2007 (2) TMI 627 - SC - Income Tax

Whether on the facts and circumstances of the case DERC was right in reducing the rate of depreciation from 6.69% to 3.75%? Held that - there is no merit in this civil appeal. Firstly accounting for costs differs according to the object and the purpose for which the exercise is undertaken. Depreciation is Allocation of Costs so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset(s). Depreciation includes amortization of assets whose useful life is pre-determined. It includes depletion of resources through the process of use. Depreciation in Commercial Accounting differs from depreciation in Tax Accounting. In this case we are concerned with Electricity Accounting. An asset is recognized in the Balance Sheet when one expects economic benefits associated with it to flow in future over a period of years. Accordingly the asset has a cost or value that can be measured. Matching of revenue and expenses is an important exercise under Accounting. Depreciation is a part of this exercise. DERC was not entitled to derive the rate from the fair life of the asset particularly when the consequence was to reduce the ARP substantially. In conclusion we reiterate that in the present case because of inflation we have to go by the Cost of Replacement instead of Historical Cost. However we state that our judgment is confined to the facts of the present case alone and the reasoning given hereinabove is in the context of the period of 5 years. This judgment should not be construed to apply for all times. It is confined to the transition period only. This civil appeal preferred by DERC stands dismissed

Summary

Issues Involved:
1. Whether DERC was right in reducing the rate of depreciation from 6.69% to 3.75%.

Issue-wise Analysis:

1. Background and Notification by Ministry of Power (MOP):
On 23.1.92, the Ministry of Power issued a notification stating that a licensee shall provide for depreciation in its Annual Statement of Accounts as per the straight-line method at the rates indicated in Schedule VI to the Electricity (Supply) Act, 1948. A note appended to the notification clarified that the reference to the straight-line method was intended to differentiate it from the reducing balance method and not to derive rates from the fair life of the assets.

2. Enactment of Delhi Electricity Reforms Act (DERA):
The Delhi Electricity Reforms Act, 2000 was enacted to establish the Delhi Electricity Regulatory Commission (DERC) and restructure the electricity industry in Delhi. Subsequently, the Government of National Capital Territory of Delhi (GoNCTD) decided to unbundle Delhi Vidhyut Power (DVB) and vest its assets in six successor companies, including three distribution companies (DISCOMs).

3. Tariff Orders and Depreciation Rates:
On 23.5.01, DERC issued its Retail Supply Tariff Order for the financial year 2001-02, computing the Annual Revenue Requirement (ARR) of DVB and approving a Weighted Average Depreciation Rate (WADR) of 6.83%. This rate was later reduced to 6.69% for the financial year 2001-02. The depreciation was chargeable to ARR and quantified at Rs.232 crores for 2000-01 and Rs.262 crores for 2001-02.

4. Policy Directions and BST Order:
On 22.11.01, GoNCTD issued Policy Directions under Section 12 of DERA, clarifying that the transition period for privatization would be five years (2002-07). DERC was bound by these directions. On 22.2.02, DERC issued the Bulk Supply Tariff (BST) Order, approving the tariff principles for the transition period, which included a depreciation rate of 6.69%.

5. Reduction of Depreciation Rate by DERC:
On 26.6.03, DERC reduced the rate of depreciation from 6.69% to 3.75%. North Delhi Power Ltd. (NDPL) filed a Review Petition, which was dismissed by DERC on 25.11.03. DERC held that depreciation is a charge to the Profit and Loss Account and represents a measure of loss in value of an asset. It further stated that depreciation is a non-cash expenditure and since there was no loan repayment in the financial years 2002-03 and 2003-04, the allowed depreciation rate of 3.75% would not affect the DISCOMs' operations.

6. Appeal to Appellate Tribunal for Electricity (ATE):
NDPL challenged the reduction in depreciation rate before the Appellate Tribunal for Electricity (ATE). On 24.5.06, ATE held that DERC had not given any reasons for deviating from the principles mentioned in Schedule VI to the 1948 Act. ATE stated that depreciation is a process of cost allocation and not a source of funds. It also held that DERC's reasoning for reducing the depreciation rate was legally unsustainable.

7. Supreme Court's Judgment:
The Supreme Court upheld ATE's order, stating that DERC's decision to reduce the depreciation rate was erroneous. The Court emphasized that depreciation should be calculated based on the principles set out in the MOP notifications and not derived from the fair life of the assets. The Court noted that the MOP notifications provided for higher rates of depreciation to account for the rapid increase in replacement costs due to inflation. The Court also highlighted that the Policy Directions and BST Order provided certainty to investors regarding tariff entitlements for the transition period. The reduction in the depreciation rate from 6.69% to 3.75% extended the Asset Replacement Period (ARP) and made the overall return on equity illusory, thus violating the doctrine of Legitimate Expectation.

Conclusion:
The Supreme Court dismissed the civil appeal filed by DERC, upholding ATE's order and restoring the depreciation rate to 6.69%. The Court emphasized the importance of adhering to the principles set out in the MOP notifications, Policy Directions, and BST Order to ensure certainty and consistency in tariff determination during the transition period.