Carrying costs and discounting factor, or discounting rate, are vital principles in calculating the relief awarded to parties in commercial disputes. Although both these economic concepts are based on the principle of the time value of money, they are quite different in nature and application. While carrying costs compensate for the money that was already owed at a certain point in the past but was not paid, a discounting factor is employed to adjust the present value of a payment that is due to be received at some point in the future.
In the power sector, factoring in the discount rate while calculating tariffs or incremental tariffs is essential because the revenues of the generating companies (genco) are received in a staggered manner throughout the term of the power purchase agreement. A clear understanding of their underlying distinctions should prove helpful in resolving the many disputes concerning the award of carrying costs along with incremental tariffs.
The foremost differences lie in their principle. It is commonly felt that these terms are similar and can be used interchangeably. However, this mis understanding has led to a spurt in power sector litigation in which the carrying cost was claimed as compensation for the time value of money.
Some distribution companies (discom) argue that since the discount factor forms a component of tariff already allowed, permitting carrying costs as well would lead to a double recovery of tariff by the gencos. For their part, gencos often claim incremental tariffs, as compensation along with, and independent to the claim for carrying costs, where the incremental tariff is calculated using the discount factor.
An example is the cost impact on solar power developers (SPD) from the imposition of safeguard duty (SGD) on imports of solar modules. In disputes concerning compensation, the courts have often denied the claims for carrying cost, despite settled precedents, on the premise that the discount rate has already been factored in the calculation of incremental tariff.
Carrying costs and the discounting factor are also computed differently. Carrying costs strive to bridge the gap in revenue that the aggrieved party suffered. As such, it may be linked to an interest rate imposed on the defaulting party. It is a forward calculation to account for the money owed at a particular time but not paid.
The discounting rate, by contrast, is a backward calculation to arrive at the present value of payments in respect of a future amount. It is used to adjust the value of payments that are slated to be recovered at some point in the future.
Lastly, these concepts differ on their periods of application. It is trite, that Indian courts allow interest for the three phases of a dispute resolution process, namely the pre-reference, the pendente lite and the post-decision periods. Bearing this in mind, one of the most crucial differences between them can be seen. Both these principles are deployed to recompense the aggrieved party, but for different phases of the litigation.
In the SGD example above, assuming that an SPD is simply awarded an incremental tariff recoverable after the decree, it may be said that the SPD is only being compensated for the post-decree period. This is so because the calculation of incremental tariffs uses a discount factor for compensating the staggering of payments from the date the actual payment begins. In this instance, for the period corresponding to pre-reference phase up to the dispute resolution phase the SPD will not be compensated, unless it is granted carrying costs from the date of expenditure to the date of the decree.
Taken as a whole, both the carrying cost and the discounting factor are economic principles that are employed to implement the principle of restitution in power sector disputes. They are, therefore, the vehicles for restoring the aggrieved parties to the same economic positions they enjoyed before suffering the legal or financial injury. Understanding the differences between the two principles can be of significant help in reducing the plethora of disputes concern-ing the award of carrying costs along with incremental tariffs. This will certainly lead to a substantial saving of litigants’ time, costs, and will help to reduce the backlog of cases before regulatory commissions and tribunals.
Puja Priyadarshini is a partner and Sagnik Maitra is an associate at HSA Advocates
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