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Rating — Rateable value — Assessment — Land, buildings, structures occupied and used by electricity company for generation, transmission and supply of electricity — Receipts and expenditure method — Effect of scheme of control agreement with Government — Divisible balance — Tenant's reasonable return — Representation of tenant's share (Consolidated)
Mr. Guy ROOTS, QC, leading Mr. Godfrey LAM, SC, instructed by Messrs JSM, for Appellant. Mr. Benjamin YU, SC, leading Mr. Bernard MAN, instructed by the Department of Justice, for Respondent.
_______________H H Judge Thomas Au, Presiding Officer: A. Introduction  This the hearing of the appeals lodged by the Hong Kong Electric Company Ltd ("HEC") against the rateable value ascribed to its tenement for the rate year of 2004/2005. LDRA 358/2004 concerns an appeal under section 42 of the ("RO") and LDGA 224/2004 concerns an appeal made under section 26 of the ("GRO") HEC has also lodged respective appeals against Government Rent and rates for the Tenement for various subsequent years 2005/2006, 2006/2007 and 2007/2008. By the various orders of the Tribunal, these other appeals have been stayed pending the decision of the present two appeals..  The subject matter tenement ("the Tenement") under these appeals comprises the land, buildings, structures occupied and used by HEC for the generation, transmission and supply of electricity. In other words, it relates to the entire electricity supply system from its generation to the end users in Hong Kong Island, Ap Lei Chau and Lamma Island, which comprises the following essential features:
(1) Electricity generation at Lamma Island.
(2) Electricity transmission by means of 400 kilometres of cables laid underground, undersea, in tunnels and overhead, with associated transmissions substations housed in some 32 buildings; and
(3) Electricity distribution by means of about 5,000 kilometres of cables together with numerous substations.
 At the material times, the business of HEC has been governed by a Scheme of Control Agreement The relevant SOC comprises an agreement made on 15 July 1993, and the supplemental agreements made on 6 May 1999 and 29 March 2004.("SOC") made between it and its holding company, Hongkong Electric Holdings Ltd ("HE") on the one hand, and the Hong Kong Government on the other hand. The SOC is intended and stated to govern the financial affairs of the electricity-related activities of HEC.  The effect of the SOC on the rating valuation of the Tenement forms the most fundamental debate between the parties in these appeals. We would discuss this in greater detail later.  For 2004/2005, the Commissioner of Rating and Valuation ("CRV") assessed the rateable value of the Tenement (a) for rate-paying purposes to be HK$6,294 million, and (b) for Government Rent purposes to be HK$2,6052 million.  Simply understood:
(1) The "rateable value" of a tenement as defined under s. 7(2) of the RO is the amount equal to the "rent" at which the tenement might reasonably be expected to let on a yearly tenancy, provided that the tenant undertook to pay all usual tenant’s rates and taxes, and the landlord undertook to pay the Government Rent, the various expenses and costs of repair to maintain the tenement in a rentable state. The rates payable under the tenant is taken to be a percentage on this rateable value.
(2) 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 leasedSections 6 and 7(2) of GRO.. For this purpose, the RO applies to the ascertainment of the rateable value of a tenement (i.e., the land leased)Section 8(2) of GRO..
 Given that it is now agreed between the parties that the rateable value for Government Rent purposes may be calculated by the application of an agreed percentage to the rateable value to be determined for rating purposes, the principal issue for the Tribunal to determine in these appeals is what is the proper rateable value of the Tenement under the RO.  It is generally accepted that there are 3 valuation methods that could be adopted to determine the rateable value or rent of a tenement:
(1) The comparison method.
(2) The receipts and expenditure method ("the R&E Method").
(3) The contractor’s basis method ("the CB Method").
 Both parties agree that the comparison method is inappropriate for assessing the rateable value of the Tenement. We could therefore put this aside.  In assessing the rateable value (i.e., the rent) of the Tenement, the CRV has applied the R&E Method. 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, 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.
 By the time of this hearing, it has also become common ground that the R&E Method is in principle the proper method to be applied to assess the rateable value of the Tenement.  However, in support of these appeals, it is HEC’s central contentions that:
(1) In applying the R&E Method to assess the rateable value of Tenement, the CRV had proceeded on the wrong basis in failing to take into proper account of the features of the SOC.
(2) In particular, the CRV was wrong in ascertaining the tenant’s share under the DB by applying the Weight Average of Cost of Capital ("WACC") on the net book value ("NBV") of the tenant’s assets to assess what is a reasonable return for the tenant.
(3) If the SOC had been properly taken into account in the valuation method, the tenant’s shares should be determined by (a) first apportioning a sum to the tenant representing the permitted return of revenue under the SOC on the proportion of the tenant’s assets value as determined under the SOC, and (b) by further assigning 25% of the DB to the tenant to reward its enterprise and risk.
(4) Had the SOC been so properly taken into account under the R&E method, as it ought to have been, the rateable value of the Tenement would have been much reduced to some HK$3.35 billion for the year 2004/05.
 Thus, under the central contentions, the principal issue is on the determination of the tenant’s share under the R&E Method, which involves the following primary questions:
(1) Whether and how the SOC should be taken into account.
(2) If so, whether the tenant’s reasonable return in investing in the business undertaking in taking up the tenancy is to be assessed and measured by (a) the permitted return under the SOC on the tenant’s average net fixed assets value, together with (b) a 25% of the value of the DB.
(3) If not, whether the tenant’s share is to be represented by WACC on the NBV of the tenant’s assets.
 Other than these primary issues, in light of the evidence adduced in the appeals and the parties’ arguments, a number of subsidiary issues arise, which could be summarized as follows:
(1) Under the R&E Method, and if the WACC is to be used, what is the proper WACC that should be applied.
(2) Notwithstanding that the R&E Method is the primary method that should be adopted to assess rateable value of the Tenement, whether the Tribunal should still have regard to the CB Method in determining the rateable value of the Tenement.
(3) If so, what are the proper and correct parameters that should be employed under the CB Method.
(4) Whether the assets that were still under construction ("AUC") at the time of the assessment of the rateable value should be included or excluded when determining the rateable value under the R&E Method and the CB Method.
 We would first deal with central issues and the rateability of the AUC as a matter of law under this part of the judgment. For the subsidiary issues set out in paragraph 14 above, they would be dealt later under Member Lo’s judgment, which I have read and agreed. We will elaborate on the arguments raised under all these issues when we address each of them.  But in order to understand the parties’ contentions in proper context, it is necessary for us to first set out (a) some of the more fundamental principles concerning the assessment of rateable values under the RO, (b) the essential features of the Tenement, and (c) the relevant features and terms of the SOC.  Unless otherwise specified below, these are uncontroversial. To a large extent, they are taken and adopted from the parties’ submissions. B The Rating exercise under the Rating Ordinance B1. The Rating Ordinance  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.  By virtue of section 18, the amount of rates payable is calculated as a percentage of the "rateable value" of the tenement. The percentage is prescribed from time to time. It is currently 5% of the rateable value.  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 1st April. B2. The rateable value  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 ."
 Thus, the CRV is required to ascertain the "rateable value", which is a figure representing an annual rent payable for a tenancy on the terms defined by section 7(2) of the RO.  However, in order to enable the rating exercise to be legitimately and possible to be carried under the various requirements and preconditions created by statute, judicial authorities over the years have established what is known as the hypothetical rating world, with various legal hypothesis. As Godfrey JA once observed in China Light & Power Co Ltd v CRV  2 HKC 42 , at 43G-I as follows:
"This Court is concerned, in these appeals, with questions of rating. The world of rating appears, to one unfamiliar with the arcane, to be cloud-cuckoo land, a world of virtual unreality from which real cuckoos are excluded (although it seems that permission to land will be granted to a cuckoo flying in from the real world if it can demonstrate that its presence in cloud-cuckoo land is essential, not merely accidental: see Dawkins (VO) v Ash Brothers & Heaton Ltd  AC 366 per Lord Pearce at p 382B-C). A valuation for rating purposes must be based on hypothetical, not real, facts. Nevertheless, the authorities establish that such a valuation is itself treated as a matter of fact, impeachable only if the person responsible for the valuation has fallen into some error of law in arriving at it. "
 The "tenancy", which for rating purpose is an imaginary one, has come to be known as the "hypothetical tenancy" and the imaginary parties to the hypothetical tenancy are usually referred to as the "hypothetical landlord" ("HL") and "hypothetical tenant" ("HT").  The legal assumptions and hypotheses that have so far been developed judicially which are relevant for the present purpose can be summarized as follows. B3. The relevant legal hypotheses and assumptions B3.1 Vacant and to let  The tenement must be valued on the basis that it is "vacant and to let": London County Council v Erith  AC 562 , 588. As explained in Fir Mill Ltd v Royton UDC and Jones (VO) (1960) 7 RRC 171 , at 185 this means that the tenement is "vacant in the physical sense and in the sense that the existing business has ended and any process machinery has been removed " See also Cruden, Land Compensation and Valuation Law in Hong Kong (3rd ed.), pp 425-426..  Arising out of this principle is also the assumption that any incoming new HT would have no difficulty in acquiring the assets (at market value) and management staff of the sitting HT at the instance of the tenancy.  Thus, in Railway Assessment Committee v Southern Railway  AC 266 , an example is given of an enterprise of a nature which requires the HT to make a large investment in plant and equipment it has to be assumed that the incoming HT can acquire the necessary plant and equipment without difficulty (at market value) and that he would be able to dispose of it without difficulty (at market value) on termination of the tenancy. At 285, Viscount Hailsham LC observed on the assumptions of a HT as follows:
"A further general observation occurs to me and that is that one may be led astray in the case of a railway undertaking by attempting too detailed or elaborate a personification of the hypothetical tenant. In the case of an ordinary house, a rating authority may well visualize an ordinary citizen with all the usual desires, tastes and avocations of mankind as the tenant who is to pay the rent; but when we come to a railway undertaking in which vast sums have been invested and in which the share of the tenant’s capital amounts to many millions it is apparent that the effort to visualize an actual tenant involves an almost impossible strain. In my opinion it would be a mistake to allow the percentage to be influenced by the largeness of the sum which the tenant is supposed to supply for capital, or by the difficulty of finding a tenant with such extensive means, or by the difficulty the tenant might find either in realizing his rolling stock and other chattels or in reinvesting so large an amount of capital on the expiry of his tenancy. Since the landlord is to be contemplated as a possible tenant, none of these considerations might be allowed to come in."
And at p 287:
"If it were to be construed as bearing the meaning which the appellants allege, if your Lordships were to assume that the Court based their allowance for tenant’s capital on the view that the tenant must be treated as somebody who came to take over this great railways system with no means of running it, with no directors or managers or staff, and that he had to be compensated for the risk which he ran of being unable to assemble such an organization in order to carry on his undertaking, then indeed, I think the appellants would be right in saying that the calculation had proceeded upon a wrong basis."
 The main purpose of this principle is to ensure that all possible tenants are considered on an equal footing and that the actual occupier is not assumed to have an advantage in not having to incur the costs of moving in. B3.2 The HT and the HL  One should assume that the HT and HL would act reasonably, as other reasonable people would be likely to do in real life, in letting and renting the type of property in question:
(1) The HT is to be assumed to behave reasonably, making proper enquiries about the property and not being too eager to rent: Inland Revenue Commissioners v Gray  STC 360 .
(2) The HL not being extortionate, and the HT not being under pressure, with the tenement vacant and to let. In R v Paddington (VO) ex p Peachey Property Corp  1 QB 360 at 412E-F, Lord Denning MR said:
"The rent prescribed by the statute is a hypothetical rent, as hypothetical as the tenant. It is the rent which an imaginary tenant might be expected to pay to an imaginary landlord for a tenancy of this [tenement] in this locality, on the hypothesis that they are both reasonable people, the landlord not being extortionate, the tenant not being under pressure, the [tenement] being vacant and to let, not subject to any control, the landlord agreeing to do the repairs and pay the insurance, the tenant agreeing to pay the rates, the period not too short nor yet too long, simply from year to year."
 It is legitimate to consider any possible occupier as a prospective tenant. The actual occupier may be taken into account as a possible tenant even though in the real world he would never contemplate taking a tenancy from year to year: R v London School Board (1866) 17 QBD 738 and LCC v Erith Parish  AC 562 , at 588-589 and 596.  Where there is only one or more than one possible tenant for the tenement, it is legitimate to have regard to the factors which would influence that person’s bid, including the respective bargaining strength of the HT and the HL: Tomlinson (VO) v City of Plymouth and Plymouth Argyle Football Club Ltd (1960) 6 RRC 173 . Pearce LJ said at 178-179:
"Therefore, it was important for the Tribunal to try to decide what in the ‘higgling of the market’ would be the resulting rent of this special hereditament as a result of the probably negotiations between the lessors and the ratepayer tenants. Each had powerful bargaining arguments. The landlord needed a tenant for a valuable hereditament which demanded some thousands of pounds to be spent on it annually by way of repairs. On the other hand, the ratepayers’ existence depended on their taking the hereditament. I cannot but think that they would have arrived at some reasonable compromise and that compromise would represent the rent. Nowhere in the case is there any reference to the bargaining power which the ratepayer tenants had against the lessors by virtue of their being the only bidders for the hereditament and, indeed, the case was decided on the basis that they had no such power. That I think is bound to give an unreal picture of the rent which is likely to result and in my view that defect springs from the fact that the Tribunal assumed more than one hypothetical tenant, where in fact it was clear that there would be only one."
 The HL needs no identification. He is not the actual owner of the tenement: Dawkins (VO) v Ash Bros and Heaton Ltd  2 AC 367 , at p382. He is merely to be assumed to be willing and able to let the whole tenement on a year-to-year basis. He is however assumed to be a reasonable landlord, who goes about the negotiations as a prudent man of business, without being over anxious or unduly reluctant: Inland Revenue Commissioners v Gray  STC 360 . B3.3 The hypothetical tenancy  The definition of the hypothetical tenancy is not an easy one. As said by Scott LJ in Robinson Brothers (Brewers) Ltd v Houghton and Chester-Le-Street Assessment Committee  2 KB 446 at 465:
"The statutory task set looks like a simple economic problem, but few problems have given rise to more litigation and more difference of judicial opinion. It is obvious, therefore, that is not as simple as it looks."
 The role of the hypothetical tenancy was explained by Lord Pearce in Dawkins (VO) v Ash Bros and Heaton Ltd , supra, at 381H-382A as follows:
"Rating seeks a standard by which every hereditament in this country can be measured in relation to every other hereditament. It is not seeking to establish the true value of any particular hereditament, but rather its value in comparison with the respective values of the rest. Out of various possible standards of comparison it has chosen the annual letting value. This is appropriate since the tax is charged annually. One therefore has to estimate ‘the rent at which the hereditament might reasonably be expected to let from year to year’, the tenant paying rates, repairs etc. This standard must be universal even though in many cases it demands various hypotheses."
B3.4 The duration of the hypothetical tenancy  Although the hypothetical tenancy is from year-to-year and may be put to an end by notice, its duration is indefinite See: R v Staffordshire Waterworks Co (1865) 16 QBD 359 at 370, (approved by the House of Lords in Railway Assessment Authority v Southern Railway  AC 266 ); Great Eastern Railway v Overseers of Haughley (1866) LR 1 Eq 666 ; Smith v. Birmingham (Churchwardens) (1889) 22 QBD 703 ; Dawkins (VO) v Ash Bros and Heaton Ltd  2 AC 366 , 387G per Lord Wilberforce.. At the same time, the rent however is assumed to be capable of review at the end of the year.  Moreover, in order to carry out the calculations necessary to apply the R&E Method of valuation, it may be necessary to adopt a finite period for the length of the tenancy. In China Light and Power v Commissioner of Rating and Valuation (No 1)  4 HKC 461 , at 469-471,the Hong Kong Lands Tribunal adopted, in the light of the evidence in that case, four years The four years adopted by the Tribunal was merely a mid point between the Appellant whose expert contended for five years and the Commissioner whose expert contended for three years.and the Court of Appeal held that they were not wrong in law to do so  2 HKC 42 (CA), at 45D-46B.. Godfrey JA said at page 45G-H that:
"…it would not be legitimate for the Lands Tribunal to value the tenements on the footing that the hypothetical tenant had a term of, say, ‘X’ years certain. But it would be legitimate for the Lands Tribunal to value the tenements on the footing of a tenancy from year to year, with a reasonable prospect that the tenancy would in fact continue for ‘X’ years."
B3.5 The rent  The ‘rent’ is intended to represent the value of occupation of premises: Poplar Assessment Committee v Roberts  AC 93 , per Lord Buckmaster at 103. Thus, in Orange PCS Ltd v Bradford  2 All ER 651 , at 658d, Thomas LJ said: "The rent for the purposes of the statutory hypothesis is the value of the occupation to a hypothetical tenant ".  It is an open market rent that which HT would pay in a competitive market, taking into account of every intrinsic quality of the tenement, and all relevant circumstances, and what the HL and HT would agree upon after "higgling of the market": Halsbury’s Laws of England , Vol 39(1), para 688; Warren Chow v Commissioner of Rating and Valuation  HKLTLR 277 , approved in Commissioner of Rating and Valuation v Agrila and Others (2001) 4 HKCFAR 83 at 107G.  The concept of the open market assumes that the whole world is free to bid and then requires a judgement as to what would, in those circumstances in real life, have been the best rent reasonably obtainable: Inland Revenue Commissioners v Gray  STC 360 .  In Robinson Bros , supra, Scott LJ said at 470 The decision of the Court of Appeal in this case was affirmed by the House of Lords  AC 321. Part of the judgment of Scott LJ in the Court of Appeal (concerning the admissibility of evidence) was later rejected by the Court of Appeal in Garton v Hunter  2 QB 37 , but this does not affect the passage cited here.:
"The rent to be ascertained is the figure at which the hypothetical landlord and tenant would, in the opinion of the valuer or the Tribunal, come to terms as a result of bargaining for the hereditament, in the light of competition or its absence in both demand and supply, as a result of the ‘higgling of the market’… The true rent is often called the ‘market value’, but I hesitate to use that expression, as it seems to me prone to mislead, for it gives rise to the notion of something absolute, something having an objective existence, independent of all the various particular sources of demand, which together constitute the totality of demand."
He also said at 469 that,
"…it is the duty of the valuer to take into consideration every intrinsic quality and every intrinsic circumstance which tends to push the rental value either up or down, just because it is relevant to the valuation and ought therefore to be cast into the scales of the balance before he looks to se the resultant figure on the dial at which the pointer finally rests."
He emphasized at 474 that:
"While the tenant is hypothetical and the landlord who is to let to the tenant is necessarily also hypothetical, the hereditatment is actual – namely, the hereditatment described in the valuation list with all its actualities. Two consequences follow. All the intrinsic advantages and disadvantages must be considered and weighed. It is just that particular hereditatment which is supposed to be in the market with all its attractions for would-be tenants, to whatever kind of human emotions or interest or sense of duty they may appeal – economic, social, asthetic, political (for example, in order to perform statutory duty) – and also with all its imperfections and drawbacks which may deter or reduce competitions for it. That’s why in valuing a public-house you must take into account of the licence, as for instance, on the one hand, its monopoly value, and on the other, the degree to which in that are the competition with other licensed houses may reduce the profit-making quality of that particular house and so prejudice the demand for it. The second consequence is that the totality of opposing forces of demand and supply must be assessed and weighed in order to hit off the point at which the two opposing negotiators are to be deemed likely to strike their bargain."
B3.6 The date of valuation and the "rebus sic stantibus" principle  The rateable value must be assessed by reference to "the relevant date" which is the 1st October prior to the coming into force of the valuation list on 1st April of the following year. However, certain factors must be taken as they were on 1st April. This is the effect of section 7A(2) of the RO which provides as follows:
"The rateable value of any tenement to be included in a valuation list shall be ascertained by reference to the relevant date [i.e. for the purpose of the present appeals, 1 October 2003] on the assumption that at that date –
(a) the tenement was in the same state as at the time the list comes into force [i.e. for the purpose of the present appeals, 1 April 2004];
(b) any relevant factors affecting the mode or character of occupation were those subsisting at the time the list comes into force [i.e. 1 April 2004]; and
(c) the locality in which the tenement is situated was in the same state, with regard to other premises situated in the locality, the occupation and use of those premises, the transport services and other facilities available in the locality and other matters affecting the amenities of the locality, as at the time the list comes into force."
 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 1st October 2003.  The factors which must be taken as at 1st April 2004 are those listed in (a), (b) and (c) of section 7A(2).  Section 7A(2) is a statutory expression of the long established "rebus sic stantibus " principle In Commissioner of Rating and Valuation v Agrila and others (2001) 4 HKCFAR 83 , Sir Anthony Mason NPJ in the Court of Final Appeal commented (at p 106D) that section 7A(2) incorporates this rule. See also: Lai Kit Lau Mutual Aid Committee v CRV  HKLR 31 (Lands Tribunal) and  HKLR 93 (CA).. 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.  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 1st October and 1st April. B3.7 Principle of reality  The term "the principle of reality " was introduced in this context by Peter Gibson LJ in Hoare (VO) v National Trust  RA 391 , when he said at 415:
"…I would emphasise the necessity to adhere to reality subject only to giving full effect to the statutory hypothesis, so that the hypothetical lessor and lessee act as a prudent lessor and lessee. I would call this the principle of reality…"
Schiemann LJ also said at 408,
"The statutory hypothesis is only a mechanism for enabling one to arrive at a value for a particular hereditament for rating purposes. It does not entitle the valuer to depart from the real world further than the hypothesis compels."
 Moreover, 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 ". See: Townley Mill Co (1919) Ltd v Oldham Assessment Committee  1 KB 585 at 643 per Scott LJ. B4. Assessment of rateable value a question of fact  As said by Viscount Hailsham in Southern Railway , supra, at 283, assessing the rateable value of a tenement is a question of fact to be determined on the basis of evidence.  For the same purpose, Earl of Halsbury LC pointed out in Mersey Docks & Harbour Board v The Assessment Committee of Birkenhead  AC 175 at 179-180 as follows:
"The thing that the Legislature has called upon the overseers to do is to solve a simple question of fact, and although it may be by no means simple as regards the mode in which they arrive at it… they are to arrive at that value, so far as I know, unfettered by any statute as to the way in which they can do it. I am not aware of any rule of law or any statute which has limited them as to the mode in which they shall arrive at it. It is not a question of law at all – it is a question of fact. These questions have from time to time come before the courts, and have been argued as questions of law; but that is where, instead of doing what the statute has directed them to do, the overseers, or those who were acting on behalf of the parish, have thought proper either to include something which by law ought not to be included, or to exclude something which ought to have been included. Of course, in that sense, when you are dealing with a question of fact which has to be answered by any tribunal, it may be that a question may come up in the argument as a matter of law; but still one must bear in mind that the thing to be done is to answer the plain question of fact, namely, what is the rent which a tenant might reasonably be expected to give for premises, subject to the deductions mentioned in the statute, as a tenant from year to year?"
C. The Tenement C1. The rateable tenement as defined under the RO  A tenement is defined in section 2 of the RO to mean "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 ".  But the definition is supplemented by sections 8 and 8A of the RO and a tenement for the purposes of rating law therefore covers more than land and buildings. Sections 8 and 8A of the RO provide that:
"8. For the purpose of ascertaining the rateable value of a tenement under sections 7 and 7A –
(d) 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;
(e) 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."
(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."
 Therefore, a "plant" within the meaning of section 8A of the RO is included as a tenement. Under section 8A(3), this includes cables, ducts, pipelines, etc. and supports for plant or machinery. Under section 8, machinery (including lifts) used as adjuncts to the tenement shall be regarded as part of the tenement, but no account shall be taken of the value of any machinery in or on the tenement for the purpose of manufacturing operations or trade purposes.  The Tenement is enormous.  As we mentioned above, in these appeals, the Tenement includes part of HEC’s entire generation, transmission and distribution of electricity to Hong Kong Island, Lamma Island and Ape Lei Chau. Hence the Tenement in the present case covers more than land and buildings. For examples, it also covers certain plants and machinery, the cables for the transmission and distribution of electricity in addition to the land they occupy.  HEC’s assets could be described in greater details as follows, as have been helpfully summarized in HEC’s opening submissions. C1. Electricity generation  The installation at Lamma Island occupied, in 2004, a site of a little over 62 hectares the majority having been developed over the period between 1982 and 1997. By 2004, electricity was being generated by means of 8 coal fired generating units, five gas turbines and one combined cycle gas turbine. There is a main station building and a number of smaller buildings, three high chimneys, a coal yard, conveyor systems for the coal, storage tanks for oil and water and an ash lagoon.  An extension to the Lamma Island site of about 22 hectares was created by reclamation works which had been substantially completed by 1st April 2007 providing the capacity to accommodate six gas fired combined cycle generating units. One additional gas fired combined cycle unit was installed there for which gas is supplied by an undersea pipeline of about 92km from Shenzhen. These facilities are not directly relevant to the appeal in respect of 2004/05 (being at that time under construction) and only became part of the tenement in 2006/07. In that year, there was a substantial amount of unused capacity in the land extension.  At Lamma Island, the tenement for rating purposes (the HL’s property) comprises the land, buildings, structures and certain machinery whereas, in the main, the huge amount of plant present on the site is treated for rating purposes as belonging to the HT. C3. Transmission  The transmission system comprises cables which transmit electricity at 275kV, 132kV and (in 2004/05 appeal year only) 66kV The 66kv transmission network was decommissioned by 1st April 2005, so is relevant only to the 2004/05 appeal.and some 32 substations where the voltage is stepped down for distribution purposes. The cables are largely laid underground, although there are some overhead cables. These cables are laid on or in land and, in places, in tunnels. In addition to the land, the cables themselves are treated, by virtue of section 8A, as part of the tenement (and therefore belonging to the HL). The substation structures comprise part of the Tenement but the transformers, switching gear and other substation apparatus are treated as machinery used for manufacturing or trade processes with section 8(b). C4. Distribution  The distribution system comprises cables which convey electricity in voltages of 22kV, 11kV and 380V and over 3,000 substations The number of such substations varies slightly in each of the appeal years.where the voltage is stepped down to the level used by consumers. The great majority of these substations are situated within buildings owned and controlled by third parties. When new buildings are constructed, it has been the practice for some years to expect the developer to make sufficient space available within the building to accommodate the substation and switching equipment necessary to supply electricity to users within the buildingA few also supply other buildings as well.. These are referred to as ‘customer-provided sub-stations’The customers are the consumers of electricity. They are the occupiers of the buildings to which electricity is supplied. The space for sub-stations is made available by the building developer or owner.. HEC occupies those substations through the presence of its apparatus but it pays no rent or fee.  HEC’s undertaking is large and complex, and is spread over a geographically wide area. Although physically contiguous, application of the normal principles relating to the identification of tenements suggests that it might comprise a number of separate tenements, but under section 10 of the RO, the CRV has power to treat property which otherwise might comprise several tenements as one single tenement. We understand that the CRV has exercised that power in relation to HEC’s property and it is not in dispute that it is appropriate to assess the land and premises used for HEC’s electricity generation, transmission and distribution business as a single tenement. So, the tenement the subject of this appeal comprises the majority of the land and buildings occupied by HEC for the purposes of its undertaking. There is a small number of tenements occupied by HEC which are separately assessed. These are not the subject of this appeal.  Sections 8 and 8A of the RO make express provision about what machinery and plant should be treated as forming, or, as the case may be, not forming, part of the HL’s tenement. In short:
(1) By virtue of section 8, no account is to be taken of any machinery in or on the tenement for the purpose of manufacturing operations or trade processes (in other words, such machinery is to be treated as belonging to the HT, not the HL) although machinery which is used as "adjuncts" to the tenement is to be regarded as part of the tenement; and
(2) By virtue of section 8A, where any land is "occupied by means of plant", that land is to be treated as a tenement and the plant is to be treated as part of the tenement (in other words, belonging to the HL). Plant is defined as including (amongst other things) cables, ducts, pipelines, oil tanks and the supports for such plant.
 The land occupied by HEC contains a large amount of machinery and plant. The distinction made by rating law between the HL and the HT makes it necessary to distinguish which of HEC’s assets are to be treated as the HL’s (and therefore part of the tenement) and which are to be treated as the HT’s.  For rating purposes, having identified all the features which comprise the HL’s tenement, it must be valued in its existing state on 1st April in accordance with the rebus sic stantibus rule.  In these appeals, the experts for the parties have managed to come to an agreement as to which part of the HEC’s assets should be treated as the HL’s (and thus forming the Tenement) and which as the HT’s non-rateable assets.  It is a feature of the HEC tenement that works are almost constantly in progress to update both the assets which rating treats as the HL’s tenement and the assets which rating treats as the HT’s. On 1st April in any given year, a wide variety of works would have been in progress but not complete. These are what constitute the AUC in these appeals. C5. Cumulo assessment of the Tenement  The Tenement thus can be said to comprise and cover many separate tenements.  Normally, the rateable values of separate tenements are to be assessed separately. However, under section 10 of the RO, where the value of a tenement is affected by the value of any other tenement, and the tenements are used in connection with one another, then the tenements may, in the discretion of the CRV, be valued together as a single tenement. Such a valuation is called an in cumulo assessment.  The CRV has valued the Tenement as a single tenement. HEC also agrees that it is legitimate and appropriate to do so.  Thus, we are concerned with the assessment of the rateable value of the Tenement as a whole and as one single tenement. D. The SOC  In 1993, the HEC and HEH entered into the SOC with the Government, which has since regulated HEC’s business. The SOC’s has a term for 15 years from 1994 to 2008. This was effectively a result of the demands in the community for greater control by the Government on utility supply companies in Hong Kong. The Government started negotiations with HEC and HEH (as well as China Light and Power Hong Kong Ltd ("CLP")) on the form of regulations that she would introduce to monitor and control these electricity companies’ business and tariffs.  After extensive negotiations, and instead of introducing statutory regulations and measures to achieve the control and monitoring on the tariffs chargeable by, and the performance of, HEC’s electricity business, the parties entered into the SOC CLP also similarly and separately entered into its scheme of control agreement with the Government..  The context in which the SOC was entered into is described in the recitals, which are as follows:
"(A) The Government and HEC are parties to a Scheme Of Control Agreement dated 13th April 1980 (as amended) which will expire on 31st December 1993 and pursuant to clause 9 (3) thereof have agreed on the Scheme Of Control as contained herein which shall commence on 1st January 1994.
(B) Holdings is the holding company of HEC.
(C) The Supplemental Agreement dated 13th April 1980 (as amended) between the Government and Holdings will not be renewed upon its expiry and the commencement of this Agreement.
(D) HEC recognises its continuing obligation to contribute to the development of Hong Kong by providing sufficient facilities to meet the present and future demand for electricity and in pursuit of this objective, would construct additional generation, transmission and distribution facilities for sale of electricity to its consumers.
(E) The Government recognises that HEC and its shareholders are entitled to earn a return which is reasonable in relation to the risks involved and and the capital invested in and retained in the businesses; in return the Government has to be assured that service to all consumers shall at all times be adequate to meet demand, will be efficient and of high quality, and is provided at the lowest possible cost which is reasonable in the light of financial and other considerations and is consistent with Government policy objectives on energy efficiency and conservation in the light of the need to protect the local and global environment and to meet international obligations.
(F) In pursuance of the above, the parties hereto have agreed to adopt the procedures set out in this Agreement to govern the financial affairs of HEC and Holdings so far as they refer to Electricity-Related activities."
 In short, HEC recognized its continuing obligation to provide sufficient facilities to meet present and future demands for electricity while the Government was to be assured that service to all customers would be adequate to meet demand, efficient and of high quality, and would be provided at lowest possible cost and consistently with Government objectives on energy efficiency and need to protect the environment.  It is also expressly provided in the SOC Clause 2 of the SOC.that it shall govern the financial affairs of HEC’s "Electricity-Related" activities, which are defined to mean all the activities that are directly or indirectly appertaining to the generation, transmission, distribution and sale of electricity and energy efficiency and conservation.  The main mechanism provided in the SOC to enable HEC 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 HEC is controlled is called the Permitted Return ("PR"). Effectively, HEC is entitled to set the tariff for a particular year with an objective of achieving the maximum profit at PR.
(2) The PR for particular year is the aggregate product of 13.5% of "Average Net Fixed Assets" ("ANFA") plus 1.5% of shareholders investments made after 31 December 1978 for financing the acquisition of "Fixed Assets" as defined See: paras 5(2)(a) and (b) of the SOC.. 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 HEC to work out what is the maximum permissible profit HEC could earn through the tariffs for each particular year. (3) At the same time, HEC is required to maintain:
(a) 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 maintains a surplus, then in a particular year where HEC could not in fact achieve the PR, funds could be transferred from the Development Fund to ensure that HEC earns its PR for that particular year.(b) A Rate Reduction Reserve which is intended to reduce, by means of rebates, the tariffs charged to customers normally in the year immediately following. The account is credited with interest at 8% that is charged to shareholders on the average balances in the Development Fund.(c) A Fuel Clause Recovery Account which is a mechanism by which the basic tariffs, which includes the standard fuel cost, remain constant despite fluctuating prices for fuels in world markets. Each year, the tariffs are set by reference to a "standard" cost of fuel and difference between the standard and the actual are passed on to customers by means of rebates or surcharges. Interest is allocated based on the balance of the funds in the Fuel Claus Account, the interest being credited/debited to the account itself.
 Thus, although putting a cap on what it could earn from the business, it can be seen that through the PR and the tariffs setting mechanism embodied in the SOC, which link the PR to effectively the value of the assets HEC has invested in the business, HEC would have an incentive to continue to invest further in the business, in order to entitle it to earn more. This would in turn achieve the Government’s goals of (a) monitoring the tariffs chargeable by HEC, and (b) ensuring that HEC would meet its obligations to maintain stable and consistent electricity supply and to meet future demands by customers.  Bearing these principles and hypotheses in mind, we now turn to deal with the issues. E. The issues E1. What are the proper parameters to be adopted under the R&E Method for assessment of the rateable value of the Tenement E1.1 The common ground  Through the commendable efforts of the parties and their respective experts, there are a number of important matters relating to the valuation of the rateable value of the Tenement which have been agreed upon. It is therefore useful to set them out first to form the basis of discussions for the outstanding issues.  These common grounds could be summarized as follows:
(1) There should be a cumulo assessment of the rateable value of the Tenement under s. 10 of the RO.
(2) The CRV accepts that, in assessing the rateable value (or the hypothetical rent) of the Tenement, it is legitimate to assume that the HT is subject to the SOC or a similar regulatory agreement which bears essentially the same terms and conditions of the SOC. The exact extent of how the SOC applies in the valuation is however subject to debate, which would be discussed below.
(3) Given that the SOC should be taken into account for rating the Tenement, both parties accept that the R&E Method is the primary and appropriate method of valuation for the rateable value of the Tenement.(4) The essential steps of the R&E Method of valuations are agreed. They are as follows:
(a) Using the gross income recorded in the accounts of HEC as a proxy for arriving at the general receipts of the HT’s business carried out in renting the Tenement.(b) Using the general costs and expenditures recorded in the accounts of HEC as a proxy for arriving at the general costs and expenditures of the HT’s business carried out in renting the Tenement.(c) The DB is the difference between the gross income and the general expenditures and cost.(d) The rent is represented by the residue of the DB after deducting from the DB what would represent a reasonable return, for the HT’s investment in capital and reward for risk and enterprise, sufficient to induce the HT to undertake the business to be carried out in renting the Tenement.(e) The valuer then stand back and look at the valuation.
(5) For this purpose, the parties agree on the identification and the respective percentage of apportionment of the HEC’s entire assets into the HT’s assets (thus non-rateable) and the HL (the Tenement). This is roughly in the ratio of 48% to 52%.
(6) Quantum-wise, the parties agree also on the amount of the DB (which is HK$8,036 million) for the purpose of assessing the rateable value of the Tenement for 2004/05, subject to the arguments on whether there should be adjustment in excluding the AUC value.
(7) The duration of hypothetical yearly tenancy is assumed likely to be more than 4 years.
E1.2 HEC’s primary contentions for the tenant’s share the R&E Method  Given the above extent of agreements, the central (and fundamental) issue between the parties is on how to assess and find out the tenant’s share from the DB.  HEC’s case is that the tenant’s share should be determined by starting with the PR under the SOC to be earned on the proportion of assets hypothetically assumed to be owned by the HT, and then making a further adjustment to allow the HT to earn an appropriate amount for management and risk. In effect:
(1) From the DB, it should first be apportioned to the HT its share by reference to the return on assets permitted under the SOC. In other words, there should be an apportionment to the HT as part of the tenant’s share of PR x HT’s ANFA value.
(2) Then, the HT should also be rewarded for the risk and enterprise in running the business by having a 25% share of the DB.
 It is this suggested determination which defines the fundamental difference between HEC and CRV in these appeals.  HEC’s thesis on how the tenant’s share should be split is premised fundamentally on its contentions that, in the negotiation for rent, in determining what would constitute a reasonable return for HT’s investment in the undertaking to embark on the hypothetical tenancy, it is only commercially reasonable and right for the HT to look at (a) what the HT is entitled as a return under the SOC (i.e., PR x the tenant’s asset’s value, ANFA), and (b) what is the reasonable reward for its risk and enterprise in running the business at the Tenement.  HEC says this is so because:
(1) It is the terms under the SOC which govern and give rise to the income of the entire business, as well as the calculations of the expenditures and cost in running entire business, which taken together eventually give rise to the DB for the HT and HL to share.
(2) The SOC governs and regulates the financial affairs of the entire business, and provides for the mechanism as to how and how much the business is entitled to earn form its operation.
(3) The HT and HL are in equal or symmetrical bargaining power when negotiating for rent, since the HL’s assets (i.e., the Tenement) are integrated with the HT’s assets (as they are designed and built together), and thus need the HT’s assets to enable the profit-making electricity business to be carried on.
(4) In the circumstances, it is only natural and reasonable for the HT to look to the SOC to estimate what it is likely to be entitled as a return in embarking on the business.
(5) Further, under the SOC, the PR allowed represents the reasonable return that should be provided to HEC to reflect (a) the risks involved and (b) the capital invested in and retained in the business by HEC Recital (E) of the SOC provides: “The Government recognizes that HEC and its shareholders are entitled to earn a return which is reasonable in relation to the risks involved and the capital invested in and retained in the business…”. But the PR so permitted under the SOC is referenced to the entire assets of HEC’s undertaking (i.e, PR x HEC’s ANFA)
(6) However, for rating purposes, HEC’s entire assets have been hypothetically split into the HL’s rateable assets (ie., the Tenement) and the HT’s non-rateable assets.
(7) At the same time, in negotiating for the hypothetical rent, the HT’s first estimated return (as discussed above) is only the PR on HT’s own assets (i.e, only part of the entire assets), which is appreciably less than the PR on the HEC’s entire assets. This would therefore not represent a sufficient reward, if any, for the risk and enterprise undertaken by the HT (in the rating world), which in fact would be similar or the same as HEC’s risk and enterprise (in the real world).
(8) As a result, in bargaining for the hypothetical tenancy, it is reasonable and right for the HT to negotiate to be rewarded further for the risk and enterprise undertaken by it in running the business, in addition to the return represented by reference to the proportion of assets between the HT and the HL. HEC’s expert Mr Parsons suggests that this reward should be 25% of the DB.
 HEC therefore submits that, subject to various minor adjustments, the tenant’s share should be the summation of (a) PR x HT’s ANFA, and (b) 25% of the DB value.  The CRV disagrees. We will now set out the gist of CRV’s contentions as to how the tenant’s share should be determined. E1.3 CRV’s primary contentions on the determination of the tenant’s share  The CRV agrees that in determining the tenant’s share under the R&E Method, in order to induce it to take up the business in occupying the Tenement, it should be a sum which would represent the reasonable return to reward the HT’s capital investment and risk.  However, the CRV says that this reward (i.e., the tenant’s share) is and should be suitably measured by what is known in the study of economics as the WACC (the Weighted Average Cost of Capital) on the NBV of the HT’s assets.  WACC is the short term of a mathematical formula that measures the company’s opportunity cost of capital. It reflects the percentage return that the company must provide to its investors, both bondholders and equity investors Bondholders are the investors who make loans to the company in return for a promised regular interest payment and principal at the maturity of the loan. Equity investors are not guaranteed of interest payment, but have the right to share in whatever profits or earnings made by the company after the interest on the company’s debt has been paid. . For a company that contemplates a new investment, the WACC tells it the return on the investment that will be sufficient to cover the interest payments of any new debt which is issued to finance the investment, as well as the additional profit which will be needed to maintain the return that will be required by equity investors.  The WACC therefore is said to reflect the expected return that the investors of the company may obtain from an alternative investment of comparable risk. For example, if the WACC is say x%, this would mean that the investors would require the alternative investment that would at least make a yield of x% to satisfy the investors that it is worthwhile to invest in the alternative project.  Thus, the CRV says the tenant’s share should be the WACC of HT’s business on the value of the HT’s assets, which (as further submitted by the CRV) should be their Net Book Value ("NBV"). In other words, the tenant’s share should be calculated as: WACC x HT’s NBV.  The CRV says this is so because simply that, in economic terms, this return represents what would be sufficient to induce a potential HT to take up the hypothetical tenancy and run the business. The hypothetical rent is thus: DB – (WACC x HT’s NBV).  The CRV further says if any other HT insists on (as suggested by HEC) having a tenant’s share which is greater than WACC (which for the present purpose would have been the case if it is determined in accordance with HEC’s thesis), he would simply be out-bid by the HT who would take WACC as its return in the haggling of the market in negotiating for the tenancy, as this HT would be willing to pay a higher rent.  This is particularly so, as it is the CRV’s case that the HL would have a superior bargaining power over the HT, as the Tenement has the special feature of monopoly of place. In other words, this is the only tenement which would enable the business to be undertaken by any HT. E1.4 Discussion E.1.4.1 The division of the DB by first apportioning to the HT PR x HT’s ANFA  In our view, we accept HEC’s submissions that, in negotiating for the rent, it is reasonable for a HT to start by looking at what he is likely to be entitled as a return under the SOC to decide whether he is willing to embark on the undertaking to be carried on by occupying the Tenement. Our reasons are as follows.  First, it is accepted by the CRV that the HT would be subject to the same or essentially the same terms and conditions of the SOC. As such, the HT is subject to various contractual and stringent obligations under the SOC, which to name the more important ones, include:
(1) It has a continuous obligation to provide sufficient facilities to meet the present and future demand for electricity by constructing additional generation, transmission and distribution facilities for sale of electricity to its consumers Recital (D)..
(2) The freedom and ability on how to charge and fix its tariffs in the business are regulated Clause 3 and 5 of the SOC.. In other words, the HT undertaking the business is not free, as usually with other business operators, to decide and fix the tariffs (ie., the price of its products) simply in accordance with the market, economic and its business strategy considerations. This would directly affect the ability to earn income. As the CRV consistently argues, this is a "bad" thing for the business operator, as it puts a cap on its earning capacity while at the same time provides no guarantee to such an earning
(3) The Development Fund is contractually provided Clause 6 of the SOC.that the balance in it, other than for the purpose of enabling the business undertaking to achieve the PR at times, represents a liability of the operator and shall not accrue to the benefit of the shareholders.
(4) An upper limit is set for the balance that could be maintained with the Development Fund. The operator is required to return any excess to consumers in the next year following in the form of one-off rebate or tariff reduction Clause 6 of Supplemental Agreement in respect of the SOC dated 6 May 1999..
(5) The operator is not allowed to pledge or secure in any manner whatsoever any of its current and future assets or resources or otherwise guarantee any liability of any person, firm or otherwise save solely for the direct benefit of the operator itself Clause 9(3) of the SOC..
(6) It is contractually provided on how depreciation on different assets of the undertaking should be madeClause B and C of Schedule 2 of the SOC.. There is also a strict regulation on how to deal with the profit and loss on the disposal of assets.
 At the same time, the business operator agrees to be subject to these obligations set out in the SOC, which regulate and limit the business operation model and revenue generating mechanism, in return for the right to earn the PR under the SOC. As mentioned above, it is recognized under Recital (E) of the SOC that the operator is to "earn a return which is reasonable in relation to the risks involved and the capital invested ".  Looking at this objectively and from a realistic commercial point of view, we believe it is only natural and reasonable for the HT, in considering whether to embark on the business undertaking subject to all these obligations under the SOC, to look at the very "profit" provided under the SOC as to what would constitute a sufficient return for it.  Although the CRV accepts that it is to be assumed that in the rating world, effectively the same SOC exists as a background between the HT and HL, and that it is relevant to take that into account for rating purposes, HEC raises the observation that it not entirely clear as to the CRV’s position on how the SOC is taken to apply to the HT and HL in the rating world. In particular, HEC says it is unclear as to whether the CRV accepts that all the rights and obligations apply to both the HT and HL.  We believe the CRV’s position at the hearing is clear in that she accepts that the SOC should feature in the rating world as in the same way as it applies in the real world. She also accepts the SOC would affect the value of occupation and that it should therefore be taken into account by being assumed to exist in the hypothetical world. This can be seen from paragraphs 116 to 118 of CRV’s Closing Submissions which are as follows:
"116. As explained in Section C4 of the CRV's Written Opening, the reason why the parties have assumed that the SOC exists in materially the same terms in the rating world is because it is an "essential feature" of the tenement.
117. In other words, since rating seeks to measure the value of occupation, and since the SOC is something which affects the value of occupation, then it should be taken into account by being assumed to exist in the hypothetical world.
118. For these reasons, there appears to be no dispute that any effect of the SOC on the value of the occupation of the tenement should be taken into account, and should be reflected in the RV."
 If we are wrong in understanding the CRV’s position as to how the SOC should apply in the rating world, we would accept HEC’s submissions that the terms and conditions must be assumed to have applied equally to the HT and HL with the same obligations and rights. We could not see how logically and practically the SOC, when presumed to have existed in the rating world, could be assumed to have applied differently. The only hypothesis is the creation of the HT and HL and the splitting of the entire assets of the integrated business into the HT’s and HL’s. It is not desirable to, and one should not, create any further unnecessary hypothesis to enable the rating exercise to be carried out if one can, by common sense, apply what are in the real world to the hypothetical scenario.  Further, this is also consistent with the adoption of the R&E Method as the valuation method of choice:
(1) The use of the R&E Method is only appropriate and feasible if the valuer can rely on the books of accounts which are reliable and accurately reflect the undertaking’s receipts and expenditures.
(2) The CRV accepts that the accounts kept by HEC as prescribed under the SOC would serve as a reliable and accurate basis to estimate these receipts and expenditures. In other words, the SOC provides for the measure of the receipts and expenditures.
(3) In the premises, it is only logical that the SOC should also provide and guide the operator’s assessment as to what would constitute his likely return as profit in running the business.
 The CRV however contends that the operator under the SOC is not guaranteed with the PR as the revenue. This is not the minimum but the maximum that it is entitled to earn. Therefore, there is no basis to say that HT should start by looking at the maximum return as what he would have reasonably expected to induce him to embark on the undertaking.  We do not think this is correct:
(1) The situations where the PR would not be achieved is where (a) the operator decides not to achieve it in a particular year for a particular reason, and (b) there is an overestimate of the income for the year in setting the tariffs, coupled with a deficient Development Fund balance, as a result of which no or insufficient fund could be transferred to make up the difference to achieve the PR.
(2) Insofar as (a) is concerned, we believe it should be disregarded in the rating assessment in considering the negotiation between the HT and HL, unless there is anything to suggest that in that particular year, when negotiating for rent, it is already featured in the mind of the HT that he does not intend the business to achieve the PR, and he takes that into account for the purpose of negotiating the rent. There is nothing in the evidence or in the submissions in the present appeals which supports such an approach.
(3) Insofar as (b) is concerned, this is by nature something which will only materialize long after the negotiation, when there is in fact an over-estimation. This therefore could not have featured in the minds of the HT or HL when negotiating for rent for the coming year.
(4) We also accepts HEC’s submissions that even when at times there is insufficient balance in the Development which results in a shortfall between the actual return and the PR, the shortfall relates to all the assets evenly and equallyThis is accepted by Ms Jim, the rating valuation expert for CRV.. This is so because the PR is defined under the SOC by reference to the ANFA of all the assets. Any shortfall would have related thus as much to the assets which have been for rating purposes hypothetically defined to be the HL’s as to the assets which rating defines as the HT’s. The shortfall would have applied to both parties’ assets.
 The CRV also argues that the SOC regulates the integrated business (i.e., HEC’s entire business) but not the rent. There is nothing in the SOC which suggests how the rent is to be determined. It is therefore wrong, as the submission goes, to take the PR of the HL’s assets as a starting proposition for the hypothetical rent.  In our view, this is not a valid objection:
(1) It is right to say that the SOC does not intend to regulate the rent. The SOC is not created to deal with the rating exercise.
(2) However, as we understand it, the HEC’s thesis is not suggesting that, for rating purposes, the rent should be determined on the basis of what the HL is presumed to have expected to earn under the SOC as its revenue (which is PR x HL’s ANFA).
(3) What we understand HEC is saying is that, in first deciding the tenant’s share, which is the proper exercise to be carried out under the R&E Method, the HT would look to what he is entitled under the SOC as his reasonable return to induce him to take on the investment. What is left from the DB is the starting point for rent (subject to HEC’s further contentions of the further 25% risk reward). This happens to be the same as PR x HL’s ANFA.
(4) This approach is consistent with the accepted principles under the R&E Method, and does not require any assumption that the SOC also regulates the rent.
 The CRV further contends that the HEC’s approach is wrong as the HT cannot assume that his cashflow from the business (i.e., the expected return) would be his ANFA x PR. This is so because the SOC does not determine the permitted return of the HT but only the integrated business (which is PR x HEC’s ANFA. As such, and without first knowing what rent should be paid for the Tenement, the HT simply cannot assume that his cashflow to be derived from the business is PR x HT’s ANFA. The CRV relies on the evidence of HEC’s own expert, Mr Jones to support this submission, which is as follows: Under cross-examination Day 6 of transcript.:
"24 Q. However, if you are looking at it on the view of
25 a tenant, not of the enterprise of the owner occupier,
1 the position, I suggest to you, may be different.
2 If I can explain what I mean by giving you
3 an example. If I were the owner occupier of a car
4 rental business and I have a fleet of, let's say, 10
5 cars, and then I work out that if I were to buy one more
6 car, what would be the gross return that I would have on
7 that car, then, of course, I would be looking at the
8 rental that I'd be able to attract for that car
9 multiplied by the frequency of that car being made
10 available or being rented out; right? So, I would be
11 looking at --
12 A. It is probably sufficient for your analysis but it's
13 actually a very, forgive me, naive analysis, the
14 economics of doing that because bringing one extra car
15 means that you may reduce the utilisation of your other
17 Q. Of course. It would be therefore quite -- well, that is
18 one thing. But apart from that, you would have
19 overlooked the expenses that you would have. For
20 example, that your present staff has been dealing with
21 only 10 cars and if you were to buy one more car, then
22 your staff would obviously have to stretch themselves
23 out for the extra car. The more you do, instead of
24 buying one car, you buy 10 cars, you would find not only
25 that your expenses are higher in terms of the staff and
1 management, you will probably have to take in more
2 space; right?
3 A. And, indeed, pay more rent.
4 Q. Indeed pay more rent, exactly. That is what I am coming
5 back to. If you look at it simply from the point of
6 view of the HT in the assumption that I suggest to you
7 we are operating, then it is not correct simply to look
8 at the PR as a return to the enterprise.
9 That is correct when you look at the whole
10 enterprise. But you have looked only at the tenant, the
11 return to the asset would not be the PR; is that right?
12 A. Well, any economics of the tenement depend upon the
13 rent. So, I can't tell you what the earnings to the
14 tenant from these assets are until you tell me the rent.
15 Q. Yes.
16 A. Which kind of leaves us in another circular problem, I
18 Q. Yes. But I would suggest to you that if you look at the
19 economic value of the tenant's asset, then the correct
20 approach is to look at the NBV of the asset because this
21 is what the tenant will get, namely, the WACC multiplied
22 by the NBV. This is what the tenant is going to get
23 year after year.
24 A. I'm sorry, that assumes the rent. You've assumed --
25 we're still in your particular fiction of the world.
Under re-examination Day 7 of transcripts.:
17 MR ROOTS: But clearly the cashflow has to be identified for
18 that assessment to be carried out?
19 A. Yes.
20 Q. In order to identify the cashflow does the Scheme of
21 Control provide any assistance?
22 A. I think we need to distinguish here as to what exactly
23 it is that the tenant is purchasing for the business.
24 If he's just buying the assets, if you like, with the
25 commission to charge for those assets, then the assets
1 and the Scheme of Control define it completely. If
2 we're saying that he's buying a business in which he
3 incurs the cost of rent, then you would need to know the
4 rent figure in order to do this calculation which you
5 would have circularity problems."
 We are equally not persuaded by these submissions. Our reasons are as follows:
(1) The valuation exercise is never an exact science, but an attempt to find the way which would reflect most closely to what the likely rent would be under the hypothetical world. In particular, given the various hypotheses in the rating world, including the creation of the HT, HL and the hypothetical tenancy, it is understood and accepted that sometimes there may not be a method or means which would result in perfect accuracy.
(2) The insufficiency identified by CRV above in relation to adopting PR x HT’s ANFA equally applies to the WACC model adopted by the CRV. This is what Mr Jones has been trying to emphasize that the WACC adopted by CRV (which is HEC’s WACC) is not the same as the HT’s WACC, because of (a) the potential difference in the risk profile, and (b) the lack knowledge of the amount of the rent.
(3) In the premises, this difficulty does not in any way weaken or rebut the reasons we have explained above as to why it is reasonable and right for the HT to look at what he is entitled under the SOC to represent a reasonable return for his investment.
 Mr Yu, Leading Counsel for CRV, further argues that HEC’s approach in first dividing the DB with a proportion of the HT and HL’s assets (even if in accordance with the SOC) is inconsistent with the economics theory of rent, which underpins the R&E Method. He therefore says HEC’s approach is wrong.  Central to Mr Yu’s submission seems to be that, in order to have the R&E Method carried out properly, the approach has to comply or be consistent with the economic theory of rent. The theory is summarized by Mr Yu as follows:
(1) Land rent is residual payment. It is determined by the price of the commodity generated by the land. It is fixed by ascertaining what is left after all other factors of production are satisfied. The landlord would want to have the maximum left after all other factors of production are paid.
(2) Land rent is not fixed by reference to the landlord’s cost of acquisition of land.
 The CRV relies on various dicta of the following authorities to support the submissions that the theory of rent is central to the R&E Method.
(1) In Kingston Union , supra, Viscount Cave LC said at 329 as follows:
"From the gross receipts of the undertakers for the preceding year they deducted working expenses, an allowance for tenant’s profit, and the cost of repairs and other statutable deductions, and treated the balance remaining (which would presumably represent the rent which a tenant would be willing to pay for the undertaking ) as the rateable value for the entire concern." (emphasis added)
(2) Lord Atkin explained further in St James’ and Pall Mall Electric Light Co , supra, at 11:
"This system [the R&E method] which seems to be intended to be an application of an economic theory of rent, is founded on an inquiry as to how much the tenant will pay for the privilege of occupying the premises and making what he can out of the undertaking he carries on there. The system roughly speaking is that the gross receipts of the undertaker are taken for the year of calculation; from them are deducted the expenses of earning those receipts; from the residue a tenant’s share is subtracted, a hypothetical sum which represents what the tenant might reasonably be satisfied with for his ‘profits’ which will include interest on capital remuneration for his industry and compensation for risk; and the residue will be the landlord’s share or rent." (emphasis added)
(3) In Cairngorm Chairlift v Assessor for the Highland Region  SLT 35 , the Scottish Lands Tribunal quoted at page 41H-K the theory as expounded by Adam Smith as follows:
"On behalf of the assessor reliance was placed on passages, quoted in Armour, from Adam Smith’s The Wealth of Nations, in which it was stated that rent, as the price paid for the use of land, is naturally the highest which the tenant can afford to pay in the actual circumstances of the land, and that it is a monopoly price, not proportioned to what the landlord may have laid out upon the improvement of the land, or to what he can afford to take, but to what the tenant can afford to give… The starting point must always be what the tenant is able and willing to pay, and the landlord will then have the whole balance. The basis on which the revenue is divided will therefore depend on the relative bargaining strengths of the landlord and the tenant respectively… the rental value of the heritage is to be assessed without reference to the cost to the landlord of supplying it, and that it will be a residual amount after deduction of what is required to induce the tenant to take the tenancy and to carry on the business." (emphasis added)
 Reading the above quoted dicta, in particular the parts underlined by us, we believe the following about the application of the economic theory of rent under the R&E Method could also be deduced:
(1) Under the theory of rent, the first most important thing is still to find out and determine what would constitute a reasonable return for the tenant. It is only after working out this portion, that the "residual" portion could be ascertained.
(2) The theory itself however does not provide any restriction, formula or limitation as to how to determine the tenant’s reasonable return, save that it should be what the tenant "might reasonably be satisfied with for his ‘profits’ which will include interest on capital remuneration for his industry and compensation for risk". This is consistent with the fact that there are 4 methods identified in the Rating Forum Guidance NotesAt para 5.47.on how to assess the tenant’s share.
(3) In determining the tenant’s reasonable profit, and thus also the residue balance, the starting position is what the tenant may be willing to pay, which also depends on the relative bargaining power of the parties.
(4) The residue portion, when so determined is only presumably the rent. This we see it as allowing flexibility for the valuers to cater for and to deal with different circumstances and factors that may arise and be faced with in a competitive and bargaining market.
(5) In any event, the economic theory of rent is the starting position under the R&E Method. It sets out the general approach and principle. So long as the valuation exercise is to and could determine what the tenant would reasonably expect for as his profit, giving the remaining balance from the DB as rent, it still falls within this theory.
 When the rationale and application of the economic theory of rent in the R&E Method are understood in this light, we do not find HEC’s approach inconsistent with the method or the theory:
(1) As we have already observed above, HEC’s approach in dividing the DB first by reference to the respective proportion of the HT’s and HL’s assets is but just part of the exercise to determine what constitutes a reasonable profit for the tenant in embarking on the undertaking. It is just a way to ascertain what would form part of the tenant’s reasonable expectation of his profit, without the determination of which, the residual rent would not have been able to be worked out. This is thus consistent and in line with the economic theory of rent.
(2) Further, even if the exercise in determining the rent involves the assessment of the position of the HT, it could still be regarded as appropriate under the R&E Method:
(a) In Cross-Harbour Tunnel v Commissioner of Rating and Valuation [1977-1979] HKC 81 , in considering whether the residue should be regarded as all "rent", the Tribunal proceeded to consider the risk position of the HL, and concluded that the real risk in the tunnel (i.e, the tenement) was with the HL, who had a substantial amount of capital locked up in it, and the HT arrived on the scene when the engineering and financial soundness of the undertaking had been shown.
(b) In Cairngorm Chairlift , supra, in considering whether the residue is to be regarded as all rent, the Lands Tribunal at 43L-44A found it of assistance to have regard to the return that it would give the HL on his capital.
 We therefore reject Mr Yu’s submissions.  Mr Yu raises another criticism of the HEC’s approach in dividing the DB with the assets proportion of the HL and HT. He says this is in effect treating them as joint adventurers, which has been expressly rejected by the House of Lords in Southern Railway .  In Southern Railway , it was contended on the part of the rating authority that see page 280 per Viscount Hailsham LC.:
"…the [Railways (Valuation for Rating) Act 1930] has put an end to the old system of calculating the amount of the capital required by a tenant for the working of the undertaking and allowing him a percentage thereon, and that it is now necessary to follow some other method. In particular it is urged that the hypothetical landlord is entitled, having regard to the large amount of capital which has been expended by him in creating the railway company's undertaking, to some proportion of the net receipts obtained either by a comparison of the landlord's capital and of the tenant's capital, or by allowing the rent at which the railway hereditaments might reasonably be expected to let as a whole from year to year to be influenced and presumably increased by a consideration of the large amount of capital expended in creating the immovable parts of the undertaking." :
 In rejecting the contention, Viscount Hailsham LC said at 281-282 as follows:
"What however is more important is the circumstance that the only custom or practice which the Authority is declared to be at liberty to depart from is a custom or practice ‘in regard to the deduction or allowance to be made in respect of the capital of a tenant.’ It is thus beyond question that the Legislature contemplates that there will be a deduction or allowance in respect of the tenant's capital, and, having regard to the universal practice which obtained before the Act came into force of making such a deduction or allowance in the shape of a percentage upon the tenant's capital, it is in my opinion clear that the section in no way directs the Authority to depart from this method and to adopt some other method which is left wholly undefined. It is not in dispute that it is essential in some way to exclude the profits earned by the hypothetical tenant's rolling stock, plant, and other implements, and your Lordships were not informed of any clear and satisfactory method of doing this except by means of a percentage on the capital employed in providing such chattels. The appellants laid especial stress on the concluding words of the sub-section. They contend that the reference to a fair and just division of the net receipts shows that the old method of ascertaining the rent which the tenant is prepared to pay, must be abandoned, since that basis of calculation provides for the tenant receiving his share of the net receipts before the landlord gets anything and might, in some cases, involve the landlord getting nothing; and they point out that the conception of a division of the net receipts is inconsistent with the ordinary relationship of landlord and tenant. My Lords, I am quite unable to accept this argument. It is true that the expression ‘division of the net receipts’ is not a very happy phrase to describe the deduction from the net receipts of the amount necessary to induce the hypothetical tenant to embark upon the enterprise, but I see no justification in that fact for altering the conception of the relationship of landlord and tenant to a conception of joint adventurers, an alteration which is really involved in the appellants' argument . The explanation for the use of the word ‘division’ is probably to be found in the fact that it was the usual expression in rating law at the date of the Act, and that, if the amount which the tenant would require in order to induce him to take and operate the hereditaments is properly ascertained and deducted from the total net receipts, the result is to divide the net receipts fairly and justly between landlord and tenant, even though, in an extreme case, the landlord's share might be nothing at all. It is the rent which is to be estimated in such a way as to represent a fair and just division, and it is evident that the rent and nothing else is to be the landlord's share. When this is ascertained, the balance is the tenant's share of the net receipts. The ‘division’ therefore is not to be an aliquot division on some unspecified basis, but is to be the result of a process involving the ascertainment of the landlord's share in the form of rent." (emphasis added)
 With respect, we are not convinced by CRV’s submissions that HEC’s approach is suggesting that the HT and HL should be treated as joint adventurers:
(1) Again, as explained above, we regard the HEC’s approach is only a way of working out what constitutes part of the reasonable profit expected by the HT in determining what the tenant’s share ought to be. This is not a way of suggesting that the HL and HT were to split or share profit out of the undertaking, although given the SOC, the way to look at what the tenant’s expected reasonable "profit" may result in the coincidence that the prima facie residue falls to be the same or similar to PR x the value of the HL’s assets. This is a result of the hypothetical splitting of HEC’s entire assets into HL’s and HT’s, but not because of an exercise seeking to treat them as joint adventurers.
(2) As submitted by HEC, which we accept, in the Southern Railway case, Viscount Hailsham used the term joint-venture to answer an argument which had been advanced that, having regard to the particular words of the statute in question in that case, the landlord was to be assumed to be sharing the profits of the undertaking. Viscount Hailsham said that this was wrong; the landlord received rent, not a share of the profits. This is consistent with our above views.
(3) In any event, we do not see Southern Railway as a case covering the unique situation as the present one, where the financial affairs and tariff setting mechanism are governed by the SOC.
 The CRV contends also that it is binding on this Tribunal to adopt the WACC approach in determining the tenant’s share by reason of the decisions of CLP v Commissioner of Rating and Valuation by the Lands Tribunal CLP v Commissioner of Rating and Valuation  4 HKC 461 .and the Court of Appeal  HKC 42 (CA)..  Alternatively, the CRV submits that the CLP decision is persuasive and it has been followed in England by the Valuation Tribunal in British Telecommunications Plc v Central Valuation Officer British Telecommunications Plc v Central Valuation Officer  RVR 86 . , the decision of the Valuation Tribunal in Southampton Container Terminal case Transcript of decision of the Hampshire South Valuation Tribunal, 17 October 2008, Marshall (Chairman), Aldous, Otley.and the interim decision of the Valuation Tribunal in Dolgarrog Power Station case. Transcript f the decision, 29 November 2007, Owen (Chairman), McEnvoy & Wheldon. Given the CRV’s submissions, it is necessary to see what was decided in the Lands Tribunal’s decision in the CLP case.  The CLP case concerned CLP’s appeal to the Lands Tribunal against the CRV’s cumulo rating assessment of the tenement of electricity generation and transmission system assessed for the year 1991/1992. CRV assessed the tenement’s rateable value to be $2,953.3 million. CLP contended that the rateable value should only be HK$1,375 million.  CLP’s appeal was allowed by the Tribunal, which determined that the rateable value for the tenement should be $2,000 million.  At the hearing of the appeal before the Tribunal, many relevant and material (for the present consideration) issues and matters were in fact agreed between the parties and thus not argued. They included the following:
(1) The use of the R&E method for valuation At page 472G..
(2) There was common ground on the level of the divisible balance, with the Divisible Balance advocated by CLP at $5,979m and $6,075.5m by RVDAt pp 477F-479C..
(3) The use of WACC on NBV for the purpose of ascertaining an appropriate return for the HT. They also agreed to assume that the tenant’s share in the R&E method should be equal to his cost of capital and no more.
(4) To use CLP’s WACC as at 1 July 1990 as the HT’s WACC At 418B..
(5) To use CAMP Which will be explained further below in our discussion of the expert evidence in this case.to calculate CLP’s WACC including the applicable formula and what data needed to be input At 482C-E..
(6) They agreed that the best indication of expected future market returns was the return achieved in the past. They also agreed that beta was to be calculated on the basis of CLP share price movementsAt 482G, 485F..
(7) To apply WACC to the NBV of the tenant’s assets for the purpose of calculating the required return At 480F-G..
(8) To make an allowance quantified as 10% of the separately assessed tenements for occupation by the HL of part of the premises for the purpose of carrying out repairsAt 491I-492B..
 Importantly for the present purpose, it was agreed between the parties in the CLP case that the WACC on HT’s NBV represented a reasonable return for the HT in calculating the tenant’s share.  Despite this agreement, when the decision was reviewed by the Tribunal, it expressly observed that  4 HKC 500 , at 509E.: "he tribunal did not accept the weighted average cost of capital [i.e., WACC] as the exclusive method of analysis nor find that it produced a definitive result. Our findings were to the contrary. … [W]hile the weighted average cost of capital was expressed by the parties to be their agreed preferred method, we found that input disputes led to major disagreements over its answers ".  On review, the Tribunal increased the rateable value to HK$2,020 million.  The CRV appealed the decision to the Court of Appeal, which was eventually dismissed. The CRV raised four grounds of appeal, which could be summarized as follows:
(1) The Tribunal erred in law in valuating the tenement on a definite tenancy of four years, instead of on the basis of a hypothetical tenancy from year to year. The Court of Appeal held that the Tribunal committed no error of law in making an assumption as the duration of what a reasonable period time for tenant to continue to be a tenant, albeit on a year to year tenancy At 45E-H..
(2) The Tribunal was wrong in law, in applying the R&E valuation method that the market value of the tenant’s assets was the book value at the end of the tenancy. The Court of Appeal rejected this ground saying that it concerned a valuation judgment, which was not matter of law, which the Tribunal was entitled to make. Even if it fell into error on this, it was not an error of law At 46B-E..
(3) The Tribunal had misapprehended the extent of the agreement between the parties to the use of WACC when expressing the view that "the parties were agreed that the appropriate return was to be determined by calculating [the ratepayer’s] [WACC] as at 1 July 1990." In dismissing this ground, Godfrey JA said At 46G-H.as follows:
"It does appeal that the parties’ agreement may have been limited to the use of the WACC calculation only as a benchmark, a check on the level of return which could reasonably be expected by the hypothetical tenant; but I do not think it matters. The Lands Tribunal was entitled, as a matter of valuation judgment, to arrive at the appropriate rate of return by using WACC in the manner which it did, as a preferred, if not definitive, method of valuation."
(4) The Lands Tribunal was wrong in law in failing to take into account the permitted return under the scheme of control under which CLP operated, to consider which constituted a reasonable return for the HT. Again, the Court of Appeal rejected the ground on the basis that this was a valuation judgment of which the Tribunal was entitled to take, and it disclosed no error of lawAt 46H-I..
 Reading the Land Tribunal’s decisions and the Court of Appeal judgment as summarized above, and noting the agreements on various issues made between the parties, we do not think the Court of Appeal is laying down any rule of law or general legal principle that, in applying the R&E method for valuating the tenement, where the HT is expecting to be operating under a scheme of control with a permitted return, one should or must adopt the WACC calculation for determining the tenant’s share (or the reasonable return for the HT). In fact, we would be surprised if the Court of Appeal were intending to do so, when it emphasized repeatedly that this was a matter of valuation judgment, which was not a question of law. What the Court of Appeal did was saying that with the evidence and the contentions raised before the Tribunal, the Tribunal was entitled to arrive at the valuation as it did, which was not a question of law.  This Tribunal therefore does not find itself to be bound by the Court of Appeal’s judgment to apply WACC as a proper and only way to assess the tenant’s share.  In any event, given that the contentions raised by HEC in these appeals relating to the application of the SOC in determining the tenant’s share, the challenge on appropriateness and correctness of the WACC model applied by the CRV, and the use of the CB Method were not advanced, argued and determined in the CLP case (first instance or on appeal), we believe it is open to us to deal with these arguments in these appeals, notwithstanding the CLP decisions.  There is also no question of a consistency application, when Mr Yu urges us to follow the CLP decisions, as many of these issues were not raised before.  Given our above reading on the effect the CLP case, the fact that it was followed in the British Telecommunications case, the Southampton Container Terminal case and the Dolgarrog Power Station case do not assist the CRV’s submissions. In particular, when these cases do not deal with the situations where a scheme of control providing for a permitted return is in existence, and that the respective decisions in the Southampton Container Terminal case and the Dolgarrog Power Station case are subject to their respective pending appeals.  It is also CRV’s contention that the evidence supports that there would be interested HT who is willing to take on the undertaking with a return of profit based on WACC. In the premises, any HT asking for more (such as the way contested by the HEC), would be out-bid by such interested HT for the tenancy. Thus, effectively, for the purpose of rating valuation, the WACC calculation should be the appropriate one to assess the tenant’s share.  The evidence relied on by the CRV comes from Mr Jones, HEC’s expert economist. On the topic of whether there would be potential candidates who would be willing to take over HEC ’s business, under cross-examination, Mr Jones appeared to suggest that if the return was to be measured by the WACC, there might only be a low level of interest from potential investors. But if the return was a bit more (say 1, 2 or 3% above) than WACC, the level of interest would be even more.  To deal with this submission, it is important to look at what Mr Jones actually said in evidence and the context in which it was given.  When one examines the evidence closely Day 6/50:13 – 62:3, it is clear that Mr Jones was addressing the potential sale of the integrated business of HEC as a whole, but not the HT’s undertaking. Mr Yu for the CRV is also premising his submissions on the proposition of the sale of the entire integrated businessSee: Transcript of evidence, Day 6/60:11-22; Appendix A of CRV’s Written Closing Submissions..  This puts a question mark as to whether Mr Jones was considering the scenario of the hypothetical rating world, where rent had to be paid, and thus be factored in, by the potential purchasers in acquiring the HT’s business. As such, we have doubts as to whether these parts of Mr Jones’ evidence could be treated as clear and sufficient evidence to deal with the issue on whether, if it is only the HT’s business that is on sale, there would be interested potential HT who would be prepared to purchase it with a return expected at WACC level. This is particularly so, as it has always been Mr Jones’ position that the owner occupier’s WACC (even assuming it to be same as the HEC’s WACC) is not a good proxy to the HT’s WACC. This is so because, where the HT would only have part of the necessary assets required for the business, and would have to pay rent, his WACC could not be determined until after knowing what rent it is required to pay, which is unknown. This creates a circular problem. In other words, it is Mr Jones’ view that the level of rent that the HT (or the potential purchaser) is required to pay represents another risk factor which the potential purchaser or HT would have to consider before deciding whether (and at who’s) WACC is sufficient to induce him to embark on the acquisition of the business.  Further, Mr Jones’ evidence should be understood in the context of his own views on what the economic value of the business’ assets is. His evidence on this respect is that the earning stream that the assets create for the enterprise represents the economic value of those assetsSee: Jones’ 2nd report, para 75; Transcript of evidence, Day 6, pp 15-16, 86-88, 93-94..  In the premises, we accept HEC’s submissions, even if one is to assume that Mr Jones’ evidence supports the proposition that there are potential purchasers who would be prepared to purchase the HT’s business at WACC return on the value of the assets, this would be the same as HEC’s approach on a share of the DB for the HT based on the asset ratio split for the HT under the SOC. For this purpose, we adopt HEC’s examples of calculation set out as follows:
"4. The following illustrative calculation shows how the evidence identified in paragraph 3 above would be applied:
The earnings stream that the tenant's assets bring under the SoC(ANFA of HT's assets x PR)
HK$22404.1m x 17% = HK$3,808.7m
Present Value of that earnings stream (using WACC as discount rate) (income stream ¸ WACC)
HK$3,808.7m ¸ 8.31% = 45,832.7m
The amount that the HT would expect to receive to give him a return at WACC (WACC x capital value)
HK$45,832.7m x 8.31% = HK$3,808.7m
 For either or both of the reasons set out above, we would not accept that Mr Jones’ evidence is on balance sufficient proof that there are interested purchasers who, as submitted by the CRV, would be (a) prepared to take up the HT’s business for a return based on WACC, and (b) therefore be in a position to out-bid the sitting or other potential HT who would insist on having a tenant’s share based on the return expected under the SOC by reference to PR on the HT’s asset value.  The CRV also disagrees that the HT and the HL are of equal bargaining power in negotiating for rent as suggested by HEC. The CRV submits that the HL would enjoy a superior bargaining power because of the monopoly of the place of the Tenement.  HEC accepts that there is a de facto of the business, which has to be carried out on the Tenement. However, it says because of the fact that the HT’s assets and HL’s assets were designed and built together, these assets are effectively integrated. The HL and HT therefore require and need each other’s assets for the purpose of the business. The same thus applies for the hypothetical renting out of the Tenement. The HL could only rent the Tenement to the potential HT who has acquired the HT’s assets. In the circumstances, it renders the parties at equal bargaining power.  In this respect, we accept the expert evidence of Mr Jupp and Mr Taylor for HEC that effectively:
(1) The Tenement and the non-rateable tenant’s assets have been designed and built as an integrated system.
(2) Realistically and practically, the Tenement in its existing state could only be used with the existing HT’s assets.
(3) As a result, if a new set of HT’s assets were to be brought in by a new tenant, substantial modifications and changes would have to be made to the civil engineering elements of the Tenement.
 The CRV and her corresponding expert, Mr Allan, do not in fact dispute that these assets were built and designed together. Mr Allan’s essential evidence is that the Tenement could still be used with a new set of tenant’s assets (which say are different from the existing HT’s assets) with modifications and changes. This is not inconsistent with the evidence of Mr Jupp and Mr Taylor as summarized above. Their difference seems to lie only on whether these changes could be considered major or substantial changes.  This is material for the present consideration because, in considering the rating valuation of the Tenement, it should be done without the violation of the rebus sic stantibus rule. Under this rule, the relevant test as laid down recently by the English Court of Appeal is Williams (VO) v Newcastle Retail Ltd  RA 41 is whether the changes to the Tenement are major or minor, which is a comparative question, to be considered by reference to the size and scale of the tenement. As Robert Walker LJ said at paras 74-76 as follows:
 Turning to the first limb of the rule, I consider that the Lands Tribunal was clearly right, following Fir Mill Ltd v Royton Urban District Council and Jones (Valuation Officer) and Other Appeals (1960) 7 RRC 171, to allow for the possibility of minor alterations in the hereditament on the occasion of its hypothetical letting. The absurdity of any other view appears vividly from the circumstances of these appeals, with numerous very well-known retail chains seeking to establish their identities and brand loyalties by distinctive fascias and fittings installed in uniform, featureless units. The first limb cannot be applied so rigidly as to prevent (for instance) Burger King being considere d as a possible bidder in competition with McDonald's (which occupies a large unit just opposite the City Fayre/City Duck).
 Mr Holgate criticised the test of 'minor' alterations as being imprecise, which indeed it is. But the Lands Tribunal was in my view right to prefer it to drawing the line at a suggested distinction between structural and non-structural alterations, which would be even less satisfactory. On the Lands Tribunal's formulation both limbs do raise issues of fact and degree which will in the first place be matters for negotiation between the valuation officer and the ratepayer's surveyor. If the valuation officer and the surveyor cannot agree, they will be issues of secondary fact for the appropriate tribunal.
 I would respectfully dissent from the Lands Tribunal's view (para 171 of the decision) that in deciding whether alterations should be classified as minor: 'Cost is a factor to be taken into account, but as an absolute figure and not in relation to the increased rental value which can be realised by the works’. If the Lands Tribunal really meant 'absolute' that cannot be right, since (as was pointed out in argument) the absolute cost of even trivial alterations to the Dome at Greenwich is likely to be very high. I think the Lands Tribunal must have meant to say merely that the relative increase in rental value is not determinative, a proposition with which I agree."
 In other words, if the changes required to be done for the Tenement to enable it to be used with a new set of tenant’s assets can be considered to be major by applying the above test, this cannot be taken into account in the rating world because of the rebus sic standibus rule. As a result, for rating purposes, the Tenement has to be regarded to be used only with the existing HT’s assets, albeit, by reason of the vacant and to let principle, any incoming HT without any difficulty could acquire the existing HT’s assets and instantly.  Looking at the evidence of Mr Allan, who only cited one or two examples of what changes could be made, together with the evidence of Mr Jupp and Mr Taylor, and after viewing some of assets on site at Lamma Island and the substations, coupled with giving regard to the common ground that these assets have been designed and builttogether as an integrated system, we come to the view that, for rating purposes, it would require major changes to be made to enable the Tenement to be used with a new set of tenant’s assets.  We therefore accept HEC’s submissions that, for rating purposes, the Tenement practically could only be used with the existing HT’s assets. As a result, we also accept that there is equal bargaining power between the HT and HL. E.1.4.2 The 25% of the DB adjustment to reward risk and enterprise  HEC’s rating valuation expert, Mr Parsons, is of the view that, in assessing the tenant’s share, other than that there be an apportionment of value of PR x HT’s ANFA (which we have accepted above), there should be a further allocation of 25% of the DB value to the HT.  As we understand them, the reasons Mr Parsons advances in support of this further adjustment run as follows:
(1) Under the SOC, it is the PR x HEC’s ANFA which is regarded as the reasonable reward to the operator (i.e., HEC) for its capital investment, risk and enterprise.
(2) However, for rating purposes, if the HT (as suggested by Mr Parsons) is only to be given PR x HT’s ANFA, this would not be regarded as sufficient to provide for a reasonable return for risk and enterprise, because (a) this sum is significantly less than HEC"s ANFA, and (b) that apportionment is only to be treated as a return for the capital investments.
(3) As a result, there should be a further allowance as a reasonable return to reward for the risk and enterprise taken up by the HT in running the business. Mr Parsons, in the exercise of a valuer’s judgment, is of the view that 25% of the DB value would provide such reasonable return.
 We do not believe HEC has established and proved that this is correct for the assessment of the tenant’s share. We explain our reasons as follows.  First, we are looking at the HT’s position, who is investing only in the HT’s assets, not the entire assets of the integrated business. For rating considerations, the amount of capital investment that the HT is to invest is corresponding to the HT’s assets only. This will be much less than the owner occupier’s investment (i.e., HEC’s investment), which is to be rewarded by the PR x HEC’s ANFA under the SOC. As a result, one cannot start in the rating world, as Mr Parsons seeks to do, with the entirety of PR x HEC’s ANFA as representing a reasonable return also for the HT’s undertaking.  Secondly, there is also nothing to support Mr Parsons’ approach to treat the PR x HT"s ANFA as only a reward for HT’s capital investment. Under the SOC, there is nowhere to be found any support to say which portion of the PR x HEC’s ANFA is regarded as a reasonable return for capital investment, and which portion represents reward for enterprise and risk. The permitted return as a whole is taken as a sufficient and reasonable return for globally the risk and enterprise, as well as the interest in capital investment. By the same token, one cannot say the HT’s return by reference to the PR x HT’s ANFA would represent only for interest in capital but not risk and enterprise.  Thirdly, we accept the submissions of Mr Yu (for CRV) that Mr Parsons’ evidence under cross-examination shows clearly that the 25% of the DB assessment is highly arbitrarily and without support:
(1) Mr Parsons accepts under cross-examination that the 25% is very rough and merely a valuer’s judgment. When pressed further as to how he comes up with the basis of 25%, he repeatedly says he has to "put his hands up" and confessed that he has no hard evidence on the figure.
(2) Mr Parsons seeks to rely on materials (in the form of correspondences) in relation to settlement negotiations made in 2004 between the English Valuation Office Agency and the private parties (Electricity Distribution Network Operators) in agreeing to allocate a percentage of the relevant divisible balance as part of the tenant’s share to support the 25% assessment. We do not find these materials constituting good or sufficient evaluation evidence. This was a result of private negotiations, the facts behind which we are not privy to. The materials also shed no light on the basis and rationale upon which the final percentage was agreed. We therefore do not attach any weight to them.
(3) Further, although saying that this 25% reward is for HT’s "enterprise and risk", Mr Parsons had not thought through to whom this 25% is to go, and for what purpose. At one point under cross-examination, he said that this was to go to the shareholders of the HT. On the next day, under cross-examination, he changed and said some of the 25% should go to the staff to reward them for effort and to incentivize them.
(4) However, it is plain that there should be no award to the HT for effort of the staff:
(a) As explained in the Rating Manual, Vol 5 – Section 371 – Electricity Distribution Networks , cited by Mr Parsons himself:
"All the individuals employed by the hypothetical tenant, including the senior management and the Board, are paid for their time and expertise. Their salaries appear in expenditure in the valuation. Therefore, tenant’s share does not compensate the individuals running the business – it is merely there to provide a return to those that have invested in the business, in effect, the ‘tenants’ are the shareholders."
(b) Mr McGee (HEH’s Group Finance Director) had confirmed in evidence that in this particular case, all remuneration and emoluments to HEC’s directors and staff had been included in the expenses in HEC’s accounts.
(c) When the extract from the Rating Manual was put to him, Mr Parsons agreed that it was against what he invited to the Tribunal to accept.
(d) The only reason he gave for not following the extract of the Rating Manual was that he felt that, apart from a reasonable reward on his capital, the HT ought to be further rewarded for effort, since if the HT supplied no capital, he should still be rewarded for his effort. We do not accept this explanation: In a case where the HT has supplied no capital, remuneration for his efforts (as director and/or staff) would also come out of the expenses of the enterprise. There would be no need for compensation for risk since he has supplied no capital. The idea of an award of 25% (or any percent) of the DB for risk and effort would not hold.
(e) Thus, since before one arrives at the DB, the staff (who has expended the effort for the enterprise) has been rewarded, and there is no need to reward them again by giving anything to the HT out of the DB.
(f) Insofar as the shareholders are concerned, they would have already been rewarded by the reasonable return based on the PR x HT’s ANFA as explained above.
 For these reasons, we reject HEC’s submissions that, for assessing the tenant’s share, the HT should be further given a 25% of the DB value. E1.5 Conclusion under E1  We therefore conclude that the tenant’s share under the DB shall be the value of PR x HT’s ANFA. The DB shall be adjusted by making the relevant depreciation on the HT’s and HL’s assets as suggested by Mr Parsons in his first report. These depreciation adjustments are not challenged. E2. Assets under construction (AUC) E2.1 The questions  The parties have identified various assets which were still under construction (and thus not occupied) as at the relevant date of rating assessment. HEC says these assets are not rateable and should be discounted in the assessment, whether under the R&E Method or the CB Method. CRV contends that they are rateable and in any event should not be discounted in the valuation.  This AUC issue therefore raises the questions of whether (a) the AUC are rateable as a matter of law, and (b) whether they should be discounted in the valuation methods in any event. E2.2 Discussion  The question of the rateability of AUC is a matter of law, where one starts with the relevant provisions of the RO defining the tenement and the liability to pay rates. We have already discussed them in greater details above. As a recap, they are primarily:
(1) Section 2, which defines "tenement" to mean any land which is "held or occupied". Sections 8 and 8A supplement this definition in relation to machinery and plants.
(2) Section 18 provides that there is liability to pay rates in respect of every tenement, and the liability applies whether or not a tenement is occupied, except that, in limited circumstances provided in section 30, refunds may be obtained in respect of certain categories of unoccupied property.
(3) Section 21 identifies that both the owner and occupier of the tenement are liable to pay but various provisions govern in what circumstances the rates may be collected from the occupier or owner, as the case may be. It is not disputed that section 21(1) makes the occupier of a tenement primarily liable for rates, although both the owner and occupier can be liable.
 Although the rating law in Hong Kong is developed from English law, there is a difference between them in that, the English rates are charged only on the occupier, while in Hong Kong, by reason of section 21 of RO, both the owner and occupier are liable for rate. Judge Cruden in Yiu Lian Machinery v CRV Yiu Lian Machinery v CRV  1 HKC 55 .identified at pages 61I - 62D three differences between the English Act and RO as follows:
"There seem to be at least three differences, all of which are material. First, as to liability in England under the General Rate Act 1967, the general concept is that the occupier and not the owner is rateable -- Ryde Rating (13th Ed) p 20. English courts are concerned with occupation not ownership. In Hong Kong, the position is quite different. Both the occupier and the owner are liable for rates. In Hong Kong, what in rating law is called the unit of assessment is the 'tenement'. The tenement includes the property mentioned in s 2, which is either 'held' or 'occupied'. So the definition of 'tenement' itself recognizes dual liability for owner and occupier. Section 21 expressly provides that both owner and occupier are liable for payment of rates. It is true that the section goes on to provide that, as to payment, the rates shall be deemed to be an occupier's rate and, in the absence of any agreement to the contrary, shall be paid by the occupier. The effect of s 21 seems to be twofold. First, it declares that both the owner and the occupier shall be liable for rates. Secondly, it provides that as between the owner and occupier, the occupier shall be primarily liable for payment. The dual liability of both owner and occupier is common in many other Commonwealth jurisdictions but is a very different to the more limited concept which historically exists in England."
 Seizing on these differences, in particular the liability of an owner of a tenement to pay rates in Hong Kong and the reference to "held or occupied" in definition of tenement under section 21, Mr Yu for CRV submits that under Hong Kong rating law, it is not necessary for there to be an occupier or the need for "occupation" before a tenement is rateable and rates can be charged.  We agree with the submission that under the RO, a tenement is rateable whether or not it is factually occupied. Insofar as this is concerned, we do not think Mr Roots for HEC is contending otherwise.  What Mr Roots however submits is that, in order to be rateable, the tenement must be of a state capable of being occupied, even though it is not in fact occupied. As a result, AUC which are not yet capable of being occupied at the relevant date of assessment are as a matter of law not rateable.  We accept Mr Roots’ submissions:
(1) Historically, rating was a tax on the occupation of land, and the rateable value is referred to an assessment of the value of occupation or benefit of occupation Poplar Assessment Committee v Roberts  AC 93 at 103 per Lord Buckmaster; Orange PCS Ltd v Bradford  2 All ER 651 at 658d per Thomas LJ.. The fact that the liability to pay rates is now imposed upon persons other than occupiers does not in our view alter the meanings of rateable value and rateable property. We have seen nothing in the RO or heard submissions to the effect that it is the intention of the legislature in enacting the RO to alter the nature of rateable value to mean something more or different from the value or benefit of occupation.
(2) Such an understanding is in our judgment also consistent with section 21(1) of the RO, which provides that the rates payable shall be deemed to be an "occupier’s rate", and the legislative effect of imposing primary liability on the occupier to pay.
 Thus, it defies common sense that if a property which is not even capable of occupation would be chargeable for rate for the benefit or value of occupation. Unless there is clear language in the RO, which we have not seen, to show that it is the intention of the legislature to do so, we do not think such a construction is capable of the RO. E2.3 Conclusion under E2  We therefore find that AUCs are not rateable as a matter of law.  As to whether, notwithstanding the non-rateability of the AUCs, there should be corresponding adjustment in valuations under the R&E Method or the CB Method for the Tenement, we could discuss it later below in Member Lo’s judgment when we deal with subsidiary issues under these methods. E3. The use of CB Method for rating valuation of the Tenement E3.1 The CB Method  The following about the CB Method are uncontroversial.  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 See: Crofton Investment Trust Ltd v Greater London Rent Assessment Committee  2 QB 955 at 970B-C per Widgery J (with Lord Parker CJ and O’Conner J); Fife Regional Assessor v Distillers Company  RA 71 , at 89 per Lord Prosser..  The classic explanation of the theory underlying the CB Method can be found in Dawkins (VO) v Royal Leamington Spa Corporation and Warwickshire County Council (1961) 8 RRC 241 , at p 251 as follows:
"…the argument is that the hypothetical tenant has an alternative to leasing the hereditament and paying rent for it; he can build a precisely similar building himself. He could borrow the money, on which he would have to pay interest; or use his own capital on which he would have to forego interest to put up a similar building for his owner-occupation rather than rent it, and he will do that rather than pay what he would regard as an excessive rent – that is, a rent which is greater than the interest he foregoes by using his own capital to build the building himself. The argument is that he will therefore be unwilling to pay as annual rent for a hereditament more than it would cost him in the way of annual interest on the capital sum necessary to build a similar hereditament. On the other hand, if the annual rent demanded is fixed marginally below what it would cost him in the way of annual interest on the capital sum necessary to build a similar hereditament, it will be in his interest to rent the hereditament rather than build it" This statement on the CB Method is accepted in Hong Kong in Royal Hong Kong Golf Club v Commissioner of Rating and Valuation (1977) HKLTLR 236 ..
 The CB Method has been in practice applied in five stages These stages were endorsed in Hong Kong by the Lands Tribunal in Royal Hong Kong Golf Club v Commissioner of Rating and Valuation (1977) HKLTLR 236 . See also Mobil Oil Hong Kong Ltd v Commissioner of Rating and Valuation  HKDCLR 77 :
(1) Estimate the cost of construction of buildings equivalent to those to be valued.
(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’ 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 capital ‘value’ by applying an appropriate percentage.
(5) Make final allowances and adjustments if appropriate.
 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 himselfSee: Joint Professional Institutions’ Rating Forum (“the Rating Forum”). . 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 dateParagraphs B.1 – B.16 of the Rating Forum.. 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 imponderablesParagraph B.8 of the Rating Forum..  In relation to these comments, the English Lands Tribunal in Monsanto Plc v Farris (VO)  RA 107 observed at 140-142 as follows:
"The essence of the principles stated in Dawkins is that: (1) the hypothetical tenant has an alternative to leasing and paying rent because he can build similar premises; "the tenant’s alternative". (2) the hypothetical tenant would not pay more in rent, and may well pay somewhat less, than the interest charged or foregone on the capital sum employed in providing ‘the tenant’s alternative’. Applying those principles to the valuation method and valuation practice in evidence two fundamental matters emerged. Firstly, the hypothetical tenant of the rating world falls to be treated as an owner/occupier for stages 1 to 3 inclusive of the method because the concern there is entirely with capital sums. Secondly, stages 4 and 5, where the currency of the method is annual value, a ceiling or maximum rental value arises at stage 4; a situation not accepted by Mr Sanderson [for the Valuation Officer]. These principles provide a logical, yet simple, economic framework within which to undertake the valuation because the hypothetical tenant of a specialised hereditament, like any other prospective tenant of non-specialised premises who can choose from alternatives available in the market, is thereby given an opportunity to satisfy accommodation needs other than solely by leasing the subject hereditament…
I incline towards the submission of counsel for the ratepayer company that if ‘the tenant’s alternative’, howsoever envisaged in the valuation process is removed then nothing of the Dawkins principles remains; the economic framework has been totally dismantled …
… I am not persuaded that the two fundamental tenets of Dawkins should be abandoned as counsel for the valuation officer urged. However, I would reject the literal interpretation which assumes the actual building of an alternative hereditament. In operating the five stage method, it is neither built nor valued, it is a total fiction and as such it should not be dressed in the clothes of supposed reality, because that produces even greater unreality and an array of problems as identified by Mr Sanderson. The principle of the alternative can and should be preserved to give credibility to stages 2 and 3 of the method … These stages are more than costing in an economic vacuum, but the required credibility does not have to depend upon the alternative being notionally built or created elsewhere as suggested in Dawkins. The second principle of a ceiling or maximum rent should be retained as both economically sound and as according a parity of negotiating position at stage 5 between hypothetical landlords and tenants of commonplace and specialised hereditaments. The duty at stage 5, the ultimate objective of the method, is to arrive at a rateable value upon the basis laid down by law".
 Bearing these in mind, we now examine the parties’ contentions to the use of the CB Method in assessing the rateable value of the Tenement. B3.2 The contentions  In closing submissions, Mr Roots for HEC says that if HEC’s primary contention under the R&E Method is not accepted by the Tribunal, the CB method should be used to assess the rateable value of the Tenement in the following way:
"If the method of assessing the tenant’s share which uses a % on the value of the HT’s capital is followed (regardless of whether WACC is used to identify that %), it cannot be concluded that the residue is all ‘rent’. The CB demonstrates as a starting point for negotiations ‘the floor below which the landlord would be unhappy to drop and the ceiling above which the tenant would be unhappy to raise’ Quotation from Fife Regional Assessor v Distillers Company (Bottling Services) Ltd  RA 71 at 89.. In so far as the divisible balance exceeds this figure, the division thereof is open to negotiation. The negotiation is likely to reflect the respective value of the HL’s assets and HT’s assets and the need to allow the HT to receive something for his effort and risk in operating the undertaking."
 Mr Yu for the CRV however submits that there is no room for the application of the CB Method, whether in the way as suggested by Mr Roots, or at all. His principal reasons can be summarized as follows:
(1) The CB is an unreliable method of valuation for the Tenement, as it does not and could not reflect the special "monopoly of place" and "synergy value" features of the Tenement.
(2) It is premised on a totally unrealistic assumption that the HT could build an alternative tenement similar to the Tenement. Given that the Tenement is in relation to the entire generation, supply and distribution of electricity, and given the scarcity of land in Hong Kong, there is simply no possibility that an alternative tenement could be built.
E3.3 Discussion  We agree with Mr Yu’s submissions.  In our view, it is clear and of common sense that the Tenement bears the following special features as submitted by Mr Yu:
(1) It supports and enables a business of the generation and supply of an essential commodity, which produces steady profits.
(2) There is significant value in the synergy of the tenement: there is value added by reason of the way it is connected and configured.
(3) It enjoys a monopoly of place: the relevant business, that of generation and supply of electricity to Hong Kong and Lamma Islands, can only be viably carried out on this tenement, by virtue of its location and configuration
 It is obvious that is only with the connection (thus the synergy) of all the components of the Tenements (together with the non-rateable assets) that the business could be operated and generate profits. This should be reflected in the value of occupation of the Tenement.  HEC in agreeing that it is appropriate and correct for CRV to assess the Tenement on a cumulo basis under section 10 of the RO, in our view, renders any arguments that there is no synergy value in the Tenement untenable. The basis to invoke section 10 of RO is that the value of the tenement is affected by the value of any other tenement and the tenements are used in connection with one another. It cannot be seriously suggested that under cumulo assessment for the Tenement, the rateable value is affected by a decrease .  We also agree with Mr Yu that the increased synergy value of the Tenement is in effect accepted by Mr Lynch (the land valuation expert for HEC), when he explained that the value of the substations, pylons, cables etc is reflected in the value of the power station because "without these particular features, the value of those, the power station and the transmission station, would arguably be zero because you cannot use those facilities without access to the cables or pipes and so forth."  It is also obvious that in the real world, HEC enjoys a monopoly in the generation, transmission and distribution of electricity to Hong Kong, Lamma Islands. Mr McGee and Mr Jones effectively agree that there is de facto monopoly.  Such a monopoly value should be reflected in the rateable value. As Lord Goddard CJ said in Amalgamated Relays Ltd v Burnley Rating Authority  2 KB 183 at 190:
"… the position at the present moment is that the company can say to any intending tenant, if it were minded to let at a rent, that it had a system which was working; that nobody else had it; that it was unlikely that any competitor would come into the market… The landlord would be in a position to say that if he let to the prospective tenant he would be putting him into a position in which he could make substantial profits and that he, the landlord, wanted a share of them. What share he would demand and what share the tenant would be willing to pay is a question of fact which the tribunal of fact must assess in the best way it can." See also: Kingston Union Assessment v Metropolitan Water Board  AC 331 at 338 (Viscount Cave LC); British Telecommunications Plc, supra, at 95.
 HEC however seeks to reply on a rateable value calculation chart based on the R&E Method prepared by Mr Parson and exhibited as CP45 to his 2nd report to show that there is no synergy value of the Tenement.  By way of CP45, Mr Parsons seeks to show the position under the R&E Method by adopting the WACC arrived at by Prof Chan (CRV’s expert economist) as the PR. The stated purposeParsons’ 2nd Report, paras 76, 79.of the exercise was to illustrate that if one did assume that the SOC existed in the rating world in the same terms, it would then not be legitimate to assume that the revenues in the real world (with SOC) were reliable evidence of revenues absent the SOC. In other words, the R&E Method would not be a reliable method for valuation, given that it is the wrong revenues to look at from the beginning.  The latest reliance of CP45 to rebut the synergy and monopoly value of the Tenement is explained by Mr Roots and Mr Parsons in evidence as follows:
(1) The figure produced by the hypothetical R&E based on Professor Chan’s WACC as shown in CP45 lies between the CB valuations of Mr Poon (CRV’s expert on CB valuation) and Mr Parsons.
(2) If the Tribunal at the end determines that the CB value should lie somewhere between the figures of Mr Poon and Mr Parsons, it would coincide very closely with a R&E valuation based upon economic circumstances in 2003 (as set out in CP-45).
(3) But even if the Tribunal decides that Mr Poon’s CB valuation is wholly correct, then the R&E exercise in CP45 will be somewhat lower but still in the same order of magnitude.
(4) The CB valuation is based on economic data applicable at the relevant date, and CP45 is similarly based on economic data of 2003. Not surprisingly, the outcomes are broadly similar.
(5) This demonstrates that Ms Jim’s and Mr Parsons’ R&E valuations both come out at higher figures than the CB valuations, not because of any monopoly or synergy of similar factors but simply because the historic SOC produces higher receipts than would have been achieved under a SOC renegotiated in 2003.
 We are not persuaded by HEC’s submissions. We agree with the CRV’s following contentions that HEC’s above reliance on CP45 to show that there are no synergy and monopoly increased values of the Tenement are flawed:
(1) The fundamental assumption in CP45 that if the SOC had kept up with the economic circumstances of 2003, then the PR would be fixed at the WACC arrived at by Prof Chan. This can only be right if:
(a) HEC assumes that the PR is to be fixed at WACC. Mr Parsons accepts that this is a necessary assumption that he has made. The CRV accepts that this is a sound assumption, as it accords with all the available evidence in reality.
(b) Had the SOC been renewed in 2003, the WACC of HEC would have been the same as the WACC of HEC in the real world (in which the SOC was to be renewed in 2008, not 2003).
(c) Mr Parsons under cross-examination however accepts that the above second assumption is unsound and cannot be made. WACC is partly based on market expectation of a stock’s performance, more precisely its co-variance with the market. In the real world, the market expected the SOC to be renewed in 2008, and formed its expectations on that basis. Clearly the expectations would have been totally different if the market contemplated that a different PR (one of the most integral factors affecting the performance of HEC) would be fixed five years earlier in 2003, instead of 2008.
(2) In the premises, CP45’s fundamental assumption is wrong. One therefore cannot safely rely on CP45 for this purpose. [Check font size numbering]
(3) Further, the assertion that the rateable values in CP45 and Mr Poon’s CB valuations are similar is also not borne out. The various valuation figures are as follows:
Mr Poon's CB
Mr Parsons' CB
CP45 only extended to this year.
(4) It can be seen that there is no reasonable similarity between the figures in CP45 and the CB valuations. For example, for the assessment year of 2004-2005, the difference between the CP45 figure and Mr Poon’s CB valuation is 47.32%.
(5) Finally, even if one assumes that all the parameters of CP45 are correct, and that the results do show that if the SOC had kept up with the economic conditions in 2003, then the R&E method and the CB method would yield the same RV, that still does not support HEC’s conclusion that there is no value in the monopoly or synergy of the tenement:
(a) Mr Parsons accepts under cross-examination the propositions that (i) monopoly drives up the value of a tenement; and (ii) the SOC drives down the value of a tenement. As we have said above, it is also clear that synergy could only have an upward effect on value.
(b) Even on the assumptions above, an equally logical and plausible conclusion one can draw is that it was because the SOC did not keep up with the times (and hence did not suppress the monopoly profit and synergy value in time) that in the year starting 1 October 2003 the Tenement was able to yield the receipts it did. This generated a R&E figure greatly exceeded the CB figure derived from both experts.
(c) The only thing this shows is that the value of the tenement on the R&E method (reflecting the high profit-yielding capacity of the tenement) exceeds the notional costs of the individual parts thereof (i.e. the CB value).
(d) That is equally consistent with the proposition that there are elements which drive up the profits that the tenement can yield which are not reflected in the CB method. Mr Parsons has accepted under in his oral evidence that monopoly value would not be reflected in the CB method.
(e) Hence, CP45 could at least equally be seen as confirming the proposition that there is indeed monopoly and synergy value in the Tenement, and such value had not been "capped in time" as of 1 October 2003 by the prevailing SOC.
 For the above reasons, we conclude that:
(1) The Tenement bears the special features of synergy value and monopoly of place.
(2) These features would drive up the value of occupation, which should be reflected in a proper valuation method.
(3) The CB Method would not be able to reflect and capture these enhanced values of occupation.
(4) In reality, it is very unlikely if not impossible for a potential HT to find and build an alternative tenement similar to the Tenement.
(5) Therefore, the CB Method is not a reliable, realistic and accurate method to assess the rateable value of the Tenement.
 In light of the fact that both parties agree in the present case that the R&E Method is the appropriate method of valuation, and given our conclusion that the CB Method is unreliable, we do not find it either useful or appropriate to use and adopt the CB Method for any purpose in the present case. As said by the Lands Tribunal in Best Origin v CRV Unreported, LDGA 14/1998, 25 February 2008, Lam J (President of the Lands Tribunal) and Member Lo.at §312, there is no point in carrying out a check valuation that is less reliable than the primary valuation. E3.3 Conclusion under E3  For the above reasons, we have come to the clear conclusion that we should not consider the CB Method in the way as suggested by Mr Roots or at all in arriving at the rateable value of the Tenement. Mr W K Lo, Member: Having reached the conclusions of the above primary issues, strictly speaking, the Tribunal needs not consider most of the subsidiary issues, in particular those relating to the determination of the WACC under the R&E Method and what constitutes the proper parameters and considerations under the CB Method. However, in case we are wrong above, we would have determined the relevant subsidiary issues as follows. Disputes between the parties on the assessments of the HT’s WACC Measuring the costs of capital of the HT by using WACC  Assuming that the CRV’s WACC approach for the assessment of the tenant’s share in the R & E Method of valuation were correct, and the WACC should be used instead of the PR, it would be necessary for us to determine the issues between the parties in the assessment of the WACC applicable to the HT in these rating appeals.  HEC relies on the expert evidence of Mr. Jones whilst the CRV relies on that of Professor Chan. These 2 witnesses were the only witnesses giving direct evidence on this topic. However, Mr. Roots makes it clear in the Final Written Submission that whilst Professor Chan’s instruction was to assess the WACC for HEC as at the 4 valuation dates in relation to the 4 different years of assessment under these appeals and other similar appeals, the primary objective of Mr. Jones’ evidence was only: (i) to give his assessment of the WACC in response to Professor Chan’s estimates, and (ii) to suggest, where he considered appropriate, adjustments or alternatives to Professor Chan’s computations. Therefore, despite of Mr. Jones’ response and revised estimates, Mr. Jones by no means said that his estimates was perfect or necessarily "right" simply because "any estimation of the HEC’s WACC over the period in question was subject to wide margin of uncertainty."  Professor Chan gave evidence that the Capital Asset Pricing Model ("CAPM") approach, devised by Nobel laureate William Sharpe, is now a widely accepted method. Despite his comments, Mr. Jones has never suggested that the CAPM method is inappropriate for the estimation of the HEC’s WACC. In fact, HEC confirms to the Tribunal that it does not challenge the soundness of using the CAPM method to estimate the WACC. The differences of the experts’ evidence on WACC  The conclusion and results of the experts’ evidence on WACC have been summed by HEC in its written closing submission as follows:
"289. Mr. Jones has produced results for WACC based on making adjustments to Prof Chan’s methodology. Prof Chan’s latest results and Mr. Jones’s results for WACC may be summarised in the following table.
Prof Chan's latest results
Mr. Jones' approach
290. While Mr. Jones' results are for the reasons submitted above preferable to the WACC estimates of Professor Chan, it is to be borne in mind that any estimates of HEH’s WACC over the relevant period are subject to a wide margin of uncertainty. Taking HEC’s WACC to be HEH’s WACC is acceptable though it introduces another potential source of error and uncertainty. But taking the HT’s WACC to be HEC’s WACC is wholly illegitimate for the reasons submitted in the previous section on the conceptual problems of the CRV’s WACC approach."
 Therefore, apart from the fundamental factual issue of whether the HEC’s WACC is a good proxy for HT’s WACC, the difference in the final estimate between the experts, especially for the relevant year of assessment (i.e., 2004/05) is remarkably close, with Mr. Jones’ estimate of 8.9% against Professor Chan’s estimate of 8.16%.  Professor Chan in the latest corrigendum to his third report sets out his WACC estimates under the various methods adopted by him (what he called the KC2 and KC3 methods in his reports, which we will elaborate below) as follows:
Summary of estimates of Pre-tax Nominal WACCs for HEC based on different approaches by Professor Chan
2003 (for rating year 2004/05)
CAPM to estimate the cost of equity
DGM to estimate the cost of equity
Difference between KC2 and KC3, compared with the average difference of KC2 and KC3 for 3 years (2003, 204 & 2005) under analysis= 2.59%*
Final WACC Estimates =WACC Estimates under KC2 + 0.4 x 2.59%*, adopting a weighing approach and using the average difference between KC2 & KC3
 As a result of Professor Chan’s agreements and concessions on the inputs of his WACC computations, the following table now sums up the remaining disagreed components in the WACC computations for the relevant year of these appeals, 2004/05):
WACC using the CAPM method
Final estimate of WACC
 We will first summarize below the methodology for estimating the WACC for which the experts, accepting that this has been generally adopted by the financial industry and the academics, have no dispute in principle. Then, we will consider the differences between the experts. Since Professor Chan has in his third report agreed to adopt Mr. Jones’ figures for certain inputs and to abandon his KC1 method, this has reduced the differences between the two experts. Finally, we will deal with the conceptual issue as to whether HEC’s WACC is a good proxy for HT’s WACC. Definition of the WACC  We begin by summarizing the basic, commonly agreed definition and methodology of estimating the WACC of HEC, and the few formulae for computing the WACC, all of which have been set out in Professor Chan’s first report.  In his first report, Professor Chan explained that the WACC measures the company’s opportunity cost of capital and reflects the percentage return that the company must provide to investors. Therefore, for a company that is contemplating a new investment, the WACC provides a measure of "the return on the investment that will be sufficient to cover the interest payments of any new debt which is issued to finance the investment, as well as the additional profit which will be needed to maintain the return that will be required by equity investors." Put it in another way, the WACC "reflects the expected return that investors of the company may obtain from an alternative investment of comparable risk." Professor Chan’s 3 methods of estimating the WACC  Professor Chan in his first report sets out the 3 methods for estimating the WACC. He named these methods, for convenience, as KC1, KC2 and KC3 methods. His first method (KC1) was a modified CAPM approach using the equity beta and gearing estimates to infer the asset beta. His second method (KC2) was a conventional CAPM approach where the cost of equity was combined with the cost of debt to calculate the WACC. Finally, his third method (KC3) was similar to KC1 except that the cost of equity was estimated using the Dividend Growth Model ("DGM").  Mr. Jones was of the view that KC1, being a modified approach of KC2, was also less preferred to KC2, which explicitly considered the cost of debt. In response to Mr. Jones’ comment, Professor Chan agreed in his third report that he would drop his KC1 method so that the experts could focus on the key issues that they disagreed. Professor Chan also said that, in any event, based on his first report, the difference between the WACC estimates under his KC1 and KC2 methods was small.  Mr. Jones did not object to the conceptual framework of KC3 but was concerned about the availability and reliability of data for the application of the method.  Professor Chan has set out in his first report the various formulae of his 3 methods. Since he has agreed to abandon KC1, we will only reproduce below for easy reference the various formulae of his KC2 and KC3 methods. Although the parties agreed the concepts behind the KC2 and KC3 methods, it will be appropriate to introduce at this stage Professor Chan’s formulae and the basis before we come to consider the differences between the experts. The following materials were mainly extracted from Professor Chan’s various reports. Estimating WACC based on CAPM and DGM  WACC is essentially the sum of (a) the cost of debt multiplied by the amount of debt in proportion to the total amount of both debt and equity, and (b) the cost of equity multiplied by the amount of equity in proportion to the total amount of both debt and equity.  In short, Professor Chan’s two remaining methods KC2 and KC3 differ from each other in the way the cost of equity is assessed. The KC2 method employs the CAPM approach to estimate the cost of equity whilst the KC3 method estimates the cost of equity using the DGM approach. Professor Chan’s KC2 method  Mathematically, if the company issues only debt and equity, a general formula, named as equation (1), for the WACC is as follows:
+ rd ( 1 - t)
E + D
E + D
where E = the total market value of the company’s equity
D = the total market value of the company’s debt
re = the cost of equity
rd = the cost of debt
t = the company’s tax rate
 The above formula is the same formula for WACC that was used in CLP case.  Under the CAPM, the risk of a stock could be decomposed into two components: market risk (also known as the systematic risk) and firm-specific risk. The systematic risk reflects the return variability of the individual stock due to the market movement. Firm-specific risk reflects the return variability unrelated to the market movement. Assuming that investors hold well-diversified stock portfolio, they need compensation for bearing market risk but not for firm-specific risk. The Market Risk Premium ("MRP") reflects the extra return that the investors require from holding the market portfolio relative to holding the risk-free asset. The Beta measures the amount if systematic risk of the equity relative to the market.  Based on CAPM, the cost of equity is determined by equation (2) as follow:
re = rf + be [ rm - rf ]
Where re = the cost of equity
rf = the risk-free rare
rm = the expected market return
βe = the beta of the equity of the company
 Therefore, it will be possible to estimate WACC by combining both equation (1) and equation (2) above. This is Professor Chan’s KC2 method. Professor Chan’s KC3 method  Alternatively, the cost of equity can also be estimated based on the DGM approach. According to the DGM, the current stock price is equal to the sum of the discounted value of all future dividends (named as equation (3), as follows:
1 + re
(1 + re )2
(1 + re )3
Where P = the current stock priceD1 = the dividends expected at the end of year t
re = the discount rate (or cost of equity)
 If it is assumed that the company is in a steady state of growth so that the dividends will grow at a constant rate of "g" in the long run. The above Equation (3) can be re-expressed as Equation (4) below:
re - G
 As a result, the discount rate or cost of equity can also be expressed as Equation (5) below:
 In other words, using the DGM, the cost of equity can be estimated once we know the expected dividend yield (D1 /P) and the expected growth rate of dividends (g). After estimating the cost of equity by this method, the result could be plugged into the WACC formula of Equation (1).  In his third report, Professor Chan agreed to adopt Mr. Jones’ several inputs, including the risk free rate, the cost of debt of HEC and the gearing ratio. As a result of these agreements/concessions by Professor Chan, the outstanding issues in his KC2 method (i.e. the CAPM approach) are the equity beta, the expected market return and the consequential cost of equity. The details of these inputs adopted by Professor Chan are now summed up in his 5th report.  It can therefore be seen that the main disputes between the experts in the estimation of the HEC’s WACC are (i) the estimation of Beta; (ii) the estimation of "g" in the MRP and (iii) whether any weight should be given to the result of the DGM approach. Finding on the estimation of Beta  One of the parameters used in calculating the cost of equity under the CAPM approach is the equity beta. It is necessary to estimate the equity beta before the WACC can be calculated. In the present case, there is no dispute as to the general approach in estimating the beta. The only disagreement is in the source of date that should be taken into account: Mr. Jones has used daily data over a 2 year period whilst Professor Chan has used monthly data over a 5 year period.  HEC submits that there are two fundamental problems in the present case underlie Mr. Jones’ concerns with regard to Professor Chan’s calculation, namely, (1) the large instability of beta over time and (2) the exceptional period in the market between about 2000 and 2003. These in turn led Mr. Jones to call into question Professor Chan’s use of 5 years monthly data for the estimation of beta.  On the other hand, the CRV argues that there are several reasons in support of Professor Chan’s approach in his choice of the source of data, in the present year of assessment (2004/05) as well as for the subsequent years:
(1) This has the support of the CLP decision.
(2) This also has the support of textbook authority of: Reilly & Brown’s Investment Analysis and Portfolio Management (6th edition) at pages 300-301.
 Even Mr. Jones accepts that the use of monthly observations is the standard practice, at least where a 5-year period is used.  As explained by Professor Chan, a longer period such as 5 years would enable the observations to capture the behaviour of a stock in the full cycle of the market, both when the market is going up and going down.  At first, Mr. Jones contends that a fundamental problem arose for the year of assessment 2004/05 as the market in between about 2000 and 2003 was an exceptionally bad period economically for Hong Kong. He therefore departs from the usual practice and uses 2 years of daily data as he wants the data being affected by "a particularly bad period or particularly odd period."  However, Mr. Jones also recognizes in answering the Tribunal’s question that his choice of 2 years is perhaps not the most appropriate period for the assessment year of 2004/05 (because of the abnormal downturn of the economy when Hong Kong was hit by SARS in 2003), and he accepts that it is possible that a 5-year period would be a more appropriate choice to take away the atypical effect of this unusual event.  In reply to this, the CRV submits that when one puts oneself in the position of the HL and HT at 1 October 2003 (or the relevant dates for the other years of assessment), it would be impossible to know whether the period of 2000 to 2002 would be atypical. The CRV also says it therefore cannot be assumed that investors would depart from the usual practice of using 5 years monthly data simply because they thought the 2000-2002 period was atypical and wanted to exclude it. There is therefore no reason to discard the data of an entire period. Instead, the most appropriate method, the CRV further says, is the one adopted by Professor Chan, i.e. to apply a Bayesian adjustment (accepted by Mr. Jones to be the usual practice) so as to minimize the risk of mis-estimation.  Finally, the estimation of beta by regression is now a well-recognised scientific and objective method. Although a regression analysis is required, the process of drawing a regression line is mathematical, and can be easily done through computer software.  We accept Professor Chan’s evidence and are not convinced by Mr Jones’ approach:
(1) Both experts accept that the use of a 5 year period rather than a 2 year period is the standard practice.
(2) We also accept the CRV’s argument that it would be impossible to know at the relevant time whether the period of 2000 to 2003 would be atypical.
(3) We accept CRV’s submissions summarized above in support of Professor Chan’s approach on the selection of input data, as this is consistent with the literature and practice, which would also have the effect of avoiding any atypical results caused by atypical or unusual economic events.
(4) We further agree that it is better to use monthly data instead of daily data in order to avoid the problem of "noises".
 If necessary, we therefore would have adopted the figures and the estimation of the beta by Professor Chan the details of which are shown in his revised third report (corrigenda). The estimation of "g" in the MRP  Both parties agree that it is appropriate to use the DGM model to estimate the MRP but they cannot agree as to how to calculate the element of "g".  HEC submits that in the assessment of the MRP, there are in principle three main problems: (1) the quality of inputs adopted by Professor Chan, (2) the unreliability of the application of the DGM method in Hong Kong since investors in Hong Kong (which observation was stated in the CLP decision) principally seek capital gains as opposed to dividends thus reducing the local relevance of the DGM approach, and (3) the negative and positive growth rates cancelling out, thus putting doubts on the theoretical basis of the method as a reliable method since its reliability rests on the assumption of annual growth.  HEC further says that Professor Chan had used only a DGM-based estimate of the MRP, i.e. he had used the earnings growth forecasts reported by Reuters for the annual growth rates for each company in the Hang Seng Index. The HEC criticizes that the principal problem of his approach is the poor reliability of the input data as a result of which even a correct application of a commonly accepted approach could lead to results that are subject to a significant degree of error. Besides, the DGM approach generally is based on certain strong assumptions, including that (1) future dividends are expected to grow at a constant rate perpetually, (2) future dividends can be discounted at a constant cost of equity capital, and (3) future dividends remain a constant proportion of earnings over time. However, the HEC submits that these assumptions seldom hold true hence reducing the reliability of this approach.  The CRV on the other hand submits that other than Mr Jones’ criticisms, there are two main issues between the parties on how to calculate the element of "g": (i) whether the growth rate should be compounded, and (ii) whether one should apply market capitalization weighting to the growth rate.  The CRV explains that the MRP in the CAPM approach seeks to estimate the extra returns an investor would require for investing in the market as a whole. Hence, in using the CAPM, one would have to find out the expected returns of the market, which would simply be the expected return of an investor holding all the stocks in the market, or the Hang Seng Index as it has been used as a proxy for the market in Hong Kong. However, The CRV reminds us that it is commonly known that the Hang Seng Index is calculated using the market capitalization weighting.  The CRV first explains that both parties in fact agree that for an individual stock, the expected return of that stock "r" can be obtained by the following formula: r = D1 /P + gwhere D = Expected dividend in the first year;P = Current stock price; andG = Expected growth rate of dividends. The CRV points out that the above formula is actually from the algebraic equation, which clearly shows that "geometric growth of dividend has already been taken into account. The equation is as follows:
D ( 1 + g ) ———————
D (1 + g )2 ———————
1 + r
(1 + r )2
(1 + r)3
 Therefore, the CRV says that it is just common sense in calculating the expected returns of the market, represented by the Hang Seng Index, one would have to calculate the "market capitalization weighted arithmetic average" of the expected returns of the individual stocks. During the hearing, Professor Chan has already attempted to explain this by writing out the formula for calculating the expected return of the market assuming 3 stocks See: Exhibit CRV-5..  Thus, the CRV submits that when one looks at the "g" elements, there can be no doubt that the correct way to arrive at the "g" element for the expected return of the market is to apply a market capitalization weighted arithmetic average of the expected growth rates of dividends for individual stocks. The analysis further shows that the expected market return can be derived, as suggested by Mr. Jones, by a simple expected growth of earnings of the market.  In addition, the CRV says that Professor Chan explained in the hearing that the DGM formula of "r = D1 /P + g" already reflects the expected increase in stock price. Therefore, since "g" reflects the expected increase in stock price, the market capitalization weighted average is the appropriate way of arriving at the market’s "g" from the "g" of the individual stocks. Also, the price of the stocks in the market is clearly from the price of individual stocks by reference to the market capitalization weightings.  HEC contends that (1) Professor Chan’s assessment of the MRP is subject to a very large degree of uncertainly and potential for error, and (2) if the MRP has to be estimated at all using the DGM approach, it should be assessed with the adjustments suggested by Mr. Jones even though there will still be a large range of uncertainty.  In respect of the two main issues between the experts, i.e., whether the growth rate should be compounded and whether one should apply market capitalization weighting to the growth rate, we find that we are persuaded by and accept the evidence of Professor Chan that his opinion on these two issues are correct. They are supported by the mathematical calculations, and are consistent with common sense. We further accept CRV’s reasons as summarized above.  In the premises, despite of Mr Jones’ suggested uncertainties of estimating "g" and thus the MRP, we would adopt the figures as estimated by Professor Chan.  For the year of 2004/05, the respective MRP as assessed by Professor Chan and Mr. Jones are 6.37% and 9.32% respectively, after taking into account all the latest amendments and adjustments suggested by the two experts. Therefore, for the year of 2004/05, if necessary, we would have adopted Professor Chan’s estimate of 6.37% for these appeals. The use of the DGM method to arrive at the WACC  The DGM method is what Professor Chan called the KC3 method. Professor Chan recognizes that this approach is less popular than the CAPM method. Hence, he has put less weight on it. He also accepts that this method is dependent on the forecast of the growth rate of the company and the assumption that such a growth rate is to be constant.  According to Mr. Jones, this approach is based on the notion that the investors in the company’s shares have expectations of cash flow they will receive by way of dividends. The discount rate that equates the present value of the dividend stream to the prevailing share price provides a measure of the cost of equity that the marginal investor requires.  HEC in its submissions reminds us that "all the problems associated with the DGM method in relation to the estimation of the MRP apply here ." Also, Mr. Jones has identified two specific factors that render the use of the DGM particularly inappropriate namely, the anticipated revision of the SOC in 2008 and the payment of a special dividend in 2005, both of which would have had a significant effect on investors’ expectation of cash flow from HEH shares and undermine the fundamental assumption in DGM that there is a constant growth rate of dividend in perpetuity. For these reasons, the HEC submits that Mr. Jones was right to discard KC3 completely because of the very substantial unreliability of the method both generally and in the specific circumstances of this case.  The CRV submits that the WACC yielded by Professor Chan using this method is higher than the WACC yielded under the CAPM method. Hence, Professor Chan’s reference to this method in fact increases his WACC estimates, with the result that the tenant’s share is increased and the RV is decreased. His use of this method therefore operates in favour of HEC.  In considering whether the DGM approach should also be adopted for arriving WACC, we find that it is irrelevant whether the approach operates in favour of one party or another.  Instead, it is appropriate to consider whether the method is recognized widely in the financial profession and the academic body. We understand from both experts that this DGM method, though less popular than the CAPM method is also a well recognized method of assessing WACC.  Given its acceptance in the field of economics, we find that this method provides an alternative approach to assess the cost of equity, the major area of disagreement that has to be resolved.  Therefore, we agree with Professor Chan that notwithstanding the risks of the forecasts of the inputs for the DGM method, it should be accepted alongside with the CAPM. In this regard, we also agree with Professor Chan to use a weighing approach in using the results of the WACC derived from the CAPM method and the DGM method, with a lesser weighting of 40% for the latter.  We therefore accept that in any event, finding the HEC’s WACC by a method other than the CAPM method ensures that we do not have to rely solely on the results of one particular method in finding the cost of equity, given the existence of risks and uncertainties in whichever method one chooses to adopt. Since only Professor Chan gave evidence and computation for the estimation of HEC’s WACC using the DGM method, we decide to accept his figures. Conceptual problem of the CRV’s WACC approach The HEC’s case  HEC submits that there is an insurmountable problem in CRV’s adoption of HEC’s WACC as the HT’s WACC for the purpose of the R&M Method. It is said by Mr Jones that HEC’s WACC simply could not be taken as the HT’s WACC because of the different risk profile and factors, for example, the risk and need to pay rent. At the same time, this is also the circular problem identified by Mr Jones, which has been explained above in H H Judge Au’s judgment, that the HT’s WACC can only be determined after knowing the amount of the rent he has to pay, while under the R&E Method, the rent can only be determined after knowing the HT’s WACC. In other words, the rent is a prime determinant of the HT’s WACC, and not vice versa.  HEC further adds that although the CRV knew from Mr. Jones’ second report that the HEC challenged the CRV’s basic assumption, CRV had chosen not to ask Professor Chan, her expert on WACC, to assess the HT’s WACC. Instead, all Professor Chan was asked to do was to estimate the HEC’s WACC, which Ms. Jim then deployed in her R & E valuation. The CRV’s case  Dr. Lam for the CRV in his second report claimed that the HL had greater risks and that HEC’s WACC could be used as a proxy for the HT’s WACC.  The CRV accepts that strictly speaking, what the experts had done was to calculate the WACC of HEH, the holding company of HEC. However, the CRV reminds us that even Mr. Jones had agreed that it is fair to use the WACC of HEH as a proxy for the WACC of HEC. The CRV also pointed out that Mr. Jones had accepted that the WACC, being an estimation of the returns required, is a measure of risk. In the present case, Mr. Jones had actually accepted that firstly, "if the risk of the owner occupier is the same as the HT", then it would be fair to use the WACC of the OO as a proxy for the WACC of the HT; and secondly, "if the risk of the OO is higher than the HT, then the WACC of the OO is higher than that of the HT."  Hence, the CRV says that using the OO’s WACC as a proxy for the HT’s WACC would only over-estimate the HT’s WACC, which would then result in an over-estimation of the tenant’s capital (and hence, an under-estimation of the RV, which would be to the benefit of the HEC).  In addition, the CRV states that the HEC (again assuming that its risk is taken to be the same as that of the HEH), the OO of the Tenement in real life, being an integrated business, is a combination of the HL and HT. As such, the CRV submits that the risk of the HT in the present case cannot not higher than that of the HL, or the OO.  The CRV concludes that since the risk of the OO is either higher or the same as the HT, it would be fair to the HEC to use the HEC’s WACC as a proxy for the HT’s WACC (as the Lands Tribunal did in the CLP case). Determination of the HT’s WACC  In our view, we find that even on the assumption that the WACC for the OO, the HL and the HT could all be assessed, there was no evidence on the quantification of the WACC of these different entities. What Professor Chan has done was an attempt to estimate the HEH and in turn the HEC’s WACC (assuming that the HEH’s WACC is very close to or equal to that of the HEC). As contended by the HEC, the CRV has not given any instruction to Professor Chan to try to estimate the WACC of other entities. Mr. Jones, on the other hand, mainly criticized the estimation of Professor Chan but was also not asked to assess the WACC of the other entities.  Having considered all the evidence adduced before us, we are of the view that Professor Chan’s evidence is to be preferred. Professor Chan had addressed the main criticisms raised by Mr. Jones with reasons, which we accept.  At the same time, it appears to us that Mr. Jones’ evidence is tantamount to saying that it is almost an impossibility to estimate the HT’s WACC for valuation exercise under the R&E Method.  We find Mr. Jones’ evidence and position difficult to accept. This is because: (1) it is agreed between the parties that the various methodologies for estimating WACC have been well established over the past years and under these methods, certain estimates have to be made out of available information from the business and the market, (2) estimates in the financial market by nature bound to carry some inherent uncertainties, but these per se do not give rise to sufficient ground for not trying to make the best estimates out of available information from the business and the market, (3) if Mr. Jones were right, it would be very difficult, if not impossible to estimate the appropriate WACC for any business for the purpose of carrying out any R & E valuation in rating, and the R&E Method can never be properly used or relied upon, which is contrary to the practice.  In light of the limited evidence before us, and after rejecting Mr Jones’ criticisms, we therefore share the view of the CRV that the risk of the HT is not higher than that of the HL or the OO. As a result, we find that it is reasonable and fair to assume that the HEC’s WACC can be used as a proxy for the HT’s WACC.  We have already, for reasons given above, accepted Professor Chan’s estimates on MRP and the Beta that are required under the CAPM/DGM method.  Hence, had we decided that the CRV’s WACC approach was the appropriate one to assess the tenant’s share for the Tenement under the R&E Method, we would have decided to adopt Professor Chan’s estimate of 8.16% as the estimate of the HEC’s WACC of 8.16% as a good proxy for the HT’s WACC for the assessment of the rateable value of the Tenement in these appeals for 2004/05. Disputes between the parties under the CB Method Outstanding issues under the CB valuation  We have already concluded above that in these rating appeals, it is not appropriate to use the CB Method either as a method of valuation or a check of the valuation arrived at by the R & E valuation. However, if we were wrong on this, we would have dealt with the issues arising under the CB Method as follows.  The CB method involves the assessment of the replacement costs of all parts of the Tenement to arrive at the effective capital value ("ECV"). Consequently, it is necessary to identify as accurate as possible, all parts of the Tenement to be costed and included in the valuation.  The 5-stages approach of the CB Method have been set out at paragraph 174 above.  Although the parties could agree the valuation figures up to Stage 2, and have also come to agreements on other figures, the parties made it clear that these agreements were possible because the figures or the differences between the parties’ estimates were small. The experts actually disagreed on some figures, not only because they differed in the findings of facts, or valuation, but also because they disagreed on matters of principle.  In their initial valuations, neither Mr. Parsons nor Mr. Poon included the AUC as forming part of the Tenement to be costed in their CB valuation. However, following legal advice, Mr. Poon was instructed to revise his valuation to include the AUC, as shown in his third report dated 13 October 2009.  The outstanding issues under the CB Method can be summarized as follows: -
(1) What are the proper carrying costs and the costs of financing the construction.
(2) The proper valuation of the land in the Stage 3 figure.
(3) The valuation of the occupation of spaces for which in the real world the HEC pays nothing.
(4) What should be the proper Stage 4 decapitalisation rate.
(5) Whether a discount should be given for functional obsolescence of the Ap Lei Chau buildings; and
(6) Rateability of the AUC under CB valuation
The rationale and stages of the CB method  Both experts for the parties on the CB, Mr. Simon Lynch and Mr. Eric Poon agreed that the basic theory behind the CB method, as set out in paragraph B.1 of "The Contractor’s Basis of Valuation for Rating Purposes – A Guidance Note, produced by the Joint Professional Institutions’ Rating Valuation Forum in November 1995" is that,
"…the hypothetical tenant, instead of taking the subject property a rent, has the option of building a precisely similar property for his own occupation, and that his rental bid for the subject property will be related to the annual equivalent of the capital cost of providing the site for and building such a property."
 The rationale of the CB method has also be given in the English Lands Tribunal’s decision of Dawkins (VO) v Royal Leamington Spa Corporation and Warwickshire County Council (1961) 8 RRC 241 at page 251. This has been set out under section E3.1 (The CB Method) above in this Judgment.  As set out in the above said Guidance Note, it is generally recognized that the CB method of valuation comprises the following 5 stages. Again this has been set out earlier under section E3.1 of H H Judge Au’s judgment. This basic methodology has been adopted by the Lands Tribunal in Hong Kong in the cases of Royal Hong Kong Golf Club v Commissioner of Rating & Valuation  HKLTLR 236 , Royal Hong Kong Yacht Club v Commissioner of Rating & Valuation  HKDCLR 1 and Mobil Oil Hong Kong Ltd v Commissioner of Rating & Valuation  HKDCLR 77 .  Both experts for the parties agreed the adoption of the same basic methodology. They were also able to agree on the estimates of costs in Stage 1 of the 5-stage approach in the CB valuation. They only had disputes on certain inputs in the remaining stages. We shall consider these disputes below. Carrying costs and the costs of financing the construction HEC’s case  Mr. Parsons explained in his first report the three possible approaches in the CB valuation: one could either (a) assume that the construction has completed by the valuation date, but then the costs of land and construction would have to be taken at dates well prior to the valuation dates, and it would then be necessary to take account of costs of financing the land acquisition and construction cost during the construction period; or (b) assume that the construction commenced on the valuation date; or (c) assume that the construction commences on the valuation date, and then the premises are "instant built". He chose to adopt possibility (c), hence assuming that it is his fiction in the rating world that the Tenement was built instantly without for interest.  HEC also submits that although similar considerations apply to the issue of adding interest on the assessed value of land, there is an additional dimension that should be considered. In this respect, the HEC submits that it can normally be assumed that the value of land will appreciate broadly in line with inflation. Hence, applying a nominal interest rate to the assessed value of land (as Mr. Poon did in his valuation) "would duplicate at least to some extent the capital gain through holding the land for a period of time." In addition, HEC points out that even though Mr. Poon opined for the provision of an additional "carrying cost" of land, he has failed to adduce any evidence that the HT would have incurred any net cost over the construction period.  Although HEC admits that whilst in the real world, interest would of course be added when assessing the ECV, it says it is pertinent to note that the Rating Forum Guidance Note does not make any recommendation that interest be added either to the construction cost or to the land value in the CB valuation.  HEC further points out that in the Mobil decision, as both parties included interest on construction in their valuation, there was in fact no debate as to whether the approach was appropriate in principle. It is also not clear from the Tribunal’s Judgment, which was made in 1993 (before the publication of the Rating Forum Guidance Note), as to how the construction costs were arrived at or what they represented. The HEC says that the Tribunal’s decision in the Mobil case gave an even less satisfactory justification for including interest on land during the construction. Neither party included such "carrying cost". In fact no evidence or submissions from either party was recorded in the Judgment of the case. Although the Tribunal in Mobil said that it had taken into account the Tribunal’s previous decision in Shun Fung Ironworks Ltd v Director of Buildings and Lands Shun Fung Ironworks Ltd v Director of Buildings and Lands  2 HKLR 311 ., HEC submits that the methodology of valuation in Shun Fung , which is a land resumption case, should have no relevance to the appropriateness of including interest on land during the construction for valuation by the CB method, or indeed in any CB valuation of any other rating case including the present case.  In the circumstances, HEC contends that it would be correct for Mr. Parsons and Mr. Lynch to take the estimated costs and the estimated land values at the relevant date and to assume that the Tenement was built instantly, hence without allowing for (i) any interest on the construction costs and (ii) any interest on the land values. HEC admits that although this is a fiction, it is a more satisfactory fiction than assuming a four-year construction period either before or after the valuation date. The CRV’s case  The CRV submits that Mr. Parsons was wrong to have ignored the interests on construction costs and the carrying costs of the land values because his approach would make the "instant built" fiction of rating even more removed from reality.  The CRV also disputes the hypothesis that one has to factor in the possible gain in land value for the period of say 4 years because the experts assessed the cost of land as at 1 October 2003, not the cost of land 4 years ago. It is wrong to suggest that the gain in land value should cancel out any cost of holding the land.  The CRV sums up in paragraphs 422 and 423 of her Final Written Submission the reasons for rejecting HEC’s approach as follows:
"422. Given that the underlying theory of the CB method is that the HT would take account of how much it would cost him to build alternative premises, it must be wrong to omit any necessary item of expenditure, including the interests on the estimated replacement costs. It is plainly not legitimate to assume (against reality) that the construction would take no time and therefore (again against reality) that no interest has to be paid on those costs. Interest is plainly an expenditure, which has to be incurred. It cannot simply be "assumed away". Clearly, the further one moves away from reality, the less reliable the method: Rating Forum Guidance Note on the CB Method…
423. In considering this question, it is submitted, the focus should be what the CB method requires, not what the instant build fiction requires. To make the instant build fiction is already a departure from reality (which already adversely impacts on the soundness of the CB method), whether it is right to further assume that there is no carrying or financing costs should be answered by asking what the CB method would require (and the answer would be that those costs should be taken into account); not what the instant build fiction would require. The latter approach would be to put the cart before the horse."
The Tribunal’s findings  In Mobil Oil Hong Kong Ltd. V CRV , supra, the Lands Tribunal held, at page 94 that,
"The law is well settled that when arriving at the estimated cost of replacement, all the elements making up the actual cost, must be included. Both Mr Richardson and Mr Brown provided for interest on improvements in their calculations. However, neither included any sum for carrying costs. Interest on land is an important carrying cost. If the land value were $450 million then during the construction period that sum does not produce any income for the owner. In the real world, there may have been a variety of investments available to an owner, for that sum to produce income. The reality is that the owner, by purchasing the land, has during the construction period, lost the return on that sum if otherwise invested. In the hypothetical world it may be assumed that the owner has at least foregone interest on that sum."
 We respectfully adopt the reasoning in Mobil as both cases concern the CB valuation of rateable tenements.  As a matter of facts, there is no dispute between the parties that their estimation of construction costs and the land values were both made at the relevant date for the year of assessment 204/05 (i.e. 1 October 2003). Therefore, it is clear that unless the estimates of costs include the additional elements of carrying or financing costs, such as what Mr. Poon had done in the CB valuation of the Tenement, the estimates would otherwise have not included the full costs for the construction and the land due to the time element of construction in the real world (where we do not have the benefit of "instant built" fiction).  We agree that the interest on the estimated total cost of construction as at the valuation date of 1 October 2003 is obviously an expenditure item that has to be incurred. So is the interest on the value of land, or the holding cost of the land during the construction period. We find these items are required by the CB method, and would not be affected by the "instant built" fiction or assumption that the CB method assumes.  Therefore, for these reasons and the above said reasons submitted by the CRV (which we accept), we find that under the CB Method, the carrying costs should be included, and if one were to apply the CB Method, we would have adopted Mr. Poon’s evidence on the construction carrying cost for this purpose. The value of the land in the Stage 3 figure  The Stage 3 figure concerns with the value of the land.  In these appeals, the land element of the Tenement represents a relatively small portion of the total ECV because it was agreed by the parties that a large quantity of electricity-related structures and cables were treated as the HL’s assets, within the agreed figures for Stages 1 and 2.  Although there is a large measure of agreement between the experts (Mr Lynch for HEC, and Mr Poon for CRV) on the valuation of the land elements, a few issues remain to be resolved.  The principal differences between the parties relate to:
(1) The value of the land occupied for distribution pillars, poles and pylons, of which, by virtue of the block licence made between the Lands Department for the Government and the HEC, no monetary payment is required of HEC to pay for the use.
(2) The value of the "wayleaves" over the land occupied by the cables, again by virtue of the same block licence as for distribution pillars, poles and pylons, HEC in the real world is not required to pay for their use.
(3) The value of the customer-provided substations, of which HEC has been able to use free of charge in the real world. The HEC has 3666 distribution substations. About 95% of them are located in customers’ premises and are provided by the customers pursuant to the electricity supply agreement between the HEC and those customers. The HEC pays no rent for all but 3 of these substations. Essentially, the building owners provide the necessary space within their buildings to the HEC so as to enable the HEC to supply electricity to occupiers of their buildings or other buildings in the vicinity of their buildings. No payment is made by the HEC to the owners of these buildings.
HEC’s case  HEC submits that although Mr. Poon sought to rely on the English Court of Appeal’s decision in Orange v Bradford (VO) , supra, to justify attributing significant values to each of the above 3 items of land and properties in dispute, the circumstances of the present case are different.  HEC’s arguments run as follows.  First, the evidence of the actual arrangements between the owners of the buildings that provide the substations and HEC in the real world should be accepted as evidence of what the HT would have to pay in the rating world. There is no other reliable evidence that the expert or the Tribunal could adopt as the basis for valuing the right to occupy these substations. Also, it would be reasonable to assume that the actual arrangement under which the HEC occupied the substations is assumed to be part of "the regulated commercial environment" in which the HT would have to operate. Furthermore, the HEC contends that since the actual receipts and expenses (that include the nominal payments for the customer-provided substations) were considered in the R & E Method, it would be appropriate to do the same in the CB valuation.  Secondly, for the land occupied by virtue of the block licence (including the "wayleaves" for the cables), similar reasons as for the customer-related substations apply. There is no reason to suggest that the Lands Department would allow the land to be used for a nominal sum if they thought that it was worth more. Also, "the regulated commercial environment" in which HEC actually operates should be assumed to remain the same in the rating world where the HT is assumed to operate. In addition, the HEC submits that "in the fiction of the CB in which the HT envisages building an equivalent tenement, he should be assumed to be able to procure the same wayleaves from the Government (e.g., with his cables running side by side those of HEC) at the same nominal fee because that was Government’s general policy for utilities cables as stated in the Revenue Assessment Manual, not as a personal right granted to HEC."  The HEC contends that the best evidence of the value of these lands and properties is that in the real world: they are supplied to the HEC at nil consideration. The CRV’s case  In response, the CRV submits that the contention that the actual rent passing gives the best evidence for these lands and properties is plainly wrong for the following reasons:
(1) It is manifestly obvious that the distribution pillars, poles, pylons, cables and customer provided substations (and the land occupied thereby) are of substantial value to HEC. They are evidently essential to an integrated generation, transmission and distribution system. These parts of the tenement connect up the system, and hence HEC’s occupation thereof is of obvious value to them.
(2) Indeed, the evidence shows that there are 3 substations for which HEC has paid for its occupation in the real world. This proves that clearly the occupation of substations was of value, which is accepted by Mr Parsons in oral evidence. The value of such occupation cannot change depending on whether the substation was provided by a customer or someone else. Mr Parsons also accept that the actual consideration paid for the tenement may not represent the actual value of the tenement.
 The CRV further submits that it is well established that private agreements and restrictive covenants are ignored in rating world, especially when they represent an artificially reduced (or enhanced) rent, which distorts the investigation into true value of occupation. Thus, in Poplar Assessment Committee v Roberts  2 AC 93 , Lord Parmoor said at 119 as follows:
"It has long been recognized, as a matter of principle in rating law, that to make actual rentals the basis of rateable value would contravene the fundament principle of equality, both between the rate contributions from individual ratepayers, and between the totals of rate contributions levied in different contributory rating areas. In effect the result would be to make the amount on which the occupier of property is liable to pay rates dependent in many cases on the contractual relationship between a particular landlord and tenement, whereas it is dependent in all cases on a statutory direction applicable on the same principle to all hereditaments, and intended to insure equality of treatment as between the occupiers of rateable property and the rating authority.
His Lordship went on at 121 to say:
"The argument on behalf of the respondent is based on the proposition that, although a contractual or statutory rental applicable to an existing tenancy would not be conclusive, yet it becomes conclusive if made applicable, not only to an existing tenancy, but to any tenancy created during the time while the Act is in operation. I am unable to assent to this proposition. In my opinion the objections, as already stated, to adopting an actual rental as the basis of the rateable value apply with the same force, whether such rental is limited to an existing tenancy, or is made applicable to all tenancies created during the operation of the Act. The fundamental distinction remains that the assumed rental, based on statutory directions for the purpose of ascertaining occupation value, is in itself a different thing from an actual rental which denotes the liability between owner and tenant, and which may depend on a variety of conditions other than those affecting the beneficial or profitable occupation of the property."
Lord Atkinson similarly said at 113 that,
"to make the rent payable by the actual tenant the measure of the rateable value of premises … would be an absolute innovation, in direct conflict with the principles of the law of rating as established for over a century."
Thomas LJ also laid down statements of principle to the same effect in Orange PCS v Braford  2 All ER 651
 Therefore, the CRV submits that the fact that in the real world, no rent or licence fee is paid in respect of particular parcels of land or properties does not mean that the rateable value attributable to such land parcels or properties should be nil. One still has to investigate into its value of occupation. The Tribunal’s finding  We agree with the CRV’s submissions. We accept that:
(1) As a matter of law, as submitted by the CRV, in valuating the rateable value of the Tenement, we should ignore any private agreements which affect the rental assessment.
(2) We find that the arrangements for free-use of the customer-provided substations, and the free use of the distribution pillars, poles, pylons, cables are a result of private agreements, which we should disregard for rating purposes.
(3) We further find that the use and occupation of these substations and assets are clearly of value to the HEC and thus the HT. It is only through and coupled with the use of these assets of the Tenement that the business of electricity supply could be carried on to generate profit for HEC and the HT.
(4) There should thus be rateable value attributable to these assets to reflect the value and benefit of their occupation by the HT.
 For the same reasons above, we reject that the facts that HEC needs not pay anything for these assets constitutes the proper evidence of their rental valuation.  Given that only Mr Poon has provided expert evidence on the valuation of these assets, and we do not find that this part of the evidence is in any material materially shaken under cross-examination, we accept Mr Poon’s valuations on all these properties Stage 4 decapitalisation rate Differences between the parties  Mr. Parsons and Mr. Poon assessed the decapitalisation rate by different methods. As a result, whilst the yields identified by them are fairly close for the years of 2006/07 and 2007/08, they are wide apart in respect of the year of 2004/5 (i.e. as at 1 October 2003, for the present appeals) and 2005/06.  Mr. Parsons followed the route that derived the decapitalisation rate from the cost of borrowing. This route had always been followed in England until a decision was taken some years ago to determine the rate by legislation. Prior to the decision in Mobil , this was also followed in Hong Kong.  The HEC summarizes in its closing submissions the approach of Mr. Parsons as follows:
(1) Mr. Parsons did not simply take the borrowing rates as the decapitalisation rates, but only as the starting point.
(2) Although his approach followed the traditional owner-occupier interest rate approach, he then made an upward adjustment to reflect the lesser covenant of the HT and a further upward adjustment for asset replacement cost not keeping pace with inflation, the latter being a WACC type of adjustment for asset risk.
 Mr. Parsons approach was criticized by the CRV in essence on the ground that the WACC would be a better measure of the cost of financing a large construction project. In reply to this criticism, the HEC submits that it is no easier to find a WACC for the cost of financing such a project than it is to find a yield for comparable property.  In contrast, Mr. Poon derived the decapitalisation rate from the property yields. He quoted the Lands Tribunal decision in Mobil for the proposition that the property yields are "better in principle". However, Mr. Poon admits that there is no category of property sufficiently similar to the Tenement (which is occupied for the use of electricity generation, transmission and distribution) to provide reliable yield evidence, having had regard to such salient factors as physical features, structures, plants, size and the nature of business carried thereon. Consequently, Mr. Poon finds it necessary to make an adjustment of 20% to reflect the differences between his comparables, the flatted factories, and the Tenement. HEC’s case  HEC submits that its experts all are of the view that flatted factories in Hong Kong are not comparables at all to the Tenement. In particular, Mr. Jones has made a careful analysis of comparability and concludes that it is impossible to establish that any other property sector is comparable to the power sector.  More specifically, HEC submits that as (1) the generation of electricity in a power station (such as the Tenement) consists of a lot of machinery, and (2) the ECV of the Tenement comprises cables and structures that bear no resemblance to any flatted factories, any industrial building or any conventional building that we could find in the market, it is simply wrong to compare the Tenement with flatted factories.  Without prejudice to the above, the HEC futher says that even if it is concluded that the opinion expressed by the Lands Tribunal in Mobil should be followed in this case, the Mobil decision does not provide support for Mr. Poon’s 20% adjustment for the following three reasons:
(1) A finding of fact in one case (Mobil ) is not evidence of that fact in another case.
(2) There was rental evidence in Mobil and the rental was only being used as a check.
(3) It is far from clear as to how the Tribunal arrived at its decapitalisation figures in Mobil .
The CRV’s case  On the other hand, the CRV submits that the "cost of borrowing" is, on HEC’s own case, not the full cost of financing. It is bound to underestimate the decapitalisation rate, and correspondingly, underestimating the rateable value. In this respect, Mr. Jones has confirmed in his evidence at the hearing that what Mr. Parsons has done is "only an estimate of the headline cost, and it is not the full cost. " This is accepted by Mr Parsons. In the circumstances, the decapitalisation rate adopted by Mr. Parsons is (the CRV submits) wholly unreliable.  In addition, the CRV says that, conceptually, if one were to approach the question of cost of financing, one should be using the appropriate cost of capital to estimate the decapitalisation rate. Therefore, (the CRV argues) on the CB fiction, it is the HT, not just anyone, who is considering how much it would cost him to build the notional alternative. Plainly, after the HT had built the notional alternative, he would not just be an HL. He would be the HT plus HL. He would become the owner occupier. Accordingly, there is no reason why the OO’s WACC should not be used to assess the decapitalisation rate. The Tribunal’s findings  We are of the view that the decapitalisation rate for the Tenement should not be assessed by reference to the property yield of flatted factories, but should be assessed by reference to the cost of borrowing: (1) We are not convinced by the evidence that the property yield of flatted factories provides a good reference to the cost of borrowing for the reasons submitted by HEC. (2) Further, in our judgment, if it were right to use the yield of flatted factories as the basis of the decapitalisation rate for the Tenement in this case, it would have also been appropriate to adopt the yield of flatted factories as the basis of the decapitalisation rate for all other tenements (regardless of the differences between these tenements and the flatted factories) that are to be assessed under the CB method of valuation. However, the very reason for adopting the CB method of valuation is usually because there is an absence of suitable rental evidence. As a result of this, there is usually no evidence of capital and rental values of the tenements for which a check of the adopted property yield could be used. Therefore, it is incorrect to assess each and every of these tenements using the property yield of flatted factories as the basis of decapitalisation rate and applying the subjective adjustments to reflect the differences between these tenements and the flatted factories (such as in the present case where Mr. Poon suggested a 20% adjustment). On the other hand, whilst we have accepted in the principle to use the cost of borrowing as the basis of the decapitalisation rate in the CB valuation for the Tenement, we agree with the CRV that there is no reason why the owner occupier’s WACC (i.e. the HEC’s WACC) should not be used to assess the decapitalisation rate. This should be used to assess the full cost of borrowing, instead of the headline cost as assessed by Mr. Parsons. Whether a discount should be given for functional obsolescence of the Ap Lei Chau buildings  Mr. Poon has valued the former operational headquarters and the carpark buildings at Ap Lei Chau on a rental basis. It was agreed that these buildings were no longer used for the operations of the HEC and had been vacant for a long time.  Whilst the parties have agreed on the rental values, Mr. Parsons has given a 50% discount to account for the functional obsolescence of the buildings. This is not agreed by Mr. Poon who gives evidence to the effect that in the rating world, there is no reason to suggest that the HL, being a prudent landlord, given the choice that he can have, will not simply give a 50 per cent allowance purely because the HT said that the buildings are surplus to him.  Mr. Poon further explains that the Town Planning zoning allows these buildings to be used as offices, workshops and stores. As such, any restriction under the Government lease would have to be ignored and all possible alternative uses should be taken into account. Mr. Poon also adds that these buildings should be taken out of section 10 cumulo assessment as they are no longer part of the buildings used by HEC.  We agree with the reasoning of Mr. Poon and hold that there is no justification to give an additional 50% discount to allow for the functional obsolescence of the buildings in question. Rateability of the AUC under the CB valuation  HEC submits that since the AUC is not rateable property, it is wrong for Mr. Poon to have included the valuation of the AUCs in the CB valuation.  On the other hand, the CRV submits that (i) as a matter of law, AUCs are rateable and therefore, insofar as there is any value of occupying the AUCs, such values should be reflected in the rateable of the Tenement in the CB valuation; (ii) further and in the alternative, even if the values of occupying the AUCs should be excluded from the rateable, no adjustment is required under the R & E valuation.  In section E2 of H H Judge Au’s judgment, we have already decided that as a matter of law, the AUCs are not rateable. As such, it follows that the values of the AUC should not be included as the value of the Tenement under the CB Method.  We will come to consider the separate question as to whether the exclusion of the values of the AUC should be reflected in the R & E valuation below. Miscellaneous Matters in the R & E valuation Summary of the matters that require determination  There are a few minor matters in the R & E valuation that may require the Tribunal’s determination. The CRV sums up these in her closing submissions and her position in relation to them as follows:
(1) The question of hindsight and adjustment for state. However, the CRV submits that the matter is not important because it is only a step preceding the arrival of the DB, which has already been agreed in the relevant assessment year of 2004/05.
(2) The question of whether the separately assessed parts of the generation, transmission and distribution tenements of the HEC should be taken into account. However, the CRV also submits that this matter is also not important as it has no impact on the total rateable value.
(3) The question of landlord’s occupation. This matter is also not important and the amount involved is very small compared with the assessment of the Tenement as a whole.
(4) Whether there is the need to make any deduction in respect of AUC under the R & E method.
(5) Whether the WACC, if to be applied, is to be taken on the NBV or depreciated replacement costs ("DRC") of the HT’s assets.
 We agree with the CRV’s submissions that the first two outstanding issues need no determination for the present purposes, as they are not live issues before the tribunal.  We will briefly deal with the remaining three issues as follows Landlord’s occupation  The problem of landlord’s occupation arises as follows in Ms Jim valuation.  Ms. Jim says that the reason giving rise to the value for the landlord’s occupation is the definition of rateable value in section 7(2) of the RO, which provides that the HL is to be assumed to pay for the cost of repairs. Therefore, in order to implement this assumption, valuers have to adjust the HEC’s accounts in order to identify and remove from the operating expenses any items which are taken as the cost of repairs. For this reason, the DB has been calculated on the basis that the HT does not have to pay for any of the actual costs incurred in repairing the Tenement. Ms. Jim further assumes that in discharging his obligations under the RO, the HL does not only have to bear the actual costs of repairs but also have to occupy certain parts of the Tenement for this purpose. Ms. Jim believes therefore that the HT has to bear the cost of occupation or the rent for such parts of the Tenement for the purpose of effecting the repairs.  There is no dispute between the parties on the adjustments for the cost of repairs but they dispute over Ms Jim’s assumption that certain cost or rent for such parts of the Tenement should be estimated, and then be added to the estimated rent after deducting the Tenant’s share from the DB.  HEC submits that the Tribunal should hold that "the landlord’s occupation" is a further fiction which does not need to be allowed for in the R&E method. Also, the quantification of the value of this item is pure speculation.  With respect, we cannot follow Ms Jim’s reasoning:
(1) It is common sense that under the tenancy in the real world, when the landlord bears the burden of carrying out the repairs, the tenant/occupier will provide the space for the landlord to effect its obligation to repair freely. We therefore cannot agree that an allowance should be made for the occupation of space by the HL for the purpose of carrying out the repairs in the hypothetical tenancy in the rating world.
(2) We agree with Mr Roots’ submissions that the HL’s obligation is to pay for the cost of repair. This does not necessarily mean that the HL has to actually carry out the repair by himself or his agents. The question of landlord’s occupation therefore does not necessary arise as assumed by Ms Jim.
 Hence, we conclude that no adjustment needs to be made for landlord’s occupation in the R&E valuation for the Tenement. The need to make any deduction in respect of AUC under the R & E method  The CRV submits that even if AUC is not rateable, there is no need to make any deductions of the valuation of rateable value under the R&E Method.  This is so because (the CRV submits) under the R & E method, the rateable is to be assessed by the profit that the Tenement can generate. However, since the AUC do not contribute to the operations of HEC, and hence the profit generation, their presence or absence does not make any difference to the profit-making ability of the tenement. Therefore, under the R & E method, the AUC have no effect at all on the rateable value. Consequently, whether the AUC are rateable or not in law does not make any different in the computation of the rateable value and hence, there is no need to make any downward adjustment even if the Tribunal decides that AUCs are not rateable in law.  In addition, the CRV argues that even if adjustments are required, the calculations as suggested by Mr. Parsons are not reliable. This is supported by Ms. Jim’s evidence.  Ms. Jim raises a few questions relating to the practical issues of whether Mr. Parsons or indeed any rating valuer could accurately assess the AUC for the purpose of adjustment. Ms. Jim disagrees with Mr. Parson’s calculations of the deduction of the DB for AUC because she does not know whether there would be any change in tariff information announced in the press release documents. She also points out that Mr. Parsons might not have the evidence of what assets were under construction on 1st April and had in fact used evidence as at 31st December. Finally, she says that she did not understand why an adjustment had to be made for the HT’s AUC as Mr Parsons seeks to do.  The HEC refers to the definition of the "Net Assets" in the SOC (which includes assets under construction and capital stores) to rebut Ms. Jim’s evidence that the AUC do not generate additional revenue. It is HEC’s submissions that when the tariff is fixed each year, it would reflect the objective of enabling the PR to be earned on the AUC in addition to the fixed assets, which have been completed and comprise part of the tenement. The purpose of this provision is plain: to encourage HEC to continue investing in new assets. As a result, the AUC do contribute to the generation of the business’ profit.  We accept HEC’s submissions:
(1) We agree that, by reference to the SOC (which should be taken into account in the rating valuation), the AUC does contribute to generate the business’ income, which has been taken into account in the R&E Method as receipts. In the circumstances, a downward adjustment in principle should be made to reflect their non-rateability.
(2) Insofar as the practical valuation assessment is concerned, we have followed through Mr. Parsons’ suggested adjustments to the inputs in the R&E valuations. We find these to be reasonable and we do not find that the objections raised by Ms. Jim are real as to make these assessed adjustments impossible, impracticable or unreliable.
(3) We therefore accept Mr Parsons’ evidence on the downward adjustment in the R&E Method valuation to reflect the non-rateability of the AUC.
Valuing the HT’s capital: by NBV or DRC  The disagreement between the parties is simply whether NBV or DRC should be used to represent the value of the HT’s assets under CRV’s WACC approach of the R&E Method.  Ms. Jim has used the NBV of the HT’s assets as a proxy for their value whilst Mr. Parsons contends that on Ms. Jim’s method, the proper proxy for the HT’s capital should be DRC. However, neither Mr. Parsons nor any other witness has done any valuations of the HT’s assets on the DRC basis.  The CRV states that it is agreed at the outset that the only difference between using "NBV x nominal WACC" as against "DRC x real WACC" is a difference in the depreciation profile.  Mr. Yu in his Final Written Submission summarizes the grounds for using the NBV as follows:
(1) It is clear that if DRC (which reflects the present costs of replacing the assets) is used, then inflation in price since the date of acquisition will have to be taken into account in the valuation of the tenant’s assets, hence the WACC to be applied to it should be the real WACC. To use nominal WACC (which includes inflation) would double count inflation. Mr. Jones had no disagreement with that. Hence, the question is whether the tenant’s share should be DRC x real WACC or NBV x nominal WACC.
(2) Mr. Jones accepted that, in the long run, the summation of these figures over the years would be the same. The only difference is in profile. This is also the view of Dr Lam.
(3) The disagreement therefore boils down to the question whether it is reasonable to adopt the profile of NBV x nominal WACC. The depreciation profile of the NBV in dictated by the accounting policy stipulated in the SOC: Schedule 2. The only question is therefore whether it is reasonable to adopt that as a proxy for the value of the HT’s assets.
 Mr. Yu further adds that there are good grounds for adopting the depreciation profile of the NBV as stated in SOC as a proxy for valuing the HT’s assets. The parties have accepted that the SOC exists in materially the same terms in the rating world. That is, the return of the integrated business would be determined by the PR x ANFA (i.e. NBV of the assets) of the owner occupier (including those of the HT). The tariffs would also be set by the mechanisms of making reference to the PR on the NBV of the assets of the owner occupier, including those of the HT.  Therefore, there is nothing exceptional and conceptually unacceptable to use the straight-line depreciations as agreed between HEC and the Government under the SOC. In fact, the NBV has been widely used as a fair value of assets. It was also used as the proxy for the value of the HT’s capital in the CLP decision. The CRV therefore submits that whilst HEC was happy to adopt this measure as a measure of asset value under the SOC, and in its annual reports, it is not understood why the HEC refuses to use the same basis in the R & E valuation.  We agree with Mr Yu’s above submissions. The use of NBV to represent the value of the HT’s assets is consistent with the provisions under the SOC, which even in HEC’s own case should form the very basis of the assessment of the rateable value of the Tenement. There are no good reasons to depart from the real world, when this is not in violation of any of the rating hypothesis.  We therefore hold that if the CRV’s WACC approach was adopted for the R&E Method, it is the NBV of the HT’s assets which should be employed to assess the tenant’s share from the DB. H. H. Judge Au, Presiding Officer: That leaves us with one further matter that we need to deal with.  Mr Yu has submitted that Mr Parsons is not an impartial expert, and has invited us to reject his evidence entirely. In support of his submissions, Mr Yu has raised a number of essential grounds to say why Mr Parsons’ impartiality as an expert is doubtful.  It is clear from the above that we have accepted part of Mr Parsons’ evidence for the reasons already given. We also reject parts of Mr Parsons’ evidence for the reasons we have also given above.  It is therefore clear that we do not agree with Mr Yu that Mr Parsons is not an impartial expert witness. Our reasons are as follows.  We have seen Mr Parsons giving viva voce evidence at the hearing. We have observed his demeanour. We find it to be one of general openness, with an intention to assist the Tribunal in answering questions. From the evidence we have discussed above, it can be seen that Mr Parsons is prepared to give evidence which does not benefit HEC. For example, he readily and frankly accepts that his adjustment of 25% of the DB value is nothing but his valuer’s judgment, with no solid evidence to support. He also readily accepts many propositions, which are not favourable to HEC’s position put to him by Mr Yu under cross-examinations. This in our view shows that Mr Parsons as an expert is genuinely seeking to help the Tribunal instead of being partisan.  Secondly, we accept Mr Roots’ submissions that Mr Parsons’ reports are a model of thoroughness and transparency of explanation. There is clear distinction between what he regarded as his instructions, and his own analysis. There are clear statements of the assumptions he was making. There are many instances that he tried to act fairly by not simply adopting the position that was most favourable to HEC.  Thirdly, insofar as the principal grounds of criticisms made by Mr Yu of Mr Parsons lack of impartiality are concerned, we also accept Mr Roots’ reply submissions that none of the grounds, when properly looked at with the evidence, shows that Mr Parsons was intending to mislead the Tribunal or to foster a view which he did not genuinely hold as an expert but was simply advanced as a "hired gun" for HEC. We will deal with them summarily as follows:
(1) Mr Yu says, in the face of all the compelling circumstances, Mr Parsons had still not even attempted a WACC calculation as a cross check is that he realised that this would yield a higher rateable value to the CRV’s conclusions. This, Mr Yu submits, is not impartial. We however agree with Mr Roots that, when Mr Parons’ evidence (including his reports) is looked at together, it is clear that he forms the clear view that the WACC approach is simply inappropriate where there is in operation the SOC. In the premises, we accept that it is not incumbent on an expert to do a calculation on a basis which he has clearly and transparently explained to be in his view inappropriate.
(2) Mr Yu further submits that Mr Parsons put forward the CB Method for no other reasons but to produce a lower figure than the R&E Method. We do not think this is established. It must be noted that Mr Parons has made clear in his first report that, if the SOC is not to be taken into account (as he believed to be the CRV’s position), then the R&E Method is inappropriate, and it would then be necessary to rely on the CB Method. It is on this basis that the CB Method is first introduced. The CRV’s position on how the SOC should be taken into account is only made clear by the time of the hearing of the appeals.
(3) Mr Parsons is also criticised for maintaining the position that he sees no synergy value or monopoly value in the Tenement. This shows, as the CRV submits, that he is not impartial. In relation to this, we accept Mr Roots’ submissions that it has not been demonstrated that Mr Parsons’ said opinions are so irrational that they could not have been advanced by any reasonable expert, and were advanced to solely mislead the tribunal. Mr Parsons has explained why he believes that there is no synergy value in the Tenement. Although we have eventually rejected his explanation, we do not think they are so irrational that no reasonable expert could have formed the same view.
(4) It is also said that Mr Parsons is prepared to say anything in the witness box (regardless of its truth) if he perceives it to be advantageous to his case. Mr Yu in support cites various answers that were given by Mr Parsons in cross-examination. Some of these answers relate in particular to the change of use of CP45 (as discussed above). We have heard and seen Mr Parson in giving these answers. We are of the view that, insofar as it has been shown that some of these answers turn out to be incorrect (particular on the dates when he became aware of certain matters), they are more likely than not the result of genuine confusion on the part of Mr Parsons, after giving evidence for quite some time. In our view, it is not uncommon for witnesses (even the most honest one) to have remembered wrongly matters under the pressure and anxiety of giving evidence. This alone does not necessarily mean that the witness is dishonest or is prepared to say anything to mislead the court knowing that it is incorrect.
(5) Mr Parsons is also criticised for not setting out in his reports that the full cost of borrowing (as worked out by Mr Jones) for the purpose of the CB Method were not in fact reflected in the calculations he had carried out. It is correct that Mr Parsons has not made this clear in his reports. However, we accept Mr Roots’ explanation that Mr Parsons has relied on Mr Jones’ reports, which have been served together with Mr Parsons’ report. Mr Jones has explained that he has only worked out the headline costs but not the full costs of borrowing. Further, in his own calculation of the decapitalisation rate, Mr Parsons has made a number of adjustments and did not just use Mr Jones’ headline rate. In the circumstances, although we agree that it would have been better if Mr Parsons has pointed out clearly in his report that Mr Jones’ evidence on the costs of borrowing is not the full costs, there is insufficient materials before us to conclude that Mr Parson has deliberately tried to conceal this in his reports in order to mislead the Tribunal or to put forward a position to lower the rateable value without an honest and genuine belief in it.
(6) Finally, the CRV says Mr Parsons advocates two cross-checks in his reports which are purely illusory. Mr Parsons has given full reasons and explanations as to why he thinks these two cross-checks could be used. It has not been shown to us that these reasons and explanations are so utterly without basis that they could not have been advanced by any reasonable expert in the position of Mr Parson. We also reject this as a ground to show that Mr Parsons is not an impartial expert.
 We are of the clear view that the criticisms that Mr Parsons is not an impartial expert witness have not been made out. Conclusion  For the reasons given above, we conclude that:
(1) The rateable value of the Tenement for the year 2004/2005 should be determined by the R&E Method, whereby the tenant’s share is to be assessed on the basis of the PR x HT’s ANFA.
(2) Subject to the depreciation adjustment and the adjustment in relation to the AUC’s exclusion as suggested by Mr Parsons, the rateable value of the Tenement under the RO for the year 2004/2005 is thus the DB – (PR x HT’s ANFA).
 We would therefore allow HEC’s appeals, and the parties are directed to agree on the proper form and terms of the order, including the final figure on the rateable value assessed in accordance with the above conclusion, and the resultant rates and Government Rent of the Tenement, to be drawn up for these appeals, with liberty to apply for further directions if necessary.  There will also be an order nisi that costs of the appeals be to HEC to be taxed in the High Court scale, if not agreed, with certificate for two counsel. Unless any of the parties applies by Summons to vary the same, the costs order nisi shall be made absolute 14 days from today.  Lastly, we will like to thank leading counsel and their respective legal teams for the valuable assistance in this interesting matter.
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