Holding

DERC could not lawfully reduce the depreciation rate to 3.75% because the Ministry of Power notifications barred deriving rates from the fair life of assets and the reduction violated the binding Policy Directions and BST Order.

Summary

The case concerned the Delhi Electricity Regulatory Commission’s (DERC) decision to reduce the depreciation rate for the newly privatized distribution companies from 6.69% to 3.75% in its 2003 tariff order. The respondents, the distribution companies including BSES Yamuna Power Ltd., argued that the reduction violated the Ministry of Power notifications, the BST Order, and the Policy Directions which had assured a higher depreciation rate, thereby breaching the doctrine of legitimate expectation and rendering the promised 16% return on equity illusory. DERC contended that under Section 28 of the Delhi Electricity Reforms Act it could depart from Schedule VI of the 1948 Act, and that depreciation should be linked to the fair life of assets and to loan repayment, which was absent. The Supreme Court held that the Ministry of Power notifications expressly prohibited deriving depreciation rates from the fair life of assets, and that DERC’s departure was unlawful as it was not within the framework of the Policy Directions and lacked proper reasoning. Consequently, the Court upheld the Appellate Tribunal’s order allowing the higher depreciation rate and dismissed DERC’s appeal. The judgment was limited to the five‑year transition period and does not create a general rule for all times.

Issues considered

Whether DERC was empowered under Section 28 of the Delhi Electricity Reforms Act to reduce the depreciation rate from 6.69% to 3.75% without recording reasons.
Whether the reduction violated the Ministry of Power notifications and the note that depreciation rates should not be derived from the fair life of assets.
Whether the reduction infringed the doctrine of legitimate expectation created by the Policy Directions, BST Order and Transfer Scheme.
Whether the reduction rendered the assured 16% return on equity illusory and violated the Sixth Schedule to the Electricity (Supply) Act, 1948.
Whether any departure from Schedule VI must be within the framework of the Policy Directions issued under Section 12 of the Delhi Electricity Reforms Act.

Legislation cited

Delhi Electricity Reforms Act, 2000s. 12, s. 28(2), s. 28(3)
Electricity Act, 2003s. 185(2)(e)
Electricity (Supply) Act, 1948s. 57, s. 57A, s. Sixth Schedule

Subjects

depreciationelectricity regulationtariff fixationlegitimate expectationprivatizationasset replacement periodstraight-line methodpolicy directionsDelhi Electricity Reforms ActSchedule VIAppellate Tribunal for Electricity

Judgment

DELHI ELECTRICITY REGULATORY COMMISSION A
v.
BSES YAMUNA POWER LIMITED AND OTHERS

FEBRUARY 15, 2007

[DR.ARIJITPASAYAT AND S.H. KAPADIA,JJ.] B

Electricity (Supply) Act, 1948-Depreciation of assets in Electricity
Industry-Ministry of Power prescribing straight-line method as distinguished
from reducing balance, and rates not to be derived from fair life of asset(s)-
Private companies entering into electricity distribution business based on C
assurances of government in its policy directions and other documents-
Thereafter, Commission set up under Delhi Electricity Reforms Act, 2000
reducing rate of depreciation having regard to fair life of assets on the
ground that private companies who got into business had not undertaken
any loans and were not obliged to redeem debt-Correctness of-Held- D
Object of.Ministry of Power in providing for higher rate of depreciation,
without nexus to fair life of asset(s), was to reduce Asset Replacement Period
(ARP) and fund rapid increase in replacement cost-It was also keeping in
view that prior to their privatisation electricity utilities under government
were making losses, expenses on replacement was heavy and assets needed
replacement in shorter ARP-After privatisation, aforesaid reduction in rate E
was not correct as principles of depreciation method prescribed by Ministry
of Power were reflected in five years tariff, Policy Directions and other
documents of government based on which private companies entered into
business-In these circumstances, legitimate expectation ofprivate companies
to get lawfal and reasonable recovery of expenditure was built into their F
investments and same was infringed as reduction of rate extended ARP by
10.55 years and also made overall actual return illusory-Though the
Commission was entitled to depart from principles set out by Ministry of
Power, it could not go outside framework of Policy Directions and other
documents issued by government under Section I 2 of Act of 2000-Jt was not
a case of Advance Against Depreciation wherein loan repayment was relevant, G
but case of reduction authorized expenditure viz. depreciation. wherein
repayment of loan was irrelevant-However, judgment confined to facts of
case and to transition period of five years.

747 H
)

748 SUPREME COURT REPORTS [2007] 2 S.C.R.

A Depreciation-Nature of, objects of providing, application of different ,__
methods, and difference between physical life and useful life of asset-
Discussed.

Delhi Electricity Reforms Act, 2000 was enacted to restructure the
electricity industry in Delhi, and appellant was a body established under it.
B Thereafter, the Government of National Capital Territory of Delhi (GoNCTD)
decided to unbundle DVB, its undertaking dealing with electricity, privatize
it and vest its assets in successor companies. In order that the investors could
plan their investments, it issued to the prospective bidders a Request for
Qualification (RFQ), and Request for Proposal (RFP) accompanied by Policy
C Directions wherein reference was made to the transition period of five years
and the Tariff Principles framed by appellant. A Transfer Scheme was also
notified setting out rules for transfer and vesting of assets, liabilities and
obligations of DVB. Policy Directions issued by GoNCTD under Section 12
of the Act of2000 assured the bidders that a Bulk Supply Tariff(BST) Order
shall be issued by appellant to facilitate investors to have a full idea of various
D elements in tariff fixation, before bidding. It was also clarified that appellant
shall be bound by Policy Directions on and from 22.t 1.01 till end of financial
year 2006-07. Accordingly appellant issued the BST Order approving Bulk
Supply Tariff to be charged by Delhi Power Supply Company Ltd. to the
distribution companies on the basis of their paying capacity. Based on this
E order, the bidders were expected to bid on the basis of annual reduction of
AT&C losses over a 5 year period. Accordingly, respondents, distribution
companies (DISCOMs), submitted their bids which were accepted by GoNCTD
and majority share-holding and management control of the distribution
companies owned by government was transferred to them.

p Ministry of Power (MOP) had issued a notification dated 31.1.92 stating
that licens1!e had to provide for depreciation as per straight-line method in
respect of asset(s), indicated in column no.I, at the rates indicated in the
columns of Schedule VI to the Electricity (Supply) Act, 1948. A note appended
to the said Notification stated that the reference to the straight-line method
therein was intended to differentiate the same from the concept of reducing
G balance method and not to derive rates from the fair life of the asset(s). In .
continuation of the above Notificaticn, the Schedule was amended on 29.3.94,
wherein there was no linkage between the fair life of an asset and the rate of
depreciation.

Appellant had issued Retail Supply Tariff Order on the Annual Revenue
H
DELHI ELECTRICITY REGULATORY COMMISSION''· BSES YAMUNA POWER LID. 749

Requirement (ARR) for the financial year 2001-02 and the Tariff A
Determination Principles for the financial years 2002-2003 till 2005-06.
Under the said order, appellant computed the depreciation expenditure for DVB
in relation to distribution ofasset(s) at Weighted Average Depreciation Rate
(WADR) 6.83%. On unbundling of DVB, the WADR stood reduced to 6.69%
for the financial year 2001-02. Vide Tariff Order dated 26.6.03 appellant
reduced the rate of depreciation from 6.69% to 3. 75%. B

Against the above reduction of depreciation, respondent filed a review
petition before appellant. While rejecting it appellant held that (i) as the asset
is used over its operational life, depreciation was a percentage charged over
the fair life of the asset(s) (ii) depreciation was the source of debt repayment C
for a Utility and since no loan repayment was due during the financial years
2002-03 and 2003-04, it accepted the request of respondent to treat
depreciation as a source of funding to partly fund Capital Expenditure (iii)
since there were serious deficiencies in the Fixed Asset Register it reduced
the rate of depreciation from 6.69% to 3.75%. However, appeal of respondents
against this order of appellant to Appellate Tribunal for Electricity was allowed. D
Hence the present appeal.

>- Appellant contended that (i) in Electricity Accounting, it was entitled to
adopt a fair rate of depreciation based on fair life of the assets so that the
consumer is not overburdened (ii) depreciation was ordinarily based on fair
life of the assets, the rate whereof could vary depending upon the object sought E
to be achieved, and is often prescribed on different basis, in the case of energy
saving devices, pollution control equipments etc (iii) under Section 28 of Act
of 2000, though it had to follow the Principles of Schedule VI to the Act of
1948, it also had the power to deviate therefrom for reasons to be recorded;
in exercise of that power, it fixed the rate of depreciation at 3. 75% having p
regard to the fair life of the assets and claim of 6.69% was rejected on the
ground that it could be considered only if there was a debt redemption involved
(iv) reliance on Notifications of 1992 and 1994 was misplaced as they were
based on the concept of Advance Against Depreciation (AAD) which was
limited to the actual loan liability in a given year, and these Notifications
admitted higher depreciation in the regulatory mechanism because at the G
relevant time the Utility had undertaken loan repayment liabilities (v) in the
RFQ, RFP, the Policy Directions or the BST Order, government did not
promise either 6.69% as rate of depreciation or that it will remain constant
for all live years (vi) depreciation was a non-cash expense, therefore, it could
permit only reasonable depreciation which was 3.75% (vii) BST Order was H
750 SUPREME COURT REPORTS [2007) 2 S.C.R.

A valid only for two months of February and March 2002 and it had certain
variables including items of expenditure which varied from year to year, one
such item was depreciation.

Respondent contended that (i) the reason given by appellant to depart
from the Sixth Schedule that the fair life of the assets was 25 years and
B respondent was not required to redeem any debt was contrary to the
representations made to the investors and to the MOP Notification dated
23.1.92 which stated that the rate of depreciation shall not be derived from
the fair life of the asset (ii) it was bad under Section 28(3) of Act of 2000 as •
it resulted in total dismembering of the total 5 year transition mechanism,
C rendered 16% ROE illusory and extended the replacement period for assets
from 13.45 years to almost 24 years (iii) appellant was not empowered to flout
Policy Directions and BST Order as they were binding on them under Section
12 (iv) 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%, which was
D unjustifiable (v) depreciation was a non-cash charge and reduced the
distributable profit without reducing the cash profit; it in a sense was a source
of funds only for future investments and not for the current year (vi)_ there
was no linkage between depreciation and loan repayment since depreciation ~-
is a charge on the income to be kept aside for asset replacement (vii) their
E legitimate expectation were not met as the bids were specifically invited on
the clear basis that during the transition period their tariff would be fixed in
accordance with the principles set out in the BST Order to be issued by
appellant pursuant to the Policy Directions of GoNCTD and they acted and
altered their position on that basis.

F Dismissing the appeal, the Court

HELD 1.1. 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
depreciati<in from the fair life of the asset(s). The reason is obvious. Before
G 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
H depreciation appears to be two-fold - firstly, to reduce the Asset Replacement
DELHI ELECTRICITY REGULA TORY COMMISSION'· BSES YAM UNA POWER LTD. 751
_. i
Period and secondly, to fund the rapid increase in the replacement cost. The A
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 a/ia, prescribed B
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 c
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 D
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. !Para 4211776-F, G, H; 777-B, C, DI

1.2. Conceptually, it is always possible to derive the rate of depreciation
E
from the fair life of an asset. However, it will depend on the object for which
a fund or a reserve is sought to be created. 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-'a-vis private profit-based organization. That transition is of 5 years in F
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 com11ared to a manufacturing
industry. It is for this reason that the above Note was appended to MOP G
~
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, DERC was not entitled H
752 SUPREME COURT REPORTS [2007] 2 S.C.R.

A to derive the rate from the fair life of the asset, particularly, when the
consequence was to reduce the ARP substantially. In conclusion, it is
reiterated that in the present case because of inflation, the Cost of Replacement
has to be applied instead of Historical Cost. jPara 43) 1779-F, G, H; 780-A, BJ

1.3. The basic object of providing depreciation is to allocate the amount
B of depreciation of an asset over its usefJI 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
C 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.
D !Para 44) 1780-C, D, Fl

Ahmedabad Miscellaneous Industrial Workers' Union v. Ahmedabad
Electricity Co., ltd., AIR (1962) SC 1255, relied on

"The Principles of Auditing" by F.R.M. de Paula, referred to.
E
2.1.: 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 and based on proper
reasoning. DERC was required to consider the effect of its decision.
F (Para 43) 1778-C, DJ

2.2. DERC held 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
G a differ~nce 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. jPara 4311779-D)

. 2.3. The present case is concerned with the reduction in the rate of
depreciation from 6.69% to 3.75%. Therefore, in the case of reduction of
H authorized expenditure (depreciation) repayment of loan is not the relevant
DELHI ELECTRICITY REGULATORY COMMISSION" BSES YAMUNA rOIVER LTD.
753
factor. (Para 43( (779-E( A
3.1 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, Legitimate B
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. 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 C
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 D
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. In other words, E
what is given by one hand is taken away by the other. In other words, the return
on the total package becomes illusory if the rate of depreciation is reduced
from 6.69% to 3. 75%. The certainty for 5 years is also obliterated for
reducing the rate of depreciation. This violation also infringes the doctrine
of Legitimate Expectation of the DISCO Ms to get lawful and reasonable
recovery of expenditure. DERC was expected to fix the rate in the context of F
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 th...- Electricity Industry. (Para 43] G
(778-D, E, F, G, H; 779-A, B, CJ

4. Present judgment is confined to the facts of the 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. (Para 43] (780-B, CJ H
754 SUPREME COURT REPORTS [2007] 2 S.C.R.

A CIVIL APPELLATE JURISDICTION : Civil Appeal No. 2733 of2006.

From the Judgment and final Order dated 24.5.2006 of the Appellate
Tribunal for Electricity, New Delhi in Appeal Nos. 38,39 122/2005 and 48/2006.

Vikas Singh, A.S.G., S.K. Dholakia, Harish N. Salve, S. Ganesh, J.J. Bhat,
B Suresh Chandra Tripathy, Amit Kapoor, Anupam Verma, Vibha Dhatta Makhija,
V.P. Singh, Anuj Berry (for M/s. Suresh A. Shroff & Co.), S. Wasim A. Qadri
Amrita Narayan, R.C. Kathia and D.S .. Mahra for the appearing parties.

The Judgment of the Court was delivered by

C KAPADIA, J. I. 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%.

D 2. The facts giving rise to this civil appeal are as follows.

3. On 23 .1.92 Ministry of Power ('MOP' for short) issued a notification
(which was published in Official Gazette on 3I.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
E column no. I, 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 whi<;h it was stated that the reference to the straight-line
method in the said Notification was intended to differentiate the same from
F the concept of reducing balance method and not to derive rates from the fair
life of the asset(s ).

4. 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.
G
5. 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.

6. On 6.1.200 I the Government of National Capital Territory of Delhi
H ('GoNCTD' for short) decided to unbundle Delhi Vidhyut Power ('DVB' for
DELHI ELECTRICITY REGULATORY COMMISSION,., BSES YAMUNA POWER LTD. [KAPADIA, J.] 755

short), its undertaking and assets, and vest the same in six successor companies A
--4
including three distribution companies ('OJSCOMs' 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 I 5.2.200 I 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 B
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 c
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 of2001-02 would get adjusted in 2002-03, 2003-2004, 2004-
05 and 2005-06. In para 5. 10 oftlle RFQ document, GoNCTD stated that it was
committed to the power sector reforms in Delhi; that this was its commitment D
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. 1.0 I
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 E
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 F
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
G
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
H
756 SUPREME COURT REPORTS (2007] 2 S.C.R.

A 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 t-
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
B 2.4.01 so that the pre-qualified bidders could submit their financial bids for
the proposed DlSCOMs.

7. 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 •
c Tariff Determination Principles for the financial years 2002-2003 till 2005-06.
This Tariff Order computed the ARR of DVB forthe 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 st;·ategy so that
tariff levels could be indicated for the next five years [See: para 1.6.6]. Under
D 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-
E
composition at the beginning offinancial 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 tlie financial year 2000-0 I and at Rs.262 crores for the
F financial year 2001-02.
;.
8. 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,
iiabilities and obligations of DVB in the three DISCOMs herein. Under the
said Scheme DVB was unbundled, the Opening Balance Sheet of each of the
G 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 I. 7.02. .;._

9. On 22.11.01 GoNCTD issued Request for Proposal document ('RFP
document' for short). The said document was accompanied by the Policy
H
DELHI ELECTRICITY REGULATORY COMMISSION"· BSES YAMUNA POWER LID (KAPADIA. l] 757

Directions issued to the prospective bidders referring to the transition period A
--+ 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.

10. On 22.11.01, GoNCTD after considering the views expressed by
DERC issued Policy Directions under Section 12 of DERA for restructuring B
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. lt was further clarified that the transition period shall be of 5
years (2002 till 2007) to attract private participati~n in respect of AT&C loss
reduction, tariff structure including return on equity of 16% and 50% additional
c
revenue arising from AT&C loss reduction with inbuilt incentive to DISCO Ms.
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 D
22.11.0 I till end of financial year 2006-07.

11. 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 E
Company Ltd. to the said DISCO Ms, 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 F
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.

12. Accordingly, M/s. Tata Power Company Limited submitted its bid for G
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 'Yo equity in the
other Distribution Companies owned by GoNCTD.
H
758 SUPREME COURT REPORTS [2007] 2 S.C.R.

A 13. For the sake of convenien~e we are stating the facts concerning the
bids submitted by Mis. Tata Power-Go.mpany Limited in the context of purchase t-
of 51 % equity in the North North~West Delhi Distribution Company.
....
14. On 29.5.02, GoNCTD accepted the bid of Mis. Tata Power Company
Ltd. based on the loss reduction profile, RFP documents etc. Accordingly, Ml
B s. Tata Power Company Ltd. was invited to sign Share Acquisition Agreement
by GoNCTD. This was on 31.5.2002.

15. 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
c private bidders. Mis. Tata Power Company Ltd. was one of the three DISCOMs.

16. 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 stat_hig that all directiv°es issued before ·the
commencement of 2003 Act und~r:DE.~ shall stand expressly saved. L
D
17. Vide Tariff Order dated 26.6:0~ ·DERC'reduced the rate of depreciation
from 6.69%to 3.75%.

18. On 25.7.03 North Delhi Power,Ltd. ('NDPL' for short), a joint venture ....
~fMls. Tata Power Company Ltd., filed aReview Petition before DERC which
E l'
was dismissed on 25.11.03. The Review Petition was made by NDPL seeking
to challenge the reduction in the rat~ of depreciation. While rejecting the
' '
Review Petition it was held by DERCJhat depreciation is a charge to the Profit
and Loss Account and it represents ~.measure of loss in value of an asset
arising from use, efflux of time and inarket changes. It was further held that ,,
F 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
G was based on WADR since the details of the asset(s) a! 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
H that the erstwhile DVB was required to file ARR by 31.12.0 I for the financial

...
. ,.
DELHI ELECTRICITY REGULATORY COMMISSION oc BSES YAMUNA POWER LTD [KAPADIA, J.] 759

year 2002-03 which they failed to do so and instead the three Distribution A
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 B
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 C
.: 3I .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 ofNDPL 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 D
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 d~termination of ARR: Ji was further held that DERA empowered
DERC io depart· from the Prindples mentioned in Schedule VI of the said 1948
Act, during the process of tariff determination, by providing in writing the E
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. F
It was further he Id 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 G
Review Petition ofNDPL came to be dismissed as per the order of DERC on
25.11.03.
>
19. 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 H
760 SUPREME COURT REPORTS [2007] 2 S. C.R.

A to NDPL the assured return on equity at 16% as well as depreciation
expenditure at the rate of 6.69%.

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

B 21. On 23.7.04 NDPL preferred Writ Petition No.15175 of2004 before this
Court. That petition was disposed of on 9.8.05 upon constitution of Appellate
Tribunal for Electricity ('ATE' for short).

22. The above Review Petition dated 8.7.04 was dismissed by DERC on
29.10.04.
c
23. 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
D 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
E mentioned in Schedule VI to the said 1948 Act. By the said order, ATE further
hdd that DISCOMs were entitled to 16% ROE, which is accepted as final by
DERC.

24. As stated above, aggrieved by the decision of ATE dated 24.5.06,
DERC filed the present Civil Appeal No.2733 of2006 before this Court limited
F to, the question of depreciation.

25. 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.

G 26. On 23.8.06 Civil Appeal No.2733 of2006 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
H the purpose of making a departure from the Schedule VI rates. The
DELHI ELECTRICITY REGULATORY COMMISSION"· BSES YAMUNA POWER LTD. {KAPADIA, J J 76 J

- basic issue involved in this appeal is whether the Appellate Tribunal A
'f.as 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 B
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 C
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 ord~r dated 13th June, 2006, we had permitted
the process of determination to be continued by the appellant as D
directed by the Appellate Tribunal (by mistake recorded as High
Court). The final decision may be taken, but the same shall be open
to challenge by the affected parties. Thi~ 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 E
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."
F
27. 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 G
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 H
762 SUPREME COURT REPORTS [2007] 2 S.C.R.
..,..
A 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
r-
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
B 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 t
depreciation under Schedule VJ was admissible even in cases where the
c 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
D and if the rate of depreciation is reduced from 6.69% to 3. 75% the same will
disable the DlSCOMs 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,
E 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 holdi_ng that depreciation stood built into tariff computation to
provide source of funding to repay debt capital, ioan 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
F life of lines and cables in the distribution system was 25 years and, therefore,
c
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
G
not open to DERC to derive the rate of depreciation at the rate of3.75% from
the fair life of the equipment as is sought to be done by DERC. According ,I..
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,
H NDPL was entitled to depreciation in terms of MOP notification dated 29.3.94,
DELHI ELECTRICITY REGULATORY COMMISSION"· BSES YAMUNA POWER LTD. [KAPADIA, J.) 763

Policy Directions dated 22.11.01 and BST Order dated 22.2.02 and, therefore, A
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 ofDERA to DERC, according to ATE, were binding on the DlSCOMs
which DERC failed to notice. According to the impugned order, DERC had
accepted the WADR proposed for Generation Company in terms of MOP B
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 C
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 D
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 E
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. La5tly, according F
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
DISCO Ms herein differently. According to ATE, MOP Notification dated
29.3.94 enabled the DISCO Ms herein to claim the accelerated rate of depreciation
so that the Utility can meet Higher Capital Expenditure and Higher Operational G
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 H
764 SUPREME COURT REPORTS [2007] 2 S.C.R.

A byDERC. '-

28. 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 DISCO Ms and the consumers. Under Section 28,
according to learned counsel, DERC is required to follow the Principles of
B 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
c 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 ailowing
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
D 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
E 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.
F 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
G 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
H the relevant time the Utility had undertaken loan repayment liabilities which
BAR COUNCIL OF INDIA"· BOARO OF MMG. DAY ANAND COLLEGE OF LAW [BALASUBRAMA~YAN, J.] 765

did not exist for the financial years 2002-03, 2003-04 and 2004-05. A
29. Mr. Dholakia, learned counsel for DERC, next contended that the
Policy Directions issued by GoNCTD on 22. 11.0 l 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 B
a non-cash expense, therefore, DERC could permit only reasonable depreciation
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 C
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 D
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.
E
30. 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 F
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 ha.d 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 ofRs.45.62 crores as depreciation. The
total sum was, therefore, Rs.117 .31 crores and, therefore, NDPL was wrong in G
saying that its return on equity got adversely affected on account of lower
> rate of depreciation.

31. On the concept of depreciation, learned counsel urged, relying on
certain textbooks, that depreciation is ordinarily based on fair life of the H
766 SUPREME COURT REPORTS [2007] 2 S.C.R.

A 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 e(c.
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
B 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
C 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, DISCO Ms 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 DJSCOMs herein assured 16%
return on equity. Accordingly, DISCOMs were required to reduce the AT&C
D losses. Higher the recovery from consumers meant higher revenue to the
DISCO Ms and lower the tariff. Learned Counsel submitted that the DISCO Ms
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
E losses and to 16% ROE. Learned counsel submitted that it was never the case
of DISCO Ms 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
F years there was no debt redemption involved.

32 .. 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
G it has to record reasons in writing. Learned counsel submitted that the said
reasons t~ depart and the flexibility of DERC to depart are both subject to
provisions of DERA including Section 12(3) read with statutory Policy

H
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 -
DELHI ELECTRICITY REGULA TORY COMMISSION '" BSES YAM UNA POWER LTD. [KAPADIA, J] 767

of the word "clear profit". The definition shows that clear profit has to be A
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 B
sum calculated in accordance with the principles as the Central Government
may, after consulting the Authority, by notification in the Official Gazette, lay
i
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 C
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 colum.n 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: D
"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"
E
33. Jn 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
MOP Notification and it was not open to DERC to recalculate the rates on F
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 22.11.0 I.
G
34. 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 en;itled
to derive the rate of depreciation at 3.75% having regard to the fair life of the
H
768 SUPREME COURT REPORTS [2007] 2 S.C.R.

A 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 r
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.
B
35. 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 I 6% ROE illusory and it extends the
c 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 22.11.0 I read with
para 3.6.2 of the BST Order dated 22.2.02 by changing the depreciation rat.:
from 6.69% to 3.75% without any justifiable reason after having induced
D 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 22.11.0 I issued by GoNCTD. In this context, it was
E 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
F 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
G submitted that if DERC is allowed to reduce the rate then such tinkering
would frustrate the reforms. It was further pointed out that in order to ensure
ARR to be met through the tariff, DERC was required to provide the basis {
on which the return on equity was to be computed. It was contended on
behalf ofNDPL that ROE and the rate of depreciation were significant features
H of the scheme and ifthe rate of depreciation is reduced from 6.69% to 3.75%
DELHI ELECTRICITY REGULATORY COMMISSION" BSES YAMUNA POWER LTD. (KAPADIA, J] 769

then the entire package/privatization process would fail. In this connection, A
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 B
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 C
principles for tariff entitlements for next 5 years was not the key factor in the
privatization process.

36. 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 D
of funds". The source is always the "sale price" of goods. Depreciation is a
non-cash charge. It reduces the distributab'.e 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 E
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 F
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 ofDERC 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 G
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 H
I I

770 SUPREME COURT REPORTS [2007] 2 S.C.R.

A relev~nt 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
B above MOP Notification dated 23.1.92 (as amended) 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
C Section 12 ofDERA. 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%.
' .
37.'Mr. S. Ganesh, learned senior counsel appearing on behalf of BYPL
D and BRPL, submitted that during the transition period, 2002-07, the tariffs of
the aforestated to DISCOMs had to be fixed strictly in cqnformity with the
0

BST Order dated 22.2.02. According to learned counsel, tlie said order dated
22.2.02 had laid down Normative Principles for tariff fixation. It was ~ubmitted
that the said BST Order followed the MOP Notifications dated 23 .1.92 and
E 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 lie considered to a good or cogent ground or reason for
F 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.

G 38. 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
H submit their bi~s on the basis of tariff mentioned in the BST -Order dated
DELHI ELECTRICITY REGULATORY C0'1MISSION ,., BSES YAMUNA POWER LTD. [KAPADIA, J.] 77 J

22.2.02. In this connection, our attention was invited by learned counsel to A
--i the RFQ document dated 15.2.0 I. 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 ofRFP 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 B
submitted that, therefore, the bids for privatization were specifically invited
on the clear basis that during the transition period the tariff of the DISCO Ms
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 c
on the basis of the tariffs mentioned in the BST C;·der 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 of ATE has D
been accepted by DERC. It was held by ATE that the Policy Directions dated
22.11.0 I 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 E
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 b~come final. F
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
G
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, H
772 SUPREME COURT REPORTS [2007] 2 S.C.R.

A in terms of the Policy Directions dated 22.11.0 I. Learned counsel submitted
that the BST Order and the Policy Directions were intended to be relied upon r-
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 %
B 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
C 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 pern1issible in terms of the financial principles
set out in the Sixth Schedule to the said 1948 Act.

39. Learned counsel for BYPL and BRPL adopted the contentions
D 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
E depreciation allowed.is reduced from 6.69% to 3.75%, the result would be that
the differ_ence between the amount denied by DERC, on account ofreduction
in the depreciation rate and the amount granted as ROE, wiii'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 in the BST order would result in obliteration of the entire basis of
F 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 perfonmmce on part of the respondept DISCO Ms. This was
also a part of Policy Directions. In the circumstances, it is I'lOt open to DERC
G to deviate from the Principles mentioned in the BST Order.
40 .. Learned counsel for the respondent DISCO Ms 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
H is required to be calculated in accordance with the principles set out in the
DELHI ELECTRICITY REGULATORY COMMISSION"· BSES YAMUNA POWER LTD. [KAPADIA.JI 773

MOP Notifications: The schedule given for calculation of the rates of A
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.
B
41. 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 C
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 Accouriting. 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 D
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 E
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 F
_. 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, G
as held by this Court in the case of Ahmedabad Miscellaneous Industrial
Workers' Union v. Ahmedabad Electricity Co., Ltd., AIR (1962) SC 1255, in
,,. the context of the Electricity Supply Act, depreciation 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 H
''
~
t·

774 SUPREME COURT REPORTS [2007] 2 S. C.R.

A 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
B 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
c 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
D accepted by this Court in its judgment in the case of Associated Cement
Companies Ltd., Dwarka Cement Works, Dwarka v. Its Workmen and Anr.,
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
E 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 observatioris of F. R. M. de Paula in his "Principles of Auditing"
that
F "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 Accoul\tants in
G
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
H big to be bridged by a provision made for replacement spread over
-I

DELHI ELECTRICITY REGULA TORY COMMISSION"· BSES YAM UNA POWER LTD. [KAPADIA, J.) 775

a period of years either by way of supplementing the depreciation A
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 B
necessary from its share in the available surplus.

34. The theory that the whole of the rehabilitation charges need
-t not come out of the trading profits of the industry does not appear
to be generally accepted. As has been observed by Paula himself,
c
"In the past the accepted principle has been that the main object
of providing for the depreciation of wast:,1g 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 D
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 E
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 F
"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
G
"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
H
776 SUPREME COURT REPORTS [2007] 2 S.C.R.

A 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
B 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
C 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
D as for that of labour; and so reasonable provision made in that behalf
must be regarded as justified."

42. 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
E 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
F of savings at 30 to 35%. Infrastructure including electricity is one of the
problems faced by our economy. Electricity - generation, distribution and
transmission - is a Capital Intensive Industry. The MOP Notifications have
refmed 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).
G The 1reason 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
H for higher rate of depreciation appears to be two-fold firstly, to reduce the
DELHI ELECTRICITY REGULATORY COM~11SSION ''· BSES YAMUNA POWER LTD [KAPADIA. J.] 777

Asset Replacement Period ('ARP' for short) and secondly, to fund the rapid A
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 B
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 C
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 D
intended replacement to take place not after 25 years but at the end of I 3 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 22.1I.01.
E
43. Secondly, we may refer to the provisions ofDERA. 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 F
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) G
from time to time in the matter of calculating the expected revenue from
charges which the licensee was permitted to recover under the terms of its
licences. Under Section 28(2), DERC was entitled to prescribe the terms and
conditions for the determination of the licensee's revenues and tariffs in such
manner as DERC considers appropriate. However, Section 28(2) was subject
to a proviso which stated that the DERC shall be guided in the matter of H
778 SUPREME COURT REPORTS [2007] 2 S.C.R.

A 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 57 A 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
B 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,
C 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 I2.
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
D 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
E 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,
F 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
G prospective investors. The effect of the order of DERC dated 26.6.03 is to
extend the ARP by I 0.55 (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%
H to 3.75%, the overall actual return from the package becomes illusory. For
DELHI ELECTRICITY REGULATORY COMMISSION''· BSES YAM UNA POWER LTD. (KAPADIA, J] 779

example, for the financial year 2004-05, DERC approved 16% ROE amounting A
to Rs.61.69 crores. However, for the same financial year on account of fall in
the rate of depreciation from 6.69% to 3.75%, DERC has disallowed depreciation
to the tune of Rs.60.57 crores (Rs.106.19 crores minus Rs.45.62 crores). In
other words, what is given by one hand is taken away by the other. In other
words, the return on the total package becomes illusory if the rate of depreciation
is reduced from 6.69% to 3.75%. The certainty for 5 years is also obliterated B
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 C
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 D
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 E
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 F
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-a-vis private profit-based
organization. That transition is of 5 years in the present case. The Historical G
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 H
780 SUPREME COURT REPORTS [2007] 2 S.C.R.

A prescribed the rates of authorized expenditure which was more than the rate r-
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
B 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
C apply for all times. It is confined to the transition period only.

44. Before concluding, we may state that the basic object of providing
depreciation is to allocate the amount of depreciation of an asset over its
useful life and not actual life so as to exhibit a true and fair view of the
financial statements of an enterprise. Useful life is a period over which a
D 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,
E 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 betwee.n the
physical life of an asset and the useful life of the asset.

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

v.s. Appeal dismissed.