COURT OF FINAL APPEAL, HKSAR
CHIEF JUSTICE GEOFFERY MA
JUSTICE KEMAL BOKHARY PJ
JUSTICE R.A.V. RIBEIRO PJ
JUSTICE LITTON NPJ
21 JUNE 2011
Chief Justice Ma
In this appeal, issues arise as to the methodology used in the assessment of the rateable value (for the purposes of calculating the rates and government rent under, respectively, the Rating Ordinance, Cap 116 and the Government Rent (Assessment and Collection) Ordinance, Cap 515) of the tenement occupied by the appellant, the Hong Kong Electric Company Limited (“the Company”). A discrete issue also arises in relation to what has been termed by the parties the “assets under construction” issue, this point essentially going to the question whether certain assets belonging to the Company which were in the course of construction, were rateable by the respondent, the Commissioner of Rating and Valuation. The appeal is from the Court of Appeal, which in turn had heard an appeal from the decision of the Lands Tribunal.
For the reasons and conclusions contained in the judgments of Mr Justice Ribeiro PJ (on the “assets under construction” issue) and Lord Millett NPJ (on the methodology issue), with which I agree, the appeal should be allowed.
I should add here that at the conclusion of submissions, this Court left open (for further arguments and decision if necessary) the issues raised by the Company in the event the methodology issue was determined against it. These further issues were in substance those contained in the Respondent’s Notice before the Court of Appeal. As the issue of methodology has now been resolved in favour of the Company, it becomes unnecessary to deal with those Respondent’s Notice issues.
Justice Bokhary PJ
Lord Millett NPJ’s judgment covers everything apart from assets under construction. Such assets are covered by Mr Justice Ribeiro PJ’s judgment. I wholly agree with both of those judgments. What Mr Justice Litton NPJ says about valuation prompts me to add a word of my own in that connection.
Throughout my life in the law, I have always regarded reality as a touchstone. If there truly is a separate “rating world”, then I am a mere visitor to it. And as such, I was initially somewhat bemused by the statements made in some of the cases to the effect that rating operates in a world of unreality or worse. As it seems to me upon closer inspection, however, there is no unreality in rating beyond that which is forced upon it by the requirement that the rateable value of a tenement be ascertained in terms of the hypothetical year to year tenancy laid down by s.7(2) of the Rating Ordinance, Cap.116. Sometimes, as in the present case, the tenement concerned is of such a kind that its rateable value does not lend itself to determination by the comparative method of valuation. So a notional method of valuation has to be used. That may render valuation even more open than usual to rival approaches yielding different results. Where it does, two things become, I think, particularly important to bear in mind. The first is that the Lands Tribunal is entitled to adopt any method or technique of valuation by which the rateable value of a tenement can be accurately ascertained, remembering always that s.7 requires nothing more precise than the rent that “might reasonably be expected”. And the second is that the Lands Tribunal’s decisions on rateable value are those of a specialist tribunal appealable only on law and not on fact.
Justice Ribeiro PJ
I have read in draft the judgment of Lord Millett NPJ and respectfully agree with his reasoning and conclusions.
This judgment is concerned with a discrete issue arising on the appeal. As the Tribunal recorded (LT §160), certain assets of the Company were identified by the parties “as still under construction (and thus not occupied)” at the relevant date. Those assets have been referred to in argument and in the judgments below as “assets under construction” or “AUC” and were treated by the Commissioner as forming part of the Company’s rateable tenement. The question is whether such treatment of the disputed assets is correct as a matter of law.
If the answer is “No”, a second question arises: Does it follow that there must be a downward adjustment to the divisible balance adopted in the receipts and expenditure method of valuation (discussed by Lord Millett NPJ) and a consequent reduction to the assessed rateable value of the Company’s tenement?
The Tribunal held that the Commissioner was wrong in law to include the disputed assets as part of the rateable tenement (LT §§168-169) and that a downward adjustment was required. It accepted as correct the adjustment proposed by Mr Parsons, one of the Company’s experts (LT §§342 and 359(2)).
The Court of Appeal reversed the Tribunal. It held the disputed assets to be rateable and therefore held that the second question (concerning adjustment) did not arise (Court of Appeal §§99-100).
A. THE NATURE AND SCOPE OF THIS ISSUE
It is important to note the limits of the question upon which the parties join issue. Mr Holgate QC made it clear that the Company is not seeking to contend that the relevant property must be occupied in order for it to constitute a rateable tenement. Clearly, under the Rating Ordinance, a tenement may still be rateable notwithstanding that it is unoccupied (subject to the possibility of a refund of rates paid in some cases).
The question posed is when and in what circumstances a certain piece of land, a building or a structure first qualifies as a tenement attracting liability to rates under the Ordinance. Such a question arises where the asset in question is undergoing or is intended to undergo a process of construction or development designed to enable it to be used in the particular manner intended by the ratepayer.
It is therefore a question germane to the Company’s assets under construction. As the Tribunal found (LT §67):
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.
An important component of the assets under construction involves the reclamation of some 22 hectares of land on Lamma Island in order to provide capacity to expand the power station and to accommodate six gas fired combined cycle generating units. The reclamation works were not substantially completed until 1 April 2007 so that the reclamation project was ongoing in 2004/2005. As the Tribunal records (LT §58):
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.
The Court is presently not concerned with and was not informed about the circumstances in which the newly installed unit and associated pipeline “became part of the tenement in 2006/07”. However, the situation referred to illustrates the need for conceptual and legal criteria for ascertaining whether and when assets which have been undergoing construction or development become part of a ratepayer’s rateable tenement.
Similar questions arise in relation to the Company’s other assets. The Tribunal found that the Company’s rateable tenement included some 400 kilometres of transmission cables linked to substations housed in 32 buildings and some 5,000 kilometres of cables and numerous substations forming its distribution network. As new building and other development projects come into existence on Hong Kong Island, Ap Lei Chau or Lamma Island, the Company’s existing networks have to be expanded or modified to supply them with electricity. Issues necessarily arise as to when the expanded or modified networks of tunnels, ducts, substations and so forth, constructed to house cables and other equipment linking the new projects to the electricity grid, first become part of the Company’s rateable tenement as a matter of law.
The answer proposed by the Company is that all such assets only become rateable as part of its tenement when they become capable of occupation for the particular purposes of the occupier (in a sense developed in the law of rating, examined below). Where the land, building or structure in question becomes capable of occupation, it becomes rateable even if it is not thereafter in fact so occupied. But while the property is or is intended to be under construction or development but not yet capable of supporting such occupation, the Company argues that it is not rateable.
The Commissioner submits that there is no legal basis for such a criterion of rateability. She contends that in Hong Kong, the fact that the property in question may be under construction or development does not prevent it from attracting liability to rates.
Those opposing contentions frame the principal issue addressed in this judgment. The question is of considerable importance since similar issues are in principle capable of arising in connection with the rateability of building sites generally. Indeed, as the Company points out, in taking her current stand on assets under construction, the Commissioner has departed from previous practice which was consistently not to treat building sites as rateable tenements.
Resolution of the disputed question requires close examination first, of this Court’s decision in Commissioner of Rating and Valuation v Agrila Ltd (2001) 4 HKCFAR 83; and secondly, of the relevant provisions of the Rating Ordinance and subsidiary legislation.
B. THE AGRILA DECISION
B.1 The Court of Appeal’s view
Agrila was not discussed by the Tribunal in the present context. However, in the Court of Appeal, Mr Guy Roots QC (then appearing for the Company) submitted that that decision was dispositive of the present case: Court of Appeal §87.
The Court of Appeal disagreed, holding that Agrila is not relevant and distinguishing it on two main grounds, namely:
that this Court did not need to and did not engage in the exercise of determining whether building sites are rateable under the Rating Ordinance (Court of Appeal §89 and §93); and
that this Court simply accepted the parties’ agreement which in fact rested on the incorrect assumption that the position in Hong Kong is the same as in England whereas it is in fact very different: while liability for rates in England is “firmly grounded on the concept of ‘occupation’, that being the sole test of rateability” (Court of Appeal §91), in Hong Kong, occupation in the English sense is not the decisive test for rateability (Court of Appeal §95) and dual liability of both owner and occupier exists, stemming from the definition of “tenement” in the Ordinance (Court of Appeal §96).
I am, with respect, unable to agree with the Court of Appeal. In my view, properly analyzed, Agrila has an important bearing on the question whether assets under construction are rateable.
B.2 What this Court decided in Agrila
B.2a The relevance of the Rating Ordinance to Government rent
The question which the Court had to decide in Agrila was whether the lessees of 59 development sites were liable to pay Government rent under the Government Rent (Assessment and Collection) Ordinance (“the Rent Ordinance”) and the Government Rent (Assessment and Collection) Regulation (Cap 515) (“the Rent Regulations”).
The Rating Ordinance was nevertheless important because its concepts of rateability and rateable value are adopted by the Rent Ordinance for fixing the Government rent payable unless a specific provision exists in the Rent Ordinance which itself governs the assessment of Government rent in any particular case.
Thus, section 6(1) of the Rent Ordinance materially states:
.... the lessee of an applicable lease is liable to pay by way of Government rent to the Commissioner in accordance with this Ordinance an annual rent of an amount equal to 3% of the rateable value of the land leased.
And, by its section 8(2), the Rent Ordinance provides:
The Rating Ordinance (Cap 116) applies to the ascertainment of rateable values under this Ordinance subject to any specific provisions of this Ordinance.
B.2b Assets under construction
The 59 sites in question comprised 33 development sites newly acquired from the Government for development purposes; 24 redevelopment sites where the structures formerly on the land had been demolished pending redevelopment; and two agricultural sites acquired for future development: Agrila at 93.
It is essential to note the focus of the case as identified by Sir Anthony Mason NPJ (with whom the other members of the Court agreed), ibid, at 92:
The case concerns the assessment of rent during the period of construction and development only, payable by lessees of Government leases of land in course of development or redevelopment, though in some cases the development has not advanced beyond the erection of hoardings at the site.
The Court was therefore solely concerned with the liability to Government rent of land comprising building sites which were in the course of being developed or redeveloped. It was, in other words, a case about “assets under construction”.
B.2c Regulation 2 of the Rent Regulations
It was indeed common ground between the parties in Agrila that the relevant sites were not rateable under the Rating Ordinance, the view being taken that, while under construction, they were not regarded for rating law purposes as being in rateable occupation, ibid at 94.
The Commissioner, however, argued that it did not matter that the 59 sites were not rateable under the Rating Ordinance since there exists a specific provision under the Rent Ordinance itself which brings them within the charge to Government rent. That provision is regulation 2 of the Rent Regulations which provides as follows:
Where any leased land has not been developed after the commencement of the term of the applicable lease under which it is leased, the rateable value of the leased land at any time before any part of it is developed shall be ascertained as if the leased land were a tenement liable for assessment to rates under the Rating Ordinance (Cap 116).
The central issue dividing the parties involved the construction of regulation 2: Did it provide the basis – missing from the Rating Ordinance – for assessing the building sites to Government rent? The Court of Appeal in Agrila at 190, 196 and 209-212, had held that it did not. The words “as if the leased land were a tenement liable for assessment to rates under the Rating Ordinance” were thought merely to take one back to the provisions of the Rating Ordinance which, as all had agreed, did not treat the sites as being in rateable occupation.
This Court disagreed with that construction, pointing out that (as the Court of Appeal had acknowledged) it rendered regulation 2 ineffective and nugatory, ibid at 98. After considering what he considered to be “well-established principles of rating law” (to which I return below), Sir Anthony Mason NPJ held that the true purpose of regulation 2 was to overcome, rather than merely reiterate, the non-rateability of building sites under the Rating Ordinance. His Lordship stated, ibid at 99:
Viewed in the light of these well-established principles of rating law, the purpose of regulation 2 seems to be reasonably clear. It is to overcome the problem that building sites are not rateable tenements for the purposes of the Rating Ordinance. The regulation achieves this purpose by providing that the rateable value of the leased land before any part of it is developed shall be ascertained ‘as if the leased land were a tenement liable for assessment to rates under the Rating Ordinance’.
As to ascertaining the rateable value, his Lordship went on to state:
[Regulation 2] says nothing about how the rateable value is to be ascertained. That function remains to be dealt with, as s 8(2) of the Rent Ordinance prescribes, in accordance with sections 7 and 7A of the Rating Ordinance. The regulation makes no attempt to displace the operation of these sections. So the preferable meaning to be given to the words quoted above is that they require the rateable value of the leased land to be ascertained on the assumption that it is a rateable tenement. This meaning enables the regulation to have an effective operation and overcomes the point, acknowledged by Ribeiro J, that on the Court of Appeal’s construction the regulation is nugatory and of no effect.
It is therefore clear that a necessary element of the Court’s construction of regulation 2 was its acceptance of the proposition that “building sites are not rateable tenements for the purposes of the Rating Ordinance”. It held that the purpose of the regulation was to “overcome” that “problem”. It rejected the Court of Appeal’s interpretation on the basis that it rendered the regulation nugatory instead of allowing it to surmount the difficulty. It follows that the decision of this Court in Agrila prima facie provides substantial support for the proposition that building sites – and by logical extension, other assets under construction – are not tenements in rateable occupation.
Moreover, this Court’s construction of regulation 2 necessarily implies that the legislature must be taken to have accepted the non-rateability of building sites under the Rating Ordinance and so considered it necessary to enact that regulation in order to bring such sites within the charge to Government rent.
I am therefore unable to agree with Le Pichon JA’s first ground for holding that Agrila is not relevant, set out in Section B.1 above.
B.2d The Court’s acceptance of the non-rateability of building sites
I turn then to the second ground which her Ladyship advanced and which Mr Benjamin Yu SC adopted for distinguishing Agrila. This ground has two aspects.
First, it involves the proposition that the Court proceeded merely on the basis of the parties’ agreement and should not be taken to have independently decided the correctness of the point.
Secondly, it involves the argument that the agreement was based on an erroneous assumption ignoring material differences between rating law in Hong Kong and in England.
I shall deal in this section with the first proposition.
While it is true that it was common ground between the parties in Agrila that building sites are not rateable tenements, the suggestion that the Court did not reach or express its own conclusion on the point is untenable, as the following citations from the judgment demonstrate.
As previously indicated, Sir Anthony Mason NPJ construed regulation 2 against the background of what he described as well-established principles of rating. He identified those principles as follows (Agrila at 98-99):
The decision in Yiu Lian Machinery Repairing Works v Commissioner of Rating and Valuation  HKDCLR 32 at 39 established that a tenement is not in rateable occupation unless the four requirements for rateable occupation in English law are satisfied. They are:-
His Lordship continued (at 99):
Another fundamental proposition of rating law, as stated by Lord Radcliffe, is that:
(London County Council v Wilkins at 380). What is important for present purposes is that the statement expresses the proposition in terms of rateability of the property, not in terms of rateable value. The proposition explains why development sites in Hong Kong have not been rated.
Having reviewed the legislative history leading to the Rent Ordinance, he concluded (at 102):
Since 1973, it has always been permissible to ascertain the rateable value of land leased for the purpose of assessing Government rent, even though there is no rateable value under the Rating Ordinance, either because of exemption or otherwise.
His Lordship then described the Government’s view, expressed by the Secretary when rejecting a proposed amendment to regulation 2 during a Legislative Council debate, as follows (at 103):
.... although for rating purposes, no rateable value is ascribed to a newly granted site prior to completion of its development as there is no rateable occupation of construction sites, a rateable value must still be ascertained for rent purposes. Even if the proposed amendment was passed, the Government would still dispute the proposition that because there was no rateable occupation for a newly granted lease prior to completion of its development there could be no rateable value for rent purposes.
His Lordship considered it legitimate to take account of the Legislature’s awareness of the position thereby indicated, stating, ibid:
The rejection of the proposed amendment by the legislature indicates that regulation 2 was understood to mean that even where land subject to a lease is not assessable to rates under the Rating Ordinance because there is no rateable occupation, it would still be assessable for the purpose of Government rent and that it was the legislature’s intention so to provide.
The conclusion of the Court (at 113) was that:
.... on a true construction of regulation 2, the non-rateability of the leased land under the Rating Ordinance is to be disregarded and the rateable value is to be ascertained on that basis in accordance with sections 7 and 7A of the Rating Ordinance.
In my view, there can be no doubt that independently of the parties’ agreement, the Court in Agrila decided that sites in the course of development or redevelopment are not rateable tenements under the Rating Ordinance.
B.2e The correctness of the proposition
What of the second aspect mentioned above? Did the Court’s endorsement of the point treated as common ground by the parties in Agrila involve endorsement of an erroneous assumption which ignored material differences between rating law in Hong Kong and in England? The Court of Appeal’s view was that such a tainted assumption was in play.
Le Pichon JA noted that Sir Anthony Mason NPJ had read the Yiu Lian decision ( HKDCLR 32) “as establishing that in Hong Kong a tenement is not in rateable occupation unless the four requirements for rateable occupation in English law are satisfied” (Court of Appeal §94), commenting (ibid):
The underlying assumption, was that there was no difference between Hong Kong rating law and English rating law.
Her Ladyship suggested that this approach did not give sufficient weight to the qualifications that Judge Cruden had placed on applying the four requirements in Hong Kong. The relevant passage from Judge Cruden’s judgment in Yiu Lian  HKDCLR 32 at 41 runs as follows:
.... those four criteria relate neatly to English rating concepts but can only be applied in Hong Kong subject to several important qualifications. For in England occupation per se gives rise to liability for rates. It matters not whether the land occupied is freehold or leasehold or whether the occupier is in occupation as owner, lessee, licencee or otherwise. In Hong Kong under our section 2 actual occupation by itself is not enough. Before land or any building or structure can become rateable it must in addition be held or occupied as a distinct or separate tenancy or holding or under licence. So there must be either ownership or occupation under one of those three kinds of limited title. In England if the four tests are satisfied the occupation becomes rateable. But in Hong Kong the satisfaction of the four English tests would only give rise to liability for rates if, in addition, the land was occupied under one of the three limited forms of tenure set out in section 2. In England the four tests are complete and decisive criteria whether liability for rates arises. In Hong Kong they are, at most, merely an indicator that there may be a liability for rates.
It is true that Judge Cruden was pointing to certain differences between the position in England and that in Hong Kong. However, those differences do not appear to me to have any relevance to the issues either in Agrila or in the present case.
Judge Cruden was grappling with the question whether floating dry docks were themselves “tenements”, it having been argued that they were neither land, nor buildings nor structures within the meaning of section 2 of the Rating Ordinance and that even if they were, that they were not held or occupied under a tenancy, holding or licence (at 39). It was in that context that His Honour was keen to emphasise that in Hong Kong, “occupation by itself is not enough” and that before land or any building or structure can become rateable “it must in addition be held or occupied as a distinct or separate tenancy or holding or under licence”. He stated:
In England if the four tests are satisfied the occupation becomes rateable. But in Hong Kong the satisfaction of the four English tests would only give rise to liability for rates if, in addition, the land was occupied under one of the three limited forms of tenure set out in section 2.
Yiu Lian does not suggest that the four requirements for possession are inapplicable in Hong Kong, but only that they are not sufficient to make the land, building or structure in question a rateable tenement. It is necessary, in addition, for the property to be occupied under one of “the three limited forms of tenure set out in section 2”.
In Agrila, there was no issue about “tenure”. The 59 sites were all held under “applicable leases” for the purposes of the Rent Ordinance: Ibid at 93. The question was whether the fact that they were building sites in the course of construction took them outside the provisions defining rateability in the Rating Ordinance, so that their liability to Government rent depended solely on regulation 2 of the Rent Regulations. It is therefore unsurprising that Sir Anthony Mason NPJ did not consider it necessary to make any mention of the “tenure” requirements laid down by section 2.
But what is important for present purposes is that the Court in Agrila accepted that land in the course of development or redevelopment does not constitute a rateable tenement under the Rating Ordinance partly by virtue of “well-established principles of rating law” which included the four requirements discussed above. The Court may thus be taken to have held that where land under development is not susceptible to (i) actual occupation or possession; (ii) which is exclusive for the particular purposes of the occupier; and (iii) of value or benefit to the occupier; and (iv) not for too transient a period, such land does not constitute a rateable tenement under the Rating Ordinance.
It follows that insofar as “capability of occupation” provides the legal test for determining whether land, a building or a structure under construction or development has reached a stage constituting it a rateable tenement, that test is applied by asking whether the property is capable of meeting those four requirements.
B.2f Conclusion as to the relevance of Agrila
For the foregoing reasons, it is my view that this Court’s decision in Agrila is highly relevant to the question presently in issue, supporting the view that the assets identified by the parties as under construction at the material time do not form part of the Company’s rateable tenement.
It is nevertheless true that Agrila was not directly concerned with rateability under the Rating Ordinance and did not involve any detailed examination of the provisions of that Ordinance and its subsidiary legislation in relation to the issue under discussion. It is therefore to those provisions that I now turn.
C. THE RELEVANT STATUTORY PROVISIONS
C.1 The Commissioner’s principal argument
The Commissioner’s main argument has the merit of simplicity. It focuses on the definition of “tenement” in section 2 of the Rating Ordinance which provides:
“tenement” means 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.
The words “held” and “occupied” (so the argument runs) must be read disjunctively. It follows that for the land, building or structure in question to qualify as a “tenement”, it is sufficient that it be “held”, whether or not it is also “occupied”. It is “held” by the “owner” as defined, there being no need for there to be any occupier. There is accordingly no room for reading in any requirement that the property be “capable of occupation” before it qualifies as a tenement: the asset may perfectly well be “held” even if it is not capable of being occupied. Once the asset is a “tenement”, it falls within the charge to rates since section 18(1) makes rates payable “on the rateable value of every tenement” entered in the valuation list in force.
C.2 Should the Commissioner’s main argument be accepted?
The Commissioner’s main argument is attractive and carries considerable force. If it is correct, it would mean that Agrila has to be re-considered since it undermines the Court’s acceptance of the proposition that building sites under development or redevelopment are not rateable tenements. The 59 sites were “held” even if they were not occupied or capable of occupation in the sense of meeting the four requirements adopted in the Yiu Lian decision.
It is however my view, quite apart from the authority of Agrila, that the Commissioner’s principal argument should not be accepted. Its primary weakness is the narrowness of its approach. The Rating Ordinance must be read as a whole. I do not think that the issue dividing the parties can properly be addressed without considering the section 2 definition in conjunction with the other material provisions of the Ordinance or without looking at the rating scheme purposively.
Section 2 obviously does not seek to lay down a definition as an end in itself, but with a view to identifying the basic unit – the tenement – upon which rates are to be levied. It is therefore relevant to consider that definition in conjunction with the provisions laying down the charge to be levied upon that basic unit.
Section 7(2) provides:
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, [on certain assumed rental conditions].
In fixing the rates to be levied by reference to the “rent at which the tenement might reasonably be expected to let”, the legislative intention is for the rates assessed to reflect the value of occupation of the tenement to the hypothetical tenant. As the Tribunal pointed out (LT §38), this was recognized by Lord Buckmaster in Poplar Assessment Committee v Roberts  2 AC 93, who, in construing a provision in materially the same terms as section 2, approved counsel’s submission that (at 99 approved at 103):
The object of the whole system of rating law, built up partly by legislation, partly by judicial decision, is to assess occupiers of rateable property equally in proportion to the value of their occupation.
And Lord Buckmaster himself stated (at 104):
.... the standard in the Act is nothing but a means of finding out what the value of that occupation is for the purposes of assessment.
Significantly, his Lordship also pointed out (at 103):
.... although the tenant is imaginary, the conditions in which his rent is to be determined cannot be imaginary. They are the actual conditions affecting the hereditament at the time when the valuation is made.
See also Orange PCS Ltd v Bradford (VO)  2 All ER 651, §20.
Thus, if one reads the section 2 definition together with section 7(2), one is led to conclude that the legislative intention is that the tenement must be in such condition as to enable the rating hypothesis to be applied. One must be able sensibly to ask what rent the hypothetical tenant might reasonably be expected to pay, taking into account the actual conditions affecting the tenement at the relevant time. This strongly suggests that the land, building or structure in question must be capable of being occupied before it qualifies as a rateable tenement.
This is reinforced by section 7A(2) which sets out certain assumptions to be made in ascertaining a tenement’s rateable value including the assumption that “any relevant factors affecting the mode or character of occupation were those subsisting at the time the list comes into force”.
C.3 Interim valuations
The provisions of the Ordinance dealing with interim valuations lend further support to the Company’s position on assets under construction. Section 25 states that the Commissioner “may at any time make an interim valuation of a tenement which is not included in a valuation list and is liable for assessment to rates”. This is apt to cover cases where newly completed construction projects are brought within the charge to rates. Where this occurs, it is necessary to provide some means of knowing when the property, not previously rateable, begins to attract liability for rates as a result of the interim valuation.
That is the function of section 28(1) which specifies when an interim valuation takes effect:
Subject to section 49, an interim valuation in respect of a tenement shall become effective on a date (the “effective date”) being or to be-
To take paragraph (a) first, the regulations made pursuant to section 53 are to be found in the Rating (Effective Date of Interim Valuation) Regulation (Cap 116). Sections 3 and 5 deal with the effective date of an interim valuation in relation to newly constructed buildings. By their combined effect, such interim valuations become effective after a specified period (generally 90 days where the tenement is used for domestic purposes and 180 days where used for other purposes) following the issue of relevant official documents which certify the building’s completion or approve its occupation. These provisions plainly make rateability of the tenement dependent on the newly constructed building having attained a state in which it is capable of being occupied. Before that stage is reached, it is not treated as a rateable tenement.
Paragraph (b) of section 28(1) is equally supportive of the Company’s position. It is not confined to new buildings but relates to “any other tenement”. It therefore covers land and structures which are the subject-matter of an interim valuation and makes the effective date in relation thereto “the date on which the tenement was first occupied”. That can only occur where the tenement is capable of occupation.
It is true (as Mr Yu SC pointed out at the hearing) that paragraph (c) gives the Commissioner a discretion to appoint some other effective date but it is a discretion only exercisable in particular cases on justifiable grounds. The general rule, reflecting the legislative policy, is as set out in paragraphs (a) and (b). That policy is to make rateability dependent on the completion and occupiability of the tenement in question. These provisions apply of course only to interim valuations. However, as I have previously stated, they are apt to catch assets which were until recently under construction. It is moreover hard to see why there should be any difference in legislative policy regarding the treatment of tenements in the general list prepared under section 12 and those which enter that list by amendment pursuant to an interim valuation.
C.4 Land, buildings or structures occupied by means of plant
Section 8A(1) provides additional support. It states:
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.
Since “plant” is defined to include “cables, ducts, pipelines, railway lines, tramway lines, oil tanks, settings and supports for plant or machinery”, section 8A is of direct relevance to the Company’s undertaking.
Under section 8A, it is sufficient to deem land, buildings or structures rateable tenements if they are occupied by a person by means of plant. But the section makes it clear that such liability only arises “to the extent that the land, building or structure is so occupied”. It follows that where the property in question is under construction and is not yet capable of actually being occupied by means of plant, it does not qualify as a rateable tenement under section 8A.
The four requirements of occupation referred to in the Yiu Lian decision are likely to be of particular relevance here, in that the occupation contemplated by section 8A is, in my view, occupation satisfying those requirements. Thus, the tenement must be capable of actual occupation or possession “for the particular purposes of the occupier” as stated in the first and second Yiu Lian requirements. It may well be, for example, that liability to rates under section 8A is not triggered by there being cables laid on the sea-bed or in specially constructed ducts or tunnels underground unless and until such cables are capable of carrying out their intended purpose of transmitting and distributing electricity.
C.5 Contrary arguments
C.5a Section 21
Three contrary arguments should be addressed. The first relates to section 21(1) which states:
The owner and occupier of a tenement shall both be liable to the Commissioner for payment of the rates assessed thereon, but the same 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 Court of Appeal considered this a provision which militates against accepting the Company’s position on assets under construction, representing one of the “significant differences between Hong Kong and English rating law”. Pointing to section 21, Le Pichon JA stated (Court of Appeal §96):
In Hong Kong, there is dual liability of the owner and occupier stemming from the definition of ‘tenement’, whereas in England liability was limited to occupiers. That was the position from 1601 until 1992 when the Local Government Finance Act 1992 had to be enacted to extend liability to owners for certain limited classes of vacant or unoccupied hereditaments whereas in Hong Kong, what constitutes a ‘tenement’ does not hinge on whether or not it is occupied.
With respect, I do not think section 21 throws any light on the matter at hand. It is premised on the existence of a rateable tenement and does not address the question of when a property under development or construction first attains the status of such a tenement. True it is that after a rateable tenement has come into existence, owner and occupier are subject to a dual liability to pay the rates. The owner would therefore be liable even if the tenement is or becomes unoccupied. But that does not bear on the debate in the present case.
C.5b Section 30
The second contrary argument rests on section 30 which provides as follows:
Subject to subsection (2C), if a tenement not being a building or part thereof and not comprising a structure or part thereof, other than a structure used solely for the purpose of providing shelter for a watchman is unoccupied for any period for which rates have been paid, a refund of the amount payable for that period may be recovered in the manner provided in this section.
Subsection (2B) shall not apply to any tenement, or any tenement comprising a number of tenements valued together under section 10 as a single tenement, which is unoccupied if-
If rates are payable-
A person claiming the refund may, not later than 24 months after the last day on which rates were payable, apply to the Commissioner in the specified form for a refund.
Where rates have been paid for any period and the Commissioner is satisfied that the tenement was unoccupied for that period, the rates shall be refundable in accordance with this section.
A refund may be made under this section only if-
The Court of Appeal considered this section a powerful indication against the correctness of the Company’s position on assets under construction. Le Pichon JA stated:
Section 30, which deals with ‘refunds in respect of unoccupied land’, supports the view that an unoccupied tenement is rateable: that section would be otiose if rateability of a tenement depended on the fact of occupation. Moreover, the fact that section 30 applies and a refund is made cannot alter the fact that the tenement is rateable in the first place.
The argument so stated is off the mark since, as noted in Section A of this judgment, the Company’s contention is not that rateability is dependent on occupation. Nevertheless, the logic of the objection based on section 30 is clear. It is that a right to a refund presupposes that the unoccupied land is rateable in the first place, and that the existence of such rateability shows that it is irrelevant whether the unoccupied land is capable of occupation as contended for by the Company.
In my view, section 30 cannot bear the weight of that argument. It is essentially an administrative or procedural provision rather than one assuming substantive liability. It gives a right to a refund of rates which have been paid in respect of unoccupied land but it does not imply that there was a substantive liability to make such payment in the first place. The right to a refund arises where the Commissioner is satisfied that the whole of the tenement was unoccupied for the period in question and, importantly, only if the requirements regarding the giving of notice referred to in sections 30(3) and 30(4) have been complied with, as stipulated by section 30(6).
Subsection (3) links section 30 to sections 22 and 29 of the Ordinance. The latter two sections impose a liability to pay rates in compliance with demand notes issued by the Commissioner. Failure to pay exposes one to surcharges as provided for by sections 22(2), 22(2A) and 22(3). Furthermore, section 22(3A) stipulates that in proceedings by the Commissioner to recover rates in default “the court shall not entertain any plea that the rates assessed are excessive, incorrect, subject to a proposal or an objection, or under appeal.” The same applies to demands for rates made pursuant to an interim valuation under section 29(3).
What section 30 therefore does is to provide a summary form of relief by way of a refund after rate payments have compulsorily been made as required by sections 22 and 23 in the specific circumstances identified. Such relief is available where those payments are in respect of unoccupied land but withheld if the site is or has been used as a car-park. Refunds are similarly provided for by section 31 where rates have been overpaid in certain circumstances. Refunds under such provisions are premised on rates having been paid pursuant to an administratively convenient “pay now, complain later” system for collecting rates. But they do not imply that any underlying liability to make those payments exists. Where there is a substantive legal challenge along the lines of the present case, the ratepayer may avail itself of the procedures involving proposal, objection and appeal set out in Part IX of the Ordinance.
Indeed, the legislative grant of a right to a refund in respect of unoccupied land is consistent with the proposition that such land is not rateable in so far as it is incapable of occupation in the rating sense. Section 30 actually goes further since it grants a refund for unoccupied land whether or not that land is pending development. However, it is unnecessary to explore further the scope and effect of section 30. It is sufficient for present purposes to conclude that refunds under section 30 do not justify any assumption regarding the underlying rateability of the land in question.
C.5c Section 31(ba)
The third and final contrary argument that requires consideration is also concerned with refunds of rates paid. It is based on section 31(ba) which relevantly states:
The Commissioner shall refund any amount paid in respect of rates ..., if it is not recoverable apart from this section, and he is satisfied that –
The argument was put by Le Pichon JA as follows (Court of Appeal §100):
A tenement that is ‘incapable of occupation’ is specifically addressed in section 31(ba) of the Rating Ordinance. That provision mandates a refund where the Commissioner is satisfied that a tenement has become ‘incapable of occupation, as a result of any order made by a court on the application of Government’. The fact that a specific refund provision was considered necessary but only in strictly circumscribed circumstances puts paid to the notion that, as a matter of general rating law, no liability to rates can arise where a tenement is incapable of occupation.
With respect, that argument involves a non sequitur. As her Ladyship noted, section 31(ba) confers a right to a refund in the strictly circumscribed circumstances defined. Those are the circumstances where “the tenement has become unoccupied or incapable of occupation”, as a result of a relevant court order. The subsection therefore addresses a situation where a rateable tenement exists, where rates have been paid in respect thereof, and where that tenement has subsequently become unoccupied or incapable of occupation for the stated reason. The subsection does not purport to address the antecedent question of whether in order for land, a building or a structure which is under development or construction to qualify as a rateable tenement in the first place, it must have attained a state making it capable of occupation.
It is accordingly my view, on the basis both of this Court’s decision in Agrila and the proper construction of the relevant statutory provisions, that the Commissioner was wrong in law to treat the assets identified by the parties as assets under construction as part of the Company’s rateable tenement. It follows that the second question must now be addressed: Is an adjustment resulting in a reduction to the assessed rateable value consequently required?
D. WHETHER AN ADJUSTMENT IS NECESSARY
The Commissioner argues that even if the relevant assets under construction are not rateable, no consequential adjustment to the rateable value of the Company’s tenement is warranted. The point is put as follows in her printed case (at §228):
.... the SOC only governs the integrated business, and it is a misconception to view any part of the income as being generated from each discrete item of asset on the SOC register. After all the revenue of the business was in reality generated by the assets actually in use. If HEC’s accounts were to be adjusted in the manner advocated by HEC, one would be left with a completely different business from the actual one that was being conducted by the occupier. This would be a departure from reality.
The Company’s riposte in its supplemental case is that this argument embraces the fallacy of treating rates as a tax on profits rather than on the value of occupation of the premises (at §141). The Commissioner denies this, contending that her argument does not seek to tax the Company’s profits “but to recognize that the value of occupation is related to the profit making ability of the tenement”, that being “the fundamental rationale of the receipts and expenditure method”.
As previously noted, section 7(2)’s reference to the “rent at which the tenement might reasonably be expected to let” involves fixing rates which reflect the value to the hypothetical tenant of occupation of the tenement. While everyone accepts that one way to assess such hypothetical rent is to use the receipts and expenditure or “profits” method (as was done in the present case), it has often been stressed that the profits which are estimated to flow from occupation of the tenement are only evidence to guide the valuer’s assessment. In Port of London Authority v Orsett Union  AC 273 at 295, Lord Dunedin put it thus:
What is the inquiry which the Commissioners and quarter sessions are engaged on? It is to find the net annual value of the hereditament in question .... Now there are several ways of attacking the problem. One way is to consider what profit the hypothetical tenant could make out of the hereditament, not in order to rate that profit, but in order to find out what he was likely to give in order to have the opportunity of making that profit.
And as Schiemann LJ stated in Hoare (Valuation Officer) v National Trust  RA 391 at 394:
Sometimes in the case of properties which are rarely if ever let it is appropriate to arrive at the annual value by a method of valuation known as the profits basis. This is a somewhat confusing name since profits as such are not rated and are non rateable. But the broad theory is that where a property can be used so as to yield profits then the hypothetical tenants would be prepared to pay a rent for the use of that property in order to be able to make those profits and that the level of rent would reflect the level of anticipated profits.
In the present case, it is common ground that assets under construction were included in the Company’s asset register kept for the purposes of the Scheme of Control. The value of such assets was therefore taken into account in calculating the maximum permitted return. However, this plainly does not mean that such assets contributed as part of the integrated business towards producing the Company’s actual receipts. As the Commissioner noted in her printed case quoted above, the revenue of the business was generated by the assets actually in use. It is fair to assume that assets which were under construction and incapable of occupation during 2004/2005 did not in fact contribute to the Company’s actual receipts which were used as evidence to assess the hypothetical rent achievable by the Company’s tenement.
It follows that assets under construction should be excluded both from (i) the corpus of assets constituting the integrated business which produced the actual receipts; and (ii) from being treated as part of the Company’s tenement whose hypothetical rent is being assessed, using the actual receipts as evidence. The latter exclusion is necessary since, as I have held, assets incapable of occupation do not constitute rateable tenements at law.
Labouring under the mistaken view that the assets under construction were rateable, the Commissioner did not make the second exclusion, but treated those assets as part of the Company’s tenement. An adjustment is therefore required so that the rating hypothesis is applied to the correctly identified tenement and not to a tenement inflated by assets which ought to be excluded. In principle, such an adjustment should lessen the hypothetical rent achievable and so reduce the rateable value. How the adjustment is actually made is a question of valuation entrusted by the Rating Ordinance to the Tribunal. As noted above, it accepted the adjustment proposed by Mr Parsons and there has been no suggestion in this Court that such acceptance involved any error of law.
I would accordingly set aside the order of the Court of Appeal and affirm the Tribunal’s decision regarding the non-rateability of assets under construction and the need for adjustment on the abovementioned basis, leaving it up to the parties to draw up an Order in appropriate terms.
Justice Litton NPJ
In regard to the methodology used for assessing the rateable value of the tenement, I agree with Lord Millett NPJ’s judgment in its entirety and confine my remarks to the process by which the case came from the Lands Tribunal through its various stages ultimately to this Court.
The Commissioner’s counsel Mr Benjamin Yu SC in his printed case says that there are at present seven assessment years under appeal; the hope is that once a determination is made on the proper methodologyof the present appeal (confined to the year 2004/5) the rateable values for the other years could be determined without further hearings. I respect that hope, but do not think that proper methodology is an accurate description of the issue involved in this case. And it may well be that this way of identifying the issue had bedevilled the proceedings in the court below.
Valuation for rating purposes, in a case like this, is ultimately a notional exercise, though based upon some established facts. Necessarily so, since under s.7(2) of the Rating Ordinance, Cap. 116, to ascertain the rateable value for the year in question, it must be assumed that the tenement is let at a reasonable rent from year to year. This therefore brings in a hypothetical landlord and a hypothetical tenant. Some act of judgment must ultimately be made as to what rent these hypothetical parties would agree for letting the tenement from year to year. What methodology would best achieve this statutory objective is open to intense debate among valuers, since the entire exercise is based on multiple hypotheses. No particular methodology can hope to achieve perfection, to reach an ultimate number which represents the notional annual rent.
The English Joint Professional Institution’s Rating Forum’s Guidance Note (July 1997) indicates four possible ways of achieving this result. And within each of these methods (here we are concerned with the Receipt & Expenditure method) there are broad parameters. There is much elasticity in the whole exercise. It is beyond the range of function of a court of law to say which particular methodology is “proper”.
Nor would I, for my part, be inclined to go to the other extreme and describe the realm in which the valuers must necessarily operate as “cloud-cuckoo land”, as Godfrey JA did in the CLP case (China Light & Power Co. Ltd v Commissioner of Rating and Valuation  2 HKC 42 at 43G). Real exercise of judgment by the experts is involved in the valuation even though, at the end of the day, it is based upon multiple hypotheses.
Because the same formula in s.7(2) applies to every different kind of tenements within the whole of Hong Kong, the function of rating cannot hope to achieve the perfect “annual rent” in each case, with regard to the market value of each tenement. Hence the object is to seek a standard by which every tenement appearing in the valuation list can be measured in relation to every other tenement; it is not seeking to establish the true value of any particular tenement, but rather its value in comparison with the respective values of the rest as they appear in the valuation list (see Lord Pearce’s formulation in Dawkins (VO) v Ash Bros and Heaton Ltd  2 AC 366 at 381H to this effect). Accordingly there is in rating such a thing as “the tone of the list”: see Mauriello v Commissioner  HKC 596 at 608H.
The Function of the Lands Tribunal
Section 42(1) of the Rating Ordinance gives an aggrieved ratepayer a right of appeal to the Lands Tribunal, when a proposal to alter the rateable value as appearing in the valuation list has been rejected.
Where a notice of appeal has been duly lodged, the Lands Tribunal (under s.8(4) of the Lands Tribunal Ordinance Cap. 17) has jurisdiction to determine the appeal. Although it is, in form, an appeal against the decision of the Commissioner not to alter the rateable value as proposed, the matter is in fact at large. Section 10(1) of Cap. 17 says that the Tribunal may, so far as it thinks fit, follow the practice and procedure of the Court of First Instance in the exercise of its civil jurisdiction. This is what in fact happened in the present case. The Tribunal in the course of an appeal lasting 19 hearing days entertained a large number of written reports and heard witnesses called by both sides. Much of the Tribunal’s determination is based upon the opinion evidence of expert witnesses.
Section 11(1) of Cap. 17 provides that the Tribunal’s judgment shall be final, subject only to an appeal to the Court of Appeal on the ground that such judgment is erroneous in point of law.
The Court of Appeal: The Grounds of Appeal
A point of law, if valid as such, is capable of succinct formulation: Normally in one simple sentence.
The Notice of Appeal lodged by the Commissioner lists eleven “grounds of appeal” which make for curious reading. Para. 1 reads:
Whilst the Tribunal correctly held that the tenement enjoyed a monopoly of place, the Tribunal erred in law in holding that such monopoly had been neutralised by the fact that the tenement and the non-rateable tenant’s assets have been designed and built as an integrated system, or that realistically and practically, the tenement in its existing state could only be used with the existing HT’s assets, such that the HL and HT had equal bargaining power. The assumptions which the Tribunal are required to make under the rating hypothesis precluded such factors to be taken into account.
What counsel appears to be arguing in this ground of appeal is this: The company had a monopoly in the production of electricity (“monopoly of place”) and this somehow gave to the hypothetical landlord greater bargaining power over the hypothetical tenant, resulting in a lesser “tenant’s share”; the Tribunal therefore “erred in law” in assuming that “the HL and HT had equal bargaining power”.
Take this scenario: Valuer A says that the hypothetical landlord who holds the land has the edge over the hypothetical tenant; Valuer B says on the contrary that the hypothetical tenant who has the machinery has the edge over the hypothetical landlord. How is a court of law to determine who is right and who is wrong? How can this possibly be a “point of law”?
And take ground 5 in the grounds of appeal:
The Tribunal erred in law in holding that by virtue of the SOC, the HL and the HT would agree that the rent would be determined on the basis that the HT’s share would be ANFA x HT’s assets ....
This eventually came to the forefront of the argument in the Court of Appeal. But it totally misrepresents the approach as adopted by the Tribunal. The Tribunal never “held” that the hypothetical landlord and tenant would agree that the rent would be determined on the basis that the tenant’s share would be ANFA x HT’s asset. To have so held would have been absurd, since the entire exercise was being conducted in an imaginary rating world. All that the Tribunal in fact “held” was that the formula PR x HT’s ANFA put forward by the company’s valuer was a rational basis for arriving at the tenant’s share. Whether the hypothetical tenant would, in the imaginary rating world, look to the permitted return in the SOC as a sufficient reward for its investment of capital, effort and risk is a matter of valuation judgment; no point of law is involved.
This misrepresentation of the Tribunal’s approach, as set out in the notice of appeal, found its way into the Court of Appeal’s analysis of the methodology involved.
It would be futile to examine further those eleven “grounds of appeal”, which raise mainly polemics rather than points of law. Those grounds by their very prolixity stultify themselves. The two grounds referred to above (grounds 1 and 5) were then formulated as “points of law” as follows:
AND FURTHER TAKE NOTICE that the questions of law to be decided by the Court of Appeal are as follows:
Court of Appeal
Where I differ respectfully from the Court of Appeal is in this cardinal point, expressed succinctly by Sir Anthony Mason NPJ in Agrila at 108G:
The appropriate mode of valuation, apart from what is prescribed by relevant principles of law, is a matter for the Lands Tribunal to determine. It is not for this Court to express an opinion about valuation or about the appropriateness of any method of valuation.
What Sir Anthony Mason NPJ said about the function of this Court applies, of course, with equal force regarding the intermediate court. This is necessarily so, having regard to s.11(1)(b) of the Lands Tribunal Ordinance which prescribes finality in the Tribunal’s determination, subject only to an appeal on points of law to the Court of Appeal.
Let me illustrate what I say in the paragraph above with one example: The Court of Appeal’s finding that the company’s approach to valuation, using the permitted return under the SOC, gave “an inflated value to the tenant’s assets”. This was one of the key findings resulting in the Court of Appeal discharging the Tribunal’s judgment.
Fundamental to both parties’ approach to valuation is that the assets are “split” into rateable and non-rateable assets. But they come from the same source (the assets register kept under the SOC). They are recorded at net book value. The market value, on this approach, is not relevant to the exercise. If they are undervalued for the landlord, they are undervalued also for the tenant.
The finding in the Court of Appeal that the company’s approach to valuation gave an inflated value to the tenant’s assets came about in this way.
The tenant’s share of the assets under the “split”, on a ratio of 48-52, came to $22,404 million. Taking the maximum permitted return as 17% this produced an annual income stream of $3,808.7 million.
If one assumed that the WACC discount rate of 8.31% applied, it meant that, to produce this annual income, one needed to put up capital of $45,832.7 million
The Court of Appeal (§42) then went on:
The analysis underlying those calculations which the tribunal accepted involves the assumption that the incoming (hypothetical) tenant will have to pay the incumbent tenant (i.e. the sitting tenant) the present capital value of his assets. In short, what those calculations show is that the difference between 45 billion and 22 billion will go to the sitting tenant since only a sitting tenant is in a position to charge a premium over the net book value of its assets.
This “difference between 45 billion and 22 billion” is the product of an assumption: That the incoming tenant would use the WACC discount rate of 8.31% to assess the capital needed to take over the enterprise. It presupposes that the Commissioner’s approach was correct in the first place. This assumption is a valuation assumption, not a point of law. There is no principle of law that says that, to assess the incoming tenant’s capital requirement, the WACC discount rate must be used.
Once it is accepted that, as a matter of valuation judgment, an incoming tenant might think that the earnings from the enterprise are governed by the permitted return under the SOC, then this ground simply evaporates.
In my judgment the Court of Appeal’s reasons stated in its §42 (see para. 120 above) for overturning the Tribunal’s judgment cannot be sustained.
Assets Under Construction (“AUC”)
I have had the advantage of reading in draft Ribeiro PJ’s judgment and agree with it.
In Hong Kong virtually all land is held as leasehold land, in contrast to the situation in England where much land is owned in fee simple. This explains why in the Rating Ordinance the term “hereditament” is not used in Hong Kong to indicate the rateable asset, and “tenement” is used instead. “Hereditament” in English law is real property whereas leases are held as personalty: See Megarry and Wade: The Law of Real Property (7th ed)1-011 to 1-013. Hence, where section 2 of the Ordinance refers to tenement, it is land, building, structure etc held or occupied. No greater significance attaches, in my view, to those disjunctive words “held or occupied” in s.2 upon which Mr Yu SC, counsel for the Commissioner, laid such great stress.
Fundamentally, valuation under s.7(2) seeks to ascertain the value of occupation of all tenements in the valuation list. The rating regime, based largely upon English law, part statute, part judicial decisions, focusses upon the value of occupation. It would be a very odd thing if, on a crucial issue like this, Hong Kong law should vary from English law to the extent indicated by the Court of Appeal in this case.
Take the typical building site, held by a developer but occupied by the general contractor. If this was a rateable tenement, s.21(1) applies and, prima facie, the general contractor is liable for rates. That would be a most surprising thing. As general contractor for the erection of a building, the benefit comes from the work he has contracted to do on the land; he gets nothing from occupying the land.
In my view the AUCs are not rateable assets and must be excluded from the Commissioner’s computation for the purposes of assessment for rates.
I too would discharge the Court of Appeal’s judgment and restore the Tribunal’s determination: subject to such adjustments as might be appropriate.
Lord Millett NPJ
This appeal is concerned with the methodology for assessing the rateable value of the tenement owned and occupied by the Hong Kong Electric Company Ltd (“the Company”) for the purposes of its undertaking. The appeal is brought by the Company from a judgment of the Court of Appeal (Rogers VP, Le Pichon JA and Stone J) dated 14 September 2010 which allowed the appeal of the Commissioner of Rating and Valuation (“the Commissioner”) from a decision of the Lands Tribunal (Judge Au and Member Lo) dated 30 November 2009. The Commissioner originally assessed the rateable value of the tenement for the year 2004-5 at $6,294,000,000, but this was later adjusted to $5,684,000,000. The Lands Tribunal, using a different methodology, reduced the assessment to $3,945,000. The Court of Appeal allowed the Commissioner’s appeal, adopted her methodology, and restored the Commissioner’s adjusted assessment. The Company now appeals to this Court.
There are two appeals, one in respect of the rateable value of the tenement for rating purposes and the other in respect of the rateable value of the tenement for Government rent purposes, but it was common ground that the rateable value for Government rent purposes could be calculated by applying a percentage to the rateable value for rating purposes. Accordingly the decisions below were concerned only with the assessment of the rateable value of the tenement for rating purposes and it is not necessary to say anything further in this judgment in relation to the assessment of the rateable value for the purposes of Government rent.
The Company brought similar appeals in respect of each of four years 2004/2005, 2005/2006, 2006/2007 and 2007/2008. The appeals were initially consolidated so as to be heard together but subsequently the Lands Tribunal directed that the appeals relating to 2004/2005 be heard first and the other appeals adjourned sine die pending the outcome of the present appeals. The Company has since lodged appeals in relation to 2008/2009, 2009/2010 and 2010/11.
The decision of the Lands Tribunal is final and the right of appeal is on a point of law only. Questions of fact and valuation are for the Lands Tribunal, and it has been repeatedly held that the rateable value of the tenement is a question of fact. The decision of the Lands Tribunal cannot be impugned unless it involves an error of law, including a failure to take into account matters which it should have taken into account or taken into account matters which it should not have done: Railway Assessment Authority v Southern Railway Co. AC 266 (“the Southern Railway case”) at p.283 per Viscount Hailsham LC. The methodology used in reaching its decision is a matter of valuation, and the Lands Tribunal’s choice cannot be overturned as “improper” but only if it is inappropriate or wrongly applied.
Rates are assessed annually on the rateable value of a unit of property known as a tenement. The owner and the occupier of the tenement are both liable for the payment of rates, though in the absence of contrary agreement the rates are payable by the occupier: Section 21. The amount payable is a percentage (currently 5%) of the rateable value of the tenement.
“Tenement” is defined in Section 2 as
any land (including land covered with water) or any building, structure, or part thereof which is held or occupied as a distinct or separate tenancy or holding or under any licence.
Section 2 is supplemented by ss 8 and 8A which deal with the treatment of machinery and plant respectively.
Section 8 provides that, for the purpose of ascertaining the rateable value of the tenement, (a) machinery used as an “adjunct” to the tenement is to be regarded as part of the tenement, but (b) no account is to be taken of the value of any machinery in or on the tenement required for the purpose of manufacturing operations or trade processes. Section 8A provides that plant, together with land, buildings or structures occupied by means of any plant, is deemed for rating purposes to be a separate tenement. Cables, ducts, pipelines, oil tanks, and settings and support for plant or machinery fall within the definition of “plant”: Section 8A(3). While plant and fixed machinery both form part of the tenement, therefore, the value of such machinery used for manufacturing operations or trade processes is to be disregarded in ascertaining the rateable value of the tenement.
It follows that the assets employed by the Company in its undertaking are divided for rating purposes into two categories. The first consists of the rateable assets (“RA”) being those assets which form part of the tenement and whose value is to be taken into account in ascertaining its rateable value. The second comprises those assets which do not form part of the tenement or whose value is to be disregarded in ascertaining its rateable value and are accordingly non-rateable assets (“NRA”).
The tenement with which the present case is concerned consists of the land, buildings and structures occupied and used on 1 April 2004 by the Company for the generation, transmission, distribution and supply of electricity on Hong Kong Island, Ap Lei Chau and Lamma Island. These comprise a large number of separate tenements but the Commissioner exercised her power to treat them as one single tenement (under s.10). Such an assessment is described as an in cumulo assessment and its adoption in the present case is not controversial.
The assets employed by the Company for the purposes of its undertaking are described at length in the decision of the Lands Tribunal. It was based upon detailed evidence which was not in dispute. On the relevant date (1 April 2004):
Electricity was generated by means of eight coal fired generating units, five gas turbines and one combined cycle gas turbine installed on a 62 hectare site on Lamma Island. A 22 hectare extension to the site, consisting of reclaimed land, was under construction but not in use. While the land, buildings, structures, plant and some of the machinery are part of the tenement and rateable, the generating station houses a huge amount of machinery and apparatus which, while part of the tenement, fall to be disregarded in assessing its rateable value and are NRA. While the turbines which generate the electricity are NRA, the specially designed reinforced concrete foundations to which they are bolted are rateable. Similarly, while the boilers are NRA, they are held in place within specially designed structures which are part of the tenement and rateable. The moving parts of the coal conveyor system are NRA but the structure which supports them is part of the tenement. The switchgear and transformers are NRA but the cables which are specially designed to connect to them in order to transmit, distribute and supply the electricity are plant and form part of the tenement.
Electricity was transmitted at very high voltages by cables which are largely underground or in tunnels, although some are overhead supported by pylons, to 32 substations where it was stepped down for distribution. The cables comprise plant and form part of the tenement. The substation buildings are also part of the tenement but the transformers, switch gear and other apparatus which they contain are NRA.
Electricity was then distributed in cables to over 3,000 sub-stations where it was further stepped down to the voltages used by consumers. Most of these sub-stations were located within buildings owned and occupied by third parties. Again, the cables comprise plant and so form part of the tenement. The space within buildings where the sub-station equipment is located is also part of the tenement but the transformers, switch gear and other apparatus installed there are NRA.
The Scheme of Control
As a public utility enjoying a monopoly the Company’s undertaking was at the material time regulated by an extra-statutory Scheme of Control (“SOC”) entered into in 1993 between the Company, its holding company and the Government for a term of 15 years from 1994 to 2008. By the SOC the Company recognised 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 where necessary to construct additional generation, transmission and distribution facilities for the supply of electricity to consumers. In return the Government recognised that the Company and its shareholders were entitled to earn a return which was reasonable in relation to the risks involved and the capital invested in and retained in the business.
The SOC regulates the tariffs which the Company can charge consumers, but it does so indirectly by capping the Company’s returns. It allows the Company a “permitted return”, being the aggregate of two components:
13.5% of its average net fixed assets, and
1.5% of shareholders’ investments made after 31 December 1978 for financing the acquisition of assets.
“Net fixed assets” is defined to mean historic costs less depreciation calculated as provided in the SOC. Accordingly, average net fixed assets (“ANFA”) represents the net book value of the Company’s assets. The permitted return is a post-tax return and equates roughly to 17% pre-tax.
Since the Company’s return depends upon the tariff it charges to consumers, the permitted return serves to cap the tariff. The SOC contains detailed provisions which apply where the Company’s return in any year exceeds the permitted return, or falls below it after having exceeded it in previous years. These provisions had no application at the material time, when the Company did not achieve the permitted return, and need not be considered further.
The SOC stipulates the rate of depreciation to be applied to the Company’s assets for the purpose of determining the permitted return and requires it to maintain a register (“the SOC register”) containing a list of its assets and their net book value after depreciation. The purpose of the SOC register is to enable the regulator to ascertain whether the permitted return has been exceeded and has nothing to do with rating. But it enables the Commissioner to ascertain the net book value of the Company’s total assets for rating purposes without having to inspect the Company’s books or recalculate the rate of depreciation. But, as the Lands Tribunal appreciated, it says nothing about the net book values of the RA or NRA individually. Fortunately the parties were able to agree that the net book value of the RA amounted to approximately 52% and the net book value of the NRA to approximately 48% of the net book value of the totality of the Company’s assets appearing in the SOC register.
The rateable value of the tenement represents the measure of the value of the right to occupy it. It is defined as an amount equal to “the rent at which the tenement might reasonably be expected to let, from year to year” the tenant paying the tenant’s rates and taxes and the landlord paying the Government rent, the cost of repairs and other expenses (section 7(2)). The amount of the rateable value is a question of fact. There is no rule of law which prescribes how it is to be determined.
Rating seeks a standard by which every tenement appearing in the valuation list can be measured in relation to every other tenement. It does not seek to establish the true value of any particular tenement, but rather its value in comparison with the respective values of the rest. Out of various possible standards of comparison the legislature has chosen the annual letting value: See Dawkins (VO) v Ash Bros and Heaton Ltd  2 AC 366 at 381 per Lord Pearce.
The Rating hypothesis
The Commissioner’s task is to determine the rent which would be paid for a tenancy from year to year even in a case like the present when, as has been observed, in reality no sane person would take such a tenancy of premises in which he would have to install expensive machinery and for which he would have to assemble a skilled workforce. It has therefore been long recognised that the statute postulates a hypothetical tenancy negotiated between a hypothetical landlord (“HL”) and a hypothetical tenant (“HT”) in circumstances where the HT cannot become the owner of the tenement and cannot acquire a lease for a term of years. Moreover, it is necessary to postulate a situation in which not only the HT is in this position, but everybody else is, Ib. Even the landlord is to be contemplated as a possible tenant: The Southern Railway case at p.285.
The statutory hypothesis was summarised by the Lands Tribunal as follows:
The rent is that which would be negotiated between the HL and the HT both behaving reasonably. The HL is not the actual owner of the tenement but a hypothetical person who is assumed to be willing and able to let the tenement from year to year and is neither over anxious to let the tenement nor unduly reluctant.
Their relative bargaining strength must be taken into account.
The hypothetical tenancy is from year to year, with a reasonable prospect that it would continue for an indefinite duration, although the rent must be assumed to be capable of review at the end of the year.
The rent is intended to represent the value of occupation of the tenement to the HT in the open market, taking into account every intrinsic quality of the tenement and all relevant circumstances. Although the tenancy and the parties to the tenancy are hypothetical, the tenement and the market are real. The concept of the open market assumes that the tenement is available to let and the whole world is free to bid and requires a judgment as to what would, in those circumstances, in real life, have been the best rent reasonably obtainable.
It must be assumed that the HT could acquire the NRA at market value but without difficulty and instantly. The purpose of this hypothesis is to ensure that all possible tenants are considered on an equal footing and that the sitting tenant is not to have an advantage in not having to incur the expense of moving in.
The receipts and expenditure basis of valuation
There are two indirect methods of valuation in common use both in and outside the rating context. They are (1) the contractor’s basis and (2) the receipts and expenditure basis (“R&E”). The Contractor’s basis values the tenement by reference to what would have been the cost of constructing an alternative tenement. It assigns a separate value to every asset employed in the business and adds them together. The Lands Tribunal considered and rejected it as inappropriate in the present case since it would not capture the special features of synergy value and monopoly of place. These would drive up the profits which the tenement is capable of yielding and hence the value of occupation and should be reflected in a proper valuation method.
The R&E basis of valuation is very different. It has been in common use for decades, and was formerly known as the “profits basis”. It is based on the anticipated profits of the actual business carried on upon the tenement valued as a going concern. It automatically captures all those features such as synergy and monopoly of place which contribute to and are reflected in the profits. As the Commissioner herself observed, “it is a misconception to view any part of the income as being generated from [any] discrete item of asset on the SOC register.”
The Lands Tribunal determined the case on the basis of the R&E method and, apart from a discrete issue relating to assets under construction, the appeals to the Court of Appeal and this Court have been concerned only with issues arising out of the application of this method.
Although profits as such are not rateable, the R&E method of assessing the rent which the HT would offer to pay is based on the idea that where a tenement can be used to yield profits as part of a going concern then the HT would be prepared to pay rent for the use of the tenement in order to make the expected profits, and the level of rent would reflect the level of those profits: See Hoare (Valuation Officer) v National Trust  RA 391, 394 per Schiemann LJ.
The R&E method is therefore not based on the value of the individual assets comprised in the tenement, but on the receipts and expenditure of the undertaking carried on as a going concern upon the tenement. It involves two steps. First, the gross receipts and expenditures that the HT would expect to derive from his occupation of the tenement in the forthcoming year are quantified. These are not necessarily the same as the gross receipts and expenditures in the previous year, which may need adjustment to reflect increasing or declining business. The difference between the expected gross receipts and gross expenditure, known as the “divisible balance”, represents the anticipated profits in the year of the tenancy. In the present case the amount of the divisible balance, derived from the Company’s books, was agreed to be HK$8,036 million. The Company had not achieved the permitted return under the SOC, so this sum represented a rate of return of somewhat less than 15% post-tax of the Company’s total ANFA.
The second step is to divide the divisible balance between the HL and the HT. This forms the central issue in the present case. The division must be accomplished by determining the amount of the HT’s share and deducting it from the divisible balance. The HT’s share represents the sum that provides him with a reasonable return on his capital and a reward for his efforts and risks sufficient to induce him to rent the tenement and embark on the enterprise. What is left over is prima facie (see para.159 post) the rent.
This process is based on the economic view of rent as a residual payment and the HT’s share as a “first charge” on the returns of the undertaking. The latter expression implies that it is a minimum and not a maximum. Although it is regarded as a first charge on the divisible balance, the valuation must properly reflect the relative strengths and weaknesses of the HL and the HT as they negotiate the rent. The amount which the HL would demand and the HT would be willing to pay will reflect their relative bargaining power.
In the Southern Railway case (at p.282) Lord Hailsham observed that the expression “division of the net receipts” (like similar expressions such as “the divisible balance”) is not a very happy phrase to describe the process which is involved, viz. the deduction from the net receipts of the amount necessary to induce the HT to embark upon the undertaking. But, as he observed, this was no justification for treating the hypothetical parties as joint adventurers. Their relationship remained that of landlord and tenant, but if the amount which the HT would require in order to induce him to embark upon the undertaking is properly ascertained and deducted from the total net receipts, the result is to divide the net receipts fairly and justly between the HL and the HT, even though, in an extreme case, the landlord’s share, i.e. the rent, might be nothing at all.
Having insisted that the hypothetical parties were to be treated as landlord and tenant and not as joint adventurers, Lord Hailsham observed that the HT (at p.288)
is not to be regarded merely as an investor in railway shares and to be treated therefore as reasonably compensated by the ordinary rate of interest which can be obtained by such an investment. He is a person embarking upon a commercial undertaking in which he is to sink his capital, in which he takes all the risks of success or failure, and in which he has not merely to be compensated by receiving a reasonable interest upon the capital invested, but also to receive such a profit upon his venture as reasonably to compensate him for the risk which it involves and to induce him to embark upon its prosecution. How much that percentage ought to be is a question of fact which is for the Authority and not for your Lordships’ House.
No rules are prescribed for the manner in which the HT’s share of the divisible balance may be determined. The Guidance Note produced by the English Joint Professional Institutions’ Rating Forum in July 1997 described four possible of ways in which the exercise might be carried out: by taking (a) a percentage of the HT’s capital; (b) a percentage of the gross receipts; (c) a percentage of the divisible balance; or (d) a “spot” figure. The choice is a matter of valuation judgment for the Lands Tribunal. It chose (c).
The R&E method is only an aid to the ascertainment of the rent which HT would be willing to pay; it is not an inflexible code or set of rigid rules. The valuation must take account of “every intrinsic quality and every intrinsic circumstance which tends to push the rental value either up or down”: Robinson Bros. (Brewers) Ltd v Houghton and Chester-Le-Street Assessment Committee 2 KB 445. The methodology must be sufficiently flexible to accommodate any feature which affects the amount of rent, whether it is common or rare. It has also been recognised that the R&E method, when applied to very profitable undertakings, may result in figure which is too high to be properly regarded as rent: Sandown Park Ltd v Esher UDC and Castle (V0) (1954) 47 R&IT 351, 356, 375. In such cases the figure may require a downwards adjustment.
The rival contentions
Both parties ascertained the HT’s share of the divisible balance by calculating the return which it would require expressed as a percentage of its ANFA. They did not, however, agree upon the percentage. The Commissioner used the Company’s weighted average cost of capital (“WACC”) and arrived at a figure of 8.31%. WACC is a mathematical formula used in corporate finance to determine the return which investors might find acceptable when investing their capital. It is an opportunity cost which represents the amount which an investor would expect to receive for a given capital investment based on market yields. The cost of capital in Hong Kong, which was extremely high not long ago, is currently extremely low. The adoption of WACC has the disadvantage of producing what one of the expert witnesses described as a “roller coaster ride” for the rent. This was not a factor which the Lands Tribunal took into account, but whether it is a reason to adopt WACC or reject it, and indeed whether it has any relevance, is a matter for the Lands Tribunal.
The Lands Tribunal accepted the Company’s WACC as a good proxy for the HT’s WACC. The HT’s share of the divisible balance for which the Commissioner contended can therefore be expressed by the formula: the Company’s WACC x HT’s ANFA. This method of determining the HT’s share of the divisible balance had been adopted by the Commissioner without challenge in previous years, but there is no rule of law which requires a particular methodology to be adopted because it has been adopted before.
The Company’s contention, which the Lands Tribunal accepted, was that the rate of return on its ANFA which the HT would require would be at the same rate as the Company’s actual return on the total ANFA. This was higher than 8.31% but, since the Company failed to achieve the permitted return under the SOC in the relevant year, it was somewhat lower than 15%. The claim was not based on the Company’s cost of capital but premised on the footing that the divisible balance was earned at the same rate on all the Company’s ANFA whether they belonged to the HT or the LT, as the Commissioner accepted and the Lands Tribunal found: See para.167(e) post.
The same result could of course be achieved by simply dividing the divisible balance in the proportions which HT’s ANFA bore to HL’s ANFA, i.e. 48 to 52, but the Lands Tribunal was at pains to stress that this was “a coincidence” (though it was mathematically inevitable) and did not represent the approach which it had actually adopted. Its anxiety on this score was unnecessary. It was concerned that it should not be thought that it was treating the HT and the HL as joint adventurers contrary to the speech of Lord Hailsham in the Southern Railway (see para.156 supra) case. But Lord Hailsham was saying only that the HL and the HT were not joint adventurers; it was the HT’s business, and the risks, obligations and rewards were his alone. He was not saying that the HT’s share should not be ascertained as a percentage of the divisible balance, however this might be done arithmetically; and the Rating Forum’s Guidance Note described this as one of the possible ways in which the HT’s share of the divisible balance may be determined: See para.158 supra.
The relevance of the SOC
The relevance of the SOC was the subject of prolonged and in my view unnecessary debate below. The parties are agreed that it is relevant in ascertaining the amount of the divisible balance, but disagree whether it is relevant to the ascertainment of the HT’s share. The Company argues that it is; the Commissioner that it is not. In my opinion, in the present case where the permitted return was not achieved in the relevant year, it is not relevant to either.
It is common ground that, although the SOC takes the form of a contract between the Company and the Government, it is regulatory in nature, and that accordingly the parties to the hypothetical tenancy would be subject to a scheme on similar terms. Accordingly the SOC clearly has some relevance. First, it caps the returns which the HT can achieve; secondly, it imposes obligations on the HT which must be taken into account in assessing the HT’s share; and thirdly it contains a register of the assets employed in the undertaking and gives their ANFA.
But in my opinion the SOC has no further relevance in determining the amount of the divisible return. This represents the Company’s actual return and is derived from its books, not from the SOC; the HT needs only to satisfy himself that it is not greater than the permitted return under the SOC. Nor is it relevant to the assessment of the HT’s ANFA. The SOC is not concerned with rating or the notion that for this purpose the return must be artificially divided between Company as HT and the Company as HL. So far as the regulator is concerned, it does not matter whether the Company earns 10% on its share of the ANFA and 20% on the HL’s share, so long as its total return does not exceed 15% of their combined ANFA.
The Decision of the Lands Tribunal
In a long, detailed and careful judgment reached after hearings spread over 19 days and involving many expert witnesses the Lands Tribunal found the following crucial facts:
The tenement and the NRA were designed and built together as an integrated system. The tenement in its existing state could only be used with the HT’s existing assets, although it must be assumed that any incoming HT would be able to acquire those assets without difficulty and instantly.
It followed that the HT and the HL needed each other’s assets for the purpose of the undertaking carried out on the tenement. Accordingly the HL and the HT had equal bargaining power.
The Company enjoyed a monopoly in the generation, transmission and supply of electricity. This could only viably be carried out on the tenement, which accordingly enjoyed monopoly of place.
There was significant value by reason of the way the separate tenements were connected and configured. It was only with the connection (and thus the synergy) of all the components of the tenements together with the NRA that the business could be operated and generate profits.
The Lands Tribunal clearly recognised that the divisible balance represented the Company’s actual return and that this was less than the permitted return. It expressly referred to the “shortfall” and held that this was derived “equally and evenly” (meaning at the same rate) from all the assets. This was a critical finding, since it implicitly recognised that the Company’s actual return represented by the divisible balance was also derived at the same rate from all its assets whether RA or NRA.
The Lands Tribunal recognised that the amount of the rent which the HT would be willing to pay would depend on the relative bargaining power of the parties. It also recognised that the tenement’s monopoly of place and the synergy arising from the connection of the several tenements with one another and with the NRA should be reflected in the value of the tenement and the right to occupy it.
The Lands Tribunal rejected the Commissioner’s reliance on the HT’s WACC on the ground that it failed to capture the synergy and monopoly of place which drove up the value of the tenement and the right of occupation, and did not represent the economic value of the contribution which the HT’s assets made to the actual returns earned by the Company from the undertaking viewed as a whole. It also rejected the Company’s claim that the HT should first receive 25% of the divisible balance for enterprise and risk. But it accepted the Company’s contention that the rate of return on its ANFA which the HT would require would be at the same rate as the Company’s actual return on its total ANFA.
The Lands Tribunal recorded its understanding of the Company’s case (para.108(3))
What we understand [the Company] 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.
It had earlier given its reasons for accepting this argument (para.100):
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.
These passages are clumsily expressed and should be understood as referring to the very profit which he would expect to make, being one which was permitted by the SOC: See paras 172-173 post.
These were findings of fact which the Court of Appeal should not have disturbed unless in making them the Lands Tribunal made an error of law.
Regrettably the Lands Tribunal repeatedly described the return on the HT’s share by the formula PR x HT’s ANFA, where PR stands for the permitted return under the SOC. This was a mistake, for as the Lands Tribunal appreciated, the divisible balance represented the Company’s actual return and this was somewhat less than the permitted return. It is, however, plain that the formula does not accurately represent what the Company contended for or what the Lands Tribunal intended. It confirmed this at the hearing of the application for leave to appeal and caused its decision to be amended to explain the formula PR x HT’s ANFA as “being a portion of the divisible balance in proportion to the asset split between the HL and the HT”, in other words, in the proportions 48 to 52. It also caused its order to be amended to refer to the formula “PR x HT’s ANFA as explained above”. This was the basis on which the experts calculated and agreed the rateable valueof the tenementwhen carrying the Lands Tribunal’s decision into effect.
Unfortunately the Lands Tribunal did not direct appropriate amendments to be made to other passages in its decision like those quoted in para.170 above, or to calculations which took return on the Company’s ANFA which the divisible balance represented to be 15%. These passages need to be understood in the light of the clarification made by the amendments. In her written Case before us the Commissioner accepted that the Lands Tribunal intended to refer to the actual return represented by the divisible balance and not the permitted return under the SOC which the Company did not achieve, although her Counsel was strangely unwilling to do so.
The Conclusion of the Lands Tribunal
The Lands Tribunal concluded that the rateable value of the tenement for the relevant year was (1) to be determined by the R&E method whereby the tenant’s share was to be assessed on the basis of the PR x HT’s ANFA and (2) subject to a depreciation adjustment and an adjustment to exclude assets under construction, both of which have been agreed, was DB-(PR x HT’s ANFA) as explained above.
The Judgment of the Court of Appeal
The Court of Appeal allowed the Commissioner’s appeal. Unfortunately it misunderstood the Lands Tribunal’s decision and thought that it had held that the tenant’s share should be assessed on the basis of the permitted return under the SOC multiplied by the HT’s ANFA. It found the definition of PR x HT’s ANFA introduced by amendment (see para.172 supra) to be “somewhat opaque”, but held that any discrepancy between that passage and the Order should be ignored. There was, however, no discrepancy unless one ignores the words “as explained above” in the Order as amended, as the Court of Appeal appears to have done. It is surprising that the confusion was not cleared up in the course of the hearing, as any inquiry into what led to the amendments or how the rateable value of the tenement had been calculated following the Lands Tribunal’s decision would have brought the truth to light.
The Court of Appeal found numerous supposed errors of law in the Lands Tribunal’s reasoning, as follows:
The HT’s share should not have been derived from the SOC, because the SOC regulates the overall return of the Company’s integrated business and does not regulate rent. Moreover, it was set in accordance with the economic climate at the time of its execution (1993) and should not be used to set rent in 2003.
An approach based on the permitted return is premised on the HT achieving it. The Lands Tribunal had overlooked the fact that the Company had not in fact done so.
It is not possible to arrive at the hypothetical tenant’s cash flow or expected return without first knowing the amount of rent that has to be paid.
The Lands Tribunal’s decision gave an unjustifiably inflated value to the HT’s assets.
No landlord (not even a hypothetical one) would agree to a rent on the basis of
using the net book value (historic costs) of his assets;
leaving certain assets of his out of account; and
disregarding the value of monopoly of place and synergy.
The fact that the HT’s assets and the HL’s assets had been designed and built together (the integration argument) did not give the HT any special bargaining power and must be disregarded under the principles laid down in the Southern Railway case.
The Lands Tribunal failed to have regard to the “vacant and to let” principle, which requires an assumption that the premises are vacant and all the process machinery removed.
Use of the permitted return. The Court of Appeal’s criticisms described in subparagraphs (a) and (b) above can be taken together. They are vitiated by the Court of Appeal’s misunderstanding of what the Lands Tribunal actually decided. Its statement that the Lands Tribunal overlooked the fact that the Company had not achieved the permitted return in the relevant year was rightly not supported by the Commissioner before us. The Lands Tribunal expressly referred to the “shortfall” (that is to say the amount by which the Company’s actual return fell short of its permitted return) and found that the shortfall arose at the same rate “equally and evenly” from all the Company’s assets irrespective of whether they were the HT’s assets or the HL’s assets.
The circularity problem. This resurrects the “circularity problem” identified by the Commissioner which the Lands Tribunal rejected. The problem, she said, is that one cannot determine the net return which the HT would require (i.e. the return after payment of rent), and so the rent which he would be willing to pay, without first knowing the amount of the rent. The only way out of the conundrum, according to the Court of Appeal, was to make an assumption as to the rent, which was not what the SOC or the Rating Ordinance required. In my opinion the Lands Tribunal was right to reject the argument. If accepted, it would preclude recourse to the R&E basis of valuation approach in every case, despite the fact that it is a long recognised and well established method of determining rateable value.
The Court of Appeal thought that the logic of the Commissioner’s submission was difficult to fault. In fact the fallacy which it involves is easily exposed. It is true that the R&E method of valuation seeks to ascertain the net return, that is to say the return after paying rent, which the HT would require from his occupation of the tenement, and proceeds to deduct this from the divisible balance in order to determine the rent which he would be willing to pay. But the rent is not paid out of the HT’s share of the divisible balance, which is net of rent, but represents what remains after deduction of the HT’s share. If a given sum is composed of two components, it is possible to quantify either by quantifying and deducting the other. No circularity is involved in such a process.
Inflation of the value of HT’s assets. The essence of the Court of Appeal’s criticism is that the Lands Tribunal attributed to the HT the whole of the difference between the rate of return actually achieved by the Company and the rate based on the HT’s lower cost of capital, and that this was wrong because “only a sitting tenant is in a position to charge a premium over the net book value of its assets”. This, according to the Court of Appeal, must be left out of account because it would give the sitting tenant an advantage which the law does not allow.
On this approach, it seems, the whole of the difference should be attributed to the HL’s share by way of rent. But the Court of Appeal’s reasoning is flawed. In the first place, it ignores the Lands Tribunal’s reasons for rejecting the Commissioner’s valuation based on the HT’s WACC, viz. that it did not represent the economic value of the NRA’s contribution to the divisible balance, and its acceptance of the higher return for which the Company contended. They were based on the inherent features of the tenement and the NRA (see paras 166-167 supra) which enabled them to generate a return when combined which they could not generate separately, and which the HT would take into account when negotiating for the tenancy. These features of the NRA, which gave them a value over and above their net book value, did not belong to the sitting tenant alone; they must be treated as available to all potential tenants. They are all, as was put in argument “in the same boat”, offering a rent for the tenement with the NRA either already in place or available to be installed without cost and instantly in order to carry on the undertaking as a going concern.
The use of net book value. It may well be the case that no landlord would let his property for a return based on the historic cost of his land as opposed to market value. This would be a serious error under the Contractor’s basis of valuation. By contrast the R&E basis arrives at the rent by ascertaining the return which the HT would require, not by adding together the market value of each individual asset comprised in the tenement, but by assessing the contribution which the hypothetical parties’ assets respectively make to the profits of the business as a going concern. The Court of Appeal failed to pay regard to the Lands Tribunal’s central findings that the tenement could only be used in its existing state with the HT’s existing assets, that the HL and the HT needed each other’s assets in order to generate the high return which the Company’s integrated business earned, and that accordingly they had equal bargaining power. In these circumstances, a post-tax return of a little under 15% on the net book value of assets only a small part of which consists of land and the bulk of which consists of assets (such as cables which one witness considered had little more than scrap value considered by themselves) is not obviously unreasonably low. In this regard it is relevant to observe that the Government regarded a post-tax return of 15% to be reasonable in relation to the risks involved and that the Company was permitted to earn such a return as a reward in part for the onerous obligations imposed on it by the SOC (see para.140 above), obligations to which the HT, being the party intending to carry on the business, would be subject and the HL would not.
Leaving assets and the value of synergy and monopoly of place out of account. The assets which the Court of Appeal had in mind consisted of distribution pillars, poles and pylons and the land they occupied, wayleaves over land occupied by cables and some 3,500 substations provided by customers, all of which (it said) were obviously of substantial value and essential to the undertaking. The Court of Appeal was evidently under the impression that none of these were listed in the SOC register. In fact the distribution pillars, poles and pylons and substations were listed in the SOC register; only the parcels of land which they occupied were not listed. Only a minimal consideration is paid for the use of such land, because it is either the subject of a block licence granted by the Government for a nominal consideration or because the facilities are accommodated on private land for the benefit of the owners and in most such cases no consideration is paid. In the few cases where payments are made they are operating expenses which serve to reduce the divisible balance; conversely, of course, the absence of payment serves to increase the divisible balance and enures to the benefit of both parties.
The whole passage in the Court of Appeal’s judgment, however, in which it said that no landlord would agree to a rent on the basis of leaving assets out of account and disregarding the value of monopoly of place and synergy, betrays a fundamental misunderstanding of the manner in which the R&E basis of valuation operates. As I have explained, while the Contractor’s basis of valuation assigns a separate value to every asset comprised in the tenement, the R&E basis does not. It employs the concept of the divisible balance which represents the profits of the undertaking carried on as a going concern which are derived from all the assets employed in it. The divisible balance automatically takes into account the value of all the elements whose presence contributes to the profits of the undertaking, including the essential but otherwise immeasurable contribution made by wayleaves, synergy and monopoly of place and the like.
In saying that the land over which there are wayleaves for cables or where the sub-stations are situated is of substantial value, the Court of Appeal relied on a passage in the Lands Tribunal’s decision where it was dealing with the Contractor’s basis of valuation. The Lands Tribunal rejected this method of valuation precisely because these various elements, like the cables, were of little or no value when assessed separately. On their own, the cables probably had only scrap value and the wayleaves value only when used in conjunction with the other assets of the business. But in combination with the other assets, they were indispensable to the operation of the business and the generation of profits and so captured by the R&E basis of valuation, which pays regard not to the cost or value of the individual items but to their earning power as part of a going concern.
Integration of assets. The Court of Appeal rejected the Company’s argument that the integration of the HT’s assets with the HL’s assets gave “the [HT] a strong bargaining position which must be taken into account.” This was not, however, what the Lands Tribunal actually found. It found that the parties had equal bargaining power. Nor did it reach this conclusion merely from the fact that the HL’s assets and the HT’s assets were “integrated” in the physical sense that over a long period of time they had been specially designed to fit together and had been built and installed simultaneously. The tenement in the present case is quite unlike most tenements such as factories, offices or shops where landlords normally construct the structure without a particular tenant’s business in mind and it is left to the tenant, when found, to bring in whatever equipment he needs. But the Lands Tribunal’s conclusion was not based solely or perhaps even mainly on this feature, but on the fact that there was only one set of assets, viz. that belonging to the HT, which could be used with the tenement to generate profits. In the words of the Lands Tribunal, the HT and the HL needed each other’s assets for the purpose of the undertaking carried out on the tenement because the tenement in its existing state could only be used with the HT’s existing assets. This is what gave the parties equal bargaining power.
The Court of Appeal seems to have thought that this was to value the HT’s assets in situ, that this would give the sitting tenant an advantage, and that the principles of the Southern Railway case required any such advantage to be disregarded. As I have already explained, valuing the HT’s assets in situ does not give the sitting tenant an advantage because the assets must be treated as available in the same state to all potential tenants. The relevant hypothesis required by the Southern Railway case is that the HT can acquire the necessary assets and staff without difficulty or interruption. The hypothesis is necessary in order to allow the HT (and every possible HT) the ability to take over the existing business with the existing assets in situ as a going concern without interruption and without cost.
The Lands Tribunal’s primary findings recited in paras 167(a) and (b) above were findings of fact, and its conclusion that the parties had equal bargaining power would seem inescapable but in any case was plainly not irrational. The Court of Appeal had no right to disturb it. The extent of its failure to appreciate the consequences of the Lands Tribunal’s findings sufficiently appears from its observation that
Conceptually, the need to acquire machines and apparatus that fit the tenement is no different from having to tool up a factory or to assemble the necessary staff. Indeed, Southern Railway involved acquiring rolling stock that plainly had to fit the railway tracks.
Whatever may be the conceptual position, factually and relevantly the situations are very different. Of course, a railway operator needs rolling stock of the appropriate gauge, but he does not need the HT’s rolling stock. It is the fact that in the present case the HL needed the particular assets of the HT for the undertaking to continue, just as the HT needed the tenement in its existing state, which gave them equal bargaining power.
Vacant and to let. The Court of Appeal interpreted “vacant” in the physical sense of “the business being ended and all the process machinery removed”. It seems to have thought that the relevant hypothesis was that the HT’s assets should be treated as removed from the tenement and then re-installed, the tenement being valued in the split second between removal and reinstallation. In the present case this would give a remarkably low figure for both the tenement and the NRA. With respect the rating hypothesis is not completely absurd. It may lead us into a world of make believe, but not pace Godfrey JA (see China Light & Power Co. Ltd v Commissioner for rating and Valuation  2 HKC 42 at p.43) into cloud cuckoo land. The relevant hypothesis is only that any costs of removal and installation, if required, should be ignored.
The expression “vacant and to let” first appears in LCC v Erith  AC 562 at p.588. The caseconcerned a tenement owned and occupied for the purpose of a public utility which was incapable of yielding a profit so long as it continued to be used for that purpose. The House of Lords held that the true test of rateable occupation was not whether a profit could be made but whether the occupation was of value. It was irrelevant that the current owner could not derive a profit from its occupation of the tenement if another owner could do so by putting the tenement to a different use. In such a case, the question to be answered was: Supposing the premises were vacant and to let, what rent might reasonably be expected from them? The valuation in that case did not proceed (and could not have proceeded) on the R&E basis, since there was no divisible balance.
The expression “vacant and to let” was also used by Lord Denning MR in R v Paddington Valuation Officer, ex parte Peachey Property Corp. Ltd  1 QB 380 at p.412. The case was concerned with the rateable value of a rent-controlled flat occupied by a tenant. The valuation officer assessed the rateable value by reference to comparables, and the question was whether he was bound by the actual rent paid by the tenant. The Court of Appeal held that he was not. As Lord Denning said, in a characteristically graphic phrase, the tenancy was as hypothetical as the tenant. The hypothetical tenancy, he said, was a tenancy of a dwelling which was vacant and to let.
The third case in which the expression was used is the Fir Mill case on which the Court of Appeal relied: See para.176 supra. The case concerned cotton mills at a time when the industry was in a parlous state and anyone seeking to enter the industry would be deterred from doing so. The rateable value was again assessed by reference to comparables, and the question was whether the rateable value was to be determined by reference only to the rents which persons in the cotton industry might reasonably be expected to pay or on some other basis. The English Lands Tribunal held that the rateable value of the tenements should be valued on the footing that they could be used as a factory but not any particular kind of factory.
The context in which these cases were decided is very different from the present. All three cases were concerned with the use of comparables to determine the rateable value of the tenement and the question was what rent would be paid for the right to use the tenement and put it to a different and more profitable use or let it to a different tenant not enjoying the benefit of rent control. The common feature of all three cases is that the existinguse of the tenement did not reflect the value of occupation. None of them was concerned with the R&E method of valuation, which values the right to carry on an existing business as a going concern.
The relevant principle in the present case is to be found in s.8(b), that for the purpose of ascertaining the rateable value of the tenement no account is to be taken of the value of any process machinery in or on the tenement. This does not envisage the physical removal of the process machinery from the tenement but requires only that the effect of its presence on the valuation of the tenement, whether positive or negative, be ignored: See the English Rating Manual Vol. 4 s.3 referring to the relevant regulations.
In two English cases it has been held by a process of judicial interpretation that the corresponding provision of the English statute requires both the value and the presence of the machinery in question to be ignored: See Townley Mill v Assessment Committee for Oldham  AC 419 and Edmondson (Valuation Officer) v Teessidee Textiles Ltd  RA 247. But in both cases the business had come to an end, the presence of machinery on the premises was an incumbrance which reduced the value of the tenement since any incoming tenant would have to remove it, and the valuation did not (and could not) proceed on the R&E basis. In the earlier case the relevant statutory provision expressly stated that it was not to apply to a valuation carried out by reference to the profits of the undertaking.
In Amies Law of Rating it is said that the assumption that the tenement is vacant in the literal sense “would not seem to apply” to tenements of which continuity of operation is essential for the maintenance of their value. The whole concept of the valuation of a public utility is based on the assumption that it is taken as a going concern and that the actual occupier hands over to the new tenant (or takes a new tenancy himself, since he is conceived as a possible tenant) and receives or credits himself with the value of his tenant’s capital. The passage continues with references to the Southern Railway case, pointing out that the hypothesis required by that case is inconsistent with treating the tenement as vacant in the literal sense, and concludes
Existing non-rateable process plant suitable only for use in the large steel works in which they are used must be assumed to be available to the hypothetical tenant, .... and it is wrong to assume that the factory is stripped of all its plant other than motive plant and that the hypothetical tenant is exposed to all the hazards of going into the market to look for new plant.
Amies op. cit at p.418 (referring to Neath Steel Sheet & Galvanising Co. Ltd v Neath Assessment Committee (1943) 36 R & IT 418).
The Court of Appeal cited these passages but drew the wrong conclusion, saying that the vacant and to let principle “operates in tandem” with the Southern Railway and Humber principles. It does not, for it is inconsistent with them.
In my judgment the so-called vacant and to let principle is not a free-standing rating hypothesis but a judicial extension of s.8(b) or its English equivalent, and has no application when the tenement is valued as a going concern by the R&E method.
Assets under Construction
I have read in draft the judgment of Mr Justice Ribeiro PJ and respectfully agree with him and for the reasons he gives that assets under construction are not rateable assets in Hong Kong.
The conclusions of the Lands Tribunal were based on findings of fact and value judgments which involved no errors of law and are unassailable. The Court of Appeal ought not to have disturbed them. The pervasive error in its judgment is that it took principles from other methodologies and applied them to the R&E basis of valuation where they have no place. I would restore the order of the Lands Tribunal and direct that the rateable value of the tenement be assessed in accordance with its decision subject to whatever further adjustment may be necessary to reflect the non-rateability of assets under construction.
Chief Justice Ma
For the above reasons, the appeal is unanimously allowed; the order of the Court of Appeal should be set aside and the decision of the Lands Tribunal restored. The parties should proceed to draw up an order as indicated by paragraphs 99 and 201 above. As for costs, we make a costs order nisi that the respondent pays the costs of the appellant both here and in the Court of Appeal. In the event that either party contends that a different order as to costs should be made, that party must lodge written submissions with the Registrar within 21 days of the date of this judgment and any written submissions in reply should be lodged within 21 days thereafter. Failing this, the costs order nisi will become absolute.
 It was agreed that the Company’s various tenements should be assessed as a single tenement under section 10 of the Rating Ordinance.
 See the discussion of sections 30 and 31 of the Ordinance in Sections C.5b and C.5c below.
 “Hypothetical landlord’s”.
 “Hypothetical tenant’s”.
 See Section B.2e below.
 See Section B.2e below.
 Citing John Laing & Son Ltd v Kingswood Assessment Area Committee  1 KB 344; and London County Council v Wilkins (Valuation Officer)  AC 362 from which the four requirements originate.
 See Section B.2d above.
 Section 2:
|“owner” means the holder of any tenement direct from the Government, whether under lease, licence or otherwise, or the immediate landlord of any tenement, or the agent of any such holder or landlord and also means a mortgagee or chargee.|
 Section 18(1):
|Subject to this Ordinance, there shall be payable, with effect from 1 April in each year on the rateable value of every tenement included in a valuation list in force, rates which are to be computed on the basis of the percentage of the rateable value of the tenement concerned ....|
 Which is not material.
 As provided for by section 26.
 Scheme of Control.
 HL stands for hypothetical landlord. HT stands for hypothetical tenant.
|“weighted average cost of capital”; a formula used in corporate finance to determine what might be regarded as an acceptable return on capital investment. It is always expressed as a percentage. This was fundamental to the Commissioner’s approach and accounted for the great difference in the respective parties’ valuations.|
 Section 21(1)
|The owner and occupier of a tenement shall both be liable to the Commissioner for payment of the rates assessed thereron, but the same 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 two are not identical because, while the “tenement” for rating purposes comprises all the land occupied by the Company for its undertaking, the “tenement” for the purposes of Government rent comprises only land which is the subject of “an applicable lease”, and some of the land occupied by the Company for its undertaking is held otherwise than under “an applicable lease”.
 A year in this context is 1 April to the following 31 March: Section 2 of the Rating Ordinance (Cap. 116). Unless otherwise indicated, all references in this judgment are references to sections in the Rating Ordinance.
 Lands Tribunal Ordinance s.11(2).
 See the cases cited in note  post.
 In England the unit is called a “hereditament”.
 The facts described above are those obtaining on 1 October 2003, but s.7(2)(a) requires the tenement to be regarded as being in the same state on 1 April 2004 as it was on 1 October 2003. This was described by the Lands Tribunal as “the rebus sic stantibus principle”.
 Mersey Docks and Harbour Board v Assessment Committee of Birkenhead Union  AC 175 at p.180, endorsed in the Southern Railway Case at p.283 and applied in China Light & Power Co. v Commissioner of Rating & Valuation  2 HKC 42.
 In Humber v Jones (1960) 6 RRC 161, 171 per Willmer LJ, who concluded that “in the end we are in the world of make believe”.
 Willmer LJ spoke of a factory and Lord Hailsham of a railway. A power station is a fortiori.
 In the course of her printed case when dealing with assets under construction. The full passage is quoted by Mr Justice Ribeiro PJ in para.92 of his judgment.
 See note  supra.
 The Company did not appeal against this part of the Land Tribunal’s decision to the Court of Appeal and this aspect is therefore not before this Court.
 The Lands Tribunal also referred to the HL’s share of the divisible balance by the formula PR x HL’s ANFA. If taken to refer to the permitted return rather than the actual return, the divisible balance would have to be divided in shares which together added up to more than the whole.
 The Court of Appeal took this expression and the assumption referred to above from Fir Mill Ltd v Royton Urban District Council and Jones (Valuation Officer) (1960) 7 RRC 171 at p.185, a decision of the English Lands Tribunal. The Court of Appeal described this principle as operating “in tandem with” the Southern Railway principle and being “consistent with” s.8(b). In fact, as will appear, the assumption made by the Court of Appeal and the terms of s.8(b) are very different.
 This shows that the approach described above is not confined to public utilities but applies to any case where the R&E method of valuation is employed.
Mr Benjamin Yu SC and Mr Bernard Man (instructed by the Department of Justice) for the respondent
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