Kwong Fat Loong Shipyard v. Commissioner of Rating and Valuation

LDRA000005/1988

Rating - rateable value appeal - beat building and repair yard at Tsing Yi Island - Commissioner reduced his original assessment of $ 168,000 to $ 147,000 and appellant sought further reduction to $ 90,000 - dispute whether comparative or contractcr's method of valuation appropriate - whether actual rent represented open market rent - dispute over decapitalisation rates -

Held

1. Comparative method to be preferred and applicable on facts to 3 of 4 elements of rateable tenement;

2. Actual rent based on standard Government rates and below market rent ;

3. Contractor's method appropriate to value fourth slipway element;

4. Decapitalisation rate should principally be based on property market yields when available but financial market interest rates also relevant and support rate of 10.5%; appeal upheld and rateable value reduced to $ 136,900 with effect from 1.4.88.

IN THE LANDS TRIBUNAL OF HONG KONG

(Appellate Jurisdiction)

Rating appeal No. 5 of 1988

Coram: His Honour Judge Cruden, Presiding Officer

Date of Judgment: 9 January 1990

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JUDGMENT

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1. The Appellant is the occupier of a tenement situate at Yau Kom Tau, Tsing Yi Island under Short Term Tenancy No. 367 from the Crown, Under the 1988 - 89 General Revaluation the Commissioner of Rating and Valuation assessed the rateable value of the subject tenement at $ 168,000 On 22nd March 1988 the Appellant gave notice of a proposal for alteration of the rateable value to the Commissioner pursuant to Section 37 of the Rating Ordinance Cap 116. On 17th August 1988 the Commissioner, pursuant to Section 39, delivered his decision on the Appellant's proposal, reducing the rateable value from $ 168,000 to $ 147,000. From that decision the Appellant, pursuant to Section 42, now appeals to this Tribunal In the Notice of Appeal the Appellant requests that the rateable value be reduced from $ 147,000 to $ 70,000.

2. The relevant date designated under Section 11(1)(b) for the 1988 - 89 General Revaluation was 1st October 1986 The Valuation List containing the rateable value of $ 147,000 now subject to appeal, came into force on 1st April 1988. Under Section 7 the rateable value is an amount equal to the rent at which the tenement as at lst October 1986, might reasonably be expected to be let, from year to year on the hypothetical statutory conditions that the tenant pays rates and taxes and the landlord pays Crown rent, costs, repairs and insurance necessary to command that rent.

3. However, while 1st October 1986 is the relevant date for determing the market rent, it is ascertained on the further statutory assumptions set out in Section 7A, that the tenement was in the same state, mode or character as existed on 1st Apri1 1988. So to determine the objective market rent the clock must be turned back to the relevant date of 1st October 1986. But when it comes to consider the subjective state, mode or character of the tenement, the clock is only turned back to the reference date of 1st April 1988.

4. The Appellant's witnesses included Mr. Lawrence Pang ARICS, AHKIS, Chartered Surveyor, who produced his Valuation Report as Exhibit A1. Upon consideration he assessed the rateable value at $ 90,000 which was $ 20,000 higher that the reduction sought in the Notice of Appeal. The Commissioner called Mr. P.M. O'Donovan ARICS, Chartered Surveyor, whose Valuation Report Exhibit R1 - supported a rateable value of $ 147,000 Mr. O'Donovan stated that the matters raised by the Appellant before the Tribunal, had already been taken into account by the Commissioner in the earlier reduction from 168,000 to $ 147,000 which he considered to be fair and reasonable The respective valuations which now divide the parties are therefore $90,000 and $ 147,000

5. The tenement comprises 1681.5 square metres and may be divided into four elements :

1.   The land above sea level;

2.   The seabed;

3.   Buildings;

4.    Slipway.

6. The appellant's tenure of the tenement has over the years changed as Government land policy has changed. The appellant's boatyard, together with other boatyards, were relocated from Cheung She Wan to Tsing Yi Island in the early 1960s under new land grants at a premium payable by instalments. In the late 1960s the original grants were changed to annual tenancies. In 1979 the annual tenancies were changed to short term tenancies at a standard rent of $ 6.46 per square metre for the whole tenement including the seabed. In 1983 the annual rent was increased to $ 15 per square metre.

7. The last rental review took place in 1988 but the new rent was backdated to 1st October 1986 which happens also to be the relevant date under Section 7A for determining the rateable value under this appeal. Although the tenement held under the short term tenancy continues to include both the working area and the seabed, in accordance with current Government land policy, the new rent was negotiated in respect of the working area only comprising 1020 square metres. The Crown first sought a new annual rent of $ 116,760 but after negotiations it accepted a new rent at the rate of $ 60 per square metre which calculated on the working area of 1020 square metres produced a new rent of $ 61,200 per annum.

8. Under the Rating Ordinance the unit of assessment is the tenement. Section 2 defines a "tenement" as

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

9. Lessees or occupiers of seabed are therefore liable for rates. This principle has been conceded in a number of cases including Yiu Lian Machinery Repairing Works v. Commissioner of Rating and Valuation (1982) HKDCIR 32. The fact that the seabed was excluded from the calculation of the current contractual rent is therefore irrelevant to the calculation of the rateable value. The tenement to be valued for rating purposes is the whole of the area contained in the short term tenancy. Accordingly, I hold that the rateable value is to be determined in respect of the whole tenement, including the seabed, comprising the total area of 1681.5 square metres.

10. The respondent's surveyor, Mr. Pang, was of the opinion that there were no comparable tenements on which to base the rateable value of the subject tenement and therefore felt obliged to value the tenement in accordance with the contractor's method. In applying the contractor's method he adopted the 5 stages commonly followed in Hong Kong and most recently referred to in Royal Hong Kong Yacht Club v Commissioner of Rating and Valuation (1987) HKDCLR 1. Under the contractor's rethod Mr. Pang valued improvements at $ 332,500 to which he applied a capitalisation rate of 8.5% which produced a figure of 28,262.50 After adopting the actual rent of $ 61,200 as the best evidence of the value of the land, he added that sum to the decapitalised figure of $ 28,262.50 to arrive at a total of $ 89,462.50 which he rounded up to $ 90,000.

11. Mr. Pang then proceeded to the fifth stage of the contractor's method which required him to stand back and review the calculations in the light of his experience and consider whether an annual rent of $ 90,000 would be an amount a hypothetical tenant would be willing to pay. Mr. Pang also referred to the decision of the English Lands Tribunal in Imperial College of Science and Technology b. Ebdon (1985) 1 EGLR 209, where a further Stage 6 was added to the conventional stages. This sixth stage requires consideration to be given to whether the figure arrived at by the fifth stage, is likely to be increased or decreased in negotiations between the hypothetical landlord and hypothetical tenant, having regard to the relative bargaining strength of the parties.

12. I record that an appeal against the English Lands Tribunal decision was dismissed by the Court of Appeal in Imperial College of Science and Technology v. Ebdon (1987) 1 EGLR 164 The contractor's method and the appropriate number of stages, of course have, no statutory force but are merely established by convention as an acceptable method of valuation, when lack of adequate comparables prevents the superior comparable method of valuation being adopted. After reviewing the figure of $90,000 in accordance with the established fifth stage and the more recently suggested sixth stage Mr. Pang remained satisfied that his assessment of $ 90,000 was reasonable.

13. The Commissioner's surveyor, Mr. O'Donovan in maintaining that the rateable value of the tenement was $ 147,000,disputed that there was insufficient evidence to permit the comparable method to be used. In Mr. O'Donovan's opinion there was adequate evidence of comparables to allow the working area, seabed and buildings to be valued under the comparable method but he accepted that it was necessary to use the contractor's method to value the remaining element of the tenement, namely the slipway.

14. Mr. O'Donovan reminded the Tribunal that as Lord Keith stated in Shotts Iron Company v Edinburgh Assessor (1946) SC 283 the contractor's method should only be applied as a last resort. A number of more recent Scots cases have also described the contractor's method as a notoriously unreliable method - Western Heritable Investment Co Ltd v. Husband (1983) SLT 578, HL. Despite continued judicial criticism of the dangers inherent in the necessarily subjective and notsonal approach, there is at times no alternative but to adopt the contractor's method. Indeed, even in Scotland where much of the more articulate criticism originates, it continues to be used, when necessary - Heart of Midlothian Football Club Ltd. v Lothian Regional Assessor (1988) RA 113; BP Petroluem Development Ltd. v Lothian Region Assessor (1988) RA 145, (1989) RA 5 CA; Fife Regional Assessor v Distillers Company (Bottling Services) Ltd. (1989) RA 71; Shell UK Exploration and Production v Fife Region Assessor (1989) RA 115; Imperial Chemical Industries PLC v Central Region Assessor (1989) RA 333.

15. I hold that the comparable method is to be preferred to the contractor's method. However, the comparable method depends on the availability of adequate comparables and in their absence recourse may have to be made to more subjective and notional based alternatives such as the contractor's method or the profits method. It is to be noted that even in the present case while the Commissioner criticised the valuation being carried out exclusively by the contractor's method, he accepted that it required to be used to value the slipway.

16. Mr. O'Donovan, while satisfied there was adequate evidence to allow the comparable method to be used, accepted that there was no satisfactory direct comparable. He was therefore forced to adopt an elemental approach, dividing the tenement into four elements and using the comparable method to value three of those four elements. I am satisfied that provided the comparable for each element are adequate, there is nothing inherently wrong with an elemental approach. An elemental approach is frequently adopted and has been expressly referred to and approved in a number of cases of which George v. South Western Electricity Board (1985) RVR 70 is an example.

17. Before turning to consider each of the four elements, it is necessary to refer to two factors relevant to the actual state of the tenement as at the reference date, namely 1st April 1988. First, the mode or character of occupation subsisting at that date, as referred to in Section 7A (2)(b), in accordance with the permitted user under the Short Term Tenancy, was that the tenement was being lawfully used for boat or ship building and repairing purposes. Secondly, as at the reference date, the transport facilities and amenities referred to in Section 7A (2)(c) enjoyed by the tenement, included improved accessibility provided by the nearby second Tsing Yi Bridge which opened during December 1987.

18. The first element to be considered under the Commissioner's comparative approach is the land above sea level. The respondent asserted that the actual annual rent of $62,100 represented the market rent. That rent equals a unit rate of $5 per square metre per month. Mr. O'Donovan attacked that unit rate on a number of grounds. First, he disputed that the as at 1st October 1986 the open market rent was as low as $5 per square metre per month. According to Mr. O'Donovan the original rent fixed in 1979, was based on Government standard rates and not open market rents. Subsequent rent reviews, he asserted, were based on that below market rate. On rent reviews Government also took into account improvements effected by tenants. To the extent that shipyard rentals from other localities were taken into account, they too were based on standard rates and not open market rents. Secondly, the unit rate of $ 5 was limited to the land above sea level. For rating purposes the whole tenement had to be valued, which reduced the unit rate of $5 to the even lower unit rate of $ 3.03 per square metre.

19. Dealing first with the second point, I accepted that even if the actual rent of $ 62,100 represents the open market rent for the land above sea level it would have to be increased by a sum equal to the open market rental value of the seabed to arrive at the rateable value of the tenement. I accept that Mr. O'Donovan's sea bed comparables themselves produce unit rates of $ 4.17 to $ 6.29 per square metre per month. I also accept that the best evidence of open market value of the land is provided by the Commissioner's comparables at Tsing Yi and Yau Kom Tau which support an open market value of $ 6 per square metre per month. Mr. O'Donovan adopted that rate for the working area of the land above sea level.

20. I find that Mr. O'Donovan adopted a conservative approach by valuing the sea bed at one-third of the land value. The sea bed comparables arguably support a higher rate. But the Commissioner was prepared to follow the approach in Royal Yacht Club v. Commissioner of Rating and Valuation   (supra) where sea bed was valued at the rate of one-third of the land value. The unit rate of $6 per square metre produce a monthly rate for the 847 square metres of open unpaved land above low water mark of $ 5,082. The value of the 661.6 square metres at 2 per square metre is $ 1,323.

21. Mr. O'Donovan conceded that rental evidence of shipyard buildings was extremely scarce and he was forced to rely on evidence of other buildings but of similar nature and condition. This approach is acceptable provided the other buildings are sufficiently similar and appropriate adjustments are allowed. I find that Comparables 6 and 7 were particularly helpful as in addition to being situated on Tsing Yi Island, their permitted user was for shopyards and sawmills. On the comparable evidence I find that for the buildings monthly unit rates of $ 20 per squar metre for the ground floor, $ 8 per square metre for the enclosed upper floor and $ 3 to $ 5 per square metre for the open sided portion of the upper floor buildings are reasonable.

22. These figures for land, seabed and buildings total $10,562 per month or $ 126,744 per annum. It remains to consider the valuation of the slipway. Mr. O'Donovan's contractor's valuation of the slipway amounted to $1833 per month which increased his monthly valuation to $ 12,395 which, rounded down to $ 12,250, produced an annual rateable value of $ 147,000. As to the slipway Mr. O'Donovan accepted that there was no rental evidence for slipways. There was an initial dispute whether the slipway was rateable although the Commissioner conceded that the cradle used in conjunction with the slipway was not rateable. The position governing machinery used as an adjunct to a tenement is governed by Section 8. I hold that the slipway is rateable but the cradle is not rateable.

23. Mr. O'Donovan adopted the sum of $ 300,000 as the construction cost of the slipway in 1983 and after allowing for inflation arrived at a cost as at l st October 1986 of $ 363,000. After making a 50% deduction for obsolesence he arrived at an effective capital value of $ 181,500. Adopting a decapitalisation rate of 12¹/₂% he reached an annual equivalent of $ 22,687 per annum which he rounded down to $ 22,000 per annum or $ 1,833 per month.

24. In cross-examination he confirmed that the 1983 cost of $ 300,000, was not the actual cost for the tenement slipway but was a calculation he made from information collected from other shipyards in 1983. An analysis of the costs incurred by those other shipyards was produced as Exhibit R.6. In cross-examination it was put to Mr. O'Donovan that the cost of the slipway cradle represented two-thirds of the total cost and was non-rateable Mr. O'Donovan replied that only one-third of the total cost was non-rateable and that the remaining two-thirds was estimated to equal the $ 300,000 used in his calculation.

25. When Mr. Chau Kwai Sun, the appellant's proprietor, gave evidence he stated that the slipway represented one-third and the cradle two-thirds of the total cost of building the slipway and ancillary equipment. However, when he came to quantify those proportions he asserted that the total cost was 400,000 of which $ 300,000 was apportionable to the cradle and $100,000 to the slipway. At other times he reverted to his one-third and two-thirds division. When it was put to him that in the case of five neighbouring shipyards, the proportion was reversed, he stated that the other shipyards were different to the subject tenement. He also observed 'that the 1983 information obtained by the Commissioner from the other shipyards was not detailed. Certainly no primary documents of cost were produced. On the other hand, Mr. Chau was unable to produce any documents detailing the actual cost to the appellant of building the subject slipway.

26. In the absence of more detailed evidence it is difficult to resolve both the total cost of the slipway and the proportion of that cost applicable to the cradle. I accept. Mr. Chau's evidence that the total cost was in the region of $ 400,000. I an prepared to infer that the proportionate cost of his cradle may have been different to that of the other shipyards. However, the evidence from those other shipyards strongly contradicts a cradle cost equal to two-thirds of the total cost. The evidence obliges the Tribunal to adopt a broad approach and on that basis I find that the cost of the cradle would have been in the region of $ 200,000 and the cost of slipway in the region of $200,000.

27. Mr. O'Donovan found the timbers and rails of the slipway old and worn but still adequate. He applied a 50% allowance for age and obselesence. The Tribunal's subsequent inspection of the tenement more than confirmed the aged condition of the slipway. Any allowance is to some extent subjective but I am satisfied that 50% in respect of it state as at 1st April 1988 is inadequate. I allow 60% for age and obselesence. It remains to consider the decapitalisation rate of 12½% This rate is to be compared with Mr. Pang's rate of 8.5%. Both Mr. Pang and Mr. O'Donovan referred to the decapitalisation rate of 8% allowed by the Lands Tribunal in Royal Yacht Club v. Commissioner of Rating and Valuation which was based on financial market interest rates.

28. Decapitalisation rates are a fertile field for disagreement. Mr. O'Donovan considered decapitalisation rates under two different bases. First, financial market interest rates and secondly, property market yields. So far as the financial market interest based figure of 8% in the Royal Yacht Club v. Commissioner of Rating and Valuation was concerned Mr. O'Donovan pointed out that as the tenement was used for recreational club purposes,  the Tribunal was obliged to accept financial market rates in the absence of property market yield evidence. In fact the Tribunal did not consider those alternatives. If the Tribunal's previous approach were adopted, then because of an increase on 10 year prime rate moving average from 10.3% in 1983 to 10.9% in 1986, the rate would be 8.4%. Mr. Pang used very similar figures to arrive at a rate of 8.38% which he rounded up to 8.5%.

29. The break down of the valuers respective figures were : -

30. However, for an industrial tenement compared to a recreational tenement Mr. O'Donovan considered that more constant repairs and maintenance would be required. Assuming a figure of 2% he arrived at 9.4% as the rate of return for an industrial tenement acceptable to a hypothetical tenant. Mr. O'Donovan then made the further assumption, that industrial tenements tend to have a shorter lifespan and that the hypothetical tenant would require a higher annual return. This approach produced rates of return ranging from 12.7% for 15 years to $ 15.86% for 10 years.

31. The Commissioner's approach suffered from at least two defects. First, the tenement does not fall within the very wide general category of industrial tenements but into the more restricted mode or character of boat or ship building or repairing. The Tribunal's inspection of the subject tenement and some of the comparables reinforced the conclusion to be drawn from the oral evidence, that the improvements to the subject tenement were simply if not crudely constructed. I find that the repairs and maintenance required for the subject tenement would be much less than would be required for a more representative industrial tenement.

32. Secondly, Mr. O'Donovan for his higher rate also relied on the practice in the United Kingdom to apply a higher rate forrplant. But the Tribunal is concerned with the value of the subject tenement and not with the value of plant. In Hong Kong plant is not per se rateable. In the United Kingdom under various statutory provisions certain categories of plant are rateable in accordance with statutory formula. Where plant in the United Kingdom is not caught by express statutory provisions, it may still be rateable under the common law doctrine of chattels enjoyed with land. An important difference between Hong Kong and United Kingdom rating law, is that in Hong Kong that common law doctrine does not apply - Commissioner of Rating and Valuation v. Yiu Lian Machinery Repairing Works Ltd.(1986) HKLR 93CA

33. Mr. O'Donovan then went on to consider decapitalisation rates based on property market yields, expressing the opinion that this was the better basis of valuation. He referred to recent Scots cases which reflect a preference for capitalisation rates based on property market yields to those calculated on financial market interest rates. In this particular appeal Mr. O'Donovan was at once faced with the difficulty of obtaining evidence of property market yields for boat or ship building and repairing yards. In fact he relied on information from the much wider category of industrial premises. Publications of two local firms of chartered surveyors indicated a yield of 13% to 14% and 13% to 15% for industrial premises in 1986. The Commissioner of Rating and Valuation publication "Property Market Statistics" recorded for the third quarter of 1986, an average yield for flatted factories in New Kowloon of 13.4%.

34. On this evidence Mr. O'Donovan considered that the average yield for industrial premises as at 1st October 1986 was 12% to 15%. For the subject tenant he adopted 12% as the rate for land and buildings and 12.5% for the slipway. The slightly higher rate for the slipway was selected because in Mr. O'Donovan's opinion :

"For plant such as slipway yards, I apply a slightly higher figure at 12.5% to compensate the landlord for the additional risk of technological redunancy and limited lifespan."

35. Mr. O'Donovan again errs in his terminology A rateable tenement includes land, buildings and structures. It does not include plant. Machinery is rateable to the limited extent provided for in Section 8. In accordance with Hong Kong law the Tribunal has already held that the cradle is non-rateable and the slipway is rateable. Mr. O'Donovan seemed to be excessively influenced by United Kingdom legislation. Section 21of the English Rating Act expressly refers to plant as well as machinery but problems of both definition and valuation are largely overcome by reliance on statutory orders deeming certain types of plant and machinery to be rateable-Plant and Machinery (Rating) Order 1960. In Scotland the equivalent provision is the Valuation (Plant and Machinery) (Scotland) Order 1983.

36. The Commissioner also produced a letter from The Regional Assessor for Fife, which sets out current practice in Scotland. Both financial market and property market yields are taken into account. It is dangerous to give weight to actual rates in other countries where interest rates and property yields are invariably different. However, it is interesting to note that in Fife during 1986, 8% was used for industrial properties and from 6% to 8% for club and community property. One factor resulting in the relatively high regional industrial rate of 10% was the more limited capital growth compared with other parts of Scotland. Conversely capital growth in Hong Kong, if volatile, generally tends to be high.

37. On the evidence, the formula adopted in the Royal Yacht Club v. Commissioner of Rating and Valuation, time adjusted to 1st October 1986, produced rates of 8.4% and 8.5%. The Commissioner's interest based rate over a 15 year lifespan, was 12.7%. The Commissioner's alternative calculations on industrial property market yields produced a rate of 12% for land and buildings and 12.5% for the slipway. As to the former rate, I accept that in the case of rateable machinery, allowance has to be made for relatively high rates of obsolesence. A substantial deduction to the reference date has already been allowed. So far as the slipway is concerned, the element more readily susceptible to obsolesence is the non-rateable cradle which for present purposes must be ignored.

38. The rateable slipway is principally a non-moveable fixture, analogous to the permanent way of a railway. For fixtures of this character the rate of obsolesence is very much lower than for other more representative industrial fixtures and machinery. This certainly is the case for the post-reference date period. In the case of the differently based property market yields, they were merely averages, produced from two general industrial property reports and one limited to average yields for flatted factories which are a different mode or character to the subject tenement.

39. In the absence of more detailed evidence, it is only possible to adopt a broad approach in determining the decapitalistation rate. On that evidence I find that the proper decapitalisation rate for the slipway is 10.5%. On the Tribunal's findings, the contractor's valuation of the slipway is $ 847 per month made up as follows:

40. I would also record that the Commissioner properly preferred to follow the comparative method, but carried out a valuation for the whole tenement under the contractor's method by way of comparison with the applicant's contractor's method valuation and also as a check. The Commissioner's contractor's valuation for the whole tenement was $ 182,000. In view of the conclusions I have already reached it is not necessary to consider that alternative valuation in detail. It compares with the appellant's contractor's valuation of $ 90,000. The Commissioner's contractor's method valuation is too high for a number of reasons. These include the excessively high decapitalisation rate and the insufficient allowance for obsolesence. Conversely, the appellant's valuation was too low. The major factors leading to the latter low valuation were the appellant's error in adopting the below market value actual rent as the market rent and his low decapitalisation rate.

The Tribunal's findings produce the following valuation:

41. The Tribunal proposes to allow the appeal and round the figure of $ 136,908 down to $ 136,900 and make the following orders:

1.     The rateable value of the subject tenement is fixed at $ 136,900;

2.     The Collector of Rates is directed to amend the Valuation List accordingly with effect from 1st April 1988;

3.     The Collector of Rates is directed to issue an amended notification for the decreased rates payable and make a refund of any rates overpaid.

42. There shall be an order nisi, to be made absolute if no application is made to the contrary within 14 days, that the Commissioner shall pay the appellant's costs to be taxed if not agreed in accordance with the scale of the High Court. There shall be a certificate for Counsel. Liberty to apply is reserved on any consequential matters.

Representation:

Mr. Peter Graham instructed by Y.K. Fung & Co, Solicitors for the appellant.

Mr. S.P. O'Sullivan, Crown Counsel for the respondent.