Delhi Electricity Regulatory ... vs Bses Yamuna Power Limited & Others

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 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 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 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 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 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.

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.

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 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.

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.

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

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"

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.

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.