A Bench of the Supreme Court consisting of Justices UU Lalit and Vineet Saran has upheld the levy of royalty by the State of Kerala for use of controlled water by captive power producers operating in the state. The Court dismissed appeals filed by M/s. Indsil Hydro Power and Manganese Limited (INDSIL) and Carborundum Universal Limited (CUMI) against the Judgment of a Division Bench of the Kerala High Court that allowed the appeal filed by the State against the Judgment of a Single Judge.

Both the companies had challenged clause 14 of the Policy formed by the State Government/Kerala State Electricity Board in 1990 for allowing private agencies and public undertakings to set up hydel schemes for generating electricity for their own consumption (captive power consumption). The said clause 14 empowers the State to levy royalty for the use of controlled supply of water for generation of power. A single-judge Bench of Kerala High Court had held that the State had no jurisdiction to recover royalty.

The Supreme Court considered (i) whether the appellants did, in fact, have the advantage of getting controlled supply of water, (ii) whether Clause 14 of the policy that was incorporated in the agreements entered into by the State with the Appellants was unconscionable or manifestly arbitrary, (iii) whether the State discriminated between Captive Power Producers (CPPs) and Independent Power Producers (IPPs) who generate power only to sell to the State and (iv) whether the imposition of royalty will amount to taxation without authority.

The Bench found that the appellants did get the advantage of controlled water supply.

The Court found that clause 14 was not manifestly arbitrary or unconscionable. The Court found that "The law is thus clear that in cases where a term of contract or agreement entered into between the parties is completely one sided, unfair and unreasonable, where the other party having less bargaining power had to accept such term by force of circumstances, the relief in terms of the decision of this Court in Central Inland Water Transport Corporation can be extended. It may be stated that the Agreements were entered into after long deliberations where both CUMI and INDSIL had the advantage of legal counsel." The Court noted that the appellants cannot approbate and reprobate by denying the validity of a clause in the contract after accepting benefits from the contract.

On the question about discrimination between CPPs and IPPs, the Court held that there was a reasonable classification based on a clear rationale with the object of reducing the additional burden on the consumers since IPPs generate electricity that will ultimately be used by general consumers.

On the issue regarding the power to levy royalty, the Court considered the difference between a royalty or fee and tax. While considering the meaning of royalty, the Bench held, "The expression 'Royalty' has consistently been construed to be compensation paid for rights and privileges enjoyed by the grantee and normally has its genesis in the agreement entered into between the grantor and the grantee. As against tax which is imposed under a statutory power without reference to any special benefit to be conferred on the payer of the tax, the royalty would be in terms of the agreement between the parties and normally has direct relationship with the benefit or privilege conferred upon the grantee."

The Bench found that irrespective of the nomenclature, the charges for use of controlled release of water were for the privilege enjoyed by the appellants and therefore their submission that royalty was compulsory exaction and thus assumed the characteristics of a tax wascompletely incorrect.

The appeals were accordingly dismissed.