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As filed with the Securities and Exchange Commission on June 24, 2005

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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549



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FORM 20-F



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x    Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934



For the fiscal year ended December 31, 2004



Commission file number 001-15004



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Kowloon-Canton Railway Corporation

(Exact Name of Registrant as Specified in Its Charter)



Not Applicable.

(Translation of Registrants Name Into English)



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The Hong Kong Special Administrative Region of the
Peoples Republic of China

(Jurisdiction of Incorporation or Organization)



KCRC House, 9 Lok King Street, Fo Tan, Sha Tin, New Territories, Hong Kong

(Address of Principal Executive Offices)



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Securities registered or to be registered pursuant to Section 12(b) of the Act:



|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of each class |  | Name of each exchange on which registered
|8% Notes due 2010   |  | New York Stock Exchange                  



Securities
registered or to be registered pursuant to Section 12(g) of the Act:



None.



Securities for which there is a
reporting obligation pursuant to Section 15(d) of the Act:



None.



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Indicate the number of outstanding shares of each of the issuers classes of capital or common stock as of the close of the period covered by the
annual report.



As of December 31, 2004

391,200 shares outstanding



Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈



Indicate by check mark which financial statement item the Registrant has elected to follow.    Item
17  x    Item 18 ̈



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TABLE OF CONTENTS



|                                                   |  |                                                                              |  |     
|-------------------------------------------------- |  | ---------------------------------------------------------------------------- |  | ----
|                                                   |  |                                                                              |  | Page
|GENERAL INFORMATION                                |  | ii                                                                          
|EXCHANGE RATE INFORMATION                          |  | ii                                                                          
|FORWARD-LOOKING STATEMENTS                         |  | ii                                                                          
|PART I                                             |  |                                                                              |  | 1   
|ITEM 1.                                            |  | IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS                        |  | 1   
|ITEM 2.                                            |  | OFFER STATISTICS AND EXPECTED TIMETABLE                                      |  | 1   
|ITEM 3.                                            |  | KEY INFORMATION                                                              |  | 1   
|ITEM 4.                                            |  | INFORMATION ON THE CORPORATION                                               |  | 9   
|ITEM 5.                                            |  | OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                 |  | 31  
|ITEM 6.                                            |  | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                   |  | 53  
|ITEM 7.                                            |  | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                            |  | 59  
|ITEM 8.                                            |  | FINANCIAL INFORMATION                                                        |  | 60  
|ITEM 9.                                            |  | THE OFFER AND LISTING                                                        |  | 61  
|ITEM 10.                                           |  | ADDITIONAL INFORMATION                                                       |  | 61  
|ITEM 11.                                           |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS                  |  | 66  
|ITEM 12.                                           |  | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       |  | 69  
|PART II                                            |  |                                                                              |  | 69  
|ITEM 13.                                           |  | DEFAULT, DIVIDEND ARREARAGES AND DELINQUENCIES                               |  | 69  
|ITEM 14.                                           |  | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS |  | 69  
|ITEM 15.                                           |  | CONTROLS AND PROCEDURES                                                      |  | 69  
|ITEM 16A.                                          |  | AUDIT COMMITTEE FINANCIAL EXPERT                                             |  | 69  
|ITEM 16B.                                          |  | CODE OF ETHICS                                                               |  | 69  
|ITEM 16C.                                          |  | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                       |  | 69  
|ITEM 16D.                                          |  | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES                   |  | 70  
|ITEM 16E.                                          |  | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS       |  | 71  
|PART III                                           |  |                                                                              |  | 71  
|ITEM 17.                                           |  | FINANCIAL STATEMENTS                                                         |  | 71  
|ITEM 18.                                           |  | FINANCIAL STATEMENTS                                                         |  | 71  
|ITEM 19.                                           |  | EXHIBITS                                                                     |  | 71  
|                                                   | 
|SIGNATURES                                         |  | S-1                                                                         
|INDEX TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS |  | F-1                                                                         



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GENERAL INFORMATION



Except as
otherwise required by the context, references in this Annual Report to KCRC, Corporation or we refer to Kowloon-Canton Railway Corporation. The term you refers to holders of our 8% notes due 2010
issued in March 2000 (the Notes). The terms Hong Kong and Government refer to the Hong Kong Special Administrative Region of the Peoples Republic of China and its government, respectively.



EXCHANGE RATE INFORMATION



We
publish our financial statements in Hong Kong dollars. In this Annual Report, references to Hong Kong dollars or HK$ are to the currency of Hong Kong, and references to U.S. dollars or US$ are to the
currency of the United States. This Annual Report contains translations of Hong Kong dollar amounts into U.S. dollar amounts, solely for your convenience. Unless otherwise indicated, the translations have been made at HK$7.7723 = US$1.00, which was
the noon buying rate in New York City for cable transfers in Hong Kong dollars as certified for customs purposes by the Federal Reserve Bank of New York on December 31, 2004. See Item 3. Key Information  Exchange Rate Information
for historical information regarding this noon buying rate. You should not construe these translations as representations that the Hong Kong dollar amounts actually represent such U.S. dollar amounts or could have been or could be converted into
U.S. dollars at the indicated or at any other rates.



The Hong
Kong dollar is freely convertible into other currencies (including the U.S. dollar). Between 1983 to 2005, the Hong Kong dollar was officially linked to the U.S. dollar at the rate of approximately HK$7.80 to US$1.00. The central element in the
arrangements which give effect to the link is an agreement between the Government and the three Hong Kong banknote issuing banks, The Hongkong and Shanghai Banking Corporation Limited, the Standard Chartered Bank and the Bank of China (Hong Kong)
Limited. Under this agreement, the Hong Kong Government Exchange Fund issues certificates of its indebtedness to the banknote issuing banks against payment in U.S. dollars at the fixed exchange rate of HK$7.80 to US$1.00. The banknote issuing banks
hold the certificates of indebtedness to cover the issuances of banknotes. When the banknotes are withdrawn from circulation, the banknote issuing banks surrender the certificates of indebtedness to the Hong Kong Government Exchange Fund and are
paid the equivalent U.S. dollars at the fixed rate. On May 18, 2005, the Hong Kong Monetary Authority announced that it would introduce an upper ceiling to the currency peg at HK$7.75 to US$1.00, and would shift the exchange rate by 100 pips on
every Monday for five weeks starting with HK$7.81 on May 23, 2005 until the lower limit reached HK$7.85 to US$1.00 on June 20, 2005, effectively putting the Hong Kong dollar into a fixed trading band of HK$7.75 to HK$7.85 to US$1.00.



FORWARD-LOOKING STATEMENTS



Some
statements made in this Annual Report are forward-looking statements, which are subject to various risks and uncertainties. These include statements with respect to us, our corporate plans, strategies and beliefs and other statements that are not
historical facts. These statements can be identified by the use of forward-looking terminology such as may, will, expect, anticipate, intend, estimate, continue,
plan or other similar words. The statements are based on our managements assumptions and beliefs in light of the information currently available to us.



These assumptions involve risks and uncertainties which may cause the actual results, performance or achievements to be
materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Important factors that may cause results to differ from expectations include, for example:



| |  | the general political, social, public health and economic conditions in Hong Kong and elsewhere in Asia;
|- |  | --------------------------------------------------------------------------------------------------------



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| |  | the decision of the Government on the merger between KCRC and MTR Corporation Limited (MTRCL);
|- |  | ------------------------------------------------------------------------------------------------



| |  | population growth and demographical movement of population in Hong Kong;
|- |  | ------------------------------------------------------------------------



| |  | the terms on which we finance our working capital and capital expenditure requirements;
|- |  | ---------------------------------------------------------------------------------------



| |  | accidents and natural disasters;
|- |  | --------------------------------



| |  | our ability to complete our rail network expansion and upgrade projects on time and within budget;
|- |  | --------------------------------------------------------------------------------------------------



| |  | costs of equipment which we import as part of our rail network expansion and upgrade;
|- |  | -------------------------------------------------------------------------------------



| |  | competition from alternative modes of transportation, such as buses, tour coaches, taxis, private cars, trucks, ferries, ocean going vessels and airplanes;
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | our ability to implement increases in fares or service charges;
|- |  | ---------------------------------------------------------------



| |  | the decision of the Government on the award of new railway projects;
|- |  | --------------------------------------------------------------------



| |  | our relationship with railway authorities in mainland China;
|- |  | ------------------------------------------------------------



| |  | the level of cross-boundary economic activities;
|- |  | ------------------------------------------------



| |  | regulatory, construction and other problems in completing our property developments; and
|- |  | ----------------------------------------------------------------------------------------



| |  | the level of prevailing interest and foreign exchange rates.
|- |  | ------------------------------------------------------------



We do not expect to update forward-looking information to reflect actual results or changes in assumptions or other factors that could affect those
statements.



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PART I



ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS



Not applicable.



ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE



Not applicable.



ITEM 3. KEY INFORMATION



3.A SELECTED FINANCIAL
DATA



You should read the selected consolidated financial and
operating data below together with our audited consolidated financial statements, including the accompanying notes, included in this Annual Report and Item 5. Operating and Financial Review and Prospects. The information under the
headings Consolidated Income Statement Data for each of the three years ended December 31, 2002, 2003 and 2004 and Consolidated Balance Sheet Data as of December 31, 2003 and 2004 are extracted without adjustment from our
audited consolidated financial statements, including the accompanying notes, which are included in this Annual Report beginning on page F-1. We derived the information under the headings Consolidated Income Statement Data for each of the
two years ended December 31, 2000 and 2001 and Consolidated Balance Sheet Data as of December 31, 2000, 2001 and 2002 from our audited financial statements, which are not included in this Annual Report. The information under the headings
Other Consolidated Financial Data and Railway Operation Data below has been derived without material adjustment from our unaudited operating records and our audited consolidated financial statements. Our audited consolidated
financial statements are prepared in accordance with accounting principles generally accepted in Hong Kong (HK GAAP), which differ in certain material respects from accounting principles generally accepted in the United States of America
(US GAAP). See Note 44 to our audited consolidated financial statements for a summary of differences between HK GAAP and US GAAP applicable to us.



|                                                      |  |                                      |   |  |        |   |  |        |   |  |        |   |  |        |   |  |          |  
|----------------------------------------------------- |  | ------------------------------------ | - |  | ------ | - |  | ------ | - |  | ------ | - |  | ------ | - |  | -------- | -
|                                                      |  | Year Ended December 31,              |  
|                                                      |  | 2000                                 |   |  | 2001   |   |  | 2002   |   |  | 2003   |   |  | 2004   |   |  | 2004(11) |  
|                                                      |  | HK$                                  |   |  | HK$    |   |  | HK$    |   |  | HK$    |   |  | HK$    |   |  | US$      |  
|                                                      |  | (in millions, except per share data) |  
|Consolidated Income Statement Data:                   |  |                                      |   |  |        |   |  |        |   |  |        |   |  |        |   |  |          |  
|HK GAAP:                                              |  |                                      |   |  |        |   |  |        |   |  |        |   |  |        |   |  |          |  
|Revenue                                               |  | 4,731                                |   |  | 4,797  |   |  | 4,830  |   |  | 4,426  |   |  | 4,976  |   |  | 640      |  
|Operating costs before depreciation                   |  | (2,160                               | ) |  | (2,225 | ) |  | (2,171 | ) |  | (2,129 | ) |  | (2,807 | ) |  | (361     | )
|                                                      |  |                                      |   |  |        |   |  |        |   |  |        |   |  |        |   |  |          |  
|Operating profit before depreciation                  |  | 2,571                                |   |  | 2,572  |   |  | 2,659  |   |  | 2,297  |   |  | 2,169  |   |  | 279      |  
|Depreciation                                          |  | 670                                  |   |  | 661    |   |  | 725    |   |  | 748    |   |  | 1,632  |   |  | 210      |  
|                                                      |  |                                      |   |  |        |   |  |        |   |  |        |   |  |        |   |  |          |  
|Operating profit before net finance income/(expenses) |  | 1,901                                |   |  | 1,911  |   |  | 1,934  |   |  | 1,549  |   |  | 537    |   |  | 69       |  
|Net finance income/(expenses)                         |  | 302                                  |   |  | 490    |   |  | 618    |   |  | 353    |   |  | (41    | ) |  | (5       | )
|                                                      |  |                                      |   |  |        |   |  |        |   |  |        |   |  |        |   |  |          |  
|Operating profit after net finance income/(expenses)  |  | 2,203                                |   |  | 2,401  |   |  | 2,552  |   |  | 1,902  |   |  | 496    |   |  | 64       |  
|Profit on property development                        |  | 87                                   |   |  | 24     |   |  | 94     |   |  |       |   |  |       |   |  |         |  
|Share of profits/(losses) of associate                |  | (1                                   | ) |  | 11     |   |  | 16     |   |  | 8      |   |  | 16     |   |  | 2        |  
|                                                      |  |                                      |   |  |        |   |  |        |   |  |        |   |  |        |   |  |          |  
|Profit before taxation                                |  | 2,289                                |   |  | 2,436  |   |  | 2,662  |   |  | 1,910  |   |  | 512    |   |  | 66       |  
|Taxation                                              |  | (1                                   | ) |  | (1     | ) |  | (452   | ) |  | (529   | ) |  | (83    | ) |  | (11      | )
|                                                      |  |                                      |   |  |        |   |  |        |   |  |        |   |  |        |   |  |          |  
|Profit after taxation                                 |  | 2,288                                |   |  | 2,435  |   |  | 2,210  |   |  | 1,381  |   |  | 429    |   |  | 55       |  
|                                                      |  |                                      |   |  |        |   |  |        |   |  |        |   |  |        |   |  |          |  
|Dividend                                              |  |                                     |   |  |       |   |  | 620    |   |  | 620    |   |  | 172    |   |  | 22       |  
|Earnings per share(1) Basic                          |  | 7,352                                |   |  | 6,444  |   |  | 5,649  |   |  | 3,530  |   |  | 1,097  |   |  | 141      |  
|Dividend per share                                    |  |                                     |   |  |       |   |  | 1,585  |   |  | 1,585  |   |  | 440    |   |  | 57       |  
|                                                      |  |                                      |   |  |        |  
|US GAAP:                                              |  |                                      |   |  |        |   |  |        |   |  |        |   |  |        |   |  |          |  
|                                                      |  |                                      |   |  |        |  
|Depreciation                                          |  | 699                                  |   |  | 689    |   |  | 733    |   |  | 757    |   |  | 1,813  |   |  | 233      |  
|Operating profit before net finance income/(expenses) |  | 1,799                                |   |  | 1,822  |   |  | 1,800  |   |  | 1,406  |   |  | 313    |   |  | 40       |  
|Net finance income/(expenses)                         |  | 2,670                                |   |  | 2,424  |   |  | 1,591  |   |  | 650    |   |  | 28     |   |  | 4        |  
|Operating profit after net finance income/(expenses)  |  | 4,469                                |   |  | 4,246  |   |  | 3,391  |   |  | 2,056  |   |  | 341    |   |  | 44       |  
|Profit before taxation                                |  | 4,555                                |   |  | 4,354  |   |  | 3,428  |   |  | 2,064  |   |  | 357    |   |  | 46       |  
|Net income                                            |  | 4,113                                |   |  | 3,792  |   |  | 2,951  |   |  | 1,512  |   |  | 312    |   |  | 40       |  
|Earnings per share(1)                                 |  | 13,217                               |   |  | 10,035 |   |  | 7,543  |   |  | 3,865  |   |  | 798    |   |  | 103      |  



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|                                                              |  |                                      |   |  |         |   |  |         |   |  |         |   |  |         |      |  |          |     
|------------------------------------------------------------- |  | ------------------------------------ | - |  | ------- | - |  | ------- | - |  | ------- | - |  | ------- | ---- |  | -------- | ----
|                                                              |  | Year Ended December 31,              |  
|                                                              |  | 2000                                 |   |  | 2001    |   |  | 2002    |   |  | 2003    |   |  | 2004    |      |  | 2004(11) |     
|                                                              |  | HK$                                  |   |  | HK$     |   |  | HK$     |   |  | HK$     |   |  | HK$     |      |  | US$      |     
|                                                              |  | (in millions, except per share data) |  
|Consolidated Balance Sheet Data:                              |  |                                      |   |  |         |   |  |         |   |  |         |   |  |         |      |  |          |     
|HK GAAP:                                                      |  |                                      |   |  |         |   |  |         |   |  |         |   |  |         |      |  |          |     
|Working capital(2)                                            |  | 5,727                                |   |  | 2,135   |   |  | 1,397   |   |  | (748    | ) |  | (2,294  | )    |  | (295     | )   
|Total assets(3)                                               |  | 70,419                               |   |  | 82,537  |   |  | 86,108  |   |  | 89,204  |   |  | 91,432  |      |  | 11,764   |     
|Long-term obligations(3)(4)                                   |  | 16,395                               |   |  | 16,831  |   |  | 17,753  |   |  | 20,771  |   |  | 20,465  |      |  | 2,633    |     
|Shareholders funds                                           |  | 48,901                               |   |  | 59,580  |   |  | 59,512  |   |  | 60,205  |   |  | 60,147  |      |  | 7,739    |     
|Issued and outstanding shares                                 |  | 311,200                              |   |  | 391,200 |   |  | 391,200 |   |  | 391,200 |   |  | 391,200 |      |  |         |     
|                                                              |  |                                      |   |  |         |  
|US GAAP:                                                      |  |                                      |   |  |         |   |  |         |   |  |         |   |  |         |      |  |          |     
|Total assets(3)                                               |  | 82,374                               |   |  | 96,815  |   |  | 102,414 |   |  | 108,664 |   |  | 110,361 |      |  | 14,199   |     
|Long-term obligations(3)                                      |  | 23,759                               |   |  | 24,606  |   |  | 27,205  |   |  | 33,513  |   |  | 33,506  |      |  | 4,311    |     
|Shareholders equity                                          |  | 51,977                               |   |  | 63,778  |   |  | 66,205  |   |  | 66,743  |   |  | 65,986  |      |  | 8,490    |     
|                                                              | 
|                                                              |  | Year Ended December 31,              |  
|                                                              |  | 2000                                 |   |  | 2001    |   |  | 2002    |   |  | 2003    |   |  | 2004    |      |  | 2004(11) |     
|                                                              |  | HK$                                  |   |  | HK$     |   |  | HK$     |   |  | HK$     |   |  | HK$     |      |  | US$      |     
|                                                              |  | (in millions, except per share data) |  
|Other Consolidated Financial Data:                            |  |                                      |   |  |         |   |  |         |   |  |         |   |  |         |      |  |          |     
|HK GAAP:                                                      |  |                                      |   |  |         |   |  |         |   |  |         |   |  |         |      |  |          |     
|Capital expenditure(5)                                        |  | 10,829                               |   |  | 14,595  |   |  | 12,308  |   |  | 11,122  |   |  | 9,022   |      |  | 1,161    |     
|Revenue per employee excluding project staff                  |  | 1.248                                |   |  | 1.240   |   |  | 1.222   |   |  | 0.950   |   |  | 0.994   |      |  | 0.128    |     
|Total debt(6)                                                 |  | 16,395                               |   |  | 16,831  |   |  | 17,753  |   |  | 20,013  |   |  | 19,748  |      |  | 2,541    |     
|Debt/equity ratio(6)                                          |  | 1:3.0                                |   |  | 1:3.5   |   |  | 1:3.4   |   |  | 1:3.0   |   |  | 1:3.0   |      |  | 1:3.0    |     
|Net cash inflow from operating activities                     |  | 2,848                                |   |  | 2,429   |   |  | 2,500   |   |  | 1,870   |   |  | 1,929   |      |  | 248      |     
|                                                              |  |                                      |   |  |         |  
|US GAAP:                                                      |  |                                      |   |  |         |   |  |         |   |  |         |   |  |         |      |  |          |     
|Net cash provided by operating activities                     |  | 3,603                                |   |  | 2,929   |   |  | 3,087   |   |  | 1,333   |   |  | 2,012   |      |  | 259      |     
|                                                              |  |                                      |   |  |         |  
|Railway Operation Data:                                       |  |                                      |   |  |         |   |  |         |   |  |         |   |  |         |      |  |          |     
|Route kilometers (km):                                        |  |                                      |   |  |         |   |  |         |   |  |         |   |  |         |      |  |          |     
|East Rail(7)                                                  |  | 34                                   |   |  | 34      |   |  | 34      |   |  | 34      |   |  | 46.5    |      |  |         |     
|Light Rail                                                    |  | 31.75                                |   |  | 31.75   |   |  | 31.75   |   |  | 36.2    |   |  | 36.2    |      |  |         |     
|West Rail(8)                                                  |  |                                     |   |  |        |   |  |        |   |  | 30.5    |   |  | 30.5    |      |  |         |     
|Total number of passengers (in millions):                     |  |                                      |   |  |         |   |  |         |   |  |         |   |  |         |      |  |          |     
|East Rail(7)                                                  |  | 288                                  |   |  | 292     |   |  | 296     |   |  | 278     |   |  | 292     |      |  |         |     
|Light Rail                                                    |  | 118                                  |   |  | 117     |   |  | 114     |   |  | 106     |   |  | 132     |      |  |         |     
|West Rail(8)                                                  |  |                                     |   |  |        |   |  |        |   |  | 1       |   |  | 48      |      |  |         |     
|                                                              |  |                                      |   |  |         |  
|Average fare revenue per passenger carried (HK$)              |  |                                      |   |  |         |   |  |         |   |  |         |   |  |         |      |  |          |     
|East Rail(7)                                                  |  | 11.65                                |   |  | 11.66   |   |  | 11.73   |   |  | 11.22   |   |  | 11.04   |      |  | 1.42     |     
|Light Rail                                                    |  | 3.59                                 |   |  | 3.56    |   |  | 3.53    |   |  | 3.52    |   |  | 3.07    |      |  | 0.39     |     
|West Rail(8)                                                  |  |                                     |   |  |        |   |  |        |   |  |        |   |  | 6.29    |      |  | 0.81     |     
|                                                              |  |                                      |   |  |         |  
|Railway operating profit/(loss) per passenger carried(9)(HK$) |  |                                      |   |  |         |   |  |         |   |  |         |   |  |         |      |  |          |     
|East Rail(7)                                                  |  | 5.45                                 |   |  | 5.55    |   |  | 5.56    |   |  | 4.74    |   |  |        | (10) |  |         | (10)
|Light Rail                                                    |  | (1.12                                | ) |  | (1.19   | ) |  | (1.00   | ) |  | (0.88   | ) |  |        | (10) |  |         | (10)
|West Rail(8)                                                  |  |                                     |   |  |        |   |  |        |   |  |        |   |  |        | (10) |  |         | (10)

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|(1) | See the table below for details of the computation of earnings per share information.
|--- | -------------------------------------------------------------------------------------



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|(2) | Working capital is defined as the sum of current assets, e.g. stores and spares, properties held for resale, interest receivable, other receivables, tax recoverable
and cash and cash equivalents, minus the sum of current liabilities, e.g. interest payable, other payables, accrued charges and provisions for capital projects.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Total assets and long-term obligations under US GAAP are derived from the corresponding amounts under HK GAAP, adjusted by the relevant items specified in Note 44 to
our audited consolidated financial statements. Total assets and long-term obligations under US GAAP include defeased lease deposits and lease payment commitments in respect of certain lease out and lease back arrangements not recognized under HK
GAAP. See Note 44(i) to our audited consolidated financial statements.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Under HK GAAP, long-term obligations include interest-bearing borrowings, and lease payment commitments arising from certain lease out and lease back arrangements
which meet the definition of a liability and are recognized as obligations in the balance sheet. See Note 2(o) to our audited consolidated financial statements.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | The capital expenditure figure is presented on an accruals basis and a detailed breakdown of capital expenditure is depicted in the table on page 48.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Total debt under HK GAAP represents interest-bearing borrowings.
|--- | ----------------------------------------------------------------

|(7) | Excludes through-trains. From 2004 onwards, route kilometers, passenger and fare figures include the Tsim Sha Tsui Extension and Ma On Shan Rail which commenced
operations on October 24, 2004 and December 21, 2004, respectively.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | West Rail Phase I commenced operations on December 20, 2003. Information relating to annual average fare revenue per passenger carried in 2003 for West Rail Phase I
is not shown due to the limited period of operation.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(9) | The railway operating profit/(loss) per passenger carried is derived after depreciation and excludes net finance income/(expenses). The cost of feeder bus services
is included in the operating costs of East Rail and Light Rail. Furthermore, fare revenue, rather than total divisional revenue of both East Rail and Light Rail, is used for calculating operating profit/(loss) for consistency.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) | In December 2003, East Rail Division, West Rail/Light Rail Division were combined to form a single Transport Division to allow our management more flexibility in the
deployment of resources and enable us to achieve synergy and savings, particularly for those services common to all railway networks, such as maintenance. The Transport Division manages all the transport services including East Rail, Light Rail,
West Rail and Freight. Since December 2003, most of the costs are common to various railway services including East Rail, Light Rail, West Rail and Freight. Consistent with our internal organizational and management structure, a transport services
segment has been created in place of East Rail, Light Rail, West Rail and Freight. Commencing 2004, separate profit/(loss) figures for individual business segments are not available.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(11) | Solely for your convenience, we have translated certain Hong Kong dollar amounts into U.S. dollar amounts at the rate of HK$7.7723 = US$1.00, the noon buying rate in
New York City for cable transfers in Hong Kong dollars as certified for customs purposes by the Federal Reserve Bank of New York on December 31, 2004. The U.S. dollar amounts under Consolidated Income Statement Data and
Consolidated Balance Sheet Data are rounded to the nearest million.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Computation of Earnings per Share:



|                                           |  |      |         |      |     |         |  |      |         |      |     |         |  |     |         |  |     |    
|------------------------------------------ |  | ---- | ------- | ---- | --- | ------- |  | ---- | ------- | ---- | --- | ------- |  | --- | ------- |  | --- | ---
|                                           |  | 2000 |         | 2001 |     | 2002    |  | 2003 |         | 2004 |     | 2004   
|Weighted average number of ordinary shares |  |      | 311,200 |      |     | 377,867 |  |      | 391,200 |      |     | 391,200 |  |     | 391,200 |  |     |    
|                                           |  |      |         |      |     |        
|HK GAAP:                                   |  |      |         |      |     |         |  |      |         |      |     |         |  |     |         |  |     |    
|Profit after taxation (HK$ million)        |  |      | 2,288   |      |     | 2,435   |  |      | 2,210   |      |     | 1,381   |  |     | 429     |  |     |    
|EPS - Basic                                |  | HK$  | 7,352   |      | HK$ | 6,444   |  | HK$  | 5,649   |      | HK$ | 3,530   |  | HK$ | 1,097   |  | US$ | 141
|                                           |  |      |         |      |     |        
|US GAAP:                                   |  |      |         |      |     |         |  |      |         |      |     |         |  |     |         |  |     |    
|Profit after taxation (HK$ million)        |  |      | 4,113   |      |     | 3,792   |  |      | 2,951   |      |     | 1,512   |  |     | 312     |  |     |    
|Earnings per share - Basic                 |  | HK$  | 13,217  |      | HK$ | 10,035  |  | HK$  | 7,543   |      | HK$ | 3,865   |  | HK$ | 798     |  | US$ | 103



Exchange Rate Information



The table below sets forth, for the periods indicated,
the average, high, low and period-end noon buying rate between the Hong Kong dollar and the U.S. dollar.



On June 20, 2005, the noon buying rate for the Hong Kong dollar was HK$7.7737 = US$1.00.



|                       |  |                  |  |        |  |        |  |           
|---------------------- |  | ---------------- |  | ------ |  | ------ |  | ----------
|                       |  | Noon Buying Rate
|Year                   |  | Average (1)      |  | High   |  | Low    |  | Period-End
|2000                   |  | 7.7936           |  | 7.8008 |  | 7.7765 |  | 7.7999    
|2001                   |  | 7.7996           |  | 7.8004 |  | 7.7970 |  | 7.7980    
|2002                   |  | 7.7996           |  | 7.8080 |  | 7.7970 |  | 7.7988    
|2003                   |  | 7.7864           |  | 7.8001 |  | 7.7640 |  | 7.7640    
|2004                   |  | 7.7899           |  | 7.8010 |  | 7.7632 |  | 7.7723    
|                       |  |                  |  |       
|Months                 |  |                  |  |        |  |        |  |           
|2004                   |  |                  |  |        |  |        |  |           
|November               |  |                  |  | 7.7815 |  | 7.7718 |  | 7.7760    
|December               |  |                  |  | 7.7821 |  | 7.7698 |  | 7.7723    
|2005                   |  |                  |  |        |  |        |  |           
|January                |  |                  |  | 7.7994 |  | 7.7775 |  | 7.7993    
|February               |  |                  |  | 7.7999 |  | 7.7990 |  | 7.7992    
|March                  |  |                  |  | 7.7998 |  | 7.7987 |  | 7.7990    
|April                  |  |                  |  | 7.7995 |  | 7.7946 |  | 7.7946    
|May                    |  |                  |  | 7.7995 |  | 7.7767 |  | 7.7788    
|June (through June 20) |  |                  |  | 7.7842 |  | 7.7735 |  | 7.7737    

---

|(1) | Represents the average of the noon buying rates on the last business day of each month during the relevant year.
|--- | ----------------------------------------------------------------------------------------------------------------



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##### Table of Contents

3.B CAPITALIZATION AND INDEBTEDNESS



Not applicable.



3.C REASONS FOR THE OFFER AND USE OF PROCEEDS



Not applicable.



3.D RISK FACTORS



Because we are owned
by the Government and substantially all our revenues are derived from operations in Hong Kong, changes in Hong Kongs political situation may affect the manner in which our business is conducted as well as business confidence and economic
conditions in Hong Kong, which could affect our business.



From July 1, 1997, Hong Kong ceased to be a Crown Colony of the United Kingdom and became a Special Administrative Region of the Peoples Republic of China. The basic policies of China regarding Hong Kong are embodied in the Basic Law
of the Hong Kong Special Administrative Region, which was adopted by the National Peoples Congress of the Peoples Republic of China on April 4, 1990 and came into effect on July 1, 1997. Although the Basic Law provides that Hong Kong
will have a high degree of legislative, legal and economic autonomy, there can be no assurance that China will not exercise, directly or indirectly, increased sovereignty over Hong Kong. In 2004, China issued a conclusive interpretation of the
procedural requirements under the Basic Law on the electoral reform process, and in 2005, China issued a conclusive interpretation on the Basic Law on the procedures governing the tenure of the Chief Executive returned in a mid-term election. There
can be no assurance that China will not issue further binding interpretations on the Basic Law that may or may not impact Hong Kongs autonomy of political and economic control. In that event, the political and economic climate in Hong Kong may
be adversely affected or our operations may be changed, which could adversely affect our financial condition and results of operations.



We generate revenues primarily from fares paid by Hong Kong residents and commercial activities within Hong Kong, including property-related revenues; adverse
developments in Hong Kongs social, public health and economic conditions could reduce these revenues and hurt our business and operating results.



Most of our revenues are derived from our business activities in Hong Kong, which are directly affected by the performance of Hong Kongs economy.
Hong Kongs economy is in turn affected, directly and indirectly, by the performance of the economies of mainland China and neighboring Asian countries. As a result, adverse economic developments in Hong Kong or elsewhere in the Asian region
could result in fewer passengers on our railway or reduced rentals and other ancillary revenues which could have a material adverse effect on our financial condition and results of operations.



From the second half of 1997 to 2004, Hong Kong suffered adverse economic
developments and experienced a deflationary phase of the economic cycle. We have not raised fares for seven years in a row due to poor economic conditions. Notwithstanding the improved economic developments in Hong Kong in 2004, we did not raise our
fares due to other social factors. Further, as we have agreed with the Government that the completion of our joint venture residential projects along the Ma On Shan Rail should not take place earlier than 2008, we will not be able to generate
revenue from such residential unit sales until such time. The delay in completion of residential projects along the Ma On Shan Rail and West Rail Phase I will also adversely affect the recurrent revenue from the commercial activities arising from
these new railways. Also, any adverse social, public health and economic developments in Hong Kong or elsewhere in the Asian region could have a material adverse effect on our revenues.



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Our future financial performance, as well as our ability to meet our debt obligations, will depend on the level of
revenues generated from and the costs of operating our new railway projects, which are capital-intensive infrastructure projects, the successful development of which involves many uncertainties.



The construction of large infrastructure projects involves many potential
risks, including land acquisition problems, work stoppages, interruptions resulting from inclement weather, unforeseen engineering, environmental and geological problems and unanticipated cost increases and claims, any of which could give rise to
delays or cost overruns.



Although we have significant
experience in the design and construction of railway projects, there can be no assurance that the new railway projects will be completed within budget and the planned completion schedule or that they will have the scope initially awarded.
Furthermore, economic viability of these capital-intensive transportation projects will depend on the achievement of projections for ridership levels and fares, which in turn may be affected by macro-economic factors such as population growth,
changes in demographic and economic conditions.



Fares have been and will
remain our primary source of revenue. We face competition from other transport providers. The increase in their market shares might adversely affect our revenue growth. Hence, this might inhibit our ability to raise fares or set fare levels that
will adequately cover our costs if we do not want to lose market share.



Although we are the only rail operator providing passenger and freight rail services from Hong Kong to mainland China, our passenger and freight services face competition from other transport providers, primarily
operators of road and sea transport. The lower capital costs of our competitors might allow them to offer transportation services at lower prices and higher frequencies. We might be unable to raise our fares if our competitors do not increase their
fares.



The extension of the opening hours of the Lok Ma
Chau-Huangguang boundary crossing to 24 hours has intensified the competition from cross-boundary coach services. The Government introduced a quota system in August 2004, which restricted the number of coaches in operation. However, our share of the
cross-boundary market, both in percentage terms and in actual numbers of passengers carried, fell and continues to fall almost every month despite the overall cross-boundary market having grown by approximately 18% from 2003 to 2004. As our profits
depend heavily on our cross-boundary passenger services, the increase in the market share of our competitors has adversely affected our revenue growth and profitability. Competition from such cross-boundary coach services may continue to increase
and may adversely affect our revenues in the future. In light of such competition, we might be unable to raise fares without further adversely affecting our market share of the cross-boundary market.



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Our fare revenues depend, in part, on fare levels, and the Government has the ultimate authority to change our
fares; a reduction in our ability or our inability to raise fares to cover future operating costs could adversely affect our financial performance.



Although we are empowered by the KCRC Ordinance to establish our own fares for passenger, freight and other services, the Chief Executive of Hong Kong
may, if he considers it to be in the public interest, give us a direction in writing to adjust our fares. While the Chief Executive of Hong Kong has not exercised this power since the establishment of KCRC, the Chief Executive of Hong Kong may
require us to set fares that do not adequately cover our operating and other costs. Although the KCRC Ordinance provides that we are entitled to receive reasonable compensation from the Government if such direction requires us to act in a manner
contrary to prudent commercial principles, we cannot assure you that restrictions imposed on our fare policies may not adversely affect our results of operations and financial condition or restrict our ability to make payments on our debt
obligations in a timely manner. Furthermore, members of the Legislative Council of Hong Kong may introduce bills to take away our power to determine our fares. Although one such attempt was defeated by a wide margin in 1997, we cannot assure you
that similar bills will not be introduced in the future.



In
August 2003, the Government issued a paper on a new fare-setting mechanism based on a price-cap model, which would allow transport fares to increase or decrease depending on certain factors and by reference to a specified formula. While we are
empowered by the KCRC Ordinance to establish our own fares for passenger, freight and other services and, therefore, are not bound by the recommendations proposed by the Government, the proposals in the paper could potentially lead to lower bus
fares from the bus operators, which could place further downward pressure on our fares, leading to lower revenues.



Accidents, natural disasters and other technological problems could affect the performance or perception of our railway and prevent us from generating rental and
other ancillary revenues or reduce our operating flexibility.



Our operations may be affected from time to time by equipment failures, collisions, derailments and natural disasters, such as typhoons or floods. Natural disasters could interrupt our rail services leading to decreased revenues, increased
maintenance and higher engineering costs. Accidents could interrupt our rail services, subject us to increased liabilities or bring about pressure for greater regulation of our services. Although we have acquired insurance that is consistent with
industry practice against such risks, our insurance may not be sufficient to cover our losses or the losses of others, and the insurance may not continue to be available to us on a commercially reasonable basis. Since we changed our policy from
reporting service delays of 20 minutes or more to service delays of eight minutes or more, the number of service delays we reported in 2004 increased over the number reported in 2003, even though the performance of the East Rail and Light Rail had
generally improved and, in particular, the safety and reliability performance of the latter had improved by 44% in 2004.While there have been no public requests for additional regulation of our services to date, we cannot assure you that the
increased reporting of service delays will not have an adverse impact on the publics perception of our railways safety record and negatively impact our ridership.



We are regulated by the Government, which could modify the scope of our activities or impose obligations on us or our customers which
could reduce revenues, increase costs or otherwise change our business from its current scope.



We are a statutory body established by the KCRC Ordinance, with the Government as our sole shareholder. The KCRC Ordinance, like other statutes and
ordinances of Hong Kong, may be amended, modified or repealed by the Government in accordance with the Hong Kong legislative process. Any amendment, modification or repeal could modify our scope of authorized activities or adversely affect our
financial condition and results of operations by reducing our ability to generate fares or ancillary service revenues or imposing obligations that increase operating costs. Although we are not aware of any proposed material amendments or
modifications to, or efforts to repeal the KCRC Ordinance, we cannot assure you that these kinds of changes will not occur in the future. Furthermore, because our operations are restricted to authorized activities set forth in the KCRC Ordinance,
our ability to enter into new businesses is limited and, to the extent amendments to the KCRC Ordinance are needed, subject to the legislative process.



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Since we are developing additional large-scale infrastructure projects, such as the Lok Ma Chau Spur Line and the
Kowloon Southern Link, we may encounter a shortage of technical staff which could affect our ability to complete the projects in a timely manner or increase the costs of the projects.



While the supply of qualified engineers with expertise in railways in Hong
Kong is limited, we have over the last few years built up an in-house project management team with expertise and experience in railway construction through our experience in developing the West Rail, Tsim Sha Tsui Extension and Ma On Shan Rail
projects, and we have also strengthened our operations, engineering and maintenance capability to operate the new rail projects once completed. Our engineering, safety and operational standards have been enhanced in the past few years. However, due
to the improvement in the economy, we cannot assure you that we will not encounter difficulties in the future in attracting and retaining qualified personnel to successfully complete other new projects in the pipeline in a cost-effective and timely
manner.



If we are unable to obtain financing on reasonable terms
to fund the substantial capital expenditure we expect to incur, we may not be able to implement our planned projects.



We are in the process of expanding our rail network. We expect the total cost of such committed expansion projects to be approximately HK$36.2 billion. In
2005, we will begin incurring capital expenditure on the Kowloon Southern Link, the total project cost of which is currently estimated to be HK$9.0 billion. The details of the capital expenditure related to the Kowloon Southern Link, however, are
not final and will be subject to change even after the execution of the relevant project agreement governing such project. The size of the planned expansion projects, the level of capital expenditure required and the green field nature of some of
the routes will increase the risk to our business and financial operations. We currently expect to finance the projects from internal resources and new debt. We anticipate that we will need to expand our borrowings to meet the project costs for the
construction of the Kowloon Southern Link. We have in the past incurred, and may in the future incur, operating losses. Our actual expenditure in connection with the projects may exceed our planned expenditure due to a number of factors, including
the following:



| |  | change of project design and configuration,
|- |  | -------------------------------------------



| |  | costs of related property developments,
|- |  | ---------------------------------------



| |  | utility costs, such as electricity and energy, which may increase due to the increase in fuel costs,
|- |  | ----------------------------------------------------------------------------------------------------



| |  | costs of equipment for our railroad network,
|- |  | --------------------------------------------



| |  | regulatory and construction problems,
|- |  | -------------------------------------



| |  | the terms on which we finance our working capital and capital expenditure requirements,
|- |  | ---------------------------------------------------------------------------------------



| |  | delays in implementing the projects or commencing operation of the projects and
|- |  | -------------------------------------------------------------------------------



| |  | the level of prevailing interest rates and foreign exchange rates.
|- |  | ------------------------------------------------------------------



We cannot assure you that additional financing will be available on satisfactory terms, if at all. If adequate funds are not available on satisfactory
terms, we may be forced to curtail our project expansion plans or delay project completion dates, which could result in our inability to achieve projected revenues and limit the growth of our operations. We expect our debt level to peak between 2008
and 2011, when HK$26.4 billion of our borrowings are projected to fall due and when new railway construction will still be in progress. For detailed discussion relating to our capital commitments and resources for capital expenditure, see
Item 5. Operating and Financial Review and ProspectsLiquidity and Capital Resources.



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Because we are undertaking certain U.S. dollar denominated capital expenditure for our expansion and expect to
finance a portion of the cost in U.S. dollars, a devaluation of the Hong Kong dollar may increase costs associated with our capital expansion or our Hong Kong dollar cost to repay our indebtedness.



On May 18, 2005, the Hong Kong Monetary Authority adjusted the Hong Kong
dollar currency peg by effectively putting the Hong Kong dollar into a fixed trading band of HK$7.75 to HK$7.85 to US$1.00. Previously, the Hong Kong dollar was linked to the U.S. dollar at the rate of approximately HK$7.80 to US$1.00 since October
17, 1983. We cannot assure you that the Government will not make further adjustments to the currency peg or maintain the link between the Hong Kong dollar and the U.S. dollar at the current exchange rate or at all. Any devaluation of the Hong Kong
dollar would increase the Hong Kong dollar cost of our future capital expenditure, including purchases of equipment, denominated in U.S. dollars or other foreign currencies. In addition, the Hong Kong dollar cost of our current and future
liabilities denominated in U.S. dollars or other foreign currencies would increase. Since substantially all our revenues are denominated in Hong Kong dollars, any devaluation of the Hong Kong dollar may increase capital costs and related
depreciation costs and increase Hong Kong dollar interest expenses on indebtedness in U.S. dollars, thereby reducing our net income, and making it more difficult to repay principal on our U.S. dollar-denominated debt obligations in a timely manner.
For more detail, see Item 5. Operating and Financial Review and ProspectsEffects of Interest Rate and Foreign Exchange Movements on Our Borrowings and Item 11. Quantitative and Qualitative Disclosures About Market
Risks.



At the request of the Government, we have submitted a joint
report with MTRCL to the Government on a possible merger between MTRCL and us. Pending the outcome of the Governments decision on the merger, we are unable to ascertain the effects of such merger on our business, operations, financial results
and financing capabilities.



On February 24, 2004, the
Government invited MTRCL and us to commence negotiations for a possible merger based on the following key parameters: the adoption of a more transparent fare adjustment mechanism; the abolition of the second boarding charge and review of the fare
structure with the objective of reducing fares; early resolution of interchange arrangements for rail projects under planning, notably the Sha Tin to Central Link; ensuring job security for front-line staff at the time of the merger; and provision
of seamless interchange arrangements in the long run. On September 16, 2004, KCRC and MTRCL submitted a joint merger report to the Government which outlined a plan to integrate the railway operations of the two corporations and the results of a
preliminary study on the Hong Kong section of the Express Rail Link. We believe the report has addressed all the key parameters laid down by the Government. The Government has announced that it is studying the report and will announce its decision
in due course.



Pending the announcement of the
Governments decision, it is difficult for us at this time to evaluate the possible impact on our business, operations, financial results and financing capabilities if the merger were to occur. For more detail, see Item 4. Information on
the CorporationGovernment RegulationsMerger between KCRC and MTRCL.



You may have difficulty in enforcing judgments regarding the Notes you hold against us or our management outside the United States.



We are a statutory corporation established under the laws of a jurisdiction other than the United States. All of our Managing Board members and members of
our management reside outside the United States. As a result, in connection with any claims you may have against us relating to the Notes or the indenture, it may be difficult or impossible to serve legal process on us, the members of our management
or our respective experts, or to force any of them to appear in a U.S. court. It may also be difficult or impossible to enforce a judgment of a U.S. court against any of these parties, or to enforce a judgment of a foreign court regarding the Notes
or the indenture against any of these parties in the United States.



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ITEM 4. INFORMATION ON THE CORPORATION



4.A
HISTORY AND DEVELOPMENT



Our legal and commercial name is the
Kowloon-Canton Railway Corporation. We are a statutory corporation, wholly-owned by the Government. We were established in Hong Kong by the Kowloon-Canton Railway Corporation Ordinance (Chapter 372 of the Laws of Hong Kong) (the KCRC
Ordinance) on December 24, 1982. We operate, extend and improve railways in Hong Kong.



We were incorporated to undertake the operation of the Hong Kong section of the Kowloon-Canton Railway. We constructed a Light Rail system in the north-western New Territories and, in 1988, started to operate the
Light Rail system. In December 2003, we commenced operations of West Rail Phase I, which links suburban areas along the north-western New Territories to the Kowloon urban area. In 2000, we undertook the construction of several new railway projects,
namely the Tsim Sha Tsui Extension, the Ma On Shan Rail and the Lok Ma Chau Spur Line (collectively, the East Rail Extensions). Two of the three East Rail Extensions projects were completed in 2004. In October 2004, we opened the Tsim
Sha Tsui Extension which extends the East Rail from Hung Hom to East Tsim Sha Tsui and provides an additional interchange with the Mass Transit Railway (MTR). In December 2004, we opened the Ma On Shan Rail which extends the East Rail
service to Ma On Shan. The construction work of the third East Rail Extension line, the Lok Ma Chau Spur Line is expected to be completed in 2006.



We have completed environmental surveys and detailed design surveys for the Kowloon Southern Link project, which is a natural extension of our existing
West Rail line and will join the West Rail with the East Rail at Tsim Sha Tsui. After the Kowloon Southern Link goes into service, passengers will enjoy convenient rail access from the north-western New Territories to the heart of Kowloon and from
there to any point along the East Rail. The Kowloon Southern Link project will add another HK$9.0 billion to the HK$27.2 billion in projects already underway. The Kowloon Southern Link, when completed, will enable KCRC to realize a long term vision
of connecting urban Kowloon and the New Territories within a comprehensive railway network.



We have submitted the draft final proposal for the Sha Tin to Central Link project to the Government, which would extend the KCRC network to Hong Kong Island. When completed, the Sha Tin to Central Link will enable
passengers to take a train from Hong Kong Island and travel to the boundary with mainland China without leaving the KCRC network. We are awaiting the Governments response to the draft final proposal.



The KCRC Ordinance was amended in 1986, 1998 and 2001. The amendment in 1986
enabled us to construct and operate the Light Rail system. The amendment in 1998 expanded our powers by permitting us to construct and operate any additional railway that the Secretary for the Environment, Transport and Works (the Secretary for
Transport at the time of amendment) may authorize us to construct. The amendment in December 2001 provided for the separation of the functions and duties of the Chairman from those of the Chief Executive Officer by creating the office of Chief
Executive Officer. The Chief Executive Officer was also appointed as a member of the Managing Board.



Our principal executive offices are located at KCRC House, 9 Lok King Street, Fo Tin, Sha Tin, New Territories, Hong Kong, telephone (852) 2688-1333,
facsimile (852) 2688-0185. Our authorized agent in the United States is CT Corporation System and its address is 111 Eighth Avenue, 13thFloor, New York, New York 10011. Our website is www.kcrc.com.



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##### Table of Contents

Business Development



We have continued to expand our rail operations in recent years through the opening of West Rail Phase I in December 2003, the Tsim Sha Tsui Extension and
Ma On Shan Rail in 2004. We continue to prepare for the construction of the Lok Ma Chau Spur Line and Kowloon Southern Link. We expect to continue to devote a large percentage of our efforts in the near future to expanding our rail network and
monitoring current project development. We entered into a HK$8 billion credit facilities agreement with 18 local and international banks in September 2004 to meet part of the project costs in connection with the construction of our new railway
projects. We may see further declines in our revenues from the cross-boundary market due to increased competition from cross-boundary coach services. However, we expect that new property developments and related commercial and property management
activities along the West Rail and Ma On Shan Rail could improve our operating results. These new activities present both opportunities and potential risks to us, and we expect our business expansion and additional competition will result in
substantial changes from our historical operating results. We expect that our revenue mix will change with the addition of new services, and our results of operations will reflect the higher depreciation, interest and operating expenses associated
with operating the new railway systems. If the proposed merger between KCRC and MTRCL proceeds, there may be significant changes in our rail operations, technical interconnections and management personnel, as well as to our plans regarding new
services, rail line extensions and future capital expenditure. We expect that the merger may also have a significant impact on our future liquidity, capital expenditure and financing requirements, but we are unable to estimate the full effect at
this present moment as the merger proposal is still being reviewed by the Government.



Capital Expenditure



We incurred capital
expenditure totaling HK$9,022 million (US$1,160.8 million) in 2004, of which HK$7,992 million (US$1,028.3 million) was incurred for the construction of West Rail Phase I and the East Rail Extensions. This included expenditure on detailed design,
land acquisition, construction and purchase of systems and plant for West Rail Phase I and the East Rail Extensions. A further HK$545 million (US$70.1 million) was spent on the study of new railway projects, including the Kowloon Southern Link and
Sha Tin to Central Link. The remainder was spent on investments to increase passenger growth in the existing businesses and safety and environmental improvements.



Our capital expenditure for 2003 and 2002 was HK$11,122 million and HK$12,308 million respectively, which was principally
incurred for the East Rail Extensions, West Rail Phase I, the Kowloon Southern Link, the Sha Tin to Central Link, the purchase of new rolling stock, the Light Rail Extension to Tin Shui Wai and the grade separation at the Light Rail Transit
junction.



Our capital expenditure for 2005 is estimated at
HK$10,888 million (US$1,400.9 million) and includes HK$4,496 million (US$578.5 million) for West Rail Phase I, HK$3,477 million (US$447.4 million) for the East Rail Extensions, and HK$1,970 million (US$253.5 million) for new railway projects.



4.B BUSINESS OVERVIEW



We operate a commuter railway system linking the suburban areas of Hong Kong
with the urban areas. Our main lines are the 46.5-kilometer East Rail line (which includes the Tsim Sha Tsui Extension and the Ma On Shan Rail) (the East Rail) and the 30.5-kilometer West Rail line (West Rail Phase I).



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##### Table of Contents

Our East Rail line comprises a total of 14 stations from the newly opened station in East Tsim Sha Tsui,
the main terminus in urban Kowloon, to Lo Wu, the terminus on the boundary with mainland China, and a further eight stations on the Ma On Shan Rail from Tai Wai to Wu Kai Sha. This line carried, on average, about 785,000 passengers a day from
January to September in 2004 and increased to 874,000 in the month of December after the opening of the Tsim Sha Tsui Extension and Ma On Shan Rail in October and December 2004, respectively. It is a mass transit carrier with a peak hour frequency
of 2.5 and 3 minutes for the East Rail main line and Ma On Shan Rail, respectively. We also operate intercity passenger services to Guangzhou on our own trains and provide access for other intercity passenger trains running to and from six cities in
mainland China, including Dongguan, Guangzhou, Beijing and Shanghai. Our West Rail Phase I line comprises a total of nine stations from Tuen Mun to Nam Cheong, and commenced revenue service in December 2003. West Rail Phase I operates up to 18
seven-car trains per hour, with a peak hour frequency of 3.5 minutes. This line carried on average 131,500 passenger-trips a day in 2004. Our Light Rail system serves the north-western New Territories, by linking up the townships of Tuen Mun, Yuen
Long and Tin Shui Wai (the Light Rail). The system principally comprises tram-like vehicles which carried about 359,800 passenger-trips a day in 2004. We also carry cargo, primarily textiles, foodstuffs, metals, chemicals and livestock
on the East Rail, and have feeder buses in our Light Rail network as well as connecting the East Rail and West Rail Phase I stations to the neighboring areas.



In 2004, our railway network carried a total of 472 million passengers, or an average of 1.29 million passengers per day, an increase of 23% from 2003.



We supplement our railway revenues with revenues from property
development, ownership and management of investment properties, property management services and commercial activities ancillary to our railway business, such as shop leasing, advertising and telecommunications.



Since we are wholly-owned by the Government, our motivation in operating our
services differs from private corporations, which would seek to maximize corporate profits. Nevertheless, under the KCRC Ordinance, we are required to operate on prudent commercial principles. Our financial strategy is to generate sufficient
revenues from customers to cover operating costs, maintain and improve the quality of plant, equipment and service, repay our debt and earn a reasonable rate of return for the Government.



The following table sets out the revenue and operating profit/(loss) after depreciation and before net finance
income/(expenses) and tax for each of our operating divisions for the periods indicated:



|                     |  |                         |  |                                                           |      |  |          |      |                                                          |   |  |          |     |  |                                                            
|-------------------- |  | ----------------------- |  | --------------------------------------------------------- | ---- |  | -------- | ---- | -------------------------------------------------------- | - |  | -------- | --- |  | -----------------------------------------------------------
|                     |  | Year Ended December 31,
|                     |  | 2002                    |  |                                                           | 2003 |  |          | 2004
|                     |  | Revenues                |  | Operatingprofit/(loss)before netfinance income/(expenses) |      |  | Revenues |      | Operatingprofit/(loss)before netfinanceincome/(expenses) |   |  | Revenues |     |  | Operatingprofit/(loss)before netfinanceincome/(expenses)(1)
|                     |  | HK$                     |  | HK$                                                       |      |  | HK$      |      | HK$                                                      |   |  | HK$      |     |  | HK$                                                        
|                     |  | (in millions)          
|Passenger services   |  |                         |  |                                                           |      |  |          |      |                                                          |   |  |          |     |  |                                                            
|East Rail            |  | 3,569                   |  | 1,666                                                     |      |  | 3,266    |      | 1,353                                                    |   |  | 3,415    | (2) |  |                                                           
|Light Rail           |  | 558                     |  | (95                                                       | )    |  | 468      |      | (94                                                      | ) |  | 416      |     |  |                                                           
|West Rail            |  |                        |  |                                                          |      |  | 11       |      | (61                                                      | ) |  | 382      |     |  |                                                           
|Freight              |  | 86                      |  | (27                                                       | )    |  | 74       |      | (36                                                      | ) |  | 68       |     |  |                                                           
|                     |  |                         |  |                                                           |      |  |          |      |                                                          |   |  |          |     |  |                                                            
|Transport Services   |  | 4,213                   |  | 1,544                                                     |      |  | 3,819    |      | 1,162                                                    |   |  | 4,281    |     |  | 58                                                         
|Property Services(3) |  | 617                     |  | 390                                                       |      |  | 607      |      | 387                                                      |   |  | 695      |     |  | 479                                                        
|                     |  |                         |  |                                                           |      |  |          |      |                                                          |   |  |          |     |  |                                                            
|Total                |  | 4,830                   |  | 1,934                                                     |      |  | 4,426    |      | 1,549                                                    |   |  | 4,976    |     |  | 537                                                        
|                     |  |                         |  |                                                           |      |  |          |      |                                                          |   |  |          |     |  |                                                            

---

|(1) | In December 2003, East Rail Division, West Rail/ Light Rail Division were combined to form a single Transport Division to allow management more flexibility in the
deployment of resources and enable us to achieve synergy and savings, particularly for those services common to all railway networks, such as maintenance. The Transport Division manages all the transport services including East Rail, Light Rail,
West Rail and Freight. Since December 2003, most of the costs are common to various railway services including East Rail, Light Rail, West Rail and Freight. Consistent with our internal organizational and management structure, a transport services
segment has been created in place of East Rail, Light Rail, West Rail and Freight. Commencing 2004, separate profit/(loss) figures for individual business segments are not available.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(2) | Includes the Tsim Sha Tsui Extension and Ma On Shan Rail which commenced operations on
October 24, 2004 and December 21, 2004, respectively.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Includes recurrent commercial, property ownership and management revenues from the Property Division such as leasing, rental, advertising and estate management, but
excludes property development income.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Rail Operations



East Rail



The East Rail line is a 46.5-kilometer railway with 22 stations, which
includes the Tsim Sha Tsui Extension and Ma On Shan Rail which opened in 2004. Passenger services on the East Rail main line are provided by 37 electric multiple units of 12 cars each, and services on the Ma On Shan Rail are provided by 18 electric
multiple units of 4 cars each. Our train punctuality rate of 99.7%, train service delivery rate of 99.9% and ticket vending machine availability rate of 99.47% in 2004 exceeded our internal performance targets.



Overview



In 2004, our East Rail operations accounted for 68.6% of our total revenue.
Domestic passenger ridership in 2004 increased by 5.3% to 566,300 passengers a day, from 537,800 a day in 2003. Average cross-boundary patronage increased by 3.6% to 232,500 a day in 2004, from 224,500 a day in 2003, although the East Rail continued
to lose market share to road-based transportation. The East Rail retained a 41.8% share of the domestic market travel between the New Territories and urban areas and a 61.2% share of the cross-boundary market, compared to 50.1% and 68.6%
respectively in 2003. Revenue increased by 4.6% from HK$3,266 million (US$420.2 million) in 2003 to HK$3,415 million (US$439.4 million) in 2004, mainly due to the recovery in patronage after the impact of the Severe Acute Respiratory Syndrome
(SARS) outbreak in 2003 and the opening of the Tsim Sha Tsui Extension, which was partially offset by the loss of cross-boundary market share to road-based transportation.



The Tsim Sha Tsui Extension and Ma On Shan Rail



The Tsim Sha Tsui Extension and Ma On Shan Rail were opened for public service on October 24, 2004 and December 21, 2004,
respectively.



Construction on the Tsim Sha Tsui Extension and
Ma On Shan Rail was undertaken throughout 2004. Architectural finishing and building services installation works on the pedestrian subway in the East Tsim Sha Tsui station were completed in June 2004, and statutory inspections were carried out
successfully between May and July 2004. On the Ma On Shan Rail, all architectural finishing works and building services installation at the nine stations were substantially completed in mid-2004, and all building services systems were tested from
the second quarter of 2004. The Tsim Sha Tsui Extensions overhead line system was energized on March 15, 2004 and the entire system was tested from April to July 2004. The Ma On Shan Rails overhead line system was energized on April 1,
2004 and the entire system was completed by the end of July 2004, and system acceptance tests were then carried out to ensure that all systems met performance standards.



Formal trial operations on the Tsim Sha Tsui Extension started on August 1, 2004 and were successfully completed on August
27, 2004. For the Ma On Shan Rail, formal trial operations began on September 28, 2004 and continued for two months. The results for both the Tsim Sha Tsui Extension and Ma On Shan Rail substantially exceeded the set performance targets. The trial
operations and tests also allowed our operations and maintenance staff to familiarize themselves with the new systems and contingency plans and drilled them in troubleshooting and emergency response skills.



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We had made public consultation and involvement in both the Tsim Sha Tsui Extension and the Ma On Shan
Rail projects a priority since the design stage. Community Liaison Groups, composed of local residents, members of estate management committees and District Councilors, were formed in Tsim Sha Tsui and Ma On Shan. The groups met regularly with our
staff and were briefed on the progress of the works and matters such as temporary traffic arrangements. We also published a bi-monthly projects update, describing the latest progress on both projects, which were distributed in the communities. The
Legislative Council, relevant District Councils, the Transport Advisory Committee and community leaders were briefed and consulted on the principles by which the fares for the new railways were determined. A passenger survey was also conducted on
the new fares.



Cross-Boundary and Through-Train Services



We are responsible for operating local and cross-boundary
passenger services between Hung Hom and Lo Wu on our East Rail line. We also operate through-train services to Guangzhou on our double deck Ktt train and provide access for other through-trains operated by other mainland China railway
operators or authorities running to and from six cities in mainland China, namely Dongguan, Guangzhou, Foshan, Zhaoqing, Beijing and Shanghai.



In 2004 the daily patronage of through-trains was 8,070 passengers, an increase of 37.5% compared to 2003, largely due to the reluctance of the public to
travel due to the SARS outbreak in the early half of 2003, the increased number of business and leisure travelers between mainland China and Hong Kong, and the increased frequency of the Guangzhou-Kowloon through-trains to 12 pairs per day from
April 2004. The average daily number of passengers traveling to Lo Wu and onward to mainland China increased by 3.6% from 224,500 in 2003 to 232,500 in 2004; however our market share of cross-boundary passenger traffic decreased by 7.4% from 68.6%
in 2003 to 61.2% in 2004. This decrease in market share is primarily due to the increasing competition from cross-boundary road-based transportation.



Cross-Boundary Services



As Lo Wu is in a restricted area near the boundary between Hong Kong and mainland China, to which KCRC has exclusive access on the Hong Kong side, we
have, in previous years, enjoyed the benefits of increasing cross-boundary traffic. Lo Wu, directly across the boundary from Shenzhen downtown area, is the more convenient boundary crossing for travelers going to Shenzhen on business or shopping, a
leisure activity that has been popular with Hong Kong residents in recent years. We are able to charge passengers traveling to Lo Wu a higher fare. The current domestic fare from the East Tsim Sha Tsui station in Kowloon to Sheung Shui station (the
last station before Lo Wu) is HK$12.5 one way, compared to the cross-boundary fare of HK$36.5 from the East Tsim Sha Tsui station to the Lo Wu station.



On January 27, 2003, the Government extended the opening hours of the Lok Ma Chau-Huanggang boundary crossing to 24 hours. This resulted in intensified
competition from cross-boundary coach services. In August 2004, the Government introduced a quota system which restricted the number of cross-boundary coaches in operation. However, our share of the cross-boundary market, both in percentage terms
and in actual numbers of passengers carried, continues to fall almost every month despite the overall cross-boundary market having grown by approximately 18% from 2003 to 2004. Currently rail transport has a market share of approximately 60% of the
cross-boundary market as compared to a market share of approximately 30% to 40% of the Hong Kong domestic public transport market. As the economic relationship between Hong Kong and mainland China continues to grow closer, we expect that more road
crossings, such as the Western Corridor, will be opened. It would be reasonable to assume that the market share for cross-boundary rail transport will gradually fall. Given the lower fare structure of the coach operations, it will be a challenge for
us to maintain a premium on cross-boundary fares. It is likely that the competition from road-based cross boundary transport will continue to erode the market share and revenues of the East Rail going forward.



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|                               |  |                               |  |                         |  
|------------------------------ |  | ----------------------------- |  | ----------------------- | -
|Cross-Boundary Lo Wu Ridership | 
|                               |  |                              
|                               |  | Daily Average Passenger trips |  | Year on year Growth (%) |  
|1999                           |  | 206,481                       |  | 15.5                    |  
|2000                           |  | 229,120                       |  | 10.9                    |  
|2001                           |  | 236,800                       |  | 3.4                     |  
|2002                           |  | 251,600                       |  | 6.3                     |  
|2003                           |  | 224,500                       |  | (10.8                   | )
|2004                           |  | 232,500                       |  | 3.6                     |  



Through-Train
Services



In addition to the through-train service between
Hong Kong and Guangzhou, through-train services between Hong Kong and Beijing, and between Hong Kong and Shanghai commenced operations in May 1997 with one train operating to either destination on alternate days. The Beijing and Shanghai Railway
Administrations respectively operate these intercity trains. We cooperate with railway operators in mainland China in establishing a joint ticketing system for the through-train services and share the revenues and costs of these services based
principally on the distances traveled on the respective railways.



In July 2003, mainland China authorities introduced the Individual Visitor Scheme, which relaxed visa restrictions for residents of some mainland cities who wish to visit Hong Kong. As of March 2005, residents of Guangdong, Beijing,
Shanghai, Tianjin, Chongqing and certain cities in Zhejiang, Jiangsu and Fujian provinces are able to apply for tourist visas. The signing of the Closer Economic Partnership Agreement (CEPA), a free trade agreement between Hong Kong and
mainland China, which was effective as of January 1, 2004, has increased cross-boundary business opportunities and led to increased demand for cross-boundary and through-train services on the East Rail as more Hong Kong and mainland China residents
cross the boundary for business and leisure.



We launched a
number of on-board service enhancements and marketing initiatives with travel and leisure industry partners in 2004. As a result of such initiatives, we were able to increase our passenger numbers on our through-train services. The market share of
the Hong Kong - Guangzhou passenger traffic of the through-train services increased by 2.5% from 22.9% in 2003 to 25.4% in 2004. We are currently working with our mainland counterparts to open new routes to other mainland cities such as Guilin and
Jiujiang.



The growing social and economic ties between Hong
Kong and mainland China present new business opportunities for us, as we operate the only Hong Kong railway that connects with mainland Chinas rail network. In May 2004, our Chairman and Chief Executive Officer (Acting) met the Minister of
Railways in Beijing where a decision was made to form a Joint Committee of the Chinese Ministry of Railways and KCRC to provide a forum to address cross-boundary rail passenger and freight transportation issues. It replaced the Four-way Joint
Committee formed by KCRC, the Beijing Railway Administration, the Shanghai Railway Administration and the Guangzhou Railway (Group) Corporation. In December 2004, a delegation led by the Chief Executive Officer (Acting) held the first joint session
with the Chinese Ministry of Railways. Working groups on passenger and freight issues were established and the initial timetable for the groups meetings was set at this meeting.



We have also developed a cooperative relationship with the Shenzhen Metro which opened in December 2004, as we believe
convenient interchanges between the East Rail and the Shenzhen Metro at Lo Wu and Lok Ma Chau will facilitate cross-boundary passenger flows. The scheduled opening of the Hong Kong Disneyland in September 2005 should also contribute to the growth in
cross-boundary passenger traffic in coming years. We plan to expand cooperation with travel agencies, hotels, airlines and theme park operators to offer more travel-related services. New routes to other mainland China cities are also being explored.
Given the increasing traffic crossing the boundary, through-train patronage is expected to continue to grow in the short and medium term.



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Facility Improvements



We plan to continue our section-by-section track replacement program, install noise barriers on selected sections of our
line and make improvements to selected stations. To date, we have completed noise barriers at 23 sites along the East Rail alignment. We have also started to install noise barriers at the southern part of the Sheung Shui station. The construction
contract for stage one installation works was awarded in April 2004 with the contract for stage two installation works anticipated to be awarded by the third quarter of 2005 for completion in 2006. During the year, we also successfully introduced
five environmentally-friendly diesel locomotives for the East Rail, which are much quieter and have less smoke emission.



In the past few years, we carried out a number of station improvement projects to widen station concourses, construct new entrances and install or upgrade
the facilities at the Hung Hom, Mong Kok, Fo Tan, University and Fanling stations with a view to increasing the passenger handling capacities to meet the growing demand. The design and construction of a new 18,000 square meter southern concourse at
the Kowloon Tong station as well as a second 60-meter subway link to the existing Mass Transit Railway (MTR) station began in 2001 and was opened for public use in April 2004. We commenced station improvement works at the Sheung Shui
station in July 2003 to extend the station concourse, widen the northbound platform and improve station facilities by installing more entry and exit gates, ticket vending machines and escalators. The station improvement works are planned to be
completed by the third quarter of 2006 in advance of the commencement of operation of the Lok Ma Chau Spur Line.



We made further improvements to the Lo Wu station to assist passenger movement, such as the completion of a new passenger platform in March 2004, the
widening of existing passenger platforms, installation of additional escalators and new ticket flap gates. We also segregated the boarding and alighting of passengers to facilitate better passenger flow. We believe that these improved terminal
facilities will enhance the quality of travel for our local and foreign travelers, which in turn will improve our competitiveness against cross-boundary coach services.



Operations and Safety



The East Rail maintained high service and safety performance in 2004. The East Rail maintained a train service delivery rate of 99.90%, and a train
punctuality rate of 99.70%, both exceeding our target rates. The East Rail also significantly improved train reliability with a record low of only one failure per 795,717 car-kilometers, which represents a decrease of 16.6% from 2003. Further, the
number of complaints per million passengers dropped from 2.32 in 2003 to 1.85 in 2004. The passenger accident rate was 0.74 per million passengers.



To further increase safety levels, we implemented new size limitation for luggage that can be carried on all our trains, and we deployed 80 safety
assistants in the East Rail stations from July to September 2004 to promote, advise and assist passengers in the safe use of escalators and lifts and ensure that passengers follow proper boarding and alighting instructions.



The Beacon Hill Tunnel built in 1980 was not equipped with any smoke
extraction system. Should a serious fire occur inside the tunnel, smoke will accumulate and lead to severe hazards as it will hinder effective rescue and fire fighting. As part of the safety improvement plan for the East Rail, we have budgeted
capital expenditure of HK$137 million for the construction of a smoke extraction system in the Beacon Hill Tunnel which will be in line with the current railway design standard, NFPA 130 Standard for Fixed Guideway Transit and Passenger Rail
Systems. The scope of work includes the construction of tunnel ventilation buildings, supply and installation of smoke extraction fans, upgrading of the power supply, provision of a temperature monitoring system, diversion of existing services and
associated civil construction work. The contract for the construction work was awarded in October 2004. It is expected that upon the completion of the project in 2005, we will have fast and accurate monitoring of high temperatures, thus lowering the
risk of severe fatalities and enabling quick responses to incidents as well as a smoke-free environment for passenger evacuation and fire fighting. Over 300 members of the public participated in a safety drill held in the Beacon Hill Tunnel in
October 2004 to increase public awareness of emergency preparedness and responses.



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Fare Promotions



To encourage ridership on the East Rail in light of intense competition, we introduced a 20% trip discount for travelers who
took a second trip on the East Rail domestic section on the same day. The discount scheme, which initially ran from April 2003 to September 2003, was extended to May 31, 2005. In addition, in April 2005 we introduced a monthly pass scheme, which
would enable passengers to take unlimited rides on the East Rail domestic section for a fixed monthly fee. The monthly pass scheme is scheduled to end on September 30, 2005.



West Rail Phase I



The West Rail is a mass transit commuter rail line linking suburban areas along the north-western corridor of the New Territories to the Kowloon urban
area. It is designed to resolve the long-standing transport problems for residents in the north-western New Territories by linking west Kowloon with Tuen Mun in the western New Territories. West Rail Phase I has nine stations with a 30.5-kilometer
railway, and operates on an electrically-powered rail system that is environmentally friendly. West Rail Phase II is planned to connect West Rail Phase I from Kam Tin to Lok Ma Chau, Sheung Shui and Lo Wu, and would connect the cross-boundary
passenger and freight services with west Kowloon. However, Phase II may be replaced by the Northern Link which would join the East Rail and West Rail Phase I at the northern section. See Item 4. Information on the CorporationBusiness
OverviewFuture Railway Development.



West Rail
Phase I was officially inaugurated on December 20, 2003, and full passenger operations commenced as of that date. Passenger services on West Rail Phase I are provided by 18 electric multiple units of seven cars each, and are anticipated to be
increased to nine-car lengths as ridership increases and demand grows. West Rail Phase I reduces commuters traveling time from the north-western New Territories to urban Kowloon by half, with a complete journey from one end of the alignment to
the other taking less than 30 minutes. Since West Rail Phase I commenced commercial operation, we have focused our efforts on ensuring the smooth operation of and securing ridership for West Rail Phase I, and we have undertaken activities to
maximize public confidence and enhance West Rail Phase Is connectivity and accessibility. These efforts, along with publicity and promotional campaigns and fare offers, steadily attracted passengers during 2004, helping the railway achieve a
72% growth in patronage during the year. Ridership increased from a daily average of 100,500 in January 2004 to 172,900 in December 2004. We anticipate that by year end 2005 the daily average ridership for West Rail Phase I will reach 173,200 for
the year.



West Rail Phase I is connected to the MTR system at
two junctions, namely the Tsuen Wan line at the Mei Foo station, and the Tung Chung line at the Nam Cheong station. West Rail Phase I is also connected to the Light Rail system at the Yuen Long, Tin Shui Wai, Siu Hong and Tuen Mun stations. Further,
public transport interchanges at most stations allow passengers to transfer conveniently between various kinds of feeder transport services. We have commenced free feeder bus services to increase the accessibility of the West Rail Phase I stations.
We anticipate that the West Rail will be an important service link for passengers upon the completion of the Kowloon Southern Link, which is anticipated to be completed in 2009, when passengers will be able to transit through Tsim Sha Tsui to Hung
Hom station.



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Fare Promotions



We introduced numerous fare promotions and special offers, including interchange discounts with other public transport
providers, to attract new riders. The West Rail Student One-Day Pass was introduced during the 2004 school summer holidays, and an average of about 500 passes were sold each day. The West Rail One-Month Pass received an overwhelming response when it
was introduced in August 2004, and the original month-long offer was extended to the end of 2004 and further until June 2005.



Inter-Railway Operability



Most of the railway systems of West Rail Phase I, the Tsim Sha Tsui Extension and the Ma On Shan Rail are designed to be operated compatibly with each
other to facilitate future linkage of the West Rail with East Rail. As an illustration, the new rolling stock ordered from the Itochu-Kinki-Kawasaki Consortium for the three projects is identical and the electric voltage is the same for the three
operating systems. However, while the signaling system on West Rail Phase I is compatible with that on the Ma On Shan Rail, the signaling system on the East Rail main line, including the Tsim Sha Tsui Extension, is not yet compatible with that on
West Rail Phase I. Upon the completion of the Kowloon Southern Link, the signaling system on the Tsim Sha Tsui Extension will be replaced with the system used on the West Rail to facilitate its extension to Hung Hom.



Facility Improvements



In August 2004, we completed the grade separation/viaduct project at Tsing
Lun Road. The new viaduct, which crosses over Tsing Lun Road, saves passengers traveling time, enhances operating safety and increases the capacity of the junctions along Tsing Lun Road. The bay management system at Tin Yat was completed in June
2004. The installation of the new signaling system for the existing network is continuing and will be completed by late 2005.



A total of 132 pedestrian signs and 51 traffic signs were added, relocated or modified in the vicinity of the West Rail stations to increase
accessibility. Additional directional signage was also erected at stations, and some entry and exit gates were relocated to improve passenger flow during 2004.



Light Rail Services



Our Light Rail system commenced operation in September 1988 and with the opening of the new Tin Shui Wai Extension in December 2003, comprises 36.2
kilometers of double track with 68 stops. As of December 31, 2004, the Light Rail system operates within the areas of Tuen Mun, Yuen Long and Tin Shui Wai in the north-western New Territories. It is a regional mass transit system utilizing vehicles
which are similar to trams on tracks which run parallel to public roads and as of December 2004 had 119 Light Rail vehicles. In 2003, the Light Rail vehicles recorded a punctuality rate of 99.60% and a ticket equipment availability rate of 99.86%,
which equaled or exceeded our internal performance targets.



During 2003, we reorganized our Light Rail and bus services in order to provide a more efficient feeder service to increase public access to the West Rail Phase I stations, and to give the public additional incentive to use West Rail Phase
I for internal and external travel. Light Rail ridership rose significantly during the year, from an average of 330,900 passengers per day in January to 382,800 in December 2004. In 2004, there was an average of 359,800 passenger trips on Light Rail
each day, an increase of 23.5% over 2003. However, Light Rail revenue decreased 11.1% from 2003 to 2004 to HK$416 million (US$53.5 million), mainly due to lower Light Rail feeder bus revenue as a result of the rationalization of feeder bus service
routes that followed the West Rails opening in 2003. The Light Rail maintained a 51.4% market share of the internal public transport market in the north-western New Territories, mainly due to an aggressive marketing and promotional program.
However, this still represented a decrease from a market share of 60.7% in 2003, as the KCRC bus services took on a greater share of the market in Tin Shui Wai prior to the opening of the Light Rail Extension.



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A total of 75 entry and exit Octopus Card processors were relocated on Light Rail platforms during 2004
in order to better serve the changed passenger flows resulting from the rationalization of Light Rail routes. To further enhance passenger service, 32 additional Octopus Card enquiry processors were installed on Light Rail platforms. All Light Rail
platforms are now equipped with enquiry processors, enabling passengers to check the status of their Octopus Cards at their convenience.



Passenger and public injuries per million passengers carried was 0.14 in 2004, an improvement over 0.25 in 2003. We also undertook a number of programs
designed to maintain safety levels on the Light Rail during the year. These included anti-jaywalking campaigns, the installation of additional signage, public safety and promotional campaigns, and ongoing safety training for drivers and staff.



Bus Operations



We established bus operations in 1986 to provide efficient feeder bus
services to our Light Rail system in the north-western New Territories and to our East Rail line. As of December 31, 2004, we operated 16 feeder bus services and residential and express routes. The current bus fleet consists of 129 vehicles, 90
air-conditioned buses and 39 non-air-conditioned buses. We decided to purchase 53 second-hand air-conditioned buses with low-floor facilities during the year. Most of the new buses will replace non air-conditioned buses, while the others will be
used to open new West Rail feeder bus routes. The new buses, which will be delivered during the first quarter of 2005, will increase our bus fleet to 143.



We are not entitled to charge fares on our feeder bus services for the East Rail but may charge for bus services operating in certain areas in the
north-western New Territories. We entered into a commercial agreement with Kowloon Motor Bus in May 1999 to run our feeder bus routes to Tai Po, Sha Tin and Fo Tan. At present, there are seven such routes. This arrangement enables us to generate
revenues (from fares charged by Kowloon Motor Bus) from passengers who do not use the bus services to connect to the East Rail and, by indirectly benefiting from fuel tax concessions given to franchised bus operators such as Kowloon Motor Bus, to
reduce costs. The special bus routes are stand-alone routes which charge a separate fare and to which the integrated fare system is not applicable.



The average daily bus ridership during 2004, excluding the seven feeder routes for the East Rail run by Kowloon Motor Bus, was 56,660, a decrease of 21.6%
from the average of 72,230 recorded in 2003. The market share of the Light Rail feeder buses in the north-western New Territories was 7.7% in 2004.



Freight Services



Freight services, operating on the same East Rail track as the passenger services, convey cargoes by rail between Hong Kong and mainland China. We also
provide forwarding and terminal services. We carry three main types of cargo:



| | (1) | containers;
| | --- | -----------



| | (2) | breakbulk; and
| | --- | --------------



| | (3) | livestock.
| | --- | ----------



Our containers and breakbulk cargoes comprise mainly textile fibers, foodstuffs, metals, chemicals and machinery.



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We operate container services to 42 cities and breakbulk services to 60 cities in mainland China. We have
seven representative offices in Shenzhen, Dongguan, Wuhan, Chengdu, Kunming, Xian and Changsha in mainland China for liaison with our freight business associates and customers and for services promotion. Freight revenue decreased by 8.1% to HK$68
million (US$8.7 million) from HK$74 million in 2003, mainly due to the decreased breakbulk and livestock traffic as well as lower income generated from forwarding and terminal services. Freight services accounted for 1.4% of total revenue of KCRC in
2004. In light of the continued operating losses of our freight services, we have reviewed options such as repositioning our rail freight business. As a result, we have decided to phase out our freight forwarding services by end 2005.



Southbound rail-borne freight, both breakbulk and containerized, either
originates in Guangdong province or comes from the interior provinces in Mainland China via Guangdong. From Pinghu in Longgang, rail-borne freight is distributed to Yantian and Shekou in Shenzhen and Hong Kong. Yantian and Shekou, which are
container terminals in Shenzhen just across the boundary, are competitive threats to our Hong Kong transshipment services as mainland China exporters have been choosing road freight or barge freight services and exporting through these ports as they
offer lower terminal handling charges than Hong Kong. However, we believe that the lack of infrastructural support and banking facilities compared to Hong Kong makes these ports comparatively less attractive to shippers, although such ports are
becoming more competitive.



The livestock freight service is a
regular and longstanding business for us but carries a low margin and has generated low profit. There is a general market trend towards containerized cargoes. In line with this trend, our container rail freight business accounted for a higher
proportion of our freight business than other rail freight segments. Through cooperation with Guangshen Railway Co. Ltd. in 2002, we started the Dongguan Block Train linking Hong Kong with the key manufacturing hub of Dongguan. We continue to lobby
the Ministry of Railways, local railway administrations and companies and business associates in mainland China for support in enhancing the scope and quality of our freight services. At the same time, we continue to make efforts to improve the cost
efficiency of our freight marketing and operations.



To improve
efficiency, financial control and customer service, we continue to integrate all of our electronic freight business systems and enhance our financial control and invoicing systems. In 2003, we launched the first phase of a web-based Freight Business
System for the purpose of streamlining documentation handling procedures. Once fully implemented, the system will give customers access to tracking information with respect to their wagon and container status, booking orders, quotations, and the
handling of chemicals. In May 2004, we merged the management of our freight services and intercity passenger services so that cross-boundary issues could be dealt with in a more cost efficient and consistent manner.



We were selected as the Best Rail Operator  Asia in the Asian Freight
& Supply Chain Awards in April 2004 and the Rail Freight Operator of the Year in the Asia Logistics Award 2004 in November 2004. We won the latter award, decided by a vote among freight industry professionals, for the third year in a row.



Currently Planned Rail Extensions



Lok Ma Chau Spur Line



To relieve the pressure on the Lo Wu station at the boundary with mainland
China, where the current weekend hourly passenger demand exceeds the current immigration processing capacity, we are constructing the 7.4-kilometer Lok Ma Chau spur line from the Sheung Shui station on the East Rail main line to the Lok Ma Chau
station at the boundary with mainland China (Lok Ma Chau Spur Line), as Hong Kongs second railway crossing. By providing a second railway boundary crossing between Hong Kong and mainland China, the Lok Ma Chau Spur Line will
relieve congestion at Lo Wu and facilitate growth in cross-boundary rail passenger traffic.



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The Lok Ma Chau Spur Line will consist of 5.2 kilometers of tunnels and 2.2 kilometers of viaducts. The
Lok Ma Chau Spur Line will branch off the existing East Rail alignment north of the Sheung Shui station, run in tunnels from Sheung Shui to Chau Tau, and then rise gradually onto viaducts until it reaches the new station at Lok Ma Chau.



We have worked closely with the rail, municipal and immigration
authorities in mainland China to ensure that the Lok Ma Chau Spur Line will be integrated into the transportation and immigration facilities on the mainland China side of the boundary. The Lok Ma Chau Spur Line Terminus will be linked to the
Huanggang station of the new Shenzhen Metro by a double-deck passenger bridge.



Construction commenced in January 2003 and by the end of 2004 the civil construction works were 67% complete. The railway systems installation works for the Lok Ma Chau Spur Line are underway in 2005. Tracklaying
commenced in March 2005 and is expected to be completed in 2006. The southbound tunnel, running from Sheung Shui to Chau Tau, was broken through in June 2004. The northbound tunnel was completed in April 2005. The 2.2 kilometer long viaduct consists
of 1,410 separate segments. By the end of 2004, all of the 89 viaduct spans had been erected. The installation of the parapets commenced in April 2004 and was 91% complete by the end of 2004. Overall, the viaduct construction works were 92% complete
by the end of 2004.



The structures of the three-storey
cross-boundary terminal building at Lok Ma Chau, which will house the railway, customs and immigration facilities, were about 80% complete by the end of 2004. Precast concrete elements are being used extensively to ensure better control over
construction activities in view of the close proximity to sensitive ecological areas. The station structure was completed to roof level by the end of 2004. The permanent way contractor was given earlier access for the derailment kerb construction
necessary before tracklaying, which began in March 2005. Electrical and mechanical works are scheduled to begin on the station in June 2005.



An Environmental Committee created for the Lok Ma Chau Spur Line meets quarterly to review and monitor our environmental performance on the Lok Ma Chau
Spur Line. It is composed of members from KCRC and environmental groups, including Friends of the Earth (HK) Charity Ltd., the Hong Kong Bird Watching Society and WWF Hong Kong. The Lok Ma Chau Spur Line project utilizes real-time web cameras that
monitor the site so members of the public can observe the environmental performance of the project teams.



Sha Tin to Central Link



In response to the Governments invitation in July 2001, we submitted a proposal for the design, construction, financing and operation of a new
railway line from Sha Tin to Central (the Sha Tin to Central Link). On June 25, 2002, the Government announced that we had won the bid to build and operate the Sha Tin to Central Link. Pursuant to our bid proposal, the Sha Tin to Central
Link will be an 18-kilometer rail system and will be connected with the Ma On Shan Rail. Once completed, this new line will extend the KCR network to Hong Kong Island. Passengers will then be able to cross the harbor from Kowloon and the New
Territories to Hong Kong Island without leaving the KCR network. In addition, our proposal also includes a major reconfiguration of the Hung Hom station so that it will become a mass transportation center. This facility will serve domestic,
cross-boundary and intercity trains of the Sha Tin to Central Link, East Rail and West Rail.



We have completed the scheme design for the Sha Tin to Central Link and we submitted the draft final proposal to the Government in September 2004. The railway scheme and implementation program of the Sha Tin to
Central Link are subject to the Governments final decision, which is pending the Governments decision on the proposed merger between KCRC and MTRCL.



20



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Kowloon Southern Link



In September 2002, the Government invited us to design, build and operate the 3.8 kilometers Kowloon Southern Link, which is
planned for completion in 2009. The Kowloon Southern Link will run along Canton Road and link the East Tsim Sha Tsui station to West Rails Nam Cheong station, joining the two major KCRC railway lines at the southern end. The link will provide
the traveling public with a convenient and direct point of transfer between these two railway lines. On completion, the West Rail will be extended from the Nam Cheong station to Hung Hom via West Kowloon and Tsim Sha Tsui, and both the East Rail and
West Rail will terminate at Hung Hom with convenient cross-platform interchanges provided.



Although all estimates of cost are preliminary and subject to the final project agreement and market conditions at the time, we expect that of the current total estimated project cost of HK$9.0 billion (US$1,157.0
million), HK$8.1 billion (US$1,039.0 million) will be construction costs, HK$0.2 billion (US$29.0 million) will be land costs and HK$0.7 billion (US$89.0 million) will be financing costs. We expect to finance the project from internal resources and
new debt.



We have completed the scheme design study and the
design and build tender packages for the Kowloon Southern Link. The environment impact assessment has also been completed and submitted for public consultation. After considering the engineering complexities and the extensive disruption to the
public that the construction of the Kowloon Southern Link would cause, we proposed to adopt a bored tunnel design along Canton Road to minimize land resumption and minimize disturbance to traffic, and to construct only one station at West Kowloon.
The rail link will be constructed underground.



The Kowloon
Southern Link was gazetted under the Railways Ordinance in March 2004. We amended the Railway Scheme in response to views received during the gazettal period, and the Government gazetted these amendments on January 7, 2005. Subject to the approval
of the Chief Executive in Council, contracts will be awarded in mid-2005 and construction will begin soon thereafter. The completion date is scheduled for 2009.



Northern Link



During 2004, we made significant progress on the planning of the Northern Link, which will join the northern sections of the East Rail and West Rail and
is the next natural extension of the KCR network, complementing the southern link achieved by the Kowloon Southern Link. The Northern Link will also provide a second cross-boundary rail link, connecting the West Rail from Kam Tin to Lok Ma Chau. The
likely completion timing for the Northern Link is between 2011 and 2016 depending on the development program of the strategic growth areas and the growth of the cross-boundary traffic. Upon completion of the Northern Link, East Rail and West Rail
will form a massive single loop serving the New Territories and Kowloon.



In February 2004 we submitted a preliminary in-house study report on the Northern Link to the Government. Having reviewed the study report, the Government provided the Study Brief and invited us to conduct a
Preliminary Project Feasibility Study. Consultants were engaged in September 2004 to undertake the study, which will be completed in mid 2005.



Express Rail Link



The Governments Railway Development Strategy 2000 included an Express Rail Link to facilitate the flow of people between Hong Kong and mainland
China. This Express Rail Link will meet passenger demands arising from the closer social and economic ties that have developed between Hong Kong and mainland China.



21



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In 2004 the Government invited us to study the feasibility of operating express rail services using the
West Rail and the proposed Northern Link, with a short section branching out to connect with the railway in mainland China. The preliminary findings of this feasibility study are expected in mid 2005.



Pricing of Rail Services



Under the KCRC Ordinance, KCRC is empowered to determine fares for our
passenger services and charges for freight and other services. Our Managing Board normally reviews fares on an annual basis. The Managing Board exercises this power independently of the Government, taking into consideration a number of factors, such
as increases in operating costs, financing of maintenance and improvement programs, our ability to raise and service debt, the prevailing rate of inflation, competition and affordability of price increases. Although he has never done so and is not
involved in our Managing Boards determination of fares, the Chief Executive of Hong Kong may, if he considers that public interest so requires, exercise his power to direct us to take any action in respect of fares contrary to prudent
commercial principles. If the Chief Executive of Hong Kong were to so direct, the KCRC Ordinance provides that we are entitled to reasonable compensation from the Government in respect of that direction. The annual fare review involves marketing
studies, passenger and public surveys and consultation and communication with interested parties. We also consult with both the Transport Panel of the Legislative Council and the Transport Advisory Committee to obtain their views as to the likely
public reaction to a particular fare revision. This consultation process does not apply in relation to any fare reductions and or short-term promotions, although the Government is notified in advance of such reductions and promotions.



From 1999 to 2004, we did not increase the fares of our passenger transport
networks after careful consideration of many factors which included the maintenance of competitiveness with other mass transit providers, which in general did not increase their fares, and the slow economic recovery in Hong Kong. We also experienced
significant pricing pressure as a result of public opinion, with the result that we committed to a 20% discount of our targeted West Rail Phase I fares at its initial opening, which was subsequently reduced to 10% on December 20, 2004. We have also
extended the second trip discount scheme on the East Rail until May 2005.



The table below sets out average passenger fare increases, increase/(decrease) in the Hong Kong Consumer Price Index (CPI), average fare revenues per passenger carried and increase/(decrease) in average
operating costs per passenger carried for the periods indicated:



|                                                                           |  |                         |   |  |       |   |  |       |   |  |       |     |  |       |    
|-------------------------------------------------------------------------- |  | ----------------------- | - |  | ----- | - |  | ----- | - |  | ----- | --- |  | ----- | ---
|                                                                           |  | Year Ended December 31, |  
|                                                                           |  | 2000                    |   |  | 2001  |   |  | 2002  |   |  | 2003  |     |  | 2004  |    
|Annual average passenger fare increase (%)                                 |  |                         |   |  |       |   |  |       |   |  |       |     |  |       |    
|East Rail(1)                                                               |  | 0.00                    |   |  | 0.00  |   |  | 0.00  |   |  | 0.00  |     |  | 0.00  |    
|Light Rail                                                                 |  | 0.00                    |   |  | 0.00  |   |  | 0.00  |   |  | 0.00  |     |  | 0.00  |    
|West Rail                                                                  |  |                        |   |  |      |   |  |      |   |  |      | (3) |  | 0.00  |    
|Increase/(decrease) in CPI(2)(%)                                           |  | (3.00                   | ) |  | (1.70 | ) |  | (3.20 | ) |  | (2.10 | )   |  | 0.00  |    
|Average fare revenues per passenger carried (HK$)                          |  |                         |   |  |       |   |  |       |   |  |       |     |  |       |    
|East Rail(1)                                                               |  | 11.65                   |   |  | 11.66 |   |  | 11.73 |   |  | 11.22 |     |  | 11.04 |    
|Light Rail                                                                 |  | 3.59                    |   |  | 3.56  |   |  | 3.53  |   |  | 3.52  |     |  | 3.07  |    
|West Rail                                                                  |  |                        |   |  |      |   |  |      |   |  |      | (3) |  | 6.29  |    
|Increase/(decrease) in average operating costs(4)per passenger carried (%) |  |                         |   |  |       |   |  |       |   |  |       |     |  |       |    
|East Rail(1)                                                               |  | (4.01                   | ) |  | (1.54 | ) |  | (1.56 | ) |  | 3.17  |     |  |      | (5)
|Light Rail                                                                 |  | (3.26                   | ) |  | 2.07  |   |  | (7.61 | ) |  | (2.20 | )   |  |      | (5)
|West Rail                                                                  |  |                        |   |  |      |   |  |      |   |  |      | (3) |  |      | (5)

---

|(1) | Excludes through-trains. From 2004 onwards, includes the Tsim Sha Tsui Extension and Ma On Shan Rail which commenced operations on October 24, 2004 and December 21,
2004 respectively.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(2) | Calculated using Hong Kong Consumer Price Index (A), which covers approximately 50% of households in Hong Kong with average monthly household expenditure of HK$4,500
to HK$18,499 in 1999/2000, broadly equivalent to HK$4,200 to HK$17,000 at 2004 prices. Source: Census and Statistics Department of the Government.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | West Rail Phase I commenced operations on December 20, 2003. Information relating to annual average passenger fare increase, average fare revenue per passenger
carried and increase/(decrease) in average operating costs per passenger carried for West Rail Phase I is not shown due to the limited period of operation.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | The average operating costs per passenger carried are derived before depreciation and net finance income/(expenses). The cost of the feeder bus service is included
in the operating costs of East Rail and the Light Rail.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | In December 2003, East Rail Division, West Rail/Light Rail Division were combined to form a single Transport Division to allow management more flexibility in the
deployment of resources and enable us to achieve synergy and savings, particularly for those services common to all railway networks, such as maintenance. The Transport Division manages all the transport services including East Rail, Light Rail,
West Rail and Freight. Since December 2003, most of the costs are common to various railway services including East Rail, Light Rail, West Rail and Freight. Consistent with our internal organizational and management structure, a transport services
segment has been created in place of East Rail, Light Rail, West Rail and Freight. Commencing 2004, separate profit/(loss) figures for individual business segments are not available.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The introduction of the Octopus Smart Card payment system in September 1997,
now used by over 84% of our Light Rail passengers, enabled us to charge our Light Rail passengers according to a distance-based fare structure rather than the previous zone-based fare structure. The Octopus Smart Card was used by approximately 92%
of our passengers in 2004 traveling on East Rail, and approximately 79% of our passengers in 2004 traveling on the West Rail. The Octopus Smart Card system is owned and operated by Octopus Cards Limited, in which we own a 22.1% interest. Octopus
Cards Limiteds other shareholders include other public transport carriers such as MTRCL and franchised bus operators. The system has been highly reliable, with an average malfunction rate of one in approximately 4,600 transactions, a
significant improvement over the common stored value ticket system malfunction rate of one in approximately 2,500 transactions. Implementation of the Octopus Smart Card has reduced congestion at entries into stations, lowered maintenance costs for
the entry gates and administrative costs generally, and decreased incidences of damaged cards.



Future Railway Development



Since the completion of the first railway development study by the Government in 1993, the planning context within which the study was conducted has changed significantly. In May 2000, the Government unveiled its second railway development
study. This blueprint outlined future railway development for Hong Kong leading up to 2016. The projects with the highest priority include the five projects listed below.



| |  | The Kowloon Southern Link, see Item 4. Information on the CorporationBusiness OverviewRail OperationsCurrently Planned Rail ExtensionsKowloon Southern
Link.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Sha Tin to Central Link, see Item 4. Information on the CorporationBusiness OverviewRail OperationsCurrently Planned Rail ExtensionsSha Tin to
Central Link.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Port Rail Line, which would provide a direct freight rail link between mainland China and the proposed Port Rail Terminal at Kwai Chung Container Port, thereby enhancing
connectivity between Hong Kong and its mainland hinterland and increasing the volumes of cargo transported by rail to and from Hong Kongs Kwai Chung Container Port.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Northern Link, see Item 4. Information on the CorporationBusiness OverviewRail OperationsCurrently Planned Rail ExtensionsNorthern Link.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Regional Express Line, see Item 4. Information on the CorporationBusiness OverviewRail OperationsCurrently Planned Rail ExtensionsExpress Rail
Link.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------



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The Government announced its population policy in February 2003 and is expected to release later its long
term planning study of Hong Kong 2030 which would provide a new set of planning data for population and employment projections. The study is likely to have an impact on future railway development.



Property Development and Services



Our Property Division consists of two departments, the first dealing with
property development along the railway lines, and the second with commercial activities, including leasing, advertising and property management of our own properties along the railway lines. The Property Division aims at maximizing the use of
railway land by developing properties jointly with property development companies and exploiting new revenue sources in order to generate profits that will help fund corporate strategic initiatives. In Hong Kong, properties located above or in the
proximity of railway stations and depots remain in good demand owing to the access to public transport systems. In 2004, the Property Division accounted for 13.9% of total revenue of KCRC.



Property Development



We develop property for the following reasons: to secure a permanent and
increasing flow of passengers for our railway services; to contribute towards the capital costs of new railway projects; and to generate income that can be used for the continuous improvement of our railway networks in order to keep them efficient,
modern and competitive.



Given the improving performance of the
property market in Hong Kong, we intend to move forward with our property developments. However, in an effort to contribute towards market stability, we have reached a consensus with the Government that the residential property sites along the West
Rail and Ma On Shan Rail will be completed no earlier than 2008.



Arrangements with Developers



We have entered
into arrangements with established property developers for the development of properties along our railway lines since 1985. We sell most property developments, but retain a certain amount for operational purposes and for leasing to tenants. We
select property developers for each development based on their development experience, track record and the terms and conditions of each project proposed. In the case of property developments along the existing railway lines, developers generally
fund the development costs including land premium, construction costs and finance charges and bear substantially all development risks. In the case of new railway lines such as West Rail Phase I and the Ma On Shan Rail, we may, in certain
circumstances, undertake the necessary property development enabling works in conjunction with the railway works in order to preserve the development potential above the new railway lines. Developers will then be solicited to undertake the property
developments. Profits from the developments, with the exception of the West Rail Phase I property sites, after reimbursement of development costs, (which may be capped or fixed in certain instances) are shared between KCRC and the developers. In
certain instances, the minimum profit to us has been guaranteed by the parent holding company of the property developer. The level of profits in excess of any minimum profit guaranteed by the developer would be primarily determined by market
conditions at the time. The development of the properties is managed by project coordination committees, usually with equal representation from both KCRC and the property developer, but with KCRC making the final decision with a casting vote. We
retain control over the disposal of properties completed, including decisions regarding whether to sell or lease the properties, the offer price and sale price if we decide to sell, and the lease terms if we decide to lease the properties.



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##### Table of Contents

Completed and Development Properties



Our completed properties and property under development as of December 31,
2004 are as follows:



|                                |  |                               |  |                             |    
|------------------------------- |  | ----------------------------- |  | --------------------------- | ---
|                                |  | Residential floor area (sq m) |  | Commercialfloor area (sq m) |    
|Developed properties            |  |                               |  |                             |    
|Pierhead Garden, Tuen Mun       |  | 91,400                        |  | 9,984                       |    
|Sun Tuen Mun Center, Tuen Mun   |  | 200,000                       |  | 14,000                      |    
|Manlai Court, Tai Wai           |  | 43,850                        |  | 420                         |    
|Hanford Garden, Tuen Mun        |  | 88,000                        |  | 3,200                       |    
|Sun Yuen Long Center, Yuen Long |  | 66,430                        |  | 25,880                      |    
|Royal Ascot, Sha Tin            |  | 271,656                       |  | 10,000                      |    
|Mong Kok Station                |  |                              |  | 149,590                     |    
|The Metropolis, Hung Hom        |  |                              |  | 132,218                     | (1)
|                                |  |                               |  |                             |    
|Sub-total                       |  | 761,336                       |  | 345,292                     |    
|Property under construction     |  |                               |  |                             |    
|Ho Tung Lau (Site A)            |  | 120,900                       |  | 2,000                       |    
|                                |  |                               |  |                             |    
|Total                           |  | 882,236                       |  | 347,292                     |    

---

|(1) | including 35,034 square meters of serviced apartment units.
|--- | -----------------------------------------------------------



Advanced railway re-provisioning works to make way for the development of Ho
Tung Lau (Site A) were completed in early 2004, with the foundation works for the development having commenced in April 2004. KCRC and the property developer, Full Fair Limited, a subsidiary of Sino Land Company Limited, are striving for an
environmentally-friendly design in the residential units, particularly after the SARS outbreak in 2003.



West Rail Property Development



For West Rail Phase I, we have identified 13 sites with potential for property development along nine stations. We expect to provide a total gross floor
area of 2,244,316 square meters, 91% of which would be for residential use and the remainder for commercial use. Under our current tentative plans, these projects would supply a total of about 30,000 flats during the period from 2008 to 2016. As
part of the agreement for the Governments injection of HK$29.0 billion of additional equity into us to help fund the development of West Rail Phase I, we will act as the Governments agent in the development of the property sites along
West Rail Phase I, and the Government will receive the net profits from the development of these projects, net of contingent expenses, development costs and other expenses to us as provided in an agreement signed in February 2000 between the
Government and KCRC. See Item 7. Major Shareholders and Related Party TransactionsShareholding in and Loan to WRPDL. From 2000, KCRC, through an intermediate holding company, West Rail Property Development Limited
(WRPDL) formed with the Government, has acted as the Governments property development agent for the 13 West Rail Phase I property sites. See Note 17 to our audited consolidated financial statements. We will be seeking expressions
of interest from property developers starting in the second quarter of 2005, with flats being made available for pre-sale in 2007 or 2008 at the earliest. The first invitation for expressions of interest was made in April 2005 for the Nam Cheong
station property development.



We will start to issue tender
invitations for nine property development projects with a total land area of more than 62 hectares, in phases, from the second half of 2005 onwards, namely Tsuen Wan West (comprising four sites with a total area of 9.41 hectares), Yuen Long (3.73
hectares), Nam Cheong (4.62 hectares), Long Ping (comprising two sites with a total land area of 2.61 hectares), Tuen Mun (2.7 hectares), Tin Shui Wai (3.48 hectares), Kam Sheung Road (9.85 hectares), Pat Heung Maintenance Center (24 hectares) and
Kwai Fong (1.92 hectares). We intend to select technically competent and financially capable developers to undertake these projects.



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Ma On Shan Rail Property Development



Along the Ma On Shan Rail alignment, four sites have been identified for
priority property development and these sites, together with a site at Ho Tung Lau on the East Rail, are expected to provide a total gross floor area of about 954,000 square meters, of which 93% would be residential. These four sites, namely Tai Wai
Maintenance Center (7.1 hectares), Tai Wai station (4.85 hectares), Wu Kai Sha (3.41 hectares) and Che Kung Temple (1.81 hectares), are expected to generate about 10,972 residential flats, which equates to 92% of 830,850 square meters of gross floor
areas to be built on these four sites. In accordance with the Governments property stabilization measures announced in October 2003, these four residential developments will not be completed earlier than 2008. We invited tenders for the
development of the site at Wu Kai Sha from property developers in May 2005 with a tender closing date of June 10, 2005. Seven tenders have been received from six developers and one consortium. The tender is expected to be awarded in end June
2005.



During 2004, the Property Division developed two
Public Transport Interchanges (PTI) in conjunction with property enabling works at Tai Wai and Wu Kai Sha along the Ma On Shan Rail. The PTI at Wu Kai Sha along the Ma On Shan Rail was completed in December 2004, and the PTI at Tai Wai
was completed in April 2005.



We also examined the
redevelopment opportunities in relation to the Hung Hom station given the potential of Hung Hom station to become an even more significant transportation hub in the future, which may also increase the market value of nearby properties. An extensive
land use re-zoning exercise is currently underway, paving the way for future exploitation of the sites full property development potential. We are also reviewing the commercial area shared by the Sha Tin station and Citylink Plaza for
strategic improvement and renewal of the stations design, as well as the development potential of the Mong Kok station for viable commercial uses.



Commercial Activities, Leasing and Property Management



We generate recurrent revenue from our properties located within our railway stations and in the proximity of our railway
networks. These properties include a total station trading area of 24,512 square meters at the East Rail, West Rail Phase I stations and the newly commissioned Ma On Shan Rail, an aggregate of 21,909 square meters of commercial office space at
Citylink Plaza at the Sha Tin station, 5,576 square meters at the KCRC Hung Hom Building and an aggregate of 40,649 square meters of retail shopping space at six other sites, which are Sun Tuen Mun Shopping Center, Citylink Plaza, Plaza Ascot,
Manlai Court, Hanford Plaza and Pierhead Plaza. Sources of income include leasing of space for retail shops, restaurants and offices, as well as licensing of duty-free businesses, car parks, advertising, telecommunications and exhibitions. In some
cases, we have negotiated arrangements with the operators for rents which are linked to their sales turnover. In terms of estate management, as of December 31, 2004, we managed a total of 9,854 residential flats, 3,457 carpark spaces and 91,180
square meters of commercial floor area along the railway lines of the East Rail and West Rail Phase I networks.



In 2004, the average occupancy rate of the commercial premises at our stations, commercial offices and shopping centers was 91.1%. This was attributable
to our flexible leasing strategy and our multi-faceted promotional activities. To accommodate the difficulties faced by tenants in the West Rail stations, we granted a six-month rent free period to all tenants and adopted a rent relief scheme in
2004. Recurrent revenue generated from commercial activities and property leasing totaled HK$695 million (US$89.4 million) in 2004, an increase of 14.5% over 2003. In order to improve business and traffic flows at the various KCRC shopping centers,
we conducted intensive marketing campaigns. Promotional activities included a bonus point redemption system, pet shows, Olympics promotional events and lucky draws.



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In 2004, as a result of the station improvement works at the Kowloon Tong and Lo Wu stations, ten new
station shops commenced operation. Further, with the opening of the Tsim Sha Tsui Extension and Ma On Shan Rail in 2004, we increased space for advertising sales and added 148 retail units for shops and restaurants to our property portfolio. At the
Tai Wai station, which is the interchange station for the Ma On Shan Rail and East Rail, a total of 48 new and refurbished station shops were offered. Out of these 48 shops, 33 had been leased as of the end of 2004. We had rented 33 out of 36 shops
in the East Tsim Sha Tsui station by the end of 2004. About two-thirds of the shops in the nine stations along the Ma On Shan Rail alignment had been rented by the time the railway opened in December 2004. We have commenced commercial space planning
and layout design for the Lok Ma Chau Spur Line and Kowloon Southern Link.



Future Plans



To
explore new non-fare revenue sources, we plan to unveil our on-train Passenger Information Display System in the fourth quarter of 2005, which will provide quasi-real-time general and financial news, information and entertainment programs. We
believe that these new features will provide a value added service to passengers and will be an attractive option for advertisers. We also devoted considerable efforts on new advertising initiatives, such as train advertising, in order to widen the
recurrent revenue source.



Competition



Although we operate the only passenger and freight rail service from Hong
Kong to mainland China on the East Rail line and the only passenger rail service in the north-western New Territories on the West Rail and Light Rail systems, we face and will continue to face competition from alternative modes of transportation.
Our rail services face competition from other rail operators in Hong Kong, buses, minibuses, shuttle buses, taxis and private cars in our passenger operations within Hong Kong, and from buses, tour coaches, barges and airplanes in our cross-boundary
passenger operations. We face competition mainly from trucks, barges and other oceangoing vessels in our cross-boundary freight operations. Bus, taxi, shuttle bus, coach, minibus and ferry operators that compete with us can often offer
transportation services at lower prices and, in some cases, at higher frequencies than we can. Trucks, barges and other ocean-going vessels may be able to offer lower prices or more flexible cargo or freight configurations for freight customers.
Competition in public motor bus services in Hong Kong is intense. The main competitors of our bus services are franchised bus operators, minibuses and residential coaches (private shuttle buses operated by residential developments). These
competitors often compete with our bus services on the basis of cost and convenience.



Government Regulations



Fare Setting
Mechanism



In August 2003, the Government issued a
paper on a new fare-setting mechanism based on a price-cap model, which would allow transport fares to increase or decrease in light of the relevant factors and by reference to a specified formula. The paper is under discussion and consultation with
the public transport operators, including KCRC and MTRCL. However, the paper recognized that KCRC has the autonomy to set fares and, as such, the paper would not be binding on KCRC and would only serve as a guideline.



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Merger between KCRC and MTRCL



On February 24, 2004, the Government announced that KCRC and MTRCL were
invited to commence negotiations on a possible merger. MTRCL is a company listed on The Hong Kong Stock Exchange in which the Government had a 76.5% shareholding as of December 31, 2004. In September 2004, KCRC and MTRCL submitted to the Government
a joint merger proposal. The Government is studying the proposal and will make a decision in due course as to whether or not to proceed with the merger. Any merger proposal will require the consent of MTRCLs minority shareholders and,
possibly, certain of its creditors.



KCRC Ordinance



Under the KCRC Ordinance, we are required to take
into consideration the reasonable requirements of the public transport system of Hong Kong and the efficiency, economy and safety of operation in providing services and facilities to the public. Subject to any direction from the Chief Executive of
Hong Kong to the contrary as described in the following paragraph, we are also required to operate on prudent commercial principles. We do not enjoy any status, immunity or privilege of the Government under the KCRC Ordinance.



The KCRC Ordinance empowers us to establish our own fares for passenger,
freight and other services. The KCRC Ordinance also allows the Chief Executive of Hong Kong to give us a direction in writing of a general or specific nature, including in respect of fares, if he considers it to be in the public interest. However,
neither the Chief Executive of Hong Kong nor his predecessor prior to July 1, 1997, the Governor of the British Colony of Hong Kong, has exercised this power since our establishment. If the Chief Executive of Hong Kong gives us a direction that
requires us to act contrary to prudent commercial principles, the KCRC Ordinance provides that we are entitled to reasonable compensation from the Government in respect of that direction. We believe that public reaction and the social and economic
effects of our fare changes are important factors to consider in evaluating the size and timing of fare revisions. As a result, we maintain regular contact with Government officials and departments at various levels and actively consult with both
the Transport Panel of the Legislative Council and the Transport Advisory Committee to obtain their views as to the likely public reaction to a particular fare revision.



Under the KCRC Ordinance, we may declare and pay dividends to the Government as our sole shareholder. The Financial
Secretary may, after consultation with us and after taking into account the extent of our loans and other obligations, direct us to declare a dividend in an amount up to the whole of our profits in any fiscal year after making allowance for any
allocation to reserves and any accumulated loss disclosed in the balance sheet in the prior year. Since January 1, 1995, we have made four dividend payments, HK$300 million in 1997 (representing 9.75% of our 1996 profit after taxation), HK$620
million in 2003 (representing 28.1% of our restated 2002 profit after taxation), HK$620 million in 2004 (representing 44.9% of our 2003 profit after taxation) and HK$172 million in 2005 (representing 40.1% of our 2004 profit after taxation).



In addition to our interaction with the Government as our
shareholder, we also interface with the Government in many other ways. For example, we work with the Government as a principal provider of land transportation in Hong Kong. To that end, we initiate or respond to the Government with railway
development proposals and we support the executive branch in its accountability to the legislature on rail transportation issues. Our participation in these social goals is subject to the requirement that we operate on prudent commercial principles
in accordance with the KCRC Ordinance. The Government determines which projects will be undertaken and whether we will participate.



The Government also interfaces with us as the regulator of rail services in Hong Kong. We are required to comply with the Governments safety
standards as defined by the Railway Inspectorate in respect of railway design and operations, and with the various regulations on works in respect of any construction that we undertake. We believe that we enjoy good relations with all relevant
departments of the Government, including the Railway Inspectorate, the Civil Engineering Department, the Lands Department, the Highways Department and the Environmental Protection Department.



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Environmental Matters



We believe that our existing operations are in substantial compliance with Hong Kongs environmental regulations, including Hong Kongs
stringent Noise Control Ordinance. We try to ensure that the impact of our projects and operations on the environment is kept to a minimum by implementing environmental management systems meeting the ISO 14001 standard. This is an international
certification standard published by the ISO to demonstrate a companys capability to efficiently manage its environmental impacts. The core functions of our previous East Rail Division and all functions of our previous Light Rail Division are
certified to the ISO 14001 standard. In April 2005 we successfully expanded the scope of our ISO 14001 certification to cover the whole of the Transport Division, which includes the operations of all transport services of the Corporation. Certain
departments within the Capital Projects Division are also certified to the ISO 14001 standard.



For projects under development, we are required to comply with the statutory processes prescribed by the Government, including submission of an Environmental Impact Assessment to the Environmental Protection
Department and satisfactory conclusion of a public consultation period. We are also required to comply with the requirements of the environmental permits as a result of our environmental impact assessments and applicable environmental regulations in
our construction activities. We are committed to construct our new railway projects in an environmentally responsible manner. For the Lok Ma Chau Spur Line, an Environmental Committee, which comprises KCRC members and members of environmental
groups, including Friends of the Earth (HK) Charity Ltd., the Hong Kong Bird Watching Society and WWF Hong Kong, has been set up as part of the environmental permit conditions. It meets quarterly to review and monitor performance on the planned
mitigation measures as set out in the habitat creation and management plan and the Environmental Impact Assessment. We are improving the environmental habitat around the Lok Ma Chau station terminus area where 37 hectares of fishponds, reed beds and
marshland are being recreated and improved. These works are scheduled for completion in late 2006.



Given our proximity to areas of urban density, we employ a wide range of noise mitigation measures such as using the latest designs for train cars, tracks
and noise barriers. We have substantially completed the installation of noise barriers along the East Rail which was designed to reduce the noise impact of trains running along the East Rail alignment. The new railway lines of the West Rail and Ma
On Shan Rail are constructed with floating slab track and rubber bearings, as well as multiple noise plenum on their viaducts to effectively reduce railway noise. All the new trains for the East Rail, West Rail and Ma On Shan Rail are fitted with a
regenerative braking system to conserve electrical energy. To ensure that the noise levels of the West Rail trains comply with the Noise Control Ordinance, we have adopted noise mitigation measures to minimize the noise at the source, including
installing noise absorbing lining under the train cars, beneath the walkways along the tracks and on the inside of the parapets and adding skirts to train cars. To further reduce the noise emitted by Light Rail vehicles, new measures,
such as the use of headlub, a specially formulated environmentally friendly lubricant, are being studied. In addition, we have also set up a weekly noise monitoring program to monitor and check the noise of the West Rail since its opening in late
2003. Monitoring was subsequently reduced to monthly and then half-yearly intervals as no noise levels exceeding Hong Kongs stringent statutory limit had been recorded.



We also have taken steps to improve our environmental performance. In 2004 five new diesel locomotives entered service on
the East Rail. These are substantial improvements on the old locomotives as they are more fuel efficient, significantly cut exhaust emissions by about 20% and reduce noise generation by around 17dBA. All of our bus fleet and diesel locomotives run
on ultra-low sulphur diesel and all our pre-Euro and Euro I standard engine buses have been retrofitted with catalytic converters.



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In the first quarter of 2004, the West Rail conducted an extensive study on energy saving opportunities
at all of its stations. During the second quarter we introduced refinements in station temperature and lighting control, escalator use during non-peak periods and switching off under-utilized ticket-vending and add-value machines.



In September 2004 we joined the Governments Environmental Protection
Department Wastewi$e Scheme which encourages companies to reduce the amount of waste they generate by setting clear waste avoidance and reduction targets, collecting and recycling materials and purchasing environmentally friendly materials.



4.C ORGANIZATIONAL STRUCTURE



We have the following subsidiaries:



|                                                        |  |                              |  |                        |  
|------------------------------------------------------- |  | ---------------------------- |  | ---------------------- | -
|Subsidiary name                                         |  | Jurisdiction ofincorporation |  | Proportion ofownership |  
|Manlai Court Property Management Company Limited        |  | Hong Kong                    |  | 51                     | %
|Sun Tuen Mun Center Management Company Limited          |  | Hong Kong                    |  | 100                    | %
|Royal Ascot Management Company Limited                  |  | Hong Kong                    |  | 100                    | %
|Hanford Garden Property Management Company Limited      |  | Hong Kong                    |  | 100                    | %
|Pierhead Garden Management Company Limited              |  | Hong Kong                    |  | 100                    | %
|The Metropolis Management Company Limited               |  | Hong Kong                    |  | 51                     | %
|V-Connect Limited                                       |  | Hong Kong                    |  | 100                    | %
|Capital System Limited                                  |  | Hong Kong                    |  | 100                    | %
|Buoyant Asset Limited                                   |  | Hong Kong                    |  | 100                    | %
|Advanced Asset Limited                                  |  | Hong Kong                    |  | 100                    | %
|Quality Asset Limited                                   |  | Hong Kong                    |  | 100                    | %
|Kasey Asset Limited                                     |  | Hong Kong                    |  | 100                    | %
|Circuit Asset Limited                                   |  | Hong Kong                    |  | 100                    | %
|Shining Asset Limited                                   |  | Hong Kong                    |  | 100                    | %
|Fluent Asset Limited                                    |  | Hong Kong                    |  | 100                    | %
|Unique Asset Limited                                    |  | Hong Kong                    |  | 100                    | %
|Kudos Asset Limited                                     |  | Hong Kong                    |  | 100                    | %
|Bowman Asset Limited                                    |  | Cayman Islands               |  | 100                    | %
|Statesman Asset Limited                                 |  | Cayman Islands               |  | 100                    | %
|Interwind Asset Limited                                 |  | Hong Kong                    |  | 100                    | %
|West Rail Property Development Limited(1)               |  | Hong Kong                    |  | 51                     | %
|                                                        |  |                             
|Subsidiaries of West Rail Property Development Limited  |  |                              |  |                        |  
|                                                        |  |                             
|Kam Sheung Property Development Limited(1)              |  | Hong Kong                    |  | 51                     | %
|Kwai Fong Property Development Limited(1)               |  | Hong Kong                    |  | 51                     | %
|Long Ping Property Development Limited(1)               |  | Hong Kong                    |  | 51                     | %
|Long Ping South Property Development Limited(1)         |  | Hong Kong                    |  | 51                     | %
|Nam Cheong Property Development Limited(1)              |  | Hong Kong                    |  | 51                     | %
|Pat Heung Property Development Limited(1)               |  | Hong Kong                    |  | 51                     | %
|Tin Shui Wai Property Development Limited(1)            |  | Hong Kong                    |  | 51                     | %
|Tsuen Wan West Property Development Limited(1)          |  | Hong Kong                    |  | 51                     | %
|Tsuen Wan West Cityside Property Development Limited(1) |  | Hong Kong                    |  | 51                     | %
|Tsuen Wan West TW6 Property Development Limited(1)      |  | Hong Kong                    |  | 51                     | %
|Tsuen Wan West TW7 Property Development Limited(1)      |  | Hong Kong                    |  | 51                     | %
|Tuen Mun Property Development Limited(1)                |  | Hong Kong                    |  | 51                     | %
|Yuen Long Property Development Limited(1)               |  | Hong Kong                    |  | 51                     | %

---

|(1) | These subsidiaries are held by us for the sole purpose of developing commercial or residential property along the West Rail Phase I route on behalf of the Government
and their financial statements are excluded from consolidation as we have no effective control over nor beneficial interests in the net assets of these subsidiaries, other than the amount of capital provided.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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4.D PROPERTY, PLANT AND EQUIPMENT



The majority of the land on which our railway operations are situated, including our railway stations, depots, storage areas
for other civil works, plant and other equipment and our headquarters and administrative offices, is held by us either as vested land in accordance with the KCRC Ordinance or pursuant to private treaty grants by the Government. Such grants will
expire in 2047 pursuant to the Sino-British Joint Declaration between the United Kingdom and the Peoples Republic of China, with the exception of grants made after 1997. As a condition to the grant of land by the Government, we are required to
pay a land premium to the Government. Pursuant to the KCRC Ordinance, we may not use the land for purposes other than railway operations and ancillary purposes necessary for our railway operations without the consent of the Government. We are not
allowed to assign, lease or otherwise dispose of an interest in the land for a period greater than three years without the consent of the Government. Since 1983, we have also entered into short-term tenancies and licenses with the Government which
may be renewable subject to the Governments discretion. These lands granted pursuant to short term tenancies and/or licenses constitute a small portion of the land employed in our railway operations. The Government has in the past regularly
extended or renewed these short-term tenancies and licenses upon their expiration.



ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS



You should read the following discussion and analysis in conjunction with the selected consolidated financial data, the consolidated financial statements and the accompanying notes, and the other financial
information of KCRC which appears elsewhere in this Annual Report. The following discussion includes various forward-looking statements that involve risks and uncertainties. See Forward-looking Statements for specific information
regarding the presentation of our forward-looking statements. Financial and operating data appearing in this section that is not derived from the audited consolidated financial statements of KCRC have been derived without material adjustment from
the unaudited accounting and operating records of KCRC.



5.A OPERATING
RESULTS



Critical Accounting Policies



Our significant accounting policies, including the assumptions and judgments
underlying them, are disclosed in Note 2 to the audited consolidated financial statements. Of these significant accounting policies, the following involve a higher degree of judgment and complexity and are considered as critical accounting policies.



Impairment of assets



Under HK GAAP, we comply with SSAP 31 (Impairment of Assets). Internal
and external sources of information are reviewed at each balance sheet date to identify indications that the assets, i.e. property, plant and equipment (other than investment properties carried at revalued amounts) and investments in subsidiaries
and associates, may be impaired or that an impairment loss previously recognized may no longer exist or may have decreased.



If any such indication exists, we estimate the assets recoverable amount, which is calculated by discounting the estimated future cash flows. The
recoverable amount of an asset is the greater of its net selling price and value in use. In this respect, our management exercises a high degree of judgment in terms of the projection of cash flows for future years and the assumptions used in the
calculation of the pre-tax discount rate. We recognize an impairment loss in the income statement to reduce the carrying amount of an asset to its recoverable amount.



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Under US GAAP, the recoverability of such assets is based on the sum of the undiscounted cash flows
expected to result from the use and the eventual disposal of the assets. An asset or asset group is written-down to its fair value when its carrying amount is determined to be not recoverable.



As of December 31, 2004, we assessed whether there was any impairment of our
fixed assets at that date in accordance with our accounting policies for the assessment of asset impairment. The estimated cash flows of the railway network were calculated for a period consistent with the estimated useful life of the core assets of
the railway network and were discounted using our weighted average cost of capital at December 31, 2004. As a result of this assessment, under both HK GAAP and US GAAP, management considers that our railway assets are not impaired at December 31,
2004 and, accordingly, that no provision for impairment of our railway assets is required at that date. See Note 41 to our audited consolidated financial statements.



Under both HK GAAP and US GAAP, no provision for impairment or reversal of prior years provisions for impairment
losses of our railway assets has been made for the past three years from 2002 to 2004.



Construction in progress



Assets under construction and capital works for the operating railway are stated at cost less impairment losses. Capitalization of these costs ceases and the asset concerned is transferred to fixed assets when
substantially all the activities necessary to prepare the asset for its intended use are completed. Costs incurred by us in respect of feasibility studies on proposed railway related construction projects are charged to the income statement when
there is no certainty of the projects materializing. When the proposed projects are viable, the relevant costs are recognized as deferred expenditure and then transferred to construction in progress after the relevant project agreements are reached.
In determining whether the projects are viable, our management makes an assessment on the feasibility of the projects from the technical and financial aspects, which includes a projection of cash flows related to each individual project.



Deferred expenditure



Deferred expenditure relates to costs incurred for proposed projects which
will be transferred to construction in progress after the relevant projects agreements are reached with the Government. In recognizing deferred expenditure, the expenditure is separately identifiable and there is reasonable certainty that the
projects are technically feasible and financially viable. In determining whether the projects are viable, our management makes an assessment of the feasibility of the projects from the technical and financial aspects, which includes a projection of
cash flows related to each individual project.



Depreciation



Under HK
GAAP, all fixed assets, except investment properties and the initial cost of rail tracks, ballast and sleepers are depreciated on a straight-line basis at rates based on the estimated useful lives of the assets or over the remaining period of the
lease in the case of leasehold land. No depreciation is provided in respect of investment properties with an unexpired lease term of more than 20 years since the valuation takes into account the state of each property at the date of valuation. We do
not currently hold any investment properties with an unexpired lease term of less than 20 years. The initial cost of rail tracks, ballast and sleepers is not depreciated. The cost of replacing rail tracks and sleepers is charged to the income
statement as and when incurred. We review the estimated useful lives regularly in order to ensure that the depreciable amounts of the assets reflect the future economic benefits of the assets. We determine the estimated useful lives with a high
degree of judgment by reference to the inherent lives of the assets, users experience and the appraisers report on the assets under lease, whichever is appropriate. The longer the estimated useful lives, the lesser is the depreciation
amount which will be charged to the income statement for the year, and vice versa. During the past three years from 2002 to 2004, there was no significant change in the estimated useful lives or residual values of the fixed assets.



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Under US GAAP, the cost of permanent way, i.e. rail tracks, ballast and sleepers, are depreciated over
the estimated useful lives of the assets and the costs of replacement are capitalized and depreciated over their estimated useful lives. See Note 44(b) to our audited consolidated financial statements.



Deferred taxation



Under HK GAAP, prior to 2003, provision for deferred taxation was calculated
using the liability method at current taxation rate on timing differences to the extent that it was probable that a liability would crystallize in the foreseeable future. We exercised a high degree of judgment in estimating the future capital
expenditure as well as the useful lives of fixed assets in the projection of the depreciation charges for future years.



With effect from January 1, 2003, we adopted a revised accounting policy for deferred taxation in order to comply with SSAP 12 (Income Taxes) (revised)
relating to income taxes dealing with the recognition of deferred tax assets and deferred tax liabilities. Deferred tax assets and liabilities arise from deductible and taxable temporary differences respectively, being the differences between the
carrying amounts of assets and liabilities for financial reporting purposes and the amounts for tax purposes. Deferred tax assets also arise from unused tax losses and unused tax credits. All deferred tax liabilities and all deferred tax assets, to
the extent that it is probable that future taxable profits will be available against which the asset can be utilized, are recognized. We exercise a high degree of judgment in assessing the availability of the future taxable profits which may be
generated to utilize the unused tax losses, which substantiates the recognition of deferred tax assets for the unused tax losses.



SSAP 12 (Income Taxes) (revised) became effective for financial statements relating to periods beginning on or after January 1, 2003. In accordance with
this change in accounting policy and pursuant to SSAP 2 (Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies), the opening balances of retained profits as of January 1, 2002 and 2003 have been restated. In
addition, the previously reported profit after taxation for the year ended December 31, 2002 has been adjusted to reflect changes in provision for deferred taxation during the year.



Under US GAAP, income taxes are accounted for under the asset and liability method. With effect from January 1, 2003, our
accounting policy under HK GAAP for the recognition of deferred tax is similar to US GAAP except that under HK GAAP, all deferred tax assets are recognized to the extent that it is probable that future taxable profits will be available against which
the asset can be utilized. Our tax losses do not expire under current tax legislation. During the past three years from 2002 to 2004, under both HK GAAP and US GAAP, there was no significant change on the initial estimates of the recovery of the
deferred tax assets which relate solely to the future benefit of tax losses. See Note 44(g) to our audited financial statements.



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Provisions and contingent liabilities



We recognize provisions for liabilities of uncertain timing or amount when
we have a legal or constructive obligation arising as a result of a past event, and it is probable that an outflow of economic benefits will be required to settle the obligation and a reliable estimate can be made. We exercise a high degree of
judgment in the assessment of the claims arising from construction contracts and outstanding mediation, arbitration or litigation, mainly relating to the construction of West Rail Phase I and the East Rail Extensions. We will make a provision for
claims when there is a present obligation that probably requires an outflow of economic benefits and the obligation can be estimated reliably. Where it is not probable that an outflow of economic benefits will be required, or the amount cannot be
estimated reliably, the obligation is disclosed as a contingent liability. At December 31, 2004, we had contingent liabilities arising from certain contractors claims in respect of the contracts for the construction of the West Rail and East
Rail Extensions projects where our total obligations cannot be estimated reliably. We have made provisions in the financial statements at December 31, 2004 for our best estimate of amounts which are likely to be payable in connection with these
claims. The amounts payable upon resolution of the claims may be eventually in excess of amounts estimated by us and accounted for in our audited consolidated financial statements at December 31, 2004. We are in the process of resolving these
claims.



In addition to the claims arising from construction
contracts, the lease arrangements referred to in Note 10(h) to our consolidated financial statements are subject to certain terms and conditions under the related agreements whereby one of the lease arrangements may be subject to mandatory
termination upon the occurrence of certain specified events or circumstances. Management has considered the likelihood of such events occurring and has concluded that there was a possibility that one of the lease arrangements may be subject to
mandatory termination before the end of the basic lease term. Should mandatory termination of the lease arrangement occur, our maximum exposure after deduction of the transaction benefit is estimated to be approximately HK$62 million (US$8 million)
at December 31, 2004, compared to approximately HK$65 million at December 31, 2003, the actual amount of which will depend on the interest rates prevailing at the date of termination.



Recently issued financial reporting standards



The Hong Kong Institute of Certified Public Accountants has recently issued a number of new and revised financial reporting
standards (HKFRSs) which will be applicable for accounting periods beginning on or after January 1, 2005. We have already commenced an assessment of the impact of these new and revised HKFRSs but are not yet in a position to determine
whether these new and revised HKFRSs will have a significant impact on the results of our operations and financial position.



Based on our preliminary review, we assessed that the HKFRSs which may significantly affect our financial position were Hong Kong Accounting Standard
(HKAS) 32 (Financial instruments: disclosure and presentation), HKAS 39 (Financial instruments: recognition and measurement) and HKAS 40 (Investment property).



Financial instruments: Disclosure and Presentation; Recognition and Measurement



HKAS 32 (Financial instruments: disclosure and presentation) and HKAS 39
(Financial instruments recognition and measurement) aim to establish principles for recognizing and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items. Financial assets are defined broadly and
include cash, equity investments, debt securities, trade debtors, inter-company debit balances and certain derivatives. Financial liabilities relates to contractual obligations to transfer cash or other financial assets, such as loan obligations,
trade creditors and inter-company credit balances. They may also include certain derivatives. The HKASs contain extensive and detailed requirements concerning accounting, presentation and disclosure of financial instruments. However, the application
of the requirements to simple financial instruments, such as equity securities, bank loans, trade debtors and creditors, is straight-forward and is unlikely to require changes in current accounting practices, except for the extent of disclosures.
These standards apply to financial periods beginning on or after January 1, 2005 and we will adopt the standards in the preparation of our financial statements for the year ending December 31, 2005.



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All our financial assets are to be classified into either of the following categories: fair value through
profit or loss; held-to-maturity investments; loans and receivables and available-for-sale. Whereas financial liabilities should be classified either as fair value through profit or loss or other financial liabilities. Different measurement rules
and accounting treatments apply to different classes of financial instruments. A summary of the applicable rules is depicted below-



Financial assets



| |  |  | Fair value through profit or loss  measured at fair value with changes in fair value recognized in the income statement;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



| |  |  | Held-to-maturity investments  measured at amortized cost, using the effective interest method;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | Loans and receivables  measured at amortized cost, using the effective interest method; and
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | Available-for-sale  measured at fair value with changes in fair value recognized in equity.
| | - |  | --------------------------------------------------------------------------------------------



Financial liabilities



| |  |  | Fair value through profit or loss  measured at fair value with changes in fair value recognized in the income statement; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | Other financial liabilities  measured at amortized cost, using the effective interest method.
| | - |  | ----------------------------------------------------------------------------------------------



Since the fair value of the financial instruments cannot be reasonably estimated until the date of the balance sheet, i.e.
December 31, 2005, we are unable to assess the impact of these new accounting standards on our financial statements.



Investment properties



HKAS 40 prescribes the accounting treatment for investment property and related disclosure requirements. It offers two options for accounting treatment of
investment property which is held to earn rentals and/or for capital appreciation, rather than for use in the production or supply of goods or services or for administrative purposes, or for sale in the ordinary course of business. This standard
applies to financial periods beginning on or after January 1, 2005 and we will adopt the standard in the preparation of our financial statements for the year ending December 31, 2005.



The first option, the cost model, specifies that all entities will be permitted to adopt a policy of carrying their
investment properties at cost less depreciation and impairment losses as if the properties were owner-occupied. The other option is known as the fair value model under which the investment properties are stated at valuation with all movements in
fair value being reported directly in the income statement. We are still considering which model is to be adopted in 2005.



Recently Issued Accounting Standards of the United States



In January 2003, the Financial Accounting Standard Board (FASB) issued FASB Interpretation No. 46, Consolidation of Variable
Interest Entities (FIN 46) and in December 2003, issued a revision to FIN 46 (FIN 46R) which supersedes FIN 46. FIN 46R is an effort to expand upon and strengthen existing accounting guidance as to when an entity should
consolidate the financial results of another entity. FIN 46R requires variable interest entities (VIE) as defined therein to be consolidated by an entity if that entity is obligated to bear a majority of expected losses of
the VIE or is entitled to receive a majority of expected residual returns of the VIE, or both. The entity that is required to consolidate a VIE is referred to as the VIEs primary beneficiary. The interpretation also requires certain
disclosures about VIEs that an entity is not required to consolidate, but in which it has a significant variable interest.



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KCRC is required to apply FIN 46R to variable interests in VIEs created after December 31, 2003. For
variable interests in VIEs created before January 1, 2004, FIN 46R will be applied in the financial statements for the period beginning January 1, 2005. For VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the
assets, liabilities and non-controlling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the
cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and non-controlling interest of the VIE.



We are evaluating the impact of applying FIN 46R to existing VIEs in which we
have variable interests and have not yet completed this analysis. Neither KCRC nor any of its subsidiaries (together, the Group) has any variable interests in VIEs created after December 31, 2003. However, we consider that an unrelated
entity created in December 2003 under one of the Groups lease out and lease back transactions meets the criteria to be classified as a VIE. Under this transaction, the Group has loaned a portion of the lease prepayments received from the
overseas investor to an unrelated entity created in December 2003 for the sole purpose of investing the loan proceeds in available for sale debt securities and other financial assets structured to meet the Groups lease obligations
arising from the transaction. As the Group is obligated to bear the loss or is entitled to receive the gain which may arise from the realization of the available for sale debt securities upon termination of the transaction before the end
of the basic lease term, the Group is considered to be the unrelated entitys primary beneficiary. As such, it is reasonably possible that the Group may be required to consolidate such unrelated entity under the requirements of FIN 46R in
compliance with US GAAP for the year ending December 31, 2005.



As the Groups loan receivables from this unrelated entity and lease obligations arising from this lease out and lease back transaction have already been reflected separately in the reconciliation of consolidated shareholders
funds to US GAAP, the consolidation of this unrelated entity is not expected to have material impact on the Groups financial position and results of operations. Apart from this, we do not consider that there are any other VIEs in which the
Group has significant variable interests or primary beneficial interests.



Policy on Derivative Instruments



We manage
our currency and interest rate exposures with derivative instruments, such as interest rate swaps, currency swaps and foreign exchange forward contracts in accordance with our Managing Boards approved hedging policy and guidelines. These
derivative instruments have been employed only for hedging purposes and were properly documented. We seek to reduce our foreign currency exposure in respect of debt obligations and capital expenditure by converting such obligations into either Hong
Kong dollars or U.S. dollars, and to maintain our U.S. dollar exposure in debt obligations at no greater than 30% of total debt obligations. Moreover, we seek to limit our exposure to interest rate risk by maintaining between 30% and 75% of the
total principal amount of our debt obligations at fixed interest rate.



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Business Activities



Our results of operations are affected by several factors, including the state of the Hong Kong economy, which affects the
ability of passengers to pay fares, consumer preferences among transportation modes, social and public health conditions in Hong Kong and its populations decisions relating to frequency of travel and demographic trends. With respect to
passenger and freight traffic between Hong Kong and mainland China, our results are also affected by economic, social, health and political developments in mainland China. In Hong Kong, as the population has expanded outside of Hong Kongs main
urban areas and as passenger traffic to and from mainland China has grown in the past years, we have benefited from increased ridership levels. The expansion in our portfolio of commercial properties over the past years has contributed to increased
revenues from property ownership and management and other property services. From 1988 to 1998, we have been able to achieve increases in fare levels and average fare revenues per passenger carried due to the economic growth in Hong Kong. However,
the Asian economic downturn has limited our ability to raise fares on our passenger transport networks in the past seven years. In 2004, both transport and recurrent revenues improved when compared to 2003, mainly due to the recovery from the impact
of the SARS outbreak in 2003 on passenger revenues and revenues derived from our property tenants.



East Rail



The East Rail, including the Tsim Sha Tsui Extension and Ma On Shan Rail which commenced operations on October 24, 2004 and December 21, 2004
respectively, contributed HK$3,415 million (US$439.4 million) or approximately 69% of our revenues in 2004. In December 2003, the East Rail Division, West Rail/Light Rail Division were combined to form a single Transport Division to allow management
more flexibility in the deployment of resources and enable us to achieve synergy and savings, particularly for those services common to all railway networks, such as maintenance. The Transport Division manages all the transport services including
the East Rail, Light Rail, West Rail and Freight. Since December 2003, most of the costs are common to various railway services including the East Rail, Light Rail, West Rail and Freight. Consistent with our internal organizational and management
structure, a transport services segment has been created in place of the East Rail, Light Rail, West Rail and Freight. Commencing 2004, separate profit/(loss) figures for individual business segments are not available.



East Rail passenger revenues consist of the following:



| |  | domestic passenger traffic: fares paid by passengers who travel between stations in Hong Kong;
|- |  | ----------------------------------------------------------------------------------------------



| |  | cross-boundary passenger traffic: fares paid by passengers who travel on trains which terminate or begin at the Lo Wu boundary crossing; and
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  | through-train passenger traffic: fares paid by passengers who travel directly between Hong Kong and mainland China.
|- |  | -------------------------------------------------------------------------------------------------------------------



Because our cross-boundary traffic provides the only rail service directly to
the boundary with mainland China, with the convenience of direct foot crossings from the Lo Wu station, we have historically been able to charge cross-boundary passengers relatively higher fares. With more competition from cross-boundary coach
operators, it may be difficult for us to maintain a premium on fares for cross-boundary passengers. The higher fares for cross-boundary passengers have historically subsidized domestic fares. As such, any adjustment to this fare structure would
affect the element of cross-subsidy currently enjoyed by domestic passengers.



The number of daily average cross-boundary passengers increased by 3.6% to 232,500 during 2004. This increase in cross-boundary patronage can be attributed in large part to low ridership in 2003 due to the SARS
outbreak and the increasing number of tourists and business travelers from mainland China in 2004. However, the increased ridership in 2004 was still lower than the peak daily average ridership achieved in 2002 of 251,600.



37



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##### Table of Contents

|                               |  |                               |  |                        
|------------------------------ |  | ----------------------------- |  | -----------------------
|Cross-Boundary Lo Wu ridership |  | Daily average passenger trips |  | Year on year growth (%)
|1999                           |  | 206,481                       |  | 15.5                   
|2000                           |  | 229,120                       |  | 10.9                   
|2001                           |  | 236,800                       |  | 3.4                    
|2002                           |  | 251,600                       |  | 6.3                    
|2003                           |  | 224,500                       |  | (10.8)                 
|2004                           |  | 232,500                       |  | 3.6                    



In 2004, the East
Rails through-trains to mainland China experienced a significant increase in patronage of 37.5% compared to 2003 to an average of 8,070 passengers per day. This increase was largely because of the reluctance of the public to travel because of
the SARS outbreak in the early half of 2003 and the increased frequency of the through-trains and extended hours of operation in 2004.



West Rail



West Rail Phase I commenced services on December 20, 2003. As a result of publicity and promotional campaigns and fare offers, West Rail Phase Is
average daily ridership increased 72% from 100,500 in January 2004 to 172,900 in December 2004. We anticipate that ridership will increase upon the completion of the Kowloon Southern Link in 2009, as this will enable the East Rail and West Rail to
form an integrated transportation network.



Light Rail,
Bus and Freight



We began the Light Rail and
associated bus operations in the late 1980s at the request of the Government to support projected population growth in the north-western New Territories, on the understanding that competition from bus operators would be restricted and that certain
Light Rail stops would be the only terminal for bus service to urban areas. However, population growth in the Light Rail service area was lower than Governments estimations and the Government allowed a higher level of competition from other
modes of transport in the region, which reduced passenger use of the Light Rail. Primarily as a result of these factors, the Light Rail system has not been profitable since its inception, although losses have narrowed in recent periods. In addition
to the bus services connected with the Light Rail, we began generating revenue from feeder bus services provided to the East Rail stations in 1999. Light Rail revenues decreased 11.1% in 2004 from 2003, to HK$416 million (US$53.5 million) mainly due
to lower Light Rail feeder bus revenue as a result of the rationalization of feeder bus service routes that followed the West Rails opening in 2003.



Freight operations have changed over the past ten years, with breakbulk freight volume declining and containerized freight volume increasing steadily.
Increased competition from cross-boundary truck and barge transportation, flexible and competitive freight packages offered by operators of alternative ports in the southern part of mainland China and logistical limitations created by the necessity
to transport goods from the East Rail terminus at Hung Hom to the Hong Kong container port at Kwai Chung have adversely affected rail freight usage. Freight revenue decreased by 8.1% in 2004 mainly due to the decreased breakbulk and livestock
traffic, as well as lower income generated from forwarding and terminal services. See Item 4. Information on the CorporationRail OperationsFreight Services.



38



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##### Table of Contents

Property Development



Property development and property ownership and management have been the second largest contributor to profit after
taxation. Profit on property development is not included in our revenues or operating profits. Property development income generally arises from development projects undertaken jointly with major Hong Kong property development companies. We did not
bid for the right to develop land at Government auctions. We have only undertaken property development where we have acquired the right from the Government to develop properties along our railway lines. Pursuant to an agreement signed by the
Government and us in February 2000, we have acted as the Governments property development agent through WRPDL for the 13 West Rail Phase I property sites, and the Government will receive the net profits from the development of these projects,
net of contingent expenses, development costs and other expenses payable to us.



The Government requires us to pay land premiums for acquiring the rights to use and develop land adjacent to or along our existing railway for property development purposes. The amount of the land premium we are
required to pay is calculated by the Government and is determined at fair market value by reference to the amount that other third party developers would be required to pay for comparable property development sites at similar locations. Land premium
payments to the Government are borne by the property development companies.



In most cases, we contribute the site and receive a guaranteed minimum profit, and the property developers bear substantially all the costs for construction and development including the land premium involved in
building high-rise residential and commercial buildings on either an elevated base above the relevant portion of the railways or on land adjacent to the railways. The exceptions are sites where property development enabling works are necessary to
preserve the development potential above those sites. In these cases, we will normally recover such costs, including their financing costs and interest, from the property developers in the form of upfront payments when the agreements have been
entered into with the property developers. The extent of recovery may vary from case to case in order to make the project commercially attractive. Generally, we are able to control the timing of property sales and, in most instances, the sales will
take place prior to project completion.



The amount and timing
of property development related cash inflows and profits have fluctuated as various properties have been developed. In 2000, 2001 and 2002, profit on property development accounted for 3.8%, 1.0% and 3.5% respectively, of profit before taxation.
Since 2002, the Government has imposed a moratorium on land sales in Hong Kong. We did not have any property development profits in 2003 and 2004. The last property development project we undertook before the moratorium was the Ho Tung Lau (Site A)
project in late 2002, which is expected to complete in 2007. We expect that the site at Wu Kai Sha would be the next property development project to commence construction in 2005.



Property Services



We include recurring revenues from commercial activities, property ownership and management in our revenues as a component of operating profit. We
generate such revenues primarily by leasing commercial premises at our stations and in our shopping centers as well as our office buildings. In 2004, commercial activities, property ownership and management operations accounted for 13.9% of total
revenue of KCRC and revenues increased to HK$695 million (US$89.4 million) up 14.5% from HK$607 million in 2003, mainly as a result of the expiry of the rent relief scheme for SARS and the opening of new station shops at the West Rail and East Tsim
Sha Tsui station. Lease rates have fluctuated significantly over time in Hong Kong. They fell substantially in 1997 and 1998, and were relatively stable in 2000, 2001, 2002 and 2003 and increased in 2004. Revenues and profits depend on market
conditions at the time leases are entered into and renewed.



39



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##### Table of Contents

Finance Income/(Expenses)



We had cash, cash equivalents and investments in securities of HK$7,854 million (US$1,010.5 million) as of December 31,
2004. We incurred net finance expenses of HK$41 million (US$5.3 million) during 2004. This amount does not include finance income of HK$173 million (US$22.3 million) and finance expenses of HK$1,037 million (US$133.4 million) which were capitalized
and included in the project costs of West Rail Phase I, the East Rail Extensions, the Sha Tin to Central Link and the Kowloon Southern Link. With respect to funds that are required for the development of these projects, we capitalize both the
finance income earned on such funds and the borrowing costs attributable to the related borrowings. As a result, the net finance expenses reported in the income statement does not include interest earned or interest paid with respect to such amounts
for HK GAAP purposes. See Note 44 to our audited consolidated financial statements for a summary of differences between HK GAAP and US GAAP applicable to us.



Operating Costs



Our principal operating costs are staff costs, electricity and fuel costs, and depreciation, which accounted for approximately 33.0%, 10.3% and 36.8%,
respectively, of total operating costs in 2004. Our staff costs are influenced by inflation, labor productivity, the relative supply and demand for labor in Hong Kong and other factors. Depreciation expenses in 2004 increased by 118.2% as compared
to 2003 mainly due to the depreciation of the assets associated with West Rail Phase I, the Tsim Sha Tsui Extension and the Ma On Shan Rail following their commencement of commercial operations in December 2003, October 2004 and December 2004,
respectively. Electricity costs are influenced by car miles operated, asset efficiency, market prices for fuel and other factors. We pay commercial rates for electricity based on tariffs set by CLP Power Hong Kong Limited. See Notes 4(b) and 4(c) to
our audited consolidated financial statements for a breakdown of operating costs.



Major Business Activity Performance



The
following table sets forth our revenue and operating profit after depreciation for each of the major business activities for the periods indicated:



|                                            |  |                         |   |  |       |   |  |       |     |  |      |    
|------------------------------------------- |  | ----------------------- | - |  | ----- | - |  | ----- | --- |  | ---- | ---
|                                            |  | Year Ended December 31, |  
|                                            |  | 2002                    |   |  | 2003  |   |  | 2004  |     |  | 2004 |    
|                                            |  | HK$                     |   |  | HK$   |   |  | HK$   |     |  | US$  |    
|                                            |  | (in millions)           |  
|Revenue :                                   |  |                         |   |  |       |   |  |       |     |  |      |    
|Passenger Services                          |  |                         |   |  |       |   |  |       |     |  |      |    
|East Rail                                   |  | 3,569                   |   |  | 3,266 |   |  | 3,415 | (1) |  | 439  |    
|Light Rail                                  |  | 558                     |   |  | 468   |   |  | 416   |     |  | 54   |    
|West Rail                                   |  |                        |   |  | 11    |   |  | 382   |     |  | 49   |    
|Freight                                     |  | 86                      |   |  | 74    |   |  | 68    |     |  | 9    |    
|                                            |  |                         |   |  |       |   |  |       |     |  |      |    
|Transport Services                          |  | 4,213                   |   |  | 3,819 |   |  | 4,281 |     |  | 551  |    
|Property Services                           |  | 617                     |   |  | 607   |   |  | 695   |     |  | 89   |    
|                                            |  |                         |   |  |       |   |  |       |     |  |      |    
|Total revenue                               |  | 4,830                   |   |  | 4,426 |   |  | 4,976 |     |  | 640  |    
|                                            |  |                         |   |  |       |   |  |       |     |  |      |    
|Operating Profit (Loss) After Depreciation: |  |                         |   |  |       |   |  |       |     |  |      |    
|Passenger Services                          |  |                         |   |  |       |   |  |       |     |  |      |    
|East Rail                                   |  | 1,666                   |   |  | 1,353 |   |  |       |     |  |      |    
|Light Rail                                  |  | (95                     | ) |  | (94   | ) |  |       |     |  |      |    
|West Rail                                   |  |                        |   |  | (61   | ) |  |       |     |  |      |    
|                                            |  |                         |   |  |       |   |  |       |     |  |      |    
|Total passenger services                    |  | 1,571                   |   |  | 1,198 |   |  |       |     |  |      |    
|Freight                                     |  | (27                     | ) |  | (36   | ) |  |       |     |  |      |    
|                                            |  |                         |   |  |       |   |  |       |     |  |      |    
|Transport Services                          |  | 1,544                   |   |  | 1,162 |   |  | 58    | (2) |  | 7    | (2)
|                                            |  |                         |   |  |       |   |  |       |     |  |      |    
|Property Services                           |  | 390                     |   |  | 387   |   |  | 479   |     |  | 62   |    
|                                            |  |                         |   |  |       |   |  |       |     |  |      |    
|Total operating profit                      |  | 1,934                   |   |  | 1,549 |   |  | 537   | (2) |  | 69   |    
|Net finance income/(expenses)               |  | 618                     |   |  | 353   |   |  | (41   | )   |  | (5   | )  
|Profit from property development            |  | 94                      |   |  |      |   |  |      |     |  |     |    
|Share of profit/(loss) of associate         |  | 16                      |   |  | 8     |   |  | 16    |     |  | 2    |    
|                                            |  |                         |   |  |       |   |  |       |     |  |      |    
|Profit before taxation                      |  | 2,662                   |   |  | 1,910 |   |  | 512   |     |  | 66   |    
|Taxation                                    |  | (452                    | ) |  | (529  | ) |  | (83   | )   |  | (11  | )  
|                                            |  |                         |   |  |       |   |  |       |     |  |      |    
|Profit after taxation                       |  | 2,210                   |   |  | 1,381 |   |  | 429   |     |  | 55   |    
|                                            |  |                         |   |  |       |   |  |       |     |  |      |    

---

|(1) | Includes the Tsim Sha Tsui Extension and Ma On Shan Rail which commenced operations on
October 24, 2004 and December 21, 2004, respectively.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

|(2) | In December 2003, East Rail Division, West Rail/Light Rail Division were combined to form a
single Transport Division to allow management more flexibility in the deployment of resources and enable us to achieve synergy and savings, particularly for those services common to all railway networks, such as maintenance. The Transport Division
manages all the transport services including East Rail, Light Rail, West Rail and Freight. Since December 2003, most of the costs are common to various railway services including East Rail, Light Rail, West Rail and Freight. Consistent with our
internal organizational and management structure, a transport services segment has been created in place of East Rail, Light Rail, West Rail and Freight. Commencing 2004, separate profit/(loss) figures for individual business segments are not
available.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Contribution of Major Business
Activities



The following table sets forth by category
of major business activities for the periods indicated (1) our revenue as a percentage of total revenue and (2) our operating profit/(loss) as a percentage of total operating profit:



|                            |  |                         |   |  |       |   |  |       |    
|--------------------------- |  | ----------------------- | - |  | ----- | - |  | ----- | ---
|                            |  | Year Ended December 31, |  
|                            |  | 2002                    |   |  | 2003  |   |  | 2004  |    
|                            |  | %                       |   |  | %     |   |  | %     |    
|Revenue/Total Revenue:      |  |                         |   |  |       |   |  |       |    
|Passenger Services          |  |                         |   |  |       |   |  |       |    
|East Rail                   |  | 73.9                    |   |  | 73.8  |   |  | 68.6  |    
|Light Rail                  |  | 11.6                    |   |  | 10.6  |   |  | 8.4   |    
|West Rail                   |  |                        |   |  | 0.2   |   |  | 7.7   |    
|Freight                     |  | 1.8                     |   |  | 1.7   |   |  | 1.4   |    
|                            |  |                         |   |  |       |   |  |       |    
|Transport Services          |  | 87.3                    |   |  | 86.3  |   |  | 86.1  |    
|Property Services           |  | 12.7                    |   |  | 13.7  |   |  | 13.9  |    
|                            |  |                         |   |  |       |   |  |       |    
|Total revenue               |  | 100.0                   |   |  | 100.0 |   |  | 100.0 |    
|                            |  |                         |   |  |       |   |  |       |    
|Operating Profit/(Loss)(1): |  |                         |   |  |       |   |  |       |    
|Passenger Services          |  |                         |   |  |       |   |  |       |    
|East Rail                   |  | 86.1                    |   |  | 87.3  |   |  | N/A   | (1)
|Light Rail                  |  | (4.9                    | ) |  | (6.1  | ) |  | N/A   | (1)
|West Rail                   |  |                        |   |  | (3.9  | ) |  | N/A   | (1)
|Freight                     |  | (1.4                    | ) |  | (2.3  | ) |  | N/A   | (1)
|                            |  |                         |   |  |       |   |  |       |    
|Transport Services          |  | 79.8                    |   |  | 75.0  |   |  | 11.0  | (1)
|Property Services           |  | 20.2                    |   |  | 25.0  |   |  | 89.0  | (1)
|                            |  |                         |   |  |       |   |  |       |    
|Total operating profit      |  | 100.0                   |   |  | 100.0 |   |  | 100.0 | (1)
|                            |  |                         |   |  |       |   |  |       |    

---

|(1) | In December 2003, East Rail Division, West Rail/Light Rail Division were combined to form a
single Transport Division to allow management more flexibility in the deployment of resources and enable us to achieve synergy and savings, particularly for those services common to all railway networks, such as maintenance. The Transport Division
manages all the transport services including East Rail, Light Rail, West Rail and Freight. Since December 2003, most of the costs are common to various railway services including East Rail, Light Rail, West Rail and Freight. Consistent with our
internal organizational and management structure, a transport services segment has been created in place of East Rail, Light Rail, West Rail and Freight. Commencing 2004, separate profit/(loss) figures for individual business segments are not
available.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

Results of Operations under HK GAAP



Year Ended December 31, 2004 Compared to Year Ended December 31, 2003



Total revenue from operations was HK$4,976 million (US$640.2 million) for
2004, a 12.4% increase from HK$4,426 million for 2003. This increase included a 12.5% increase in revenue from railway and bus operations (excluding freight) to HK$4,213 million (US$542.1 million), a 8.1% decrease in freight revenue to HK$68 million
(US$8.7 million), and a 14.5% increase in property services revenue to HK$695 million (US$89.4 million) for 2004 compared with that for 2003. Revenue from the East Rail increased by 4.6% from HK$3,266 million for 2003 to HK$3,415 million (US$439.4
million) for 2004. This increase in the East Rails revenue was mainly due to the recovery in patronage following the SARS outbreak and the opening of the Tsim Sha Tsim Extension. Revenues from Light Rail, both fare and non-fare, decreased
11.1% to HK$416 million (US$53.5 million) from HK$468 million in 2003, mainly due to the lower Light Rail feeder bus revenue as a result of the rationalization of feeder bus services upon the West Rails opening in late 2003. Recurrent revenue
from property activities increased to HK$695 million (US$89.4 million), up 14.5% from HK$607 million in 2003, mainly as a result of the expiry of the rent relief scheme introduced during the SARS period and the opening of new station shops at the
West Rail and East Tsim Sha Tsui stations. Revenue from freight services decreased by 8.1% to HK$68 million (US$8.7 million) in 2004 from HK$74 million in 2003, mainly due to the decreased breakbulk and livestock traffic, as well as lower income
generated from forwarding and terminal services.



Operating
profit before net finance income/(expenses) (before tax) declined by 65.3% to HK$537 million (US$69.1 million) in 2004, compared with HK$1,549 million in 2003 mainly due to the depreciation for the West Rail, Tsim Sha Tsui Extension and Ma On Shan
Rail. Operating margin decreased from 35.0% in 2003 to 10.8% in 2004. Operating costs for 2004 increased by 54.3% to HK$4,439 million (US$571.1 million) from HK$2,877 million in 2003 mainly due to increases in expenses such as depreciation which
increased by 118.2% to HK$1,632 million (US$210.0 million), electricity and fuel which increased by 68.3% to HK$456 million (US$58.7 million) and repair and maintenance which rose by 36.1% to HK$181 million (US$23.3 million).



Overall operating costs before depreciation increased mainly because of the
full year operation of the West Rail. Staff costs increased by 21.9% to HK$1,464 million (US$188.4 million) from HK$1,201 million in 2003, energy costs rose by 68.3% to HK$456 million (US$58.7 million) from HK$271 million, maintenance expenses,
including repair and maintenance, stores and spares consumed and general supplies, rose by 31.6% to HK$371 million (US$47.7 million) from HK$282 million in 2003, and other expenses increased by 37.6% to HK$516 million (US$66.4 million) from HK$375
million in 2003.



Net finance expenses of HK$41 million (US$5.3
million) were incurred in 2004, compared with net finance income of HK$353 million in 2003 because finance expenses related to the West Rail, Tsim Sha Tsui Extension and Ma On Shan Rail were no longer capitalized following the opening of these new
railways. No property development profit was realized in 2003 and 2004. A share of profit from an associate of HK$16 million (US$2.1 million) was recognized in 2004, compared with HK$8 million in 2003, representing an increase of 100.0%. Net income
tax in the amount of HK$83 million (US$10.6 million) was recognized in 2004, compared with HK$529 million in 2003, representing a decrease of 84.3%, mainly attributable to the increase in tax losses and the adjustment in 2003 for the effect on
opening deferred tax balances resulting from an increase in tax rate.



Year Ended December 31, 2003 Compared to Year Ended December 31, 2002



Total revenue from operations was HK$4,426 million for 2003, an 8.4% decrease from HK$4,830 million for 2002. This decrease included a 9.3% decrease in revenue from railway and bus operations (excluding freight) to
HK$3,745 million, a 14.0% decrease in freight revenue to HK$74 million, and a 1.6% decrease in property services revenue to HK$607 million for 2003 compared with that for 2002. Revenue from the East Rail decreased by 8.5% from HK$3,569 million for
2002 to HK$3,266 million for 2003. This decrease in the East Rails revenue reflected a 3.9% decrease in domestic passenger volume, and a 10.8% decrease in cross-boundary passenger volume from 2002. The decline in transport and recurrent
revenues was mainly attributable to the impact of the SARS outbreak on passenger revenues and revenues derived from KCRCs property tenants, as well as increased competition from cross-boundary coach operators. Revenues from the Light Rail and
bus, both fare and non-fare, decreased 16.1% to HK$468 million from HK$558 million in 2002, mainly due to the impact of SARS and the Light Rail and West Rail Phase I construction works. Recurrent revenue from property activities decreased to HK$607
million, down 1.6% from HK$617 million in 2002, mainly due to the revenue loss attributable to the relief scheme granted during the SARS outbreak and the negative impact on the retail sector in 2003. Revenue from freight services decreased by 14.0%
to HK$74 million in 2003 from HK$86 million in 2002, mainly due to decreased breakbulk traffic from northern and central China, and decreased livestock traffic.



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##### Table of Contents

Operating profit before net finance income/(expenses) (before tax) decreased by 19.9% to HK$1,549 million
in 2003, compared with HK$1,934 million in 2002. The operating margin decreased from 40.0% in 2002 to 35.0% in 2003. Operating costs for 2003 decreased by 0.7% to HK$2,877 million from HK$2,896 million in 2002. Despite increases in expenses such as
depreciation which increased by 3.2% to HK$748 million, and costs of materials and stores and spares consumed which rose by 12.0% to HK$149 million, the overall operating costs are reduced mainly attributable to the reduction in staff costs which
decreased by 2.0% to HK$1,201 million, maintenance costs which reduced by 7.6% to HK$133 million, and electricity and fuel and other expenses (excluding depreciation) which decreased by 3.3% to HK$646 million.



Net finance income decreased by 42.9% to HK$353 million in 2003, compared
with HK$618 million in 2002 primarily due to lower interest rates. No property development profit was realized in 2003, compared with HK$94 million in 2002. A share of profit from an associate of HK$8 million was recognized in 2003, compared with
HK$16 million in 2002, representing a decrease of 50.0%. Net income tax in the amount of HK$529 million was recognized in 2003, compared with the restated amount of HK$452 million in 2002, representing an increase of 17.0%, which was mainly
attributable to the effect on opening deferred tax balances resulting from an increase in tax rate in 2003.



In March 2003, the Government announced an increase in the Hong Kong profits tax rate from 16% to 17.5%. This increase was taken into account in the
preparation of our audited consolidated financial statements for 2003. Accordingly, the provision for Hong Kong profits tax for 2003 is calculated at 17.5% of the estimated assessable profits for the year, compared to 16% in 2002. The provision for
Hong Kong profits tax for 2003 was made solely in respect of the estimated assessable profits of our subsidiaries for 2003. We sustained a loss for tax purposes in 2003 and we have accumulated tax losses carried forward of approximately HK$3,800
million as of December 31, 2003, compared to HK$2,600 million at December 31, 2002, which are available to offset against future assessable profits.



Inflation



We had historically increased our scheduled fares at a rate in line with inflation. Because the rate of inflation decreased significantly in the preceding
four years prior to 2004, in light of the economic downturn affecting Asia and Hong Kong and other factors, we have not increased our fares for both the East Rail and Light Rail since 1998. The economic downturn had, to some extent, triggered
deflation in Hong Kong as reflected by an average annual decrease of 2.0% in the Hong Kong Consumer Price Index (A) for the four years from 2000 to 2003. For the years ended December 31, 2000, 2001, 2002 and 2003, the Hong Kong Consumer Price Index
(A) dropped 3.0%, 1.7%, 3.2% and 2.1%, respectively, representing deflation for four consecutive years. In 2004, according to the International Monetary Fund, strong domestic demand in Hong Kong has contributed to the rebound of the property sector
and brought an end to consumer price deflation. Notwithstanding the end of such consumer price deflation, we have not increased our fares in 2004 and up through May 2005. See Item 4. Information on the CorporationPricing of Rail
Services.



43



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##### Table of Contents

Effects of Interest Rate and Foreign Exchange Movements on Our Borrowings



Taking into account the interest rate swaps, we had HK$4,993 million
(US$642.4 million) of floating rate debts as of December 31, 2004. As a result of the increase in borrowings to finance new projects, our interest and financing charges are also expected to increase in the future. An increase in interest rates may
increase our borrowing costs and, therefore, adversely affect our results of operations. However, we limit our exposure to interest rate risk through our policy of maintaining the proportion of fixed interest rate debt of between 30% and 75%. Our
Managing Board has adopted a policy to use derivative instruments only for hedging purposes.



Substantially all our revenues and operating expenses are incurred in Hong Kong dollars. However, we have raised significant borrowings in U.S. dollars. We also have some capital expenditure and other expenses in
foreign currencies. Volatility in currency exchange rates between the Hong Kong dollar and other currencies may therefore affect our results of operations. We have reduced foreign exchange exposure relating to debt obligations and capital
expenditure by entering into currency swaps and foreign exchange forward contracts in order to convert such obligations into either Hong Kong dollars or U.S. dollars, and to maintain our U.S. dollar exposure in debt obligations at no greater than
30% of our total borrowings.



Results of Operations under US GAAP



We prepare our consolidated financial statements in
accordance with HK GAAP, which differs in certain material respects from US GAAP. A comparison and discussion, on a US GAAP basis, of the income statement line items significantly impacted by these differences is as follows:



|                                                       |  |               |  |       |  |       |   |  |      |  
|------------------------------------------------------ |  | ------------- |  | ----- |  | ----- | - |  | ---- | -
|                                                       |  | 2002          |  | 2003  |  | 2004  |   |  | 2004 |  
|                                                       |  | HK$           |  | HK$   |  | HK$   |   |  | US$  |  
|                                                       |  | (in millions) | 
|Depreciation:                                          |  |               |  |       |  |       |   |  |      |  
|HK GAAP                                                |  | 725           |  | 748   |  | 1,632 |   |  | 210  |  
|US GAAP(1)                                             |  | 733           |  | 757   |  | 1,813 |   |  | 233  |  
|Operating profit before net finance income/(expenses): |  |               |  |       |  |       |   |  |      |  
|HK GAAP                                                |  | 1,934         |  | 1,549 |  | 537   |   |  | 69   |  
|US GAAP                                                |  | 1,800         |  | 1,406 |  | 313   |   |  | 40   |  
|Net finance income/(expenses):                         |  |               |  |       |  |       |   |  |      |  
|HK GAAP                                                |  | 618           |  | 353   |  | (41   | ) |  | (5   | )
|US GAAP(2)                                             |  | 1,591         |  | 650   |  | 28    |   |  | 4    |  
|Operating profit after net finance income/(expenses):  |  |               |  |       |  |       |   |  |      |  
|HK GAAP                                                |  | 2,552         |  | 1,902 |  | 496   |   |  | 64   |  
|US GAAP                                                |  | 3,391         |  | 2,056 |  | 341   |   |  | 44   |  
|Profit before tax:                                     |  |               |  |       |  |       |   |  |      |  
|HK GAAP                                                |  | 2,662         |  | 1,910 |  | 512   |   |  | 66   |  
|US GAAP                                                |  | 3,428         |  | 2,064 |  | 357   |   |  | 46   |  

---

|(1) | Prior to 2004, depreciation differed between HK GAAP and US GAAP mainly due to the depreciation on investment properties. See Note 44(a) to our audited consolidated
financial statements. In 2004, the differences in depreciation between HK GAAP and US GAAP was due to the depreciation of certain fixed assets and the depreciation of the investment income for the capital projects of the West Rail system, the Tsim
Sha Tsui Extension and the Ma On Shan Rail. See Note 44(b) and 44(c) to our audited financial statements for the depreciation of certain fixed assets and the depreciation of investment income respectively.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | The major difference between HK GAAP and US GAAP for net finance income/(expenses) is the different accounting treatment in respect of the investment income
generated from the pre-funding investments, capitalization of interest and foreign exchange gains and losses from specific borrowings and derivative instruments, details of which are set out in Notes 44(c), 44(f) and 44(h) to our audited financial
statements.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Year Ended December 31, 2004 Compared to Year Ended December 31, 2003



Operating profit before net finance income/(expenses) declined by 77.7% to
HK$313 million (US$40.3 million) in 2004, compared with HK$1,406 million in 2003, mainly due to the depreciation for the West Rail, Tsim Sha Tsui Extension and Ma On Shan Rail. Another reason for the decline was the increase in operating costs
arising from the full year operation of the West Rail. Though the impact of SARS was limited to 2003, the operating profit before net finance income/(expenses) in 2004 was still at a level lower than 2002, due to the increase in operating costs from
the West Rail.



Depreciation increased by 139.5% to HK$1,813
million (US$233.3 million) in 2004, compared with HK$757 million in 2003, mainly due to the depreciation of the West Rail, Tsim Sha Tsui Extension and Ma On Shan Rail which commenced operations on December 20, 2003, October 24, 2004 and December 21,
2004 respectively.



Net finance income declined by 95.7% to
HK$28 million (US$3.6 million) in 2004, compared with HK$650 million in 2003, mainly due to the increase in interest expenses charged to our income statement in relation to the West Rail, Tsim Sha Tsui Extension and Ma On Shan Rail following the
commencement of operations of these new railways.



Operating
profit after net finance income/(expenses) declined by 83.4% to HK$341 million (US$43.9 million) compared with HK$2,056 million in 2003, mainly due to the depreciation for the West Rail, Tsim Sha Tsui Extension and Ma On Shan Rail, and the fact that
the capitalization of the finance expenses related to the West Rail, Tsim Sha Tsui Extension and Ma On Shan Rail ceased following the opening of these new railways.



Profit before tax declined by 82.7% to HK$357 million (US$45.9 million) in 2004 compared with HK$2,064 million in 2003. The
decrease is less than that of operating profit after net finance income/(expenses) because of the increase in the share of profits of our associate, which slightly offset the decrease in the operating profit before net finance income/(expenses).



Year Ended December 31, 2003 Compared to Year Ended
December 31, 2002



Operating profit before net finance
income/(expenses) declined by 21.9% to HK$1,406 million in 2003 compared with HK$1,800 million in 2002, mainly due to the negative impact of the SARS outbreak on passenger revenues and on the retail sector.



Depreciation increased slightly by 3.3% to HK$757 million in 2003 compared
with HK$733 million in 2002 due to the acquisition of additional fixed assets for operations in the ordinary course of business.



Net finance income declined by 59.1% to HK$650 million in 2003 compared with HK$1,591 million in 2002, primarily due to the decrease in finance income
arising from the low interest rate and a reduction in our income-generating investments.



Operating profit after net finance income/(expenses) declined by 39.4% to HK$2,056 million in 2003 compared with HK$3,391 million in 2002 mainly due to the negative impact of the SARS outbreak on passenger revenues
and on the retail sector, and the decrease in finance income arising from the low interest rate and a reduction in our income-generating investments.



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Profit before tax declined by 39.8% to HK$2,064 million in 2003 compared with HK$3,428 million in 2002.
The decrease is more than that of operating profit after net finance income/(expenses) mainly due to the decrease in the share of profits of our associate.



5.B LIQUIDITY AND CAPITAL RESOURCES



Capital Commitments



The two capital projects we are currently developing are the Lok Ma Chau Spur Line and the Kowloon Southern Link. We have completed the scheme design for
the Sha Tin to Central Link and we submitted the draft final proposal to the Government in September 2004. The railway scheme and implementation program of the Sha Tin to Central Link are subject to the Governments final decision, which is
pending the Governments decision on the proposed merger between KCRC and MTRCL. We have outstanding capital commitments and plans to upgrade and replace assets used in connection with our existing East Rail line and Light Rail systems,
including section by section track replacement programs, installation of noise barriers and other improvements to selected lines and stations.



We estimate the aggregate development costs for the two largest capital projects from project inception to the commencement of operations, including
financing costs during construction, to be as follows:



|                                  |  |                      |  |                     |  |       |  |      
|--------------------------------- |  | -------------------- |  | ------------------- |  | ----- |  | -----
|                                  |  | East Rail Extensions |  | KowloonSouthernLink |  | Total |  | Total
|                                  |  | HK$                  |  | HK$                 |  | HK$   |  | US$  
|                                  |  | (in billions)       
|Anticipated development costs:    |  |                      |  |                     |  |       |  |      
|Construction costs                |  | 22.9                 |  | 8.1                 |  | 31.0  |  | 4.0  
|Land costs                        |  | 1.3                  |  | 0.2                 |  | 1.5   |  | 0.2  
|Financing costs                   |  | 3.0                  |  | 0.7                 |  | 3.7   |  | 0.5  
|                                  |  |                      |  |                     |  |       |  |      
|Total                             |  | 27.2                 |  | 9.0                 |  | 36.2  |  | 4.7  
|                                  |  |                      |  |                     |  |       |  |      
|Anticipated financing sources:(1) |  |                      |  |                     |  |       |  |      
|Government equity                 |  | 8.0                  |  |                    |  | 8.0   |  | 1.0  
|KCRC debt                         |  | 12.6                 |  | 9.0                 |  | 21.6  |  | 2.8  
|KCRC internal funds               |  | 6.6                  |  |                    |  | 6.6   |  | 0.9  
|                                  |  |                      |  |                     |  |       |  |      
|Total                             |  | 27.2                 |  | 9.0                 |  | 36.2  |  | 4.7  
|                                  |  |                      |  |                     |  |       |  |      

---

|(1) | As of December 31, 2004, total financing sources amounted to HK$22,355.0 million (US$2,876.2 million), consisting of HK$8,000 million (US$1,029.3 million) of capital
contributions from the Hong Kong Government for the Ma On Shan Rail and Tsim Sha Tsui Extension; HK$7,738 million (US$995.6 million) in net proceeds from the US$1 billion in principal amount of the Notes; HK$4,503 million (US$579.4 million) in net
proceeds from the US$1 billion in principal amount of 7.25% notes due 2009, HK$800 million (US$102.9 million) in principal amount of 4.65% notes due 2013, and HK$300 million (US$38.6 million) at a premium in principal amount of 3% notes due 2008 and
a principal amount of HK$700 million (US$90.1 million) at a premium in principal amount of 4.8% notes due 2013; and HK$313.6 million (US$40.3 million) from deferred payment of long term credit facilities.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



For the East Rail Extensions, we incurred a total cash outlay of HK$13.8
billion (US$1.8 billion) prior to 2004 and HK$5.1 billion (US$0.7 billion) in 2004. Based on our projected construction schedule, the following is our estimated schedule of payments from 2005 onwards and the actual payments in 2004 for the East Rail
Extensions:



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|                   |  |               |  |      |  |      |  |             |  |       |  |      
|------------------ |  | ------------- |  | ---- |  | ---- |  | ----------- |  | ----- |  | -----
|                   |  | 2004          |  | 2005 |  | 2006 |  | 2007onwards |  | Total |  | Total
|                   |  | HK$           |  | HK$  |  | HK$  |  | HK$         |  | HK$   |  | US$  
|                   |  | (in billions)
|Construction costs |  | 4.5           |  | 3.1  |  | 2.3  |  | 1.5         |  | 11.4  |  | 1.4  
|Land costs         |  | 0.1           |  | 0.4  |  | 0.1  |  | 0.1         |  | 0.7   |  | 0.1  
|Financing costs    |  | 0.5           |  | 0.5  |  | 0.3  |  |            |  | 1.3   |  | 0.2  
|                   |  |               |  |      |  |      |  |             |  |       |  |      
|Total              |  | 5.1           |  | 4.0  |  | 2.7  |  | 1.6         |  | 13.4  |  | 1.7  
|                   |  |               |  |      |  |      |  |             |  |       |  |      



For the Kowloon
Southern Link, we incurred a total cash outlay of HK$149 million (US$19.2 million) prior to 2004 and HK$106 million (US$13.6 million) in 2004. Based on our projected construction schedule, the following is our estimated schedule of payments
from 2005 onwards and the actual payments in 2004 for the Kowloon Southern Link:



|                   |  |               |  |      |  |      |  |             |  |       |  |      
|------------------ |  | ------------- |  | ---- |  | ---- |  | ----------- |  | ----- |  | -----
|                   |  | 2004          |  | 2005 |  | 2006 |  | 2007onwards |  | Total |  | Total
|                   |  | HK$           |  | HK$  |  |      |  | HK$         |  | HK$   |  | US$  
|                   |  | (in billions)
|Construction costs |  | 0.1           |  | 1.8  |  | 2.0  |  | 4.0         |  | 7.9   |  | 1.0  
|Land costs         |  |              |  |     |  | 0.1  |  | 0.1         |  | 0.2   |  |     
|Financing costs    |  |              |  |     |  | 0.1  |  | 0.6         |  | 0.7   |  | 0.1  
|                   |  |               |  |      |  |      |  |             |  |       |  |      
|Total              |  | 0.1           |  | 1.8  |  | 2.2  |  | 4.7         |  | 8.8   |  | 1.1  
|                   |  |               |  |      |  |      |  |             |  |       |  |      



As of December 31,
2004, we had an aggregate of HK$4,966 million (US$638.9 million) in outstanding commitments for capital expenditure mainly for the development of the East Rail Extensions and Kowloon Southern Link and existing businesses, such as transport and
property services.



Unexpected geological conditions, economic
or political developments, accidents or natural disasters can cause delays, design changes and other factors which can increase costs. Moreover, the current estimated sources of funds for the Lok Ma Chau Spur Line and Kowloon Southern Link include
funds that KCRC expects to generate internally from operations in the future. As a result, we cannot assure you that actual project costs and sources of funds will be the same as those budgeted for these projects.



The following table sets out our capital expenditure for each of the three years ended
December 31, 2002, 2003 and 2004.



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|                                                                                |  |                         |  |        |  |       |  |      
|------------------------------------------------------------------------------- |  | ----------------------- |  | ------ |  | ----- |  | -----
|                                                                                |  | Year Ended December 31,
|                                                                                |  | 2002                    |  | 2003   |  | 2004  |  | 2004 
|                                                                                |  | HK$                     |  | HK$    |  | HK$   |  | US$  
|                                                                                |  | (in millions)          
|Railway related operational equipment(1)                                        |  | 14                      |  | 15     |  | 18    |  | 2    
|Assets under construction:(2)                                                   |  |                         |  |        |  |       |  |      
|West Rail Phase I                                                               |  | 6,503                   |  | 4,803  |  | 2,671 |  | 344  
|East Rail Extensions                                                            |  | 4,352                   |  | 4,559  |  | 5,321 |  | 685  
|Kowloon Southern Link/Sha Tin to Central Link                                   |  | 61                      |  | 732    |  | 541   |  | 70   
|Automatic Train Protection System                                               |  |                        |  |       |  |      |  |     
|Rolling Stock                                                                   |  | 387                     |  | 89     |  | 42    |  | 5    
|Others                                                                          |  | 232                     |  | 226    |  | 181   |  | 23   
|                                                                                |  |                         |  |        |  |       |  |      
|                                                                                |  | 11,535                  |  | 10,409 |  | 8,756 |  | 1,127
|Others(3)                                                                       |  | 14                      |  | 3      |  | 8     |  | 1    
|                                                                                |  |                         |  |        |  |       |  |      
|Total railway assets                                                            |  | 11,563                  |  | 10,427 |  | 8,782 |  | 1,130
|Investment property and buildings                                               |  |                        |  |       |  |      |  |     
|Assets under construction for investment property, leasehold land and buildings |  | 745                     |  | 695    |  | 240   |  | 31   
|                                                                                |  |                         |  |        |  |       |  |      
|Total capital expenditure(4)                                                    |  | 12,308                  |  | 11,122 |  | 9,022 |  | 1,161
|                                                                                |  |                         |  |        |  |       |  |      

---

|(1) | Includes signaling systems, telecommunication equipment, automatic relevant collection system machinery and equipment.
|--- | ----------------------------------------------------------------------------------------------------------------------

|(2) | Assets under construction represent project costs of railway related operational equipment, other railway related assets, and all capital expenditure of West Rail Phase I, the East
Rail Extensions, the Kowloon Southern Link and the Sha Tin to Central Link.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Includes lifts, escalators, mobile phone communication equipment, air-conditioning plant, furniture and fixtures, electronic data processing equipment, computer software, office
equipment, buses, motor vehicles, company boats and tools.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Capital expenditure excludes capitalized finance income and expenses. See Note 2(q) to our audited consolidated financial statements for our accounting policy on borrowing costs and
investment income.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Resources for Capital Expenditure



Earnings.Historically, we have generated
our capital resources primarily through earnings. For the year ended December 31, 2004, the contribution to capital resources by earnings from railway operations improved as the net cash inflow from operating activities was HK$1,929 million
(US$248.2 million), an increase of HK$59 million (US$7.6 million) as compared to that of last year.



Currently, we are not subject to contractual restrictions on the payment of dividends under any of our borrowings. We declared and made a dividend payment
of HK$172 million (US$22.1 million) in April 2005. Dividend payments would reduce the funds available to meet capital expenditure and repay indebtedness.



Earnings will not be sufficient to provide all of the significant capital resources required to complete our railway projects. To fund West Rail Phase I
and the East Rail Extensions projects, we have relied largely on capital contributions by the Government and borrowings. To fund the Kowloon Southern Link project, we expect to rely largely on borrowings. We currently expect borrowing costs to
represent about 5.1% of project costs in respect of all the above three projects and variations in costs could have a significant effect on the returns from these projects. We expect to incur significant capital expenditure in connection with the
Kowloon Southern Link with material expenditure expected to begin in 2005, when construction is expected to commence. While the details on the capital expenditure related to the Kowloon Southern Link are still being negotiated and are subject to
change, we expect to finance the project from internal resources and the HK$8 billion credit facilities arranged in 2004. We will likely expand our borrowings (by drawing down on the HK$8 billion available under the HK$8 billion credit facilities
agreement dated September 28, 2004) to meet part of the project costs for the construction of the Kowloon Southern Link.



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Equity Contributions.We received HK$14.5 billion, HK$6.0 billion and HK$8.5 billion in
April 1998, January 1999 and April 1999, respectively, constituting the total agreed equity injection of HK$29.0 billion from the Government in connection with the development of West Rail Phase I. In March 2001, we received HK$8.0 billion from the
Government in connection with the development of the Ma On Shan Rail and the Tsim Sha Tsui Extension. We do not expect any equity injections from the Government for the Kowloon Southern Link and the Sha Tin to Central Link.



Debt Facilities.Under the KCRC Ordinance, KCRC is empowered to
borrow, issue bonds, notes or other securities or otherwise raise money and charge all or any part of its property, undertaking and revenue as security for the borrowings. We may exercise such powers to provide ourselves with such sums or credits as
we may require for carrying out the purposes we are empowered under the KCRC Ordinance to undertake, repaying money we previously borrowed for such purposes, paying interest, premium or other charges on such money, or repaying sums to the
Government. During 2004, our credit ratings were generally stable. Standard & Poors Rating Group, a division of McGraw-Hill, Inc. (Standard & Poors) revised its outlook on our local currency rating from negative to
stable on June 29, 2004, and affirmed our local currency rating of AA- and foreign currency rating of A+. On May 4, 2005, Standard & Poors revised its outlook on our long-term foreign currency rating from stable to positive, and at the
same time affirmed our AA- local and A+ foreign currency ratings. In June 2004, Fitch Ratings affirmed our local currency rating at AA, and revised our local currency outlook from stable to negative. Moodys Investors Services affirmed our A1
foreign currency and Aa3 domestic currency ratings in February 2004.



With respect to our required debt financing for our railway projects, we have implemented a borrowing strategy designed to diversify funding sources and reduce financing costs. We have utilized the following funding sources:



| |  | In June 1999, we launched a US$1.5 billion Euro medium-term note program under which we may issue notes in any currency and maturities as we may agree with dealers. In January 2000,
the aggregate nominal amount of the program was increased from US$1.5 billion to US$3.0 billion. In July 1999 and November 1999, we issued 7.25% notes due 2009 in the aggregate nominal amount of US$1 billion and 7.77% notes due 2014 in the aggregate
nominal amount of US$50 million, respectively, under this program. The notes issued under this program are unsecured and repayable in full on their respective due dates.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In July 1999, we entered into a loan agreement with The Export-Import Bank of Japan, which was renamed as Japan Bank for International Cooperation on October 1, 1999 after its
merger with the Overseas Economic Cooperation Fund, and other lenders in connection with an export credit facility in a principal amount of US$337.7 million. This facility was made available for payments to the IKK Consortium (comprising Itochu
Corporation, The Kinki Sharyo Co. Ltd. and Kawasaki Heavy Industries, Ltd.) for the design, manufacture, supply, testing and commissioning of electric multiple unit trains for both West Rail Phase I and the East Rail. One-half of the borrowings
under the facility bears interest at 5.6% per year and the balance bears interest on a floating rate basis at a margin over LIBOR. The total amount of the facility was reduced to US$220.2 million as of December 31, 2004, following the cancellation
of the undrawn amount of US$47.5 million of the facility effective on June 30, 2003, and the subsequent repayment of US$70.0 million by KCRC. The loans are unsecured and repayable in 17 semi-annual installments commencing in April 2003. As of
December 31, 2004, approximately 66% of the total loan balance bears interest at a rate of 5.6% per annum and the remaining 34% bears interest at LIBOR plus a margin.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In March 2000, we issued 8% notes due in 2010 (the Notes) with an aggregate nominal value of US$1 billion. The Notes are unsecured senior obligations of KCRC and are
rated equally with all of our other unsecured senior indebtedness. The Notes are repayable in full on their due date.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | In June 2000, we signed a US$42 million export credit loan facility with Export Development Canada (formerly known as Export Development Corporation). This facility, with a 12-year
maturity, provided financing for the purchase of a train control and signaling system for West Rail Phase I. As of December 31, 2004, the outstanding balance of this facility is US$33.9 million. This facility bears interest on a floating rate basis
at a margin over LIBOR and the loans are unsecured and repayable in 17 semi-annual installments commencing in May 2004.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In June 2003, we issued two-tranche Hong Kong dollar retail bonds, including 3% notes due 2008 in the aggregate nominal amount of HK$300 million and 4.8% notes due 2013 in the
aggregate nominal amount of HK$700 million. The notes are unsecured and repayable in full on their respective due dates.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In June 2003, we issued HK$800 million in principal amount of 4.65% notes due 2013 under the Euro medium-term note program set up in June 1999. The notes issued under this program
are unsecured and repayable in full on their due date.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In September 2004, we entered into a HK$8,000 million credit facilities agreement with 18 banks and financial institutions. These facilities comprise three tranches: a HK$3,500
million five-year credit facility, a HK$3,500 million seven-year credit facility and a HK$1,000 million ten-year credit facility. Each facility is available for drawing on a revolving credit basis for the first five years. Thereafter, the
outstanding amounts under the seven-year and ten-year facilities will be converted to a term loan structure with bullet repayment upon the maturity of each facility. Each facility bears interest on a floating rate basis at a margin over HIBOR. As of
December 31, 2004, no amount was drawn under any of the credit facilities.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Investments



Our Managing Board has adopted a set of guidelines governing our investments intended to regulate our credit and currency risk exposure. Currently, all our investments must be made in Hong Kong dollars or U.S. dollars or hedged into these
currencies. As of December 31, 2004, our cash, investments and deposits with banks amounted to HK$7.9 billion (US$1.0 billion). Of this amount, about HK$5.5 billion was placed in bank deposits or invested in certificates of deposit. HK$1.6 billion
was invested in unlisted fixed income securities. About HK$5.7 billion of our investments was in obligations (or with institutions) rated in the top two rating categories of two recognized international rating agencies. As of December 31, 2004,
investments with a value of about HK$2.1 billion were denominated in Hong Kong dollars. The information on the market value of these securities was obtained from dealers in fixed income securities. The market value of these securities may fluctuate
to reflect market conditions such as movements of interest rates, liquidity and financial positions of the issuers of these securities.



Working Capital



Our working capital was a net current liability of HK$2,294 million (US$295.2 million) as of December 31, 2004. This was mainly attributable to payments
for capital expenditure for West Rail Phase I and the East Rail Extensions. Our need for operational working capital is limited, as our operating expenses are primarily funded through passenger fares paid on a current basis. It is expected that our
cash and cash equivalents and liquidation of certain investments with external investment managers will allow us to meet these payments in 2005.



Claims Impact



The claimed value of the contractors claims is regarded by our management as inflated. While we may be required to pay some additional sums to
contractors, any such sums will be fully accommodated by our project reserve, which has been taken into account in the estimated schedule of payments referred to above. We therefore firmly believe that the contractors claims will have no
material impact on our liquidity.



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##### Table of Contents

5.C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES



We do not generally conduct our own research and development with respect to major capital projects. Nor do we anticipate a
significant need for research and development services in the foreseeable future, or expect to require any such services in connection with our other businesses.



5.D TREND INFORMATION



Our cross-boundary ridership, on which we have traditionally relied to subsidize our domestic rail services, has been steadily declining both in terms of
percentage of market share and actual passenger numbers despite the overall cross-boundary market having grown by approximately 18% in 2004 over 2003. In comparison, the cross-boundary coach operators increased their market share as they took
advantage of the extension of the opening hours of the Lok Ma Chau-Huangguang boundary crossing to 24 hours. Currently rail has approximately 60% of the cross-boundary market. As more road crossings, such as the Western Corridor, are likely to be
opened, it would be reasonable to assume that rails share of the cross-boundary market will gradually fall. It is likely that this increased competition will continue to erode the market share of the East Rail going forward. However, the
opening of the Lok Ma Chau Spur Line in 2007 will provide us with a much-needed second boundary crossing. The Lok Ma Chau Spur Line, together with the opening of Phase I of the Shenzhen Metro, which will connect the Huanggang station on the mainland
China side to Lo Wu, is expected to enable us to compete more effectively with road transport operators in the cross-boundary market. The further relaxation of Chinas Individual Visitor Scheme to allow more mainland China residents to travel
to Hong Kong will be a positive factor. The opening of the Hong Kong Disneyland in September 2005 is also likely to attract about a million additional mainland China visitors per year to travel to Hong Kong via the East Rail and through-trains.



West Rail Phase I commenced services on December 20, 2003. As
a result of publicity and promotional campaigns and fare offers, its average daily ridership increased 29% from 131,500 in 2004 to 169,400 for the period from January to April 2005 and we anticipate that the average daily ridership may reach 173,200
for the year ending December 31, 2005. We anticipate that ridership will further increase upon the completion of the Kowloon Southern Link in 2009, as this will enable the East Rail and West Rail to form an integrated transportation network.



With the improvement in general economic outlook, especially
in the hospitality and services sectors and with the imminent opening of the Hong Kong Disneyland, the unemployment rate in Hong Kong is gradually declining. Wages for these sectors have increased in 2004 and to date in 2005, and employers have
generally reported that they are prepared to increase wages in 2005 after several years of wage freeze or pay cuts. We conduct our annual salary review in July and we anticipate that we will have general wage increases in tandem with the market.



On February 24, 2004, the Government announced that KCRC and
MTRCL were invited to commence negotiations on a possible merger. In September 2004 KCRC and MTRCL submitted to the Government a joint merger proposal. The Government is studying the proposal and will make a decision in due course as to whether and
how the merger should proceed.



5.E OFF-BALANCE SHEET ARRANGEMENTS



In order to maximize financial returns on the value of our fixed assets,
we have entered into several individually structured transactions or arrangements to lease out and lease back assets which include rolling stock, signaling equipment, revenue collection equipment and railway infrastructure. As of December 31, 2004,
a portion of our assets with a total original cost of HK$11,819 million (US$1,520.7 million) and net book value of HK$7,913 million (US$1,018.1 million) were covered by nine such structured arrangements, two of which were concluded during 2003. The
leasing subsidiaries which are involved in each of these arrangements are wholly-owned by us and are consolidated within our audited consolidated financial statements, and the assets and liabilities arising from these arrangements are separately
disclosed under the reconciliation of consolidated shareholders funds to US GAAP in Note 44(o) to our audited consolidated financial statements. See Notes 2(o) and 10(h) to our audited consolidated financial statements for descriptions of the
accounting treatment under HK GAAP and Note 44(i) for descriptions of the differences in treatment under HK GAAP and US GAAP. Eight of the arrangements do not qualify as off-balance sheet arrangements as defined in Item 5.E of Form 20-F. The
remaining one arrangement qualifies as an off-balance sheet arrangement as we have a retained interest in the assets of an unrelated entity which is not consolidated within our audited consolidated financial statements. However, we do not expect the
non-consolidation of this unrelated entity in our audited consolidated financial statements to have a current or future effect on our financial condition that would be material to investors.



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##### Table of Contents

5.F TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS



The following table summarizes our existing contractual obligations and commercial commitments for future debt repayments,
lease obligations, purchase obligations and contingent commitments (excluding interest expenses) as of December 31, 2004:



|                             |  |                        |  |           |  |           |  |               |  |        |  |      
|---------------------------- |  | ---------------------- |  | --------- |  | --------- |  | ------------- |  | ------ |  | -----
|                             |  | Payments Due by Period
|Contractual Obligations      |  | Less than 1 year       |  | 1-3 years |  | 4-5 years |  | After 5 years |  | Total  |  | Total
|                             |  | HK$                    |  | HK$       |  | HK$       |  | HK$           |  | HK$    |  | US$  
|                             |  | (in millions)         
|Interest-bearing borrowings  |  | 299                    |  | 600       |  | 8,691     |  | 10,158        |  | 19,748 |  | 2,541
|Capital lease obligations(1) |  | 740                    |  | 1,391     |  | 1,755     |  | 9,872         |  | 13,758 |  | 1,770
|Operating leases             |  | 40                     |  | 16        |  | 2         |  |              |  | 58     |  | 7    
|                             |  |                        |  |           |  |           |  |               |  |        |  |      
|Total                        |  | 1,079                  |  | 2,007     |  | 10,448    |  | 20,030        |  | 33,564 |  | 4,318
|                             |  |                        |  |           |  |           |  |               |  |        |  |      



|                                                   |  |                                            |  |           |  |           |  |               |  |        |  |      
|-------------------------------------------------- |  | ------------------------------------------ |  | --------- |  | --------- |  | ------------- |  | ------ |  | -----
|                                                   |  | Amount of Commitment Expiration Per Period
|Other Commercial Commitments                       |  | Less than 1 year                           |  | 1-3 years |  | 4-5 years |  | After 5 Years |  | Total  |  | Total
|                                                   |  | HK$                                        |  | HK$       |  | HK$       |  | HK$           |  | HK$    |  | US$  
|                                                   |  | (in millions)                             
|Short-term uncommitted revolving credit facilities |  | 1,650                                      |  |          |  |          |  |              |  | 1,650  |  | 212  
|Letter of credit                                   |  | 20                                         |  |          |  |          |  |              |  | 20     |  | 3    
|Overdraft facilities                               |  | 25                                         |  |          |  |          |  |              |  | 25     |  | 3    
|Medium term note program                           |  |                                           |  |          |  |          |  | 14,425        |  | 14,425 |  | 1,856
|HK$ 8 billion syndicated loan facilities           |  |                                           |  |          |  | 3,500     |  | 4,500         |  | 8,000  |  | 1,029
|Letter of credit for leveraged leases              |  | 929                                        |  | 375       |  | 976       |  |              |  | 2,280  |  | 293  
|Export credit loan facilities                      |  |                                           |  |          |  |          |  | 29            |  | 29     |  | 4    
|Purchase commitments Capital expenditure(2)        |  | 2,271                                      |  | 2,487     |  | 207       |  | 1             |  | 4,966  |  | 639  
|Recurrent expenditure                              |  | 427                                        |  | 113       |  | 1         |  |              |  | 541    |  | 70   
|                                                   |  |                                            |  |           |  |           |  |               |  |        |  |      
|Total                                              |  | 5,322                                      |  | 2,975     |  | 4,684     |  | 18,955        |  | 31,936 |  | 4,109
|                                                   |  |                                            |  |           |  |           |  |               |  |        |  |      

---

|(1) | Capital lease obligations represent all the lease payment commitments in respect of certain lease out and lease back arrangements, including those which meet the
definition of a liability and are recognized as obligations in the balance sheet (see Note 26 to our audited consolidated financial statements) and those not recognized as obligations in the balance sheet under HK GAAP (see Note 44(i) to our audited
consolidated financial statements).
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | The purchase commitments in connection with capital expenditure relate to capital works
contracted for and capital works authorized but not contracted for as of December 31, 2004. Since these works had not commenced as of December 31, 2004, they were not provided for in our audited consolidated financial statements.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES



6.A DIRECTORS AND SENIOR MANAGEMENT



We are overseen
by our Managing Board, which comprises a Chairman, the Chief Executive Officer and eight other members. The Chairman and eight other members are appointed by the Chief Executive of Hong Kong. The Chief Executive Officer is appointed by KCRC subject
to the prior approval of the Chief Executive of Hong Kong. The Chief Executive Officer is responsible for the day-to-day management and operation of KCRC, and the Chairman leads the Managing Board in addressing the strategic, policy and development
issues of KCRC. The Chairman and eight other members of our Managing Board do not have service contracts with KCRC and do not have benefits upon termination of appointment.



Several committees have been formed to assist the Board and supervise specific aspects of KCRCs operations, namely,
Finance Committee, Audit Committee, Strategic Human Resource Committee, Property Committee and Capital Projects Committee.



In order to strengthen the Managing Boards role in overseeing KCRCs operations, the Managing Board has appointed a number of expert members to
its various committees. These members will assist the committees in advising KCRC on matters requiring the Managing Boards decision. These members include civil engineers, legal counsel, an environmentalist, an accountant and human resource
managers.



Mr. Samuel M.H. Lai succeeded Mr. K.Y. Yeung as
Chief Executive Officer (Acting) on January 1, 2004. Mr. Patrick Wang and Mr. Victor So resigned from the Managing Board in January 2004, and Mr. Vincent H.C. Cheng retired from the Managing Board in November 2004. Mr. Abraham L.H. Shek and Mr.
Richard Y.C. Wong were appointed in February 2004 and Mr. L.S. Ng was appointed in November 2004.



The present members of the Managing Board together with their principal outside functions, if any, are as follows:



|                                                                                                                                               |  |                                                                                                                                                                                                                                                                                                                                                                                                              |  |             |  |                    
|---------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------- |  | -------------------
|Members of the Managing Board                                                                                                                  |  | Principal Outside Functions                                                                                                                                                                                                                                                                                                                                                                                  |  | MemberSince |  | Current TermExpires
|                                                                                                                                               |  |                                                                                                                                                                                                                                                                                                                                                                                                              | 
|Michael P.S. Tien, BBS, JP(1)(2) Chairman Chairman of Strategic Human Resource
Committee                                                       |  | Chairman of The G2000 Group since 1979, Chairman of the Standing Committee on Language Education and Research, and Chairman of the Employees Retraining Board, Member of the Education Commission,
Manpower Development Committee and Guangdong Chinese Peoples Political Consultative Conference.                                                                                                          |  | 2001        |  | December 23,2005   
|                                                                                                                                               |  |                                                                                                                                                                                                                                                                                                                                                                                                              | 
|Samuel M.H. Lai Chief Executive Officer (Acting) Member of Finance Committee Member of Capital Projects Committee Member of Property Committee |  | Vice Chairman, UITP Asia-Pacific Division, International Association of Public Transport. Member, Membership Committee, The Hong Kong Management Association.                                                                                                                                                                                                                                                |  | 2004        |  | No Expiry          
|                                                                                                                                               |  |                                                                                                                                                                                                                                                                                                                                                                                                              | 
|Vincent W.S. Lo, JP(2) Chairman of Property
Committee                                                                                          |  | Senior Partner, Gallant Y.T. Ho & Co., Director of Shanghai Commercial Bank Trustee Ltd., Chairman of the Hong Kong Red Cross Blood Transfusion Service Governing Committee and Assistant
Director of the Red Cross Council, Member of the Lotteries Fund Advisory Committee, the Social Welfare Advisory Committee, and Member of the Committee on Museums of the Leisure and Cultural Services Department. |  | 1999        |  | December 23,2006   



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|                                                                                                                                     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |  |             |  |                    
|------------------------------------------------------------------------------------------------------------------------------------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------- |  | -------------------
|Members of the Managing Board                                                                                                        |  | Principal Outside Functions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |  | MemberSince |  | Current TermExpires
|Patrick B. Paul, CBE(3) Chairman of Audit Committee Member of Strategic Human Resource Committee                                     |  | Non-Executive Director of The Hongkong and Shanghai Hotels Ltd., Johnson Electric Holdings Ltd., Kingsway International Holdings Ltd. and Pacific Basin Shipping Ltd.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  | 2002        |  | December 23, 2006  
|                                                                                                                                     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|M.Y. Wan, BBS, JP(1)(2) Chairman of Capital Projects Committee Member of Audit Committee Member of Property Committee                |  | Director of M Y Wan and Associates Limited and W Property Services Limited, Panel Member of Municipal Services Appeals Board, President of Youth Outreach, Council Member of Hong Kong Federation
of Youth Groups, Manager of Chi Lin Buddhist Secondary School (SOS), and Co-opt Member of Land, Rehousing and Compensation Committee of Urban Renewal Authority.                                                                                                                                                                                                                                                                                                                                    |  | 2002        |  | November 15, 2006  
|                                                                                                                                     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Abraham L.H. Shek, JP(2) Member of Capital Projects Committee Member of Audit Committee Member of Strategic Human Resource
Committee |  | Member of the Legislative Council representing the Real Estate and Construction Functional Constituency, Executive Director of Styletec Building Materials Ltd. and Wellco Holdings Ltd., Director
of The Hong Kong Mortgage Corporation Ltd. and Shakespeare4all Company Ltd., Non-Executive Director of Sino Elite Ltd., Independent Non-Executive Director and Audit Committee Member of Lifestyle International Holdings Ltd, Chuangs Consortium
International Ltd, New World TMT Ltd., NWS Holdings Ltd., Midas International Holdings Ltd. and Paliburg Holdings Ltd., Member, Court of The University of Hong Kong and Member, Council of The Hong Kong University of Science and
Technology. |  | 2004        |  | January 31, 2006   
|                                                                                                                                     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 
|Richard Y.C. Wong, SBS, JP(1)(2) Member of Property Committee Chairman of Finance Committee                                          |  | Deputy Vice-Chancellor and Chair of Economics at the University of Hong Kong, Director of the Hong Kong Center for Economic Research, Director of the Hong Kong Institute of Economics and
Business Strategy, Member of the Hong Kong Governments University Grants Committee, Exchange Fund Advisory Committee, and Economic and Employment Council, Independent Non-Executive Director of Sun Hung Kai Properties Ltd., Non-Executive
Director of ICBC (Asia) Limited, CK Life Sciences International (Holdings) Inc., Orient Overseas (International) Ltd., Pacific Century Insurance Holdings Ltd., Great Eagle Holdings Ltd. and Pacific Century Premium Developments Ltd.                      |  | 2004        |  | January 31, 2006   



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|                                                                                                                                                                    |  |                                                                                                                                                                                                                                                                                                                                                                                |  |             |  |                    
|------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------- |  | -------------------
|Members of the Managing Board                                                                                                                                       |  | Principal Outside Functions                                                                                                                                                                                                                                                                                                                                                    |  | MemberSince |  | Current TermExpires
|L.S. Ng, SBS, JP(1)(2) Member of Capital Projects Committee Member of Finance Committee                                                                             |  | Vice Chairman of Chiyu Banking Corporation, Independent Non-Executive Director of Smartone Telephone Holdings Ltd, Member of the Fisheries Development Loan Fund Advisory Committee, Director of
the Bank of China (Hong Kong) Charitable Foundation, Member of the Council and the Court of Lingnan University, Hong Kong Deputy to the 10th National Peoples Congress, PRC. |  | 2004        |  | November 15, 2006  
|                                                                                                                                                                    |  |                                                                                                                                                                                                                                                                                                                                                                                | 
|Sarah S.T. Liao, JP(2) Member of Capital Projects Committee Member of Strategic Human Resource Committee                                                            |  | Secretary for the Environment, Transport and Works, the Government of the Hong Kong Special Administrative Region (ex officio).                                                                                                                                                                                                                                                |  | 2002        |  | No expiry          
|                                                                                                                                                                    |  |                                                                                                                                                                                                                                                                                                                                                                                | 
|Frederick S.H. Ma, JP(2) Member of Capital Projects Committee Member of Finance Committee Member of Property Committee Member of Strategic Human Resource Committee |  | Secretary for Financial Services and the Treasury, the Government of the Hong Kong Special Administrative Region (ex officio).                                                                                                                                                                                                                                                 |  | 2002        |  | No expiry          

---

|(1) | The abbreviation SBS means Silver Bauhinia Star and the abbreviation
BBS means Bronze Bauhinia Star. The honor is awarded by the Hong Kong Special Administrative Region.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | The abbreviation JP means Justice of the Peace. This title is conferred by the Chief Secretary for Administration, in exercise of the powers delegated to
him or her by the Chief Executive of Hong Kong.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | The abbreviation CBE means Commander of the Most Excellent Order of the British Empire. The honor is awarded by the British monarch.
|--- | --------------------------------------------------------------------------------------------------------------------------------------



Sarah Liao and Frederick Ma were appointed by
our sole shareholder, the Government.



|                             |  |                                       |  |                    
|---------------------------- |  | ------------------------------------- |  | -------------------
|Members of Senior Management |  | Position                              |  | Position Held Since
|Samuel M.H. Lai              |  | Chief Executive Officer (Acting)      |  | 2004               
|Y.T. Li                      |  | Senior Director-Transport             |  | 2003               
|K.K. Lee                     |  | Senior Director-Capital Projects      |  | 2004               
|Ian M. Thoms                 |  | Director-West Rail                    |  | 1998               
|Daniel C. Lam, BBS, JP(1)(2) |  | Director-Property                     |  | 2000               
|Lawrence C.P. Li             |  | Director-Finance                      |  | 2004               
|Mimi Cunningham              |  | Director-Human Resource               |  | 2004               
|Grace Lam                    |  | General Manager-Corporate Affairs     |  | 2004               
|David A. Fleming             |  | Company Secretary and General Counsel |  | 1997               

---

|(1) | The abbreviation JP means Justice of the Peace. This title is conferred by the Chief Secretary of Administration, in exercise of the powers delegated to
him or her by the Chief Executive of Hong Kong.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | The abbreviation BBS means Bronze Bauhinia Star. The honor is awarded by the Hong
Kong Special Administrative Region.
|--- | -----------------------------------------------------------------------------------------------------------------------



The business
address of each member of the Managing Board and each of our other officers specified above is KCRC House, 9 Lok King Street, Fo Tan, Sha Tin, New Territories, Hong Kong.



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6.B COMPENSATION



The aggregate compensation paid by KCRC to all members of the Managing Board and senior management as a group for
2004 was HK$41.7 million (US$5.4 million). Fees for members of the Managing Board, including the Chairman but excluding the Chief Executive Officer (Acting) for the year 2004 are shown below:



|                                                                                         |  |                |  |     
|---------------------------------------------------------------------------------------- |  | -------------- |  | ----
|                                                                                         |  | 2004           |  | 2004
|                                                                                         |  | HK$            |  | US$ 
|                                                                                         |  | (in thousands)
|Chairman                                                                                 |  |                |  |     
|Michael P.S. Tien                                                                        |  | 220            |  | 28  
|Members                                                                                  |  |                |  |     
|Vincent H.C. Cheng(1)                                                                    |  | 96             |  | 12  
|Edmund T.C. Lau(2)                                                                       |  |               |  |    
|Dr Sarah S.T. Liao in the capacity of Secretary for the Environment, Transport and Works |  | 110            |  | 14  
|Vincent W.S.Lo                                                                           |  | 110            |  | 14  
|Frederick S.H. Ma in the capacity of Secretary for Financial Services and the Treasury   |  | 110            |  | 14  
|L.S. Ng(3)                                                                               |  | 14             |  | 2   
|Patrick B. Paul                                                                          |  | 110            |  | 14  
|Abraham L.H. Shek(4)                                                                     |  | 101            |  | 13  
|Victor H.W. So(5)                                                                        |  | 9              |  | 1   
|M.Y. Wan                                                                                 |  | 110            |  | 14  
|Patrick S.C. Wang(6)                                                                     |  | 9              |  | 1   
|Richard Y.C. Wong(7)                                                                     |  | 101            |  | 13  
|                                                                                         |  |                |  |     
|                                                                                         |  | 1,100          |  | 140 
|                                                                                         |  |                |  |     

---

|(1) | Vincent H.C. Cheng retired on November 15, 2004.
|--- | ------------------------------------------------

|(2) | Edmund T.C. Lau resigned on January 14, 2003.
|--- | ---------------------------------------------

|(3) | L.S. Ng was appointed on November 16, 2004.
|--- | -------------------------------------------

|(4) | Abraham L.H. Shek was appointed on February 1, 2004.
|--- | ----------------------------------------------------

|(5) | Victor H.W. So resigned on January 31, 2004.
|--- | --------------------------------------------

|(6) | Patrick S.C. Wang resigned on January 31, 2004.
|--- | -----------------------------------------------

|(7) | Richard Y.C. Wong was appointed on February 1, 2004.
|--- | ----------------------------------------------------



In 2003, we completed a comprehensive review of all compensation and benefits with the help of external independent consultants. One of the measures
resulting from this review was the introduction of an element of variable pay into the senior executives annual remuneration. The aim is to link the payment of variable pay to the performance of both KCRC as a whole and the individuals
concerned. We implemented the variable pay scheme to the top three tiers of management in the second half of 2004.



Members of senior management receive compensation in the form of salaries, allowances, benefits-in-kind, accruals for gratuities and annual leave
entitlements, details of which are set out below.



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|                                                    |  |                                                                                             |  |                      |  |      
|--------------------------------------------------- |  | ------------------------------------------------------------------------------------------- |  | -------------------- |  | -----
|                                                    |  | 2004 HK$ million                                                                           
|                                                    |  | Base pay, allowances,retirement benefit schemecontributions, gratuities andbenefits-in-kind |  | Variableremuneration |  | Total
|Samuel M.H. Lai(1) Chief Executive Officer
(Acting) |  | 4.89                                                                                        |  | 0.51                 |  | 5.40 
|Y.T. Li(1) Senior Director-Transport                |  | 3.91                                                                                        |  | 0.37                 |  | 4.28 
|K.K. Lee(1) Senior Director-Capital
Projects        |  | 3.83                                                                                        |  | 0.40                 |  | 4.23 
|Ian M. Thoms(1) Director-West Rail                  |  | 3.49                                                                                        |  | 0.39                 |  | 3.88 
|Daniel C. Lam(1) Director-Property                  |  | 3.72                                                                                        |  | 0.41                 |  | 4.13 
|Lawrence C.P. Li(2) Director-Finance                |  | 2.80                                                                                        |  |                     |  | 2.80 
|Mimi Cunningham(1)(3) Director-Human Resource       |  | 2.18                                                                                        |  | 0.38                 |  | 2.56 
|Jonathan H.G. Yu(4) Director-Operations             |  | 6.12                                                                                        |  |                     |  | 6.12 
|Kenneth K.S. Leung(5) Director-New Railway
Projects |  | 2.03                                                                                        |  |                     |  | 2.03 
|                                                    |  |                                                                                             |  |                      |  |      
|                                                    |  | 32.97                                                                                       |  | 2.46                 |  | 35.43
|                                                    |  |                                                                                             |  |                      |  |      

---

|(1) | Effective from July 1, 2004, a portion of total remuneration was converted to variable remuneration related to performance.
|--- | ---------------------------------------------------------------------------------------------------------------------------

|(2) | Mr Lawrence C. P. Li assumed his post with effect from January 2004.
|--- | --------------------------------------------------------------------

|(3) | Mrs Mimi Cunningham assumed her post with effect from May 2004.
|--- | ---------------------------------------------------------------

|(4) | Mr Jonathan H.G. Yus remuneration includes a contractual payment totaling $1.2 million and an end-of-service payment of $0.9 million. He left KCRC on January
3, 2005.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Mr Kenneth K.S. Leung retired on July 1, 2004.
|--- | ----------------------------------------------



In 2004, we made provisions in the amount of HK$138 million (US$17.8 million) for retirement costs for our employees, as compared to HK$137 million
(US$17.6 million) in 2003 and HK$129 million (US$16.6 million) in 2002. Please see Note 37 to our audited consolidated financial statements.



6.C MANAGING BOARD PRACTICES



The three standing committees in the area of audit, finance and compensation are as follows:



The Finance Committee deals with the investment of surplus funds and advises the Managing Board on our strategies for the
financing of future major capital projects. KCRCs Corporate Treasury Department, which reports to the Finance Committee, operates within a set of strategies, policies and guidelines, which are defined by the Managing Board to cover funding,
cash investment, and risk management. Members of the Finance Committee are Richard Y.C. Wong, Fredrick S.H. Ma, Ng Leung Sing and Samuel M.H. Lai and the expert member is Alfred H.K. Li. This committee is chaired by Mr. Richard Y.C. Wong, who
replaced Vincent H.C. Cheng on November 22, 2004.



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The Audit Committee reviews our annual accounts prior to their submission for approval by the Managing
Board. The Audit Committee also monitors accounting policies, considers matters relating to management and internal controls, and receives and appraises reports from the internal auditors and KCRCs independent registered public accounting
firm. The members of the Audit Committee are Patrick B. Paul, M.Y. Wan and Abraham L.H. Shek. This committee is chaired by Patrick B. Paul. The Internal Audit Department reviews the internal controls of all major financial and operational activities
and reports to the Audit Committee.



The Strategic Human
Resource Committee reviews and makes recommendations to the Managing Board with respect to the appointment, termination and remuneration of executive directors who are not Members of the Managing Board, and senior executives who report directly to
the Chief Executive Officer. It also recommends to the Managing Board the appropriate levels of remuneration for all staff. Members of the Strategic Human Resource Committee are Michael P.S. Tien, Patrick B. Paul, Abraham L.H. Shek, Sarah S.T. Liao
and Frederick S.H. Ma and the expert members are Paula C.M. Ko Wong and Anita M.C. To Yu. This committee is chaired by Mr. Michael P.S. Tien.



We have also established a Capital Projects Committee and Property Committee to review and advise on our projects and property developments.



6.D EMPLOYEES



We employed a total of 5,874 full-time staff as at December 31, 2004. We had
on the same date 1,485 contract staff, generally with a contract term of two years, of which about half was hired for West Rail Phase I, the East Rail Extensions, the Kowloon Southern Link and the Sha Tin to Central Link projects. Staffing levels
increased at an accelerated pace from 2001 to 2003 to meet additional manpower requirements of the construction of West Rail Phase I, the Tsim Sha Tsui Extension and the Ma On Shan Rail. Although West Rail Phase I was completed in 2003 and the
latter two projects were completed in 2004, we continued to maintain our staffing level after hiring 563 new staff in 2004 mainly for operating the Ma On Shan Rail and Tsim Sha Tsui Extension which opened towards the end of the year. Of a total of
1,983 operating staff, 882 belong to either the Railway Workers Union, carried over from when the Kowloon-Canton Railway was operated by the Government, the Operating Staff Association or the Kowloon-Canton Railway Employees Association. Union
membership is not compulsory at KCRC and there has never been any union contract in effect since we were formed. We recognize the three unions for staff relationship purposes only, but do not negotiate with the unions over staff compensation or
human resources policies. In parallel with the staff unions, we have set up 19 staff consultative committees with membership comprising elected staff representatives who meet regularly to communicate and consult with our staff on key issues that
would affect our staff in general and to collect their feedback for consideration by the management. Through these staff consultative committees, we have been successful in maintaining effective communications and consultations with our staff to
resolve matters of common concern. We have not experienced any organized labor disputes since KCRC was formed. At December 31, 2003 and 2002, we had 5,871 and 5,510 employees, respectively.



Our Human Resource Division continuously reviews, improves and streamlines
our human resources policies and practices to tie in with our business needs. We emphasize the importance of training and development, and endeavor to promote high levels of competency by encouraging all managerial and non-managerial employees to
undergo training to meet current and anticipated needs. We believe that our relations with our employees are good, and we regularly consult with our employees on key issues that would affect the staff in general. Employee turnover in 2004 was
approximately 9.6%. To address a potential shortage in engineering and maintenance staff for various capital projects when they come into operation, we have commenced a program of early recruitment and intensive training, as well as
identifying suitable staff from among our existing staff in these fields for promotion to new positions created for operating and maintaining the new railway lines.



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##### Table of Contents

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS



7.A MAJOR SHAREHOLDER



The
Government is our sole shareholder. As of December 31, 2004, the Financial Secretary Incorporated for and on behalf of the Government owns 391,200 shares of KCRC, which represents 100% of our total shares outstanding.



The Government has given us support through close cooperation in our network
development and equity injections. Under the KCRC Ordinance, the Government may direct us to declare and pay dividends up to our entire profit, after some allowances, in any given fiscal year.



7.B RELATED PARTY TRANSACTIONS



East Rail Extensions Project Agreement



On February 28, 2003, we entered into the subject agreement with the
Government for the financing, design, construction and operations of the East Rail Extensions and related services and facilities. Under the terms of the project agreement, we will be responsible for, and will bear and finance the full amount of the
capital cost for the construction and operation of the East Rail Extensions, and the costs of the removal and replacement, modification or improvement of existing facilities affected by or required as a consequence of the construction of the East
Rail Extensions.



We received an equity injection of HK$8
billion from the Government for the construction of the Tsim Sha Tsui Extension and Ma On Shan Rail in March 2001. We financed the balance of the cost for the project from commercial financing and internal resources.



We were granted the property development rights to four sites on the Ma On
Shan Rail alignment above the Tai Wai station and Maintenance Center, Che Kung Temple and Wu Kai Sha stations, and to two sites on the East Rail alignment at the Fo Tan station and Ho Tung Lau Maintenance Center. The grant of such property
development rights shall be at a premium payable to the Government to be assessed at the date of such grant, together with an annual rent of a specified percentage of the ratable value of the subject of such grant as assessed from time to time. We
will be responsible for all works required to construct the proposed property developments. Further, we and the Government have agreed that any property development profits from these sites in excess of a specified amount would be distributed to the
Government as extraordinary dividends, subject to certain exemptions.



Entrustment Agreements



We have entered into
entrustment agreements with the Government in respect of certain public infrastructure works and other works along the routes of West Rail Phase I and the East Rail Extensions, under which we have agreed to carry out works on behalf of the
Government in return for periodic reimbursements based on the work completed.



Octopus Cards Limited



In 2004, we made
payments of HK$33 million to Octopus Cards Limited, in which we have 22.1% equity interest, in respect of fees for the use of the Octopus cards system. These payments were made based on the fare revenue generated from Octopus cards. No other charges
were made or incurred by us in respect of the administration of the Octopus cards system. We received HK$8 million in 2004 from Octopus Cards Limited in ticket loading agent fees for providing add-value amounts on Octopus cards and handling fees for
issuing new cards and handling refunds for returned cards.



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Shareholding in and Loan to WRPDL



On February 24, 2000, we entered into a shareholding agreement with the Government for the establishment of WRPDL, a holding
company we formed together with the Government, to undertake all property developments along the West Rail Phase I route. The issued share capital of WRPDL comprises 51 ordinary A shares and 49 ordinary B shares, which are
held by us and the Government respectively. The ordinary A shares are not entitled to any distribution by WRPDL other than a return of capital, and the ordinary B shares are entitled to all dividends declared by WRPDL and a
return of capital.



All costs incurred or to be incurred in
relation to the West Rail property developments are to be funded by loans from us to WRPDL bearing interest at an annual rate of 1% plus our average cost of funds in the preceding year. To the extent that WRPDL is unable to repay the loan, the
Government shall seek the necessary authority to reimburse costs incurred by us. The Government has also undertaken to indemnify us against all liabilities properly incurred by us in relation to such property developments.



Subsidiaries of WRPDL have been formed to implement property developments
along the West Rail Phase I route whereby the Government will receive the profits, if any, from each development and we will earn management fees. For a list of these subsidiaries, see Item 4. Information on the Corporation 
Organizational Structure.



Indebtedness of Managing Board and
Management



No member of the Managing Board or the Senior
Management, or any officer of KCRC is or was, during the last three years, indebted to us.



7.C INTERESTS OF EXPERTS AND COUNSEL



Not applicable.



ITEM 8. FINANCIAL INFORMATION



8.A CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION



See Item 17. Financial Statements and pages F-1 through F-53.



Legal Proceedings



As of
December 31, 2004, we had contingent liabilities arising from certain contractors claims in respect of the contracts for the construction of West Rail Phase I and the East Rail Extensions in respect of which our total obligations cannot be
estimated reliably. We have made provisions in the financial statements as of December 31, 2004 for our best estimate of amounts which will likely be payable in connection with these claims. The amounts payable upon resolution of these claims may be
eventually in excess of amounts estimated and accounted for in the financial statements as of December 31, 2004. We are in the process of resolving these claims. See Note 40 to our audited consolidated financial statements.



Other than the claims mentioned above, we are not party to any legal,
mediation or arbitration proceedings which we believe would, individually or taken as a whole, have a material adverse effect on our business, financial condition or results of operations.



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Dividend Policy



Under the KCRC Ordinance, we may declare and pay dividends to the Government as our sole shareholder. The Financial Secretary may, after consultation with
us and after taking into account the extent of our loans and other obligations, direct us to declare a dividend in an amount up to the whole of our profits in any fiscal year after making allowance for any allocation to reserves and any accumulated
loss disclosed in the balance sheet in the prior year.



In
2005, we declared and paid a dividend of HK$172 million (US$22.1 million), representing 40.1% of our 2004 profit after taxation.



Significant Changes



Other than described herein, no significant change has occurred since the date of the audited consolidated financial statements included in this Annual
Report.



ITEM 9. THE OFFER AND LISTING



9.A THE OFFER AND
LISTING DETAILS



The stock of KCRC is not listed on any
market.



9.C MARKETS



The principal trading markets for the Notes are the Hong Kong Stock
Exchange, traded as selectively marketed debt securities (as defined in the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited), the New York Stock Exchange and the London Stock Exchange.



ITEM 10. ADDITIONAL INFORMATION



10.B MEMORANDUM
AND ARTICLES OF ASSOCIATION



Organization and Register.



We are a statutory corporation established in Hong Kong
by the KCRC Ordinance. We are registered in the Hong Kong Companies Business Registry and our Business Registration Certificate No. is 08371001-000-12-02-9.



We were established in 1982 by the KCRC Ordinance and are empowered to undertake activities specified therein. We operate, extend and improve railways in
Hong Kong. We took over from the Government the operation of the Hong Kong section of the Kowloon-Canton Railway. We constructed a Light Rail system in the north-western New Territories and, in 1988, started to operate the Light Rail system.



The KCRC Ordinance was amended in 1986, 1998 and 2001. The
amendment in 1986 enabled us to construct and operate the Light Rail. The amendment in 1998 expanded our powers by permitting us to construct and operate any additional railway that the Secretary for the Environment, Transport and Works may
authorize us to construct. The amendment in December 2001 provided for the separation of the functions and duties of the Chairman from those of the Chief Executive by creating the office of Chief Executive Officer of KCRC.



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Corporate Governance.



We are overseen by our Managing Board. The Managing Board comprises a Chairman, a Chief Executive Officer and eight other members. The Chairman and eight
other members are appointed by the Chief Executive of Hong Kong. The Chief Executive Officer is appointed by KCRC subject to the prior approval of the Chief Executive of Hong Kong.



Several committees have been formed under the Managing Board to supervise specific aspects of KCRCs operations,
namely, Finance Committee, Audit Committee, Strategic Human Resource Committee, Property Committee and Capital Projects Committee.



Pursuant to the enactment of the KCRC (Amendment) Ordinance in December 2001, the functions and duties of the Chairman were separated from those of the
Chief Executive Officer by creating the office of the Chief Executive Officer of KCRC. The Chief Executive Officer is responsible for the day to day management and operation of KCRC, and the Chairman leads the Managing Board in addressing the
strategic, policy and development issues of KCRC. The Board General Standing Orders and Rules for Conduct of Corporation Business and Committees of the Managing Board govern the proceedings of the Managing Board and the committees thereunder and
were amended during 2004, with the latest amendment approved on June 2, 2005. The First Schedule to the KCRC Ordinance provides that a member of the Managing Board who is in any way directly or indirectly interested in a contract made or proposed to
be made by KCRC or a subsidiary of KCRC which is brought up for consideration by KCRC must disclose the nature of his interest at a meeting of KCRC. The disclosure shall be recorded in the minutes of KCRC, and the member shall not without the
permission of the Chairman take any part in any deliberation of KCRC with respect to that contract and shall not in any event vote on any question concerning it.



Under the KCRC Ordinance, KCRC may, as it thinks fit, borrow or otherwise raise money and charge all or any part of its
property as security. KCRC may also create and issue bonds, notes or other securities which may be charged on the property, undertaking and revenue of KCRC. The Managing Board is the governing body of KCRC with authority to exercise the power to
borrow conferred upon it by the KCRC Ordinance.



The Financial
Secretary of the Government determines the salaries or fees and allowances that KCRC shall pay to the members of the Managing Board. The quorum of the Managing Board is five members. There is no provision in the KCRC Ordinance requiring retirement
at a certain age. See Item 6. Directors, Senior Management and Employees for further information about our Managing Board.



Shares



The Government is our sole shareholder. There are no corporate or shareholder documents that set forth the voting rights of the shareholder or rights, preferences and restrictions with respect to our shares.



Under the KCRC Ordinance, the Financial Secretary of the
Government may, after consulting KCRC, increase the authorized capital of KCRC. Shares in the authorized capital of KCRC are allotted to the Government at par as required in writing by the Financial Secretary.



Under the KCRC Ordinance, we may declare and pay dividends to the Government
as our sole shareholder. The Financial Secretary may, after consultation with us and after taking into account the extent of our loans and other obligations, direct us to declare a dividend in an amount up to the whole of our profits in any fiscal
year after making allowance for any allocation to reserves and any accumulated loss disclosed in the balance sheet in the prior year.



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Pursuant to the Kowloon-Canton Railway (Increase in Authorized Capital) Order 2001 effective on March 2,
2001, the authorized capital of KCRC was increased from HK$34,000,000,000 divided into 340,000 shares of HK$100,000 each to HK$42,500,000,000 divided into 425,000 shares of HK$100,000 each.



On March 2, 2001, 80,000 shares of HK$100,000 each were issued to the
Financial Secretary Incorporated for and on behalf of the Government, in consideration of the equity injection received from the Government for the construction of the Tsim Sha Tsui Extension and Ma On Shan Rail.



10.C MATERIAL CONTRACTS



On September 28, 2004, KCRC entered into a HK$8,000 million credit facilities agreement with a syndicate of 18 banks and
financial institutions. Proceeds are to be used for general working capital requirements of KCRC. These facilities comprise three tranches: a HK$3,500 million five-year tranche, a HK$3,500 million seven-year tranche and a HK$1,000 million ten-year
tranche. Drawings may be made under each tranche on a revolving credit basis for the first five years. Thereafter, the outstanding amounts under the seven-year and ten-year tranches will each be converted into a term loan with bullet repayment upon
the maturity of each facility. Borrowings under each facility bear interest on a floating rate basis at a margin over HIBOR.



Pursuant to the East Rail Extensions Project Agreement dated February 28, 2003, the Government awarded to KCRC the rights for the financing, design,
construction and operations of the East Rail Extensions and related services and facilities, which include property development rights to four sites on the Ma On Shan Rail alignment above the Tai Wai station and depot, Che Kung Temple and Wu Kai Sha
stations, and to two sites on the East Rail alignment at Fo Tan station and Ho Tung Lau maintenance center. The Government and KCRC have agreed that property development profits from these sites in excess of a specified amount will be distributed to
the Government as extraordinary dividends.



10.D EXCHANGE CONTROLS



Under existing Hong Kong law, (1) there are no foreign exchange controls
or other laws, decrees or regulations that affect the remittance of interest or other payments on the Notes to U.S. residents and (2) there are no limitations on the rights of non-resident or foreign owners to hold the Notes. The Basic Law provides
that no foreign exchange control policies are to be applied in Hong Kong.



10.E
TAXATION



The following summary of the
material Hong Kong and United States federal income tax consequences of beneficial ownership of the Notes is based upon laws, regulations, rulings, income tax conventions (treaties), administrative practice and judicial decisions in effect on the
date of this Annual Report. Subsequent legislative, judicial or administrative changes or interpretations may be retroactive and could affect these tax consequences.



Your tax treatment as a holder of Notes may vary depending upon your particular situation, and you may be subject to
special rules not discussed below. State, local and foreign (other than Hong Kong) tax consequences of ownership and disposition of the Notes are not discussed.



You should consult your own tax advisors about the particular tax consequences of the ownership and disposition of a
Note, including the applicability and effect of any state, local or foreign tax laws.



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Hong Kong Taxation



Under Hong Kong law in effect as of the date of this Annual Report, neither we nor any paying agent will be required to deduct or withhold any Hong Kong
taxes in respect of payments on the Notes. The Notes are not subject to Hong Kong stamp duty upon issue and stamp duty will not be payable on any subsequent transfer provided that the Notes are denominated in a currency other than the currency of
Hong Kong and are not repayable in any circumstances in the currency of Hong Kong or provided that the Notes do not:



| | (a) | carry a right of conversion into stock or to the acquisition of any stock (as defined in the Stamp Duty Ordinance (Cap. 117 of the Laws of Hong Kong)); or
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | carry (or did not carry) a right to interest the amount of which (i) exceeds a reasonable commercial return on the nominal amount of the capital; or (ii) falls or has fallen to be
determined to any extent by reference to the results of, or of any part of, a business or to the value of any property; or
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) | carry a right on repayment to an amount which exceeds the nominal amount of the capital and is not reasonably comparable with what is generally repayable in respect of a similar
nominal amount of capital under the terms of issue of loan capital listed on The Stock Exchange of Hong Kong Limited.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Hong Kong profits tax is chargeable on every person carrying on a trade, profession or business in Hong Kong in respect of profits arising in or derived
from Hong Kong from such trade, profession or business, excluding profits arising from the sale of capital assets. Under the Inland Revenue Ordinance (Chapter 112 of the Laws of Hong Kong) as it is currently applied, interest on the Notes may be
deemed to be profits arising in or derived from Hong Kong from a trade, profession or business carried on in Hong Kong in the following circumstances:



| |  | interest on the Notes is derived from Hong Kong and is received by or accrues to a company carrying on a trade, profession or business in Hong Kong; or
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | interest on the Notes is derived from Hong Kong and is received by or accrues to a person, other than a company, carrying on a trade, profession or business in Hong Kong and is in
respect of the funds of the trade, profession or business; or
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | interest on the Notes is received by or accrues to a financial institution, as defined in the Inland Revenue Ordinance, and arises through or from the carrying on by the financial
institution of its business in Hong Kong.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Except
for a treaty on the avoidance of double taxation on shipping profits, Hong Kong is not party to any income tax treaty with the United States.



This summary of Hong Kong taxation is of general nature only and is based on Hong Kong law in effect on the date of this Annual Report. You are urged to
consult your own tax advisors about the particular consequences of holding the Notes.



United States Taxation



The
discussion addresses only the material U.S. federal income tax consequences under present law to U.S. Holders (as defined below) who are original purchasers of the Notes. The discussion does not address all aspects of U.S. federal income taxation
that may be relevant to a particular holder in light of their individual circumstances or to certain types of holders subject to special treatment, such as certain financial institutions, insurance companies, tax-exempt organizations, dealers,
traders in securities who elect to mark to market, or persons who hold the Notes as part of a hedging transaction, straddle, conversion or other integrated transaction.



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##### Table of Contents

As used in this discussion, the term U.S. Holder means a beneficial owner of a Note that is:



| |  | a citizen or resident of the United States;
|- |  | -------------------------------------------



| |  | a corporation, partnership or other business entity created or organized under the laws of the United States or any political subdivision thereof;
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------



| |  | an estate, the income of which is subject to U.S. federal income taxation regardless of its source; or
|- |  | ------------------------------------------------------------------------------------------------------



| |  | a trust subject to the primary supervision of a court within the United States and the control of one or more U.S. persons or that has otherwise validly elected to be treated as a
U.S. person.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The term Non-U.S.
Holder means any holder that is not a U.S. Holder.



Taxation of U.S. Holders



Interest paid on the Notes will be taxable to a U.S. Holder as ordinary interest income at the time it accrues or is received, in accordance with the U.S. Holders regular method of tax accounting. The Notes were issued at no more than
a de minimis discount and, accordingly, were not treated as having original issue discount. Interest income generally will be from sources outside the United States for purposes of the foreign tax credit limitation.



Upon the sale, exchange or retirement of a Note, a U.S. Holder will recognize
taxable gain or loss equal to the difference between the amount realized on the sale, exchange or retirement and the Holders adjusted tax basis in the Note. The amount realized does not include any amount attributable to accrued interest,
which will be taxed as interest income. A U.S. Holders adjusted tax basis in a Note will generally equal the cost of the Note reduced by any principal payments received by the holder.



Gain or loss realized on the sale, exchange or retirement of a Note will be
capital gain or loss. U.S. Holders should consult their tax advisors about U.S. federal income tax treatment of capital gain or loss. Gain and loss, other than loss attributable to accrued but unpaid interest, generally will be U.S. source gain or
loss for purposes of the foreign tax credit limitation.



Taxation of Non-U.S. Holders



Interest on a Note paid to a Non-U.S. Holder generally will not be subject to United States income or withholding tax if the interest is not effectively connected with the holders conduct of a trade or business in the United States.
Gains realized by a Non-U.S. Holder on the sale, exchange or retirement of a Note will not be subject to U.S. federal income tax unless:



| |  | the gain is effectively connected with the holders conduct of a trade or business in the United States; or
|- |  | -----------------------------------------------------------------------------------------------------------



| |  | the holder is an individual present in the United States for at least 183 days during the taxable year of disposition and certain other conditions are met.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



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Information Reporting and Backup Withholding



Payments in respect of the Notes and proceeds from the disposition of the
Notes may be subject to information reporting to the United States Internal Revenue Service and to U.S. backup withholding tax. Backup withholding will not apply, however, if you furnish a correct taxpayer identification number or certificate of
foreign status or are otherwise exempt from backup withholding. Generally, a U.S. Holder will provide such certification on Form W-9 and a Non-U.S. Holder will provide such certification on Form W-8 BEN.



This summary of United States federal income tax is based on the law in
effect on the date of this Annual Report. State, local and foreign tax treatment may differ from the U.S. federal income tax treatment discussed in this summary. You are urged to consult your own tax advisors about the particular tax consequences of
the ownership and disposition of a Note and the applicability and effect of any state, local or foreign tax laws.



10.H DOCUMENTS ON DISPLAY



We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended. Accordingly, we will file reports and other
information with the Securities and Exchange Commission. You may inspect and copy the reports and other information we file at the public reference facilities maintained by the Commission at Room 1024, 450 Fifth Street, N.W., Washington, DC 20549,
and at the regional offices of the Commission located at 175 W. Jackson Boulevard, Suite 900, Chicago, Illinois 60604 and 233 Broadway, New York, New York 10279. You may also obtain copies of such material by mail from the Public Reference Branch of
the Commission at 450 Fifth Street, N.W., Washington, DC 20549, at prescribed rates. The Commission also maintains a web site at http://www.sec.gov that contains reports, proxy statements and other information regarding registrants that file
electronically with the Commission. Our annual reports and some of the other information submitted by us to the Commission may be accessed through this web site.



We will furnish our audited annual financial statements, unaudited semi-annual financial statements and certain other
reports to the trustee under the indenture. As long as any of the Notes are outstanding, we will continue to file with the Commission and provide to the trustee under the indenture and, upon request, to the holders of the Notes (1) annual reports on
Form 20-F, including annual audited consolidated financial statements with a reconciliation to US GAAP with an opinion thereon by an independent public accountant with respect to the relevant year, and (2) interim reports on Form 6-K, including
unaudited consolidated financial statements for each of the first six months of each fiscal year. You may inspect and copy these reports, when so filed, at the public reference facilities maintained by the Commission at the addresses noted above.



ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS



We have managed interest and foreign currency exchange rate risks of our investment securities portfolio and debt instruments by adjusting both the
maturity structure of the portfolio and the amount of floating interest rate and foreign currency-denominated securities and debt instruments. In addition, we employ off-balance sheet derivative instruments such as interest rate swaps, cross
currency swaps and foreign exchange forward contracts to reduce or eliminate interest and foreign currency exchange rate risks associated with interest and foreign exchange rate movements.



Our Finance Committee is responsible for overseeing our interest and foreign
currency exchange rate risk management process and recommending policies regarding interest and foreign exchange rate exposures for approval by our Managing Board. Adherence to these policies is monitored by our finance division on an ongoing basis.



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The following presents information regarding our market risk exposures as of December 31, 2004.
References in the following tables to JPY are to the Japanese Yen, EUR are to the Euro and GBP are to the Pound Sterling.



Interest Rate Risk



For investment securities and debt instruments, the following table presents the principal amounts matured and related weighted average interest rates by
expected maturity dates as of December 31, 2003 and 2004. The information is presented in Hong Kong dollars, which is our reporting currency. The instruments underlying cash flows are denominated in the currencies indicated below.



|                         |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|------------------------ |  | ------------------------------------------------------- | - |  | ----------------------- | - |  | ---- | - |  | ------ | - |  | ------- | - |  | ---------- | - |  | -------- | - |  | ----------------------- | - |  | ------ | - |  | ------------------------ | -
|                         |  | As of December 31, 2004 Expected Maturity Date          |   |  | As of December 31, 2003 |  
|                         |  | 2005                                                    |   |  | 2006                    |   |  | 2007 |   |  | 2008   |   |  | 2009    |   |  | Thereafter |   |  | Total    |   |  | AggregateFair Value (1) |   |  | Total  |   |  | Aggregate Fair Value (1) |  
|                         |  | (HK$ equivalent in millions, other than interest rates) |   |  |                         |   |  |      |  
|Investment securities:   |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Fixed rate:              |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Principal amount (HK$)   |  |                                                        |   |  |                        |   |  |     |   |  |       |   |  |        |   |  |           |   |  |         |   |  |                        |   |  | 3,892  |   |  | 3,841                    |  
|Average interest rate    |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Principal amount (US$)   |  | 1,507                                                   |   |  | 101                     |   |  |     |   |  |       |   |  |        |   |  |           |   |  | 1,608    |   |  | 1,614                   |   |  | 3,126  |   |  | 3,162                    |  
|Average interest rate    |  | 2.8                                                     | % |  | 3.0                     | % |  |     |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Principal amount (EUR)   |  |                                                        |   |  |                        |   |  |     |   |  |       |   |  |        |   |  |           |   |  |         |   |  |                        |   |  | 166    |   |  | 169                      |  
|Average interest rate    |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Variable rate:           |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Principal amount (HK$)   |  |                                                        |   |  | 20                      |   |  |     |   |  |       |   |  |        |   |  |           |   |  | 20       |   |  | 20                      |   |  | 50     |   |  | 50                       |  
|Average interest rate    |  |                                                        |   |  | 0.7                     | % |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Principal amount (US$)   |  | 347                                                     |   |  | 241                     |   |  |     |   |  |       |   |  |        |   |  |           |   |  | 588      |   |  | 589                     |   |  | 930    |   |  | 931                      |  
|Average interest rate    |  | 2.5                                                     | % |  | 2.6                     | % |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|                         |  |                                                         |   |  |                         |   |  |      |   | 
|Debt instruments:        |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Fixed rate:              |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Medium term note         |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Principal amount(US$)    |  |                                                        |   |  |                        |   |  |     |   |  |       |   |  | (7,772  | ) |  | (389       | ) |  | (8,161   | ) |  | (9,249                  | ) |  | (8,152 | ) |  | (9,452                   | )
|Average interest rate    |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  | 7.4     | % |  | 7.9        | % |  |          |   |  |                         |   |  |        |   |  |                          |  
|Principal amount(HK$)    |  |                                                        |   |  |                        |   |  |     |   |  |       |   |  |        |   |  | (800       | ) |  | (800     | ) |  | (841                    | ) |  | (800   | ) |  | (787                     | )
|Average interest rate    |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  | 4.7        | % |  |          |   |  |                         |   |  |        |   |  |                          |  
|Global note (the Note) |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Principal amount(US$)    |  |                                                        |   |  |                        |   |  |     |   |  |       |   |  |        |   |  | (7,772     | ) |  | (7,772   | ) |  | (9,124                  | ) |  | (7,764 | ) |  | (9,344                   | )
|Average interest rate    |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  | 8.2        | % |  |          |   |  |                         |   |  |        |   |  |                          |  
|Export credit loan       |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Principal amount (US$)   |  |                                                        |   |  |                        |   |  | (199 | ) |  | (265.4 | ) |  | (265.4  | ) |  | (398       | ) |  | (1,127.8 | ) |  | (1,176                  | ) |  | (1,127 | ) |  | (1,198                   | )
|Average interest rate    |  |                                                         |   |  |                         |   |  | 5.7  | % |  | 5.7    | % |  | 5.7     | % |  | 5.7        | % |  |          |   |  |                         |   |  |        |   |  |                          |  
|Retail bond              |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Principal amount (HK$)   |  |                                                        |   |  |                        |   |  |     |   |  | (300   | ) |  |        |   |  | (700       | ) |  | (1,000   | ) |  | (1,052                  | ) |  | (1,000 | ) |  | (1,000                   | )
|Average interest rate    |  |                                                         |   |  |                         |   |  |      |   |  | 3.0    | % |  |         |   |  | 4.9        | % |  |          |   |  |                         |   |  |        |   |  |                          |  
|Variable rate:           |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Export credit loan       |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Principal amount US$)    |  | (299                                                    | ) |  | (299                    | ) |  | (104 | ) |  | (39    | ) |  | (39     | ) |  | (68        | ) |  | (848     | ) |  | (848                    | ) |  | (1,118 | ) |  | (1,118                   | )
|Average interest rate    |  | 2.7                                                     | % |  | 2.7                     | % |  | 2.8  | % |  | 2.9    | % |  | 2.9     | % |  | 2.9        | % |  |          |   |  |                         |   |  |        |   |  |                          |  
|                         |  |                                                         |   |  |                         |   |  |      |   | 
|Interest rate swaps(1):  |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Fixed to variable rate:  |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  |         |   |  |            |   |  |          |   |  |                         |   |  |        |   |  |                          |  
|Notional amount (US$)    |  |                                                        |   |  |                        |   |  |     |   |  |       |   |  | 1,554.5 |   |  | 777.2      |   |  | 2,331.7  |   |  | 186                     |   |  | 3,882  |   |  | 561                      |  
|Interest pay rate        |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  | 2.0     | % |  | 7.3        | % |  |          |   |  |                         |   |  |        |   |  |                          |  
|Interest receive rate    |  |                                                         |   |  |                         |   |  |      |   |  |        |   |  | 7.3     | % |  | 8.0        | % |  |          |   |  |                         |   |  |        |   |  |                          |  
|Notional amount (HK$)    |  |                                                        |   |  |                        |   |  |     |   |  | 300    |   |  |        |   |  | 1,500      |   |  | 1,800    |   |  | 73                      |   |  | 1,800  |   |  | (32                      | )
|Interest pay rate        |  |                                                         |   |  |                         |   |  |      |   |  | 0.4    | % |  |         |   |  | 1.0        | % |  |          |   |  |                         |   |  |        |   |  |                          |  
|Interest receive rate    |  |                                                         |   |  |                         |   |  |      |   |  | 3.0    | % |  |         |   |  | 4.7        | % |  |          |   |  |                         |   |  |        |   |  |                          |  

---

|(1) | Fair values for off-balance sheet financial instruments represent the amounts we would receive or pay to close out the transactions.
|--- | ------------------------------------------------------------------------------------------------------------------------------------



67



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Foreign Currency Exchange Rate Risk



The table below provides information about our investment securities, debt instruments and derivative financial instruments
and presents such information in Hong Kong dollars. The table summarizes information on investment securities, debt instruments and foreign exchange agreements that are sensitive to foreign currency exchange rates. For investment securities, the
table presents the principal amounts matured and related weighted average interest rates by expected maturity dates as of December 31, 2003 and 2004. For foreign currency exchange agreements, the table presents notional amounts and weighted average
exchange rates by the expected (contractual) maturity dates. These notional amounts are generally used to calculate the contractual payments to be exchanged under the agreements.



|                                       |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|-------------------------------------- |  | -------------------------------------------------------------------------- | - |  | ----------------------- | - |  | ---- | - |  | ------ | - |  | -------- | - |  | ---------- | - |  | --------- | - |  | ------------------------ | - |  | ------- | - |  | ------------------------ | -
|                                       |  | As of December 31, 2004 Expected Maturity Date                             |   |  | As of December 31, 2003 |  
|                                       |  | 2005                                                                       |   |  | 2006                    |   |  | 2007 |   |  | 2008   |   |  | 2009     |   |  | Thereafter |   |  | Total     |   |  | Aggregate Fair Value (1) |   |  | Total   |   |  | Aggregate Fair Value (1) |  
|                                       |  | (HK$ equivalent in millions, other than interest rates and exchange rates) |   |  |                         |   |  |      |  
|Investment securities:                 |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Fixed rate:                            |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Principal amount (US$)                 |  | 1,507                                                                      |   |  | 101                     |   |  |     |   |  |       |   |  |         |   |  |           |   |  | 1,608     |   |  | 1,614                    |   |  | 3,126   |   |  | 3,162                    |  
|Average interest rate                  |  | 2.8                                                                        | % |  | 3.0                     | % |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Principal amount (EUR)                 |  |                                                                           |   |  |                        |   |  |     |   |  |       |   |  |         |   |  |           |   |  |          |   |  |                         |   |  | 166     |   |  | 169                      |  
|Average interest rate                  |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Variable rate:                         |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Principal amount (US$)                 |  | 347                                                                        |   |  | 241                     |   |  |     |   |  |       |   |  |         |   |  |           |   |  | 588       |   |  | 589                      |   |  | 930     |   |  | 931                      |  
|Average interest rate                  |  | 2.5                                                                        | % |  | 2.6                     | % |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|                                       |  |                                                                            |   |  |                         |   |  |      |   | 
|Debt instruments:                      |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Fixed rate:                            |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Medium term note                       |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Principal amount (US$)                 |  |                                                                           |   |  |                        |   |  |     |   |  |       |   |  | (7,772   | ) |  | (389       | ) |  | (8,161    | ) |  | (9,249                   | ) |  | (8,152  | ) |  | (9,452                   | )
|Average interest rate                  |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  | 7.4      | % |  | 7.9        | % |  |           |   |  |                          |   |  |         |   |  |                          |  
|Global note (the Note)               |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Principal amount (US$)                 |  |                                                                           |   |  |                        |   |  |     |   |  |       |   |  |         |   |  | (7,772     | ) |  | (7,772    | ) |  | (9,124                   | ) |  | (7,764  | ) |  | (9,344                   | )
|Average interest rate                  |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  | 8.2        | % |  |           |   |  |                          |   |  |         |   |  |                          |  
|Export credit loan                     |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Principal amount (US$)                 |  |                                                                           |   |  |                        |   |  | (199 | ) |  | (265.4 | ) |  | (265.4   | ) |  | (398       | ) |  | (1,127.8  | ) |  | (1,176                   | ) |  | (1,127  | ) |  | (1,198                   | )
|Average interest rate                  |  |                                                                            |   |  |                         |   |  | 5.7  | % |  | 5.7    | % |  | 5.7      | % |  | 5.7        | % |  |           |   |  |                          |   |  |         |   |  |                          |  
|Variable rate:                         |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Export credit loan                     |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Principal amount (US$)                 |  | (299                                                                       | ) |  | (299                    | ) |  | (104 | ) |  | (39    | ) |  | (39      | ) |  | (68        | ) |  | (848      | ) |  | (848                     | ) |  | (1,118  | ) |  | (1,118                   | )
|Average interest rate                  |  | 2.7                                                                        | % |  | 2.7                     | % |  | 2.8  | % |  | 2.9    | % |  | 2.9      | % |  | 2.9        | % |  |           |   |  |                          |   |  |         |   |  |                          |  
|                                       |  |                                                                            |   |  |                         |   |  |      |   | 
|Foreign exchange agreements:           |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Receive EUR/pay HK$                    |  | 40.5                                                                       |   |  | 9.3                     |   |  |     |   |  |       |   |  |         |   |  |           |   |  | 49.8      |   |  | 5.2                      |   |  | 43.2    |   |  | 8.5                      |  
|Average contractual exchange rate      |  | 9.6                                                                        |   |  | 9.1                     |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Receive GBP/pay HK$                    |  |                                                                           |   |  |                        |   |  |     |   |  |       |   |  |         |   |  |           |   |  |          |   |  |                         |   |  | 10.0    |   |  | 1.1                      |  
|Average contractual exchange rate      |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Receive JPY/pay HK$                    |  | 6.3                                                                        |   |  | 0.8                     |   |  |     |   |  |       |   |  |         |   |  |           |   |  | 7.1       |   |  | 0.4                      |   |  |        |   |  |                         |  
|Average contractual exchange rate      |  | 0.07                                                                       |   |  | 0.07                    |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Receive US$/pay HK$                    |  | 1,307.6                                                                    |   |  | 1,176.3                 |   |  |     |   |  |       |   |  |         |   |  |           |   |  | 2,483.9   |   |  | (22.3                    | ) |  | 3,368.2 |   |  | (6.9                     | )
|Average contractual exchange rate      |  | 7.7                                                                        |   |  | 7.7                     |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Receive US$/pay EUR                    |  |                                                                           |   |  |                        |   |  |     |   |  |       |   |  |         |   |  |           |   |  |          |   |  |                         |   |  | 159.2   |   |  | (13.7                    | )
|Average contractual exchange rate      |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Currency Swap                          |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  |          |   |  |            |   |  |           |   |  |                          |   |  |         |   |  |                          |  
|Notional amount (Receive US$/ pay HK$) |  |                                                                           |   |  |                        |   |  |     |   |  |       |   |  | 7,776.37 |   |  | 7,407.37   |   |  | 15,183.74 |   |  | (1,012                   | ) |  | 15,184  |   |  | (497.1                   | )
|Average interest rate                  |  |                                                                            |   |  |                         |   |  |      |   |  |        |   |  | 0.9      | % |  | 0.5        | % |  |           |   |  |                          |   |  |         |   |  |                          |  

---

|(1) | Fair values for off-balance sheet financial instruments represent the amounts we would receive or pay to close out the transactions.
|--- | ------------------------------------------------------------------------------------------------------------------------------------



The expected maturity dates represent our estimate of the timing of required
cash flows. The interest rate risk table assumes interest rates based on a market yield curve at the end of the year. Although certain liabilities may have similar maturities or periods to repricing, they may not react correspondingly to changes in
market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate with changes in market interest rates, while interest rates on other types of assets may lag behind changes in market rates. Actual future
market conditions may differ materially from such assumptions.



68



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ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES



Not applicable.



PART II



ITEM 13. DEFAULT, DIVIDEND ARREARAGES AND DELINQUENCIES



None.



ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS



None.



ITEM 15. CONTROLS AND PROCEDURES



Our management, with the participation of our Chief Executive Officer (Acting) and our Director  Finance, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) of the United
States Securities Exchange Act of 1934, as amended) as of December 31, 2004. Based on this evaluation, they have concluded that our disclosure controls and procedures are effective.



There were no significant changes in our internal control over financial reporting (as defined in Rules 13a  15(e) and
14d  15(e) of the United States Securities Exchange Act of 1934 as amended) that occurred during the fiscal year ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.



ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT



Our Managing Board has determined that while none of the members of the Audit Committee qualifies as a financial expert as defined under the applicable rules of the U.S. Securities and Exchange Commission issued
pursuant to Section 407 of the Sarbanes-Oxley Act of 2002, our Managing Board is satisfied that Mr. Patrick B. Paul, the Chairman of the Audit Committee, being a former managing partner of PricewaterhouseCoopers in Hong Kong, is sufficiently
experienced and skilled in the area of financial management, application of accounting principles and internal control procedures.



ITEM 16B. CODE OF ETHICS



Our
Code of Ethics, which sets out standards designed to deter wrongdoing and promote ethical conduct among our senior financial officers, is publicly available on our website at http://www.kcrc.com.



ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES



The fees for the professional services rendered by our independent registered public accounting firm in 2003 and 2004 are depicted in the table below. Audit-related services mainly relate to services such as the
issuance of comfort letters required for the update of the medium-term note program and the issuance of the retail bonds in 2003. Tax services mainly relate to the statutory filing of profits tax returns for KCRC and its subsidiaries, and tax
advisory services in connection with its leasing arrangements.



69



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|                       |  |               |  |               |  |                                         |   |  |                                                                         
|---------------------- |  | ------------- |  | ------------- |  | --------------------------------------- | - |  | ------------------------------------------------------------------------
|                       |  | Fees for 2004 |  | Fees for 2003 |  | Percentage of ServicesApproved for 2004 |   |  | Percentage of ServicesDelivered by Part-time Staff ofthe Accounting Firm
|                       |  | (HK$ million) |  |               |  |                                         |  
|Audit services         |  | 3             |  | 3             |  | 100                                     | % |  |                                                                        
|Audit-related services |  | 1             |  | 1             |  | 100                                     | % |  |                                                                        
|Tax services           |  | 1             |  | 6             |  | 100                                     | % |  |                                                                        



Pursuant to the
requirements of the Sarbanes-Oxley Act of 2002, the Audit Committee has approved and established the pre-approval policies and procedures relating to the approval of all services provided by our independent registered public accounting firm for the
audit of KCRCs annual financial statements, as summarized below:



Policy



The Audit Committee shall be
responsible for the oversight of all functions performed by KCRCs independent registered public accounting firm in respect to all services provided in relation to KCRC and its subsidiaries and, in meeting that responsibility, shall pre-approve
all services and the fees to be charged for such services provided by the independent registered public accounting firm except for those services prescribed in Section 14B of the KCRC Ordinance regarding the audit of KCRCs statutory accounts
which is approved by the Managing Board by delegation of authority from KCRCs shareholder granted on November 2, 2000.



Procedures



In order to give effect to the Audit Committees Policy in regard to the pre-approval of services provided by KCRCs independent registered
public accounting firm, the following procedures have been adopted:



| |  | The independent registered public accounting firm shall be required to submit to the Audit Committee as and when required, proposals specifying the nature and extent of services
which it will provide for the forthcoming year and the fees it intends to charge for such services.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Audit Committee shall, in consultation with the independent registered public accounting firm, consider the proposal, determine what services shall be provided and the fees to
be charged for such services, and approve the same.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | When exercising its power to approve the proposal, the Audit Committee shall not approve any appointment or re-appointment of the independent registered public accounting firm for
audit services rendered pursuant to Section 14B of the KCRC Ordinance but will consider any submissions made by the independent registered public accounting firm in this regard and make recommendations to the Managing Board.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES



None.



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ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS



Not applicable.



PART III



ITEM 17. FINANCIAL STATEMENTS



See pages F-1 through F-53 incorporated herein by reference.



ITEM 18. FINANCIAL STATEMENTS



KCRC has responded to Item 17 in lieu of responding to this Item.



ITEM 19. EXHIBITS



|*1.1 | Kowloon-Canton Railway Corporation Ordinance (Cap. 372).
|---- | --------------------------------------------------------



|*1.2 | Kowloon-Canton Railway Corporation Regulations (Cap. 372A).
|---- | -----------------------------------------------------------



|*1.3 | Kowloon-Canton Railway Corporation By-laws (Cap. 372B).
|---- | -------------------------------------------------------



|1.4 | Board General Standing Orders and Rules for Conduct of Corporation Business and Committees of the Managing Board (as amended).
|--- | ------------------------------------------------------------------------------------------------------------------------------



|***1.5 | Kowloon-Canton Railway Corporation (Amendment) Ordinance 2001.
|------ | --------------------------------------------------------------



|*2.1 | Form of Indenture between the Registrant and The Bank of New York, as Trustee, including the form of the Notes.
|---- | ---------------------------------------------------------------------------------------------------------------



|**2.2 | Instruments defining the rights of holders of KCRCs Medium Term Note Program.
|----- | ------------------------------------------------------------------------------



|4.1 | Credit Facilities Agreement dated September 28, 2004 between KCRC and certain financial institutions as Senior Lead Managers, Lead Managers and Lenders.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------



|****4.2 | East Rail Extensions Project Agreement dated February 28, 2003 between KCRC and Government of the Hong Kong Special Administration Region of the Peoples Republic of China.
|-------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|8.1 | Subsidiaries of the Registrant: See Item 4. Information on KCRC  Organizational Structure.
|--- | ---------------------------------------------------------------------------------------------



|12.1 | Certification of the Chief Executive Officer (Acting) pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
|---- | ----------------------------------------------------------------------------------------------------------------



|12.2 | Certification of the Director-Finance pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
|---- | ------------------------------------------------------------------------------------------------



|13.1 | Certification of the Chief Executive Officer (Acting) pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



|13.2 | Certification of the Director-Finance pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------

---

|* | Incorporated by reference to Registrants Registration Statement on Form F-1, filed February 28, 2000 (Registration No. 33-11564)
|- | ---------------------------------------------------------------------------------------------------------------------------------



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|** | Incorporated by reference to Registrants Annual Report on Form 20-F, filed May 30, 2001 (Registration No. 1-15004)
|-- | -------------------------------------------------------------------------------------------------------------------

|*** | Incorporated by reference to Registrants Annual Report on Form 20-F, filed June 28, 2002 (Registration No. 1-15004)
|--- | --------------------------------------------------------------------------------------------------------------------

|**** | Incorporated by reference to Registrants Annual Report on Form 20-F, filed June 27, 2003 (Registration No. 1-15004).
|---- | ---------------------------------------------------------------------------------------------------------------------

| | Portions of the exhibit have been omitted pursuant to an application for confidential treatment, which has been filed separately with the Commission.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------



72



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SIGNATURE PAGE



The registrant
hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.



Kowloon-Canton Railway CorporationBy:

/s/ Samuel M.H. LaiSamuel M.H. LaiChief Executive Officer (Acting)




Date: June 24, 2005



S-1



---

##### Table of Contents

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

OF

KOWLOON-CANTON RAILWAY CORPORATION



|                                                                                                  |  |    
|------------------------------------------------------------------------------------------------- |  | ---
|Audited Consolidated Financial Statements                                                         |  |    
|                                                                                                  | 
|Report of Independent Registered Public Accounting Firm                                           |  | F-2
|                                                                                                  | 
|Consolidated Income Statements for the years ended December 31, 2002, 2003 and 2004               |  | F-3
|                                                                                                  | 
|Consolidated Balance Sheets as of December 31, 2003 and 2004                                      |  | F-4
|                                                                                                  | 
|Consolidated Statements of Changes in Equity for the years ended December 31, 2002, 2003 and 2004 |  | F-5
|                                                                                                  | 
|Consolidated Cash Flow Statements for the years ended December 31, 2002, 2003 and 2004            |  | F-6
|                                                                                                  | 
|Notes to the Audited Consolidated Financial Statements                                            |  | F-7



F-1



---

##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



Members of the Managing Board

Kowloon-Canton Railway Corporation:



We have audited the accompanying consolidated balance sheets of Kowloon-Canton Railway Corporation (the
Corporation) and its subsidiaries (the Group) as of December 31, 2003 and 2004, and the related consolidated statements of income, changes in equity and cash flow for each of the years in the three-year period ended December 31,
2004. These consolidated financial statements are the responsibility of the Groups management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



We conducted our audits in accordance with auditing standards generally
accepted in Hong Kong and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the
Corporation and its subsidiaries as of December 31, 2003 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with accounting principles generally
accepted in Hong Kong.



Accounting principles generally
accepted in Hong Kong vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in note 44 to the consolidated
financial statements.



The accompanying consolidated financial
statements as of and for the year ended December 31, 2004 have been translated into United States dollars solely for the convenience of the reader. We have audited the translation and, in our opinion, the consolidated financial statements expressed
in Hong Kong dollars have been translated into United States dollars on the basis set forth in note 2(y) to the consolidated financial statements.



KPMG

Hong Kong

February 28, 2005



F-2



---

##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



CONSOLIDATED INCOME STATEMENTS



|                                                        |  |      |  |                         |      |  |       |      |  |       |      |  |     |  
|------------------------------------------------------- |  | ---- |  | ----------------------- | ---- |  | ----- | ---- |  | ----- | ---- |  | --- | -
|                                                        |  | Note |  | Year Ended December 31, |     
|                                                        |  | 2002 |  |                         | 2003 |  |       | 2004 |  |       | 2004 | 
|                                                        |  |      |  | HK$                     |      |  | HK$   |      |  | HK$   |      |  | US$ |  
|                                                        |  |      |  | (in millions)           |     
|Revenue                                                 |  | 4(a) |  | 4,830                   |      |  | 4,426 |      |  | 4,976 |      |  | 640 |  
|Operating costs before depreciation                     |  | 4(b) |  | 2,171                   |      |  | 2,129 |      |  | 2,807 |      |  | 361 |  
|                                                        |  |      |  |                         |      |  |       |      |  |       |      |  |     |  
|Operating profit before depreciation                    |  |      |  | 2,659                   |      |  | 2,297 |      |  | 2,169 |      |  | 279 |  
|Depreciation                                            |  | 4(c) |  | 725                     |      |  | 748   |      |  | 1,632 |      |  | 210 |  
|                                                        |  |      |  |                         |      |  |       |      |  |       |      |  |     |  
|Operating profit before net finance income / (expenses) |  |      |  | 1,934                   |      |  | 1,549 |      |  | 537   |      |  | 69  |  
|Net finance income / (expenses)                         |  | 5    |  | 618                     |      |  | 353   |      |  | (41   | )    |  | (5  | )
|                                                        |  |      |  |                         |      |  |       |      |  |       |      |  |     |  
|Profit after net finance income/(expenses)              |  |      |  | 2,552                   |      |  | 1,902 |      |  | 496   |      |  | 64  |  
|Profit on property development                          |  |      |  | 94                      |      |  |      |      |  |      |      |  |    |  
|Share of profit of associate                            |  |      |  | 16                      |      |  | 8     |      |  | 16    |      |  | 2   |  
|                                                        |  |      |  |                         |      |  |       |      |  |       |      |  |     |  
|Profit before taxation                                  |  |      |  | 2,662                   |      |  | 1,910 |      |  | 512   |      |  | 66  |  
|Income tax                                              |  | 6(a) |  | (452                    | )    |  | (529  | )    |  | (83   | )    |  | (11 | )
|                                                        |  |      |  |                         |      |  |       |      |  |       |      |  |     |  
|Profit after taxation                                   |  | 7    |  | 2,210                   |      |  | 1,381 |      |  | 429   |      |  | 55  |  
|Transfer to development reserve                         |  |      |  | (94                     | )    |  |      |      |  |      |      |  |    |  
|                                                        |  |      |  |                         |      |  |       |      |  |       |      |  |     |  
|Retained profit for the year                            |  |      |  | 2,116                   |      |  | 1,381 |      |  | 429   |      |  | 55  |  
|                                                        |  |      |  |                         |      |  |       |      |  |       |      |  |     |  
|Dividend attributable to the year:                      |  |      |  |                         |      |  |       |      |  |       |      |  |     |  
|Final dividend proposed after the balance sheet date    |  | 8    |  | 620                     |      |  | 620   |      |  | 172   |      |  | 22  |  
|                                                        |  |      |  |                         |      |  |       |      |  |       |      |  |     |  



The accompanying notes
are an integral part of these financial statements.



F-3



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



CONSOLIDATED BALANCE SHEETS



|                                                    |  |      |  |                    |      |  |        |      |  |        |  
|--------------------------------------------------- |  | ---- |  | ------------------ | ---- |  | ------ | ---- |  | ------ | -
|                                                    |  | Note |  | As of December 31, |     
|                                                    |  | 2003 |  |                    | 2004 |  |        | 2004 | 
|                                                    |  |      |  | HK$                |      |  | HK$    |      |  | US$    |  
|                                                    |  |      |  | (in millions)      |     
|Assets                                              |  |      |  |                    |      |  |        |      |  |        |  
|Fixed assets                                        |  |      |  |                    |      |  |        |      |  |        |  
|Investment properties                              |  | 10   |  | 878                |      |  | 1,026  |      |  | 132    |  
|Other properties, plant and equipment              |  | 10   |  | 50,979             |      |  | 66,766 |      |  | 8,590  |  
|                                                    |  |      |  |                    |      |  |        |      |  |        |  
|                                                    |  |      |  | 51,857             |      |  | 67,792 |      |  | 8,722  |  
|Construction in progress                            |  | 11   |  | 15,101             |      |  | 6,991  |      |  | 900    |  
|Deferred expenditure                                |  | 12   |  | 900                |      |  | 1,462  |      |  | 188    |  
|Properties under development                        |  | 13   |  | 1,448              |      |  | 1,892  |      |  | 244    |  
|Interest in associate                               |  | 15   |  | 42                 |      |  | 57     |      |  | 7      |  
|Loan receivable                                     |  | 16   |  | 774                |      |  | 733    |      |  | 95     |  
|Loan to subsidiary                                  |  | 17   |  | 3,232              |      |  | 3,576  |      |  | 460    |  
|Investments                                         |  | 18   |  | 12,244             |      |  | 4,323  |      |  | 556    |  
|Stores and spares                                   |  | 19   |  | 254                |      |  | 319    |      |  | 41     |  
|Interest receivable                                 |  | 20   |  | 63                 |      |  | 49     |      |  | 6      |  
|Other receivables                                   |  | 21   |  | 612                |      |  | 707    |      |  | 91     |  
|Cash and cash equivalents                           |  | 22   |  | 2,677              |      |  | 3,531  |      |  | 454    |  
|                                                    |  |      |  |                    |      |  |        |      |  |        |  
|                                                    |  |      |  | 89,204             |      |  | 91,432 |      |  | 11,764 |  
|                                                    |  |      |  |                    |      |  |        |      |  |        |  
|Liabilities                                         |  |      |  |                    |      |  |        |      |  |        |  
|Interest payable                                    |  | 23   |  | 474                |      |  | 485    |      |  | 62     |  
|Other payables                                      |  | 24   |  | 2,098              |      |  | 2,444  |      |  | 315    |  
|Accrued charges and provisions for capital projects |  | 25   |  | 1,782              |      |  | 3,971  |      |  | 511    |  
|Lease payable                                       |  | 26   |  | 758                |      |  | 717    |      |  | 92     |  
|Interest-bearing borrowings                         |  | 27   |  | 20,013             |      |  | 19,748 |      |  | 2,541  |  
|Deferred income                                     |  | 28   |  | 743                |      |  | 708    |      |  | 91     |  
|Deferred tax liabilities                            |  | 6(d) |  | 3,131              |      |  | 3,212  |      |  | 413    |  
|                                                    |  |      |  |                    |      |  |        |      |  |        |  
|                                                    |  |      |  | 28,999             |      |  | 31,285 |      |  | 4,025  |  
|                                                    |  |      |  |                    |      |  |        |      |  |        |  
|Net Assets                                          |  |      |  | 60,205             |      |  | 60,147 |      |  | 7,739  |  
|                                                    |  |      |  |                    |      |  |        |      |  |        |  
|Capital and Reserves                                |  |      |  |                    |      |  |        |      |  |        |  
|Share capital                                       |  | 29   |  | 39,120             |      |  | 39,120 |      |  | 5,033  |  
|Development reserve                                 |  | 30   |  | 6,535              |      |  | 6,535  |      |  | 841    |  
|Investment property revaluation reserve             |  | 31   |  | 117                |      |  | 265    |      |  | 34     |  
|Investment revaluation reserve                      |  | 32   |  | (1                 | )    |  | (16    | )    |  | (2     | )
|Proposed dividend                                   |  | 8    |  | 620                |      |  | 172    |      |  | 22     |  
|Retained profits                                    |  | 33   |  | 13,814             |      |  | 14,071 |      |  | 1,811  |  
|                                                    |  |      |  |                    |      |  |        |      |  |        |  
|                                                    |  |      |  | 60,205             |      |  | 60,147 |      |  | 7,739  |  
|                                                    |  |      |  |                    |      |  |        |      |  |        |  



The accompanying notes
are an integral part of these financial statements.



F-4



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY



|                                                                                    |  |        |  |                         |      |  |        |      |  |        |      |  |       |  
|----------------------------------------------------------------------------------- |  | ------ |  | ----------------------- | ---- |  | ------ | ---- |  | ------ | ---- |  | ----- | -
|                                                                                    |  | Note   |  | Year ended December 31, |     
|                                                                                    |  | 2002   |  |                         | 2003 |  |        | 2004 |  |        | 2004 | 
|                                                                                    |  |        |  | HK$                     |      |  | HK$    |      |  | HK$    |      |  | US$   |  
|                                                                                    |  |        |  | (in millions)           |     
|Opening balance  Total equity                                                      |  |        |  |                         |      |  |        |      |  |        |      |  |       |  
|- as previously reported                                                            |  |        |  | 59,580                  |      |  | 59,512 |      |  | 60,205 |      |  | 7,746 |  
|- prior period adjustment arising from change in accounting policy for deferred tax |  | 3 & 33 |  | (2,153                  | )    |  |       |      |  |       |      |  |      |  
|                                                                                    |  |        |  |                         |      |  |        |      |  |        |      |  |       |  
|- as restated                                                                       |  |        |  | 57,427                  |      |  | 59,512 |      |  | 60,205 |      |  | 7,746 |  
|                                                                                    |  |        |  |                         |      |  |        |      |  |        |      |  |       |  
|Surplus/(deficit) on revaluation of investment properties                           |  | 31     |  | (42                     | )    |  | (17    | )    |  | 148    |      |  | 19    |  
|Surplus/(deficit) on revaluation of investments                                     |  | 32     |  | (102                    | )    |  | (76    | )    |  | (54    | )    |  | (7    | )
|                                                                                    |  |        |  |                         |      |  |        |      |  |        |      |  |       |  
|Net profits/(losses) not recognized in the income statement.                        |  |        |  | (144                    | )    |  | (93    | )    |  | 94     |      |  | 12    |  
|                                                                                    |  |        |  |                         |      |  |        |      |  |        |      |  |       |  
|                                                                                    |  |        |  | 57,283                  |      |  | 59,419 |      |  | 60,299 |      |  | 7,758 |  
|                                                                                    |  |        |  |                         |     
|Revaluation deficit transferred to income statement on disposal of investments      |  | 32     |  | 19                      |      |  | 25     |      |  | 39     |      |  | 5     |  
|                                                                                    |  |        |  |                         |     
|Retained profit for the year                                                        |  |        |  |                         |      |  |        |      |  |        |      |  |       |  
|- as previously reported                                                            |  |        |  | 2,567                   |      |  |        |      |  |        |      |  |       |  
|- prior period adjustment arising from change in accounting policy for deferred tax |  | 3 & 33 |  | (451                    | )    |  |        |      |  |        |      |  |       |  
|Retained profit for the year (2002: as restated)                                    |  |        |  | 2,116                   |      |  | 1,381  |      |  | 429    |      |  | 55    |  
|                                                                                    |  |        |  |                         |     
|Transfer to the development reserve                                                 |  | 30     |  | 94                      |      |  |       |      |  |       |      |  |      |  
|                                                                                    |  |        |  |                         |     
|Dividend paid during the year                                                       |  | 8      |  |                        |      |  | (620   | )    |  | (620   | )    |  | (79   | )
|                                                                                    |  |        |  |                         |      |  |        |      |  |        |      |  |       |  
|Closing balance  Total equity                                                      |  |        |  | 59,512                  |      |  | 60,205 |      |  | 60,147 |      |  | 7,739 |  
|                                                                                    |  |        |  |                         |      |  |        |      |  |        |      |  |       |  



The accompanying notes
are an integral part of these financial statements.



F-5



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



CONSOLIDATED CASH FLOW STATEMENTS



|                                                                                             |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|-------------------------------------------------------------------------------------------- |  | ----- |  | ----------------------- | ---- |  | ------ | ---- |  | ------ | ---- |  | ---- | -
|                                                                                             |  | Note  |  | Year Ended December 31, |     
|                                                                                             |  | 2002  |  |                         | 2003 |  |        | 2004 |  |        | 2004 | 
|                                                                                             |  |       |  | HK$                     |      |  | HK$    |      |  | HK$    |      |  | US$  |  
|                                                                                             |  |       |  | (in millions)           |     
|Operating activities                                                                         |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|Net cash inflow from operations                                                              |  | 34    |  | 2,903                   |      |  | 2,179  |      |  | 2,306  |      |  | 296  |  
|Net cash outflow from property development                                                   |  | 34    |  | (402                    | )    |  | (308   | )    |  | (376   | )    |  | (48  | )
|Hong Kong profits tax paid                                                                   |  |       |  | (1                      | )    |  | (1     | )    |  | (1     | )    |  |     |  
|                                                                                             |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|Net cash inflow from operating activities                                                    |  |       |  | 2,500                   |      |  | 1,870  |      |  | 1,929  |      |  | 248  |  
|                                                                                             |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|Investing activities                                                                         |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|Decrease / (increase) in deposits with banks with more than 3 months of maturity when placed |  |       |  | 3,066                   |      |  | 743    |      |  | (740   | )    |  | (95  | )
|Payments to acquire investments                                                              |  |       |  | (4,328                  | )    |  |       |      |  |       |      |  |     |  
|Payments for capital expenditure                                                             |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|- West Rail project                                                                          |  |       |  | (7,049                  | )    |  | (5,367 | )    |  | (1,371 | )    |  | (176 | )
|- East Rail Extensions project                                                               |  |       |  | (3,449                  | )    |  | (5,282 | )    |  | (4,534 | )    |  | (584 | )
|- other capital projects and purchase of fixed assets                                        |  |       |  | (2,008                  | )    |  | (1,587 | )    |  | (1,076 | )    |  | (139 | )
|Loan repaid by associate                                                                     |  |       |  | 4                       |      |  |       |      |  |       |      |  |     |  
|Interest received                                                                            |  |       |  | 1,813                   |      |  | 725    |      |  | 1,358  |      |  | 175  |  
|Receipts from sale of fixed assets                                                           |  |       |  | 6                       |      |  |       |      |  |       |      |  |     |  
|Loan to subsidiary                                                                           |  |       |  | (512                    | )    |  | (382   | )    |  | (24    | )    |  | (3   | )
|Receipts from redemption of investments                                                      |  |       |  | 12,376                  |      |  | 6,783  |      |  | 6,740  |      |  | 867  |  
|                                                                                             |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|Net cash inflow/(outflow) from investing activities                                          |  |       |  | (81                     | )    |  | (4,367 | )    |  | 353    |      |  | 45   |  
|                                                                                             |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|Net cash inflow/(outflow) before financing                                                   |  |       |  | 2,419                   |      |  | (2,497 | )    |  | 2,282  |      |  | 293  |  
|                                                                                             |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|Financing activities                                                                         |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|Net cash flow on (repayment)/drawdown of loans                                               |  |       |  | 928                     |      |  | 2,271  |      |  | (273   | )    |  | (35  | )
|Dividend paid                                                                                |  |       |  |                        |      |  | (620   | )    |  | (620   | )    |  | (79  | )
|Interest paid                                                                                |  |       |  | (1,256                  | )    |  | (1,329 | )    |  | (1,387 | )    |  | (179 | )
|Net income from derivative instruments                                                       |  |       |  | 60                      |      |  | 111    |      |  | 138    |      |  | 18   |  
|Other borrowing costs paid                                                                   |  |       |  | (30                     | )    |  | (37    | )    |  | (11    | )    |  | (1   | )
|Amounts paid in respect of expenses for the issue of interest-bearing borrowings             |  |       |  |                        |      |  | (7     | )    |  | (15    | )    |  | (2   | )
|                                                                                             |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|Net cash inflow/(outflow) from financing activities                                          |  |       |  | (298                    | )    |  | 389    |      |  | (2,168 | )    |  | (278 | )
|                                                                                             |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|Increase/(decrease) in cash and cash equivalents                                             |  |       |  | 2,121                   |      |  | (2,108 | )    |  | 114    |      |  | 15   |  
|Cash and cash equivalents at January 1,                                                      |  |       |  | 2,464                   |      |  | 4,585  |      |  | 2,477  |      |  | 318  |  
|                                                                                             |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|Cash and cash equivalents at December 31,                                                    |  |       |  | 4,585                   |      |  | 2,477  |      |  | 2,591  |      |  | 333  |  
|                                                                                             |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|Analysis of the balances of cash and cash equivalents                                        |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|Cash at bank and in hand                                                                     |  | 22(a) |  | 20                      |      |  | 54     |      |  | 36     |      |  | 4    |  
|Deposits with banks within 3 months of maturity when placed                                  |  | 22(a) |  | 4,565                   |      |  | 2,423  |      |  | 2,555  |      |  | 329  |  
|                                                                                             |  |       |  |                         |      |  |        |      |  |        |      |  |      |  
|                                                                                             |  |       |  | 4,585                   |      |  | 2,477  |      |  | 2,591  |      |  | 333  |  
|                                                                                             |  |       |  |                         |      |  |        |      |  |        |      |  |      |  



The accompanying notes
are an integral part of these financial statements.



F-6



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS

December 31, 2002, 2003, 2004



|1 | Establishment of the Corporation
|- | --------------------------------



The Kowloon-Canton Railway Corporation (the Corporation) was incorporated under the Kowloon-Canton Railway Corporation Ordinance (the
Ordinance) on December 24, 1982 to undertake the operation of the Hong Kong section of the Kowloon-Canton Railway and to construct and operate a Light Rail Transit System in the North West New Territories of the Hong Kong Special
Administrative Region (HKSAR).



The assets, rights
and liabilities of the then existing railway were vested in the Corporation on February 1, 1983 in accordance with Section 7 of the Ordinance.



The Kowloon-Canton Railway Corporation (Permitted Activities) Order 1996 came into operation on February 17, 1996. It enabled the Corporation to plan,
design and prepare for the construction of a new railway system in the North West New Territories (the West Rail) and pursuant to an amendment to the Kowloon-Canton Railway Corporation Ordinance which came into effect on April 3, 1998,
the Corporations powers were extended to permit it to construct and operate additional railways.



|2 | Significant accounting policies
|- | -------------------------------



|(a) | Statement of compliance
|--- | -----------------------



Although not required to do so under the Ordinance, the Corporation has prepared these financial statements in accordance with all applicable Hong Kong
Financial Reporting Standards (which include all applicable Statements of Standard Accounting Practice and Interpretations) issued by the Hong Kong Institute of Certified Public Accountants, accounting principles generally accepted in Hong Kong and
the disclosure requirements of the Hong Kong Companies Ordinance. These financial statements also comply with the applicable disclosure provisions of the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited. A summary
of the significant accounting policies adopted by the Corporation and its subsidiaries (the Group) is set out below.



|(b) | Basis of preparation of the financial statements
|--- | ------------------------------------------------



The measurement basis used in the preparation of the financial statements is historical cost modified by the revaluation of investment properties and the
marking to market of investments as explained in the accounting policies set out below.



|(c) | Basis of consolidation
|--- | ----------------------



The consolidated financial statements include the financial statements of the Corporation and its subsidiaries made up to 31 December each year. The
results of subsidiaries acquired or disposed of during the year are included in the consolidated financial statements from or to the date of their acquisition or disposal, as appropriate.



Intra-group balances and transactions are eliminated in full in preparing the consolidated financial statements.



The financial statements of certain subsidiaries held by the Corporation
for the sole purpose of developing, on behalf of the Government, commercial or residential properties along the West Rail, Phase I route are excluded from the consolidation as the Corporation has no effective control over nor beneficial interests in
the net assets of these subsidiaries, other than the amount of capital provided.



F-7



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|2 | Significant accounting policies (continued)
|- | -------------------------------------------



|(d) | Investments in subsidiaries
|--- | ---------------------------



A subsidiary, in accordance with the Hong Kong Companies Ordinance, is a company in which the Group, directly or indirectly, holds more than half of the
issued share capital, or controls more than half the voting power or controls the composition of the board of directors. Subsidiaries are considered to be controlled if the Corporation has the power, directly or indirectly, to govern the financial
and operating policies, so as to obtain benefits from their activities.



An investment in a controlled subsidiary is consolidated into the consolidated financial statements, unless it is acquired and held exclusively with a view to subsequent disposal in the near future or operates under severe long-term
restrictions which significantly impair its ability to transfer funds to the Group, in which case, it is stated in the consolidated balance sheet at fair value with changes in fair value recognized in the same way as for other investments.



Intra-group balances and transactions, and any unrealized
profits arising from intra-group transactions, are eliminated in full in preparing the consolidated financial statements. Unrealized losses resulting from intra-group transactions are eliminated in the same way as unrealized gains, but only to the
extent that there is no evidence of impairment.



|(e) | Associate
|--- | ---------



An associate is an entity in which the Group has significant influence, but not control or joint control, over its management, including participation in the financial and operating policy decisions.



Unless the investment in an associate is acquired and held exclusively with a
view to subsequent disposal in the near future or operates under severe long-term restrictions that significantly impair its ability to transfer funds to the investor, in which case it is stated at fair value with changes in fair value recognized in
the same way as for other investments, an investment in an associate is accounted for in the consolidated financial statements under the equity method and is initially recorded at cost and adjusted thereafter for the post acquisition change in the
Groups share of the associates net assets. The consolidated income statement reflects the Groups share of the post-acquisition results of the associate for the year.



Unrealized profits and losses resulting from transactions between the Group and its associates are eliminated to the extent
of the Groups interest in the associates, except where unrealized losses provide evidence of an impairment of the asset transferred, in which case they are recognized immediately in the income statement.



F-8



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|2 | Significant accounting policies (continued)
|- | -------------------------------------------



|(f) | Fixed assets
|--- | ------------



| | (i) | Fixed assets are carried in the balance sheet on the following bases:
| | --- | ---------------------------------------------------------------------



| |  |  | Fixed assets, except investment properties, are stated at cost less accumulated depreciation (see note 2(g)) and impairment losses (see note 2(h)), and include land, initial costs
of rail tracks and sleepers, the cost of ballast, buildings, infrastructure, rolling stock and other equipment utilized by the Group in the operation of its rail networks and ancillary commercial activities.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The cost of fixed assets vested by the Government has been determined as
follows:



| | (i) | for fixed assets vested on February 1, 1983 - as determined by the Financial Secretary.
| | --- | ---------------------------------------------------------------------------------------



| | (ii) | for fixed assets vested subsequent to February 1, 1983 - based on actual cost as reflected in the Governments records.
| | ---- | -----------------------------------------------------------------------------------------------------------------------



Fixed asset expenditure below $20,000 per item is expensed to the income
statement as incurred.



| |  |  | Investment properties with an unexpired lease term of more than 20 years are stated in the balance sheet at their open market value which is assessed annually by external qualified
valuers.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (ii) | Changes in the value of investment properties arising upon revaluations are dealt with in the investment property revaluation reserve. The only exceptions are as follows:
| | ---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | if the total of this reserve is insufficient to cover a revaluation deficit, on a portfolio basis, the excess of the deficit is charged to the income statement.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | where a deficit has previously been charged to the income statement and a revaluation surplus subsequently arises, this surplus is firstly credited to the income statement to the
extent of the deficit previously charged to the income statement and is, thereafter, taken to the investment property revaluation reserve.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (iii) | Subsequent expenditure on an existing fixed asset is added to the carrying amount of the asset if, either future economic benefits will flow to the Group, or the condition of the
asset will improve beyond its originally assessed standard of performance.
| | ----- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Expenditure on repairs or maintenance of an existing fixed asset to restore or maintain the originally assessed standard of performance of the asset is recognized as an expense when incurred.



| | (iv) | Gains or losses arising from the retirement or disposal of a fixed asset are determined as the difference between the net disposal proceeds and the carrying amount of the asset and
are recognized as income or expense in the income statement on the date of retirement or disposal.
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



On disposal of an investment property, the related portion of surpluses or deficits previously taken to the investment property revaluation reserve is
transferred to the income statement.



F-9



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|2 | Significant accounting policies (continued)
|- | -------------------------------------------



| | (v) | Leased assets
| | --- | -------------



| |  |  | Fixed assets held under lease agreements that give rights equivalent to ownership are treated as if the Group owns them outright.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | Fixed assets held for use in operating leases are included in the balance sheet according to their nature and, where applicable, are depreciated in accordance with the Groups
depreciation policies, as set out in note 2(g). Impairment losses are accounted for in accordance with the accounting policy, as set out in note 2(h). Revenue arising from operating leases is recognized in accordance with the Groups revenue
recognition policies, as set out in note 2(n).
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Where the Group has the use of assets under operating leases, payments made under the leases are charged to the income statement in equal installments over the accounting periods
covered by the lease term.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(g) | Depreciation
|--- | ------------



| | (i) | No depreciation is provided in respect of investment properties with an unexpired lease term of more than 20 years since the valuation takes into account the state of each property
at the date of valuation. The Group does not currently hold any investment properties with an unexpired lease term of less than 20 years.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (ii) | Leasehold land other than that relating to investment properties is depreciated over the remaining period of the lease.
| | ---- | -----------------------------------------------------------------------------------------------------------------------



| | (iii) | The initial cost of rail tracks, ballast and sleepers is not depreciated. The cost of replacing rail tracks and sleepers is charged to the income statement as and when incurred.
| | ----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (iv) | All other fixed assets are depreciated on a straight-line basis at the following rates per annum calculated to write off the cost of each asset over its estimated useful life:
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                                                  |  |         |  
|----------------------------------------------------------------- |  | ------- | -
|Tunnels, bridges and roads                                        |  | 1       | %
|Buildings                                                         |  | 2       | %
|Rolling stock (electrical)                                        |  | 2.5-3.3 | %
|Rolling stock (diesel)                                            |  | 3-20    | %
|Lifts and escalators                                              |  | 5       | %
|Ballast replacement programs                                      |  | 7       | %
|Machinery and equipment                                           |  | 3-10    | %
|Telecommunication and signaling systems and airconditioning plant |  | 7-10    | %
|Fare collection systems                                           |  | 7-10    | %
|Mobile phone systems                                              |  | 10-14   | %
|Furniture and fixtures                                            |  | 7-33    | %
|Computer and office equipment (including computer software)       |  | 20-33   | %
|Buses                                                             |  | 6-10    | %
|Other motor vehicles                                              |  | 7-25    | %



| | (v) | The useful lives of the various categories of fixed assets are reviewed regularly in the light of actual asset condition and asset replacement programs. The depreciation charge for
the current and future periods will be adjusted if there are significant changes from previous estimates.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|2 | Significant accounting policies (continued)
|- | -------------------------------------------



|(h) | Impairment of assets
|--- | --------------------



Internal and external sources of information are reviewed at each balance sheet date to identify indications that the following assets may be impaired or
an impairment loss previously recognized no longer exists or may have decreased:



| |  |  | fixed assets (other than investment properties carried at revalued amounts);
| | - |  | ----------------------------------------------------------------------------



| |  |  | construction in progress;
| | - |  | -------------------------



| |  |  | deferred expenditure; and
| | - |  | -------------------------



| |  |  | interest in associate.
| | - |  | ----------------------



If any such indication exists, the assets recoverable amount is estimated. An impairment loss is recognized in the income statement to reduce the
carrying amount of an asset to its recoverable amount.



| | (i) | Calculation of recoverable amount
| | --- | ---------------------------------



The recoverable amount of an asset is the greater of its net selling price and value in use. In assessing value in use, the estimated future cash flows
are discounted to their present value using a pre-tax discount rate that reflects current market assessments of time value of money and the risks specific to the asset. Where there are assets that do not generate cash inflows largely independent of
those from other assets, recoverable amounts are determined for the smallest group of assets that generates cash inflows independently (i.e. a cash-generating unit).



| | (ii) | Reversals of impairment losses
| | ---- | ------------------------------



An impairment loss is reversed if there has been a favorable change in the estimates used to determine the recoverable amount.



A reversal of impairment losses is limited to the assets carrying
amount that would have been determined had no impairment loss been recognized in prior years. Reversals of impairment losses are credited to the income statement in the year in which the reversals are recognized.



|(i) | Construction in progress
|--- | ------------------------



Assets under construction and capital works for the operating railways are stated at cost less impairment losses (see note 2(h)). Costs comprise direct
costs of construction, such as materials, staff costs and overheads, as well as net borrowing costs/finance income (see note 2(q)) capitalized during the period of construction or installation and testing. Capitalization of these costs ceases and
the asset concerned is transferred to fixed assets when substantially all the activities necessary to prepare the asset for its intended use are completed, at which time it commences to be depreciated in accordance with the policies detailed in note
2(g).



Costs incurred by the Group in respect of feasibility
studies on proposed railway related construction projects (including consultancy fees, in-house staff costs and overheads) are dealt with as follows:



| |  |  | where the proposed projects are at a preliminary review stage with no certainty of the proposed project proceeding, the costs concerned are written off to the income statement.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | where the proposed projects are at a detailed study stage, having demonstrated an acceptable financial viability and having obtained the Managing Boards approval to proceed
further, the costs concerned are initially dealt with as deferred expenditure and then transferred to construction in progress after the relevant project agreements are reached with the Government.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-11



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|2 | Significant accounting policies (continued)
|- | -------------------------------------------



|(j) | Deferred expenditure
|--- | --------------------



As described in note 2(i), deferred expenditure relates to costs incurred for proposed projects which will be transferred to construction in progress
after the relevant project agreements are reached with the Government.



|(k) | Property development
|--- | --------------------



The Group is involved in a number of property development projects. When the Group determines or reaches agreement with its property developers to develop
a site for resale or for rent, the net book value of existing land and buildings on the development site included in fixed assets are transferred to properties under development. Costs related to the respective projects are also charged to
properties under development until such time that profit on the development is recognized by the Group.



Profits on property development are recognized in the income statement as follows:



| |  |  | where the Group receives payments from developers as a consequence of their participation in a project to develop a property: after taking into account the outstanding risks and
obligations in connection with the development, if any, retained by the Group.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | where the Groups share of profit is based on the actual sales proceeds from the sale of properties: after the completion of sales agreements for a substantial proportion of
the development, the issue of occupation permits and the receipt of a substantial proportion of the sales proceeds.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | where the Groups profit is based on the retention of certain properties from the development: when the properties retained are ready for use by the Group after taking into
account outstanding risks, if any, retained by the Group in connection with the development. The profit recognized is measured at the fair value of the properties retained less any costs incurred by the Group thereon.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



(l) Jointly controlled operations



Assets that the Group controls and the liabilities that it incurs in respect
of its interests in jointly controlled operations are recognized in the balance sheet and classified according to the nature of the relevant item. The Groups share of the income that it earns from the sale of goods or services by the jointly
controlled operations along with the expenses that it incurs are included in the income statement when it is probable that economic benefits associated with the transactions will flow to or from the Group, as applicable.



F-12



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|2 | Significant accounting policies (continued)
|- | -------------------------------------------



|(m) | Investments
|--- | -----------



Investments comprise:



| | (i) | Temporary investment of funds from the equity injection received and borrowings obtained specifically for the construction of the East Rail Extensions, the Kowloon Southern Link and
the Sha Tin to Central Link before the funds are used for such purposes (pre-funding investments); and
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (ii) | Investment of surplus funds from the Groups operations (other investments).
| | ---- | ------------------------------------------------------------------------------



All investments are stated in the balance sheet at their fair value.



Changes in fair value of pre-funding investments, together with all income
generated from such investments including interest income, exchange gains or losses, gains or losses arising from transactions in derivative financial instruments for hedging against foreign currency investments and gains or losses arising from the
disposal of such investments, are capitalized as construction in progress or deferred expenditure, as appropriate.



Changes in fair value of other investments are recognized in the investment revaluation reserve until the investment is sold, collected or otherwise
disposed of or until there is objective evidence that the investment is impaired, at which time the relevant cumulative gain or loss is transferred from investment revaluation reserve to the income statement.



Transfers from the investment revaluation reserve to the income statement as
a result of impairments are reversed when the circumstances and events that led to the impairment cease to exist and there is persuasive evidence that the new circumstances and events will persist for the foreseeable future.



Profits or losses on disposal of other investments are accounted for in the
income statement as they arise. The profit or loss includes any amount previously held in the investment revaluation reserve in respect of these investments.



|(n) | Revenue recognition
|--- | -------------------



Provided it is probable that the economic benefits will flow to the Group and the revenue and costs, if applicable, can be measured reliably, revenue is
recognized in the income statement as follows:



| | (i) | Passenger and freight services
| | --- | ------------------------------



| |  |  | When the services are provided.
| | - |  | -------------------------------



| | (ii) | Rental and license income
| | ---- | -------------------------



| |  |  | Rental income receivable under operating leases is recognized in the income statement in equal installments over the accounting periods covered by the lease term, except where an
alternative basis is more representative of the pattern of benefits to be derived from the leased asset. Lease incentives granted are recognized in the income statement as an integral part of the aggregate net lease payment receivable. Contingent
rentals are recognized as income in the accounting period in which they are earned.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (iii) | Interest income
| | ----- | ---------------



| |  |  | Interest income from dated debt securities, as it accrues adjusted by the amortization of the premium or discount on acquisition so as to achieve a constant rate of return over the
period from the date of purchase to the date of maturity.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Interest income from bank deposits, on a time-apportioned basis by reference to the principal outstanding and the rate applicable.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| | (iv) | Other income
| | ---- | ------------



| |  |  | Once the related services or goods are delivered.
| | - |  | -------------------------------------------------



F-13



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|2 | Significant accounting policies (continued)
|- | -------------------------------------------



|(o) | Lease out and lease back transactions
|--- | -------------------------------------



A series of lease out and lease back transactions with third parties is linked and accounted for as one arrangement when the overall economic effect
cannot be understood without reference to the series of transactions as a whole and when the series of transactions is closely interrelated, negotiated as a single arrangement and takes place concurrently or in a continued sequence.



The primary purpose of such arrangements is to achieve a particular tax
result for the third parties in return for a fee received by the Group. The arrangements do not, in substance, involve a lease under the Statement of Standard Accounting Practice (SSAP) 14 (Leases) since the Group retains all the risks
and rewards incident to the ownership of the underlying assets and enjoys substantially the same rights to their use as before the transactions. The transactions are, therefore, not accounted for as leases. Where commitments by the Group to make
long-term lease payments have been defeased by the placement of security deposits, those commitments and deposits are not recognized as obligations and assets of the Group. In the case where the Groups commitments and deposits meet the
definition of a liability and an asset, such commitments and deposits are recognized as obligations and assets in the balance sheet. The income and expenses arising from the arrangements are accounted for on a net basis in order to reflect the
overall commercial effect of the transactions. The net amounts are accounted for as deferred income and are amortized over the applicable lease terms of the transactions.



|(p) | Stores and spares
|--- | -----------------



Stores and spares are valued at cost of purchase on a weighted average basis. Obsolete stores and spares are written off to the income statement. When
stores and spares are consumed, the carrying amount of those stores and spares is recognized as an expense in the year in which the consumption occurs.



|(q) | Borrowing costs and finance income
|--- | ----------------------------------



Borrowing costs incurred on borrowings during the year are dealt with in the income statement except to the extent that they are capitalized as being
directly attributable to the acquisition, construction or production of an asset which necessarily takes a substantial period of time to get ready for its intended use or sale.



Borrowing costs include interest on borrowings; amortization of discounts relating to borrowings; amortization of ancillary
costs incurred in connection with the arrangement of borrowings, gains or losses arising from transactions in derivative financial instruments for hedging against foreign currency borrowings and exchange differences arising from foreign currency
borrowings. Exchange differences are capitalized to the extent that they are regarded as an adjustment to interest costs.



Investment income includes interest income, gains or losses arising from transactions in derivative financial instruments for hedging against foreign
currency investments, gains or losses on disposals of investments and exchange differences arising from investments.



Finance income earned on the temporary investment of the equity injection received and borrowings obtained specifically for the acquisition, construction
or production of an asset which necessarily takes a substantial period of time to get ready for its intended use prior to the date of expenditure for such purpose is credited to construction in progress or deferred expenditure, as appropriate.



|(r) | Translation of foreign currencies
|--- | ---------------------------------



Foreign currency transactions during the year are translated into Hong Kong dollars at the exchange rates ruling at the transaction dates. Monetary assets
and liabilities denominated in foreign currencies are translated into Hong Kong dollars at the market exchange rates ruling at the balance sheet date. Forward foreign exchange contracts, swaps and options used as a hedge against foreign currency
investments and liabilities are revalued at the balance sheet date at the exchange rates ruling at that date. Gains and losses on currency hedging transactions are used to offset gains and losses resulting from currency fluctuations inherent in the
underlying foreign currency investments and liabilities. Differences arising on foreign currency translation and revaluation of forward exchange contracts, swaps and options are dealt with in the income statement except that they are capitalized to
the extent as discussed in note 2(q).



F-14



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|2 | Significant accounting policies (continued)
|- | -------------------------------------------



|(s) | Income tax
|--- | ----------



| | (i) | Income tax for the year comprises current tax and movements in deferred tax assets and liabilities. Current tax and movements in deferred tax assets and liabilities are recognized
in the income statement except to the extent that they relate to items recognized directly to equity, in which case they are recognized in equity.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (ii) | Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantively enacted at the balance sheet date and any adjustment to tax
payable in respect of previous years.
| | ---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (iii) | Deferred tax assets and liabilities arise from deductible and taxable temporary differences respectively, being the differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts for tax purposes. Deferred tax assets also arise from unused tax losses and unused tax credits.
| | ----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



All deferred tax liabilities and all deferred tax assets, to the extent that it is probable that future taxable profits will
be available against which the asset can be utilized, are recognized.



The amount of deferred tax provided is based on the expected manner of realization or settlement of the carrying amount of the assets and liabilities, using tax rates enacted or substantively enacted at the balance sheet date. Deferred tax
assets and liabilities are not discounted.



The carrying
amount of a deferred tax asset is reviewed at each balance sheet date and is reduced to the extent that it is no longer probable that sufficient taxable profits will be available to allow the related tax benefit to be utilized. Any such reduction is
reversed to the extent that it becomes probable that sufficient taxable profits will be available.



| | (iv) | Current and deferred tax assets and liabilities are offset if, and only if, the Group has the legally enforceable right to set off current tax assets against current tax liabilities
and the following additional conditions are met:
| | ---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | in the case of current tax assets and liabilities, the Group intends either to settle on a net basis, or to realize the asset and settle the liability simultaneously; or
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | in the case of deferred tax assets and liabilities, if they relate to income taxes levied by the same taxation authority on either:
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | the same taxable entity; or
| | - |  | ---------------------------



| |  |  | different taxable entities, which, in each future period in which significant amounts of deferred tax liabilities or assets are expected to be settled or recovered, intend to
realize the current tax assets and settle the current tax liabilities on a net basis or realize and settle simultaneously.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(t) | Provisions and contingent liabilities
|--- | -------------------------------------



Provisions are recognized for liabilities of uncertain timing or amount when the Group has a legal or constructive obligation arising as a result of a
past event, and it is probable that an outflow of economic benefits will be required to settle the obligation and a reliable estimate can be made. Where the time value of money is material, provisions are stated at the present value of the
expenditure expected to settle the obligation.



Where it is not
probable that an outflow of economic benefits will be required, or the amount cannot be estimated reliably, the obligation is disclosed as a contingent liability.



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|2 | Significant accounting policies (continued)
|- | -------------------------------------------



|(u) | Employee benefits
|--- | -----------------



Obligations for contributions to the defined contribution scheme operated by the Group and to the Mandatory Provident Fund as required under the Hong Kong
Mandatory Provident Fund Schemes Ordinance, are recognized as an expense in the income statement as incurred, except to the extent that they are capitalized as part of the costs of construction in progress, deferred expenditure and properties under
development.



Salaries, annual bonuses, paid annual leave,
leave passage and non-monetary benefits are accrued in the year during which the services are provided by employees.



|(v) | Cash and cash equivalents
|--- | -------------------------



Cash and cash equivalents comprise cash at bank and on hand, demand deposits with banks and other financial institutions, and short-term, highly liquid
investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value, having been within three months of maturity at acquisition.



For the purposes of the consolidated cash flow statement, cash equivalents
would also include bank overdrafts that are repayable on demand and form an integral part of the Groups cash management but exclude bank deposits with more than three months of maturity when placed.



|(w) | Related parties
|--- | ---------------



For the purposes of these financial statements, parties are considered to be related to the Group if the Group has the ability, directly or indirectly, to
control the party or exercise significant influence over the party in making financial and operating decisions, or vice versa, or where the Group and the party are subject to common control or common significant influence. Related parties may be
individuals or other entities.



|(x) | Segment reporting
|--- | -----------------



A segment is a distinguishable component of the Group that is engaged either in providing products or services (business segment), or in providing
products or services within a particular economic environment (geographical segment), which is subject to risks and rewards that are different from those of other segments.



Business segment information is the primary reporting format in accordance with the Groups internal financial
reporting. Segment revenue, expenses, results, assets and liabilities include items directly attributable to a segment as well as those that can be allocated on a reasonable basis to that segment.



Segment capital expenditure is the total cost incurred during the period to
acquire segment assets that are expected to be used for more than one period.



Unallocated items mainly comprise financial and corporate assets, interest-bearing loans, borrowings, corporate and financing expenses.



|(y) | Translation of 2004 consolidated financial statements to United States Dollars
|--- | ------------------------------------------------------------------------------



The Group publishes its consolidated financial statements expressed in Hong Kong Dollars. In these consolidated financial
statements references to US Dollars or US$ are to United States Dollars and references to Hong Kong Dollars or HK$ are to Hong Kong Dollars. Solely for the convenience of the reader, the 2004
consolidated financial statements have been translated into US Dollars at the specified rate below. These translations should not be construed as representations that the Hong Kong Dollar amounts actually represent such US Dollar amounts or could be
converted into US Dollars at the rate indicated. The translation of Hong Kong Dollars into US Dollars has been made at the rate of US$1.00 to HK$7.7723, which was the noon buying rate in New York City for cable transfers in Hong Kong Dollars as
certified for customs purposes by the Federal Reserve Bank of New York on December 31, 2004.



F-16



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|3 | Change in accounting policies
|- | -----------------------------



In August 2002 the Hong Kong Institute of Certified Public Accountants issued a revised Statement of Standard Accounting Practice (SSAP) 12,
Income taxes, which sets out a revised method for the recognition of and accounting for deferred tax and additional disclosure requirements for income tax and deferred tax. SSAP 12 (revised) is applicable for accounting periods beginning on or after
January 1, 2003. The Group has adopted the provisions of SSAP 12 (revised) with effect from January 1, 2003. In adopting the provisions of SSAP 12 (revised) the Group has recalculated deferred tax relating to prior years which would have been
recognized in prior years under the new accounting policy in order to comply with SSAP 12 (revised) and has restated the figures relating to prior years accordingly, as set out below.



In prior years, deferred tax liabilities were provided using the liability method in respect of the taxation effect arising
from all material timing differences between the accounting and tax treatment of income and expenditure, to the extent that it was probable that a liability would crystallize in the foreseeable future. Deferred tax assets were not recognized unless
their realization was assured beyond reasonable doubt. With effect from January 1, 2003, in order to comply with SSAP 12 (revised), the Group adopted a new policy for deferred tax as set out in note 2(s). One of the significant changes introduced by
SSAP 12 (revised) is that all deferred tax liabilities must be provided for irrespective of whether a liability will crystallize or not in the foreseeable future. As required by SSAP 2, Net profit or loss for the period, fundamental errors and
changes in accounting policies, a change in accounting policy should be applied retrospectively unless the amount of any resulting adjustment that relates to prior periods is not reasonably determinable or is immaterial. The effects of adopting SSAP
12 (revised) are set out as follows:



|                                       |  |                  |   |  |                  |   |  |                  |  |                 
|-------------------------------------- |  | ---------------- | - |  | ---------------- | - |  | ---------------- |  | ----------------
|                                       |  | December 31,2002 |   |  | December 31,2003 |   |  | December 31,2004 |  | December 31,2004
|                                       |  | HK$              |   |  | HK$              |   |  | HK$              |  | US$             
|                                       |  | (in millions)   
|Balance Sheet                          |  |                  |   |  |                  |   |  |                  |  |                 
|- Increase in deferred tax liabilities |  | 2,604            |   |  | 3,131            |   |  |                 |  |                
|- Decrease in retained profits         |  | (2,604           | ) |  | (3,131           | ) |  |                 |  |                
|                                       |  |                  |   | 
|                                       |  | 2002             |   |  | 2003             |   |  | 2004             |  | 2004            
|                                       |  | HK$              |   |  | HK$              |   |  | HK$              |  | US$             
|                                       |  | (in millions)   
|Income statement                       |  |                  |   |  |                  |   |  |                  |  |                 
|- Increase in income tax               |  | 451              |   |  | 527              |   |  |                 |  |                



Retained profits at
January 1, 2002 have decreased by HK$2,153 million as a result of the retrospective application of SSAP 12 (revised).



F-17



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|4 | Revenue, operating costs and operating profit before net finance income/(expenses)
|- | ----------------------------------------------------------------------------------



|(a) | Revenue represents the revenue from passenger, freight and property services after eliminating inter-company transactions. The amounts of revenue recognized in revenue by principal
activities during the year are as follows:
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                   |  |               |  |       |  |       |  |     
|------------------ |  | ------------- |  | ----- |  | ----- |  | ----
|                   |  | 2002          |  | 2003  |  | 2004  |  | 2004
|                   |  | HK$           |  | HK$   |  | HK$   |  | US$ 
|                   |  | (in millions)
|Passenger services |  | 4,127         |  | 3,745 |  | 4,213 |  | 542 
|Freight services   |  | 86            |  | 74    |  | 68    |  | 9   
|Property services  |  | 617           |  | 607   |  | 695   |  | 89  
|                   |  |               |  |       |  |       |  |     
|                   |  | 4,830         |  | 4,426 |  | 4,976 |  | 640 
|                   |  |               |  |       |  |       |  |     



|(b) | Operating costs comprise the following:
|--- | ---------------------------------------



|                                                                                                                          |  |               |   |  |        |   |  |       |   |  |      |  
|------------------------------------------------------------------------------------------------------------------------- |  | ------------- | - |  | ------ | - |  | ----- | - |  | ---- | -
|                                                                                                                          |  | 2002          |   |  | 2003   |   |  | 2004  |   |  | 2004 |  
|                                                                                                                          |  | HK$           |   |  | HK$    |   |  | HK$   |   |  | US$  |  
|                                                                                                                          |  | (in millions) |  
|Staff costs                                                                                                               |  |               |   |  |        |   |  |       |   |  |      |  
|- Gross amount including retirement costs of HK$138 million (US$18 million)(2003: HK$137 million; 2002: HK$129 million)   |  | 2,140         |   |  | 2,262  |   |  | 2,156 |   |  | 277  |  
|- Amount capitalized including retirement costs of HK$17 million (US$2 million)(2003: HK$29 million; 2002: HK$19 million) |  | (914          | ) |  | (1,061 | ) |  | (692  | ) |  | (89  | )
|                                                                                                                          |  |               |   |  |        |   |  |       |   |  |      |  
|                                                                                                                          |  | 1,226         |   |  | 1,201  |   |  | 1,464 |   |  | 188  |  
|Electricity and fuel                                                                                                      |  | 262           |   |  | 271    |   |  | 456   |   |  | 59   |  
|Stores and spares consumed                                                                                                |  | 110           |   |  | 115    |   |  | 158   |   |  | 20   |  
|General supplies                                                                                                          |  | 23            |   |  | 34     |   |  | 32    |   |  | 4    |  
|Repairs and maintenance                                                                                                   |  | 144           |   |  | 133    |   |  | 181   |   |  | 23   |  
|Government rent and rates                                                                                                 |  | 75            |   |  | 64     |   |  | 68    |   |  | 9    |  
|Octopus cards usage fees                                                                                                  |  | 30            |   |  | 29     |   |  | 33    |   |  | 4    |  
|Cost of services acquired                                                                                                 |  | 111           |   |  | 105    |   |  | 144   |   |  | 19   |  
|Property ownership and management expenses                                                                                |  | 44            |   |  | 56     |   |  | 63    |   |  | 8    |  
|Others                                                                                                                    |  | 146           |   |  | 121    |   |  | 208   |   |  | 27   |  
|                                                                                                                          |  |               |   |  |        |   |  |       |   |  |      |  
|                                                                                                                          |  | 2,171         |   |  | 2,129  |   |  | 2,807 |   |  | 361  |  
|                                                                                                                          |  |               |   |  |        |   |  |       |   |  |      |  



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|4 | Revenue, operating costs and operating profit before net finance income/(expenses) (continued)
|- | ----------------------------------------------------------------------------------------------



|(c) | Depreciation comprises the following:
|--- | -------------------------------------



|                                             |  |               |   |  |      |   |  |       |   |  |      |  
|-------------------------------------------- |  | ------------- | - |  | ---- | - |  | ----- | - |  | ---- | -
|                                             |  | 2002          |   |  | 2003 |   |  | 2004  |   |  | 2004 |  
|                                             |  | HK$           |   |  | HK$  |   |  | HK$   |   |  | US$  |  
|                                             |  | (in millions) |  
|Depreciation                                 |  |               |   |  |      |   |  |       |   |  |      |  
|- assets held for use under operating leases |  | 17            |   |  | 17   |   |  | 16    |   |  | 2    |  
|- other assets                               |  | 711           |   |  | 735  |   |  | 1,622 |   |  | 209  |  
|- depreciation charged capitalized           |  | (3            | ) |  | (4   | ) |  | (6    | ) |  | (1   | )
|                                             |  |               |   |  |      |   |  |       |   |  |      |  
|                                             |  | 725           |   |  | 748  |   |  | 1,632 |   |  | 210  |  
|                                             |  |               |   |  |      |   |  |       |   |  |      |  



|(d) | Operating profit before net investment income is arrived at after charging:
|--- | ---------------------------------------------------------------------------



|                                                                                                                                                                                                                                                    |  |               |  |      |  |      |  |     
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- |  | ---- |  | ---- |  | ----
|                                                                                                                                                                                                                                                    |  | 2002          |  | 2003 |  | 2004 |  | 2004
|                                                                                                                                                                                                                                                    |  | HK$           |  | HK$  |  | HK$  |  | US$ 
|                                                                                                                                                                                                                                                    |  | (in millions)
|Fixed assets written off on disposal                                                                                                                                                                                                                |  | 27            |  | 9    |  | 24   |  | 3   
|Auditors remuneration                                                                                                                                                                                                                              |  |               |  |      |  |      |  |     
|- Audit services                                                                                                                                                                                                                                    |  | 3             |  | 4    |  | 4    |  | 1   
|- Tax compliance services                                                                                                                                                                                                                           |  | 1             |  | 1    |  | 1    |  |    
|- Other services (2003: net of HK$5 million (US$1 million) and 2002: HK$ nil deferred)                                                                                                                                                              |  | 1             |  |     |  |     |  |    
|Operating lease charges (minimum lease payments)                                                                                                                                                                                                    |  |               |  |      |  |      |  |     
|- Hire of plant and machinery                                                                                                                                                                                                                       |  | 18            |  | 21   |  | 29   |  | 4   
|- Rental of property                                                                                                                                                                                                                                |  | 11            |  | 14   |  | 13   |  | 2   
|Remuneration of Members of the Managing Board and Executive Directors who are not Members of the Managing Board                                                                                                                                     |  | 38            |  | 42   |  | 36   |  | 5   
|                                                                                                                                                                                                                                                    |  |               |  |      |  |      |  |     
|and after crediting:                                                                                                                                                                                                                                |  |               |  |      |  |      |  |     
|Rentals receivable from operating leases less direct outgoings of HK$17 million (US$2 million) (2003: HK$13 million; 2002: HK$12 million)
(including contingent rentals of HK$29 million (US$4 million) (2003: HK$20 million; 2002: HK$26 million)) |  | 449           |  | 449  |  | 499  |  | 64  
|Rentals receivable from investment properties less direct outgoings of HK$18 million (US$2 million) (2003: HK$16 million; 2002: HK$21
million)                                                                                                      |  | 71            |  | 68   |  | 62   |  | 8   
|                                                                                                                                                                                                                                                    |  |               |  |      |  |      |  |     



F-19



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|4 | Revenue, operating costs and operating profit before net finance income/(expenses)(continued)
|- | ---------------------------------------------------------------------------------------------



|(e) | Fees for Members of the Managing Board including the Chairman but excluding the Chief Executive Officer are shown below:
|--- | ------------------------------------------------------------------------------------------------------------------------



|                                                                                         |  |                |  |       |  |     
|---------------------------------------------------------------------------------------- |  | -------------- |  | ----- |  | ----
|                                                                                         |  | 2003           |  | 2004  |  | 2004
|                                                                                         |  | HK$            |  | HK$   |  | US$ 
|                                                                                         |  | (in thousands)
|Chairman                                                                                 |  |                |  |       |  |     
|Mr Michael P S Tien                                                                      |  | 220            |  | 220   |  | 29  
|                                                                                         |  |                | 
|Members                                                                                  |  |                |  |       |  |     
|Mr Vincent H C Cheng *                                                                   |  | 110            |  | 96    |  | 12  
|Mr Edmund T C Lau **                                                                     |  | 4              |  |      |  |    
|Dr Sarah S T Liao in the capacity of Secretary for the Environment, Transport and Works  |  | 110            |  | 110   |  | 14  
|Mr Vincent W S Lo                                                                        |  | 110            |  | 110   |  | 14  
|Mr Frederick S H Ma in the capacity of Secretary for Financial Services and the Treasury |  | 110            |  | 110   |  | 14  
|Mr L S Ng ***                                                                            |  |               |  | 14    |  | 2   
|Mr Patrick B Paul                                                                        |  | 110            |  | 110   |  | 14  
|The Honourable Abraham L H Shek ****                                                     |  |               |  | 101   |  | 13  
|Mr Victor H W So #                                                                       |  | 106            |  | 9     |  | 1   
|Mr M Y Wan                                                                               |  | 110            |  | 110   |  | 14  
|Mr Patrick S C Wang ##                                                                   |  | 110            |  | 9     |  | 1   
|Professor Richard Y C Wong ##                                                            |  |               |  | 101   |  | 13  
|                                                                                         |  |                |  |       |  |     
|                                                                                         |  | 1,100          |  | 1,100 |  | 141 
|                                                                                         |  |                |  |       |  |     

---

|* | Mr Vincent H C Cheng resigned on November 15, 2004.
|- | ---------------------------------------------------

|** | Mr Edmund T C Lau resigned on January 14, 2003.
|-- | -----------------------------------------------

|*** | Mr L S Ng was appointed on November 16, 2004.
|--- | ---------------------------------------------

|**** | The Honourable Abraham L H Shek was appointed on February 1, 2004.
|---- | ------------------------------------------------------------------

|# | Mr Victor H W So resigned on January 31, 2004.
|- | ----------------------------------------------

|## | Mr Patrick S C Wang resigned on January 31, 2004.
|-- | -------------------------------------------------

|### | Professor Richard Y C Wong was appointed on February 1, 2004.
|--- | -------------------------------------------------------------



F-20



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|4 | Revenue, operating costs and operating profit before net finance income/(expenses) (continued)
|- | ----------------------------------------------------------------------------------------------



|(f) | Emoluments of the Chief Executive Officer and Executive Directors who are not Members of the Managing Board include salaries, retirement benefit scheme contributions, allowances,
benefits-in-kind and accruals for gratuities and annual leave entitlements. Details are shown below:
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                                         |  |                                                                                           |  |                      |  |       |  |                                                                                                  
|-------------------------------------------------------- |  | ----------------------------------------------------------------------------------------- |  | -------------------- |  | ----- |  | -------------------------------------------------------------------------------------------------
|                                                         |  | 2004 HK$ million                                                                          |  | 2003 HK$ million    
|                                                         |  | Base pay,allowances,retirementbenefit schemecontributions,gratuities
and benefits-in-kind |  | Variableremuneration |  | Total |  | Base pay, allowances, retirement benefit schemecontributions,gratuities and benefits-in-kindtotal
|Mr Samuel M H Lai * (Acting Chief Executive Officer)     |  | 4.89                                                                                      |  | 0.51                 |  | 5.40  |  | 5.11                                                                                             
|Mr K K Lee * (Senior Director-Capital Projects)          |  | 3.83                                                                                      |  | 0.40                 |  | 4.23  |  | 4.16                                                                                             
|Mr Y T Li * (Senior Director-Transport)                  |  | 3.91                                                                                      |  | 0.37                 |  | 4.28  |  | 3.81                                                                                             
|Mr Ian M Thoms * (Director-West Rail)                    |  | 3.49                                                                                      |  | 0.39                 |  | 3.88  |  | 4.05                                                                                             
|Mr Daniel C Lam * (Director-Property)                    |  | 3.72                                                                                      |  | 0.41                 |  | 4.13  |  | 4.10                                                                                             
|Mr Lawrence C P Li ** (Director-Finance)                 |  | 2.80                                                                                      |  |                     |  | 2.80  |  |                                                                                                 
|Mrs Mimi Cunningham * @ (Director-Human Resource)        |  | 2.18                                                                                      |  | 0.38                 |  | 2.56  |  |                                                                                                 
|Mr K Y Yeung # (Chief Executive Officer)                 |  |                                                                                          |  |                     |  |      |  | 6.47                                                                                             
|Mr James Blake # (Senior Director-Capital Projects)      |  |                                                                                          |  |                     |  |      |  | 5.27                                                                                             
|Mr Jonathan H G Yu ## (Director-Operations)              |  | 6.12                                                                                      |  |                     |  | 6.12  |  | 4.00                                                                                             
|Mr Kenneth K S Leung ### (Director-New Railway Projects) |  | 2.03                                                                                      |  |                     |  | 2.03  |  | 3.96                                                                                             
|                                                         |  |                                                                                           |  |                      |  |       |  |                                                                                                  
|                                                         |  | 32.97                                                                                     |  | 2.46                 |  | 35.43 |  | 40.93                                                                                            
|                                                         |  |                                                                                           |  |                      |  |       |  |                                                                                                  

---

|* | Effective from July 1, 2004, a portion of total remuneration was converted to variable remuneration related to performance. The 2004 emoluments of individual Executive Director were
higher or lower than those of 2003 mainly due to the variable remuneration, a general 0.2% increase in remuneration, an additional special allowance for acting responsibility applicable to some Executive Directors and an increase or a decrease in
accruals for annual leave.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|** | Mr Lawrence C P Li assumed his post with effect from January 2004.
|-- | ------------------------------------------------------------------

|@ | Mrs Mimi Cunningham assumed her post with effect from May 2004.
|- | ---------------------------------------------------------------

|# | Mr K Y Yeung and Mr James Blake retired on January 1, 2004.
|- | -----------------------------------------------------------

|## | Mr Jonathan H G Yus remuneration includes a contractual payment totaling $1.2 million and an end-of-service payment of $0.9 million. He left the Corporation on January 3,
2005.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|### | Mr Kenneth K S Leung retired on July 1, 2004.
|--- | ---------------------------------------------



The above includes the remuneration of the five highest paid employees.



F-21



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|5 | Net finance income / (expenses)
|- | -------------------------------



|                                                                       |  |               |   |  |        |   |  |        |   |  |      |  
|---------------------------------------------------------------------- |  | ------------- | - |  | ------ | - |  | ------ | - |  | ---- | -
|                                                                       |  | 2002          |   |  | 2003   |   |  | 2004   |   |  | 2004 |  
|                                                                       |  | HK$           |   |  | HK$    |   |  | HK$    |   |  | US$  |  
|                                                                       |  | (in millions) |  
|Investment income                                                      |  |               |   |  |        |   |  |        |   |  |      |  
|Interest income from deposits with banks                               |  | 91            |   |  | 50     |   |  | 48     |   |  | 6    |  
|Interest income from investments                                       |  | 1,301         |   |  | 510    |   |  | 166    |   |  | 21   |  
|Interest income on loan receivable                                     |  |              |   |  | 3      |   |  | 53     |   |  | 7    |  
|Interest income from loan to subsidiary                                |  | 139           |   |  | 211    |   |  | 241    |   |  | 31   |  
|Interest income on other receivables                                   |  | 148           |   |  |       |   |  |       |   |  |     |  
|Net income from derivative financial instruments                       |  |              |   |  | 143    |   |  | 95     |   |  | 12   |  
|Net exchange gain                                                      |  |              |   |  |       |   |  | 15     |   |  | 2    |  
|Net realized loss on redemption and disposal of non-trading securities |  | (55           | ) |  | (60    | ) |  | (67    | ) |  | (8   | )
|                                                                       |  |               |   |  |        |   |  |        |   |  |      |  
|                                                                       |  | 1,624         |   |  | 857    |   |  | 551    |   |  | 71   |  
|* Less: Amount capitalized                                             |  | (975          | ) |  | (435   | ) |  | (173   | ) |  | (22  | )
|                                                                       |  |               |   |  |        |   |  |        |   |  |      |  
|                                                                       |  | 649           |   |  | 422    |   |  | 378    |   |  | 49   |  
|                                                                       |  |               |   |  |        |   |  |        |   |  |      |  
|Borrowing costs                                                        |  |               |   |  |        |   |  |        |   |  |      |  
|Interest expense on lease payable                                      |  |              |   |  | 3      |   |  | 52     |   |  | 7    |  
|Interest expenses on other loans                                       |  | 1,279         |   |  | 1,355  |   |  | 1,384  |   |  | 178  |  
|Net expenses from derivative instruments                               |  | (90           | ) |  |       |   |  |       |   |  |     |  
|Other borrowing costs                                                  |  | 17            |   |  | 37     |   |  | 20     |   |  | 3    |  
|Net exchange loss                                                      |  | 3             |   |  | 28     |   |  |       |   |  |     |  
|                                                                       |  |               |   |  |        |   |  |        |   |  |      |  
|                                                                       |  | 1,209         |   |  | 1,423  |   |  | 1,456  |   |  | 188  |  
|# Less: Amount capitalized                                             |  | (1,178        | ) |  | (1,354 | ) |  | (1,037 | ) |  | (134 | )
|                                                                       |  |               |   |  |        |   |  |        |   |  |      |  
|                                                                       |  | 31            |   |  | 69     |   |  | 419    |   |  | 54   |  
|                                                                       |  |               |   |  |        |   |  |        |   |  |      |  
|Net finance income / (expenses)                                        |  | 618           |   |  | 353    |   |  | (41    | ) |  | (5   | )
|                                                                       |  |               |   |  |        |   |  |        |   |  |      |  

---

|* | Interest income capitalized was earned at rates ranging between 1.37% (2003: 2.20%) and 2.54% (2003: 4.04%) per annum.
|- | ----------------------------------------------------------------------------------------------------------------------

|# | Interest expenses capitalized were charged at rates ranging between 6.02% (2003: 6.10%) and 6.88% (2003: 6.75%) per annum.
|- | --------------------------------------------------------------------------------------------------------------------------



|6 | Income tax
|- | ----------



|(a) | Income tax in the consolidated income statement represents:
|--- | -----------------------------------------------------------



|                                                                                                                          |  |               |  |      |  |      |  |     
|------------------------------------------------------------------------------------------------------------------------- |  | ------------- |  | ---- |  | ---- |  | ----
|                                                                                                                          |  | 2002          |  | 2003 |  | 2004 |  | 2004
|                                                                                                                          |  | HK$           |  | HK$  |  | HK$  |  | US$ 
|                                                                                                                          |  | (in millions)
|Current tax                                                                                                               |  |               |  |      |  |      |  |     
|Provision for Hong Kong profits tax at 17.5% (2003: 17.5% and 2002: 16%) of the estimated assessable profits for the year |  | 1             |  | 1    |  | 1    |  |    
|                                                                                                                          |  |               |  |      |  |      |  |     
|Deferred tax                                                                                                              |  |               |  |      |  |      |  |     
|Origination and reversal of temporary differences                                                                         |  | 451           |  | 283  |  | 81   |  | 11  
|Effect of increase in tax rate on deferred tax balances at January, 1                                                     |  |              |  | 244  |  |     |  |    
|                                                                                                                          |  |               |  |      |  |      |  |     
|                                                                                                                          |  | 451           |  | 527  |  | 81   |  | 11  
|                                                                                                                          |  |               |  |      |  |      |  |     
|Share of associates deferred tax                                                                                         |  |              |  | 1    |  | 1    |  |    
|                                                                                                                          |  |               |  |      |  |      |  |     
|                                                                                                                          |  | 452           |  | 529  |  | 83   |  | 11  
|                                                                                                                          |  |               |  |      |  |      |  |     



In March 2003, the
Government announced an increase in the Hong Kong profits tax rate from 16% to 17.5%. This increase is taken into account in the preparation of the Groups 2003 financial statements. Accordingly, the provision for Hong Kong profits tax for 2003
is calculated at 17.5% (2002: 16%) of the estimated assessable profits for the year.



F-22



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|6 | Income tax (continued)
|- | ----------------------



The provision for Hong Kong profits tax is all in respect of the estimated assessable profits for the year of the subsidiaries of the Corporation. The
Corporation sustained a loss for tax purposes during the year and has accumulated tax losses carried forward of approximately HK$7,100 million (US$914 million) at December 31, 2004 (2003: approximately HK$3,800 million; 2002: HK$2,600 million) which
are available to set off against future assessable profits.



|(b) | Reconciliation between tax expense and accounting profit at applicable tax rates:
|--- | ---------------------------------------------------------------------------------



|                                                                                               |  |               |  |       |   |  |      |   |  |      |  
|---------------------------------------------------------------------------------------------- |  | ------------- |  | ----- | - |  | ---- | - |  | ---- | -
|                                                                                               |  | 2002          |  | 2003  |   |  | 2004 |   |  | 2004 |  
|                                                                                               |  | HK$           |  | HK$   |   |  | HK$  |   |  | US$  |  
|                                                                                               |  | (in millions) | 
|Profit before taxation                                                                         |  | 2,662         |  | 1,910 |   |  | 512  |   |  | 66   |  
|                                                                                               |  |               |  |       |   |  |      |   |  |      |  
|Tax on accounting profit before tax                                                            |  | 426           |  | 334   |   |  | 90   |   |  | 12   |  
|Tax effect of non-deductible expenses                                                          |  | 13            |  | (39   | ) |  | 30   |   |  | 4    |  
|Tax effect of non-taxable revenue                                                              |  | 13            |  | (10   | ) |  | (37  | ) |  | (5   | )
|Effect on opening deferred tax balances resulting from an increase in tax rate during the year |  |              |  | 244   |   |  |     |   |  |     |  
|                                                                                               |  |               |  |       |   |  |      |   |  |      |  
|Actual tax expense                                                                             |  | 452           |  | 529   |   |  | 83   |   |  | 11   |  
|                                                                                               |  |               |  |       |   |  |      |   |  |      |  



|(c) | Current tax in the balance sheet represents:
|--- | --------------------------------------------



|                                                 |  |               |   |  |      |   |  |     
|------------------------------------------------ |  | ------------- | - |  | ---- | - |  | ----
|                                                 |  | 2003          |   |  | 2004 |   |  | 2004
|                                                 |  | HK$           |   |  | HK$  |   |  | US$ 
|                                                 |  | (in millions)
|Provision for Hong Kong profits tax for the year |  | 1             |   |  | 1    |   |  |    
|Provisional profits tax paid                     |  | (1            | ) |  | (1   | ) |  |    
|                                                 |  |               |   |  |      |   |  |     
|                                                 |  |              |   |  |     |   |  |    
|                                                 |  |               |   |  |      |   |  |     



|(d) | Deferred tax assets and liabilities of the Group recognized:
|--- | ------------------------------------------------------------



The components of deferred tax (assets) / liabilities of the Group recognized in the Groups balance sheet and the movements during the year are as
follows:



|                                                          |  |                              |   |  |                                                           |  |       |  |      
|--------------------------------------------------------- |  | ---------------------------- | - |  | --------------------------------------------------------- |  | ----- |  | -----
|                                                          |  | Future benefit of tax losses |   |  | Depreciationallowances inexcess of therelateddepreciation |  | Total |  | Total
|                                                          |  | HK$                          |   |  | HK$                                                       |  | HK$   |  | US$  
|                                                          |  | (in millions)               
|At January 1, 2003                                        |  | (412                         | ) |  | 3,016                                                     |  | 2,604 |  | 335  
|                                                          |  |                              |   | 
|Charged / (credited) to the consolidated income statement |  | (253                         | ) |  | 780                                                       |  | 527   |  | 68   
|                                                          |  |                              |   |  |                                                           |  |       |  |      
|At December 31, 2003                                      |  | (665                         | ) |  | 3,796                                                     |  | 3,131 |  | 403  
|                                                          |  |                              |   |  |                                                           |  |       |  |      
|At January 1, 2004                                        |  | (665                         | ) |  | 3,796                                                     |  | 3,131 |  | 403  
|                                                          |  |                              |   | 
|Charged / (credited) to the consolidated income statement |  | (585                         | ) |  | 666                                                       |  | 81    |  | 10   
|                                                          |  |                              |   |  |                                                           |  |       |  |      
|At December 31, 2004                                      |  | (1,250                       | ) |  | 4,462                                                     |  | 3,212 |  | 413  
|                                                          |  |                              |   |  |                                                           |  |       |  |      



F-23



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|6 | Income tax (continued)
|- | ----------------------



|                                                                        |  |               |   |  |        |   |  |      |  
|----------------------------------------------------------------------- |  | ------------- | - |  | ------ | - |  | ---- | -
|                                                                        |  | 2003          |   |  | 2004   |   |  | 2004 |  
|                                                                        |  | HK$           |   |  | HK$    |   |  | US$  |  
|                                                                        |  | (in millions) |  
|Deferred tax assets likely to be recovered after more than 12 months    |  | (665          | ) |  | (1,250 | ) |  | (161 | )
|Deferred tax liabilities likely to be settled after more than 12 months |  | 3,796         |   |  | 4,462  |   |  | 574  |  
|                                                                        |  |               |   |  |        |   |  |      |  
|                                                                        |  | 3,131         |   |  | 3,212  |   |  | 413  |  
|                                                                        |  |               |   |  |        |   |  |      |  



|7 | Profit after taxation
|- | ---------------------



Of the consolidated profit after taxation, HK$418 million (US$54 million) (2003: HK$1,376 million; 2002: HK$2,193 million) has been dealt with in the
financial statements of the Corporation.



|8 | Proposed dividend
|- | -----------------



|    |  |                                                                                                                               |  |               |  |      |  |      |  |     
|--- |  | ----------------------------------------------------------------------------------------------------------------------------- |  | ------------- |  | ---- |  | ---- |  | ----
|    |  |                                                                                                                               |  | 2002          |  | 2003 |  | 2004 |  | 2004
|    |  |                                                                                                                               |  | HK$           |  | HK$  |  | HK$  |  | US$ 
|    |  |                                                                                                                               |  | (in millions)
|(a) |  | Dividends attributable to the year:                                                                                           |  |               |  |      |  |      |  |     
|    |  | Final dividend proposed after the balance sheet date of HK$439.67 (US$56.57) per share (2003 and 2002: HK$1,584.87 per share) |  | 620           |  | 620  |  | 172  |  | 22  
|    |  |                                                                                                                               |  |               |  |      |  |      |  |     



The final dividend
proposed after the balance sheet date has not been recognized as a liability at the balance sheet date, but has been included in the balance sheet as a separate component of equity.



|    |  |                                                                                                                                                                                             |  |               |  |      |  |      |  |     
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- |  | ---- |  | ---- |  | ----
|    |  |                                                                                                                                                                                             |  | 2002          |  | 2003 |  | 2004 |  | 2004
|    |  |                                                                                                                                                                                             |  | HK$           |  | HK$  |  | HK$  |  | US$ 
|    |  |                                                                                                                                                                                             |  | (in millions)
|(b) |  | Dividends attributable to the previous financial year, approved and paid during the year:                                                                                                   |  |               |  |      |  |      |  |     
|    |  | Final dividend in respect of the previous financial year, approved and paid during the year, of HK$1,584.87 (US$203.91) per share (2003: HK$1,584.87 per share and 2002: HK$ nil per
share) |  |              |  | 620  |  | 620  |  | 79  
|    |  |                                                                                                                                                                                             |  |               |  |      |  |      |  |     



|9 | Segmental reporting
|- | -------------------



Business segment information is chosen as the primary reporting format because this is more relevant to the Groups internal financial reporting.
According to SSAP 26 (Segment reporting), a business segment is a distinguishable component of an enterprise that is engaged for providing an individual product or service and is subject to risks and returns different from other business segments.
In determining the nature of risks and returns, SSAP 26 states that an enterprises internal organisational and management structure and its system of internal financial reporting form the basis for identifying the predominant source and nature
of risks and returns facing the enterprise.



In December 2003,
East Rail Division and West Rail/Light Rail Division were combined to form a single Transport Division to allow management more flexibility in the deployment of resources and enable the Corporation to achieve synergy and savings, particularly for
those services common to both railway networks, such as maintenance. The Transport Division manages all the transport services including East Rail, Light Rail, West Rail and Freight. Since December 2003, most of the costs are common to various
railway services including East Rail, Light Rail, West Rail and Freight.



F-24



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|9 | Segmental reporting (continued)
|- | -------------------------------



Consistent with the internal organizational and management structure of the Corporation, a transport services segment has been created in place of East
Rail, Light Rail, West Rail and Freight and the figures for 2003 have been restated for comparison purposes.



No geographical segment information is shown as virtually all of the turnover and operating profit is derived from activities in Hong Kong.



2004

Operating results



|                                                |  |                   |   |  |          |   |  |                    |   |  |       |  
|----------------------------------------------- |  | ----------------- | - |  | -------- | - |  | ------------------ | - |  | ----- | -
|                                                |  | TransportServices |   |  | Property |   |  | Consolidated Total |   |  | Total |  
|                                                |  | HK$               |   |  | HK$      |   |  | HK$                |   |  | US$   |  
|                                                |  | (in millions)     |  
|Revenue                                         |  | 4,281             |   |  | 695      |   |  | 4,976              |   |  | 640   |  
|Segment operating costs before depreciation     |  | (2,450            | ) |  | (128     | ) |  | (2,578             | ) |  | (332  | )
|Inter-segment charges (1)                       |  | 35                |   |  | (35      | ) |  |                   |   |  |      |  
|                                                |  |                   |   |  |          |   |  |                    |   |  |       |  
|Segment result before depreciation              |  | 1,866             |   |  | 532      |   |  | 2,398              |   |  | 308   |  
|Depreciation                                    |  | (1,581            | ) |  | (29      | ) |  | (1,610             | ) |  | (207  | )
|                                                |  |                   |   |  |          |   |  |                    |   |  |       |  
|Segment result                                  |  | 285               |   |  | 503      |   |  | 788                |   |  | 101   |  
|                                                |  |                   |   |  |          |   |  |                    |   |  |       |  
|Unallocated corporate expenses and depreciation |  |                   |   |  |          |   |  | (251               | ) |  | (32   | )
|                                                |  |                   |   |  |          |   |  |                    |   |  |       |  
|Operating profit before net finance expenses    |  |                   |   |  |          |   |  | 537                |   |  | 69    |  
|Net finance expenses                            |  |                   |   |  |          |   |  | (41                | ) |  | (5    | )
|Share of profit of associate                    |  |                   |   |  |          |   |  | 16                 |   |  | 2     |  
|Income tax                                      |  |                   |   |  |          |   |  | (83                | ) |  | (11   | )
|                                                |  |                   |   |  |          |   |  |                    |   |  |       |  
|Profit after taxation                           |  |                   |   |  |          |   |  | 429                |   |  | 55    |  
|                                                |  |                   |   |  |          |   |  |                    |   |  |       |  

---

|(1) | Inter-segment charges represent cost recoveries from other segments for services rendered.
|--- | ------------------------------------------------------------------------------------------



Assets and liabilities



|                              |  |                   |  |          |  |                    |  |       
|----------------------------- |  | ----------------- |  | -------- |  | ------------------ |  | ------
|                              |  | TransportServices |  | Property |  | Consolidated Total |  | Total 
|                              |  | HK$               |  | HK$      |  | HK$                |  | US$   
|                              |  | (in millions)    
|Segment assets                |  | 66,576            |  | 1,682    |  | 68,258             |  | 8,782 
|Properties under development  |  |                  |  | 1,892    |  | 1,892              |  | 244   
|Interest in associate         |  |                  |  |         |  | 57                 |  | 7     
|Railways under construction @ |  |                  |  |         |  | 7,981              |  | 1,027 
|Unallocated assets #          |  |                  |  |         |  | 13,244             |  | 1,704 
|                              |  |                   |  |          |  |                    |  |       
|                              |  | 66,576            |  | 3,574    |  | 91,432             |  | 11,764
|                              |  |                   |  |          |  |                    |  |       
|Segment liabilities           |  | 367               |  | 636      |  | 1,003              |  | 129   
|Deferred income               |  | 584               |  | 124      |  | 708                |  | 91    
|Unallocated liabilities *     |  |                  |  |         |  | 29,574             |  | 3,805 
|                              |  |                   |  |          |  |                    |  |       
|                              |  | 951               |  | 760      |  | 31,285             |  | 4,025 
|                              |  |                   |  |          |  |                    |  |       

---

|@ | Comprising construction costs of Lok Ma Chau (HK$6,519 million (US$839 million)) and planning and design costs of Sha Tin to Central Link, Kowloon Southern Link and Northern Link
(HK$1,462 million (US$188 million)).
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|# | Comprising construction in progress for Corporate (HK$46 million (US$6 million)), Corporate assets (HK$363 million (US$47 million)), investments (HK$4,323 million (US$556 million)),
loan receivable (HK$733 million (US$95 million)), loan to subsidiary (HK$3,576 million (US$460 million)), interest receivable (HK$49 million (US$6 million)), other receivables (HK$623 million (US$80 million)) and cash and cash equivalents (HK$3,531
million (US$454 million)).
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|* | Comprising interest-bearing borrowings (HK$19,748 million (US$2,541 million)), interest payable (HK$485 million (US$62 million)), accrued charges and provisions for capital projects
(HK$3,875 million (US$499 million)), lease payable (HK$717 million (US$92 million)), other payables (HK$1,537 million (US$198 million)) and deferred tax liabilities ($3,212 million (US$413 million)).
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-25



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|9 | Segmental reporting (continued)
|- | -------------------------------



Other information



|                                  |  |                   |  |          |  |                    |  |      
|--------------------------------- |  | ----------------- |  | -------- |  | ------------------ |  | -----
|                                  |  | TransportServices |  | Property |  | Consolidated Total |  | Total
|                                  |  | HK$               |  | HK$      |  | HK$                |  | US$  
|                                  |  | (in millions)    
|Capital expenditure               |  |                   |  |          |  |                    |  |      
| Existing businesses             |  | 6,675             |  | 61       |  | 6,736              |  | 867  
| Railways under construction     |  |                  |  |         |  | 2,278              |  | 293  
| Unallocated capital expenditure |  |                  |  |         |  | 8                  |  | 1    
|                                  |  |                   |  |          |  |                    |  |      
|                                  |  | 6,675             |  | 61       |  | 9,022              |  | 1,161
|                                  |  |                   |  |          |  |                    |  |      



2003

Operating results



|                                                                                                  |  |                   |   |  |          |   |  |                    |  
|------------------------------------------------------------------------------------------------- |  | ----------------- | - |  | -------- | - |  | ------------------ | -
|                                                                                                  |  | TransportServices |   |  | Property |   |  | Consolidated Total |  
|                                                                                                  |  | HK$               |   |  | HK$      |   |  | HK$                |  
|                                                                                                  |  | (in millions)     |  
|Revenue                                                                                           |  | 3,819             |   |  | 607      |   |  | 4,426              |  
|Segment operating costs before depreciation                                                       |  | (1,779            | ) |  | (121     | ) |  | (1,900             | )
|Inter-segment charges (1)                                                                         |  | 21                |   |  | (21      | ) |  |                   |  
|                                                                                                  |  |                   |   |  |          |   |  |                    |  
|Segment result before depreciation                                                                |  | 2,061             |   |  | 465      |   |  | 2,526              |  
|Depreciation                                                                                      |  | (698              | ) |  | (24      | ) |  | (722               | )
|                                                                                                  |  |                   |   |  |          |   |  |                    |  
|Segment result                                                                                    |  | 1,363             |   |  | 441      |   |  | 1,804              |  
|                                                                                                  |  |                   |   |  |          |   |  |                    |  
|Unallocated corporate expenses and depreciation                                                   |  |                   |   |  |          |   |  | (255               | )
|                                                                                                  |  |                   |   |  |          |   |  |                    |  
|Operating profit before net finance income                                                        |  |                   |   |  |          |   |  | 1,549              |  
|Net finance income                                                                                |  |                   |   |  |          |   |  | 353                |  
|Share of profit of associate                                                                      |  |                   |   |  |          |   |  | 8                  |  
|Income tax                                                                                        |  |                   |   |  |          |   |  | (529               | )
|                                                                                                  |  |                   |   |  |          |   |  |                    |  
|Profit after taxation                                                                             |  |                   |   |  |          |   |  | 1,381              |  
|                                                                                                  |  |                   |   |  |          |   |  |                    |  
|                                                                                                  |  |                   |   |  |          |   |  |                    |  
|(1)    Inter-segment charges represent cost recoveries from other segments for services
rendered. | 
|                                                                                                  |  |                   |  
|Assets and liabilities                                                                            |  |                   |   |  |          |   |  |                    |  
|                                                                                                  |  |                   |  
|                                                                                                  |  | TransportServices |   |  | Property |   |  | Consolidated Total |  
|                                                                                                  |  | HK$               |   |  | HK$      |   |  | HK$                |  
|                                                                                                  |  | (in millions)     |  
|Segment assets                                                                                    |  | 51,279            |   |  | 1,462    |   |  | 52,741             |  
|Properties under development                                                                      |  |                  |   |  | 1,448    |   |  | 1,448              |  
|Interest in associate                                                                             |  |                  |   |  |         |   |  | 42                 |  
|Railways under construction @                                                                     |  |                  |   |  |         |   |  | 14,991             |  
|Unallocated assets #                                                                              |  |                  |   |  |         |   |  | 19,982             |  
|                                                                                                  |  |                   |   |  |          |   |  |                    |  
|                                                                                                  |  | 51,279            |   |  | 2,910    |   |  | 89,204             |  
|                                                                                                  |  |                   |   |  |          |   |  |                    |  
|Segment liabilities                                                                               |  | 1,499             |   |  | 529      |   |  | 2,028              |  
|Deferred income                                                                                   |  | 629               |   |  | 114      |   |  | 743                |  
|Unallocated liabilities *                                                                         |  |                  |   |  |         |   |  | 26,228             |  
|                                                                                                  |  |                   |   |  |          |   |  |                    |  
|                                                                                                  |  | 2,128             |   |  | 643      |   |  | 28,999             |  
|                                                                                                  |  |                   |   |  |          |   |  |                    |  

---

|@ | Comprising construction costs of East Rail Extensions (HK$14,091 million) and planning and design costs of the Sha Tin to Central Link and Kowloon Southern Link (HK$900 million).
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|# | Comprising construction in progress for Corporate (HK$12 million), Corporate assets (HK$471 million), investments (HK$12,244 million), loan receivable (HK$774 million), loan to
subsidiary (HK$3,232 million), interest receivable (HK$63 million), other receivables (HK$509 million) and cash and cash equivalents (HK$2,677 million).
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|* | Comprising interest-bearing borrowings (HK$20,013 million), interest payable (HK$474 million), accrued charges and provisions for capital projects (HK$896 million), lease payable
(HK$758 million), other payables (HK$956 million) and deferred tax liabilities (HK$3,131 million).
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-26



---

##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|9 | Segmental reporting (continued)
|- | -------------------------------



Other information



|                                                                                                  |  |                    |   |  |          |   |  |                    |  
|------------------------------------------------------------------------------------------------- |  | ------------------ | - |  | -------- | - |  | ------------------ | -
|                                                                                                  |  | Transport Services |   |  | Property |   |  | Consolidated Total |  
|                                                                                                  |  | HK$                |   |  | HK$      |   |  | HK$                |  
|                                                                                                  |  | (in millions)      |  
|Capital expenditure                                                                               |  |                    |   |  |          |   |  |                    |  
| Existing businesses                                                                             |  | 5,744              |   |  | 70       |   |  | 5,814              |  
| Railways under construction                                                                     |  |                   |   |  |         |   |  | 5,290              |  
| Unallocated capital expenditure                                                                 |  |                   |   |  |         |   |  | 18                 |  
|                                                                                                  |  |                    |   |  |          |   |  |                    |  
|                                                                                                  |  | 5,744              |   |  | 70       |   |  | 11,122             |  
|                                                                                                  |  |                    |   |  |          |   |  |                    |  
|                                                                                                  |  |                    |  
|2002                                                                                              |  |                    |   |  |          |   |  |                    |  
|Operating results                                                                                 |  |                    |   |  |          |   |  |                    |  
|                                                                                                  |  |                    |  
|                                                                                                  |  | Transport Services |   |  | Property |   |  | Consolidated Total |  
|                                                                                                  |  | HK$                |   |  | HK$      |   |  | HK$                |  
|                                                                                                  |  | (in millions)      |  
|Revenue                                                                                           |  | 4,213              |   |  | 617      |   |  | 4,830              |  
|Segment operating costs before depreciation                                                       |  | (1,807             | ) |  | (112     | ) |  | (1,919             | )
|Inter-segment charges (1)                                                                         |  | 22                 |   |  | (22      | ) |  |                   |  
|                                                                                                  |  |                    |   |  |          |   |  |                    |  
|Segment result before depreciation                                                                |  | 2,428              |   |  | 483      |   |  | 2,911              |  
|Depreciation                                                                                      |  | (671               | ) |  | (28      | ) |  | (699               | )
|                                                                                                  |  |                    |   |  |          |   |  |                    |  
|Segment result                                                                                    |  | 1,757              |   |  | 455      |   |  | 2,212              |  
|                                                                                                  |  |                    |   |  |          |   |  |                    |  
|Unallocated corporate expenses and depreciation                                                   |  |                    |   |  |          |   |  | (278               | )
|                                                                                                  |  |                    |   |  |          |   |  |                    |  
|Operating profit before net finance income                                                        |  |                    |   |  |          |   |  | 1,934              |  
|Net finance income                                                                                |  |                    |   |  |          |   |  | 618                |  
|Profit on property development                                                                    |  |                    |   |  |          |   |  | 94                 |  
|Share of profit of associate                                                                      |  |                    |   |  |          |   |  | 16                 |  
|Income tax                                                                                        |  |                    |   |  |          |   |  | (452               | )
|                                                                                                  |  |                    |   |  |          |   |  |                    |  
|Profit after taxation                                                                             |  |                    |   |  |          |   |  | 2,210              |  
|                                                                                                  |  |                    |   |  |          |   |  |                    |  
|                                                                                                  |  |                    |   |  |          |   |  |                    |  
|(1)    Inter-segment charges represent cost recoveries from other segments for services
rendered. | 
|                                                                                                  |  |                    |  
|Assets and liabilities                                                                            |  |                    |   |  |          |   |  |                    |  
|                                                                                                  |  |                    |  
|                                                                                                  |  | Transport Services |   |  | Property |   |  | Consolidated Total |  
|                                                                                                  |  | HK$                |   |  | HK$      |   |  | HK$                |  
|                                                                                                  |  | (in millions)      |  
|Segment assets                                                                                    |  | 45,855             |   |  | 1,427    |   |  | 47,282             |  
|Properties under development                                                                      |  |                   |   |  | 1,153    |   |  | 1,153              |  
|Interest in associate                                                                             |  |                   |   |  |         |   |  | 35                 |  
|Unallocated assets #                                                                              |  |                   |   |  |         |   |  | 37,638             |  
|                                                                                                  |  |                    |   |  |          |   |  |                    |  
|                                                                                                  |  | 45,855             |   |  | 2,580    |   |  | 86,108             |  
|                                                                                                  |  |                    |   |  |          |   |  |                    |  
|Segment liabilities                                                                               |  | 2,318              |   |  | 631      |   |  | 2,949              |  
|Deferred income                                                                                   |  | 330                |   |  | 104      |   |  | 434                |  
|Unallocated liabilities *                                                                         |  |                   |   |  |         |   |  | 23,213             |  
|                                                                                                  |  |                    |   |  |          |   |  |                    |  
|                                                                                                  |  | 2,648              |   |  | 735      |   |  | 26,596             |  
|                                                                                                  |  |                    |   |  |          |   |  |                    |  



F-27



---

##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|9 | Segmental reporting (continued)
|- | -------------------------------



|# | Comprising construction in progress for East Rail Extensions (HK$8,850 million) and Corporate (HK$15 million), deferred expenditure for other proposed railway projects (HK$156
million), Corporate assets (HK$468 million), investments in securities (HK$19,165 million), loan to subsidiary (HK$2,048 million), interest receivable (HK$299 million), other receivables (HK$1,109 million) and cash and cash equivalents (HK$5,528
million).
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|* | Comprising interest-bearing borrowings (HK$17,753 million), interest payable (HK$443 million), accrued charges and provisions for capital projects (HK$1,506 million), other payables
(HK$907 million) and deferred tax liabilities (HK$2,604 million).
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Other information



|                                  |  |                   |  |          |  |                   
|--------------------------------- |  | ----------------- |  | -------- |  | ------------------
|                                  |  | TransportServices |  | Property |  | Consolidated Total
|                                  |  | HK$               |  | HK$      |  | HK$               
|                                  |  | (in millions)    
|Capital expenditure               |  |                   |  |          |  |                   
| Existing businesses             |  | 7,798             |  | 63       |  | 7,861             
| Railways under construction     |  |                  |  |         |  | 4,318             
| Unallocated capital expenditure |  |                  |  |         |  | 129               
|                                  |  |                   |  |          |  |                   
|                                  |  | 7,798             |  | 63       |  | 12,308            
|                                  |  |                   |  |          |  |                   



|10 | Fixed assets
|-- | ------------



Fixed assets comprise:



|                                       |  |                       |  |                                  |   |  |                            |  |           |   |  |               |  |                 |   |  |        |   |  |       |  
|-------------------------------------- |  | --------------------- |  | -------------------------------- | - |  | -------------------------- |  | --------- | - |  | ------------- |  | --------------- | - |  | ------ | - |  | ----- | -
|                                       |  | Investment properties |  | Leasehold land and permanent way |   |  | Tunnels, bridges and roads |  | Buildings |   |  | Rolling stock |  | Other equipment |   |  | Total  |   |  | Total |  
|                                       |  | HK$                   |  | HK$                              |   |  | HK$                        |  | HK$       |   |  | HK$           |  | HK$             |   |  | HK$    |   |  | US$   |  
|                                       |  | (in millions)         | 
|Cost or valuation:                     |  |                       |  |                                  |   |  |                            |  |           |   |  |               |  |                 |   |  |        |   |  |       |  
|At January 1, 2004                     |  | 878                   |  | 9,540                            |   |  | 10,815                     |  | 20,297    |   |  | 8,055         |  | 8,997           |   |  | 58,582 |   |  | 7,537 |  
|Reclassification                       |  |                      |  | (2,326                           | ) |  | 2,121                      |  | 233       |   |  |              |  | (28             | ) |  |       |   |  |      |  
|Transfer from construction in progress |  |                      |  | 865                              |   |  | 3,471                      |  | 7,172     |   |  | 1,219         |  | 2,123           |   |  | 14,850 |   |  | 1,911 |  
|Additions                              |  |                      |  | 1,046                            |   |  | 299                        |  | 1,159     |   |  | 8             |  | 87              |   |  | 2,599  |   |  | 334   |  
|Disposals                              |  |                      |  | (7                               | ) |  |                           |  | (3        | ) |  |              |  | (90             | ) |  | (100   | ) |  | (13   | )
|Surplus on revaluation                 |  | 148                   |  |                                 |   |  |                           |  |          |   |  |              |  |                |   |  | 148    |   |  | 19    |  
|                                       |  |                       |  |                                  |   |  |                            |  |           |   |  |               |  |                 |   |  |        |   |  |       |  
|At December 31, 2004                   |  | 1,026                 |  | 9,118                            |   |  | 16,706                     |  | 28,858    |   |  | 9,282         |  | 11,089          |   |  | 76,079 |   |  | 9,788 |  
|                                       |  |                       |  |                                  |   |  |                            |  |           |   |  |               |  |                 |   |  |        |   |  |       |  
|Accumulated depreciation:              |  |                       |  |                                  |   |  |                            |  |           |   |  |               |  |                 |   |  |        |   |  |       |  
|At January 1, 2004                     |  |                      |  | 195                              |   |  | 90                         |  | 970       |   |  | 2,005         |  | 3,465           |   |  | 6,725  |   |  | 865   |  
|Reclassification                       |  |                      |  | (14                              | ) |  | 21                         |  |          |   |  |              |  | (7              | ) |  |       |   |  |      |  
|Charge for the year                    |  |                      |  | 141                              |   |  | 124                        |  | 448       |   |  | 239           |  | 686             |   |  | 1,638  |   |  | 211   |  
|Written back on disposal               |  |                      |  |                                 |   |  |                           |  | (1        | ) |  |              |  | (75             | ) |  | (76    | ) |  | (10   | )
|                                       |  |                       |  |                                  |   |  |                            |  |           |   |  |               |  |                 |   |  |        |   |  |       |  
|At December 31, 2004                   |  |                      |  | 322                              |   |  | 235                        |  | 1,417     |   |  | 2,244         |  | 4,069           |   |  | 8,287  |   |  | 1,066 |  
|                                       |  |                       |  |                                  |   |  |                            |  |           |   |  |               |  |                 |   |  |        |   |  |       |  
|Net book value:                        |  |                       |  |                                  |   |  |                            |  |           |   |  |               |  |                 |   |  |        |   |  |       |  
|At December 31, 2004                   |  | 1,026                 |  | 8,796                            |   |  | 16,471                     |  | 27,441    |   |  | 7,038         |  | 7,020           |   |  | 67,792 |   |  | 8,722 |  
|                                       |  |                       |  |                                  |   |  |                            |  |           |   |  |               |  |                 |   |  |        |   |  |       |  
|At December 31, 2003                   |  | 878                   |  | 9,345                            |   |  | 10,725                     |  | 19,327    |   |  | 6,050         |  | 5,532           |   |  | 51,857 |   |  | 6,672 |  
|                                       |  |                       |  |                                  |   |  |                            |  |           |   |  |               |  |                 |   |  |        |   |  |       |  



| | (a) | Permanent way principally comprises the initial costs of rail tracks and sleepers, a portion of the initial cost of ballast and subsequent expenditure on major ballast replacement
programs.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | Other equipment comprises lifts and escalators, telecommunication and signaling systems, machinery, furniture and fixtures, motor vehicles, computer and office equipment.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-28



---

##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|10 | Fixed assets (continued)
|-- | ------------------------



| | (c) | The Groups leasehold land with a net book value of HK$5,663 million (US$729 million) (2003: HK$4,449 million) and HK$28 million (US$4 million) (2003:HK$29 million) is held in
Hong Kong under medium term and long-term leases respectively.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) | The Group leases out investment properties and certain properties which are either used in or ancillary to the Groups rail business, under operating leases. The leases
typically run for an initial period of two to five years, with an option to renew the lease after that date at which time all terms are re-negotiated. The leases may include additional rentals based on sales revenue of the tenants in excess of the
basic rentals.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) | The Groups investment properties, held in Hong Kong under long-term leases, were valued at December 31, 2004 by an independent firm of surveyors, Knight Frank, which has among
its staff fellow and associate members of the Hong Kong Institute of Surveyors, on the basis of capitalization of the net income with due allowance for reversionary income potential. The revaluation surplus of HK$148 million (US$19 million) (2003:
deficit of HK$17 million) has been transferred to the investment property revaluation reserve (see note 31).
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (f) | Other than investment properties, included in fixed assets are assets held for use under operating leases with gross carrying amounts and related accumulated depreciation charges as
follows:
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                     |  |                     |  |                                |  |                     |  |                                |  |                     |  |                               
|------------------------------------ |  | ------------------- |  | ------------------------------ |  | ------------------- |  | ------------------------------ |  | ------------------- |  | ------------------------------
|                                     |  | Grosscarryingamount |  | Relatedaccumulateddepreciation |  | Grosscarryingamount |  | Relatedaccumulateddepreciation |  | Grosscarryingamount |  | Relatedaccumulateddepreciation
|                                     |  |                     |  | 2003                           |  |                     |  | 2004                           |  | 2004                |  | 2004                          
|                                     |  | HK$                 |  | HK$                            |  | HK$                 |  | HK$                            |  | US$                 |  | US$                           
|                                     |  | (in millions)      
|Goods yard at Hung Hom Bay           |  | 131                 |  | 12                             |  | 85                  |  | 9                              |  | 11                  |  | 1                             
|Hung Hom Station Car Park            |  | 55                  |  | 22                             |  | 55                  |  | 22                             |  | 7                   |  | 3                             
|Offices at Hung Hom Station          |  | 21                  |  | 5                              |  | 21                  |  | 6                              |  | 3                   |  | 1                             
|Offices at Hung Hom freight building |  | 8                   |  | 1                              |  | 6                   |  | 1                              |  | 1                   |  |                              
|Citylink Plaza at Sha Tin Station    |  | 104                 |  | 58                             |  | 104                 |  | 60                             |  | 13                  |  | 8                             
|Goods yard at Mongkok Station        |  | 45                  |  | 5                              |  | 45                  |  | 6                              |  | 6                   |  | 1                             
|Shops at stations                    |  | 545                 |  | 52                             |  | 672                 |  | 59                             |  | 87                  |  | 7                             
|Mobile phone coverage system         |  | 70                  |  | 31                             |  | 87                  |  | 37                             |  | 11                  |  | 5                             
|Trackside Villas                     |  | 19                  |  | 3                              |  | 19                  |  | 4                              |  | 2                   |  |                              
|                                     |  |                     |  |                                |  |                     |  |                                |  |                     |  |                               
|                                     |  | 998                 |  | 189                            |  | 1,094               |  | 204                            |  | 141                 |  | 26                            
|                                     |  |                     |  |                                |  |                     |  |                                |  |                     |  |                               



Although these
properties are leased to tenants, they are either used in or are ancillary to the Groups rail business and are not held for their investment potential and are, accordingly, not classified as investment properties.



F-29



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|10 | Fixed assets (continued)
|-- | ------------------------



| | (g) | The Groups total future minimum lease payments under non-cancellable operating leases are receivable as follows:
| | --- | -----------------------------------------------------------------------------------------------------------------



|                                |  |               |  |       |  |     
|------------------------------- |  | ------------- |  | ----- |  | ----
|                                |  | 2003          |  | 2004  |  | 2004
|                                |  | HK$           |  | HK$   |  | US$ 
|                                |  | (in millions)
|Within 1 year                   |  | 596           |  | 659   |  | 85  
|After 1 year but within 5 years |  | 1,171         |  | 914   |  | 118 
|After 5 years                   |  | 108           |  | 41    |  | 5   
|                                |  |               |  |       |  |     
|                                |  | 1,875         |  | 1,614 |  | 208 
|                                |  |               |  |       |  |     



| | (h) | The Group has entered into a number of individually structured transactions or arrangements with unrelated parties to lease out and lease back assets which include rolling stock,
signaling equipment, revenue collection equipment and railway infrastructure. Under each arrangement, the Group has leased the assets to an overseas investor, who has prepaid all the rentals in relation to a lease agreement. Simultaneously, the
Group has leased the assets back from the overseas investor and will pay the rentals on a semi-annual or annual basis in accordance with a pre-determined payment schedule. The Group has an option to purchase the overseas investors leasehold
interest in the assets at a pre-determined date for a fixed or agreed amount. Part of the rental prepayments received from the overseas investor has been placed in deposits or invested in debt securities, or loaned to an unrelated party, the
repayments of which will be sufficient to meet the Groups rental obligations and the amount payable for exercising the purchase option under the lease agreement. As long as the Group complies with the requirements of the lease agreements, the
Group will continue to be entitled to quiet enjoyment of and continued possession, use or operation of the assets. The arrangements have been entered with investors in the United States and the United Kingdom.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



As at December 31, 2004, a portion of the Groups assets with a total
original cost of HK$11,819 million (US$1,521 million) (2003: HK$11,836 million) and net book value of HK$7,913 million (US$1,018 million) (2003: HK$8,300 million) is covered by nine arrangements. Six arrangements involve rolling stock, with basic
lease terms of 15 to 28 years. Two arrangements, one involving signaling equipment and the other involving the revenue collection system, have a basic lease term of 15 years. The remaining arrangement involving railway infrastructure has basic lease
terms of between 24 years and 27 years. Since the Group retains the risks and rewards incident to ownership of the underlying assets in respect of each arrangement and enjoys substantially the same rights to their use as before the arrangements, no
adjustment has been made to fixed assets. As a result of the nine arrangements, the Group has received cash of HK$13,410 million (US$1,725 million) (2003: HK$13,410 million) and, assuming exercise of the purchase option in each arrangement, will be
obligated to make long-term lease payments with a total estimated net present value of HK$12,681 million (US$1,632 million) (2003: HK$12,681 million), which obligations are expected to be funded with the proceeds of existing deposits and investments
totalling HK$11,964 million (US$1,539 million) (2003: HK$11,923 million).



The total net amounts of cash received by the Group from the arrangements have been recorded as deferred income and are being amortized to the income statement over the applicable lease terms of the arrangements. The
total amount of HK$39 million (US$5 million) (2003: HK$23 million) recognized for the year has been included in turnover in the income statement.



| | (i) | Included in additions are amounts paid and payable to the Government by the Group in respect of the following:
| | --- | --------------------------------------------------------------------------------------------------------------



| | (i) | HK$9 million (US$1 million) (2003: HK$51 million) for the lease of land required for construction sites for the West Rail project. The land does not have a measurable value as it
cannot be assigned and can only be used by the Group and/or its contractors.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-30



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|10 | Fixed assets (continued)
|-- | ------------------------



| | (ii) | HK$37 million (US$5 million) (2003: HK$40 million) for land resumption work on the West Rail project undertaken by the Government on behalf of the Group.
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| | (iii) | HK$958 million (US$123 million) (2003: HK$181 million) for compensation in respect of resumed land in respect of the West Rail project paid and payable by the Government on behalf
of the Group. The Group is obligated to reimburse such sums to the Government.
| | ----- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|11 | Construction in progress
|-- | ------------------------



| | (a) | Construction in progress comprises:
| | --- | -----------------------------------



|                                 |  |                               |   |  |                                |   |  |                          |   |  |                                 |   |  |                                 |  
|-------------------------------- |  | ----------------------------- | - |  | ------------------------------ | - |  | ------------------------ | - |  | ------------------------------- | - |  | ------------------------------- | -
|                                 |  | Balance as at January 1, 2004 |   |  | Costs incurred during the year |   |  | Transfer to fixed assets |   |  | Balance as at December 31, 2004 |   |  | Balance as at December 31, 2004 |  
|                                 |  | HK$                           |   |  | HK$                            |   |  | HK$                      |   |  | HK$                             |   |  | US$                             |  
|                                 |  | (in millions)                 |  
|East Rail Extensions             |  |                               |   |  |                                |   |  |                          |   |  |                                 |   |  |                                 |  
|Building and other civil works   |  | 8,473                         |   |  | 2,507                          |   |  | (7,456                   | ) |  | 3,524                           |   |  | 454                             |  
|Rolling stock                    |  | 135                           |   |  | 821                            |   |  | (931                     | ) |  | 25                              |   |  | 3                               |  
|Plant and equipment              |  | 1,541                         |   |  | 967                            |   |  | (2,080                   | ) |  | 428                             |   |  | 55                              |  
|Consultants fee                 |  | 1,380                         |   |  | 255                            |   |  | (1,259                   | ) |  | 376                             |   |  | 48                              |  
|Land and related costs           |  | 715                           |   |  | 396                            |   |  | (509                     | ) |  | 602                             |   |  | 78                              |  
|Overheads                        |  |                               |   |  |                                |   |  |                          |   |  |                                 |   |  |                                 |  
|- Staff costs and other expenses |  | 1,366                         |   |  | 411                            |   |  | (1,289                   | ) |  | 488                             |   |  | 63                              |  
|- On-cost recovery               |  | (299                          | ) |  | (58                            | ) |  | 336                      |   |  | (21                             | ) |  | (3                              | )
|                                 |  |                               |   |  |                                |   |  |                          |   |  |                                 |   |  |                                 |  
|                                 |  | 13,311                        |   |  | 5,299                          |   |  | (13,188                  | ) |  | 5,422                           |   |  | 698                             |  
|Net finance expenses             |  | 780                           |   |  | 859                            |   |  | (542                     | ) |  | 1,097                           |   |  | 141                             |  
|                                 |  |                               |   |  |                                |   |  |                          |   |  |                                 |   |  |                                 |  
|                                 |  | 14,091                        |   |  | 6,158                          |   |  | (13,730                  | ) |  | 6,519                           |   |  | 839                             |  
|                                 |  |                               |   |  |                                |   |  |                          |   |  |                                 |   |  |                                 |  
|Other assets under construction  |  |                               |   |  |                                |   |  |                          |   |  |                                 |   |  |                                 |  
|Buildings and other civil works  |  | 463                           |   |  | 199                            |   |  | (523                     | ) |  | 139                             |   |  | 18                              |  
|Rolling stock                    |  | 161                           |   |  | 23                             |   |  | (181                     | ) |  | 3                               |   |  | 1                               |  
|Other equipment                  |  | 314                           |   |  | 230                            |   |  | (216                     | ) |  | 328                             |   |  | 42                              |  
|Overheads                        |  | 72                            |   |  | 130                            |   |  | (200                     | ) |  | 2                               |   |  |                                |  
|                                 |  |                               |   |  |                                |   |  |                          |   |  |                                 |   |  |                                 |  
|                                 |  | 1,010                         |   |  | 582                            |   |  | (1,120                   | ) |  | 472                             |   |  | 61                              |  
|                                 |  |                               |   |  |                                |   |  |                          |   |  |                                 |   |  |                                 |  
|                                 |  | 15,101                        |   |  | 6,740                          |   |  | (14,850                  | ) |  | 6,991                           |   |  | 900                             |  
|                                 |  |                               |   |  |                                |   |  |                          |   |  |                                 |   |  |                                 |  



F-31



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|11 | Construction in progress (continued)
|-- | ------------------------------------



| | (b) | East Rail Extensions
| | --- | --------------------



(i) Included in land and related costs incurred during the year are amounts paid and payable to the Government by the Group in respect of
the following:



| |  |  | HK$42 million (US$5 million) (2003: HK$52 million) for the lease of land required for construction sites for the East Rail Extensions project. The land does not have a measurable
value as it cannot be assigned and can only be used by the Group and/or its contractors.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | HK$190 million (US$24 million) (2003: HK$170 million) for land resumption work undertaken by the Government and compensation in respect of resumed land paid and payable by the
Government on behalf of the Group in respect of the East Rail Extensions project. The Group is obligated to reimburse such sums to the Government.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (ii) | Included in on-cost recovery credited during the year is an amount of HK$48 million (US$6 million) (2003: HK$52 million) received and receivable from the Government for certain
essential public infrastructure works and other works along the route of East Rail Extensions undertaken by the Group on its behalf pursuant to the entrustment agreements in respect of such entrustment works.
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Other assets under construction



Included in other assets under construction credited during
the year are on-cost recoveries received and receivable in respect of the following:



| |  |  | HK$11 million (US$1 million) (2003: HK$39 million) from the Government for certain essential public infrastructure works and other works along the West Rail, Phase I route
undertaken by the Group on its behalf pursuant to the entrustment agreements in respect of such entrustment works.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | HK$16 million (US$2 million) (2003: HK$35 million) from the subsidiary, West Rail Property Development Limited, for property development along the West Rail, Phase I route as
governed by the Shareholding Agreement between the Group and the Government (see note 17).
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|12 | Deferred expenditure
|-- | --------------------



Deferred expenditure comprises:



|                        |  |                              |  |                            |  |                    |  |                                 |  |                                
|----------------------- |  | ---------------------------- |  | -------------------------- |  | ------------------ |  | ------------------------------- |  | -------------------------------
|                        |  | Balance as at January 1,2004 |  | Expenditure during theyear |  | Netfinanceexpenses |  | Balance as at December 31, 2004 |  | Balance as at December 31, 2004
|                        |  | HK$                          |  | HK$                        |  | HK$                |  | HK$                             |  | US$                            
|                        |  | (in millions)               
|Sha Tin to Central Link |  | 731                          |  | 437                        |  | 11                 |  | 1,179                           |  | 152                            
|Kowloon Southern Link   |  | 169                          |  | 107                        |  | 3                  |  | 279                             |  | 36                             
|Northern Link           |  |                             |  | 4                          |  |                   |  | 4                               |  |                               
|                        |  |                              |  |                            |  |                    |  |                                 |  |                                
|                        |  | 900                          |  | 548                        |  | 14                 |  | 1,462                           |  | 188                            
|                        |  |                              |  |                            |  |                    |  |                                 |  |                                



Included in
expenditure incurred during the year are amounts paid and payable to the Government by the Group in respect of the following:



| |  |  | HK$3 million (US$ nil) (2003: HK$5 million ) for land resumption work on the Sha Tin to Central Link project undertaken by the Government on behalf of the Group.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | HK$5 million (US$1 million) (2003: HK$2 million) for land resumption work on the Kowloon Southern Link project undertaken by the Government on behalf of the Group.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-32



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|13 | Properties under development
|-- | ----------------------------



Properties under development held in Hong Kong under long-term leases comprise:



|                              |  |               |   |  |       |  |     
|----------------------------- |  | ------------- | - |  | ----- |  | ----
|                              |  | 2003          |   |  | 2004  |  | 2004
|                              |  | HK$           |   |  | HK$   |  | US$ 
|                              |  | (in millions)
|Balance as at January 1,      |  | 1,153         |   |  | 1,448 |  | 186 
|Expenditure during the year   |  | 314           |   |  | 444   |  | 58  
|Transfer from deferred income |  | (19           | ) |  |      |  |    
|                              |  |               |   |  |       |  |     
|Balance as at December 31,    |  | 1,448         |   |  | 1,892 |  | 244 
|                              |  |               |   |  |       |  |     



The balance of
expenditure on properties under development is mainly related to the development sites at Che Kung Temple Station, Tai Wai Maintenance Centre, Tai Wai Station and Wu Kai Sha Station. To strengthen the measures for stabilization of property prices,
the Secretary for Housing, Planning and Lands announced on October 15, 2003 that the Government and the Group had agreed not to invite expression of interests for the four property development projects along the Ma On Shan Rail before 2005, and the
first phase of these projects would not be completed earlier than 2008.



|14 | Investment in subsidiaries
|-- | --------------------------



Details of the subsidiaries are as follows:



|                                                   |  |                                    |  |                                       |  |                   |    |                                           |        |    |                                      |        |   |                   |                                 
|-------------------------------------------------- |  | ---------------------------------- |  | ------------------------------------- |  | ----------------- | -- | ----------------------------------------- | ------ | -- | ------------------------------------ | ------ | - | ----------------- | --------------------------------
|Name of company                                    |  | Place ofincorporationand operation |  | Number ofissued andfully paidshares** |  | Parvalue ofshares |    | Percentageof sharesheld by theCorporation |        |    | Percentageof sharesheld bysubsidiary |        |   | Nature ofbusiness
|Manlai Court Property Management Company Limited   |  | Hong Kong                          |  | 25,500A24,500B                    |  | HK$HK$            | 11 |                                           | 100Nil | %  |                                      | NilNil |   |                   | Propertymanagement              
|                                                   |  |                                    |  |                                       |  |                  
|Sun Tuen Mun Centre Management Company Limited     |  | Hong Kong                          |  | 25,000A25,000B                    |  | HK$HK$            | 11 |                                           | 100100 | %% |                                      | NilNil |   |                   | Propertymanagement              
|                                                   |  |                                    |  |                                       |  |                  
|Royal Ascot Management Company Limited             |  | Hong Kong                          |  | 25,000A25,000B                    |  | HK$HK$            | 11 |                                           | 100100 | %% |                                      | NilNil |   |                   | Propertymanagement              
|                                                   |  |                                    |  |                                       |  |                  
|Hanford Garden Property Management Company Limited |  | Hong Kong                          |  | 10,000                                |  | HK$               | 1  |                                           | 100    | %  |                                      | Nil    |   |                   | Propertymanagement              
|                                                   |  |                                    |  |                                       |  |                  
|Pierhead Garden Management Company Limited         |  | Hong Kong                          |  | 25,000A25,000B                    |  | HK$HK$            | 11 |                                           | 100Nil | %  |                                      | Nil100 | % |                   | Propertymanagement              
|                                                   |  |                                    |  |                                       |  |                  
|The Metropolis Management Company Limited          |  | Hong Kong                          |  | 25,500A24,500B                    |  | HK$HK$            | 11 |                                           | 100Nil | %  |                                      | NilNil |   |                   | Propertymanagement              
|                                                   |  |                                    |  |                                       |  |                  
|Capital System Limited                             |  | Hong Kong                          |  | 5,000                                 |  | HK$               | 1  |                                           | 100    | %  |                                      | Nil    |   |                   | Investmentholding               
|                                                   |  |                                    |  |                                       |  |                  
|Buoyant Asset Limited                              |  | Hong Kong                          |  | 100                                   |  | HK$               | 10 |                                           | 100    | %  |                                      | Nil    |   |                   | Rolling stockleasingfacilitation



F-33



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|14 | Investment in subsidiaries (continued)
|-- | --------------------------------------



|                        |  |                                    |  |                                       |  |                    |    |                                           |     |   |                                      |     |                    |                                             
|----------------------- |  | ---------------------------------- |  | ------------------------------------- |  | ------------------ | -- | ----------------------------------------- | --- | - | ------------------------------------ | --- | ------------------ | --------------------------------------------
|Name of company         |  | Place ofincorporationand operation |  | Number ofissued andfully paidshares** |  | Par valueof shares |    | Percentage ofshares heldby theCorporation |     |   | Percentageof sharesheld bysubsidiary |     | Nature of business
|Advanced Asset Limited  |  | Hong Kong                          |  | 100                                   |  | HK$                | 10 |                                           | 100 | % |                                      | Nil |                    | Signaling systemleasing facilitation        
|                        |  |                                    |  |                                       |  |                   
|Quality Asset Limited   |  | Hong Kong                          |  | 100                                   |  | HK$                | 10 |                                           | 100 | % |                                      | Nil |                    | Signaling systemleasing facilitation        
|                        |  |                                    |  |                                       |  |                   
|Kasey Asset Limited     |  | Hong Kong                          |  | 100                                   |  | HK$                | 10 |                                           | 100 | % |                                      | Nil |                    | Rolling stockleasing facilitation           
|                        |  |                                    |  |                                       |  |                   
|Circuit Asset Limited   |  | Hong Kong                          |  | 100                                   |  | HK$                | 10 |                                           | 100 | % |                                      | Nil |                    | Rolling stockleasing facilitation           
|                        |  |                                    |  |                                       |  |                   
|Shining Asset Limited   |  | Hong Kong                          |  | 100                                   |  | HK$                | 10 |                                           | 100 | % |                                      | Nil |                    | Revenuecollection systemleasing facilitation
|                        |  |                                    |  |                                       |  |                   
|Fluent Asset Limited    |  | Hong Kong                          |  | 100                                   |  | HK$                | 10 |                                           | 100 | % |                                      | Nil |                    | Rolling stockleasing facilitation           
|                        |  |                                    |  |                                       |  |                   
|Kudos Asset Limited     |  | Hong Kong                          |  | 100                                   |  | HK$                | 10 |                                           | 100 | % |                                      | Nil |                    | Rolling stockleasing facilitation           
|                        |  |                                    |  |                                       |  |                   
|Unique Asset Limited    |  | Hong Kong                          |  | 100                                   |  | HK$                | 10 |                                           | 100 | % |                                      | Nil |                    | Rolling stockleasing facilitation           
|                        |  |                                    |  |                                       |  |                   
|Bowman Asset Limited    |  | Cayman Islands                     |  | 1,000                                 |  | US$                | 1  |                                           | 100 | % |                                      | Nil |                    | Railwayinfrastructureleasing facilitation   
|                        |  |                                    |  |                                       |  |                   
|Statesman Asset Limited |  | Cayman Islands                     |  | 1,000                                 |  | US$                | 1  |                                           | 100 | % |                                      | Nil |                    | Railwayinfrastructureleasing facilitation   
|                        |  |                                    |  |                                       |  |                   
|Interwind Asset Limited |  | Hong Kong                          |  | 100                                   |  | HK$                | 10 |                                           | 100 | % |                                      | Nil |                    | Railwayequipment leasingfacilitation        



F-34



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|14 | Investment in subsidiaries (continued)
|-- | --------------------------------------



|                                                       |  |                                    |  |                                       |  |                    |      |                                           |        |   |                                      |        |   |                    |                                     
|------------------------------------------------------ |  | ---------------------------------- |  | ------------------------------------- |  | ------------------ | ---- | ----------------------------------------- | ------ | - | ------------------------------------ | ------ | - | ------------------ | ------------------------------------
|Name of company                                        |  | Place ofincorporationand operation |  | Number ofissued andfully paidshares** |  | Par valueof shares |      | Percentage ofshares heldby theCorporation |        |   | Percentageof sharesheld bysubsidiary |        |   | Nature of business
|V-Connect Limited                                      |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | 100    | % |                                      | Nil    |   |                    | Mobile communicationsystem operation
|                                                       |  |                                    |  |                                       |  |                   
|*West Rail Property Development Limited                |  | Hong Kong                          |  | 51A49B                            |  | HK$HK$             | 1010 |                                           | 100Nil | % |                                      | NilNil |   |                    | Property development                
|                                                       |  |                                    |  |                                       |  |                   
|*Kam Sheung Property Development Limited               |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | Nil    |   |                                      | 100    | % |                    | Property development                
|                                                       |  |                                    |  |                                       |  |                   
|*Kwai Fong Property Development Limited                |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | Nil    |   |                                      | 100    | % |                    | Property development                
|                                                       |  |                                    |  |                                       |  |                   
|*Long Ping Property Development Limited                |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | Nil    |   |                                      | 100    | % |                    | Property development                
|                                                       |  |                                    |  |                                       |  |                   
|*Long Ping South Property Development Limited          |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | Nil    |   |                                      | 100    | % |                    | Property development                
|                                                       |  |                                    |  |                                       |  |                   
|*Nam Cheong Property Development Limited               |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | Nil    |   |                                      | 100    | % |                    | Property development                
|                                                       |  |                                    |  |                                       |  |                   
|*Pat Heung Property Development Limited                |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | Nil    |   |                                      | 100    | % |                    | Property development                
|                                                       |  |                                    |  |                                       |  |                   
|*Tin Shui Wai Property Development Limited             |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | Nil    |   |                                      | 100    | % |                    | Property development                
|                                                       |  |                                    |  |                                       |  |                   
|*Tsuen Wan West Property Development Limited           |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | Nil    |   |                                      | 100    | % |                    | Property development                
|                                                       |  |                                    |  |                                       |  |                   
|*Tuen Mun Property Development Limited                 |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | Nil    |   |                                      | 100    | % |                    | Property development                
|                                                       |  |                                    |  |                                       |  |                   
|*Yuen Long Property Development Limited                |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | Nil    |   |                                      | 100    | % |                    | Property development                
|                                                       |  |                                    |  |                                       |  |                   
|* Tsuen Wan West Cityside Property Development Limited |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | Nil    |   |                                      | 100    | % |                    | Property development                
|                                                       |  |                                    |  |                                       |  |                   
|* Tsuen Wan West TW6 Property Development Limited      |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | Nil    |   |                                      | 100    | % |                    | Property development                
|                                                       |  |                                    |  |                                       |  |                   
|* Tsuen Wan West TW7 Property Development Limited      |  | Hong Kong                          |  | 100                                   |  | HK$                | 10   |                                           | Nil    |   |                                      | 100    | % |                    | Property development                

---

|* | These subsidiaries are held by the Corporation for the sole purpose of developing commercial or residential property along the West Rail, Phase I route on behalf of the Government
and their financial statements are excluded from consolidation as the Corporation has no effective control over nor beneficial interests in the net assets of, other than the amount of capital provided, these subsidiaries.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|** | All the issued and fully paid shares of the subsidiaries are ordinary shares.
|-- | -----------------------------------------------------------------------------



F-35



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|15 | Interest in associate
|-- | ---------------------



The interest in associate is as follows:



|                         |  |               |  |      |  |     
|------------------------ |  | ------------- |  | ---- |  | ----
|                         |  | 2003          |  | 2004 |  | 2004
|                         |  | HK$           |  | HK$  |  | US$ 
|                         |  | (in millions)
|Unlisted shares, at cost |  |              |  |     |  |    
|Share of net assets      |  | 42            |  | 57   |  | 7   
|                         |  |               |  |      |  |     
|                         |  | 42            |  | 57   |  | 7   
|                         |  |               |  |      |  |     



Details of the
associate, which is incorporated and operates in Hong Kong are as follows:



|                      |  |                                        |  |                     |  |                           |  |                                                      
|--------------------- |  | -------------------------------------- |  | ------------------- |  | ------------------------- |  | -----------------------------------------------------
|Name of company       |  | Number of issued and fully paid shares |  | Par value of shares |  | Percentage of shares held |  | Nature of
business                                   
|Octopus Cards Limited |  | 42,000,000 ordinary                    |  | HK$1                |  | 22.1%                     |  | Development and operation of the Octopus cards system



On January 17, 2001,
the Corporation entered into a service agreement with Octopus Cards Limited in order to formalize the existing arrangements for the provision of services to each other relating to the use of Octopus cards. Under the service agreement, the
Corporation will continue to accept the use of Octopus cards for payment of fares and to provide add-value, refund and other ancillary services to Octopus Cards Limited.



During the year, the Group made payments to Octopus Cards Limited amounting to HK$33 million (US$4 million) (2003: HK$29
million) in respect of fees for the use of the Octopus cards system. These payments were made based on the fare revenue generated from Octopus cards. No other charges were made or incurred by the Group in respect of the administration of the Octopus
cards system. The Group received HK$8 million (US$1 million) (2003: HK$7 million) from Octopus Cards Limited in respect of ticket loading agent fees for providing add-value amounts on Octopus cards and handling fees for issuing new cards and
handling refunds for returned cards.



|16 | Loan receivable
|-- | ---------------



|                |  |               |  |      |  |     
|--------------- |  | ------------- |  | ---- |  | ----
|                |  | 2003          |  | 2004 |  | 2004
|                |  | HK$           |  | HK$  |  | US$ 
|                |  | (in millions)
|Loan receivable |  | 774           |  | 733  |  | 95  
|                |  |               |  |      |  |     



Under one of those
lease arrangements entered into by the Group referred to in note 10(h), the future lease payments are funded by the interest earned on the loan receivable and the repayment of the loan receivable made by the Group to an unrelated party. The interest
rate on the loan receivable is predetermined.



The loan
receivable is scheduled to be repaid by instalments over the duration of the lease arrangement until its expiry in 2018, as follows:



|              |  |               |  |      |  |     
|------------- |  | ------------- |  | ---- |  | ----
|              |  | 2003          |  | 2004 |  | 2004
|              |  | HK$           |  | HK$  |  | US$ 
|              |  | (in millions)
|Within 1 year |  | 42            |  | 31   |  | 4   
|After 1 year  |  | 732           |  | 702  |  | 91  
|              |  |               |  |      |  |     
|              |  | 774           |  | 733  |  | 95  
|              |  |               |  |      |  |     





F-36



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|17 | Loan to subsidiary
|-- | ------------------



On February 24, 2000, the Corporation and the Government entered into a shareholding agreement (the Shareholding Agreement) for the formation
of a sub-group of the Corporation under an intermediate holding company, West Rail Property Development Limited (WRPDL), to undertake all property developments along the West Rail, Phase I route. The issued share capital of WRPDL
comprises 51 ordinary A shares and 49 ordinary B shares, which are held by the Corporation and the Government respectively. The ordinary A shares are not entitled to any distribution by WRPDL other than a return
of capital, and the ordinary B shares are entitled to all dividends declared by WRPDL and a return of capital.



All costs incurred or to be incurred in relation to the West Rail property developments are to be funded by loans from the Corporation to WRPDL bearing
interest at an annual rate of 1% over the Corporations average cost of funds in the preceding year. To the extent that WRPDL is unable to repay the loan, the Government shall seek the necessary authority to reimburse costs incurred by the
Corporation. The Government has also undertaken to indemnify the Corporation against all liabilities properly incurred by the Corporation in relation to such property developments.



Subsidiaries of WRPDL have been formed to handle the property developments along the West Rail, Phase I route whereby the
Government will receive the profits less losses from the developments and the Group or Corporation will earn management fees.



|18 | Investments
|-- | -----------



|(a) | Investments comprise:
|--- | ---------------------



|                                                                 |  |               |  |       |  |     
|---------------------------------------------------------------- |  | ------------- |  | ----- |  | ----
|                                                                 |  | 2003          |  | 2004  |  | 2004
|                                                                 |  | HK$           |  | HK$   |  | US$ 
|                                                                 |  | (in millions)
|Debt securities                                                  |  |               |  |       |  |     
|- Listed outside Hong Kong                                       |  | 1,165         |  | 578   |  | 74  
|- Listed in Hong Kong                                            |  | 5             |  |      |  |    
|- Unlisted                                                       |  | 6,968         |  | 1,645 |  | 212 
|Interest-bearing deposits temporarily placed with custodian bank |  | 4,106         |  | 2,100 |  | 270 
|                                                                 |  |               |  |       |  |     
|Total fair value of investments                                  |  | 12,244        |  | 4,323 |  | 556 
|                                                                 |  |               |  |       |  |     
|Total market value of listed investments                         |  | 1,170         |  | 578   |  | 74  
|                                                                 |  |               |  |       |  |     



No debt securities
issued by the Government and Government-owned entities in Hong Kong are included in investments.



|(b) | Investments are expected to mature as follows:
|--- | ----------------------------------------------



|              |  |               |  |       |  |     
|------------- |  | ------------- |  | ----- |  | ----
|              |  | 2003          |  | 2004  |  | 2004
|              |  | HK$           |  | HK$   |  | US$ 
|              |  | (in millions)
|Within 1 year |  | 11,231        |  | 3,960 |  | 509 
|After 1 year  |  | 1,013         |  | 363   |  | 47  
|              |  |               |  |       |  |     
|              |  | 12,244        |  | 4,323 |  | 556 
|              |  |               |  |       |  |     





F-37



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|19 | Stores and spares
|-- | -----------------



Stores and spares are expected to be consumed as follows:



|              |  |               |  |      |  |     
|------------- |  | ------------- |  | ---- |  | ----
|              |  | 2003          |  | 2004 |  | 2004
|              |  | HK$           |  | HK$  |  | US$ 
|              |  | (in millions)
|Within 1 year |  | 124           |  | 164  |  | 21  
|After 1 year  |  | 130           |  | 155  |  | 20  
|              |  |               |  |      |  |     
|              |  | 254           |  | 319  |  | 41  
|              |  |               |  |      |  |     



|20 | Interest receivable
|-- | -------------------



Interest is receivable as follows:



|              |  |               |  |      |  |     
|------------- |  | ------------- |  | ---- |  | ----
|              |  | 2003          |  | 2004 |  | 2004
|              |  | HK$           |  | HK$  |  | US$ 
|              |  | (in millions)
|Within 1 year |  | 63            |  | 48   |  | 6   
|After 1 year  |  |              |  | 1    |  |    
|              |  |               |  |      |  |     
|              |  | 63            |  | 49   |  | 6   
|              |  |               |  |      |  |     



|21 | Other receivables
|-- | -----------------



|(a) | Other receivables comprise:
|--- | ---------------------------



|                                  |  |               |  |      |  |     
|--------------------------------- |  | ------------- |  | ---- |  | ----
|                                  |  | 2003          |  | 2004 |  | 2004
|                                  |  | HK$           |  | HK$  |  | US$ 
|                                  |  | (in millions)
|Amount due from associate         |  | 3             |  | 1    |  |    
|Amount due from the Government    |  | 393           |  | 510  |  | 66  
|Debtors, deposits and prepayments |  | 216           |  | 196  |  | 25  
|                                  |  |               |  |      |  |     
|                                  |  | 612           |  | 707  |  | 91  
|                                  |  |               |  |      |  |     



The amount due from
the Government represents HK$446 million (US$57 million) (2003: HK$341 million) in respect of certain essential public infrastructure works and other works along the routes of the West Rail and East Rail Extensions undertaken on behalf of the
Government pursuant to the respective entrustment agreements with the Government in respect of such entrustment works and HK$64 million (US$8 million) (2003: HK$52 million) for on-costs charged to the Government in respect of such
entrustment works.



|(b) | Other receivables are expected to be recovered as follows:
|--- | ----------------------------------------------------------



|              |  |               |  |      |  |     
|------------- |  | ------------- |  | ---- |  | ----
|              |  | 2003          |  | 2004 |  | 2004
|              |  | HK$           |  | HK$  |  | US$ 
|              |  | (in millions)
|Within 1 year |  | 585           |  | 684  |  | 88  
|After 1 year  |  | 27            |  | 23   |  | 3   
|              |  |               |  |      |  |     
|              |  | 612           |  | 707  |  | 91  
|              |  |               |  |      |  |     



|(c) | Included in other receivables are debtors with the following ageing analysis :
|--- | ------------------------------------------------------------------------------



|                           |  |               |  |      |  |     
|-------------------------- |  | ------------- |  | ---- |  | ----
|                           |  | 2003          |  | 2004 |  | 2004
|                           |  | HK$           |  | HK$  |  | US$ 
|                           |  | (in millions)
|Current                    |  | 526           |  | 652  |  | 84  
|Less than 1 month overdue  |  | 8             |  | 6    |  | 1   
|1 to 3 months overdue      |  | 14            |  | 17   |  | 2   
|More than 3 months overdue |  | 11            |  | 2    |  |    
|                           |  |               |  |      |  |     
|Total debtors              |  | 559           |  | 677  |  | 87  
|Deposits and prepayments   |  | 53            |  | 30   |  | 4   
|                           |  |               |  |      |  |     
|                           |  | 612           |  | 707  |  | 91  
|                           |  |               |  |      |  |     



For debtors of
commercial property leasing and franchise operations, no credit is allowed except for revenue sharing arrangements. For debtors of other business dealings, the normal credit period extended is one month.



F-38



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|22 | Cash and cash equivalents
|-- | -------------------------



|(a) | Cash and cash equivalents comprise:
|--- | -----------------------------------



|                                                                          |  |               |   |  |       |   |  |      |  
|------------------------------------------------------------------------- |  | ------------- | - |  | ----- | - |  | ---- | -
|                                                                          |  | 2003          |   |  | 2004  |   |  | 2004 |  
|                                                                          |  | HK$           |   |  | HK$   |   |  | US$  |  
|                                                                          |  | (in millions) |  
|Deposits with banks                                                       |  |               |   |  |       |   |  |      |  
|- Within 3 months of maturity when placed                                 |  | 2,423         |   |  | 2,555 |   |  | 329  |  
|- More than 3 months of maturity when placed                              |  | 200           |   |  | 940   |   |  | 121  |  
|Cash at bank and in hand                                                  |  | 54            |   |  | 36    |   |  | 4    |  
|                                                                          |  |               |   |  |       |   |  |      |  
|Cash and cash equivalents in the balance sheets                           |  | 2,677         |   |  | 3,531 |   |  | 454  |  
|Less: deposits with banks with more than 3 months of maturity when placed |  | (200          | ) |  | (940  | ) |  | (121 | )
|                                                                          |  |               |   |  |       |   |  |      |  
|Cash and cash equivalents in the cash flow statement                      |  | 2,477         |   |  | 2,591 |   |  | 333  |  
|                                                                          |  |               |   |  |       |   |  |      |  



|(b) | At December 31, 2004, the deposits with banks were placed to mature within one year.
|--- | ------------------------------------------------------------------------------------



|23 | Interest payable
|-- | ----------------



Interest payable is expected to be settled within one year.



|24 | Other payables
|-- | --------------



|(a) | Other payables comprise:
|--- | ------------------------



|                              |  |               |  |       |  |     
|----------------------------- |  | ------------- |  | ----- |  | ----
|                              |  | 2003          |  | 2004  |  | 2004
|                              |  | HK$           |  | HK$   |  | US$ 
|                              |  | (in millions)
|Deposits and advances         |  | 1,326         |  | 1,173 |  | 151 
|Creditors and accrued charges |  | 770           |  | 1,271 |  | 164 
|Amount due to the Government  |  | 2             |  |      |  |    
|                              |  |               |  |       |  |     
|                              |  | 2,098         |  | 2,444 |  | 315 
|                              |  |               |  |       |  |     



|(b) | Other payables are expected to be settled as follows:
|--- | -----------------------------------------------------



|              |  |               |  |       |  |     
|------------- |  | ------------- |  | ----- |  | ----
|              |  | 2003          |  | 2004  |  | 2004
|              |  | HK$           |  | HK$   |  | US$ 
|              |  | (in millions)
|Within 1 year |  | 1,138         |  | 1,569 |  | 202 
|After 1 year  |  | 960           |  | 875   |  | 113 
|              |  |               |  |       |  |     
|              |  | 2,098         |  | 2,444 |  | 315 
|              |  |               |  |       |  |     



|(c) | Included in other payables are creditors with the following ageing analysis :
|--- | -----------------------------------------------------------------------------



|                                  |  |               |  |       |  |     
|--------------------------------- |  | ------------- |  | ----- |  | ----
|                                  |  | 2003          |  | 2004  |  | 2004
|                                  |  | HK$           |  | HK$   |  | US$ 
|                                  |  | (in millions)
|Due within one month or on demand |  | 265           |  | 468   |  | 61  
|Due after six months              |  | 271           |  | 313   |  | 40  
|                                  |  |               |  |       |  |     
|Total creditors                   |  | 536           |  | 781   |  | 101 
|Deposits and advances received    |  | 1,326         |  | 1,173 |  | 151 
|Accrued charges                   |  | 236           |  | 490   |  | 63  
|                                  |  |               |  |       |  |     
|                                  |  | 2,098         |  | 2,444 |  | 315 
|                                  |  |               |  |       |  |     



F-39



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|25 | Accrued charges and provisions for capital projects
|-- | ---------------------------------------------------



The balance includes accrued charges related to capital projects which are settled upon certification of work in progress and also provisions for claims
on contracts in respect of the West Rail and East Rail Extensions projects. It also includes the amount of HK$1,361 million (US$175 million) (2003: HK$383 million) for amounts payable to the Government in relation to the West Rail, East Rail
Extensions, Sha Tin to Central Link and Kowloon Southern Link projects.



Accrued charges and provisions for capital projects of the Group are all expected to be settled or utilized within one year.



|26 | Lease payable
|-- | -------------



The lease payments under the lease arrangement disclosed in note 16 are expected to be made as follows:



|              |  |               |  |      |  |     
|------------- |  | ------------- |  | ---- |  | ----
|              |  | 2003          |  | 2004 |  | 2004
|              |  | HK$           |  | HK$  |  | US$ 
|              |  | (in millions)
|Within 1 year |  | 42            |  | 31   |  | 4   
|After 1 year  |  | 716           |  | 686  |  | 88  
|              |  |               |  |      |  |     
|              |  | 758           |  | 717  |  | 92  
|              |  |               |  |      |  |     



The payments are to be
funded by the interest earned on loan receivable and the repayment of the loan receivable as discussed in note 16 in accordance with the terms of the lease arrangement.



|27 | Interest-bearing borrowings
|-- | ---------------------------



Interest-bearing borrowings comprise:



|                                             |  |               |  |        |  |      
|-------------------------------------------- |  | ------------- |  | ------ |  | -----
|                                             |  | 2003          |  | 2004   |  | 2004 
|                                             |  | HK$           |  | HK$    |  | US$  
|                                             |  | (in millions)
|Capital market instruments                   |  |               |  |        |  |      
|US dollar notes due 2009 (a)                 |  | 7,770         |  | 7,771  |  | 1,000
|HK dollar notes due 2013 (a)                 |  | 800           |  | 800    |  | 103  
|US dollar notes due 2014 (a)                 |  | 388           |  | 388    |  | 50   
|US dollar notes due 2010 (b)                 |  | 7,780         |  | 7,785  |  | 1,002
|HK dollar Retail notes due 2008 and 2013 (c) |  | 1,023         |  | 1,020  |  | 131  
|                                             |  |               |  |        |  |      
|                                             |  | 17,761        |  | 17,764 |  | 2,286
|                                             |  |               |  |        |  |      
|Bank loan                                    |  |               |  |        |  |      
|Export credit loans (e)                      |  | 2,252         |  | 1,984  |  | 255  
|                                             |  |               |  |        |  |      
|                                             |  | 20,013        |  | 19,748 |  | 2,541
|                                             |  |               |  |        |  |      

---

|(a) | The Corporation issued 7.25% notes due 2009 with a principal amount of US$1 billion at a discount on July 27, 1999 and 7.77% notes due 2014 with a principal amount of US$50 million
at a discount on November 17, 1999 and 4.65% notes due 2013 with a principal amount of HK$800 million at par on June 9, 2003 under its US$3 billion Euro medium term note program. All the notes issued are unsecured and repayable in full on the
respective due dates.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(b) | The Corporation issued 8.00% global notes due 2010 with a principal amount of US$1 billion at a discount on March 16, 2000. These notes are registered with the United States
Securities and Exchange Commission and listed on the Stock Exchange of Hong Kong Limited, the London Stock Exchange Limited and the New York Stock Exchange, Inc. All the notes issued are unsecured and repayable in full on the due date.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(c) | The Corporation issued 3% notes due 2008 with a principal amount of HK$300 million at a premium and 4.8% notes due 2013 with a principal amount of HK$700 million at a premium on
June 6, 2003. All the notes issued are unsecured and repayable in full on the respective due dates.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|
|



F-40



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|27 | Interest-bearing borrowings (continued)
|-- | ---------------------------------------



|(d) | All the net proceeds received from the notes issued are invested in fixed income instruments or placed on deposit with banks or issuers with triple B or above credit ratings until
they are required to meet development costs.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(e) | During the year, the Corporation has repaid US$33.4 million in accordance with the provisions of the loan agreement in respect of a US$337.7 million export credit loan facility
provided by Japan Bank for International Cooperation. As at December 31, 2004, the outstanding balance of the facility amounted to US$220.2 million, of which about 66% bore interest at a fixed rate and the remaining 34% bore interest at a rate of
LIBOR plus a margin. The loan is unsecured and repayable by seventeen semi-annual installments commencing on April 21, 2003.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



During the year, US$2.7 million has been drawn and US$4.3 million has been repaid by the Corporation under a US$42 million export credit loan facility
provided by Export Development Canada. As at December 31, 2004, the outstanding balance of the facility amounted to US$33.9 million, which bore interest at a rate of LIBOR plus a margin. The loan is unsecured and repayable by seventeen semi-annual
installments commencing on May 4, 2004.



|(f) | At December 31, 2004, the interest-bearing borrowings were repayable as follows:
|--- | --------------------------------------------------------------------------------



|                                |  |               |  |                              |  |               |  |           |  |          
|------------------------------- |  | ------------- |  | ---------------------------- |  | ------------- |  | --------- |  | ---------
|                                |  | Total2003     |  | Capitalmarketinstruments2004 |  | Bankloans2004 |  | Total2004 |  | Total2004
|                                |  | HK$           |  | HK$                          |  | HK$           |  | HK$       |  | US$      
|                                |  | (in millions)
|Within 1 year                   |  | 297           |  |                             |  | 299           |  | 299       |  | 38       
|After 1 year but within 2 years |  | 298           |  |                             |  | 300           |  | 300       |  | 39       
|After 2 year but within 5 years |  | 1,211         |  | 8,075                        |  | 916           |  | 8,991     |  | 1,157    
|After 5 years                   |  | 18,207        |  | 9,689                        |  | 469           |  | 10,158    |  | 1,307    
|                                |  |               |  |                              |  |               |  |           |  |          
|                                |  | 20,013        |  | 17,764                       |  | 1,984         |  | 19,748    |  | 2,541    
|                                |  |               |  |                              |  |               |  |           |  |          



|28 | Deferred income
|-- | ---------------



|(a) | Movements on deferred income comprise:
|--- | --------------------------------------



|                                         |  |               |   |  |      |   |  |      |  
|---------------------------------------- |  | ------------- | - |  | ---- | - |  | ---- | -
|                                         |  | 2003          |   |  | 2004 |   |  | 2004 |  
|                                         |  | HK$           |   |  | HK$  |   |  | US$  |  
|                                         |  | (in millions) |  
|Balance at January 1,                    |  | 434           |   |  | 743  |   |  | 96   |  
|Net amount accrued during the year       |  | 18            |   |  | 4    |   |  |     |  
|Net amount received during the year      |  | 337           |   |  | 8    |   |  | 1    |  
|Transfer to properties under development |  | (19           | ) |  |     |   |  |     |  
|Transfer to the income statement         |  | (27           | ) |  | (47  | ) |  | (6   | )
|                                         |  |               |   |  |      |   |  |      |  
|                                         |  | 743           |   |  | 708  |   |  | 91   |  
|                                         |  |               |   |  |      |   |  |      |  



|(b) | Deferred income is expected to be recognized in the income statement as follows:
|--- | --------------------------------------------------------------------------------



|              |  |               |  |      |  |     
|------------- |  | ------------- |  | ---- |  | ----
|              |  | 2003          |  | 2004 |  | 2004
|              |  | HK$           |  | HK$  |  | US$ 
|              |  | (in millions)
|Within 1 year |  | 48            |  | 48   |  | 6   
|After 1 year  |  | 695           |  | 660  |  | 85  
|              |  |               |  |      |  |     
|              |  | 743           |  | 708  |  | 91  
|              |  |               |  |      |  |     



F-41



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##### Table of Contents

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|29 | Share capital
|-- | -------------



|                          |  |              |  |                   |  |              |  |                   |  |              |  |                   |  |                  
|------------------------- |  | ------------ |  | ----------------- |  | ------------ |  | ----------------- |  | ------------ |  | ----------------- |  | -----------------
|                          |  | 2002         |  | 2003              |  | 2004         |  | 2004             
|                          |  | No. ofshares |  | HK$ (in millions) |  | No. ofshares |  | HK$ (in millions) |  | No. ofshares |  | HK$ (in millions) |  | US$ (in millions)
|Share capital:            |  |              |  |                   |  |              |  |                   |  |              |  |                   |  |                  
|                          |  |              |  |                   |  |              | 
|Authorized:               |  |              |  |                   |  |              |  |                   |  |              |  |                   |  |                  
|Shares of HK$100,000 each |  | 425,000      |  | 42,500            |  | 425,000      |  | 42,500            |  | 425,000      |  | 42,500            |  | 5,468            
|                          |  |              |  |                   |  |              |  |                   |  |              |  |                   |  |                  
|Issued and fully paid:    |  |              |  |                   |  |              |  |                   |  |              |  |                   |  |                  
|At January 1,             |  | 391,200      |  | 39,120            |  | 391,200      |  | 39,120            |  | 391,200      |  | 39,120            |  | 5,033            
|                          |  |              |  |                   |  |              |  |                   |  |              |  |                   |  |                  
|At December 31,           |  | 391,200      |  | 39,120            |  | 391,200      |  | 39,120            |  | 391,200      |  | 39,120            |  | 5,033            
|                          |  |              |  |                   |  |              |  |                   |  |              |  |                   |  |                  



|30 | Development reserve
|-- | -------------------



The development reserve represents appropriations of all profits from property developments to retained reserves within the Corporation. The development
reserve has been created and can only be released in accordance with the relevant provisions of the Kowloon-Canton Railway Corporation Ordinance.



|                                   |  |               |  |       |  |       |  |     
|---------------------------------- |  | ------------- |  | ----- |  | ----- |  | ----
|                                   |  | 2002          |  | 2003  |  | 2004  |  | 2004
|                                   |  | HK$           |  | HK$   |  | HK$   |  | US$ 
|                                   |  | (in millions)
|Balance at January 1,              |  | 6,441         |  | 6,535 |  | 6,535 |  | 841 
|Transfer from the income statement |  | 94            |  |      |  |      |  |    
|                                   |  |               |  |       |  |       |  |     
|Balance at December 31,            |  | 6,535         |  | 6,535 |  | 6,535 |  | 841 
|                                   |  |               |  |       |  |       |  |     



|31 | Investment property revaluation reserve
|-- | ---------------------------------------



The investment property revaluation reserve comprises:



|                                                                     |  |               |   |  |      |   |  |      |  |     
|-------------------------------------------------------------------- |  | ------------- | - |  | ---- | - |  | ---- |  | ----
|                                                                     |  | 2002          |   |  | 2003 |   |  | 2004 |  | 2004
|                                                                     |  | HK$           |   |  | HK$  |   |  | HK$  |  | US$ 
|                                                                     |  | (in millions)
|Balance at January 1,                                                |  | 176           |   |  | 134  |   |  | 117  |  | 15  
|Surplus / (deficit) arising on revaluation during the year (note 10) |  | (42           | ) |  | (17  | ) |  | 148  |  | 19  
|                                                                     |  |               |   |  |      |   |  |      |  |     
|Balance at December 31,                                              |  | 134           |   |  | 117  |   |  | 265  |  | 34  
|                                                                     |  |               |   |  |      |   |  |      |  |     



|32 | Investment revaluation reserve
|-- | ------------------------------



The revaluation reserve arising on investments comprises:



|                                                        |  |               |   |  |      |   |  |      |   |  |      |  
|------------------------------------------------------- |  | ------------- | - |  | ---- | - |  | ---- | - |  | ---- | -
|                                                        |  | 2002          |   |  | 2003 |   |  | 2004 |   |  | 2004 |  
|                                                        |  | HK$           |   |  | HK$  |   |  | HK$  |   |  | US$  |  
|                                                        |  | (in millions) |  
|Balance at January 1,                                   |  | 133           |   |  | 50   |   |  | (1   | ) |  |     |  
|                                                        |  |               |   |  |      |   |  |      |   |  |      |  
|Deficit arising on revaluation                          |  | (516          | ) |  | (197 | ) |  | (103 | ) |  | (13  | )
|Less: Amount capitalized                                |  | 414           |   |  | 121  |   |  | 49   |   |  | 6    |  
|                                                        |  |               |   |  |      |   |  |      |   |  |      |  
|                                                        |  | (102          | ) |  | (76  | ) |  | (54  | ) |  | (7   | )
|                                                        |  |               |   |  |      |   |  |      |   |  |      |  
|Deficit realized on redemption and disposal             |  | 55            |   |  | 60   |   |  | 79   |   |  | 10   |  
|Deficit capitalized in prior years                      |  | (36           | ) |  | (35  | ) |  | (40  | ) |  | (5   | )
|                                                        |  |               |   |  |      |   |  |      |   |  |      |  
|Deficit transferred to the income statement on disposal |  | 19            |   |  | 25   |   |  | 39   |   |  | 5    |  
|                                                        |  |               |   |  |      |   |  |      |   |  |      |  
|Balance at December 31,                                 |  | 50            |   |  | (1   | ) |  | (16  | ) |  | (2   | )
|                                                        |  |               |   |  |      |   |  |      |   |  |      |  



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|33 | Retained profits
|-- | ----------------



Profits are retained as follows:



|                                                            |  |               |   |  |        |   |  |        |   |  |       |  
|----------------------------------------------------------- |  | ------------- | - |  | ------ | - |  | ------ | - |  | ----- | -
|                                                            |  | 2002          |   |  | 2003   |   |  | 2004   |   |  | 2004  |  
|                                                            |  | HK$           |   |  | HK$    |   |  | HK$    |   |  | US$   |  
|                                                            |  | (in millions) |  
|Retained profits at January 1,                              |  |               |   |  |        |   |  |        |   |  |       |  
|- as previously reported                                    |  | 13,710        |   |  | 16,277 |   |  | 14,434 |   |  | 1,857 |  
|- prior period adjustment                                   |  |               |   |  |        |   |  |        |   |  |       |  
|- change in accounting policy (note 3)                      |  | (2,153        | ) |  | (2,604 | ) |  |       |   |  |      |  
|                                                            |  |               |   |  |        |   |  |        |   |  |       |  
|- as restated                                               |  | 11,557        |   |  | 13,673 |   |  | 14,434 |   |  | 1,857 |  
|                                                            |  |               |   |  |        |   |  |        |   |  |       |  
|Dividends approved in respect of the previous year (note 8) |  |              |   |  | (620   | ) |  | (620   | ) |  | (79   | )
|                                                            |  |               |   |  |        |   |  |        |   |  |       |  
|Retained profit for the year.                               |  |               |   |  |        |   |  |        |   |  |       |  
|- as previously reported                                    |  | 2,567         |   |  |        |   |  |        |   |  |       |  
|- prior period adjustment                                   |  |               |   |  |        |   |  |        |   |  |       |  
|- change in accounting policy (note 3)                      |  | (451          | ) |  |        |   |  |        |   |  |       |  
|                                                            |  |               |   |  |        |   |  |        |   |  |       |  
|Retained profit for the year (2002: as restated)            |  | 2,116         |   |  | 1,381  |   |  | 429    |   |  | 55    |  
|                                                            |  |               |   |  |        |   |  |        |   |  |       |  
|Retained profits at December 31,                            |  | 13,673        |   |  | 14,434 |   |  | 14,243 |   |  | 1,833 |  
|                                                            |  |               |   |  |        |   |  |        |   |  |       |  
|Representing:                                               |  |               |   |  |        |   |  |        |   |  |       |  
|Proposed dividend (note 8)                                  |  | 620           |   |  | 620    |   |  | 172    |   |  | 22    |  
|                                                            |  |               |   | 
|Retained profits after proposed dividend                    |  | 13,053        |   |  | 13,814 |   |  | 14,071 |   |  | 1,811 |  



Included in the
retained profits of the Group is an amount of HK$48 million (US$6 million) (2003: HK$33 million; 2002: HK$26 million), being the retained profits attributable to an associate.



|34 | Notes to the consolidated cash flow statement
|-- | ---------------------------------------------



Reconciliation of operating profit before net finance income / (expenses) to net cash inflow from operations:



|                                                          |  |               |   |  |       |   |  |       |   |  |      |  
|--------------------------------------------------------- |  | ------------- | - |  | ----- | - |  | ----- | - |  | ---- | -
|                                                          |  | 2002          |   |  | 2003  |   |  | 2004  |   |  | 2004 |  
|                                                          |  | HK$           |   |  | HK$   |   |  | HK$   |   |  | US$  |  
|                                                          |  | (in millions) |  
|Operating profit before net finance income / (expenses)   |  | 1,934         |   |  | 1,549 |   |  | 537   |   |  | 69   |  
|Depreciation                                              |  | 725           |   |  | 748   |   |  | 1,632 |   |  | 210  |  
|Fixed assets written off                                  |  | 27            |   |  | 9     |   |  | 24    |   |  | 3    |  
|Increase in stores and spares                             |  | (27           | ) |  | (41   | ) |  | (65   | ) |  | (8   | )
|Increase in other receivables                             |  | (539          | ) |  | (69   | ) |  | (262  | ) |  | (34  | )
|Increase/(decrease) in other payables and deferred income |  | 783           |   |  | (17   | ) |  | 440   |   |  | 56   |  
|                                                          |  |               |   |  |       |   |  |       |   |  |      |  
|                                                          |  | 2,903         |   |  | 2,179 |   |  | 2,306 |   |  | 296  |  
|                                                          |  |               |   |  |       |   |  |       |   |  |      |  



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|35 | Related parties
|-- | ---------------



The Corporation is wholly owned by the Government. The Corporation has entered into transactions with the Government in respect of the developments of the
West Rail, Phase I and East Rail Extensions which are considered to be related party transactions under Statement of Standard Accounting Practice 20 and these are disclosed in notes 1, 2(c), 10(i), 11(b) and (c), 12, 14, 17, 21 and 25 to the
financial statements. Transactions with Government departments and agencies in the course of their normal dealings with the Corporation are not considered to be related party transactions.



Members of the Managing Board and the Executive Directors who are not Members
of the Managing Board and parties related to them are also related parties of the Corporation. During the year there were no significant transactions with any such parties other than their remuneration which is disclosed in note 4 to the financial
statements.



The Corporation and four other local transport
companies (including the MTR Corporation Limited) entered into an agreement in 1994 to develop and operate the Octopus cards system through a central body called Octopus Cards Limited. During the year, Octopus Cards Limited earned fees for the use
of the Octopus cards system from the Corporation and paid ticket loading agent fees to the Corporation. Details of the transactions are disclosed in note 15 to the financial statements.



|36 | Outstanding commitments
|-- | -----------------------



(a) Commitments outstanding at December 31, 2004 in respect of capital expenditure not provided for in the financial statements were as follows:



|                                  |  |               |  |        |  |       |  |     
|--------------------------------- |  | ------------- |  | ------ |  | ----- |  | ----
|                                  |  | 2002          |  | 2003   |  | 2004  |  | 2004
|                                  |  | HK$           |  | HK$    |  | HK$   |  | US$ 
|                                  |  | (in millions)
|Authorized and contracted for     |  | 15,011        |  | 7,151  |  | 2,951 |  | 380 
|Authorized but not contracted for |  | 4,576         |  | 6,154  |  | 2,015 |  | 259 
|                                  |  |               |  |        |  |       |  |     
|                                  |  | 19,587        |  | 13,305 |  | 4,966 |  | 639 
|                                  |  |               |  |        |  |       |  |     



(b) As December 31, 2004, the total
future minimum lease payments under non-cancellable operating leases for property are payable as follows:



|                                |  |               |  |      |  |      |  |     
|------------------------------- |  | ------------- |  | ---- |  | ---- |  | ----
|                                |  | 2002          |  | 2003 |  | 2004 |  | 2004
|                                |  | HK$           |  | HK$  |  | HK$  |  | US$ 
|                                |  | (in millions)
|Within 1 year                   |  | 148           |  | 87   |  | 40   |  | 5   
|After 1 year but within 5 years |  | 125           |  | 53   |  | 18   |  | 2   
|                                |  |               |  |      |  |      |  |     
|                                |  | 273           |  | 140  |  | 58   |  | 7   
|                                |  |               |  |      |  |      |  |     



The operating leases
are mainly related to work areas used for construction of new railways. During the year amounts payable under operating leases totalling HK$54 million (US$7 million) (2003: HK$105 million) were capitalized as part of construction in progress or
deferred expenditure, as appropriate.



F-44



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|37 | Retirement benefit scheme
|-- | -------------------------



The Kowloon-Canton Railway Corporation Retirement Benefit Scheme (the Scheme) was established on February 1, 1983 under trust. With effect
from November 16, 1994, the Scheme has been registered under Section 18 of the Occupational Retirement Schemes Ordinance.



Prior to January 1, 2000, the Scheme was a defined benefit retirement scheme which provided benefits for all eligible employees of the Corporation.
Benefits were calculated by reference to the unit price, accrued service, salary and number of accumulated units of a member. With effect from January 1, 2000, a new defined contribution section has been introduced to the Scheme by means of a Deed
of Variation dated February 24, 2000. All eligible employees joining the Corporation on or after January 1, 2000 joined the new defined contribution section of the Scheme.



Following the agreement of more than 90% of the members of the defined benefit section of the Scheme, with effect from April
1, 2000, all 3,709 members (excluding 37 non consenters) joined the defined contribution section and the 37 non consenters ceased to be members of the Scheme on April 1, 2000. Pursuant to a Deed of Variation dated March 31, 2000, the defined benefit
section of the Scheme was terminated and a Mandatory Provident Fund (MPF) Appendix was introduced to the Scheme. From April 1, 2000, all benefits payable under the Scheme are calculated by reference to the Corporations
contributions and members own contributions, together with investment returns on these contributions.



For members joining the Scheme before January 1, 2000, the Corporations contribution rates are 12% and 16% of the respective salaries of
non-management staff and management staff. For members joining on or after January 1, 2000, the Corporations contribution rates for the first eight years are 8% and 12% of the respective salaries of non-management staff and management staff
and, thereafter, the contribution rates will be 10% and 15% of the respective salaries of non-management staff and management staff.



On July 17, 2000, the Scheme was granted an exemption certificate by the Mandatory Provident Fund Schemes Authority under Section 5 of the Mandatory
Provident Fund Schemes Ordinance. This means that all potential future members of the Scheme must be given a one-off opportunity to elect to join either the Scheme or an MPF Scheme. As of December 31, 2001, most of the eligible members of the Scheme
opted to join the Scheme.



Where there are employees who leave
the Scheme prior to their entitlement to all or part of the Corporations contributions vesting fully, such contributions shall be used to reduce the future contributions of the Corporation due under the Scheme.



The Groups total retirement cost charged to the income statement during
the year ended December 31, 2004 amounted to HK$121million (US$16 million) (2003: HK$108 million; 2002: HK$110 million) net of a capitalized amount of HK$17 million (US$2 million) (2003: HK$29 million; 2002: HK$19 million), after a forfeiture of
unvested contributions of HK$3 million (US$ nil) (2003: HK$2 million; 2002: HK$4 million).



F-45



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|38 | Debt facilities and programs
|-- | ----------------------------



Total unutilised debt facilities and programs available to the Group comprise:



|                                                                                                                                      |  |               |  |        |  |      
|------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- |  | ------ |  | -----
|                                                                                                                                      |  | 2003          |  | 2004   |  | 2004 
|                                                                                                                                      |  | HK$           |  | HK$    |  | US$  
|                                                                                                                                      |  | (in millions)
|HK$1,650 million (US$212 million) (2003: HK$2,350 million; 2002: HK$2,250 million) short-term uncommitted revolving credit
facilities |  | 2,350         |  | 1,650  |  | 212  
|HK$20 million (US$3 million) (2003: HK$20 million; 2002: HK$20 million) letters of credit                                             |  | 20            |  | 20     |  | 3    
|HK$25 million (US$3 million) (2003: HK$25 million; 2002: HK$25 million) overdraft facilities                                          |  | 25            |  | 25     |  | 3    
|HK$8,000 million (US$1,029 million) (2003: HK$ nil; 2002: HK$ nil) syndicated loan facilities                                         |  |              |  | 8,000  |  | 1,029
|US$3,000 million (2003: US$3,000 million; 2002: US$3,000 million) Euro medium term note program                                       |  | 14,399        |  | 14,425 |  | 1,856
|US$292 million (2003: US$292 million; 2002: US$236 million) letters of credit for leveraged leases                                    |  | 2,276         |  | 2,280  |  | 293  
|US$258 million (2003: US$296 million; 2002: US$380 million) export credit loan facilities                                             |  | 51            |  | 29     |  | 4    
|                                                                                                                                      |  |               |  |        |  |      
|                                                                                                                                      |  | 19,121        |  | 26,429 |  | 3,400
|                                                                                                                                      |  |               |  |        |  |      



|39 | Off-balance sheet financial instruments
|-- | ---------------------------------------



The Group uses off-balance sheet derivative financial instruments such as interest rate swaps, currency swaps and foreign exchange forward contracts to
manage its interest rate and foreign currency risks. All transactions in derivative instruments are undertaken by the Group solely for hedging purposes. The Group does not engage in the trading or speculation of derivative financial instruments. As
at December 31, 2004, the Group has outstanding derivative financial instruments in the notional amount of HK$21,867 million (US$2,813 million) (2003: HK$24,850 million) comprising:



|                                   |  |               |  |        |  |      
|---------------------------------- |  | ------------- |  | ------ |  | -----
|                                   |  | 2003          |  | 2004   |  | 2004 
|                                   |  | HK$           |  | HK$    |  | US$  
|                                   |  | (in millions)
|Interest rate swaps                |  | 5,697         |  | 4,142  |  | 533  
|Cross currency swaps               |  | 15,573        |  | 15,184 |  | 1,953
|Foreign exchange forward contracts |  | 3,580         |  | 2,541  |  | 327  
|                                   |  |               |  |        |  |      
|                                   |  | 24,850        |  | 21,867 |  | 2,813
|                                   |  |               |  |        |  |      



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|40 | Contingent liabilities
|-- | ----------------------



(a) At December 31, 2004, the Group had contingent liabilities arising from certain contractors claims in respect of the contracts for the construction of the West
Rail and East Rail Extensions projects where the Groups total obligations cannot be estimated reliably. The Group has made provision in the financial statements at December 31, 2004 for its best estimate of amounts which are likely to be
payable in connection with these claims. The amounts payable upon resolution of the claims may be eventually in excess of amounts estimated by the Group and accounted for in the financial statements at December 31, 2004. The Group is in the process
of resolving these claims.



(b) The lease arrangements referred to in note
10(h) are subject to certain terms and conditions under the related agreements whereby one of the lease arrangements may be subject to mandatory termination upon the occurrence of certain specified events or circumstances. Management has considered
the likelihood of such events occurring and has concluded that there was a possibility that one of the lease arrangements may be subject to mandatory termination before the end of the basic lease term. Should mandatory termination of the lease
arrangement occur, the maximum exposure of the Group after deduction of the transaction benefit is estimated to be approximately HK$62 million (US$8 million) at December 31, 2004 (2003: $65 million), the actual amount of which will depend on the
interest rates prevailing at the date of termination.



|41 | Assessment of impairment of fixed assets
|-- | ----------------------------------------



At December 31, 2004 the Group assessed whether there was any impairment of the Groups fixed assets at that date in accordance with the Groups
accounting policies for the assessment of asset impairment.



In
assessing the value in use of the Groups railway assets the entire railway network, current and committed, has been treated as representing the smallest cash-generating unit on the basis that once the Kowloon Southern Link, which has been
gazetted by the Government, is completed in 2009 the current East Rail and West Rail networks will be linked and it will not be possible to allocate passenger revenue to any specific part of the network.



The estimated cash flows of the railway network were calculated for a period
consistent with the estimated useful life of the core assets of the railway network and were discounted using the Corporations weighted average cost of capital at December 31, 2004.



As a result of this assessment, management consider that the railway assets of the Group are not impaired at December 31,
2004 and, accordingly, that no provision for impairment of the Groups railway assets is required at that date.



|42 | Possible merger of the Corporation and MTR Corporation Limited
|-- | --------------------------------------------------------------



On February 24, 2004, the Government invited the two railway corporations to commence negotiations on a possible merger. On September 16, 2004, the two
corporations submitted their Joint Merger Report to the Government on the outcome of their negotiations, including preliminary transaction terms and the framework of a draft operating agreement with key terms on, inter alia, the fare adjustment
mechanism, and safeguards and measures to deal with service disruption. The Government is currently considering the content of the Report.



These financial statements have not included any adjustments to the carrying value of assets or liabilities which may be required once the Government
announces the results of its study of the report as it is uncertain what will be the outcome and the consequent effect on the Corporations operations and financial condition.



|43 | Recently issued financial reporting standards
|-- | ---------------------------------------------



The Hong Kong Institute of Certified Public Accountants has recently issued a number of new and revised financial reporting standards (HKFRSs)
which will be applicable for accounting period beginning on or after January 1, 2005. The Corporation has already commenced an assessment of the impact of these new and revised HKFRSs but is not yet in a position to determine whether these new and
revised HKFRSs will have a significant impact on the results of operations and financial position of the Corporation.



F-47



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|44 | Summary of differences between accounting principles generally accepted in Hong Kong and the United States
|-- | ----------------------------------------------------------------------------------------------------------



The Groups consolidated financial statements are prepared in
accordance with accounting principles generally accepted in Hong Kong (HK GAAP), which differ in certain significant respects from accounting principles generally accepted in the United States (US GAAP). The differences
relate to the following items and the adjustments considered necessary to reconcile the Groups consolidated profit after taxation and consolidated balance sheet information to US GAAP are as follows:



|(a) | Investment property revaluation and depreciation
|--- | ------------------------------------------------



Under HK GAAP, investment properties are stated on the basis of appraised values and depreciation expense is not provided on investment properties (see
notes 2(f) and 2(g)). Under US GAAP, such revaluations are not permitted. Accordingly, the investment properties of the Group, which are stated at open market value, have been restated at historical cost less accumulated depreciation.



Depreciation has been based on the historical cost of the properties and a
useful life of 50 years. The gross historical cost of properties subject to depreciation under US GAAP which are not depreciated under HK GAAP amounted to HK$761 million, HK$761 million and HK$761 million (US$98 million) at December 31, 2002,
December 31, 2003 and December 31, 2004, respectively.



|(b) | Depreciation on certain fixed assets
|--- | ------------------------------------



As permitted by HK GAAP, the initial costs of the Groups permanent way, which principally comprises rail tracks, ballast and sleepers, is not
depreciated. The costs of replacement of permanent way are charged to the income statement as and when the expenses are incurred (see note2(g)).



Under US GAAP the costs of permanent way are depreciated over the estimated useful lives of the assets and the costs of replacement are capitalized and
depreciated over their estimated useful lives.



In previous
years, no adjustments under US GAAP were made for the permanent way relating to the East Rail and Light Rail systems on the basis that the original costs of the permanent way would have already been fully depreciated under US GAAP and on the basis
that the cumulative effect of the difference in accounting for the costs of replacement of the permanent way under HK GAAP and US GAAP was not significant.



The Groups new railway system and extensions, the West Rail system, the Tsim Sha Tsui Extension and the Ma On Shan Rail, were put into use on
December 20, 2003, October 24, 2004 and December 21, 2004 respectively. As permitted by HK GAAP, the costs of the permanent way of these routes are not depreciated. Under US GAAP the costs of the permanent way of these routes are depreciated over
the estimated useful lives of the assets. Accordingly, an adjustment of HK$104 million (US$13 million) has been made to the income statement to record the depreciation charge for the year ended December 31, 2004 under US GAAP calculated using a
straight line basis over the estimated useful lives ranged from 10 to 15 years. In 2003, no adjustment was made for the depreciation charge on the permanent way of the West Rail system as the effect of the 12 days period was not material.



In addition, an adjustment of HK$15 million (US$2 million)
(net of related depreciation charges of HK$1 million (US$nil)) has been made to the income statement to reverse the costs of replacement of permanent way charged to income statement for the year ended December 31, 2004 under HK GAAP.



|(c) | Investments
|--- | -----------



Under HK GAAP, investment securities are stated in the balance sheet at fair value. Changes in fair value of pre-funding investments (see note 2(m)) are capitalized to construction in progress or deferred expenditure.
Additionally, interest earned and realized gains and losses on pre-funding investments are capitalized (see note 2(q)) to construction in progress or deferred expenditure. When the construction projects are complete and the related assets are ready
for their intended use the net cumulative costs are transferred from construction in progress to fixed assets and depreciated in accordance with the Groups depreciation policies. The depreciation charge for the year under HK GAAP is based on
the net capitalized costs including interest earned and realized and unrealized gains and losses on pre-funding investments.



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|44 | Summary of differences between accounting principles generally accepted in Hong Kong and the United States (continued)
|-- | ----------------------------------------------------------------------------------------------------------------------



Under US GAAP, the Groups investments in debt securities are classified
as available for sale and reported at fair value, with unrealized gains and losses net of applicable income taxes reported in other comprehensive income. Additionally, under US GAAP, interest earned and realized gains and losses on
investments are reflected in the income statement. Accordingly, under US GAAP, the depreciation charge on fixed assets is based on the costs capitalized in accordance with US GAAP which exclude interest earned and realized and unrealized gains and
losses on pre-funding investments.



Under both HK GAAP and US
GAAP, no provision for impairment or reversal of prior years provisions for impairment of investment securities has been made for the years ended December 31, 2002, December 31, 2003 and December 31, 2004.



The costs of the Groups fixed assets in respect of the West Rail
system, the Tsim Sha Tsui Extension and the Ma On Shan Rail include interest earned and realized and unrealized gains and losses on pre-funding investments capitalized under HK GAAP. As the fixed assets in respect of the West Rail system, the Tsim
Sha Tsui Extension and the Ma On Shan Rail have been put into use and subject to depreciation since December 20, 2003, October 24, 2004 and December 21, 2004 respectively, an adjustment of HK$88 million (US$11 million) has been made to the income
statement to record the depreciation charge for the year ended December 31, 2004 under US GAAP based on the costs of the fixed assets of these routes excluding capitalized interest earned and realized and unrealized gains and losses on pre-funding
investments. In 2003, no adjustment was made for the depreciation charge on the fixed assets of the West Rail system as the effect of the 12 days period was not material.



|(d) | Revenue recognition on property development
|--- | -------------------------------------------



In 1997, the Group disposed of certain investment properties in exchange for other investment properties. The cost of the acquired properties was stated
at the fair value of the properties disposed of. Under US GAAP, the cost of the acquired properties should be stated at the cost of the properties being disposed of. Accordingly, an adjustment of HK$61 million (US$8 million) has been made to
shareholders equity to restate the cost of properties acquired under US GAAP. This adjustment will be reversed upon disposal of the related properties.



|(e) | Capitalization of certain costs
|--- | -------------------------------



Under HK GAAP, certain costs of a non-incremental nature are capitalized in connection with capital projects. Under US GAAP, it is not permissible to
capitalize these non-incremental costs. The preponderance of the capitalized costs relating to capital projects is incremental in nature and, accordingly, is properly capitalized under both HK GAAP and US GAAP.



|(f) | Capitalized interest and foreign exchange gains and losses
|--- | ----------------------------------------------------------



Under HK GAAP, prior to January 1, 1997, the Group did not capitalize interest costs to capital projects.



Under US GAAP, interest costs, to the extent incurred, are required to be
capitalized to capital projects. Capitalized interest costs are determined based on specific borrowings related to the acquisition or construction of an asset, if an entitys financing plans associate a specific new borrowing with a qualifying
asset. If average accumulated expenditure for the asset exceeds the amounts of specific new borrowings associated with the asset, additional interest costs capitalized are based on the weighted average rate applicable to other borrowings of the
entity.



With effect from January 1, 1997, the Groups
accounting policy under HK GAAP for capitalizing interest costs is similar to US GAAP. The gross interest costs not capitalized under HK GAAP prior to January 1, 1997 amounted to HK$ 613 million (US79 million) which was previously adjusted for US
GAAP purposes. In addition, adjustments of HK$10 million, HK$9 million and HK$9 million (US1 million), have been made to the income statement to record the depreciation charge for the years ended December 31, 2002, December 31, 2003 and December 31,
2004 respectively under USGAAP based on the costs of fixed assets including capitalized interest costs of HK$613 million (US79 million). The related adjustments to accumulated depreciation amounted to HK$373 million and HK$382 million (US$49
million) as of December 31, 2003 and December 31, 2004 respectively.



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|44 | Summary of differences between accounting principles generally accepted in Hong Kong and the United States (continued)
|-- | ----------------------------------------------------------------------------------------------------------------------



|(f) | Capitalized interest and foreign exchange gains and losses (continued)
|--- | ----------------------------------------------------------------------



Further, under HK GAAP, foreign exchange differences are capitalized to the extent that they are regarded as an adjustment to interest costs. Under US
GAAP, foreign exchange differences are not capitalized.



|(g) | Income taxes
|--- | ------------



Under US GAAP income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized
in income statement in the period that includes the enactment date.



With effect from January 1, 2003, the Groups accounting policy under HK GAAP for the recognition of deferred tax as set out in note 2(s) is similar to US GAAP except that under HK GAAP all deferred tax assets are recognized to the
extent that it is probable that future taxable profits will be available against which the asset can be utilised. The Groups tax losses do not expire under current tax legislation. As a result, there is currently no difference in the
recognition of deferred tax assets between HK GAAP and US GAAP.



|(h) | Derivative financial instruments (derivatives)
|--- | ------------------------------------------------



Under US GAAP, all derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. If the
derivative is designated as a fair value hedge, the changes in fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective
portions of changes in the fair value of the derivative are recorded in other comprehensive income and are recognized in the income statement when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow
hedges are recognized in earnings immediately.



Under HK GAAP,
derivatives are not required to be recorded on the balance sheet.



|(i) | Lease out and lease back transactions
|--- | -------------------------------------



Under HK GAAP, where commitments by the Group to make long-term lease payments have been defeased by the placement of security deposits or advances of
loans under lease out and lease back transactions, those commitments and deposits or loans receivable are not recognized as obligations and assets of the Group. In the case where the Groups commitments and deposits or loans receivable meet the
definition of a liability and an asset, such commitments and deposits or loans receivable are recognized as obligations and assets in the balance sheet (see note 2(o)).



Under US GAAP, cash deposits cannot be used to offset obligations if there is no legal right to offset. The security
deposits placed or loans advanced by the Group, which are used to defease the lease obligations and consist of cash lease deposits, cannot be used to offset the lease obligations since there is no legal right to offset. Accordingly, under US GAAP
the security deposits placed or loans advanced to defease the lease obligations and the related commitments to make long-term lease payments would be reflected separately in the balance sheet.



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|44 | Summary of differences between accounting principles generally accepted in Hong Kong and the United States (continued)
|-- | ----------------------------------------------------------------------------------------------------------------------



|(j) | Recently issued accounting standard
|--- | -----------------------------------



In January 2003, the Financial Accounting Standard Board (FASB) issued FASB Interpretation No. 46, Consolidation of Variable Interest
Entities (FIN 46) and in December 2003, issued a revision to FIN 46 (FIN 46R) which supersedes FIN 46. FIN 46R is an effort to expand upon and strengthen existing accounting guidance as to when an entity should
consolidate the financial results of another entity. FIN 46R requires variable interest entities (VIE) as defined therein to be consolidated by an entity if that entity is obligated to bear a majority of expected losses of
the VIE or is entitled to receive a majority of expected residual returns of the VIE, or both. The entity that is required to consolidate a VIE is referred to as the VIEs primary beneficiary. The interpretation also requires certain
disclosures about VIEs that an entity is not required to consolidate, but in which it has a significant variable interest.



The Group is required to apply FIN 46R to variable interests in VIEs created after December 31, 2003. For variable interests in VIEs created before
January 1, 2004, FIN 46R will be applied in the financial statements for the period beginning January 1, 2005. For VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and non-controlling
interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting
change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and non-controlling interest of the VIE.



The Corporation is evaluating the impact of applying FIN 46R to existing VIEs
in which it has variable interests and has not yet completed this analysis. The Group does not have any variable interests in VIEs created after December 31, 2003. However, the Corporation believes that an unrelated entity created in December 2003
under one of the Groups lease out and lease back transactions meets the criteria to be a VIE. Under this transaction, the Group has loaned a portion of the lease prepayments received from the overseas investor to an unrelated entity created in
December 2003 for the sole purpose of investing the loan proceeds in available for sale debt securities and other financial assets structured to meet the Groups lease obligations arising from the transaction. As the Group is
obligated to bear the loss or is entitled to receive the gain which may arise from the realisation of the available for sale debt securities upon termination of the transaction before the end of the basic lease term, the Group is
considered to be the unrelated entitys primary beneficiary. As such, it is reasonably possible that the Group would be required to consolidate such unrelated entity under the requirements of FIN 46R in compliance with US GAAP for the year
ending December 31, 2005.



As the Groups loan receivable
from this unrelated entity and lease obligations arising from this lease out and lease back transaction have already been reflected separately in the reconciliation of consolidated shareholders funds to US GAAP, the consolidation of this
unrelated entity is not expected to have material impact on the Groups financial position. Apart from this, the Corporation does not consider that there are any other VIEs in which the Group has significant variable interests or primary
beneficial interests.



|(k) | Statement of cash flows
|--- | -----------------------



Under HK GAAP, the Group presents its cash flows for: (a) operating activities; (b) investing activities; and (c) financing activities. Interest received
is included in investing activities while interest paid and financing expenses paid are included in financing activities.



Under US GAAP, interest received, interest paid and financing expenses paid are all included in operating activities. The Group considers all highly
liquid investments purchased with a maturity of three months or less to be cash or cash equivalents. Summarized cash flow data by operating, investing and financing activities in accordance with US GAAP are set out below:



|                                          |  |               |   |  |        |   |  |        |   |  |      |  
|----------------------------------------- |  | ------------- | - |  | ------ | - |  | ------ | - |  | ---- | -
|                                          |  | 2002          |   |  | 2003   |   |  | 2004   |   |  | 2004 |  
|                                          |  | HK$           |   |  | HK$    |   |  | HK$    |   |  | US$  |  
|                                          |  | (in millions) |  
|Net cash provided / (used) by:            |  |               |   |  |        |   |  |        |   |  |      |  
|Operating activities                      |  | 3,087         |   |  | 1,333  |   |  | 2,012  |   |  | 259  |  
|Investing activities                      |  | (1,894        | ) |  | (5,092 | ) |  | (1,005 | ) |  | (129 | )
|Financing activities                      |  | 928           |   |  | 1,651  |   |  | (893   | ) |  | (115 | )
|                                          |  |               |   |  |        |   |  |        |   |  |      |  
|Change in cash and cash equivalents       |  | 2,121         |   |  | (2,108 | ) |  | 114    |   |  | 15   |  
|Cash and cash equivalents at January 1,   |  | 2,464         |   |  | 4,585  |   |  | 2,477  |   |  | 318  |  
|                                          |  |               |   |  |        |   |  |        |   |  |      |  
|Cash and cash equivalents at December 31, |  | 4,585         |   |  | 2,477  |   |  | 2,591  |   |  | 333  |  
|                                          |  |               |   |  |        |   |  |        |   |  |      |  



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|44 | Summary of differences between accounting principles generally accepted in Hong Kong and the United States (continued)
|-- | ----------------------------------------------------------------------------------------------------------------------



|(l) | Statement of changes in shareholders equity in accordance with US GAAP
|--- | -----------------------------------------------------------------------



The changes of shareholders equity in accordance with US GAAP are as follows:



|                                                                                                                            |  |               |   |  |        |   |  |        |   |  |       |  
|--------------------------------------------------------------------------------------------------------------------------- |  | ------------- | - |  | ------ | - |  | ------ | - |  | ----- | -
|                                                                                                                            |  | 2002          |   |  | 2003   |   |  | 2004   |   |  | 2004  |  
|                                                                                                                            |  | HK$           |   |  | HK$    |   |  | HK$    |   |  | US$   |  
|                                                                                                                            |  | (in millions) |  
|Balance at January 1,                                                                                                       |  | 63,778        |   |  | 66,205 |   |  | 66,743 |   |  | 8,587 |  
|Net profit for the year                                                                                                     |  | 2,951         |   |  | 1,512  |   |  | 312    |   |  | 40    |  
|Other comprehensive income / (loss)                                                                                         |  |               |   |  |        |   |  |        |   |  |       |  
|Decrease in fair value of investments in available for sale securities                                                    |  | (516          | ) |  | (197   | ) |  | (103   | ) |  | (13   | )
|Amounts transferred to net profit for the year on redemption and disposal of investments in available for sale
securities |  | 55            |   |  | 60     |   |  | 79     |   |  | 10    |  
|Decrease in fair value of cash flow hedges                                                                                  |  | (63           | ) |  | (303   | ) |  | (518   | ) |  | (67   | )
|Net increase in deferred tax benefits                                                                                       |  |              |   |  | 86     |   |  | 93     |   |  | 12    |  
|Dividend approved during the year                                                                                           |  |              |   |  | (620   | ) |  | (620   | ) |  | (79   | )
|                                                                                                                            |  |               |   |  |        |   |  |        |   |  |       |  
|Balance as at December 31,                                                                                                  |  | 66,205        |   |  | 66,743 |   |  | 65,986 |   |  | 8,490 |  
|                                                                                                                            |  |               |   |  |        |   |  |        |   |  |       |  



|(m) | Adjustments to balance sheet items under US GAAP
|--- | ------------------------------------------------



The cumulative adjustments to the balance sheet items, except deferred taxes, under US GAAP as a result of the differences between HK GAAP and US GAAP as
described in notes 44(a) to 44(f) are set out as follows:



|                                                              |  |      |   |  |               |   |  |       |   |  |      |  
|------------------------------------------------------------- |  | ---- | - |  | ------------- | - |  | ----- | - |  | ---- | -
|                                                              |  |      |   |  | 2003          |   |  | 2004  |   |  | 2004 |  
|                                                              |  |      |   |  | HK$           |   |  | HK$   |   |  | US$  |  
|                                                              |  | Note |   |  | (in millions) |  
|Fixed assets                                                  |  |      |   |  |               |   |  |       |   |  |      |  
|- investment property revaluation and depreciation            |  | 44(a | ) |  | (239          | ) |  | (401  | ) |  | (52  | )
|- accumulated depreciation on certain fixed assets            |  | 44(b | ) |  |              |   |  | (89   | ) |  | (11  | )
|- investment income capitalized under HKGAAP                  |  | 44(c | ) |  | 5,094         |   |  | 6,039 |   |  | 777  |  
|- accumulated depreciation on interest income capitalized     |  | 44(c | ) |  |              |   |  | (88   | ) |  | (11  | )
|- revenue recognition on property development                 |  | 44(d | ) |  | (61           | ) |  | (61   | ) |  | (8   | )
|- capitalization of certain costs net of related depreciation |  | 44(e | ) |  | (362          | ) |  | (498  | ) |  | (64  | )
|- capitalization of interest net of related amortization      |  | 44(f | ) |  | 240           |   |  | 231   |   |  | 30   |  
|- capitalized net foreign exchange losses                     |  | 44(f | ) |  | (44           | ) |  | (36   | ) |  | (5   | )
|                                                              |  |      |   |  |               |   |  |       |   |  |      |  
|                                                              |  |      |   |  | 4,628         |   |  | 5,097 |   |  | 656  |  
|                                                              |  |      |   |  |               |   |  |       |   |  |      |  
|Construction in progress                                      |  |      |   |  |               |   |  |       |   |  |      |  
|- investment income capitalized under HKGAAP                  |  | 44(c | ) |  | 2,839         |   |  | 1,960 |   |  | 252  |  
|- valuation of investment portfolio                           |  | 44(c | ) |  | (1            | ) |  | (8    | ) |  | (1   | )
|- capitalization of certain costs net of related depreciation |  | 44(e | ) |  | (188          | ) |  | (57   | ) |  | (7   | )
|- capitalized net foreign exchange losses                     |  | 44(f | ) |  | (15           | ) |  | (13   | ) |  | (2   | )
|                                                              |  |      |   |  |               |   |  |       |   |  |      |  
|                                                              |  |      |   |  | 2,635         |   |  | 1,882 |   |  | 242  |  
|                                                              |  |      |   |  |               |   |  |       |   |  |      |  
|Deferred expenditure                                          |  |      |   |  |               |   |  |       |   |  |      |  
|- investment income capitalized under HKGAAP                  |  | 44(c | ) |  | 12            |   |  | 22    |   |  | 3    |  
|- valuation of investment portfolio                           |  | 44(c | ) |  |              |   |  | (2    | ) |  |     |  
|- capitalization of certain costs net of related depreciation |  | 44(e | ) |  | (62           | ) |  | (81   | ) |  | (10  | )
|- capitalized net foreign exchange losses                     |  | 44(f | ) |  | 2             |   |  | 2     |   |  |     |  
|                                                              |  |      |   |  |               |   |  |       |   |  |      |  
|                                                              |  |      |   |  | (48           | ) |  | (59   | ) |  | (7   | )
|                                                              |  |      |   |  |               |   |  |       |   |  |      |  



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KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS  (Continued)

December 31, 2002, 2003, 2004



|44 | Summary of differences between accounting principles generally accepted in Hong Kong and the United States (continued)
|-- | ----------------------------------------------------------------------------------------------------------------------



|(n) | Reconciliation of consolidated profit after taxation to US GAAP
|--- | ---------------------------------------------------------------



|                                                                           |  |      |   |  |                         |   |  |       |   |  |      |   |  |      |  
|-------------------------------------------------------------------------- |  | ---- | - |  | ----------------------- | - |  | ----- | - |  | ---- | - |  | ---- | -
|                                                                           |  |      |   |  | Year ended December 31, |  
|                                                                           |  | Note |   |  | 2002                    |   |  | 2003  |   |  | 2004 |   |  | 2004 |  
|                                                                           |  |      |   |  | HK$                     |   |  | HK$   |   |  | HK$  |   |  | US$  |  
|                                                                           |  |      |   |  | (in millions)           |  
|Consolidated profit after taxation for the year in accordance with HK GAAP |  |      |   |  | 2,210                   |   |  | 1,381 |   |  | 429  |   |  | 55   |  
|Adjustments required under US GAAP                                         |  |      |   |  |                         |   |  |       |   |  |      |   |  |      |  
|Depreciation on investment properties                                      |  | 44(a | ) |  | (12                     | ) |  | (15   | ) |  | (14  | ) |  | (2   | )
|Depreciation on certain fixed assets                                       |  | 44(b | ) |  |                        |   |  |      |   |  | (89  | ) |  | (11  | )
|Depreciation on interest income capitalized                                |  | 44(c | ) |  |                        |   |  |      |   |  | (88  | ) |  | (11  | )
|Investment income capitalized under HK GAAP                                |  | 44(c | ) |  | 975                     |   |  | 292   |   |  | 76   |   |  | 10   |  
|Revenue recognition of property development                                |  | 44(d | ) |  | (73                     | ) |  |      |   |  |     |   |  |     |  
|Capitalization of certain costs net of related depreciation                |  | 44(e | ) |  | (112                    | ) |  | (119  | ) |  | (24  | ) |  | (3   | )
|Amortization of capitalized interest                                       |  | 44(f | ) |  | (10                     | ) |  | (9    | ) |  | (9   | ) |  | (1   | )
|Capitalized net foreign exchange differences                               |  | 44(f | ) |  | 1                       |   |  | (19   | ) |  | 10   |   |  | 1    |  
|Derivative financial instruments                                           |  | 44(h | ) |  | (3                      | ) |  | 24    |   |  | (17  | ) |  | (2   | )
|Tax effect of the above adjustments                                        |  |      |   |  | (25                     | ) |  | (23   | ) |  | 38   |   |  | 4    |  
|                                                                           |  |      |   |  |                         |   |  |       |   |  |      |   |  |      |  
|Consolidated net income for the year in accordance with US GAAP            |  |      |   |  | 2,951                   |   |  | 1,512 |   |  | 312  |   |  | 40   |  
|                                                                           |  |      |   |  |                         |   |  |       |   |  |      |   |  |      |  



|(o) | Reconciliation of consolidated total equity to US GAAP
|--- | ------------------------------------------------------



|                                                             |  |      |   |  |                    |   |  |         |   |  |        |  
|------------------------------------------------------------ |  | ---- | - |  | ------------------ | - |  | ------- | - |  | ------ | -
|                                                             |  |      |   |  | As of December 31, |  
|                                                             |  | Note |   |  | 2003               |   |  | 2004    |   |  | 2004   |  
|                                                             |  |      |   |  | HK$                |   |  | HK$     |   |  | US$    |  
|                                                             |  |      |   |  | (in millions)      |  
|Consolidated total equity in accordance with HK GAAP         |  |      |   |  | 60,205             |   |  | 60,147  |   |  | 7,738  |  
|Adjustments required under US GAAP                           |  |      |   |  |                    |   |  |         |   |  |        |  
|Accumulated depreciation on investment properties            |  | 44(a | ) |  | (122               | ) |  | (136    | ) |  | (18    | )
|Asset revaluation reserve                                    |  | 44(a | ) |  | (117               | ) |  | (265    | ) |  | (34    | )
|Accumulated depreciation on certain fixed assets             |  | 44(b | ) |  |                   |   |  | (89     | ) |  | (11    | )
|Accumulated depreciation on interest income capitalized      |  | 44(c | ) |  |                   |   |  | (88     | ) |  | (11    | )
|Valuation of investment portfolio                            |  | 44(c | ) |  | (1                 | ) |  | (10     | ) |  | (1     | )
|Investment income capitalized under HK GAAP                  |  | 44(c | ) |  | 7,945              |   |  | 8,021   |   |  | 1,032  |  
|Revenue recognition on property development                  |  | 44(d | ) |  | (61                | ) |  | (61     | ) |  | (8     | )
|Capitalization of certain costs net of related depreciation  |  | 44(e | ) |  | (612               | ) |  | (636    | ) |  | (82    | )
|Capitalization of interest net of related amortization       |  | 44(f | ) |  | 240                |   |  | 231     |   |  | 30     |  
|Capitalized net foreign exchange differences                 |  | 44(f | ) |  | (57                | ) |  | (47     | ) |  | (6     | )
|Derivative instruments                                       |  | 44(h | ) |  | (497               | ) |  | (1,032  | ) |  | (133   | )
|Lease obligations                                            |  | 44(i | ) |  | (12,742            | ) |  | (13,041 | ) |  | (1,678 | )
|Lease deposits and loan receivable                           |  | 44(i | ) |  | 12,742             |   |  | 13,041  |   |  | 1,678  |  
|Deferred tax liabilities                                     |  |      |   |  | (180               | ) |  | (49     | ) |  | (6     | )
|                                                             |  |      |   |  |                    |   |  |         |   |  |        |  
|Consolidated shareholders equity in accordance with US GAAP |  |      |   |  | 66,743             |   |  | 65,986  |   |  | 8,490  |  
|                                                             |  |      |   |  |                    |   |  |         |   |  |        |  



|(p) | Classification of items in the Consolidated Income Statement
|--- | ------------------------------------------------------------



Under HK GAAP, depreciation charge of HK$725 million, HK$748 million and HK$1,632 million (US$210 million) for the years ended December 31, 2002, December
31, 2003 and December 31, 2004 respectively are excluded from the operating costs and are separately presented in the consolidated income statement.



Under US GAAP, depreciation charge is included as a component of the operating costs.



F-53