CLP POWER HONG KONG LTD v. COMMISSIONER OF RATING AND VALUATION

LDGA 241 / 2004
& LDRA 365-369 / 2004

IN THE LANDS TRIBUNAL OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

GOVERNMENT RENT APPEAL NO 241 OF 2004

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J U D G M E N T

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Hon Au J :

A. INTRODUCTION

1. These are the appeals brought by China Light Power (“CLP”) against the Commissioner of Rating and Valuation (“CRV”) in relation to CRV’s assessment of the 2004/2005 rateable value for (a) the tenement, and (b) the leased land (for the purpose of Government rent) occupied by CLP[1].

2. The “rateable value” of a tenement as defined under s 7(2) of the Rating Ordinance (Cap 116) (“RO”) is the amount equal to the “rent” at which the tenement might reasonably be expected to be let on a yearly tenancy.  In this respect, the tenant is assumed to have undertaken to pay all usual tenant’s shares and taxes, and the landlord have undertaken to pay the Government Rent, the various expenses and costs of repair to maintain the tenement in a rateable state.  The rates payable under the tenant is taken to be a percentage (currently 5%) of the rateable value of the tenement.

3. Government Rent is payable by the lessee of an applicable lease, and the amount of annual rent is calculated at 3% of the “rateable value” of the land leased.  The RO applies to the ascertainment of the rateable value of the land leased.

4. The subject tenement (“the Tenement”) under these appeals comprises the land, buildings, structures occupied and used by CLP for the generation, transmission and supply of electricity to Kowloon and the New Territories.  I will describe more about the Tenement later in this judgment.

5. For 2004/2005, the CRV assessed the rateable value of the Tenement to be around HK$9,000 million.

6. These appeals relate to the fundamental issue of what was the rateable value of the Tenement for the relevant year.  This in turn depends on the finding the “rent” of the Tenement. 

7. The methodology used in finding the “rent” of the Tenement (and therefore in reaching the assessment of its rateable value) is matter of valuation. 

8. The Tribunal’s main task in these appeals is therefore to decide on which valuation method it should accept for the assessment of the rateable value of the Tenement.

9. There are generally three primary valuation methods that could be adopted to determine the “rent” (and thus the rateable value) of a tenement.  They are (a) the comparison method, (b) the receipts and expenditure method (“the R&E method”) and (c) the contractor’s basis method (“the CB method”).

10. It is common ground that the comparison method is inappropriate for assessing the rateable value of the Tenement.

11. In these appeals, in gist, CLP submits that the rateable value of the Tenement should be valued in principle by way of the R&E method, but to be adjusted by various proposed adjustments and “assisted” by the CB method.  On the other hand, CRV’s valuation proceeded solely on the R&E method.  The differences between the two valuations centred on how to value the tenant’s share of the divisible balance.

12. In this respect, it is noted that this Tribunal in another similar case (“the HEC case”)[2] has held that the choice of valuation method for assessing the rateable value of the tenement in that case was the R&E method.  Although there is no rule of law to preclude the valuer (and the Tribunal) to adopt a valuation which is composed of more than one valuation method, in the HEC case, the Tribunal rejected HEC’s submissions to adopt the CB method as an adjunct to the R&E method.  I will mention the HEC case more later in this judgment.

B.   RELEVANT RATING PRINCIPLES

13. Unless otherwise stated, the following rating principles are uncontroversial. 

14. Rating in Hong Kong is governed by the RO.  By virtue of section 21, the owner and the occupier of a “tenement” are both liable for the payment of rates, although it is deemed to be an occupier’s rate and in the absence of agreement to the contrary, it is to be paid by the occupier. 

15. The CRV is required by section 11 to prepare a “valuation list” in which all tenements liable to be rated are identified together with their rateable values.  New valuation lists are prepared periodically.  The current practice is to require the CRV to prepare a new valuation list every year coming into effect on 1 April.

16. The rateable value must be assessed by reference to “the relevant date” which is the 1 October prior to the coming into force of the valuation list on 1 April of the following year.  However, certain factors must be taken as they were on 1 April.  This is the effect of section 7A(2) of the RO.

17. The requirement to assess the rateable value “by reference to the relevant date” means that it must be assumed that the hypothetical parties negotiate and agree the “rent” for a tenancy commencing on that date.  For the purposes of these appeals which relate to the year 2004/05, the relevant date is 1 October 2003.

18. The factors which must be taken as at 1 April 2004 are those listed in (a), (b) and (c) of section 7A(2).

19. Section 7A(2) is a statutory expression of the long established “rebus sic stantibus” principle^[3].  The principle requires that the tenement must be valued having regard to its actual physical condition and actual use.  With certain limited exceptions, a tenement is not to be valued having regard to changes to its physical condition or use that may be made in future.

20. This is to enable the CRV to gather evidence of values prevailing at the relevant date and carry out the exercise of valuation based on that evidence between 1 October and 1 April.

21. The term “rateable value” is defined by section 7(2) of the RO as follows:

“The rateable value of a tenement shall be an amount equal to the rent at which the tenement might reasonably be expected to let, from year to year, if –

(a) The tenant undertook to pay all usual tenant’s rates and taxes; and

(b)  The landlord undertook to pay the Government rent, the costs of repairs and insurance and any other expenses necessary to maintain the tenement in a state to command that rent.”

22. Thus, the rateable value of the tenement represents the measure of the value of the right to occupy it.  It is defined as an amount equal to “the rent at which the tenement might reasonably be expected to let, from year to year” with the tenant paying the tenant’s rates and taxes and the landlord paying the Government rent, the cost of repairs and other expenses[4]. The amount of the rateable value is a question of fact[5].  There is no rule of law which prescribes how it is to be determined.

23. Rating seeks a standard by which every tenement appearing in the valuation list can be measured in relation to every other tenement.  It does not seek to establish the true value of any particular tenement, but rather its value in comparison with the respective values of the rest.  Out of various possible standards of comparison the legislature has chosen the annual letting value[6].

24. It has therefore been long recognised that the statute postulates a hypothetical tenancy negotiated between a hypothetical landlord (“HL”) and a hypothetical tenant (“HT”) in circumstances where the HT cannot become the owner of the tenement and cannot acquire a lease for a term of years.  Moreover, it is necessary to postulate a situation in which not only the HT is in this position, but everybody else is[7].

25. The following principles have also been established as relevant for determining the rent of such hypothetical tenancy[8]:

(1)  The rent is that which would be negotiated between the HL and the HT both behaving reasonably.  The HL is not the actual owner of the tenement but a hypothetical person who is assumed to be willing and able to let the tenement from year to year and is neither over anxious to let the tenement nor unduly reluctant.

(2)  Their relative bargaining strength must be taken into account.

(3)  The hypothetical tenancy is from year to year, with a reasonable prospect that it would continue for an indefinite duration, although the rent must be assumed to be capable of review at the end of the year.

(4)  The rent is intended to represent the value of occupation of the tenement to the HT in the open market, taking into account every intrinsic quality of the tenement and all relevant circumstances. Although the tenancy and the parties to the tenancy are hypothetical, the tenement and the market are real.  The concept of the open market assumes that the tenement is available to let and the whole world is free to bid and requires a judgment as to what would, in those circumstances, in real life, have been the best rent reasonably obtainable.

26. Further, it must be assumed that the HT could acquire the non-rateable asset at market value but without difficulty and instantly.  The purpose of this hypothesis is to ensure that all possible tenants are considered on an equal footing and that the sitting tenant is not to have an advantage in not having to incur the expense of moving in[9].

27. However, it is noted that all the legal hypotheses and assumptions are intended to help and not to hinder the just enforcement of the primary obligation to ascertain the value to the existing occupier.  They must therefore be applied in a way not to hinder this objective.  If they hinder, it is said that they must be “pro tanot be treated as inapplicable”[10]. It is thus also said that the valuer in valuing the rateable value of a tenement must not depart from the reality further than the applicable rating hypotheses compel[11]. This is sometimes known as “the principle of reality”.

C.   CLP’S BUSINESS AND THE TENEMENT

28. CLP is one of the two electricity companies in Hong Kong, the other one being Hong Kong Electric Co Ltd (“HEC”).  CLP supplies electricity to customers in Kowloon, the New Territories and outlying islands, through its electricity generation, transmission and distribution operation.

29. “Tenement” is defined in section 2 of the RO as: 

“any land (including land covered with water) or any building, structure, or part thereof which is held or occupied as a distinct or separate tenancy or holding or under any licence.”

30. Section 2 is supplemented by ss 8 and 8A which deal with the treatment of machinery and plant respectively.

31. Section 8 provides that, for the purpose of ascertaining the rateable value of the tenement, (a) machinery used as an “adjunct” to the tenement is to be regarded as part of the tenement, but (b) no account is to be taken of the value of any machinery in or on the tenement required for the purpose of manufacturing operations or trade processes.  Section 8A provides that plant, together with land, buildings or structures occupied by means of any plant, is deemed for rating purposes to be a separate tenement.  Cables, ducts, pipelines, oil tanks, and settings and support for plant or machinery fall within the definition of “plant”[12]. While plant and fixed machinery both form part of the tenement, the value of such machinery used for manufacturing operations or trade processes is therefore to be disregarded in ascertaining the rateable value of the tenement.

32. It follows that the assets employed by CLP in its undertaking are divided for rating purposes into two categories.  The first consists of the rateable assets (“RA”) being those assets which form part of the tenement and whose value is to be taken into account in ascertaining its rateable value.  The second comprises those assets which do not form part of the tenement or whose value is to be disregarded in ascertaining its rateable value and are accordingly non-rateable assets (“NRA”).

33. The main elements of the Tenement upon which CLP operates its generation, transmission and distribution business are as follows.  These are largely not disputed and taken from CLP’s evidence and summary provided in its opening.

34. Insofar as generation of electricity is concerned, CLP operates four power stations located in Hong Kong:

(1)  Castle Peak Power Station (“CPPS”) – Built in the early 1980s on reclaimed land, CPPS is a coal-fired station occupying 62 hectares, located at Tap Shek Kok, on the west coast of New Territories.  Castle Peak comprises two stations, each with four generating units.  Station A was built between 1982 to 1985 and Station B between 1986 and 1990.  Although coal is the primary fuel source, the design allows oil to be used as an alternative.  Additionally, in 1996, two of Station B’s generating units were modified to burn natural gas.  Station A is the least efficient of all the stations and, therefore, it tends to be used as a standby facility.

(2)  Black Point Power Station (“BPPS”) – BPPS is located on the coast approximately 4 miles north of CPPS.  BPPS is a combined cycle gas fired power station, comprising 8 generating units. The first two units were completed in 1996 with units 7 and 8 being commissioned in 2005 and 2006 respectively.  It is one of the largest gas fired power stations in the world, with a capacity of 2,500MW per hour.

(3)  Penny’s Bay Power Station (“PBPS”) – PBPS is located on Lantau Island on a site of 4.45 hectares of reclaimed land and was constructed in 1992.  The station comprises three 100MW gas turbines and provides standby capacity to CLP network.  It also serves as a back-up supply for the international airport at Chep Lap Kok, Tung Chung New Town and Lantau Island in the event of a breakdown in the submarine cable link to the island.

35. Insofar as the transmission and distribution system is concerned, electricity generated is transmitted from the power stations to customers via a network of 400kV, 132kV and 11kV underground and submarine cables and overhead lines.  The CLP transmission system is inter-connected with the transmission system of HEC and the power grid of the neighbouring Guangdong Province, which also supplies electricity to CLP customers from their associated Guangdong Daya Bay Nuclear Power Station and Guangzhou Pumped Storage Power Station in Conghua.  Electricity is further transmitted from the transmission network to the distribution network, which comprises 33kV, 11kV and LV underground cables, submarine cables and overhead lines.

36. Voltage is stepped down from 400kV to 132kV via bulk substations, which in turn is stepped down to 11kV via primary substations, for distribution to customers and eventually stepped down to 220V single phase or 380V three phase via secondary substations, for supply to CLP customers.

37. There is a System Control Centre located at the Strafford House in Tai Po, which was completed in 1984.  It houses the System Control and has the key role of directing, monitoring and controlling the generation, transmission and distribution of electricity on a minute by minute basis.

38. In addition, CLP owns or has an interest in assets, which lie in Mainland China.  They therefore do not form part of CLP’s rateable tenement. Nevertheless, it is CLP’s case that they provide essential services to the CLP business to ensure compliance with the Universal Service Obligation (“USO”) requirements regarding electricity supply and diversity of fuel source for power generation[13].

39. These assets in China have been referred to collectively in these appeals as the “China Assets”.  I will for convenience adopt the same term in this judgment.  The China Assets form part of CLP’s principal arguments in support of the valuation methodology it has advanced in these appeals.  I would of course need to deal with these arguments later, but it is necessary for me to describe the China Assets first.  They are as follows.

40. Guangdong Daya Bay Nuclear Power Station, China, is a pressurized water reactor nuclear power station with a capacity of 1968 MW.  70% of its output is purchased by CLP for supply to Hong Kong. The electricity supply from Daya Bay represents an average of 31% over the appeal years of CLP’s total supply requirements under the USO.  The power station is owned by Guangdong Nuclear Power Joint Venture Co Ltd, but CLP Holdings Limited (not CLP) owns a 25% share through a wholly owned subsidiary called Hong Kong Nuclear Investment Co Ltd.

41. Guangzhou Pumped Storage Power Station has a total capacity of 2,400MW supplied from 8 generating units of 300 MW each.  It uses power from Daya Bay to store energy in the form of water, by pumping water from a low elevation to the upper reservoir at night, which is then released through turbines by day to supply electricity at times of peak demand.  CLP have the right to use 50% of the capacity of the first phase of 4 generating units (ie 600 MW).

42. CLP transmission lines (400kV) in China are used to transmit electricity both into and out of Hong Kong. These lines, together with substations, do not form part of the subject tenement, but have been shown alongside the tenant’s NRA on the basis that they form an integral part of the electricity supply chain to and from CLP’s Hong Kong tenement.

43. CLP also has contracts to purchase electricity from Guangdong Nuclear Power Joint Venture Co Ltd generated by the above mentioned nuclear power stations.

D.   SCHEME OF CONTROL

44. CLP and Castle Peak Power Company Ltd (“CAPCO”)’s[14] electricity-related operations in Hong Kong have been regulated under a Scheme of Control by the Government since 1 October 1963, when the first of a series of the Scheme of Control Agreements was entered into.  The 1992 Scheme of Control Agreement (“SOC”) came into force on 1 October 1993 for 15 years and was therefore in existence during all the years of assessment under appeal.  CLP, EMEL, CAPCO and the Government set out the basis on which CLP and CAPCO recognise their obligations to contribute to the development of the Hong Kong by providing sufficient facilities to meet the present and future demand for electricity.  A new SOC Agreement was entered into in January 2008 which governs the supply of electricity from 1 October 2008.

45. In return, as provided in the SOC’s recitals, the Government recognises that CLP, CAPCO and their shareholders are entitled to earn a return which is reasonable in relation to the risks involved and the capital invested and retained in their business. Further, the recitals provide that CLP, CAPCO and EMEL must however ensure that the service to the public is adequate to meet present and future demands, make continuous efforts to improve environmental performance and promote efficient use of energy, and provide an efficient service of high quality and at the lowest cost which is reasonable in the light of financial and other considerations.

46. The SOC allows the Hong Kong Government to monitor the financial affairs and operating performance of CLP and CAPCO through a series of financial and auditing reviews.  The Government undertakes a financial review in the form of the Financial Plan of CLP and CAPCO every 5 years and reviews the annual tariff each year in October.  The Government also periodically reviews (a) any major capital additions as and when a new major project is contemplated; and (b) the tariff rates charged for electricity on an annual basis.

47. The main mechanism provided in the SOC to enable CLP and the Government to achieve these general and overall objectives is essentially a tariff setting mechanism, the essential features of which can be summarized as follows:

(1)  While the Government monitors and approves the tariffs charged to customers, the mechanism by which the performance of CLP is controlled is called the Permitted Return (“PR”). Effectively, CLP is entitled to set the tariff for a particular year with an objective of achieving the maximum profit at PR.

(2)  The PR for a particular year is the aggregate product of 13.5% of “Average Net Fixed Assets” (“ANFA”) plus 1.5% of shareholders investments made after 30 September 1978 for financing the acquisition of “Fixed Assets” as defined.  Net Fixed Assets is defined in the SOC to mean the historic cost of fixed assets less depreciation calculated in accordance with Schedule of the SOC.  The PR is thus linked with the value of the assets of CLP to work out what is the maximum permissible profit CLP could earn through the tariffs for each particular year.

48. From the PR there are four deductions, which then produces the Net Return.  At the same time, CLP is required to set up a Development Fund which is intended to assist in financing the acquisition of fixed assets.  Where the SOC net revenue exceeds the PR, the excess is transferred to the Development Fund.  Where it is less than the PR, the deficiency is transferred from the Development Fund (but not exceeding the balance of the Development Fund).  In other words, if the Development Fund maintains a surplus, then in a particular year where CLP could not in fact achieve the PR, funds could be transferred from the Development Fund to ensure that CLP earns its PR for that particular year.

49. The main purpose of the Development Fund is to assist in the acquisition of fixed assets and to reduce any impact on the Basic Tariff Rate.  Secondly, the use of the Development Fund to receive or fund any surplus in or shortfall of SOC profit helps to smooth out any fluctuation in electricity price during periods of high economic activity or depression, or when CLP plans a capital investment.  Thirdly, rebates have also been paid to customers which were funded by the Development Fund from time to time.

50. It is worth mentioning here that, for the purpose of the R&E valuation of the rateable value of a similar tenement, the Court of Final Appeal has held in the HEC case that the SOC has no relevance in determining the amount of the DB (see below) or the assessment of the HT’s share (see below) thereof[15].

51. In addition, following deferral of the installation of Units 7 and 8 at BPPS in 1999, CLP and CAPCO agreed to set aside a total of HK$803 million from the Development Fund to a Special Provision Account in order to pay for the contractual obligation to reimburse the additional costs incurred by the vendors for the delayed delivery of the two units. CLP and CAPCO have foregone the PR on the outstanding deferral premium of HK$803 million and have paid a charge of 8% per annum on the sum of the average balance of the Special Provision Account which is then credited to the Rate Reduction Reserve to be applied as a SOC rebate to customers.  The Special Provision Account was fully drawn down in 2004 to pay the additional costs of deferral and is now closed.

52. There is in the present appeals an issue as to how the Black Point Deferral Premium should be treated in the R & E valuation.

E.   THE PRINCIPAL CONTENTIONS AT A GLANCE

E1.   The R&E method

53. As I mentioned above, the real debate in these appeals is what methodology of valuation should be adopted in assessing the rateable value of the Tenement (taking into account of the applicable rating principles as set out above). 

54. Although the parties (as I understand it) agree that the R&E method should be adopted as the underlying valuation methodology, the contentions between the parties relate principally to how to carry out the R&E method valuation in this particular case.  In order to understand the dispute better, I should first set out the general principles adopted in the R&E method.

55. Essentially, the R&E method is a valuation method based on the consideration of the anticipated profit that could be derived from the occupation of a tenement.  It involves the following essential steps in the valuation:

(1)  It starts by identifying the gross receipts that the tenant would expect to derive from occupation of the tenement. 

(2)  Deductions are then made for (a) the anticipated cost of purchases to produce those receipts, and (b) the anticipated working expenses.  The result of the deductions from the gross receipts is known as the divisible balance (“the DB”), which is the sum available to be shared between the tenant and landlord.

(3)  The DB is then shared between the tenant and the landlord.  The first element is the tenant’s share (“HT’s share”), which is expected to be a sum to provide a reasonable return to the tenant, for his capital employed and a reward for his venture and risk, sufficient to induce it to take on the business to be carried out by renting the tenement.  The second element is the remainder which is usually treated as rent payable by the tenant.

56. Although profits as such are not rateable, the R&E method of assessing the rent which the HT would offer to pay is based on the idea that where a tenement can be used to yield profits as part of a going concern, then the HT would be prepared to pay rent for the use of the tenement in order to make the expected profits, and the level of rent would reflect the level of those profits[16].

57. This process is based on the economic view of rent as a residual payment and the HT’s share as a “first charge” on the returns of the undertaking.  The latter expression implies that it is a minimum and not a maximum.  Although it is regarded as a first charge on the divisible balance, the valuation must properly reflect the relative strengths and weaknesses of the HL and the HT as they negotiate the rent.  The amount which the HL would demand and the HT would be willing to pay will reflect their relative bargaining power.

58. In The Railway Assessment Authority v Southern Railway Co[17], Lord Hailsham observed that the expression “division of the net receipts” (like similar expressions such as “the divisible balance”) is not a very happy phrase to describe the process which is involved.  The deduction from the net receipts of the amount necessary to induce the HT to embark upon the undertaking.  But, as His Lordship observed, this was no justification for treating the hypothetical parties as joint adventurers.  Their relationship remained that of landlord and tenant, but if the amount which the HT would require in order to induce him to embark upon the undertaking is properly ascertained and deducted from the total net receipts, the result is to divide the net receipts fairly and justly between the HL and the HT, even though, in an extreme case, the landlord’s share, ie, the rent, might be nothing at all.

59. Having insisted that the hypothetical parties were to be treated as landlord and tenant and not as joint adventurers, Lord Hailsham further observed that the HT was not to be regarded as merely an investor in the shares of the company running the undertaking.  His Lordship said:

“[The HT] is not to be regarded merely as an investor in railway shares and to be treated therefore as reasonably compensated by the ordinary rate of interest which can be obtained by such an investment. He is a person embarking upon a commercial undertaking in which he is to sink his capital, in which he takes all the risks of success or failure, and in which he has not merely to be compensated by receiving a reasonable interest upon the capital invested, but also to receive such a profit upon his venture as reasonably to compensate him for the risk which it involves and to induce him to embark upon its prosecution. How much that percentage ought to be is a question of fact which is for the Authority and not for your Lordships’ House”[18].

60. No rules are prescribed for the manner in which the HT’s share of the divisible balance may be determined.  The JRF Guidance Note produced by the English Joint Professional Institutions’ Rating Forum in July 1997 described four possible of ways in which the exercise might be carried out: by taking (a) a percentage of the HT’s capital; (b) a percentage of the gross receipts; (c) a percentage of the divisible balance; or (d) a “spot” figure.

61. The R&E method is only an aid to the ascertainment of the rent which HT would be willing to pay; it is not an inflexible code or set of rigid rules.  The valuation must take account of “every intrinsic quality and every intrinsic circumstance which tends to push the rental value either up or down”[19]. The methodology must be sufficiently flexible to accommodate any feature which affects the amount of rent, whether it is common or rare.  It has also been recognised that the R&E method, when applied to very profitable undertakings, may result in figure which is too high to be properly regarded as rent.  In such cases the figure may require a downwards adjustment.  This has sometimes been referred by CLP in the present appeals as the “Sandown Park adjustment” [20].

E2.   The parties’ differences in the valuation method

62. The main and fundamental difference between the parties in the appeals regarding the valuation lies at the assessment of the tenant’s share of the DB.

63. Both parties in these appeals in essence ascertained the HT’s share of the DB by calculating the return which it would require expressed as a percentage of the DB, by reference to a percentage of its ANFA.  However, they did not agree upon the percentage (and how it should be arrived at).  

64. CRV’s assessment of the HT’s share uses the CLP’s weighted average cost of capital (“WACC”).  WACC is a mathematical formula used in corporate finance to determine the return which investors might find acceptable when investing their capital.  It is an opportunity cost which represents the amount which an investor would expect to receive for a given capital investment based on market yields.  

65. The HT’s share of the divisible balance for which the CRV contended can therefore be expressed by the formula: HT’s WACC x HT’s ANFA.  I would call CRV’s said approach in the Judgment as “the WACC approach”.

66. On the other hand, the CLP’s contention is that the HT’s share of the DB should be valued by reference to:

(1)  The rate of return on its ANFA which the HT would require would be at the same rate as the company’s actual return on the total ANFA.  This claim was not based on the company’s cost of capital but premised on the footing that the divisible balance was earned at the same rate on all the company’s ANFA whether they belonged to the HT or the HL.  I would refer to this approach in the valuation as “the asset split approach”; together with

(2)  Various uplift adjustments to (a) reflect the contribution of the China Assets in generating the income earned by the Tenement, and (b) reward the HT’s effort and skill and compensate its risks in running the business.  

67. Further, CLP submits that the CB method should also be adopted in this R&E method (in the way as used by its valuer Mr Davis) to ensure that the valuation reached by this method would result in a fair rent for the Tenement.  

68. The valuation methodology advanced by CLP to assess the rateable value of the Tenement is a thus hybrid one, premised in principle on the R&E method with the asset split approach, and supplemented with various adjustments and the CB method. 

69. The core issue in these appeals is therefore which of the valuation methods as advanced should be accepted by this Tribunal (with or without any modifications) as the most appropriate one to assess the rateable value of the Tenement. 

F.   THE HEC CASE

70. At this juncture, it is perhaps convenient to mention the HEC case.

71. In that case, HEC appealed against the CRV’s assessment of the rateable value of the tenement provided for the generation, distribution and supply of electricity for the year 2004/05. 

72. It was common ground in that case that the primary or principal valuation method was the R&E method.  CRV’s valuation method adopted for valuation in the HEC case was exactly the same as the one raised in the present case: that is the HT’s share of the DB was WACC x HT’s ANFA (ie, the WACC approach).  On the other hand, HEC’s valuation method adopted in that case was similar to the one now raised CLP: the HT’s share of the DB should be determined by (a) the rate of return on its ANFA which the HT would require would be a return at the same rate as the company’s actual return on the total ANFA (ie, the asset split approach), with (b) various adjustments made to reward the HT for its effort and risks.  Further, the final figure reached by this R&E method should be adjusted by reference to the use of the CB method as a cross-check. 

73. In the HEC case, the Tribunal upheld HEC’s appeals and concluded that the valuation of the rent of that tenement should be determined by allocating the HT’s share and the HL’s share based on an asset split of the DB in accordance with the NBV of the NRA and the RA respectively. The Tribunal however rejected HEC’s method to the extent of having the other uplift adjustments for the reasons set out in its judgment[21].

74. The Tribunal’s judgment in HEC was reversed by the Court of Appeal under CRV’s appeal[22].

75. However, subsequently and towards the end of the hearing of these appeals, the Court of Final Appeal (“CFA”) handed down its judgment allowing HEC’s appeal and restored the Tribunal’s order[23]. 

76. Given the significant similarities between the HEC case and the present appeals in relation to the nature of the tenement and the arguments raised, the CFA’s HEC judgment and the Lands Tribunals Judgment (to the extent that it is not disapproved by the CFA) in my view have a significant impact and effect on the arguments raised by the parties in these appeals. I would refer to them more specifically when I deal with these arguments later in this judgment.  For convenience, I would refer to the CFA judgment in the HEC case as the “CFA HEC Judgment” and the Lands Tribunal judgment “the LT HEC Judgment”.

G.   THESE APPEALS

G1.   CRV’s principal contentions in support of her valuation model

77. It is CRV’s position that her R&E valuation based on the WACC approach is fair, reasonable and thus an appropriate one for valuing the hypothetical rent of the Tenement.  In this approach, the HT’s share of the DB should and is always pinned to WACC x HT’s ANFA.  The proposition (CRV submits) is supported by the contentions that the following principal factors in the negotiation for the hypothetical tenancy would drive the HT’s share of the DB to WACC:

(1)  The HL enjoys a superior bargaining power over the HT in the negotiation for rent for the hypothetical tenancy, since the HL has a monopoly of place over the Tenement.

(2)  The competition for the tenancy would result in the HT willing to take WACC as its share to outbid any other rival HTs seeking a higher share as return.

(3)  Given that rent is residual in nature, the HL bears a much higher risk than the HT in relation to the renting of the Tenement.  As such, the HL is entitled to a higher share of the DB.

(4)  Looking in the long run of the tenancy, it is only fair and reasonable for pinning the HT’s share to WACC: since the WACC would fluctuate up and down over the years, by keeping the HT’s share to WACC consistently would result in fairness (as a matter of valuation) in the long run so as to recompense or balance HL’s suffering in receiving a low rent when the WACC is high.  CRV has called this the “swings and roundabout argument”, which I would adopt for convenience in this judgment.

78. CLP of course contends that none of these considerations are valid and thus the WACC approach should be rejected (as the Tribunal and CFA did in the HEC case).  It is noted that all these arguments made in support of the WACC approach (save the “swings and roundabout argument”) had been advanced by CRV in the HEC case (with the evidence adduced therein) but rejected by the Tribunal and the CFA.

79. I will now deal with each of these principal considerations below.

G1.1   Bargaining position

80. As mentioned above, it is legitimate for the Tribunal to look at the relative bargaining position of the HT and HL in determining what the tenant may be willing to pay (as rent).[24]

81. The starting position of the CRV is that given its monopoly of place (“MOP”) by way of the Tenement, the HL occupies a dominant and superior bargaining position over the HT.  As such, in the hypothetical higgling for the rent, the HT would be driven to be willing to take no more than the WACC x HT’s ANFA as it reasonable return (ie, HT’s share) in renting the Tenement.

82. On the other hand, the valuation method advanced by CLP[25] in these appeals starts off with the position that the HT and HL have equal bargaining power in the higgling of the rent for the Tenement. 

83. In support, it is CLP’s contention that the MOP is neutralized by, among others, the fact that the HT’s assets and HL’s assets were designed and built together and thus these assets are effectively integrated[26]. The HL and HT therefore require and need each other’s assets for the purpose of the business.  This has rendered the parties at equal bargaining power.  If necessary, CLP also relies on the fact that in the assessment year, the China Asset contributed 30% of CLP’s electricity supply to enable it to meet the demands and its obligations under the USO as an additional basis to say why the MOP is neutralised.

84. Whether the HT’s assets and the HL’s assets are so integrated functionally is a matter of evidence. 

85. In this regard, CLP relies on the evidence of their experts, Mr Taylor and Mr Jupp, to show that (a) the relevant NRA and RA built and designed together to function, and (b) in the real world, the Tenement could only practically be used with the HT’s existing assets because of the physical modifications, cost and time required to install a new set of NRA[27].

86. CRV’s corresponding expert Mr Allen to a large extent accepts in evidence that:

(1)  The HT’s and HL’s assets are designed and built as an integrated system.

(2)  The Tenement in its existing state could only be used with the existing HT’s assets.

(3)  If a new set of HT’s assets were brought into the Tenement by a new tenant, substantial modifications and changes would have to be made to the civil engineering elements of the tenement; and

(4)  The likelihood of finding a sufficient number of second hand turbines in the world market of the same dimensions as the existing turbines was extremely small and the possibility of finding exactly the same ones as nil.

87. The nature of Mr Allen’s evidence summarized above is thus consistent with CLP’s evidence, which supports CLP’s argument on the interdependency of the assets.

88. Regarding Mr Allen’s evidence that a new set of HT’s assets could be modified substantially to make it “integrated” with the HL’s assets, the Tribunal in dealing with a similar argument and evidence of Mr Allen[28] in the HEC case has concluded that this must be disregarded for rating purposes, as this would infringe the rebus principle[29].  In my view, this applies equally in the present case.

89. However, Mr Allen in the present appeals also raises some further suggestions in his evidence as to why the RA needs not be dependent upon the existing NRA.  He says: 

(1)  Instead of buying a replacement set of the HT’s assets, the incoming HT could order bespoke machinery to replace the existing machinery.

(2)  An existing turbine could be lifted free of the turbine table, with a steel plate inserted and the existing turbine bolted to the new plate.

(3)  The existing power units at Castle Peak could be “re‑powered”.

90. In relation to suggestions (1) and (2), Mr Allen in his evidence fairly accepts that, although theoretically possible, these are practically improbable, complicated and difficult[30], and also likely to be very costly which would involve significant works[31].

91. In relation to suggestion (3), Mr Allen also accepts that, in order to “re-power” the power unites, the miscellaneous pipe work required to be carried out within the power stations and the re-cabling works would be complicated, costly and time-consuming.  There would also be great difficulty in sourcing the relevant and necessary second-hand auxiliary equipment, which would not be readily available[32].

92. In light of such evidence, I accept CLP’s submissions that these further suggestions should similarly be disregarded for rating purposes under the rebus principle and on the basis that they are simply impracticable in the real world. 

93. As a result, looking at the evidence as whole, I accept CLP experts’ evidence that:

(1)  The HL’s assets and the HT’s non-rateable assets have been designed and built as an integrated system.

(2)  Realistically and practically, for the purpose of the relevant year, the Tenement in its existing state could only be used with the existing HT’s assets.

94. Notwithstanding this, Mr Yu SC for CRV made a number of submissions in his closing submissions seeking to negate the significance of the interdependency point on the relative bargaining power of the HT and HL.  They could be summarized as follows:

(1)  The importance of the monopoly of place of the Tenement and its configuration, which are not affected by interdependency between the RA and NRA (paragraphs 32, 40.2 and 53);  

(2)  The synergy value relates solely to the Tenement (paragraph 47);

(3)  There is no authority or text to suggest that interdependency is a relevant consideration (paragraph 58);

(4)  The interdependency argument is contrary to the assumptions required by the Southern Railway and the vacant and to let principle, and contrary to the Court of Appeal’s decision in HEC case that interdependency represented an impermissible sitting tenant advantage and could not enhance the HT’s bargaining power or the value of the NRA (paragraphs 70-73);

(5)  The rebus principle does not support the interdependency argument (paragraphs 76-81);

(6)  The value of assets which are physically replaceable does not exceed their depreciated replacement cost (“DRC”) (paragraph 87); and

(7)  Although in reality the HT’s assets would not be replaced because the business of power generation would not be interrupted, any value above DRC would only be attributable to the fact that they are in situ, which must be disregarded in a rating valuation (paragraphs 90, 91, 92, 93, 96, 97, 98, 99).

95. I agree with Mr Holgate’s submissions (for CLP) that Mr Yu’s above contentions must be rejected in light of the CFA Judgment in HEC, where by Lord Millet, in confirming the Tribunal’s judgment, held (among others) that[33]:

(1)  The Tribunal found that the bargaining position of the parties was equal because of the interdependency between the RA and the existing or actual NRA;

(2)  In accordance with the decision in Southern Railway, the required hypothesis is that the HT can acquire the NRA and staff without difficulty or interruption, so as to allow the HT to take over the existing assets in situ as a going concern;

(3)  The NRA should be valued in situ and treated as being available in the same state to all potential tenants;

(4)  That approach does not involve giving the sitting tenant any advantage; and

(5)  Given the Tribunal’s findings that (a) the RA and NRA were designed and built together as an integrated system; (b) the tenement in its existing state could only be used with the existing NRA; and (c) the consequence that the HT and HL needed each other’s assets for the undertaking, it would seem inescapable that, on those grounds alone, the parties would have equal bargaining power.

96. In the premises, I therefore accept CLP’s submissions that, for rating purposes, given the interdependency of the assets, the Tenement practically could only be used with the existing HT’s assets.  As a result, I also accept that there is equal bargaining power between the HT and HL over the hypothetical renting of the Tenement.

97. In reaching this conclusion, I need not refer to and decide on CLP’s further argument in support of equal bargaining power based on the China Assets.  However, if necessary, I would have inclined to accept such an argument in light of what I am going to say about the China Assets at section G3.1 below.

G1.2   Competition for the hypothetical tenancy

98. To support her valuation model based on the WACC approach, CRV also submits that, given the competition for the tenement’s tenancy, it would drive the HT to accepting WACC as its share of the DB.  In this regard, other than adducing evidence by Dr Lam (CRV’s expert) on the potential bidders for the hypothetical tenancy as identified by him, CRV also relies on the submissions that, for rating purposes, the HL himself can and should be treated as a potential bidder. 

99. On the other hand, CLP’s position is that itself is the only realistic and likely bidder for the tenancy and thus practically there is no competition.  In support of this, CLP relies on Mr Brough’s evidence.

100. However, in light of the CFA HEC Judgment, this contest of evidence has become irrelevant because:

(1)  The CFA has in its HEC judgment confirmed that, at the date of valuation, the letting of the RA and the sale of the NRA at market value are to be valued in situ as a going concern[34];

(2)  CRV in these appeals has accepted that there would be three simultaneous transactions, involving the letting of the RA and also the sale of the market value of the NRA and the China Assets[35];

(3)  In the premises, given the interdependency of the RA and NRA (as I have concluded above), it follows that whatever may be the level of competition for the RA, that would also apply to the NRA and the China Assets. The level of competition is a factor common to the assessment of the values of each asset class;

(4)  As a result, whatever is the level of competition for the tenancy, it would not have the effect of driving the HT to a lesser bargaining power and accept WACC as it share of return from the DB. There is still an equal bargaining power between the HT and HL given the interdependency of the assets.

101. I therefore agree that the question of competition would not affect the balancing power between the HT and HL, and the existence of any competition would not support the WACC approach valuation as submitted by CRV.

102. For this reason, strictly speaking it is not necessary for the Tribunal to rule on the evidence concerning competition. 

103. However, for completeness sake, if necessary, I would have preferred the evidence of Mr Brough to Dr Lam’s evidence, and found that realistically, CLP is the only likely bidder for the tenancy of the Tenement. I will set out briefly in the following my reasons.

104. Dr Lam has identified a number of potential bidders for the hypothetical tenancy.  They are: (a) Hong Kong Electric Holdings (“HEH”) and Cheung Kong Infrastructure (“CKI”); (b) ExxonMobil; (c) electric power companies and investors in the Mainland comprising give power generation companies and two transmission companies formerly comprising the State Power Corporation; and (d) Singapore Power.  He also referred to infrastructure funds, energy private equity and sovereign wealth funds as potential interested entities bidding for the tenancy, such as Temasek Holdings, Government of Singapore Investment Company and China Investment Corporation.

105. He sets out in his reports and oral evidence his reasons and analyses as to why these are likely interested bidders for the tenancy and the way in which they would be investing in carrying on the generation, transmission and distribution of electricity business at the Tenement.

106. In relation to these, I accept Mr Holgate’s submissions that Dr Lam’s approach and analyses in identifying why these entities can be likely potential bidders are flawed for the following principal reasons:

(1)  Dr Lam’s approach is premised on an analysis that the bidders for tenancy are to be interested merely as investors in the shares of the company running the business, but not to supply entrepreneurial skills[36]. This is contrary to the rating principles that the valuer is not to assume that the incoming tenant is simply an investor in a business with a staff specifically provided for him so that he does not need to apply skill or judgment in the carrying on of the undertaking[37].

(2)  Dr Lam confirms in evidence that although the revenue of the business was based on PR x NBV (net book value) (as the protected profit under the SOC), he has assumed that the bidders would only receive WACC x NBV as a residual income[38]. This analysis is unreliable as demonstrated by his difficulty in answering the Tribunal’s question as to why it is then relevant for him to mention the attraction of the protected return to the market[39]. 

(3)   Further, this aspect of Dr Lam’s assessment is also internally inconsistent:  on the one hand, he has assumed that the bidders would be attracted by the protected PR, but on the other hand, he has not actually assessed whether the bidders would still be attracted to bid if the value of the investment was going to be pinned only to NBV.  This is underlined by:

(a)  CRV’s other expert, Prof Kalok Chan’s evidence that, in the examples cited by Dr Lam on the merger of some US large electrical companies, these companies must have been earning more than simply WACC x NBV, which was in line with the investor’s expectation[40];

(b)  Mr Brough’s evidence (which I accept, as this is consistent with Prof Kalok Chan’s above evidence) that “to argue that there would be plenty of companies willing to invest $6 billion in an electricity utility business where no margin above WACC was on offer once again reveals a lack of understanding about transactions in the real world”[41].

107. I thus find Dr Lam’s analysis not reliable for being away from reality, and thus also infringing the principle of reality.[42]

108. I am also unable to accept CRV’s submissions that, for rating purposes, the HL can and should also be considered as a potential bidder.  This contention was put forward by Mr Hatchwell, CRV’s rating expert, apparently relying on what Lord Hailsham has said in Southern Railway, supra, at 285 as follows:

“Since the landlord is to be contemplated as a possible tenant, more of these considerations must be allowed to come in.”

109. I again agree with Mr Holgate’s submissions that when this remark is read in the context of the case, Lord Hailsham must be taken to refer to the owner-occupier as a potential bidder for the tenancy in question, but not the hypothetical landlord.  Earlier on the same page in the report, Lord Hailsham has already referred to the principle that in estimating the rental value, it is necessary to take into account the owner of the tenement as a possible tenant.  The subsequent statement (as quoted above) should be read as referring to the same principle, where Lord Hailsham was developing the remark against making too elaborate a personification of the HT.

110. Moreover, I regard the proposition that the HL himself should be treated as a potential bidder untenable also for the following reasons:

(1)  The proposition does not make logical sense for the purpose of valuation.  As I pointed out at the hearing, if the HL could bid for the tenancy, he himself could effectively determine whatever the rent is, by deciding on his own how much his right pocket is to pay his left. This cannot be right for a proper rental valuation exercise to determine, which is to be premised upon the higgling of an open market with a willing tenant and a willing landlord, and where the HT not being too eager to rent and the HL not being extortionate.[43]

(2)  It is inconsistent with Lord Millet’s statement in the CFA HEC judgment that the HL cannot be the actual owner of the tenement (at paragraph 147(a)).

(3)  It is also inconsistent with the CFA’s decision (at paragraphs 163, 165 and 182) that the business undertaken on the tenement is the HT’s but not the HL’s, and the risks, obligations and rewards, must be treated as that of the HT alone[44].  In fact, Mr Hatchwell agreed in evidence that this was the case under the rating hypothesis[45].

(4)  It appears also to be inconsistent with the fundamental rule of property law that such a tenancy (the HL granting the tenancy to himself as HT) cannot be created[46]. 

111. Therefore, if I were required to do so, I would have accepted CLP’s evidence and concluded that realistically, the only likely bidder for the tenancy of the Tenement is CLP.

G1.3   Relative risks

112. It is CRV’s contentions that as between the HL and HT in the renting of the hypothetical tenancy, the HL bears a higher risk because of (a) the nature of the rent being residual[47], and (b) the fact that the HL faces uncertainty as to what rent will be payable on future reviews and whether it will in fact be paid.  In the premises, given the HL’s relatively higher risk, it is entitled (CRV further submits) to be allocated the share of the DB where the actual rates of return achieved exceeds the occupier’s risk rate for compensation of such higher risks.

113. I reject that, for rating purposes, the HL bears a higher risk as submitted.  I will explain why.

114. First, central to the higher risk argument is CRV’s submission that, at the time of the commencement of the tenancy, the HL has already invested substantially in the creation of the tenement while the HT has not.  However, this proposition is inconsistent with the principles in Southern Railway, where the House of Lords at pp 280-282 rejected the argument that because the HL had invested such a large sum of capital in order to create the tenement, he was entitled to a proportion of the DB that reflected that investment.  The House of Lords further held that (a) the tenant’s share had to be deducted first by giving the HT the return necessary to induce him to take and operate the hereditaments, (b) the HL’s share might be nothing at all or a low rent, (c) the HL was entitled to be paid a rent and nothing else, and (d) the HL was not entitled to a share of the net receipts.  The rejection of the “landlord has invested” argument was also endorsed by the CFA in the HEC judgment at paragraphs 156-157 and 163. 

115. Second, this argument is inconsistent with the CFA’s statement that the valuer should assess the contribution made by each set of assets to the DB on a “going concern” basis with the actual NRA in situ.  As such, not only has the HL invested in the RA, but the vendor of the NRA (ie, the outgoing tenant) has also invested in those assets too.  In the valuation, the market value of both the NRA and RA must be taken into account.  As such, the suggested distinction between the HL who has invested and the HT who has not is misplaced and not applicable for a proper rating valuation.

116. Third, in support of the argument, CRV submits[48] that it is important to distinguish between the “required” rate of return, the “expected” rate of return and the “actual” rate of return.  She further says that the HT’s share must be assessed on the basis of HT’s “required” return and not his “expected” return (the return projected by the investor based on his assumptions about the future).

117. This distinction is not a valid one in light of the CFA’s judgment in the HEC case.  The Tribunal in HEC adopted an asset-split valuation method.  It explained in its judgment at paragraphs 100 and 108(3) that part of the reasons for adopting this method was that the HT would look to the very profit he would expect to make, being one permitted by the SOC, in negotiating for the rent.  What this means is that the actual return from recent accounts was being used to determine the HT’s expected return for the first year of tenancy following the valuation date.  Lord Millet looked at this reasoning at paragraph 170 of the CFA HEC Judgment, and also described this at paragraph 169 as the company’s actual rate of return on its total ANFA.  The learned Non‑Permanent Judge then held that the Tribunal made no error of law in such an approach.  In other words, there is no legal principle requiring the HT’s return to be restricted to a required return as defined by CRV, or to the HT’s WACC.

118. Finally, as a matter of evidence, the suggestion that the HT and HL in the higgling of the market would take into account the factor that the HL bears a higher risk as he may not recover his cost of capital at some point is speculative at best:  Mr Hatchwell’s evidence under cross-examination in this regard is that[49]:

“Well I’m sure that both sides would look into the future and speculate about how the permitted return might relate to costs of capital, especially to changes in inflation. But it would be purespeculation. As we know, nobody – nobody in Hong Kong seems to produce long-term inflation forecasts. So it would be very difficult to do” (emphasis added).

119. In my view, a proper valuation exercise should not take into account such a speculative consideration.

G1.4   The “swings and roundabouts” argument

120. Under this argument, CRV says its valuation model which pins the HT’s share of the DB to WACC x ANFA throughout represents the only fair and proper valuation.  This is so as on the rating hypothesis, and on the facts of this case, the parties would have regard to the swings and roundabouts of the rent in the long term.  Given that the HL has already invested, whereas the HT has not, it is the HL who has been taking the burden of the fluctuations in the DB in previous years, especially when the cost of capital was high and little residue remained after the HT took his tenant’s share.  It is therefore (CRV further says) only reasonable and fair that this burden would be taken off the HL’s shoulders when the cost of capital falls.

121. It is thus CRV’s contention that, on the facts of this case[50], the CRV’s valuation method in pinning CLP’s share of the DB to WACC does take into account the “swings and roundabouts”, because when the cost of capital is low, the HL will have to suffer a low rent, whereas when the cost of capital is high, the HL can receive a higher rent, offsetting the burden of low-rent years.

122. This “swings and roundabouts” argument shares some similarity to the relative risk argument discussed above.  To a certain extent, it is premised on the contention that the HL thereby bears a higher risk in the renting out of the Tenement.  Further, the linchpin of this argument is also the notion that “the HL has already invested, whereas the HT has not”. In these regards, the swings and roundabouts argument should be rejected for the same reasons set out above concerning the relative risks contentions.

123. Moreover, I think CLP’s criticism that this argument is simply too uncertain and vague to apply as a valuation method is justified because:

(1)  No benchmark has ever been identified to show what is meant by a low rent.  This leaves behind relevant and important unresolved valuation questions, such as: low in relation to what? What should the HL’s rent otherwise have been but for the high cost of capital?

(2)  There is no purpose in the “swings and roundabouts argument” unless the valuers can understand what balance they should be trying to achieve. Otherwise they will not know whether a “higher” rent in later years is over‑compensating the HL for what he has previously suffered;

(3)  Mr Hatchwell accepts that he could not define a benchmark for valuers to apply.  In answer to my question as to why the HL is entitled to any particular part of the DB because of a low rent in the past, he relies on the WACC method in all rating years, but fairly accepts that that still does not supply a benchmark[51];

(4)  Mr Hatchwell also accepts that the “swings and roundabouts” concept did not help valuers to quantify the hypothetical rent. The argument (even if relevant and correct) could not be applied without knowing the market value of the RA and the HL’s cost of capital, which are unknowns[52]; and

(5)  None of the CRV’s other witnesses were able to add to Mr Hatchwell’s evidence.

124. I therefore do not accept the “swings and roundabouts” argument in support of CRV’s valuation model.

G2.   Whether the WACC approach should be adopted

125. Given that all the above fundamental bases and justifications raised in support of the WACC approach are rejected, I conclude that (as in the HEC case) this model under the R&E method for assessing the rateable value of the Tenement must be rejected.

G3.   CLP’s valuation model

126. Having rejected in principle the CRV’s WACC approach valuation method, I turn to consider the CLP’s valuation model.

127. Mr Davis for CLP has advanced three approaches (Approach 1, 2 and 3) in his valuation model.  For the purpose of my judgment, I will only look at below issues that arise from these approaches as a matter of principle.  It is therefore unnecessary for me to look into the detailed computations in each of these approaches, and I do not propose to set them out.  However, Member Lo would provide a comprehensive description of each of these approaches later in his judgment when he looks at each of them in detail.

128. There are three aspects of the CLP’s valuation model that require consideration by this Tribunal as a matter of principle: (a) its asset split approach, (b) the various adjustments proposed to be made in favour of the HT for its return, and (c) the incorporation of the CB method to the R&E method.

129. As I mentioned earlier, in dealing with a similar tenement, the Tribunal in the HEC case has approved and adopted the asset split approach but rejected the incorporation of the CB method and the adjustments proposed in that case.  Those conclusions have been upheld by the CFA. These are of course made in the context of the arguments and evidence raised in that case.

130. In these appeals, CLP says (adopting the decision in the HEC Case) the asset split approach is at least the starting position of the valuation.  It raises however further arguments (with the support of the evidence adduced in this case) to support the incorporation of the CB method and the various adjustments as proposed by Mr Davis.

131. As I understand it, insofar as the asset split approach is concerned, CRV opposes it (as in the HEC case) essentially on the bases of its arguments raised in support of the WACC approach. 

132. Given my above rejection of the WACC approach and those arguments made in its support, I will (as and also adopting the reasoning in the HEC case) approve and adopt the split asset approach in the present case in determining the HT’s share under the R&E method for assessing the Tenement’s rateable value. 

133. This leaves me the need to consider the remaining issues relating to the various adjustments and the adoption of the CB method under CLP’s valuation method.

G3.1   Adjustment for the China Assets

134. The China Assets consist of the generation, distribution and transmission of electricity through those assets (described above) located in Guangzhou in the Mainland. CRV also treats them to include the contract CLP had to purchase such electricity therefrom.

135. It is an unchallenged fact that the China Assets accounted for some 30% of the supply of electricity by CLP to Hong Kong customers in the relevant year. 

136. The question arises in these appeals regarding the China Assets is whether and how they should be taken into account in the rating valuation.

137. In this respect, Mr Davis (for CLP) in valuing the tenant’s share has made an uplift adjustment of 10% of the DB in favour of HT to reflect the China Asset’s contribution to make up the deficiency in the generating capacity of the CLP tenement.  He did it by taking account of the proportion of the total electricity which had been supplied from China (31.17% in 2004/5), and made an uplift in the value of the generating assets which notionally would be necessary to overcome the deficiency in the Tenement.  He then made a valuer’s adjustment to further fine tune the percentage of the adjustment to take into account that the notional asset conversion and calculation may overstate the tenant’s position because in some other years, there may have been excess generation capacity within Hong Kong[53]. 

138. It is important to note that Mr Davis’ above adjustment is made only to reflect the bargaining power that the HT would apply to negotiations influencing the splitting of the DB.  It is (Mr Davis made it clear) not to reflect the cost of these investments in China nor the profit earned by companies within the CLP Group from the sale of this electricity via the CLP contracts into the SOC business[54].

139. On the other hand, CRV contends that the China Assets should not be taken into account for the purpose of rating valuation, as they are not assets within Hong Kong nor in fact owned by CLP[55].  Moreover, what (CRV submits) in substance of relevance of the China Assets is that CLP has a contract to purchase electricity from China generated and transmitted by the China Assets.  Looked as such, this is no different from a supply contract, for example, to supply coal or other raw materials to CLP (for the purpose of generating electricity in Hong Kong).  The effect and value of such contracts have been reflected in the expenses of the accounts, which are absorbed to produce the DB.  As a result, no further adjustments would be required to reflect their contribution, if any.

140. Before I look into these competing arguments, I think it is right to first set out some of the general observations made by the CFA in the HEC case on rating valuation of such tenement (as helpfully summarized by Mr Holgate) as follows:

(1)  The R & E method uses the divisible balance to represent the profits of the undertaking carried on as a going concern derived “from all assets employed in it” (paragraph 184);

(2)  Consequently the valuer must take into account all such assets, but should exclude from the value of the tenement assets used in the undertaking but which do not form part of the tenement (paragraph 137);

(3)  The non-rateable assets must be valued in situ as part of the going concern (paragraph 187);

(4)  The valuer must assess the economic value of the contribution made to the DB by the NRA (paragraphs 181-2 and 184);

141. CRV has accepted that the China Assets should be treated in the same manner as the NRA[56]. In light of this acceptance, I accept Mr Holgate’s contention that the references to NRA by the CFA in the above observations should be equally applicable to the China Assets, given that they contribute economically to the DB by enabling CLP’s earning of a significant proportion of the gross receipts.

142. As a result, I further accept that in the rating valuation of the Tenement, regard must have had to the China Assets to reflect their significant contribution to the generation of the profits of the undertaking. 

143. Mr Davis’ proposed treatment of the China Assets as summarised above at paragraph 136 is in line with treating the China Assets in the same manner as NRA (as CRV has accepted), but at the same time reflecting the fact that they do not form part of the NRA in Hong Kong.

144. I therefore accept Mr Davis’ proposed treatment of China Assets as a matter of valuation. As to whether the 10% allocated is a fair and reasonable one, I would leave this to Member Lo to look into it later in this judgment.

145. Further, I reject CRV’s submission that, for rating purposes, the China Assets should be treated as any other supply contracts CLP has.  I think the salient distinction is that those supply contracts are related to or for the purpose of generation of electricity in Hong Kong by the Hong Kong NRA.  For rating purposes, electricity so generated in Hong Kong by the Hong Kong NRA (and thus its contribution to the gross receipts) has already been taken into account by the asset split approach valuation.  Thus, it is unnecessary and inappropriate to have a separate adjustment.  This is entirely different from the China Assets’ contribution to the gross receipts, which cannot be reflected in the asset split approach valuation.

146. CRV has also raised a number of other contentions as to why the China Assets should not be taken into account for rating purposes.

147. In gist, these contentions are:

(1)  The China Assets are replaceable through various alternatives as suggested by Dr Lam and adopted by Mr Hatchwell and Ms Jim in evidence (for CRV).

(2)  Mr Hatchwell accepts that the China Assets would have to be acquired by any incoming HT at their market value. However, he considers that the said market value of the China Assets should be taken to their NBV because the SOC uses NBV for assets valuation of the NRA. He makes no distinction in terms of treatment between the China Asset and the NRA recognized in the SOC[57].

(3)  Mr Hatchwell accepts that, the Tenement differs from the HEC tenement in that the former does not enable 100% of the power needed for the catchment to be generated and supplied, and that the difference should be reflected in a deduction comparing the CLP tenement to the HEC tenement.  However, he considers that the adjustment would be sufficiently made by allowing the HT to deduct the cost of purchasing the power from China[58].

148. I do not accept CRV’s above arguments.  My reasons are as follows.

149. First, given the CFA’s general guidance as summarized above, replaceability of the China Assets itself is irrelevant to the valuation and assessment exercise.  This is underlined by Mr Hatchwell’s acceptance (rightly so) that any incoming HT would have to purchase the NRA and the China Assets at their market value as a going concern and in situ.  This is in line with CFA’s observations.

150. Second, and in any event, as a matter of evidence, CRV has failed to satisfy me (through Dr Lam’s evidence) that the 30% demand could be satisfied without the said nuclear power generated by the China Assets by alternatives.  I will explain why.

151. Effectively, Dr Lam has suggested that the said demand could be met alternatively without nuclear power:

(1)  The electricity generated by the nominal rated capacity of BPPS, CPPS A and B and Penny’s Bay together with the maximum output from the Pumped Storage facility in Guangdong.  Further, he said the installation of the deferred units 7 and 8 at BPPS could be brought forward.

(2)  For 2005, he said that a new HT could install 300MW with additional gas turbines or contract with HEC to provide additional reserve capacity of an equivalent output.  Any further increase in output for subsequent years could be met by the new HT entering into contracts to buy hydropower from the Mainland.

(3)  Dr Lam further gives evidence that:

(a)  CLP had 6883MW of capacity in Hong Kong together with the Pumped Storage capacity to meet actual demand of 6329MW in 2004;

(b)  The reserve capacity (which was about 1549MW) CLP was required to maintain could also be satisfied in the following manner:

(i)   554MW: being the difference between installed capacity and demand (6883 – 6329MW);

(ii)  625MW: by bringing forward the commissioning of Units 7 and 8 at BPPS;

(iii)  352MW: by re-commissioning the 2 remaining gas turbines at CPPS and the reinstallation or fitting as new of 4 gas turbines;

(iv)  repowering of coal-fired units at CPPS to produce about 50% more capacity;

(v)  300 or 350MW: by using the reserve from HEC.

152. I do not accept Dr Lam’s said evidence establishes the alternatives to replace the China Assets to meet the demand:

(1)  Even taking his evidence to the highest, as demonstrated by CLP in a table provided in its Closing Submissions, there is still a substantial deficit in the supply of electricity to meet the demand for 2004 without utilizing nuclear power.  For convenience, I have reproduced the table in the Appendix to this judgment.

(2)  The evidence to suggest the use of Units 7 and 8 of BPPS, the gas turbines at CPPS and repowering offend the rebus principle or the use of HEC reserve is simply not available.  These therefore for rating purposes cannot be taken into account.

(3)  Furthermore, the suggested use of these proposed alternatives is in my view speculative in nature.  None of these are supported by any concrete or substantive evidence on the estimates of the estimated output of these alternatives, nor the reliability of these sources. On the contrary, Mr Lancaster of CLP has given evidence and explanations as to why these alternatives are either not reliable (which must be viewed in light of the requirement under the SOC for CLP to provide stable electricity), or they simply do not generate the level or amount of electricity that Dr Lam suggested that they would[59]. I accept Mr Lancaster’s said evidence, given his obvious personal experience in these matters as the Managing Director of CLP. 

153. Third, the suggestion that the allowance of operating expenses would be sufficient to account for the contribution made by the China Assets to deal with deficiency in the CLP tenement was (a) inconsistent with Mr Hatchwell’s treatment of the contribution to monopoly made by the landlord’s assets, and (b) also contradicted by his own evidence on the valuation significance of the transmission system in China needed to transmit the 30% (base load) supply to Hong Kong.  I will elaborate these points.

154. Mr Hatchwell in evidence accepts that:

(1)  In functional terms, the transmission system in China (as part of the China Assets) is just as important as the transmission system in Hong Kong, at least for the supply of 30% of the total electricity demand.  Thus, the China transmission system is performing a similar function to the transmission and distribution system in Hong Kong and is therefore contributing to the MOP[60].

(2)  However, he could not rely upon the MOP attaching to the RA as a justification for not valuing those assets on NBV basis as provided in the SOC, without also applying the same logic to the China transmission system[61].

(3)  In answer to my question, if part of the HT’s assets contributed to MOP, then they should be valued on a market value basis (being the present value of the income stream attributable to those assets), which would be higher than NBV or even DRC[62].

155. As such, the suggestion that the China Assets valuation for rating purposes could be dealt with simply by expenses deduction is inconsistent with Mr Hatchwell’s own above evidence.  This must therefore be rejected.

156. I therefore accept in principle that, for valuing the rateable value of the Tenement, it is necessary to make the China Asset uplift.

G3.2   Adjustment for effort and risks

157. Mr Davis makes adjustments in his valuation in favour of the HT to reward HT’s efforts and compensation his risks in taking up and running the business at the Tenement.

158. In the HEC case, HEC’s valuer Mr Parsons also sought to award a 25% of the DB to the HT for effort.  The Tribunal rejected HEC’s said claim on the basis that HT’s effort had been reflected in the payments of salary and bonuses made to the directors and staff of the company, which had further been reflected in the expenses deducted from the gross receipts before arriving at the DB.  There was therefore no basis to separately make a reward for effort and industry by an additional share of the DB. 

159. In the present appeals, Mr Holgate submits that we should reconsider the proposition and depart from our judgment in the HEC case. As we understand it, Mr Holgate’s main submissions in support for justifying an separate award for effort and risks are that:

(1)  Under the authorities of St James and Pall Mall Electric Light Co Ltd v The Assessment Committee for the City of Westminster[63]and Southern Railway[64], the elements of risk and effort are regarded as separate items from the interest return on capital for the purpose of deciding what should be the HT’s share to induce it to take up the tenancy.  Thus, as a matter of principle, in assessing the HT’s share under the R&E Method, it is justified to award the HT separately for risk and effort in arriving at the HT’s share.

(2)  Further, the Tribunal in Cross-Harbour Tunnel v CRV[65]has similarly accepted the commissioner’s valuer’s assessment and awarded separately for the HT’s effort and risks.

(3)  Given that the HT is expected to take up and operate the business on its own, but not acting as a mere investor[66], it therefore has to put in its own effort and to bear its own risk in so taking up and running the business.  There should thus be a proper reward for such effort and risk. 

160. With respect to Mr Holgate, I do not think the above submissions assist him to justify a separate award for effort and risk for CLP.  The followings are my reasons.

161. Insofar as St James and Pall Mall and Southern Railway are concerned, what their Lordships are saying in those cases is that, in determining to allocate the HT’s share by way of a percentage, that allocation should reflect the elements of (a) interest on the HT’s capital, (b) reward for effort, and (c) compensation for risk, so as to induce the HT to take up the tenement and run the business there.  What that percentage ought to be is a question of fact. 

162. Thus, Lord Hailsham says in Southern Railway at p 288:

“… He [the HT] is a person embarking upon a commercial undertaking in which he is to sink his capital, in which he takes all the risks of success or failure, and in which he has not merely to be compensated by receiving a reasonable interest upon the capital invested, but also to receive such a profit upon his venture as reasonably to compensate him for the risk which it involves and to induce him to embark upon its prosecution. How much that percentage ought to be is a question of fact which is for the [Assessment Authority] and not for Your Lordship’s House.” (emphasis added)

163. However, in my view, these observations in the authorities do allow the valuer to valuate the HT’s share by either (a) awarding a single percentage of the DB to globally represent all these three elements, or (b) having a separate percentage allocated to each of these elements.  As to which of these approaches provides the more appropriate valuation in a particular case, it would depend on the evidence and circumstances of that case.

164. Thus, in the Cross Harbour Tunnel case, the valuer for the ratepayer advocated a global approach while the valuer for the Commissioner went for a separate approach[67]. Although the Tribunal in that case preferred the Commissioner’s valuer’s approach in light of the evidence in that case (which I would say more later), it did not as a matter of principle reject the global approach as a possible basis of valuation.

165. In relation to the present appeals, in my view, the percentage allocation based on an asset split approach already provides a proper valuation to globally represent the interest on capital, the reward for effort and the compensation for risk in the present case:

(1)  The asset split approach provides CLP with a return already significantly and obviously higher than the interest on capital.  This therefore covers something significantly more than just the interest on capital, and includes the other two elements.

(2)  Insofar as a reward for effort is concerned, we maintain the view as expressed in the HEC LT Judgment that the reward has been sufficiently or at the least largely reflected by the remuneration and bonuses paid to the directors and staff of CLP.  CLP (or the HT) manages and runs the businesses through the directors and staff.  Such directors and staff have been rewarded through their remunerations.  These are treated as expenses and are then deducted from the gross receipts before arriving at the DB.  There is no evidence in the present case which shows that other than through the board of directors and staff, the HT (as and qua shareholder of the company running the business as contended by Mr Holgate) has expended some extra significant effort in taking up and running the undertaking[68].  In the premises, other than the reward that has been already covered by the global reward made under asset split approach, it is not necessary to make a further reward for such insignificant effort.

(3)  In terms of compensation for risk, we have accepted above CLP’s own contention that, in relation to the Tenement, the risk level for HL and HT is roughly equal.  On that basis, as a matter of valuation, I think the global percentage reward provided under the asset split approach would be sufficient to cover any compensation for HT’s risk in taking up the tenancy and carrying on the undertakings.  This is to be contrasted with the Cross Harbour Tunnel case, where the Tribunal after examining the evidence in that case came to the conclusion that, in relation to that tenement, the HL bore almost all the risks. Thus, the HT should have a lower share of the DB to reflect the very little risk it had to bear.  It was on that basis that the Tribunal accepted the Commissioner’s approach to award separately for each of the items of interest, effort and risk, as this would result in a lower figure of the HT’s share than what the global approach advocated by the ratepayer would achieve (see pp 94F-99G).  This is underlined by the Tribunal’s observation (at p 88G) that, whichever of the approaches that was adopted, it was the actual amount arrived at that mattered.

166. For these reasons, I reject CLP’s case that, in addition to the asset split percentage, in valuing the HT’s share, there should be an a further separate award to CLP for effort and risks

G3.3   Sandown Park Adjustment

167. CLP also relies on the Sandown Park adjustment arguments to support those adjustments made by Mr Davis. 

168. CLP submits that, even applying the asset split approach, there should be a further adjustment made in favour of CLP in dividing the DB in light of the sheer size (ie, largeness) of the rent to be valued for the Tenement.  CLP relies on the case of Sandown Park Ltd, supra, in support of the proposition.

169. In relation to what circumstances that may warrant such an adjustment, Lord Somervell said in Sandown Park at p 369 as follows:

“It may well be that in dealing with commercial undertakings questions may arise which would not arise in dealing with public utilities. In many cases public utilities are restricted as to their profits or rates of interests and so on. Commercial undertakings may show when the deductions have been made a large residue which cannot be regarded as rent.” (emphasis added)

170. Lord Romer also observed at p 375 that:

“It is suggested that Lord Cave’s formula is only appropriate to public utility undertakings, and that it must be varied, if applied to business enterprises, as least to the extent of regarding as equally relevant the rent which a landlord would be willing to accept as rent which a tenant would be willing to pay. I am not altogether satisfied that the distinction between undertakings, of which the profits are fixed or limited on the one hand, and ordinary commercial undertakings on the other, logically justifies this or any other general variation in treatment – although the principle, as usually applied, might require some modification in certain cases, eg where the relevant net profits are extremely high.” (emphasis added)

171. What their Lordships have said in Sandown Park shows that whether a Sandown Park adjustment is justified must be dependent on the facts of each case.  In my view, given that (a) such an adjustment is to be considered after a valuation has already been carried out, and (b) valuation is not an exact science, a Sandown Park adjustment must be left to those cases where the largeness of the amount of the rent so arrived at after a valuation is so clearly and obviously disproportionate in light of all the circumstances.

172. In the circumstances of the present case, I am not satisfied that the rent arrived at by the asset split approach valuation exercise is so large that I would regard it as clearly disproportionate.  This is particularly so given CLP’s own case (and as found above) that the HT’s assets and the HL’s assets (and thus the Tenement) are interdependent to generate the profits of the undertakings. 

173. As a result, I do not find that there is any justification to have a Sandown Park adjustment in the present case.

G3.4   CB method

174. Although it is common ground that the R&E method is the principal valuation method that should be adopted for assessing the rent for the Tenement, Mr Davis has incorporated the inputs obtained from the CB method in one of his approaches[69] in his valuation as an adjunct to reach what he regards as the proper valuation of the rent. 

175. This raises therefore the question of whether the CB method should be so adopted as an ancillary to the R&E method in the present case.

176. Before I look into at arguments under this issue, it is pertinent to first look at generally what the CB method is as a valuation method.

177. In this respect, the following about the CB method are uncontroversial.

178. The CB method is one of the valuation methods, which is sometimes used to evaluate the rateable value of a tenement.  In essence, it is a method valuating the rent of the subject tenement by reference to what would have been the construction cost of an alternative tenement similar to the subject tenement if the tenant were to build one.  The interest that the tenant could have earned over this construction cost, as the theory goes, would represent the highest rent that the tenant would be willing to pay for the subject tenement, because if the rent asked for is higher than this, the tenant would rather go to build for his own, instead of paying rent.^[70]

179. It is common ground that the CB method has been in practice applied in five stages:

(1)  Estimate the replacement cost (or cost of construction) of the site works, buildings, rateable structures and rateable plant and machinery (“P&M”).

(2)  Adjust the cost of construction to reflect differences between the actual tenement to be valued and the imaginary alternative so as to arriving at the ‘effective capital value’ (“ECV”) of the tenement.

(3)  Estimate the value of the land (for the use to which the tenement is put) and add this to the result of stage 2.

(4)  Decapitalise the sum of Stage 2 and Stage 3 by the appropriate interest rate.

(5)  Stand back and look at the result of Stage 4 and make any further appropriate adjustment.

180. However, the CB method has been criticized by rating professionals as unrealistic, on the ground that the HT does not sometimes in practice have the choice between renting the property as an alternative for himself.  It has been said that the CB method is an unjustifiable departure from reality to make an assumption that either the HT, or someone else, could or would build an alternative, or that someone has already built an alternative which happens to be available at the valuation date. To adopt such assumptions also introduces considerable scope for dispute over the location of the alternative, the time it might take to build it, the arrangements for paying the costs of building and other imponderables.^[71]

181. Similar issue arose in the HEC case:  HEC’s valuation expert also in that case sought to incorporate the CB method in its proposed R&E valuation to provide what was regarded as a tool to facilitate the stand back and look to see whether the rent so valued was a fair one, or whether further adjustments needed to be made.

182. This Tribunal in the HEC LT Judgment concluded that the CB method was not a reliable, realistic or an accurate method to assess the rateable value of the tenement, and should not be adopted for the principal reasons that[72]:

(1)  It cannot reflect the value of the tenement’s monopoly of place or synergy value, and therefore its profit-making abilities.

(2)  It is premised on the unrealistic assumption that the HT could build an alternative tenement for the generation, supply and distribution of electricity.

(3)  Because of this unreliability, CB method is not useful even as a cross-check.

183. I am of the view that the same reasons must apply with equal force in the present case, given that the same synergy value and MOP contribute to the profit-making abilities of the Tenement.  As a matter of evidence, CLP’s own experts readily accept the same[73].

184. In the circumstances, inputs from the CB method similarly could not provide any useful or reliable further adjuncts to the R&E method for fairly assessing the rent^[74].

185. Mr Holgate however seeks to persuade the Tribunal to reconsider and depart from the above conclusion. 

186. Leading Counsel suggests that there is a second rationale for the CB method to be used as an adjunct, relying on the English Lands Tribunal’s comment in Monsanto plc v Farris [1998] RA 107 at 178, where the Lands Tribunal said:

“Simply put, the rational of the method of valuation is that those negotiations fall to be conducted upon the basis that the hypothetical landlord owns an investment, an asset, in respect of which he seeks a reasonable return upon its capital value and they hypothetical tenant is willing to pay that amount by way of rent.”

187. I accept Mr Yu’s submissions that in saying that the rationale of the method of valuation was that the rental negotiations fell to be conducted on the basis that the HL owned an investment in respect of which he sought a reasonable return, the English Lands Tribunal was not seeking to put forward an alternative rationale for the CB method.  The Lands Tribunal prefaced this part of the judgment with the observation that the economic framework for the CB valuation needed to be preserved to avoid valuation in a vacuum, and that entailed retaining the fundamental Dawkins[75] tenet of “the tenant’s alternative”.  This comment of the English Lands Tribunal could not possibly be construed to strip the CB method of this element of artificiality, which informs the basis of the method.

188. Mr Holgate also argues that if the HL’s asset values cannot be correctly calculated before the rent is known, the same circularity must also apply to the HT’s assets, so that when carrying out the R&E valuation, no matter whether NBV or DRC is used for the HT’s assets, this also builds in an assumption about the value of the HT’s assets, and since the HT’s assets also have monopoly and synergy value, this mis-values the HT’s assets.

189. The circularity problem (in relation to CRV’s attack on the asset split approach valuation) has been flatly rejected in the CFA HEC Judgment at paragraphs 178 and 179 (endorsing paragraphs 109-110 of the HEC LT Judgment), where Lord Millet says as follows:

“178. The circularity problem. This resurrects the ‘circularity problem’ identified by the Commissioner which the Lands Tribunal rejected. The problem, she said, is that one cannot determine the net return which the HT would require (i.e. the return after payment of rent), and so the rent which he would be willing to pay, without first knowing the amount of the rent. The only way out of the conundrum, according to the Court of Appeal, was to make an assumption as to the rent, which was not what the SOC or the Rating Ordinance required. In my opinion the Lands Tribunal was right to reject the argument. If accepted, it would preclude recourse to the R&E basis of valuation approach in every case, despite the fact that it is a long recognised and well established method of determining rateable value.

179.    The Court of Appeal thought that the logic of the Commissioner’s submission was difficult to fault.  In fact the fallacy which it involves is easily exposed.  It is true that the R&E method of valuation seeks to ascertain the net return, that is to say the return after paying rent, which the HT would require from his occupation of the tenement, and proceeds to deduct this from the divisible balance in order to determine the rent which he would be willing to pay.  But the rent is not paid out of the HT’s share of the divisible balance, which is net of rent, but represents what remains after deduction of the HT’s share.  If a given sum is composed of two components, it is possible to quantify either by quantifying and deducting the other.  No circularity is involved in such a process.”

190. Lord Millet’s analysis applies equally herein.  On this basis, Mr Holgate’s argument must also be rejected.

191. CLP also criticises that the use of the R&E method alone for being removed from the subject matter of the valuation, in beginning with the gross revenues. 

192. I do not agree.  Since the value of the Tenement lies in its profit making ability, it is appropriate to take the revenues as a starting point.

193. Moreover, given the special features of the Tenement – its monopoly of place, its synergy value, and its use in providing the indispensable utility of electricity to its supply area (thereby generating a steady and reliable profit stream), it has been repeatedly said that the R&E method as a valuation model is “particularly appropriate”.  See for examples:

(1)  Joint Forum’s Guidance Note at paragraphs 3.4 to 3.6, where it is stated:

“Where the nature of the occupation of the property is primarily concerned with achieving anticipated profit, and the tenant’s rental bid is, therefore, likely to be based upon a consideration of receipts and expenditure, then in the absence of reliable rental evidence, the R&E method may be the most appropriate method of valuation to adopt.

It is considered particularly appropriate to use the R&E method where receipts are derived from some monopoly attaching to the property. Monopoly value may be derived from law, e.g. by way of licence, or from geographical location or sometimes from a combination of both.

It should be noted that the foregoing considerations do not preclude the use of either the rental/comparative method or the contractor’s basis in appropriate cases. Indeed, a valuer may need to use more than one method to arrive at a proper value.  However, where either the relevant evidence does not exist, or the amount of adjustment needed is so great that the reliability of these alternative methods is seriously affected, the R&E method may be the only, rather than the preferred, method of valuation.”

(2)  Scottish Greyhound Racing Co v Glasgow, Rutherglen and Edinburgh Assessors [1947] SC 380 at 393, per Lord Jamieson:

“… The matter is, I think well put by Mr Armour in his work on Rating at p.158 where he says ‘where the premises are particularly advantageous for the special trade, so that it cannot be transferred without injury, then the profits of the trade form an element in the value and appear in the Roll indirectly; and where the trade is so much a part of the occupation that it cannot be carried on elsewhere, as in the case of railways, waterworks &c., then the trade profits become the direct basis upon which the value must be estimated’.”

    See also 406-407, per Lord Keith.

(3)  VOA Rating Manual, Section 371 (electricity distribution networks), paragraph 7 states:

“Historically, the R&E has been the preferred method of valuation and for a period of time was, by rule of law, the only method of valuation for public utility undertakings. The rule, established by the House of Lords in Kingston Union Assessment Committee v Metropolitan Water Board [1926] AC 3311 was that the profits basis should, in the absence of special circumstances, be adopted for utilities. There were no reported cases of ‘special circumstances’ to the extent that the basis was applied to a loss making port to give a nil rateable value (British Transport Commission v Hingley (VO) (1961) 8 RRC 68. However, the rule was abolished from 1 April 1990 by regulation 3 of the Non-Domestic Rating (Miscellaneous Provisions) (No 2) Regulations 1989…

Accordingly, we must consider both the contractors and the receipts and expenditure as possible methods of valuation. The following factors are relevant:

- the property is occupied for profit. All the DNO [Distribution Network Operators] are owned by shareholders whose sole interest in the property is to generate profit. Therefore, it is profit which drives the value for the actual occupier,

- to generate those profits, the DNOs must occupy the network – it is an effective monopoly. They could not generate the revenue without occupying the property and they could not build or rent a similar property elsewhere. Therefore, the link between the occupation of the property and the profits of the business is very strong, and

-the revenue and expenditure associated with the property can be identified with ease as the DNOs are required to ring fence their operations and publish regulatory accounts.

These factors all support strongly the use of a receipts and expenditure valuation. In the real world the actual occupiers make their business decisions by examining the receipts and expenditure associated with occupation. In the rating world, the hypothetical tenant would do the same. Therefore, the VOA has adopted a receipts and expenditure method for the 2005 revaluation of electricity distribution network hereditaments.”

(4)  See also: British Telecommunications plc v Central Valuation Officer[1998] RVR 86 at 95-96, and Sanderson, “The Value of the British Telecom”.

194. CLP also argues that the CB method could capture the monopoly value at Stage 3 with land valuation.  In particular, it is Mr Child’s evidence (for CLP) that the “shoe-box” residual valuation approach would capture the monopoly or synergy value.  What he makes in this point is that the values arrived at by the residual method give each component part of the tenement their optimum value which might well be in excess if their ordinary industrial value by, for example, assuming a minimum plot ratio of 1.  Therefore, even though they are valued on an individual basis, the value of the totality would not necessarily be different[76].

195. I am unable to accept this analysis:

(1)  One of the main shortcomings of the CB method in valuing tenement of the present nature is that there are simply no or no sufficient comparable land elements to provide for a reliable and meaningful land valuation.  As Mr Child acknowledges when questioned by Member Lo, there are simply no comparables in the present case.  Member Lo further points out that any adjustments made under the shoebox approach, or for marine rights, are really to take into account the structure of the land and have nothing to do with the special use of the land.  Although Mr Child seeks to suggest that with the values derived, it could properly reflect the value of the land as used in the Tenement after such adjustments, he accepts that no adjustment is made to take into account the fact the land formed part of a synergy as a whole[77]. Such a contention is therefore simply not available and I do not accept it.

(2)  Thus, whatever residual method Mr Child advocates to use, it would start off on an unreliable and wholly artificial basis.  This renders the valuation itself unreliable.

(3)  In any event, Mr Child’s views that the residual valuation would capture the synergy value and monopoly value are made in a speculative and uncertain manner[78].

(4)  Moreover, even taking Mr Child’s above analysis to the highest, the so-called capturing of the synergy and monopoly value is in a very different nature from what a meaningful valuation exercise should be looking at in a tenement of this nature: it is the very significant profits which could only be generated from it through the synergy and monopoly values.  This simply is not or cannot be properly reflected in the land valuation exercise suggested by Mr Child.

196. I therefore reject CLP’s contention that the CB method could meaningfully and reliably capture the type of synergy and monopoly values embodied and specific to the tenement.

197. For the above reasons, I do not accept Mr Holgate’s submissions and maintain the view that inputs CB method should not be adopted in the valuation of the rent of the present Tenement for rating purposes.

G3.5   CRV’s further criticism of the CLP model on circularity

198. Finally, I think it is only correct for me to mention that CRV advances in the present appeals also an attack on CLP’s asset split approaches of valuation on the basis of circularity.  In essence it is contended that these approaches result in circularity (and thus impossibility) on how to work out the rent. 

199. CRV advanced the same argument in the HEC case, which was rejected by this Tribunal.  Although found favour by the Court of Appeal, the contention was finally similarly rejected by the CFA.  Lord Millet gave the reasons at paragraphs 178 and 179 as quoted above in paragraph 189.

200. For the same reasons, I similarly reject the circularity criticisms.

G4.   Extent of the Tenement

201. After dealing with the models of valuation as advanced.  I would move on to look at the parties’ disputes as to whether certain assets should or should not be included as part of the Tenement and be rated.

202. The disputed assets are:

(1)  Assets under construction (“AUC”).

(2)  Dedicated substations.

(3)  Tenant’s machinery.

G4.1   AUC

203. It is CLP’s position that AUCs are non-rateable as they are not capable of occupation.  Thus, in the valuations put forward by Mr Davis, he has made deductions reflecting the value of the AUC.

204. On the other hand, it is CRV’s position that AUC are rateable.  This is what the CRV has done in assessing the rates of the Tenement. In support, Mr Yu relies on the Court of Appeal’s decision in the HEC case, where it was held (reversing the Tribunal’s conclusion) at paragraphs 84 to 100 that AUC were rateable.

205. Alternatively, CRV says even if the AUC are non-rateable per se, no deductions should be made in the valuation exercise because they do not generate any revenue, and its presence would not affect the DB.

206. The CFA has reversed the Court of Appeal’s decision on AUC.  Ribeiro PJ has held at paragraphs 7 to 91 of the CFA HEC Judgment that AUC fall outside the scope the tenement and are not rateable.  In particular, His Lordship at paragraphs 55 to 56 adopted and explained the CFA’s earlier decision in Commissioner of Rating and Valuation v Agrila Ltd[79] and confirmed that, the legal test for determining whether land, a building or a structure under construction or development has reached a stage constituting it a rateable tenement for the purpose of the RO is by asking whether the property is capable of meeting the four requirements as to (a) actual occupation or possession; (b) which is exclusive for the particular purposes of the occupier; (c) of value or benefit to the occupier; and (d) not for too transient a period.

207. Given the CFA’s decision on the non-rateability of AUC for the purposes of the RO, there is no question that the AUC in the present case should be included for rating purposes.  It is thus incorrect for the CRV to have included the AUC in the Tenement for rating valuation.  Her assessment must be wrong on this basis alone.

208. That leads me to discuss CRV’s alternative contention that, even if the AUC are not rateable, there should however be no reduction in the valuation exercise.

209. CRV advanced a similar argument in the HEC case (see paragraph 92 of Ribeiro PJ’s judgment).  The CFA rejected the argument and held that (at paragraphs 94-98 and 152):

(1)  The statutory hypothesis in s 7(2) of the RO involves rating by reference to “the value” to the HT of occupation of the tenement.

(2)  Although the hypothetical rent may be assessed by using the R&E method, the profits estimated to flow from occupation of the tenement are only evidence to guide the rates assessment or the rent which the HT would be likely to give.  But profits are not rateable.

(3)  AUC should be excluded both (a) from the body of assets constituting the integrated business which produced the actual receipts, and (b) from being treated as part of the tenement for which the hypothetical rent is being assessed.

(4)  The CRV failed to make exclusion (b) above when assessing the hypothetical rent for the tenement.  An adjustment is thus required so that the rating hypothesis is applied to the correctly identified tenement and not a tenement inflated by assets which out to be excluded. 

210. In light of the CFA’s above conclusions, it is in principle correct for Mr Davis (for CLP) to have made those relevant deductions in the valuation.

211. Mr Yu for CRV however further submits that the test of rateability is in any event satisfied where the asset is capable of occupation.  Therefore, in the present case in relation to the subject rating year, those AUC which had been completed and were either waiting for commissioning or were not in commission were in any event capable of occupation and thus rateable.  For these completed but not commissioned assets, CLP cannot (Mr Yu further says) claim any deductions. 

212. I do not accept these submissions. 

213. As I summarized above, the CFA has in substance confirmed that, in order to be rateable, the asset must meet the four requirements, including that it is or capable of beneficial occupation (thus usage) to the HT.  In my view, completed but not commissioned AUC are not ones which are or are capable of beneficial occupation or usage to the HT.  In this respect, I accept CLP’s submissions that, for the present purpose, until the buildings or structures are in commission and connected to the generation and distribution system, they are functionally useless for their intended purpose, and thus do not provide the HT any beneficial usage.  This is particularly so as I have held above that the NRA and the RA are functionally dependent upon each other.

214. It is therefore correct as a matter of principle to make corresponding and appropriate deductions in the valuation exercise to reflect such assets.

G4.2   Dedicated substations

215. At the end of 2003, CLP had 11,247 distribution customer stations.  They can be subdivided into two categories (a) those substations which provide power only to the building in which they are situated (“the Dedicated Substations”), and (b) those substations which provide power to two or more buildings (“Non-Dedicated Substations”).

216. CRV concluded that both of these substations form part of the Tenement and thus had included them in her valuation for rates.

217. Although accepting that the Non-Dedicated Substations are rateable, it is CLP’s contention that the Dedicated Substations are not. 

218. As mentioned above, it is now confirmed in the CFA HEC Judgment that whether a building or structure is rateable is to be determined by whether it is of capable of meeting the four requirements as listed above.

219. In relation to the Dedicated Substations, given that they are provided for in the building where the power is to be supplied, the “room” so provided for in the relevant building to house the substation thus belongs not to CLP but the building (and thus the owners of that building). That raises the question as to, for rating purposes, whether CLP can be regarded as in occupation of the substation. 

220. This question is to be determined by seeing whether CLP can be regarded as having in paramount occupation vis-à-vis these substations[80].

221. What amounts to paramount occupation is a matter of degree and control over the subject matter structure or building, and is to be determined on the facts of each case.  As said by Lord Russell in Southern Railway[81], the degree of control must be examined in each case, and the examination must be directed to “the extent to which its exercise would interfere with the enjoyment of the occupant of that premises in his possession for the purposes for which he occupies them, or would be inconsistent with his enjoyment of them to the substantial exclusion o all other persons”.

222. The question should also be looked at by reference to the nature of the tenement in question.  See: Vtesse, supra, paragraph 33.

223. The main reason advanced by CLP to support the contention that the Dedicated Substations are not rateable is that CLP does not have paramount occupation over them.  On the other hand, CRV’s case that they are rateable is premised primarily on the suggestion that CLP has exclusive possession over them.

224. It is common ground that the following evidence (as provided in the expert report of Mr Rose for CLP) is relevant to the determination of whether CLP has paramount or exclusive occupation over the Dedicated Substations:

(1)  The majority of substations form part of a building owner’s (“the customer”) development.  The customer requires an electricity supply for his building and provides a room for CLP to install their transformer and switchgear.  The room forms part of the building development and is usually located on the ground floor.  The rooms are self contained and kept locked by CLP, whose staff has sole access for safety reasons.  From the transformer, cables feed through a wall to the owner’s distribution board, which in turn feeds the tenants on all other building floors.

(2)  The “Supply Rules” provide the basis of agreement on which electricity is supplied to the customer.  The two relevant extracts, relating to the provision of accommodation, thereof are:

(a)  Installation of CLP equipment is supplied and installed in accordance with “Supply Rules”, to which all customers are required to agree.  Paragraph 208 of the “Rules” sets out CLP’s requirements for accommodation;

“1 A Customer shall provide, free of cost to the Company, suitable accommodation on or adjacent to his premises to house such equipment as the Company may require for the purposes of providing and metering the Supply. The accommodation, which shall be specified by the Company, may include but may not limited to substation premises together with associated building services, fire protection equipment, cable entry facilities, switchroom and structures for mounting cutouts and meter boards and facilities and physical measures to protect the Company’s equipment from the elements and unauthorized interference. The Customer shall be responsible for the maintenance of such accommodation services and equipment in order to safeguard the Company’s equipment”.

(b)  In paragraph 106, CLP provides advice regarding tariffs, and subsection 3 of the same paragraph sets out its charging policy in connection with the installation and supply of equipment:

“The Company will install and maintain the Company’s equipment to provide Supply to the Customer. The Company may charge for the installation and/or maintenance, in which event the Company will notify the Customer in writing of the charges prior to providing the installation and/or maintenance required.”

225. Viewed under the context that the use of the Dedicated Substations is to enable CLP to supply electricity to the relevant building, I am of the view that the following features of the use and the degree and control over these substations by CLP amount to paramount occupation for rating purposes:

(1)  The room is provided for CLP’s use principally if not solely for the installation of its equipment for the purposes of supplying electricity to the building.  Although the building owner of course benefits from the supply of electricity, CLP equally so benefits from it.  CLP clearly and certainly has beneficial occupation of it.

(2)  CLP staff has a high degree of control over the use of these substations by keeping them locked and have the key to them.  As confirmed by Mr Rose, the staff has sole access to these rooms.  The fact that the sole access is for safety reasons does not make it less in terms of the degree of control over the “rooms”.  It rather makes it more relevant to show paramount occupation, as this sole access is precisely there to enable and facilitate CLP’s principal (and probably sole) use of these substations.

226. For these reasons, I conclude that CLP has paramount occupation of the Dedicated Substations for rating purposes.  These substations should therefore be included in the Tenement for rating assessment.

G4.3   The rateability of some of CLP’s machinery

227. This issue relates to the rateability of (a) the boilers and supporting steelwork at CPPS “B” and BPPS; (b) the cooling water circuits at CPPS “B” and BPPS; and (c) ancillary pipe work and electrical cables within the power stations.

228. The issue arises from ss 8 and 8A of the RO, which provide as follows:

“8. Tenements containing machinery

For the purpose of ascertaining the rateable value of a tenement under sections 7 and 7A-

(a) subject to paragraph (b), all machinery (including lifts) used as adjuncts to the tenement shall be regarded as part of the tenement, but the reasonable expenses incurred in working such machinery shall be allowed for in arriving at the rateable value of the tenement;

(b) no account shall be taken of the value of any machinery in or on the tenement for the purpose of manufacturing operations or trade processes.

8A. Plant

(1) Where any land (including land covered with water) or any building or structure is occupied by a person by means of any plant, such land, building or structure shall, to the extent that the land, building or structure is so occupied, be deemed for rating purposes to be a separate tenement, whether or not such land, building or structure is otherwise a tenement and that person shall be deemed for rating purposes to be the occupier of such tenement and liable for payment of rates assessed thereon.

(2) For the purpose of ascertaining the rateable value of such tenement, the plant by means of which the person is occupying the tenement shall be regarded as part of the tenement.

(3) In this section ‘plant’ includes cables, ducts, pipelines, railway lines, tramway lines, oil tanks, settings and supports for plant or machinery.”

229. Thus:

(1)  Under s 8(b), any machinery on the tenement used for the purpose of manufacturing operations or trade processes by the HT would not be taken into account for the purpose of rating valuation.

(2)  Under s 8A, land or building occupied by means of cables, ducts, pipelines and support for plant or machinery (as plants as defined) is to be rateable as part of the tenement.

230. CLP submits that (a) the boilers and supporting steelwork at CPPS “B” and BPPS; (b) the cooling water circuits at CPPS “B” and BPPS; and (c) ancillary pipe work and electrical cables within the power stations are all not rateable, as they are either structurally part of or functionally ancillary to the HT’s machinery (such as generators, transformers, pumps and other auxiliary equipment).  They are therefore part and parcel of the process machinery and thus not rateable under s 8(b).

231. CRV on the other hand contends that s 8A(3) provides clearly and expressly that “plant” which occupies the land or building is rateable, and “plant” includes “cables, ducts, pipelines … and supports for plant or machinery”.  The above items therefore fall clearly within this definition and therefore rateable. 

232. Mr Holgate however submits that s 8A(3) must be read down to exclude anything which have been excluded by s 8(b), since as a matter of legislative history, s 8A was enacted some time after s 8, and it makes no logical sense to exclude the principal machinery from rates assessment, but then to include what could be properly regarded as part and parcel of that machinery for the said assessment.

233. With respect, I am unable to accept Mr Holgate’s submissions:

(1)  First, as matter of construction, I believe s 8 and s 8A are dealing with different things, and should not be read in the way as submitted by Mr Holgate.  S 8 deals with the position as to whether the value of the machinery in question should be taken into account for rating assessment.  S 8A however deals with the situation that the land or building occupied by plant (as defined) should be treated as part of the tenement for rating purposes.  The subject matter intended to be covered by the two provisions is different.  There is no logical (or illogical) “link” between these two to justify the reading as submitted by Mr Holgate.

(2)  In any event, the wording of s 8A is clear (as submitted Mr Yu) as to what should be included for rating, and it is not provided to be subject to s 8(b).  This is particularly so as s 8A was enacted subsequent to s 8, and therefore if the legislature had intended it to be read subject to s 8(b), it would have provided that to be so.  In the circumstances, as a matter of construction one must give way to the clear language of s 8A(iii). 

234. In the premises, as the disputed items all fall within the definition of “plant”, I accept that the land or building so occupied by (a) the boilers and supporting steelwork at CPPS “B” and BPPS; (b) the cooling water circuits at CPPS “B” and BPPS; and (c) ancillary pipe work and electrical cables within the power stations should form part of the Tenement for rating assessment.

H.   CONCLUSION

235. For the reasons I have set out above, as matter of principle:

(1)  I conclude that the R&E method is the appropriate valuation method that should be used to assess the rateable value of the Tenement.

(2)  I however reject CRV’s WACC approach in assessing the tenement’s rateable value for the relevant year.

(3)  I would accept an asset split approach in assessing the HT’s share of the DB, together with an adjustment to reflect the China Assets’ contribution to the generation of the profits. 

(4)  I reject CLP’s suggestion that inputs of the CB method should be used in the R&E method to value the tenement’s rent.  I also reject any separate adjustments made in favour of the HT’s share for effort and risks. 

(5)  AUC should not be assessed for rates and corresponding deductions should be made in the valuation exercise. However, the Dedicated Sub-Stations and the items identified at paragraph 234 above should be included as part of the Tenement to be rateable.

236. Member Lo would now proceed to look more specifically at the valuation methods adopted by CLP’s expert, Mr Davis and other issues relating to the valuation exercise.

Member Lo:

I.   INTRODUCTION

237. I have the benefit of reading Au J’s above judgment, of which I agree.

238. In light of Au J’s judgment, I would only focus in this part of the judgment on issues specifically relating to CLP’s valuation model advanced by Mr Davis, and a number of outstanding issues relating to the valuation exercise as a whole. 

239. However, before I do that, I would first (a) make a few observations and general remarks on the valuation figures arrived at by the valuation models proposed by both parties by way of background, and (b) set out my further observations as to why the WACC approach advanced by CRV and the CB method should be rejected.

J.   THE VALUATIONS MODELS

240. There is no dispute that there is no “right” or “wrong” method of valuation (Garton v Hunter [1969] 2 QB 37, 44) and that all relevant evidence is admissible in deciding the rateable value.

241. It is common ground that the comparative basis is the preferred method, but in the present case, apart from the valuation of separately assessed tenements and the valuation of the lands and certain buildings by Mr Child and Ms Tang, comparable rental evidence is not available for the Tenement.  Therefore, it would not be possible to carry out valuation for the Tenement on the Comparative Basis.

242. In relation to the Tenement, CRV and CLP both in principle agree that the primary method of valuation of its rateable value is the R&E Method.  However, the parties differ on the actual application of the valuation method, in particular on how to assess and value the tenant’s share of the DB.  In gist:

(1)  CRV’s case on the valuation method is that it should be based on the WACC approach (as explained by Au J above) in valuing the tenant’s share.

(2)  CLP’s expert Mr Davis has proposed three different approaches (respectively Approach 1, 2 and 3) under his valuation exercise.  In essence, it is Mr Davis’ opinion that (a) the tenant’s share should be ascertained by a combination of asset split division of the DB, and various adjustments made in favour of the HT to reflect the value of the China Assets, the HT’s effort and risks in running the business, and (b) the rateable value (ie, the hypothetical rent) thus reached should then be further adjusted by reference to an alternative “rent” assessed by the use of the CB method. 

243. CRV submits that given its inherent important deficiencies, it would not be appropriate to assess the Tenement by the CB method, or as part of the R & E method as adopted by Mr Davis (in his R&E valuation, Approach 2) or as a check valuation.  As a result, based on the expert opinion of her expert valuers, CRV submits that only the R&E method should be relied upon. 

244. But in any event, CRV adduces the evidence of Mr Poon and Ms Tang, as well as those of the plant and machinery valuers (which have between them and CLP’s valuers agreed on most of the plant & machinery figures in the CB valuation) in assessing the value of the Tenement on the CB method, in case the Tribunal decides to consider appropriate to adopt the CB method in full, or in part as proposed by Mr Davis.

J1.    Summary of valuations of the parties

245. It is first perhaps useful to look at in summary the rateable values arrived at by these valuation methods to put the matter in perspective.

246. As I mentioned above, Mr Davis for CLP has submitted 3 approaches (respectively Approach 1, 2 and 3) in his reports on valuation, while CRV submitted valuation based on the R&E Method related solely to the WACC approach.  CRV has also provided a valuation based on the CB method in case the Tribunal finds it necessary to refer to.

247. The parties have the following valuations under the different approaches and final estimates of values (in Millions of Hong Kong Dollars):

	CLP	CRV
CB method	$2,499[82]	$7,537[83]
R&E method		$9,465.6[84]
Approach 1-	$3,185[85]
Approach 2-	$2,887[86]
Approach 3-	$3,866[87]
Final Estimate of Rateable
Value	$3,000	$9,465.6

J1.1   CB valuation of the parties

248. There is no dispute between the parties as to the stages of the CB methodology.  They have been set out by Au J above, and I do not propose to repeat them.  Based on these stages, the experts of both parties have come up with the following figures.

249. Mr Rose, the expert valuer for CLP in CB valuation, has stated that his revised CB valuation shows a rent of HK$2,499 million for the year 2004/2005[88].

250. Mr Rose’s valuation for the valuation date of 1 October 2003 for the assessment year of 2004/2005 under the CB method are as follows (all figures in Millions of Hong Kong Dollars):

Stage One
Estimated Replacement Cost (including fees)
Buildings/Civil Works	$18,122.54
Plant & Machinery	$29779.91
Sub-total		$47,902.45
Stage Two
Deduction for Obsolescence
Buildings/Civil Works	$5,976.20
Plant & Machinery	$7,692.44	$13,668.64
Sub-total		$34,233.81
Stage Three
Land	$6,845.28
Adjusted - Capital Land Value	$1,952.97	$4,892.31
Total – Effective Capital Value (ECV)		$39,126.12
Stage Four
Decapitalise at 6%		$2,347.57
Add – Rental Land / Property Value		$151.50
Total Rental Value per year		$2,499.07
Stage Five
No adjustment is required		0
		$2,499.07
Rateable Value	say	$2,499,000,000

251. However, as I mentioned above, it is not CLP’s case that the rateable value of the Tenement for the year of assessment of 2004/2005 should be based on the rent as assessed at $2,499,000,000 in the above CB valuation of Mr Rose.  Instead, CLP submits that the assessed rent as arrived at by Mr Rose should be adopted, in the manner as used by Mr Davis in Approach 2 of his R&E valuation (which I will explain further below). 

252. His counter-part, Mr Poon for CRV, after setting out his valuation of the Tenement on CB method in his revised Appendix EP19, estimated the rateable value of the Tenement at $7,573 million.  His valuation is similar to that of Mr Rose, both in the format as well as in most of the valuation inputs.  The total ECV estimated by Mr Rose is $39,126,120,000 whilst that estimated by Mr Poon is $48,644,500,000.  The details of Mr Poon’s CB valuation are as follows (all figures in Millions of Hong Kong Dollars):

	Estimated Replacement Costs	$51,289.4
Add:	Finance Costs	$983.2
		$52,272.6
Less:	Allowance for A &O @ 28.35%	$14,817.1
	Effective Capital Value		$37,455.5
Add:	Land Value, Power Station, Control
	Centre and Substations- total	$7,067.8
	Carrying Costs-
	Finance costs 4 years @ 3.72%	$1,111.8
	Government rent on vacant land 4 yrs	$79.3
		$8,259.0
Less:	Allowance for A & O @ 28.35%	$2,341.1
	Effective Land Value		$5,917.9
Add:	AUC – substation sites		$133.0
	AUC of HL’s other assets		$5,138.1
	Total Effective Capital Value (ECV)		$48,644.5
	Decapitalise @ 12.35%	x	$0.1235
	Estimated rent		$6,007.6
Add:	Premises valued on rental basis		$1,562.5
	AUC – cable tunnels		$3.3
	2004/2005 Rateable Value		$7,573.4
		Say	$7,573,000,000

253. Nevertheless, Mr Poon considered that the above assessed figure, using the CB method, was an incomplete value and substantially understated the correct rateable value of the Tenement.  He confirmed in his evidence that the inability of the CB method to measure synergy supported his view that the R&E method would be the only appropriate method to estimate the value of the Tenement.  He reiterated that “a proper and meaningful CB valuation cannot be carried out for the Tenement because of the drawbacks of the CB method and its inability to capture the true market value of the Tenement, the inadequacies of the land valuation inputs, and the fact that it is not possible to quantify the amount of upward adjustment to be made at Stage 5 of the valuation[89].”

254. Unlike Mr Davis, Ms Sandy Jim (CRV’s expert valuer on R&E method) has not utilized Mr Poon’s estimated RV on CB method in any part of her R&E valuation. She did not agree that the R&E valuation should be carried out in the manner of any of the approaches as suggested by Mr Davis.

255. Apart from the disputes as to whether the CB method should be used at all and whether the CB method could be used in the approach as suggested by Mr Davis in the Approach 2 of his R& E valuation, the parties have managed to agree on most of the inputs to the CB valuation.  In CLP’s Notes on Final Updated Valuations dated 14 January 2011, Mr Rose summed up that the parties were not able to agree only in respect of the following few items:

(1)  Mr Poon has included in his valuation various assets of which rateability is in dispute, eg, Castle Peak B Boiler Structure, various substations, cables and pipework, etc.

(2)  There is a small difference in the Age and Obsolescence (“A&O”) allowance used: 28.53% (Rose) vs 28.35% (Poon).

(3)  Mr Poon has included the Carrying Costs and Government Rent in his valuation, whereas Mr Rose has not.

(4)  The decap rate use is different and accounts for most of the magnitude of the difference in value between the final valuations of the two parties: 6.00% (Rose) v 12.35% (Poon).

J1.2   Whether the CB Method should be adopted

256. The parties have respectively advanced their grounds in support of (by CLP) or in opposition to (by CRV) the adoption of the CB method in the valuation exercise of the rateable value of the Tenement.

257. As mentioned above, I agree with Au J’s above reasons in rejecting the use of the CB method as a matter of principle.

258. I would add my further observations in rejecting the CB method in the present case as follows.

259. In the present case, in summary, CLP submits that as both the CB method and the R&E method have advantages and disadvantages, the Tribunal should use the two indirect rating valuation methods together.  CLP in particular stresses that Mr Davis’ way to make use of Mr Rose’s assessed “CB rent” in his Approach 2 valuation would overcome the issue of assuming the market values of assets of HL and HT without any market input, as alleged by CRV.

260. CRV on the other hand has reminded us that the parties in the HEC’s case had agreed that the R&E method was the only appropriate method of valuation and rejected the use of the CB method. 

261. CLP however says that its arguments are different from HEC’s[90]. It therefore follows that the valuation of the Tenement should be carried out with both the R&E method and the CB method.  CLP emphasises that, as held in Kwong Fat Loong Shipyard v Commissioner of Rating and Valuation [1990] HKDCLR 5, it is permissible for a valuer to produce a composite valuation.  This is reinforced by the JRF Guidance, which states that in some circumstances, it may be necessary to use more than one valuation method to arrive at a proper value.[91] 

262. CLP also submits that, in the present case, it is necessary to consider both methods in order to ensure that a balanced and informed view can be taken as to the level of rent the HT would be willing to pay and the HL would be willing to accept.  In a complex business such as the CLP’s, it is entirely appropriate and even essential to employ both methods so that a more reliable answer is produced which is seen to be consistent and fair to both hypothetical parties. 

263. CLP goes further and claims that the CB and R&E methods have a relationship that can be used together to good effect: the CB method is a “bottom up” approach, which focuses on the return the HL requires from the Tenement, whilst in contrast, the R&E method is a “residual” approach, which focuses on the return the HT seeks as a return on his assets together with a reward for his skill and industry.  Thus, the CB method provides the valuer with a very necessary benchmark that can then be tested for affordability using the R&E method.  Similarly, the R&E method can confirm as to whether the CB valuation is too high and the tenant could not afford to pay the rent[92].

264. Therefore, CLP contends that it is relevant to undertake a CB valuation not only as an exercise in its own right, but to inform and assist the R&E valuation in that it provides insight into the return the HL might be seeking for his capital investment.  To support its case, CLP therefore adduces valuation evidence from expert valuers on both bases: Mr Davis on the R&E method and Mr. Rose on the CB method with other supporting witnesses on valuation of the land and the rateable plants and machineries.  Mr Rose carries out his CB valuation up to Stage 4.  However, since the evidence suggests that the HT may be willing to pay more than the CB rent which is “cost based”, the amount to be added under Stage 5 of the CB valuation is calculated under the Approach 2 of Mr Davis’ R&E valuations.  CLP claims that this results in a final value which has a solid foundation in both the CB and R&E valuation methods.

265. In support of its use of both methods in the present case, CLP refers to the case of Best Origin[93], where the R&E valuation was used as a broad check on the primary valuation which was undertaken using the CB method.  Both parties in that case agreed that it was appropriate to consider both methods and the Tribunal at the end weighed up the outcome of both before determining a value on the basis that it considered most reliable.

266. On the other hand, CRV emphasizes that the CB method is inappropriate for utility networks in theory and has not been used in practice in Hong Kong and England.  CRV also submits that the Tribunal should follow its previous decision in the HEC case and rejects the use of the CB method for the reasons therein, either as a full CB valuation, or as suggested by CLP in Mr Davis’ Approach 2 of his R&E valuations, or as a check valuation.

267. I find the use of the CB method not applicable for electricity network in general including this case mainly because: (a) it is more appropriate to use the R&E method for a profit-making tenement such as the subject Tenement, and (b) the impossibility of a notional alternative which is an essential assumption in the CB method arises.  This conclusion is underlined by the following.

268. First, I agree with the submissions of Mr Yu (for CRV) that the CB method is unable and unreliable to assess the true value of Tenement because-

(1)  The profit-making capabilities of the Tenement cannot be reflected in the CB method of valuation;

(2)  As noted by the English Lands Tribunal in BT plc v. Central Valuation Officer[94], the CB method cannot incorporate the economic factors which would greatly influence negotiations for the rental of a hereditament occupied and used for profitable purposes;

(3)  It is economically impossible to envisage the construction of a notional alternative tenement being built;

(4)  The CB method fails in particular to capture the true value of the land element of the Tenement because it relies on estimating the capital value of the land by use of comparables;

(5)  The CB method cannot capture the true value of wayleaves when they are charged at nil or nominal rates;

(6)  The CB method cannot capture the synergy value of the Tenement since it simply adds up the estimated costs of various component parts of the Tenement; and

(7)  Complex adjustments and judgments are needed when calculating decap rate and in a case such as the present, where the ECV mostly comprises adjusted replacement cost, the application of a decap rate will result an estimated annual cost, rather than an estimated annual value.

269. Second, in the valuation of the Tenement, even CLP’s witnesses support Mr Poon’s opinion that the CB valuations prepared by both parties are unable to reflect the profit-making value, the monopoly value, the synergy and the wayleave value:

(1)  Professor Cooper acknowledged that the DRC did not measure value but only measured the cost of replacement. Therefore, the unique feature or the profit-earning capacity of the various parts of the Tenement would not be reflected by the DRC[95];

(2)  Mr Rose accepted that the land values used by Mr Child had not taken into account the value arising from the Tenement’s monopoly of place, and he further agreed that the CB method did not capture the profit or monopoly element, or the profit-making ability of the Tenement[96];

(3)  Likewise, Mr Child acknowledged in cross-examination that (a) the CB method would not capture the synergy value as a whole; (b) he had not tried to value the Tenement as a whole under the CB method.  On the contrary, he only valued each discrete part of the land on which the plant and substations stood[97];

(4)  On the values of the land, Mr Child, like Ms Tang, assessed the land values for the individual power stations, sub-stations and the control centre Strafford House by reference to the land premium valuation for industrial grants made by the Lands Department.  There were otherwise no comparables. Both he and Mr Pendleton agreed that synergy value was not included in those land premium valuations[98].

270. Third, Mr Rose (CLP’s expert) confirmed that he did not in fact carry out a CB valuation as he only carried out Stages 1-4 of the CB Method and then applied the decap rate to that figure.  Mr Davis uses the assessed figure in Mr Rose’s specific CB valuation as a minimum rental return for the HL[99], but the Stage 4 figure used by Mr Davis was not the CB rent in the first place. 

271. I also do not think the case of Best Origins relied on by CRV is helpful in this issue.  As I mentioned above, the parties in that case agreed to the use of a combined valuation method, without any arguments or decision by the Tribunal.  That cannot be regarded as an authority to support the use of a combined method in this case.

272. Finally, as submitted by Mr Yu, not only that the CB method has not been used for electricity utilities in Hong Kong (as concluded in the HEC case), the method has also not been used for any network utilities in England for which prescription of assessment has been removed since 2000.  Besides, the VOA in England has all along used the R&E Method for established network utilities where rental evidence is absent.  The way in which the CB method is applied in England conforms to the principles laid down in Dakwins (VO) v Royal Leamington Spa Corporation and Warwickshire County Council[100],where the valuation proceeds on the basis that the HT will consider the cost of a notional alternative tenement (either built or purchased), and where no such alternative is possible (when the HL enjoys a monopoly of place), the HL can insist on a rent which truly reflects the profitability of the tenement.

J.2    The parties’ R&E Method

J2.1  The JRF Guidance

273. Unlike their different stances in the suitability of the CB method, both parties agree that in the case such as the Tenement where there is no possibility of finding any rental evidence, the preferred method of valuation to arrive at the correct estimate of the rental value is the R & E Method.  It is common ground of both parties that the principles and the details of the R& E methodology are generally set out in “The Receipts and Expenditure Method of Valuation for Non-Domestic Rating-A Guidance Note” (the JRF Guidance), which was prepared by the UK’s Joint Professional Institutions’ Rating Valuation Forum.  They also agree that these should be followed.

274. However, although the two leading valuation experts acting for the parties (ie Mr Davis and Ms Jim) claimed that they had sought to apply the principles to the present case, they differed in their approaches.  In addition, they also had differences in many steps of their valuations using the R & E method.  They had sought to reduce some of the differences, but most of their main differences remained before the parties finished their final submissions. 

275. Before I consider their differences, I will first set out below the relevant parts of the JRF Guidance.  They are the parts on “The tenant’s share”, “Return on tenant’s capital” and “Stand back and look”.

276. The JRF Guidance has stated the following on “The tenant’s share” section:

“5.46 The tenant’s share may be regarded as the first call upon the divisible balance. This share has to be sufficient to induce the tenant to take a tenancy of the property and to provide a proper reward to achieve profit, an allowance for risk and a return upon the tenant’s capital. The amount of the deduction is a matter of judgment in the circumstances relating to the enterprise carried on at the property. In the case of some enterprises, it has been the practice to allow for the return on tenant’s capital before arriving at the divisible balance. If the approach recommended at 5.51 is followed by ensuring that the elements of interest on capital, profit and risk are determined separately, then no practical difference will arise.

5.47 The calculation of the amount will depend upon the nature of the enterprise and is generally based upon one of the following:

(a) a percentage of the tenant’s capital;

(b) a percentage of the gross receipt;

(c) a percentage of the divisible balance;

(d) an amount in keeping with the gross receipts, the amount of the tenant’s capital and the divisible balance, i.e. a ‘spot” figure.

Although the tenant’s share may be regarded as a first charge on the divisible balance, the valuation must properly reflect the strengths and weaknesses of the hypothetical landlord and tenant, given their assumed willingness to reach agreement.

5.48 When calculating the tenant’s share, each method must be considered separately. Whichever of the three principal methods (i.e. those at 5.47 (a), (b) and (c) is adopted as the primary approach, it will be necessary to stand back and consider whether the answer looks reasonable, having regard to the motives for occupation, when compared with each of :

(a) the amount of tenant’s capital required;

(b) the turnover;

(c) the divisible balance (DB).”

277. In the section “Return on tenant’s capital”, the JRF Guidance says,

“5.51 In some of the decided cases, the tenant’s share has been calculated by applying a percentage to the tenant’s capital with no breakdown to indicate the various elements of the tenant’s share. Although this may be an acceptable for relatively small-scale undertakings, the Rating Forum considers it helpful to have regard to these elements – which comprise interest on capital, profit and risk – separately. When considering the individual elements of the tenant’s share, interest on the tenant’s capital may be found by having regard to the yield obtainable from low-risk investments. If this approach is adopted, an addition to the rate of return then needs to be made for profit and risk.

5.52 Alternative approaches to determine the tenant’s share by means of a return on capital will include considering:

(a) an approach similar to the discount rate used for DCF valuations/appraisals;

(b) the Return On Capital Employed (ROCE) achieved by public companies for any particular industry from published accounts;

(c) the target ROCE for particular comparables;

(d) the Weighted Average Cost of Capital (WACC).”

278. The JRF Guidance has also provided the following under the heading of “Stand back and look”:

“5.59 Although not strictly a separate stage in the valuation approach, when the valuer has completed a valuation on the R & E method outlined above, it is essential to review each of the elements to ascertain whether they have been correctly applied and produce a credible result.

5.60 Although it is likely that the comparables will not be available in sufficient numbers to enable a valuation to be prepared on the rental/comparative basis – otherwise the R & E method would probably not have been used – the valuer should consider the valuation produced against the background of valuation relating to similar properties and/or businesses (underline added). If the valuation does not appear to ‘fit the pattern’ so far as one is discernible, the valuer should again carry out a thorough review of the valuation adopted.” (emphasis added)

279. After going through the JRF Guidance, I find that even if the parties of a rating appeal agree to follow it in the use of the R&E method, it does not follow that the number of fundamental disputes between them can necessarily be reduced.  This is because although the JRF Guidance describes the four methods of calculating the Tenant’s Share, there is no presumption in favour of any particular method and certainly no suggestion that they are mutually exclusive. 

280. In this regard, I agree with the view expressed by Mr Davis in his first report that the JRF Guidance “does not provide advice on how the divisible balance (DB) should be apportioned when dealing with a regulated utility, particularly in circumstances where the amount which the utility is permitted to earn exceeds the current cost of capital in any one year.” More specifically, I agree with Mr Davis that the JRF Guidance also “does not give guidance as to how any of its methods may be adapted to the circumstances of the CLP tenement.” 

281. I also agree with Mr Davis that the JRF Guidance does not restrict the calculation of the tenant’s share using solely the method of a percentage of tenant’s capital, and with a complicated business like CLP, it is necessary for the valuer to rely on expert opinion as to how this return on tenant’s capital might be calculated.

282. As the JRF Guidance provides that the tenant’s share could be calculated as a percentage of tenant’s capital or as a percentage of DB, I do find that Mr Davis’ three Approaches of R&E valuations are generally in compliance with the principles of the JRF Guidance.  

283. However, the “Stand back and look” section of the JRF Guidance set out above actually asks (1) the valuer “to ascertain whether (each of the elements) of the R&E method have been correctly applied and produced a credible result”, and (2) the valuer “to consider the valuation produced against the background of valuations relating to similar properties and/or businesses.”  I therefore note that the experts in the present case have criticised their counter parts of either not carrying any “Stand back and look” stage or not carrying out a proper “Stand back and look” stage, I will consider these later.

J3.  CRV’S R&E VALUATION

284. As described by Au J above, CRV’s R&E valuation is based on the WACC approach.

285. Ms Jim appended in her Speaking Note “Appendix 11” her revised R&E valuation for the assessment year 2004/2005.  I reproduce below an extract of her R&E valuation, from the Divisible Balance (DB) onwards:

			(in Million)
Divisible Balance			$13,394.7
Less: Tenant’s Share (Return on HT’s Capital)
HT’s Capital	$32,175.6 M
Return	10.40%		($3,346.3)
Less:  Profit from China Sales ($154M x 50%)			($77.0)
Rent + Rates (Tenant)			$9,971.4
Less: Rates			($474.8)
Cumulo Rateable Value			$9,496.6
Less: Separate Assessments			($30.7)
2004/2005 Rateable Value			$9,465.6

286. I again agree with Au J’s above reasons (and I also adopt our reasons in the HEC case) in rejecting the WACC approach and have nothing to add.

287. This leaves me to consider CLP’s R&E valuation model as proposed by Mr Davis.

J4.    CLP’s R&E valuations

288. Mr Davis said that a new look at the valuation methodology would be necessary for valuing the rateable value of the Tenement to reflect the following:

(1)  falling cost of capital for both the HL and the HT;

(2)  increasing size of business;

(3)  increasing profit margin ;and

(4)  limitation of the cost of capital analysis when calculating rent.

289. In his Speaking Note, Mr Davis concluded that the correct approach to valuation must reflect all the relevant bargaining considerations that would be taken into account between the HT and HL.

290. Mr Davis carried out 3 separate valuation approaches.  Approach 1 was based on the relative asset value of each party but then split and weighted accordingly to the so-called greater role, risk and responsibility of the HT.  Approach 2 assessed the minimum returns that would be required by each party by reference to CLP Holdings’ cost of capital (for the HT’s minimum return) and to the CB’s Stage 4 rent (for the HL’s minimum return).  The return in excess of these minimum returns was then apportioned between the parties in order to calculate the amount receivable by the HL as rent. 

291. Mr Davis’ 3 Approaches adopted different proxies for market values of assets. 

292. Approaches 1 and 2 used DRC as a proxy for the market value (“MV”) of the RA and NRA. Depreciation was based on the estimated nominal asset value change during the year in order to assess the parties’ anticipated depreciation net of appreciation.  He applied this methodology equally to both Approaches 1 and 2 and that was also consistent with the use of the nominal cost of capital in Approach 2. 

293. In Approach 1, Mr Davis’ value for 2004/5 is $3,058 million whilst his valuation under Approach 2 is $2,887 million.

294. On the other hand, Approach 3 was based on the historic book values calculated under the SOC together with the SCC depreciation policy.  Under Approach 3, he apportioned the profit by reference to the NBV, which resulted in a value of $3,866 million. 

295. Mr Davis concluded that “only Approach 1 and 2 produce reliable estimates of rental value”[101] because “the use of NBV and SOC do not properly reflect the respective position of HL and HT and favour the HL by not taking into accounts its capital gain”.[102]  In relation to Approach 3, Mr Davis has thus further expressed the view in his Speaking Note that the use of NBV and SOC depreciation in that Approach meant that it would not produce a reliable estimate of rental value.  As between Approach 1 and Approach 2, he would give more weight to Approach 2.

296. Mr Davis said that he “retained Approaches 1 and 2 as his primary valuations while recognising that taking account of Approach 3 and reflecting the HL’s benefit of capital gain would not produce an overall rent materially above $3,000 million”. He added that his Approach 3 was used to illustrate the way in which the HT’s effort, risk and China interests contribute to the final valuation outcome. Taking Approach 3 alone nevertheless shows that (i) adopting NBV as the MV of RA and NRA, and (ii) incorporating the SOC depreciation/capital gains policy, would not result in an increase in value to more than $3,868 million.

297. Mr Davis added the following comments on his Approach 3 in his Speaking Note: “The SOC depreciation policy allows capital gains arising on the sale of assets to be retained in addition to the profit permitted under the SOC.  It is the HL that is more likely to benefit from such capital gains because its assets are more in the nature of land and buildings.  Utilising the SOC depreciation policy therefore unfairly benefits the HL to the detriment of the HT”.  He therefore concluded that: firstly, Approach 3 sets the maximum level of rent that could be set under any assumption as it is based on inputs disproportionally beneficial to the HL, and secondly that it is likely that the HL and HT would give more weight to Approach 1 in their bargaining[103].

298. Mr Davis therefore came to the opinion that although he has introduced Approach 3, he has not been aware of any reason to change the relative weighting applicable to Approaches 1 and 2 in his First Report and that for the year 2004/2005, he assessed the RV of the Tenement at $3,000 million. 

299. Below I will consider his valuations in greater details.

J4.1   Mr Davis’ Approach 1

300. Mr Davis’ Approach 1 started with the premise that negotiations for the tenancy between the HL and HT would be based on their respective asset values.  This followed the use of the asset values by the SOC to calculate the PR and also recognised the very substantial investments required by both as a principal consideration in their negotiations.

301. Mr Davis said that his Approach 1 valuation was based on what he believed to be the best available proxy for market value, the DRC.  He applied DRC consistently to both sets of assets.  In doing so he arrived at a proper assessment of the relative bargaining position of the HL and HT by reference to their respectively owned assets.  This was in contrast to CRV who did not attempt to calculate the value of the NRA’s by reference to any recognised means of assessing market value.  He commented that CRV only assumed in their valuation that the market value of assets might be found in their NBV, the lowest indicator of market value that could be used.  Mr Davis drew our attention that under the VOA Operational Instructions, “Non-rateable assets should be valued at their present replacement value”.[104]  Where there are practical difficulties in establishing present replacement value, the VOA Operational Instructions suggests the use of replacement cost adjusted for age and obsolescence (ie DRC).  The Sanderson paper, supra, also refers to the assessment of market value by reference to “present replacement value”, but points out that whilst balance sheet information may be a useful guide, it is unlikely to be reliable from a rating point of view due to differing accounting bases, between companies.”[105] 

302. Mr Davis further said that if the parties were equal in every respect, other than asset value, he accepted that one might simply consider apportioning the DB by reference to their respective asset values.  However, he opined that the parties were however not equal, nor were they in a partnership that would be implied by such an apportionment.

303. Mr Davis therefore suggested that the tenant’s asset value had to be adjusted to reflect the parties’ different positions in respect of (i) the tenant’s responsibility for operating almost the entire business (“reward for HT’s effort”); (ii) the tenant’s China investments and contracts (“China investment uplift”); and (iii) the tenant’s greater operational and asset risk and the nature of a tenancy (“HT/HL risk differential”).

304. Firstly, Mr Davis said that an allowance for the tenant’s effort must be appropriate as the HT clearly had significantly greater operational responsibilities than the HL.  He added, “the only way in which it would be appropriate to disregard an allowance for effort would be wrongly to assume that each party contributed effort directly proportional to the amount of their capital investment.  This is plainly not the case because each party has very different responsibilities.”  He drew our attention to the Appellant’s Legal Framework that the assumption of joint adventures was incorrect.[106]  He made “the valuer’s judgment” that a reward for effect of 7.5%[107] of gross receipts is appropriate.  It was based on the 10% suggested by CRV and determined in Cross Harbour Tunnel case.

305. Secondly, Mr Davis said that an adjustment was needed to reflect the contribution to the business of the tenant’s China investment.  It was not necessary to make an adjustment in respect of China transmission and distribution assets because these were already reflected within the tenant’s asset percentage.  Also, the adjustment was only in respect of electricity purchased from China investments under contracts for which CLP was a party.  In addition, Mr Davis understood that CRV had included in their valuation all the China sales revenue.  No adjustment was therefore made to exclude the 20% profits from the China sales which were received by CLP/CAPCO, the approach of which was also followed by Mr Davis. 

306. In order to assess how the China investment might have an impact on the bargaining over rent, Mr Davis had calculated a notional amount by which the CLP’s asset value would increase if it owned sufficient generating capacity in Hong Kong to generate the purchased electricity.  He had only considered the uplift in generating asset value because the purchased electricity would use both the HL’s and the HT’s T& D assets once it arrived in Hong Kong.  He estimated this to be 12.09%[108] for the year 2004/5.  Rather than adopting the 12.09% uplift that he had calculated, he has taken only a 10% uplift to reflect the shortfall in generating capacity which must be met by the HT’s alternative contracts for the supply of electricity from outside Hong Kong.

307. Thirdly, Mr Davis made a final adjustment in respect of the HT’s greater operational and asset risk.  He estimated this risk differential between the HT and the HL to be 35% of the CLP Group risk premium of 6.23% as assessed by Professor Cooper[109].  He calculated this to be 2.18% on the basis that this was the amount of additional return on assets that the HT would require to be compensated for the additional risk to which the HT is exposed over and above that of the HL.  This amount[110] was estimated to be $1,066 million, which was equal to 10.15% of the net of all cost DB, (or 2.18% of the HT’s asset value).

308. I summarise below an extract of Mr Davis’ Approach 1 valuation based on his Appendix AMD7 page 23 (rows 19, 27 – 38, and 48), all values in million of dollars :

19	DB (pre depreciation) after deducting amount for HL’s AUC and capital stores	$12,943
27	Residual amount subject to bargaining	$12,313
28	Less: reward for HT’s efforts- estimated at 7.5% of estimated gross receipts of Tenement at $24,963	$1,872
29	Balance to be apportioned pro rata to asset values	$10,441
30	HT’s share based on % of total asset value of HL & HT	53.95%
31	China Investment uplift- estimated at additional 10% of HT’s asset [53.95% x 10% = 5.395%]	5.395%
32	Adjusted HT’s share reflecting China Investments	59.35%
33	Estimated HT/HL risk differential to be based on CLP Group risk premium (row 182) [35% x 6.23% = 2.18%]	2.18%
34	HT risk differential based on asset value (row 8) @ Risk Premium (now at row 33) [$48,591 x 2.18%]	$1,060
35	HT risk differential expressed as a percentage of DB balance (row 34 / row 29) [ $1,060 / $10,441]	10.15%
36	Total HT’s  increased asset value share (row 35 added to row 32) [59.35% + 10.15%]	69.50%
37	HL’s Share by DRC split (remaining balance after HT’s share) [100% - 69.50%]	30.50%
38	HL’s share (including separate assessments)	$3,185
47	Less Separate Assessments	$34
48	Rental Value (Approach 1)	$3,058

309. For the purpose of the above Table: (1) The figures in [ ] are the actual calculated figures not shown in the original table, (2) the estimates, shown in bold, are Mr Davis’ adjustments under Approach 1 for (i) HT’s effort, (ii) China investment uplift and (iii) Estimated HT/HL risk differential based on CLP’s Group risk premium.

J4.2   Mr Davis’ Approach 2

310. Mr Davis’ Approach 2 sought to consider how the bargaining between the HL and HT might produce a rent by allocating the DB firstly in respect of the returns that might be required by each party.  He assumed that the landlord’s return was the CB rent.  The first part of the tenant’s return was calculated using: - (a) a sum reflecting a reward for HT’s effort (at 7.5% of the estimated gross receipts, as in Approach 1); (b) a sum reflecting the China investment uplift (again at 10%, on the basis of the reward for HT’s China assets and contracts, as in Approach 1); (c) the CLP Group’s cost of capital (based on the WACC of 10.47% as calculated by Professor Cooper); and (d) an uplift in the CLP Group’s cost of capital reflecting the way that the CLP Group’s cost of capital understated the cost of capital applicable to the HT (an uplift of 0.93% as extra funding, ie 15% of the risk premium of 6.32%).  The second stage of Approach 2 was to allocate any remaining margin (or the residue of the profits) proportional to each party’s initial share.  The resulting total tenant’s share and rent would then be reviewed using the same part of the tests as adopted for the Approach 1.  Based on the detailed valuation schedule at Appendix AMD 7, after apportioning the margin between HL and HT, the rental value under the Approach 2 was assessed as $2,887 million for the year 2004/2005.

J4.3   Approach 3

311. In his earlier valuations, Mr Davis only valued the Tenement on the basis of Approaches 1 and 2. Later, he set out a valuation using Approach 3.  In a nutshell, in this approach, he apportioned the profit by reference to NBV, adopting the SOC depreciation profit.  It resulted in a value of $3,868 million.

312. However, as I mentioned above, Mr Davis himself recognises that Approach 3 is not reliable as “the NBV and the SOC depreciation policy does not reflect the market value of the party and would benefit unfairly the HL to the detriment of the HT”, I shall not consider this approach as an independent valuation method further. 

J5.    Davis’ valuations in detail

313. One of the main reasons raised by CRV to reject Mr Davis’ R&E valuations is that there is much double counting in awarding the HT sums that should not be awarded.  According to Mr Davis, the DB should be adjusted for (i) reward for HT’s Effort, (ii) HT’s China investment up‑lift and (iii) for the HT’s greater operational and asset risk.  CRV’s expert opined otherwise, and CRV submits that these are totally unnecessary and amounts to double counting. 

314. I will first consider these adjustments one by one.

J5.1   The reward for HT’s effort

315. In his approaches, Mr Davis has awarded the HT 7.5% of the gross receipts (not the DB) for “efforts”. His starting point is the figure of 10% of gross receipts awarded in Cross Harbour Tunnel, supra.  After considering whether the percentage should require adjustment, he took 7.5% of the estimated gross receipts as the HT’s effort, which is needed to incentivize the HT to develop the business.

316. I agree with Au J’s above reasons in rejecting Mr Davis’ approach in awarding the HT a separate 7.5% of the gross receipts for efforts.  I would only add my further observations as follows in support of rejecting this proposed adjustment.

317. First, I accept CRV’s submissions that the Cross Harbour Tunnel case should be distinguished on the bases that (i) the nature of the tenement was different; (ii) the 10% gross receipts was a figure put forward by CRV, and not by the ratepayer as reward for effort; and (iii) the valuation used in that case was not based on the cost of capital so that the tenant’s share had to be assessed in a different way altogether. 

318. Indeed, as CRV says, if one is to look for examples, there are many cases where no separate award for effort was allowed: the 1994 CLP decision, the HEC case, British Telecommunications plc v Central Valuation Officer [1998] RVR 86, Dolgarrog Power Station (Interim Decision of North Wales Valuation Tribunal, 20.11.2007 and Southampton Container Terminal (Hampshire South Valuation Tribunal, 17.10.2008).  In this respect, it is pertinent to note that Mr Davis himself accepted in the hearing that his approach in awarding a reward for effort was a “novel” one[111].

319. Second, as the 2003 annual report of CLP indicates, CLP’s remuneration system consisted of two components- base pay and annual incentive, the latter determined by the achievement of pre-set objectives.  Executive directors and senior management received both annual and long-term incentives.  Mr Lancaster also confirmed during the hearing that for the majority of CLP’s staff, 80% of their pay comprised base salary and 20% performance incentive, and that senior staff and executive directors would receive only 50% of their pay as base salary, with the rest having to be earned through performance. 

320. I therefore agree with CRV that it would be double-counting to allow such a reward for HT’s effort, when remuneration to all staff, including incentives for long and short-term performance, have already been included in the expenses in the operating accounts.

321. Third, I also disagree with the CLP’s argument that it is the HT’s shareholders who put in the “effort” and the HT should accordingly be rewarded because (a) the shareholders of the HT will be the shareholders, but not the directors, managers or staff of the HT who are actually the people carrying out the list of HT’s responsibilities as set out in Mr Davis’ summary of evidence[112], and (b) little effort would be required on the part of the HT’s shareholders (as opposed to its staff) as it enjoys a monopoly of the business and it will be able to acquire both the staffs and assets necessary to run the business.

322. CLP says that whether the PR would be earned after the commencement of the tenancy would be entirely due to the efforts of the HT and not the HL so that the HT should receive a reward for doing so. However, I agree with CRV that as the rent is set at the beginning of the tenancy, on the basis of the projected performance of an average tenant, there is no reason that the HT should be rewarded for merely achieving what the average performer could do.  CLP has not been able to identify what efforts the HT, as opposed to its staff, would make towards the achievement of the PR.

323. For all these reasons, Itherefore would similarly reject the award of 7.5% of the gross receipts for effort in Mr Davis; rating valuation for the Tenement.

J5.2   China investment up-lift

324. In Approach 1 of his R&E valuation, Mr Davis made a percentage adjustment relating to the contribution to the business of the HT’s China investment (ie the China contract and assets).  It is not necessary to make an adjustment in respect of China transmission and distribution assets because these are already reflected within the HT’s asset percentage. 

325. Through its contracts with associated companies, CLP imported electricity from China that was essential for the fulfilment of the SOC obligations.  In order to assess how this might impact on the bargaining over rent, Mr Davis has calculated a notional amount by which CLP’s asset value would increase if it owned sufficient generating capacity in Hong Kong to generate the purchased electricity.  He has only considered the uplift in generating asset value because the purchased electricity utilized both the HL’s and HT’s T&D assets once it arrived in Hong Kong.  He did not consider the impact of the CLP’s China investment on the basis of the profits they contributed as the revenue was increased.  Instead of this, he used notional asset values as a benchmark of the bargaining strength that might be added to the HT’s position within the overall bargaining context of the parties as it would influence the splitting of the DB.

326. Although Mr Davis estimated that the HT’s share of the total assets, on DRC basis, had to be increased by about 12.09% in 2004/05 to compensate for the hypothetical situation that there was no such China investment of the HT, he only took a 10% uplift to reflect the shortfall in generating capacity which must be met by the HT who organized contract for the supply of electricity from outside the Hong Kong.

327. The uplift only applies to electricity purchased from China investment (China contract and assets) under contracts to which CLP is a party but not surplus electricity sold by CLP to customers in China.  For the latter, CLP and CAPCO are permitted to retain 20% of the profits.  Both CLP and CRV have included all the China sales revenue and have made no adjustment to exclude the 20% profits from China sales.

328. Au J has in his judgment above rejected CRV’s objections in principle to an uplift in the valuation to reflect the China Assets’ contribution.  I agree with those reasons.

329. What is left is for me to look at whether it is justified as a matter of valuation to give a 10% uplift as suggested by Mr Davis.

330. Mr Davis has set out his computations in arriving at the proposed percentage of the China investment up-lift.  I have summarized them above.  Mr Davis then made a valuer’s judgment in making a final 10% allocation to the HT from DB first to reflect the value of the China investment.

331. I have considered the computations in details.  From a valuation perspective and in the circumstances as set out in his reports, I find Mr Davis’ adoption of 10% for the adjustment a fair and reasonable one.  I will therefore accept this. 

J5.3   HT’s greater operational and asset risk

332. The third adjustment that Mr Davis made to the asset value ratio in his Approach 1 valuation was in respect of what he perceived to be the HT’s greater operational and asset risk which included (i) the liability to pay rent as a working expense before the HT received its profit and (ii) the inducement that the tenant would require to enter into a tenancy requiring it to purchase the NRAs and operate the business.  Mr Davis first has considered the risk differential between the HT and HL by reference to the CLP Group risk premium, which was based on the finding of Professor Cooper who described that as “the extra pre-tax return over the riskless interest rate expected by the combined providers of finance to the CLP Group”[113].

333. Mr Davis acknowledged that some of the CLP Group risk premium did apply to the HL’s assets, but he assumed that a greater amount should apply to the HT because the risks arising from the application of the HT’s assets to the operation of the business and the uncertainty of the profit the HT would earn were considered o be greater than those of the HL as a property investor. 

334. Before he made up his mind, Mr Davis took into account the assumption adopted in Mr Rose’s CB valuation that when Mr Rose decided to calculate a de-capitalization rate based on the HL’s cost of borrowing, Mr Rose has taken 40% of the risk premium as applicable to the HL.  Mr Davis noted and agreed with Mr Rose that the latter’s calculation was just a comparison of the merits of a property investment with the risk of the CLP Group business but did not reflect the type of wider bargaining process that Mr Davis was attempting to reflect in his R&E valuation.

335. In the final analysis, Mr Davis opined that erring on the side of caution, he has assumed that “35% of the risk premium should be taken as representing the differential risk between the HL and HT” because in his Approach 1 valuation, he also gave the HT the opportunity of negotiating a share of the DB in respect of all the other attributes (effort, China investment and asset value) the HT brought to the business.  On the other hand, Mr Davis said, the CB valuation of Mr Rose did not directly reflect this wider relationship between the HL and HT.

336. In terms of figures, for the year 2004/2005, Mr Davis calculation adopted the risk premium of 6.23% computed by Professor Cooper (IC paragraph 11.8 and as shown in row 182 of Appendix AMD7). Mr Davis then took a 35% of this figure which was 2.18% on the basis that this was the additional return on assets that the HT would require to compensate it for the additional risk to which it may be expose over and above that of the HL.  The amount equated to $1,066 million, which in turn was equivalent to about 10.15% of the net of all costs DB, or 2.18% of HT’s asset value.  Mr Davis also stated that he has applied the same 35% adjustment to all his valuation for the other appeal years.  He opined that this 35% seemed to be “a reasonable adjustment in the light of the tenant’s typical ownership of around 50% of the assets and his responsibility for around 99% of the annual expenditure of the business.” Finally, adding the “after weighted” 59.35%  to 10.15% gave the finally adjusted HT’s share of the total assets at 69.5%, leaving a balance of 30.5% as the HL’s share of the DB based on the total asset value calculated on DRC basis.  Applying the HL’s finally weighted ratio of 30.5% to the DB of $10,441 million resulted in an amount of $3,185 million for the HL (Appendix AMD 7 rows 37 to 38).

337. Although Mr Davis said that he based on Mr Rose’s adopted risk differential figure of 40% on the premise that that percentage of the CLP’s risk premium was applicable to HL in estimating a decap rate based on HL’s cost of capital, CRV said that there was simply also no basis for Mr Rose to take that 40% in the first place.  CRV submits that while Mr Davis described the adopted adjustment as based on “valuer’s judgment”, he accepted that “since (a) he had not made this type of adjustment before and (b) there was really nothing to go by in making such an adjustment, he could not really explain how the adjustment was quantified.”  (Respondent’s Final Written Submission paragraph 290.2).  CRV also drew to our attention that the effect of Mr Davis’s adjustment was to reduce the HL’s risk premium to half of that of HT’s.  CRV submits that Mr Davis’s approach was both wrong in principle and unsupported.

338. I again note Au J’s above reasons in rejecting an adjustment in the present case for risks.  I agree with those reasons.  Further, I would add the following observation in support of disallowing such a separate adjustment for risks as proposed by Mr Davis.

339. I agree with CRV that there was no proper basis on which Mr Davis carried out his risk adjustment on the basis of his perceived HT’s greater operational and asset risks.  In particular, I fail to see how because 99% of the business expenditure was said to be made by the HT, the HT had a greater operational risk.  I would have thought that just similar to the argument of importing an extra remuneration for the HT’s effort in the business conducted over the Tenement, these expenditures were by common sense similarly made by the management and staff of the HT in the daily operation of the business.  We therefore reject CLP’s contention in this regard.

J5.4   Which is the appropriate approach

340. Having considered these 3 adjustment issues, I will turn to the basics of the Approach 1.  I am of the view that Approach 1 is the correct approach to valuation as it properly reflects all the bargaining process that will be taken into account between the HT and HL for the renting of the Tenement.  

341. On the other hand, as also explained above, I only agree with him that the DB should be adjusted for HT’s China investment up-lift in his Approach 1 valuation but not with the other adjustments. 

342. CRV contends that the valuation of Mr. Davis involves “numerous subjective judgments, unlike the WACC approach.”  I find that this cannot be right because any method apart from using a percentage of HT’s capital (such as Ms. Jim’s WACC approach) must necessarily involve some subjective judgments.  The point should be whether these judgments are reasonable under the circumstances.  For example, in Mr Davis’ Approach 1, the Tribunal have rejected two of Davis’ three adjustments.

343. I also do not agree with CRV that the use of the relative asset values of the parties in Approach 1 is a deficiency that should lead to its rejection.  I agree with CLP that the market value of the assets, assessed on DRC basis is better than the value assessed on NBV basis.

344. I would therefore adopt Approach 1 subject to disallowing the adjustments mentioned above.

J5.5   Mr Davis’ Approach 2

345. I have set out above my reasons (together with Au J’s reasons) for rejecting the use of the CB method (whether alone or as an adjunct as proposed by Mr Davis) in the present case.  I further agree with CRV that “the use of the CB Stage 4 figure is internally inconsistent as by definition it cannot represent the HL’s minimum rent.” 

346. I therefore do not accept the use of Mr Rose’s CB rent in the working of Approach 2, and reject Approach 2 as unreliable and inappropriate as a valuation method.

J5.6   Mr Davis’ Approach 3

347. As mentioned above, Mr Davis himself did not regard this approach as reliable, I would similarly reject this. 

K.   USEFULNESS OF THE TESTS ADOPTED IN THE R&E VALUATIONS BY MR DAVIS

348. Mr Davis stated in his valuation reports that he has carried out various tests using the rents he arrived at and then comparing those rents with the various parameters he has adopted for these tests.  Mr Davis has in the last stage of the R&E valuations reviewed the return of each party and undertook a number of tests.  In his First Report, Appendix AMD7 shows the relationship between the various valuation inputs under the tests. 

349. For example, in Mr Davis’ valuation in Approach 1, he described in details how he carried out various tests after arriving at his estimates of the rental values under various approaches.  For example, in his valuation report on Approach 1 valuation (see Bundle Ref AD p 79), he said, “The next stage is to review the returns of each party and to undertake a number of tests”.  Page 3 of Appendix AMD 7 shows the relationships between the various valuation inputs as shown by the following tests:

(1)  Test 1: The value of each party’s total income including depreciation / appreciation as a percentage of asset values to calculate a rate of return;

(2)  Test 2: The CLP Group WACC calculated by Professor Cooper;

(3)  Test 3: The SOC Permitted Return;

(4)  Test 4: The CB rent;

(5)  Test 5: The resulting DB split and how it compares with the party’s respective asset values;

(6)  Test 6: The tenant’s share as a percentage of gross receipts; and

(7)  Test 7: Rent as percentage of gross receipts.

350. However, after going through the various tests by Mr Davis, and notwithstanding that I have decided to adopt Mr Davis’ Approach 1 valuation in the present case, I do not find that he has actually compared the rent he arrived for the Tenement “against the background of valuation relating to similar properties and/or businesses” (the wordings of the “Stand back and look” section of the JRF Guidance document). 

351. Also, when Mr Davis sought to compare the rent he arrived at with the various parameters he has adopted, he has not stated what percentage should be optimal and why.  There is no point in just giving the Tribunal more and more figures under the various tests.  For example, under Test 4, Mr Davis says, “The rent calculated under Approach 1 is approximately 24% higher than the CB rent.  This serves to confirm that the landlord’s minimum expectations have been more than satisfied and that he would consequently benefit very substantially, along with the tenant, in the profits of the business.”  I cannot follow the logic and draw the same conclusion.

352. Summing up, I am not satisfied that the various tests undertaken by Mr Davis under his Approach 1, and other Approaches are in any way supporting or improving his valuations since there are no benchmarks for which one can compare the result of his valuations with the parameters he has adopted in each of his tests.  I would like to add that even if he has stated a certain benchmark in any one of his tests, I still have to consider why he adopts that benchmark and whether the benchmark is a right one.  In any event, Mr Davis has not presented in his evidence the benchmark in any one of his tests.  In fact, I doubt whether there is any industry-wide benchmark in some of these tests which most ratepayers, rating authorities and their ratings advisors would agree.  Therefore, we I do not find that these tests have improved his valuations to any extent.

353. Although this case only deals with assessment of the rateable value of the Tenement for the year of assessment of 2004/2005, Mr Davis has carried out similar valuations for a number of years.  He claimed that the results show a certain degree of consistency.

354. I have not considered the valuations for the other years, as I do not find these valuations to be necessary and in any way helpful for the determination of the rateable value of the Tenement for the particular year in the present case.  If anything, the workings of other years of assessment have made the experts’ evidence almost unwieldy.

355. I also observe that as the dispute in the rateable value of the Tenement has been left unresolved and neither party applied earlier to the Tribunal for determination, it is logical to expect that it would be more and more difficult for the parties to agree on the rateable value, or to agree on the mutually acceptable method of valuation.  This is not meant to be a criticism of the parties whom we believe have been trying for a very long time to negotiate for a mutually agreeable result and attempted seriously to reduce their differences on their valuation methodology and inputs.

L.   CONCLUSIONS IN THE R&E VALUATIONS

356. I find it appropriate to adopt the Approach 1 of Mr Davis’ R&E valuation together with the China Assets uplift (but without the adjustments for effort and risk), which is the most reasonable and appropriate valuation methodology presented before us for the valuation of the rateable value of the Tenement.  I also agree with CLP’s experts to use DRC as the best available proxy for market value of the parties’ RA and NRA. 

M.  OTHER DISPUTES IN THE R&E VALUATIONS

357. After concluding that Mr Davis’ Approach 1 (without the separate adjustments for risk and effort) should be adopted for the valuation of the rateable value of Tenement, there are still a number of disputed matters related to the valuation exercise as set out in a 16-page table of summary submitted to the Tribunal by the parties. 

358. The disputes in the said table of summary are of three different types: (a) the adjustments that are appropriate before arriving at the gross receipts; (b) the adjustments from the gross receipts stage to the DB stage, and (c) the adjustments of the DB.

359. I now propose to deal with these disputed items.

M1.   Issues in the estimation of gross receipts

360. It is agreed that the actual gross receipts up to 31 December 2003 are $24,470,784 and up to 31 December 2004 are $26,577,662. However, there is disagreement as to the method of estimating the future receipts for the purpose of valuation.  The principal differences are (i) the use of customer numbers to reflect the physical and economic growth; and (ii) the choice of accounting data. 

361. On the first difference, Mr Davis has used customer numbers alone to reflect the physical growth of the Tenement as at 1 April 2004, while Ms Jim has used both customer numbers and receipts and expenses per customer to reflect the physical and economic growth of the Tenement in the state as at 1 April 2004.

362. I prefer to adopt Ms Jim’s approach, as it is clearly more logical and reasonable to use the changes in the receipts/expenses per customer to reflect the physical growth of the Tenement.

363. On the second difference of the choice of accounting data, both experts use “accounts which would not have been available at the valuation date as a proxy for a projection from that date”. This is an agreed fact because the accounts in which the valuation date fell were only published about more than one month after the deadline for the CRV to complete the valuation.  Therefore, the accounts would be looked at, according to Ms Jim, only at the time of the proposal review.  Mr Davis used the accounts up to 31 December 2003 for the year beginning 1 October 2003; in other words, “hindsight” was only used by him for the period of 1 October 2003 to 31 December 2003.  On the other hand, Ms. Jim used both the year 2003 and 2004 accounts and adopts “hindsight” in projecting the figures for the accounts for the year commencing 1 October 2003, ie the statutory valuation date for the rateable value of the tenement for the year of assessment of 2004/2005 (ie, from 1 April 2004 to 31 March 2005). 

364. Mr Davis explained that his valuation adopts “accounting information that could have reasonably been anticipated by the HT and which is available to both CRV and the Appellants at the time that the rating valuation is to be undertaken.  In this appeal, Ms Jim prefers to use accounting information that is only available some 18 to 24 months after AVD.  The approach adopted by Ms Jim can therefore only be applied in the circumstances of an appeal that takes place some two years or more after the valuation date. That approach is therefore inappropriate.”[114]  He further added, “R& E valuations, conventionally adopt accounts from the years immediately prior to the valuation date in order to estimate the future likely receipts and expenditure of the business.  In rating valuation, it is inappropriate to treat subsequent accounts which would not have been available at the valuation date as a proxy for a projection from that date when they are really no more than a set of post event outturns.”[115]

365. I agree with the reasoning and approach of Mr Davis in the choice of accounting data.

M2.   Issues in two items of expenses

366. All the expenses used in the R&E valuation are agreed, with the exception of (a) Black Point Deferral Premium, and (b) treatment of the Demand Side Management Agreement.

367. Mr Davis treated the Black Point Deferral Premium as HT’s expenses ($494.07M for year 2003 and $175.307M for year 2004) whilst Ms Jim did not treat the Premium as an HT expense because (a) the original source of payment was the Development Fund which was borne by CLP’s customers instead of shareholders; (b) it was an exceptional but not a recurrent item, and (c) the transfer from the Development Fund was made back in 2000.  On this issue, Ms Jim has summarised in her Speaking Note dated 15 April 2010 the difference between her and Mr. Davis.  Mr Jim has taken the view that “the HT would not rely on, and as such would not expect to incur the deferred premium as an item if his estimated expenses to earn his estimated revenue during the hypothetical tenancy from 1 October 2003 to 30 September 2004”.  But on CLP’s evidence, “the agreement on deferral was made many years earlier, ie in year 1999, before the HT came on 1 October 2003 to look forward and to negotiate for the hypothetical tenancy.  Within the 1999 agreement, the actual amounts were booked in the years in which they were paid[116]”.

368. I agree with CRV’s treatment for the Black Point Deferral Premium for the reasons as explained by Ms. Jim, in that “(i) it not a necessary assumption that the HT would take over the incumbent’s liabilities; and (ii) it is an assumption that the HT would refer to the owner occupier’s accounts to estimate its own accounts to inform its rental bid, but the HT would not want or be forced to take over all of the incumbent’s commitments with other parties on payments, particularly if the commitments are liabilities”[117].

M3.   Demand Side Management Agreement

369. The experts from both sides have diverging views as to the treatment of interest receivable and “write off” on Demand Side Management Agreement.  Mr Davis included (a) interest receivable onDemand Side Management Agreement recovery ($1.361M for year 2003 and nil for year 2004) as a credit, and (b) Demand Side Management Agreement write off of $17.862M for year 2003 as an expense; and write off of $0.899M for year 2004 as a credit.

370. Ms Jim opined that as the Demand Side Management Agreement already ended in June 2003 (ie before the relevant date), the HT would not be expected to take account of these accounts in estimating the expenses of the hypothetical tenancy.  She therefore excluded (a) interest receivable on Demand Side Management Agreement recovery; and (b) Demand Side Management Agreement write off in 2003 and 2004.

371. I agree with Ms Jim’s view as being logical and in line with the rating requirement to assess the rateable value at the relevant date as at 1 October 2003 for the relevant year in these appeals.  I therefore accept the CRV’s approach.

M4.   HL’s Assets Under Construction (“AUC”) and Capital Stores (“CS”)

372. According to Mr Davis, the CS are stores held in reserve for future use.[118] Mr Davis opined that both the AUC and CS are not in rateable occupation.  The treatments of the AUC and CS by Mr Davis and Ms Jim in their valuations are different but both give the same treatments to AUC and CS.  The differences have been summarised as follows: “Mr Davis has provided valuations treating HL’s AUC and CS as non-rateable and has accordingly deducted $967M from the pre‑depreciation DB reducing the pre-depreciation DB from $13,893.781M to $12,926M.  On the other hand, Ms Jim has retracted from the position in her First Report and has not made any deduction for HL’s AUC and CS and therefore the pre-depreciation DB remains as $15,461.” 

373. In addition, Ms Jim drew to our attention that CLP did not treat AUC in the same way as HEC. Simply put, “Mr Davis depresses the DB by removing the return attributed to all of HL’s AUC as they were not yet commissioned and therefore not rateable; but he does not do the same for HT’s AUC and treats the HT’s AUC as HT’s assets.”  Therefore, Ms Jim’s position was that, if HL’s AUC is to be deducted, then HT’s AUC should also be deducted from the DB, but this should be confined to uncompleted assets, not extended to assets already completed but merely un-commissioned.

374. However, Ms Jim stated clearly that even if the Tribunal decides to apply the same approach to the AUC for both HEC and CLP, before she could make the necessary adjustment to CLP’s treatment of AUC and CS, she would need to obtain from CLP the details on (a) the part of HL’s AUC from the total that had been completed despite not yet being commissioned, if any, as these HL’s assets would be rateable; and (b) the part of HT’s AUC, that were to be installed in rateable HL’s AUC under (a), if any, as these HT’s assets would form part of HT’s capital.

375. In the earlier part of this Judgment, Au J already held that all the AUC, including those that have been completed but not yet commissioned, (which in my view applies to the CS) are not rateable.

376. I therefore also find that the AUC and CS should not be included for rating purposes.  However, I am of the view that deductions should be made the same manner as we have held in the HEC case, as that is consistent with the asset split approach, and fairer and logical as a matter valuation.  As such, the parties shall proceed to compute the deductions in the way as we now hold. 

M5.   HT’s depreciation/appreciation

377. In his Approaches 1 and 2, Mr Davis used DRC for assets and depreciation.  In Approach 3, he used NBV and NBV depreciation just for illustration purpose.  I have concentrated on Mr Davis’ Approach 1 in this Judgment.  On the other hand, Ms Jim used NBV for asset values anddepreciation but did not accept the impact of potential appreciation suggested by Mr Davis.  Mr Davis estimated that the HT’s depreciation is $573 Million under Approach 1, whilst Ms Jim, estimated the HT’s depreciation of $2,067 Million.  Mr Davis has utilised “the depreciation figures calculated by Mr Rose and Mr Taylor based on DRC, allowed for capital price appreciation at the rate of inflation and in the case of the HL, 1% to reflect that his assets are essentially land and buildings”[119].  On the other hand, Ms Jim has estimated the HT’s depreciation from the SOC accounts.  Mr Davis commented that, “there is a fundamental inconsistency between NBV, which is an accounting tool not reflective of market condition at the valuation date, and market value.  The effect of using NBV is to understate the tenant’s share which therefore results in an excessive rent for the HL.”[120] He added that “Ms Jim’s approach is wrong because it is based on an unadjusted straight line depreciation which has no regard to market value and ignore nominal price change.”[121]

378. I already agree in the above to the use of DRC in Mr Davis’ Approach 1.  Hence I also accept Mr Davis’ figures for HT’s depreciation.

M6.   HL’s depreciation/appreciation

379. Mr Davis allowed for HL’s appreciation but Ms Jim did not allow for this as she disagreed with the adjustment.  According to Ms Jim, the market value adopted by Ms Davis suffered from the main drawback of failing to take into account monopoly and synergy value, the figures forDRC appreciation and NBV depreciation (which was merely based on historic cost of HL’s assets) could not be correct.  Mr Davis estimated HL’s appreciation of $169 Millions under Approach 1. 

380. As I said earlier, I agree with Mr Davis’ reasoning in the use of DRC and thus also the use of Mr Davis’ figure in his Approach 1 valuation.

M7.   Asset Split

381. Using DRC, Mr Davis estimated HT and HL’s asset split to be 53.95% and 46.05% respectively[122].

382. On the other hand, Ms Jim did not agree that the DB should be split by reference to assets using DRC values under Approach 1 of Mr Davis’ R&E method.  Therefore, Ms Jim disagreed with the use of DRC in the present case.  Moreover, Ms Jim said that the value of HT’s assets was set by SOC at NBV and would in any event be driven down to NBV by reason of competition.  Similarly, Ms Jim opined that DRC cannot reliably assess HL’s asset value.

383. However, I have decided above to adopt Approach 1 of Mr Davis’ R&E method, as amended, in the present case.  It will be necessary to compute the asset value of the HL and HT on the DRC basis, as suggested by Mr Davis in order to compute the tenant’s share under the said Approach 1.  I therefore accept the asset split ratio as worked out by Mr Davis as stated above.

M8.   Rateability of power station cables, pipework and support work

384. As Au J has concluded above, these items are rateable.

M9.   WACC

385. On the issue of the WACC (pre-tax), the parties have finally managed to agree the figure of 10.4% for the year 2004/5, but they stress that there is no agreement in respect of the method, or the figures for other years of assessment.  Also, whilst Ms Jim has used the WACC figure of 10.4% in her R&E valuation, Mr Davis’ final valuations has only used a figure of 10.64% instead of the agreed value.  CLP submits that a revised valuation could be provided after the Tribunal gives a determination in this case.  However, since we find that CRV’s approach is not appropriate in the present case, a revised valuation by CLP using the agreed WACC figure of 10.4% will not be needed.

M10.   CB Inputs

386. Since we have clearly come to the view above not to use the CB method in this case, I do not find it necessary to resolve and decide on the differences between the parties’ experts of the various CB inputs which are needed before a CB valuation can be completed. 

N.   CONCLUSION

387. For the reasons set out in this part of the judgment, I accept and adopt Mr Davis’ Approach 1 for the valuation of rateable value of the Tenement for the year 2004/2005, subject to:

(1)  The rejection of the adjustments respectively made for effort and risks as proposed therein.

(2)  The treatment of the various disputed items as set out above. 

(3)  The computation of the AUC deduction as directed at paragraph 376 above.

Hon Au J:

388. For all the above reasons set out by myself and Member Lo (of which I agree), we are satisfied that the rating value as assessed by the CRV for the Tenement for 2004/5 is incorrect, and would therefore allow the appeals. 

389. The parties are to agree on the proper form and terms of the order, including the final figure on the rateable value of the Tenement in accordance with this judgment and our conclusions made above at paragraphs 235 and 387, and the resulted rates and Government Rent of the Tenement.  There is also liberty to apply for further directions if necessary.

390. There will also be an order nisi that costs of these appeals be to CLP to be taxed if not agreed, with certificate for two counsel.  Unless of the parties applies by summons to vary the same, the order shall become absolute 14 days from today.

391. Lastly, we thank counsel and their respective legal teams for their valuable assistance.  The professionalism and efforts demonstrated by them in the preparation of these appeals deserves this Tribunal’s unreserved compliments.

APPENDIX

CAPACITY/DEMAND FOR 2004