Clp Power Hong Kong Ltd v. Commissioner of Rating and Valuation

HCMP 952/2015

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

MISCELLANEOUS PROCEEDINGS NO. 952 OF 2015

(ON AN INTENDED APPEAL FROM LDGA NO. 241 OF 2004 AND

LDRA NOS. 365-369 OF 2004)
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LDGA 241/2004
 LDRA 365-369/2004

IN THE LANDS TRIBUNAL OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

GOVERNMENT RENT APPEAL NO. 241 OF 2004

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IN THE LANDS TRIBUNAL OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

RATING APPEAL NOS. 365-369 OF 2004

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REASONS FOR JUDGMENT
AND DECISION ON COSTS
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Hon Kwan JA (giving the reasons for judgment and decision on costs of the Court):

1.This is an application for leave to appeal to the Court of Appeal against the judgment of the Lands Tribunal delivered on 3 January 2014 (“the Review Judgment”) confirming its earlier judgment on 24 April 2013 (“the Main Judgment”). Leave to appeal was refused by the Lands Tribunal on 9 April 2015 (“the Leave Decision”). The Main Judgment and Review Judgment were given by Au J as the then President of the Tribunal and by Mr M K Lo as a member. The Leave Decision was given by L Chan J as the President of the Tribunal and by Member Lo.

2.The Main Judgment was given in the appeals brought by CLP Power Hong Kong Limited (“CLP”) against the Commissioner of Rating and Valuation (“CRV”) in respect of assessments of the rateable value and government rent of the tenement and leased land occupied by CLP for the year of 2004/05.  The Tribunal allowed the appeals and the rateable value assessed by CRV was reduced from about $9.5 billion to $5 billion.

3.Before us, CLP sought leave to appeal in relation to these three holdings to further challenge the assessments:

(1) certain disputed items in power stations were held to fall within the definition of “plant” in section 8A of the Rating Ordinance, Cap 116 (“RO”) and should form part of the tenement for rating assessment (“the rateability of disputed items”);

(2) in applying the receipts and expenditure valuation method (“the R&E method”) to assess the rateable value of the tenement, the Black Point Deferral Premium should not be deducted as an expense of the hypothetical tenant (“HT”) (“the deductibility of the Black Point Deferral Premium”); and

(3) in dividing the divisible balance (“DB”) between the HT and the hypothetical landlord (“HL”), it would not be appropriate to make upward adjustment to the HT’s share in the manner as proposed by CLP to take into account (a) the business is that of the HT’s alone; (b) the difference between the effort and skill applied by the HT alone in running the business; and (c) the different risks between the HT and the HL in respect of HT’s greater operational and asset risk (“the HT’s share”).

4.CLP had sought leave from the Tribunal to appeal in respect of these three holdings.  Detailed reasons were given in the Leave Decision why leave was refused.

5.At the conclusion of the hearing, we gave leave to appeal only in respect of the holding in (1), namely, the rateability of the disputed items.  These are the reasons for our judgment.

An appeal against a Lands Tribunal decision

6.An appeal from the Lands Tribunal can only be brought on the ground that the decision is erroneous in point of law (section 11(2) of the Lands Tribunal Ordinance, Cap 17).  Leave to appeal shall not be granted unless the court is satisfied that the appeal has a reasonable prospect of success or that there is some other reason in the interests of justice why the appeal should be heard (section 11AA(6) of the same Ordinance).

7.It is pertinent to bear in mind what the Court of Final Appeal has said in the context of a rating appeal against the decision of the Lands Tribunal in Hong Kong Electric Co Ltd v Commissioner of Rating and Valuation (No 2) (2011) 14 HKCFAR 579 (“the HEC case”):

“…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 [of the RO] requires nothing more precise than the rent that “might reasonably be expected”. … the Lands Tribunal’s decisions on rateable value are those of a specialist tribunal appealable only on law and not on fact.” (§5, per Bokhary PJ)

“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 from 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.

… 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”. ” (at §§102, 103, per Litton NPJ)

“… the entire exercise was being conducted in an imaginary rating world. … Whether the hypothetical tenant would, in the imaginary rating world, look to the permitted return in the SOC [Scheme of Control] as a sufficient reward for its investment of capital, effort and risk is a matter of valuation judgment; no point of law is involved.” (§113, per Litton NPJ)

“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. 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.” (at §133, per Lord Millet NPJ)

Rateability of disputed items

8.CLP contended that the disputed items, which are all located within the curtilage of its power stations, fall within section 8(b) of the RO (which covers “machinery in or on the tenement” for the purpose of manufacturing operations or trade processes and are not rateable).  The Tribunal was in error in failing to consider whether the disputed items were rendered non-rateable by section 8(b) and in just treating them as falling within “plant” in section 8A(3) and therefore rateable.  Where section 8(b) applies, the machinery cannot form part of the tenement in or on which it is located and is non-rateable.  Section 8A only applies where items are not otherwise excluded by section 8(b) and deems a separate tenement to be created where land is occupied by means of any plant.  It was submitted that section 8A should not be read as overriding or modifying the scope of section 8(b).

9.In refusing leave to appeal, the Tribunal took the view that items falling within section 8(b) are not covered by section 8A(3) and vice versa, that there is clear absence of relationship between these provisions and that the disputed items should fall within section 8A(3).

10.We think it reasonably arguable that the disputed items should fall within section 8(b) and that a point of law arises as to the proper construction of sections 8(b) and 8A and the interface between these provisions.  We therefore gave leave to appeal in respect of this ground.

Deductibility of the Black Point Deferral Premium

11.The electricity-related operations of CLP and Castle Peak Power Company Limited (“CAPCO”) in Hong Kong have been regulated by a contract with the government called the Scheme of Control (“SOC”), which allows the government to periodically review major capital additions and tariff rates charged for electricity.  CLP is entitled to set the tariff for a particular year with an objective of achieving the maximum profit at the Permitted Return (“PR”), which is linked with the value of the assets of CLP to work out the maximum permissible profit CLP could earn through the tariffs for each year.  Where the SOC net revenue exceeds the PR, the excess is transferred to the Development Fund.  Where the net revenue falls below the PR, the deficiency is met with funds transferred from the Development Fund.  A similar SOC entered into by the Hong Kong Electric was considered in the HEC case.

12.Following the deferral of the installation of two generating units in the Black Point Power Station in 1999, CLP and CAPCO agreed to set aside $803 million from the Development Fund to a Special Provision Account to pay for the contractual obligation to reimburse the additional costs incurred by the vendors for the delayed delivery of the two units.  CLP and CAPCO have foregone the PR on the outstanding deferral premium of $803 million and have paid a charge of 8% per annum on the sum of the average balance of the Special Provision Account, which is credited to the Rate Reduction Reserve to be applied as an SOC rebate to customers.  The Special Provision Account was fully drawn down in 2004 to pay the additional costs of deferral and is closed.

13.An issue arose as to how the deferral premium should be treated in applying the R&E method, which involves two steps.  First, the gross receipts and expenditures the HT would expect to derive from his occupation of the tenement in the forthcoming year are quantified.  The difference between the expected gross receipts and gross expenditures is the DB, and represents the anticipated profits in the year of the tenancy.  The second step is to divide the DB between the HL and the HT, by determining the HT’s share and deducting it from the DB.  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, and what is left over is prima facie “the rent at which the tenement might reasonably be expected to let, from year to year”, i.e. the rateable value.

14.CLP’s expert Mr Davis treated the deferral premium as HT’s expenses, whereas CRV’s expert Ms Jim did not.  Her reasons as summarised in §367 of the Main Judgment were: the original source of payment was the Development Fund which was borne by CLP’s customers instead of the shareholders; it was an exceptional not a recurrent item; the transfer from the Development Fund was made back in 2000.  She took the view that the HT would not rely on, and as such would not expect to incur the deferred premium as an item of his estimated expenses to earn his estimated revenue during the hypothetical tenancy from 1 October 2003 to 30 September 2004.  She had noted CLP’s evidence that the agreement on deferral was made in 1999, before the HT came on 1 October 2003 to look forward and to negotiate for the hypothetical tenancy, and within the 1999 agreement, the actual amounts were booked in the years in which they were paid.

15.The Tribunal decided that the deferral premium should not be treated as an expense of the HT to be deducted from the receipts in the computation of the DB in §368 of the Main Judgment, which reads as follows:

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

16.The grounds of appeal advanced before us in relation to this holding are the same as those considered by the Tribunal in the Leave Decision.  They were discussed and analysed adequately in §§64 to 71 of the Leave Decision.

17.We are in agreement with the Tribunal that leave to appeal should be refused in relation to the holding of the deferral premium, for the reasons given by the Tribunal.  We have these additional observations.

18.Mr Litton maintained CLP’s contention that the Tribunal’s reasons for agreeing with Ms Jim’s treatment of the deferral premium should be confined to those in §368 of the Main Judgment, and should not include the other reasons set out in §367.  Even if he were right about that (and, like the Tribunal in the Leave Decision, we are not persuaded that the Tribunal had paid no regard to Ms Jim’s other reasons in §367), as pointed out by Mr Yu, SC, CRV could have lodged a respondent’s notice seeking to support the decision of the Tribunal on additional grounds, that there were clearly other factors the Tribunal could have taken into consideration in applying the principle of reality, and it was not bound to treat the deferral premium as an expense of the HT.

19.We do not agree with CLP’s contention that Ms Jim’s other reasons in §367 had departed from the reality principle. Nor do we accept Mr Litton’s submission that even if Ms Jim’s other reasons in §367 had been taken into consideration, it would still be a departure from the reality principle in view of the other factors relied on by CLP.  We see no error of law in the Tribunal’s preference of Ms Jim’s treatment of the deferral premium and the acceptance of her views in the hypothetical negotiation for the letting of the tenement.  As Lord Millett said in the HEC case at §159, the R&E method is only an aid to the ascertainment of the rent which the HT would be willing to pay, it is not an inflexible code or set of rigid rules.  And no rules are prescribed for the methodology in the computation of the DB.  The methodology used by the Tribunal in the notional exercise in reaching its decision is a matter of valuation judgment, no point of law is involved.

20.As for the complaint that the Tribunal has not given adequate reasons for its decision on this holding, it seems to us the real complaint is that the Tribunal did not deal specifically with the points made in §§8.13 to 8.15 of the closing submissions of CLP and explain why those submissions did not find favour with the Tribunal.  The points made by CLP in §§8.13 to 8.15 were essentially arguments on the reality principle, contending that Mr Davis’s approach respected that principle whereas Ms Jim’s approach did not.  Leaving aside the matter that some of the points made in the closing submissions were not put to Ms Jim in cross-examination (as Mr Yu has stated), what were adequate reasons in a judgment must be looked at in context.  We were given to understand that CLP presented over 500 pages of closing submissions in addition to three days of oral closing submissions.  The Main Judgment was already a lengthy judgment of 143 pages.  The Tribunal could not be expected to deal with every single argument raised by CLP.  As stated by Li CJ in Oriental Daily Publisher Ltd v Commissioner for Television and Entertainment Licensing Authority (1997-98) 1 HKCFAR 279 at 291F to G, ultimately, what are adequate reasons in the circumstances of a particular case has to be approached sensibly.

HT’s share

21.The Tribunal took a global approach in assessing the HT’s share of the DB, and rejected CLP’s argument of an upward adjustment to the HT’s share that the HT should be awarded a specific portion of the DB by 7.5% of the gross receipts as a reward for HT’s efforts in operating the business, and by an amount equivalent to 10.15% of the net of all cost DB as compensation for HT’s operational and asset risks.  Although it was accepted that the Tribunal was entitled to take a global approach instead of allocating a separate percentage to each of the elements of efforts and risks, the complaint is that in so doing it had nevertheless failed to take into account all relevant considerations and had taken into account irrelevant considerations and therefore made errors of law.  It was also contended that the Tribunal had failed to give adequate reasons in relation to the main issues raised by CLP in its closing submissions at §§9.2 to 9.58 and 9.223 to 9.225.

22.We do not think there are reasonable prospects of success in the arguments sought to be advanced by CLP, which have been rejected in the Main Judgment and the Leave Decision.

23.First and foremost, the assessment of the HT’s share is a matter of valuation judgment and not a matter of law.  No rules are prescribed for the manner in which the HT’s share of the DB may be determined (Main Judgment, §60).  What upward adjustment should be made to the HT’s share for efforts and risks is “a matter of judgment in the circumstances relating to the enterprise carried on at the property” (“The Receipts and Expenditure Method of Valuation for Non-Domestic Rating – A Guidance Note” prepared by the Joint Professional Institutions Rating Valuation Forum in the UK, at §5.46; “the JRF Guidance”).

24.Mr Litton sought to overcome this difficulty by contending that the Tribunal had failed to apply or had misapplied two principles of law: firstly, that the undertaking or business is the HT’s alone together with the risks, obligations and reward and the HT and the HL are not joint adventurers; secondly, the HT’s share of the DB represents the sum that provides him with a reasonable return on his capital, a reward for his efforts and a compensation for his risks, sufficient to induce him to rent the tenement and embark on the enterprise.

25.The Tribunal had clearly taken note of these legal principles, see, for example, §§58 to 59 and 110(3) of the Main Judgment.  It decided that the percentage allocation based on an asset split approach already provides a proper valuation to globally represent the interest on capital, the reward for effort and the compensation for risk in the present case (Main Judgment, §165).  It did not fail to take into account the effort and risk of the HT.  And it was well aware of the recommended approach in §5.51 of the JRF Guidance (which is to the effect that although it may be acceptable to calculate the HT’s share by applying a percentage to the HT’s capital with no breakdown to indicate the various elements for relatively small-scale undertakings, it is helpful to have regard to the elements of interest on capital, profit and risk separately), having quoted the relevant passage in full in §277 of the Main Judgment.

26.As stated in the Leave Decision at §89, CLP cannot say that the Tribunal has erred or failed to pay regard to relevant matters, simply because it did not adopt the approach CLP contended for or give a larger percentage of return to CLP in the asset split.  We agree with the reasons fully explained in the Leave Decision that the Tribunal did not fail to apply or had in any way misapplied the relevant legal principles.

27.The Tribunal declined to accept the “valuer’s judgment” of CLP’s expert Mr Davis, noting Mr Davis’s acknowledgment that his approach in awarding a reward for effort was a “novel” one (Main Judgment, §318), and as he had not made this type of adjustment for risks before, there was really nothing to go by in making the adjustment he proposed and he could not really explain how the adjustment was quantified (Main Judgment, §337).  We do not think the Tribunal’s decision could be faulted.  As stated by Croft J in Challenger Property Asset Management Pty Ltd v Stonnington City Council [2011] VSC 184 at §24:

“It is clear from the authorities that, depending on the particular circumstances, different methods of valuation may be appropriate. The Courts have not adopted a prescriptive position with respect to valuation methodology and care should be taken to ensure that no single process of reasoning is elevated into a statement of principle. The valuer’s task is then, within the context of the facts and circumstances relating to the relevant property, to apply the most appropriate method of valuation according to his or her expertise and experience. Valuation practice is principally an art, rather than a science and is an art that continues to evolve.”

28.It is open to the Tribunal to accept all, or part, or none of a valuer’s evidence.  Having examined Mr Davis’s evidence for the factual and intellectual basis of his opinion, the Tribunal decided not to accept his “novel” approach of awarding 7.5% of the gross receipts for the HT’s efforts (Main Judgment, §§315 to 323) and held there was no proper basis on which Mr Davis carried out his risk adjustment on the basis of his perceived greater operational and asset risks of the HT (Main Judgment, §339).  We see no basis to interfere with the Tribunal’s decision.

29.Mr Litton repeated the submission that in applying the asset split approach without making the further adjustment as sought by CLP, this has resulted in both the HT and the HL earning the same rate of return on their assets, contrary to the principle that the HT and HL are not joint adventurers and the business is the HT’s alone.  He accepted that the DB is not split evenly in this instance but emphasised the important point is that the HL and HT earn the same rate of return on their respective assets.

30.We agree with Mr Yu this argument is a non sequitur.  As stated in §88 of the Leave Decision, there is no basis for saying that the Tribunal had treated both the HT and the HL as operators of the business and bearers of its risks, merely because it had held that their respective assets under the SOC should be earning the profit at the same rate.  The Tribunal made a valuation judgment in adopting the global approach and in declining to make any further adjustments other than an up-lift of 10% to reflect the contribution to the business of the HT’s China investment.  In the Review Judgment, the Tribunal ruled in CLP’s favour that although the wayleaves and Dedicated Customer Substations are rateable, they should not be included in the HL’s asset base under the asset split exercise.  All these are to the benefit of the HT.  In balancing the various matters, the Tribunal was endeavouring to reach a decision that was fair and just overall.  There is no requirement that a higher rate of return must be awarded to the HT by reason of it being the party running the business.

31.Nor is there a requirement that a separate reward must be given for the HT’s effort in operating the business, see the cases cited in §318 of the Main Judgment where no separate award for effort was allowed.  Mr Litton again argued that the Tribunal was wrong in holding that the requirement to reward the HT for its entrepreneurial skills is satisfied by the salaries and bonuses paid to directors and staff which have been treated as expenses and deducted from the gross receipts before arriving at the DB, as that did not address the true issue being the difference in effort between the HT as the operator of the business and the HL who was just letting the tenement in return for rent.  He pointed to §§5.28 and 5.29 of the JRF Guidance which stated inter alia that where the expenditure takes the form of directors’ remuneration by way of salary or other reward, it is necessary to consider the nature of the remuneration to ensure that it properly forms an expense and is not an item which should be considered under the HT’s share.

32.We do not think the Tribunal had made any error of law in this valuation exercise, for the reasons given adequately in the Leave Decision at §§93 to 96.  The statement in the JRF Guidance does not take matters any further, as it all depends on the facts of a particular case.

33.As for the contention that an adjustment should be made to compensate the HT for its operational and asset risks, again much was made of §165(3) of the Main Judgment in which it was stated that the Tribunal has accepted CLP’s contention that in relation to the tenement, the risk level for HL and HT is roughly equal.  We are satisfied this is just a minor slip, as fully explained in the Leave Decision at §§105 and 106, and does not affect in any way the validity of the Tribunal’s reasoning in rejecting the claim for further adjustment.

34.We are in full agreement with the reasons in the Leave Decision that the Tribunal had considered the element of risk in adopting the global approach, and there is no basis to interfere with the valuation judgment of the Tribunal.

35.Lastly, we do not think the complaint that the Tribunal had failed to give adequate reasons for its decision on this holding is made out, for much the same reasons we have given earlier.

Costs of this application

36.We have heard arguments on costs.

37.Mr Yu sought two-thirds of the costs of this application as he has successfully resisted the leave application in respect of two out of three grounds of appeal.  He proposed that one-third of the costs should be in the cause of the appeal, which is in relation to the only ground for which we granted leave.

38.Mr Litton was opposed to granting any costs of this application to CRV, contending that CLP had to come to court and it has succeeded in obtaining leave to appeal in respect of one of the grounds.

39.We see no reason to depart from the rule that costs should follow the event.  We think it fair to apportion and award half of the costs of this application to CRV and we order the other half should be in the cause of the appeal to be brought.

40.We have considered the statement of costs submitted by CRV for summary assessment.  The total amount claimed is $885,199.  We would allow $800,000 as reasonable costs, of which $650,000 are the fees of counsel.  Half of the amount of costs allowed to CRV on this application is therefore $400,000.

Mr John Litton, instructed by Holman Fenwick Willan, for the Applicant(Appellant)

Mr Benjamin Yu SC and Ms Yvonne W S Cheng SC, instructed by Department of Justice, for the Respondent (Respondent)