation enables the Utility to work out the charges to  be recovered from consumers for supply of electricity, one  has to follow the provisions of the schedule to the said  Electricity Act and that one has not to follow the provisions  of Income-tax Act while calculating depreciation as one of  the items of expense under the Electricity Accounting.   Since, the charge is recoverable from the consumers,  depreciation is a source of funding not for the current year  but for replacement cost.  According to "The Principles of  Auditing" by F.R.M. de Paula, in the past the accepted  principle behind providing for depreciation was to recover  the original capital invested in the purchase of the assets.   Revenue is required to be held back by means of  depreciation charged to profit and loss account to recover  the original capital invested in the purchase of the assets.   Revenue is required to be held back in order to keep the  original capital intact.  However, that model of Original Cost  had to be replaced by the concept of Replacement Cost in  recent years owing to the increase in the level of prices due  to inflation.  Thus, the concept of Historical Cost to a large  extent is replaced by the concept of Replacement Cost.  In  the past, according to De Paula, accounts were prepared  upon the basis of Historical Cost but on account of inflation  in an economy like ours which is cost push economy, the  concept of Historical Cost as basis of accounting is replaced  by the concept of the Cost of Replacement of fixed assets.   The above analysis by De Paula has been accepted by this  Court in its judgment in the case of Associated Cement  Companies Ltd., Dwarka Cement Works, Dwarka  v.  Its  Workmen and another \026 AIR 1959 SC 967.  We quote  hereinbelow paras 28 and 34 of the said judgment: "28. Besides, it is said, that the theory that the  trading profits of the industry must provide for the whole  of the rehabilitation expenses is not universally accepted  by enlightened and progressive businessmen and  economists. In this connection reliance is placed on the  observations of F. R. M. de Paula in his "Principles of  Auditing" that  

"the object of depreciation is the replacement of  original investment capital and that an increase in  replacement cost is an important matter and means that  additional capital is required in order to maintain the  original earning capacity".  

It is also pointed out that the Institute of Chartered  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

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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 purchase of these assets,  therefore, when their working life comes to an end, the  earning capacity of these assets ceases. Thus they will  become valueless for the purposes of the business, and  the original capital sunk in their acquisition, less any  scrap value, will have been lost. Hence, in order to keep  the original capital of a business intact, if any part thereof  is invested in the purchase of wasting assets, revenue  must be held back by means of depreciation charges to  profit and loss account, in order to replace the capital that  is being lost by reason of the fact that it is represented by  assets that are being consumed or exhausted in the course  of trading or seeking to earn income" (F. R. M. de Paula’s  Principles of Auditing’, 1957, p. 136).  It is also stated by the same author that "in all cases where one of the direct causes of  earning revenue is gradually to consume fixed assets of  wasting nature, the depreciation of such assets should be  provided for out of revenue" (Ibid, p. 138).  It is true that the author recognises that "owing to the very considerable increase in the  price level since the termination of the 1939-45 war,  industry is finding its original money capital insufficient  for its needs. Thus the cost of replacement of fixed assets  has greatly increased and in addition, further working  capital is required to finance a given volume of  production. Many economists, industrialists, and  accountants contend that provision should be made, in  arriving at profits, for this increased capital requirement". Having noticed this view the author adds that "at  the time of writing this matter is still being debated and  final decisions have not yet been reached", and he  concludes that "until a final solution of this complex  problem is reached it would be inadvisable for the auditor  to act on any principle other than that recommended by  the Institute" ((F. R. M. de Paula’s Principles of  Auditing’, 1957, p. 80); and that principle appears to be  that depreciation should be provided for out of revenue.  Besides, it must be borne in mind that, in adjusting the  claims of industry and labour to share in the profits on a  notional basis, it would be difficult to repel the claim of  the industry that a provision should be made for the  rehabilitation of its plant and machinery from the trading  profits. On principle the guaranteed continuance of the  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%.  

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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  the asset(s).  The reason is obvious.  Before  disinvestment/privatization, the Utility was under the  Government.  At that stage itself the Government had  decided to substitute the Historical Cost Method by  Replacement Cost Method.  Depreciation is a source of  funding.  On account of inflation replacement cost increases  rapidly.  The object underlying the MOP Notifications which  provided for higher rate of depreciation appears to be two- fold \026 firstly, to reduce the Asset Replacement Period (’ARP’  for short) and secondly, to fund the rapid increase in the  replacement cost.  The MOP Notifications proceeded on the  basis that the Utilities were making losses, expenses on  replacement was heavy and that the assets needed  replacement in the shorter ARP.  It is for this reason that in  the MOP Notifications higher rate of depreciation stood  prescribed without nexus to the fair life of the asset(s).  This  Principle under the above MOP Notifications got reflected in  the subsequent BST Order which also, inter alia, prescribed  the principles for tariff determination for 5 years.  The above  principles also got reflected in the Policy Directions issued  by GoNCTD under Section 12 of DERA.  It is for this reason  that in the RFQ document the timetable shows that the  bidders were required to take note of the Tariff Structure  before making bids.  The investors were put to notice  regarding the Tariff Structure which existed before  privatization.  We are living in the complex and ever- expanding exigencies of Government.  In the matter of grant  of benefit of depreciation, the extent of the benefit lies in the  economic wisdom of the Government.  That wisdom  constituted the basis of the MOP Notifications which  emphasized Asset Replacement Period to be reduced by  prescribing higher rate of depreciation because the  Government intended replacement to take place not after 25  years but at the end of 13 to 15 years.  The order of DERC  dated 26.6.03 runs counter to the above reasoning behind  the MOP Notifications as reflected in the BST Order dated  22.2.02 and in the Policy Directions of GoNCTD dated  22.11.01.

Secondly, we may refer to the provisions of DERA.  The  said Act was enacted, inter alia, to restructure the  Electricity Industry by increasing the participation of  private sector in the Electricity Industry.  Today public- private participation is a key element to develop  infrastructure in 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

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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 mentioned in the proviso.  The  second parameter prescribed in the proviso states that in  fixing of revenues and tariffs, DERC shall keep in mind  economic use of resources, good performance, optimum  investment and other matters.  This was the second  parameter.  The third parameter mentioned in the proviso  states that the DERC shall keep in mind the interest of the  consumer.  Under Section 28(3), DERC is entitled to depart  from the factors mentioned in the Sixth Schedule to the  1948 Act while determining the licensee’s revenues and  tariffs.  However, DERC was required to record reasons for  such departure.  In the present case, we are of the view that  DERC was certainly entitled to take a departure from the  principles set out in the Sixth Schedule to the said 1948  Act.  However, that departure, in the facts and  circumstances of the case, had to be within the framework  of the Policy Directions issued by GoNCTD under Section  12.  Further, in any event, the departure from the principles  under the 1948 Act was required to be based on proper  reasoning.  In the present case, DERC was required to  consider the effect of its decision.  Privatisation and  disinvestment were the Policy decisions taken by GoNCTD.   The Utilities were incurring losses.  The assets of the  Utilities were getting depleted.  The public-private  participation is the order of the day.  Therefore, the Policy  Directions invited bids from the private sector on the basis  of certain assurances.  Under the above circumstances, on  the facts of the present case, Legitimate Expectation was  built into the investments made by the DISCOMs herein.   The representations were there in the Policy Directions, BST  Order laying down Normative Principles for tariff fixation for  5 years and the Transfer Scheme.  Drawing up of tariff for 5  years was to impart certainty.  As stated above, the tariff for  the financial year 2001-2002 was to be adjusted in the next  4 years, namely, financial years 2002-03, 2003-04, 2004-05  and 2005-06.  It is for this reason that even the RFQ  document indicated Tariff Principles in the case of NDPL for  the financial years 2002-03 and 2005-06.  Even the Tariff  Order dated 23.5.01 was based on the higher rate of  depreciation without taking into account the fair life of the  asset.  In short, a package was offered to the prospective  investors.  The effect of the order of DERC dated 26.6.03 is  to extend the ARP by 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

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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 the policy of privatization.  The object  behind fixation of principles for 5 years was to impart  certainty and consistency in tariff designing, putting the  prospective investors to notice regarding their tariff  entitlements for 5 years and to provide Level Playing Field to  the DISCOMs to compete with other competitors in the  Electricity Industry.  As stated above, DERC had to give  good reasons for departing from the principles in the Sixth  Schedule to the said 1948 Act.  In the present case, it has  been held by DERC that since the DISCOMs herein were  not obliged to redeem debt (as they had not undertaken any  loans), they were not entitled to the higher rate of  depreciation.  This assumption of DERC is wrong.  There is  a difference between the concept of Depreciation and the  concept of Advance Against Depreciation (AAD).  In the case  of AAD, loan repayment may be one of the relevant factors.   In the present case, as stated above, we are concerned with  the reduction of authorized expenditure from 6.69% to  3.75%.  In the present case, we are concerned with the  reduction in the rate of depreciation from 6.69% to 3.75%.   Therefore, in the case of reduction of authorized  expenditure (depreciation) repayment of loan is not the  relevant factor.  One more points needs to be clarified.   Conceptually, it is always possible to derive the rate of  depreciation from the fair life of an asset.  However, as  stated above, it will depend on the object for which a fund  or a reserve is sought to be created.  We have already  indicated that in the privatization process, there is a  transition from "no profit organization" to "profit-based  organization". The principles of Accounting will differ in the  case of non-profit organization vis-‘-vis private profit-based  organization.  That transition is of 5 years in the present  case.  The Historical Cost Method in a growing economy on  account of price increases (inflation) may not be appropriate  in the case of public-profit enterprises.  It will depend on  the type of industry with which one is concerned.   Electricity is a Capital Intensive Industry. It needs  replacement at a quicker rate in terms of time-period as  compared to a manufacturing industry.  It is for this reason  that the above Note was appended to MOP Notification  dated 23.1.92.  That Notification prescribed the rates of  authorized expenditure which was more than the rate of  depreciation derived from 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

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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 intensive industry is generally  shorter than its physical life.  Useful life is pre-determined  by contractual limits or by amount of extraction or  consumption dependent on the extent of use and physical  deterioration on account of wear and tear which depends on  operational factors such as the number of shifts, repair and  maintenance policy of the Utility and reduced by  obsolescence arising from technological changes,  improvement in production methods etc.  In the present  case, DERC has not considered the difference between the  physical life of an asset and the useful life of the asset.

For the reasons given hereinabove, we uphold the  order dated 29.9.06 passed by ATE and accordingly this  civil appeal preferred by DERC stands dismissed with no  order as to costs.