##### Table of Contents



As filed with the Securities and Exchange Commission on June 30, 2004 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
 FORM 20-F þ   Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2003 Commission file number 001-15004 Kowloon-Canton Railway Corporation  Not Applicable.  The Hong Kong Special Administrative Region of the Peoples Republic of China  KCRC House, 9 Lok King Street, Fo Tan, Sha Tin, New Territories, Hong Kong  Securities registered or to be registered pursuant to Section 12(b) of the Act: Title of each class
    
    Name of each exchange on which registered8% 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. 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, 2003
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  þ
    
    No  o
 Indicate by check mark which financial statement item the Registrant
has elected to follow. Item 17  þ
    
    Item 18  o




---



TABLE OF CONTENTS PageGENERAL INFORMATION
    
    
    IIEXCHANGE RATE INFORMATION
    
    
    IIFORWARD-LOOKING STATEMENTS
    
    
    IIPART I
    
    
    1ITEM 1.
    
    IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
    
    
    1ITEM 2.
    
    OFFER STATISTICS AND EXPECTED TIMETABLE
    
    
    1ITEM 3.
    
    KEY INFORMATION
    
    
    1ITEM 4.
    
    INFORMATION ON THE CORPORATION
    
    
    8ITEM 5.
    
    OPERATING AND FINANCIAL REVIEW AND PROSPECTS
    
    
    34ITEM 6.
    
    DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
    
    
    53ITEM 7.
    
    MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
    
    
    57ITEM 8.
    
    FINANCIAL INFORMATION
    
    
    59ITEM 9.
    
    THE OFFER AND LISTING
    
    
    60ITEM 10.
    
    ADDITIONAL INFORMATION
    
    
    60ITEM 11.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
    
    
    66ITEM 12.
    
    DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
    
    
    69PART II
    
    
    69ITEM 13.
    
    DEFAULT, DIVIDEND ARREARAGES AND DELINQUENCIES
    
    
    69ITEM 14.
    
    MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
    
    
    69ITEM 15.
    
    CONTROLS AND PROCEDURES
    
    
    69ITEM 16A.
    
    AUDIT COMMITTEE FINANCIAL EXPERT
    
    
    70ITEM 16B.
    
    CODE OF ETHICS
    
    
    70ITEM 16C.
    
    PRINCIPAL ACCOUNTANT FEES AND SERVICES
    
    
    70ITEM 16D.
    
    EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
    
    
    71ITEM 16E.
    
    PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
    
    
    71PART III
    
    
    71ITEM 17.
    
    FINANCIAL STATEMENTS
    
    
    71ITEM 18.
    
    FINANCIAL STATEMENTS
    
    
    71ITEM 19.
    
    EXHIBITS
    
    
    71SIGNATURES
    
    
    S-1INDEX TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
    
    
    F-1EX-1.4 BOARD GENERAL STANDING ORDERSEX-6.1 COMPUTATION OF EARNINGS PER SHAREEX-11.1 CODE OF ETHICSEX-12.1 CERT OF CEO TO SECTION 302EX-12.2 CERT OF DIRECTOR,FINANCE TO SECTION 302EX-13.1 CERT OF CEO TO SECTION 1350EX-13.2 CERT OF DIRECTOR,FINANCE TO SECTION 1350
  i




---



##### Table of Contents



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$7.7640 = 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, 2003. 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). Since 1983, the Hong Kong dollar has been
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. 
 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. ii




---



##### Table of Contents



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;
    
    the decision of the Government on the merger between KCRC and MTR Corporation Limited;
    
    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. iii




---



##### Table of Contents



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, 2001, 2002 and 2003 and Consolidated Balance Sheet Data as of December
31, 2002 and 2003 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, 1999 and 2000 and Consolidated Balance Sheet
Data as of December 31, 1999, 2000 and 2001 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 43 to our audited consolidated
financial statements for a summary of differences between HK GAAP and US GAAP
applicable to us. Year Ended December 31,20021999
    
    2000
    
    2001
    
    restated
    
    2003
    
    2003(10)HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in millions, except per share data)Consolidated Income Statement Data:HK GAAP:Revenue
    
    
    4,426
    
    
    
    4,731
    
    
    
    4,797
    
    
    
    4,830
    
    
    
    4,426
    
    
    
    570Operating costs
    
    
    (2,875
    )
    
    
    (2,830
    )
    
    
    (2,886
    )
    
    
    (2,896
    )
    
    
    (2,877
    )
    
    
    (371
    )Operating profit before net investment income
    
    
    1,551
    
    
    
    1,901
    
    
    
    1,911
    
    
    
    1,934
    
    
    
    1,549
    
    
    
    199Net investment income
    
    
    222
    
    
    
    302
    
    
    
    490
    
    
    
    618
    
    
    
    353
    
    
    
    45Operating profit after net investment income
    
    
    1,773
    
    
    
    2,203
    
    
    
    2,401
    
    
    
    2,552
    
    
    
    1,902
    
    
    
    244Profit on property development
    
    
    71
    
    
    
    87
    
    
    
    24
    
    
    
    94
    
    
    
    
    
    
    
    Share of profits/(losses) of associate
    
    
    
    
    
    
    (1
    )
    
    
    11
    
    
    
    16
    
    
    
    8
    
    
    
    1Profit before taxation
    
    
    1,844
    
    
    
    2,289
    
    
    
    2,436
    
    
    
    2,662
    
    
    
    1,910
    
    
    
    245Taxation(1)
    
    
    59
    
    
    
    (1
    )
    
    
    (1
    )
    
    
    (452
    )
    
    
    (529
    )
    
    
    (67
    )Profit after taxation
    
    
    1,903
    
    
    
    2,288
    
    
    
    2,435
    
    
    
    2,210
    
    
    
    1,381
    
    
    
    178Dividend
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    620
    
    
    
    620
    
    
    
    80Earnings per share(2)  Basic
    
    
    6,563
    
    
    
    7,352
    
    
    
    6,444
    
    
    
    5,649
    
    
    
    3,530
    
    
    
    455Dividend per share
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,585
    
    
    
    1,585
    
    
    
    204US GAAP:Net income
    
    
    3,150
    
    
    
    4,113
    
    
    
    3,792
    
    
    
    2,951
    
    
    
    1,512
    
    
    
    195Earnings per share(2)
    
    
    10,864
    
    
    
    13,217
    
    
    
    10,035
    
    
    
    7,543
    
    
    
    3,865
    
    
    
    498
 1




---



##### Table of Contents



Year Ended December 31,20021999
    
    2000
    
    2001
    
    restated
    
    2003
    
    2003(10)HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in millions, except per share data)Consolidated Balance Sheet Data:HK GAAP:Working capital(3)
    
    
    9,857
    
    
    
    5,727
    
    
    
    2,135
    
    
    
    1,397
    
    
    
    (748
    )
    
    
    (96
    )Total assets(5)
    
    
    58,291
    
    
    
    70,419
    
    
    
    82,537
    
    
    
    86,108
    
    
    
    89,204
    
    
    
    11,490Long-term obligations(4)
    
    
    8,299
    
    
    
    16,395
    
    
    
    16,831
    
    
    
    17,753
    
    
    
    20,771
    
    
    
    2,675Shareholders funds(1)
    
    
    46,588
    
    
    
    48,901
    
    
    
    59,580
    
    
    
    59,512
    
    
    
    60,205
    
    
    
    7,754Issued and outstanding shares
    
    
    311,200
    
    
    
    311,200
    
    
    
    391,200
    
    
    
    391,200
    
    
    
    391,200US GAAP:Total assets(5)
    
    
    63,664
    
    
    
    82,374
    
    
    
    96,815
    
    
    
    102,414
    
    
    
    108,664
    
    
    
    13,996Long-term obligations(5)
    
    
    11,609
    
    
    
    23,759
    
    
    
    24,606
    
    
    
    27,205
    
    
    
    33,513
    
    
    
    4,316Shareholders equity
    
    
    47,538
    
    
    
    51,977
    
    
    
    63,778
    
    
    
    66,205
    
    
    
    66,743
    
    
    
    8,596
 Year Ended December 31,20021999
    
    2000
    
    2001
    
    restated
    
    2003
    
    2003(10)HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in millions, except per share data)Other Consolidated Financial Data:HK GAAP:Capital expenditure(6)
    
    
    8,444
    
    
    
    10,829
    
    
    
    14,595
    
    
    
    12,308
    
    
    
    11,122
    
    
    
    1,433Revenue per employee
    
    
    0.966
    
    
    
    0.972
    
    
    
    0.928
    
    
    
    0.877
    
    
    
    0.754
    
    
    
    0.097Total debt(7)
    
    
    8,299
    
    
    
    16,395
    
    
    
    16,831
    
    
    
    17,753
    
    
    
    20,013
    
    
    
    2,578Debt/equity ratio(7)
    
    
    1:5.6
    
    
    
    1:3.0
    
    
    
    1:3.5
    
    
    
    1:3.4
    
    
    
    1:3.0
    
    
    
    1:3.0Net cash inflow from operating activities
    
    
    2,231
    
    
    
    2,848
    
    
    
    2,429
    
    
    
    2,500
    
    
    
    1,870
    
    
    
    241US GAAP:Net cash
provided by operating activities
    
    
    3,415
    
    
    
    3,603
    
    
    
    2,929
    
    
    
    3,087
    
    
    
    1,333
    
    
    
    172Railway Operation Data:Route kilometers (km):East Rail
    
    
    34
    
    
    
    34
    
    
    
    34
    
    
    
    34
    
    
    
    34Light Rail
    
    
    31.75
    
    
    
    31.75
    
    
    
    31.75
    
    
    
    31.75
    
    
    
    36.2West Rail(11)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    30.5Total number of passengers (in millions):East Rail(8)
    
    
    275
    
    
    
    288
    
    
    
    292
    
    
    
    296
    
    
    
    278Light Rail
    
    
    115
    
    
    
    118
    
    
    
    117
    
    
    
    114
    
    
    
    106Average fare revenue per passenger
carried (HK$)East Rail(8)
    
    
    11.29
    
    
    
    11.65
    
    
    
    11.66
    
    
    
    11.73
    
    
    
    11.22
    
    
    
    1.45Light Rail
    
    
    3.58
    
    
    
    3.59
    
    
    
    3.56
    
    
    
    3.53
    
    
    
    3.52
    
    
    
    0.45Railway operating profit/(loss) per
passenger carried(9)East Rail(8)
    
    
    4.81
    
    
    
    5.45
    
    
    
    5.55
    
    
    
    5.56
    
    
    
    4.74
    
    
    
    0.61Light Rail
    
    
    (1.52
    )
    
    
    (1.12
    )
    
    
    (1.19
    )
    
    
    (1.00
    )
    
    
    (0.88
    )
    
    
    (0.11
    )
   (1)
    
    Under HK GAAP, comparative figures for 2002 have been restated as a
result of the adoption in 2003 of the revised Statement of Standard
Accounting Practice (SSAP) 12 (Income Taxes) issued by the Hong Kong
Society of Accountants. See Note 4(a) to our audited consolidated
financial statements. Comparative figures for 2001 and prior years have
not been restated because it would be impractical to do so.(2)
    
    See Exhibit 6.1 for details of the computation of earnings per share
information. 2




---



##### Table of Contents



(3)
    
    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.(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 3(o) to our
audited consolidated financial statements.(5)
    
    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 43 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
43(h) to our audited consolidated financial statements.(6)
    
    The capital expenditure figure is presented on an accruals basis and a
detailed breakdown of capital expenditure is depicted in the table on page
47.(7)
    
    Total debt under HK GAAP represents interest-bearing borrowings.(8)
    
    Passenger and fare figures exclude through-trains.(9)
    
    The railway operating profit/(loss) per passenger carried is derived
after depreciation and excludes net investment income. The cost of feeder
bus services is included in the operating costs of the East Rail and Light
Rail. Furthermore, fare revenue, rather than total divisional revenue of
both the East Rail and Light Rail, is used for calculating operating
profit/(loss) for consistency.(10)
    
    Solely for your convenience, we have translated certain Hong Kong dollar
amounts into U.S. dollar amounts at the rate of HK$7.7640 = 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, 2003. The U.S. dollar amounts under Consolidated Income
Statement Data and Consolidated Balance Sheet Data are rounded to the
nearest million.(11)
    
    West Rail commenced operations on December 20, 2003. Information relating
to total number of passengers, average fare revenue per passenger carried
and railway operating profit/(loss) per passenger carried for West Rail is
not shown due to the limited period of operation. 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 24, 2004, the noon buying rate for the Hong Kong dollar was
HK$7.7995 = US$1.00. Noon Buying RateAverage(1)
    
    High
    
    Low
    
    Period-EndYear1999
    
    
    7.7599
    
    
    
    7.7814
    
    
    
    7.7457
    
    
    
    7.77402000
    
    
    7.7936
    
    
    
    7.8008
    
    
    
    7.7765
    
    
    
    7.79992001
    
    
    7.7996
    
    
    
    7.8004
    
    
    
    7.7970
    
    
    
    7.79802002
    
    
    7.7996
    
    
    
    7.8080
    
    
    
    7.7970
    
    
    
    7.79882003
    
    
    7.7864
    
    
    
    7.8001
    
    
    
    7.7640
    
    
    
    7.7640Months2003December
    
    
    
    
    
    
    7.7670
    
    
    
    7.7628
    
    
    
    7.76402004January
    
    
    
    
    
    
    7.7775
    
    
    
    7.7632
    
    
    
    7.7775February
    
    
    
    
    
    
    7.7845
    
    
    
    7.7686
    
    
    
    7.7845March
    
    
    
    
    
    
    7.7980
    
    
    
    7.7842
    
    
    
    7.7930April
    
    
    
    
    
    
    7.8000
    
    
    
    7.7870
    
    
    
    7.7998May
    
    
    
    
    
    
    7.8010
    
    
    
    7.7895
    
    
    
    7.7941June (through June 24)
    
    
    
    
    
    
    7.8000
    
    
    
    7.7947
    
    
    
    7.7995
   (1)
    
    Represents the average of the noon buying rates on the last
business day of each month during the relevant year.  3.B
    
    CAPITALIZATION AND INDEBTEDNESS Not applicable. 3




---



##### Table of Contents



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. 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. Since the second half of 1997, Hong Kong has suffered adverse economic
developments and experienced a deflationary phase of the economic cycle. We
have not raised fares for six years in a row due to poor economic conditions.
The Governments announcement of a moratorium on land sales in 2002 led to a
delay of our property development projects, and while the Government has since
announced that land sales will resume in 2004, the Government has requested
that the completion of our joint venture residential projects along the Ma On
Shan Rail should not take place earlier than 2008, which would lead to a delay
in revenue generation from such residential unit sales. Further, delay in
completion of other residential projects along the new railway lines will, in
addition, have an adverse impact on the recurrent revenue from the commercial
activities arising from the new railways, namely West Rail Phase I and the Ma
On Shan Rail. 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. 4




---



##### Table of Contents



Our future financial performance, as well as our ability to meet our debt
obligations, will depend on the level of revenues generated and costs of
operating West Rail Phase I, the East Rail Extensions, the
Kowloon Southern Link and the Sha Tin to Central Link, which are
capital-intensive infrastructure projects, the successful development of which
involves many uncertainties. The construction of large infrastructure projects such as West Rail Phase
I, the East Rail Extensions projects, the Kowloon Southern Link and the Sha Tin
to Central Link involve many potential risks, including land acquisition
problems, shortages of equipment, material and labor, 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 particularly
in the case of the East Rail Extensions, Sha Tin to Central Link and Kowloon
Southern Link, that they will have the scope initially awarded. For more
details on the project plans for the East Rail Extensions, Kowloon Southern
Link and Sha Tin to Central Link, see Item 4. Information on the
CorporationRail OperationsEast Rail Extensions, Kowloon Southern Link and
Sha Tin to Central Link. 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 Governments policy decision to open up the
previously restricted areas near the boundary with mainland China to road
transport and the extension of the boundary opening hours of the Lok Ma
Chau-Huangguang boundary crossing to 24 hours has intensified the competition
from cross-boundary bus services. As our profits depend heavily on
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 bus services may increase and may
adversely affect our revenues in the future. The effect on the level of
competition from the bus operators due to the Governments recent decision to
legalize and regulate the cross-boundary bus services, which were previously
operating without authorization from the Government, is uncertain. West Rail Phase I commenced revenue service in December 2003. For the
first five months of 2004, West Rail daily patronage, at around 103,200, was
47.7% below the budgeted figure of 197,200. Due to severe competition from
road transport, consumer pressure to reduce fares and a sluggish economy,
revenues generated from West Rail Phase I may not reach a level which would
make West Rail Phase I profitable for the foreseeable future. If we are unable
to achieve our ridership or fare revenue forecasts, it is likely that
construction of our other railway projects may need to be funded by increased
borrowings. 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 certain factors and by reference to a
specified formula. While we are empowered by the KCRC Ordinance (as defined
below) 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 5




---



##### Table of Contents



bus fares from the bus operators, which could place further downward pressure
on our fares, a result of which would be increased consumer pressure to offer
additional discounts and promotions on our fare system, leading to lower
revenues. 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 or adopted in the future. Accidents, natural disasters and other technological problems could affect the
performance 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. As West Rail Phase I is a new
railway, notwithstanding the extensive technical trials that were conducted on
the railway system, technological problems and other problems are still in the
process of being discovered and rectified. We also experienced some initial
problems with the signaling system during the testing phase of West Rail Phase
I, which resulted in some train delays. 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. 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. 6




---



##### Table of Contents



Since we are developing additional large-scale infrastructure projects, such as
the Kowloon Southern Link and Sha Tin to Central Link, in parallel with the
East Rail Extensions, although not anticipated, 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. Construction of the Kowloon Southern Link and Sha Tin to Central Link is
expected to begin before the completion of our current projects in the East
Rail Extensions. Since the supply of qualified engineers with expertise in
railways in Hong Kong is limited, although not anticipated, we may encounter
difficulties in recruiting experienced engineering staff for the new projects.
In addition, when the new projects are completed, we may encounter difficulties
and delays in recruiting and training qualified maintenance and operations
staff as the supply of qualified railway maintenance and operations personnel
in Hong Kong is largely limited to our employees and those of the MTR
Corporation Limited (MTRCL). Although we are actively addressing this
potential shortage in engineering, maintenance and operations staff through
early recruitment, intensive training and internal promotion, we cannot assure
you that we will not encounter difficulties in the future in attracting and
retaining qualified staff to successfully complete our infrastructure projects
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 significantly expanding our rail network. We
expect the total cost of such expansion to be approximately HK$78.9 billion.
In 2005, we will begin incurring material capital expenditure in connection
with two new projects, the Kowloon Southern Link and Sha Tin to Central Link,
the total project cost of which is currently estimated to be HK$8.9 billion and
HK$43.3 billion respectively. The details on the capital expenditure related
to the Kowloon Southern Link and Sha Tin to Central Link, however, are not
final and will be subject to change even after the execution of the relevant
project agreements governing such projects. The size of these 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 substantially to meet the project costs for the construction of the
Kowloon Southern Link and Sha Tin to Central 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 were increased 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 7




---



##### Table of Contents



and limit the growth of our operations. We expect our debt
level to peak between 2009 and 2013, when HK$33.3 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. Because we are undertaking significant 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 the capital expansion or the Hong Kong dollar cost to repay
indebtedness. While the Hong Kong dollar has been 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 maintain the link between the Hong Kong dollar and
the U.S. dollar at this 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. The Government has invited MTRCL and us to commence negotiations on a possible
merger. Pending the outcome of our negotiations, 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, with a view to completing negotiations by
August 31, 2004. KCRC and MTRCL are requested to submit to the Government the
outcome of the negotiations, including preliminary transaction terms and the
framework of key terms for an operating agreement. Pending the finalization of the merger proposal, 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. 
 ITEM 4.   INFORMATION ON THE CORPORATION 8




---



##### Table of Contents



4.A       HISTORY AND DEVELOPMENT Our legal and commercial name is 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 for an unlimited duration. 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. We recently completed the construction of West Rail Phase I, which
links suburban areas along the north-western New Territories to the Kowloon
urban area and, on December 20, 2003, started to operate the West Rail Line.
In 2003, we made substantial progress on the East Rail Extensions. We
proceeded with environmental surveys and detailed design surveys for the
Kowloon Southern Link project and Sha Tin to Central Link project awarded to us
in 2002, which would provide the vital links needed between the West Rail and
East Rail and, more importantly, 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. The Kowloon Southern Link, which is a
natural extension of our existing West Rail line, 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, together with the Sha Tin to
Central Link, will add another HK$52.2 billion to the HK$26.7 billion in
projects already underway. These projects, when completed, will enable KCRC to
realize a long term vision of connecting Hong Kong Island, urban Kowloon and
the New Territories within a comprehensive railway network. 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, 13th Floor, New York,
New York 10011. Business Development We have continued to significantly expand our rail operations in recent
years through the opening of West Rail Phase I in December 2003, our ongoing
construction of the extensions of our East Rail line and our preparation
towards the construction of the Sha Tin to Central Link and Kowloon Southern
Link. We expect to continue to devote a large percentage of our efforts in the
next seven years to expanding our rail network and monitoring project
development. We also expect to substantially expand our borrowings to meet
part of the project costs in connection with the construction of the Sha Tin to
Central Link and Kowloon Southern Link. Once completed, our revenue mix will
change with the addition of new services, and our results of operations will
reflect the initially higher depreciation, interest and greater operating
expenses associated with operating the new systems. In addition, we expect
that new property
developments and related management activities could affect our reported
results of operations. These new activities present both opportunities and
potential risks to us, and we expect our business expansion will result in
substantial changes from our historical reported results of operations. If the
proposed 9




---



##### Table of Contents



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 also may have a
significant impact on our future liquidity, capital expenditure and financing
requirements, but we are unable to estimate the effect at this present moment
as the merger is still at a preliminary stage of study. Capital Expenditure We had HK$11,122 million (US$1,432.5 million) in capital expenditure in
2003, of which HK$9,362 million (US$1,205.8 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
system and plant for West Rail Phase I and the East Rail Extensions. A further
HK$732 million (US$94.3 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. We financed our capital
expenditure in 2003 through equity injections from the Government, the export
credit loan facilities from Japan Bank for International Cooperation and Export
Development Canada, issuance of long-term bonds in 1999, 2000 and 2003, and
surplus cash from operations. Our capital expenditure for 2002 and 2001 was HK$12,308 million
(US$1,585.3 million) and HK$14,595 million (US$1,879.8 million), respectively,
which was principally for the East Rail Extensions, West Rail Phase I, the
purchase of new rolling stock, the Light Rail Extension to Tin Shui Wai and the
grade separation at the Light Rail Transit junction. The capital expenditure
in 2002 and 2001 was principally financed by equity injections of the
Government, the export credit loan facilities from Japan Bank for International
Cooperation and the Export Development Canada, and surplus cash from
operations. Our capital expenditure for 2004 is estimated at HK$13,337 million
(US$1,717.8 million) and includes HK$5,381 million (US$693.1 million) for West
Rail Phase I, HK$5,561 million (US$716.3 million) for the East Rail Extensions,
and HK$1,274 million (US$164.1 million) for new railway projects. 4.B       BUSINESS OVERVIEW We operate a commuter railway linking the suburban areas of Hong Kong with
the urban areas. Our main lines are the 34-kilometer East Rail line (the East
Rail) and the newly inaugurated 30.5-kilometer West Rail line (the West Rail
Phase I). Our East Rail line comprises a total of 13 stations from Hung Hom,
the main terminus in urban Kowloon, to Lo Wu, the terminus on the boundary with
mainland China. This line carries about 762,000 passenger-trips a day with
trains of 12 coaches long. It is a mass transit carrier with a peak hour
frequency of 2.7 minutes. We also operate intercity passenger services to
Guangzhou on our own train 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 17 seven-car trains per hour,
with a peak hour frequency of 3.5 minutes. 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 carry about 291,000 passenger-trips a day. We also
carry cargo, primarily textiles, foodstuffs, metals, chemicals and livestock on
the East Rail, and have feeder buses in our Light Rail network area as well as
to and from the East Rail and West Rail Phase I stations. In 2003, our railway
network carried a total of 384 million passengers, or an average of 1.05
million passengers per day, a decrease of 6% from 2002. 10




---



##### Table of Contents



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 mobile phone transceivers. Since we are wholly-owned by the Government, our motivation in operating
our services differ 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 debt and earn a
reasonable rate of return for the Government. In order to streamline our organizational structure, we combined the
operating divisions of West Rail, East Rail, Freight, Bus, Light Rail and the
future East Rail Extensions into a new Transport Division. This restructuring,
which was effective as of December 12, 2003, allowed us to rationalize
approximately 600 jobs, thereby achieving greater synergies and effectiveness
of manpower. Subsequent to our reorganization in December 2003, we have two
core operating divisions: Transport and Property. The following table sets out
the revenue and operating profit/(loss) after depreciation and before net
investment income and tax for each of our operating divisions for the periods
indicated: Year Ended December 31,2001
    
    2002
    
    2003Operating
    
    
    
    
    
    Operating
    
    
    
    
    
    Operatingprofit/(loss)
    
    
    
    
    
    profit/(loss)
    
    
    
    
    
    profit/(loss)before net
    
    
    
    
    
    before net
    
    
    
    
    
    before netinvestment
    
    
    
    investment
    
    
    
    investmentRevenues
    
    income
    
    Revenues
    
    income
    
    Revenues
    
    incomeHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$(in millions)Transport:East Rail
    
    
    3,487
    
    
    
    1,658
    
    
    
    3,569
    
    
    
    1,666
    
    
    
    3,266
    
    
    
    1,353Light
Rail(1)
    
    
    564
    
    
    
    (133
    )
    
    
    558
    
    
    
    (95
    )
    
    
    468
    
    
    
    (94
    )West Rail
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11
    
    
    
    (61
    )Property
Services(2)
    
    
    658
    
    
    
    415
    
    
    
    617
    
    
    
    390
    
    
    
    607
    
    
    
    387Freight
    
    
    88
    
    
    
    (29
    )
    
    
    86
    
    
    
    (27
    )
    
    
    74
    
    
    
    (36
    )Total
    
    
    4,797
    
    
    
    1,911
    
    
    
    4,830
    
    
    
    1,934
    
    
    
    4,426
    
    
    
    1,549
   (1)
    
    Starting from 2003, bus operations have been grouped under Light Rail in
segmental reporting. See Note 11 to our audited consolidated financial
statements. Revenues and operating profit/(loss) before net investment
income for 2001 and 2002 have, accordingly, been restated.(2)
    
    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 Our main rail line, East Rail, is a mass transit commuter rail line
linking suburban areas along the north-eastern corridor of the New Territories
to the Kowloon urban area. The East Rail also provides cross-boundary
passenger services to Shenzhen in mainland China, and rail linkage over
railways in mainland China further north to six cities in mainland China,
including Dongguan, Guangzhou, Shanghai and Beijing. In October 1998, we
commenced construction of West Rail Phase I. West Rail Phase I began
commercial service in December 2003 and is a mass transit commuter rail line
linking suburban areas along the north-western corridor of the New Territories
to the Kowloon urban areas. Two of the three East Rail Extensions projects,
the Ma On Shan Rail and TST Extension, were authorized by the Government in
October 2000. The third East Rail Extension, the Lok Ma Chau spur line, was
authorized by the Government in June 2002. In June 2002, we won the bid to
plan, build and operate the Sha Tin to Central Link, which will bring our rail
service across Victoria Harbor and extend our network to Hong Kong Island. In
September 2002, the Government invited us to proceed with the detailed planning
and 11




---



##### Table of Contents



design of the Kowloon Southern Link, which will join the West Rail with the
East Rail at Tsim Sha Tsui, which is planned for completion in early 2009. Current East Rail Passenger Services The East Rail line is a 34-kilometer railway with 13 stations. Passenger
services on the East Rail are provided by 37 electric multiple unit trains of
12 car lengths each. Our punctuality rate of 99.7% and ticketing equipment
availability rate of 99.8% in 2003 exceeded our internal performance targets
and published performance pledges. In 2003, our East Rail operations accounted for 73.8% of our total revenue
and 87.3% of our operating profit before net investment income (excluding
profit on property development). During the year, the East Rail improved its
productivity with cash operating costs before depreciation showing a reduction
of 0.8%. Due to the outbreak of Severe Acute Respiratory Syndrome (SARS),
intense competition and the continuing contraction of the Hong Kong economy,
the East Rail experienced a drop in patronage and revenue during the year.
Domestic passenger ridership in 2003 decreased by 3.9% to 537,800 passengers a
day, from 559,900 a day in 2002. Average cross-boundary patronage fell by
10.8% to 224,500 a day in 2003, from 251,600 a day in 2002. East Rail retained
a 50.1% share of the domestic market and a 68.6% share of the cross-boundary
market. Revenue decreased by 10.1% in 2003 compared to 2002. We are responsible for operating local and cross-boundary passenger
services between Kowloon 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 intercity trains running to and from six cities in mainland
China, including Dongguan, Guangzhou, Beijing and Shanghai. Through-train
services allow passengers to go through Hong Kong customs and immigration
processing prior to boarding rather than after de-boarding or interchange at
the boundary between Hong Kong and mainland China. To meet the increased
demand for through-train services between Kowloon and Guangdong in 2001 and
2002, an additional three pairs of through-trains per day were launched in 2003
and an additional two pairs of through-trains per day were launched in April
2004. The through-train services have since been increased to 12 pairs a day
and the frequency of service was increased to approximately one train per hour.
Of the 12 pairs of trains that run between Kowloon and Guangdong each day, we
operate three pairs, while Guangzhou Railway (Group) Corporation and its
affiliates operate the other nine pairs. Our service hours for passengers
between Hong Kong and Guangzhou were extended to 7:30am until 7:15pm for
northbound trains and 8:35am until 9:23pm for southbound trains, thus resulting
in an increase in the number of same-day return trips. With the additional
three pairs of through-trains in 2003, we were able to increase our growth rate
in terms of passenger volume in October 2003 for all through-trains to 14.0%
(year on year). We grew our market share of cross-boundary passenger traffic
via our through-train services between Kowloon and Guangdong by 1.8% from 21.1%
in 2002 to 22.9% in 2003. We are working with our mainland counterparts to
open new routes to other mainland cities such as Guilin and Jiujiang. Through-train services began to operate between Kowloon and Beijing, and
between Kowloon and Shanghai, in May 1997. The Beijing and Shanghai Railway
Administrations respectively operate these intercity trains, with one train
operating to either destination on alternate days. Journey times have been
shortened, from 27 hours to approximately 24 hours on the Beijing through-train
service and from 24 hours to approximately 23 hours on the Shanghai
through-train service. The mainland authorities also simplified immigration
and customs formalities for passengers on the Beijing and Shanghai
through-trains. As of October 1, 2003, mainland immigration and customs
formalities could be handled at the Beijing West and Shanghai train stations,
eliminating the need for passengers to go through immigration and customs
formalities at Dongguan station. We engage in a joint ticketing service for
the through-train services with railway operators in mainland China, and share
the revenues and costs of these services based principally on the distance
traveled by the trains on the respective railways. We connected the
through-train ticketing system in Hong Kong and the mainland in October 2003 to
allow the online sale of 12




---



##### Table of Contents



return tickets for through-train destinations in Guangzhou and Dongguan from an
open seat pool. This means that return tickets are more readily available, and
that passengers can buy southbound train tickets in Hong Kong up to six hours
before the departure time. 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 May 2004, residents of Guangdong, Beijing
and Shanghai have been able to apply to visit Hong Kong. The signing of the
new Closer Economic Partnership Agreement (CEPA), a free trade agreement
between Hong Kong and mainland China, effective as of January 1, 2004, is
likely to increase cross-boundary business operations, which could lead to an
increased demand for cross-boundary services on the East Rail due to more Hong
Kong and Chinese residents crossing the boundary for business and leisure.
This presents an opportunity for increases in ridership on the East Rail.
However, if the Government continues to ease restrictions on road transport for
boundary crossing, the competitive advantage of the East Rail may be further
eroded, and it may not be able to maintain its market share of the
cross-boundary passenger traffic market. In July 2003, we launched a full-fleet Automatic Train Operation (ATO)
system for the East Rail. The ATO system improves the reliability of the
operations of the East Rail by providing more control over journey times,
greater precision when stopping at stations, and a higher frequency of train
service from the existing 24 to 27 trains per hour per direction. This system
will also cater to the expected growth of morning peak hour southbound
passengers using the East Rail upon completion of the TST Extension and the Ma
On Shan Rail at the end of 2004, and make future system upgrades easier to
implement. 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. In November 2003, we completed noise barrier
works at Fa Po Street in Kowloon Tong, Elegance Garden and Tai Po Kau Hui in
Tai Po. We also plan to install noise barriers at the Sheung Shui Station and
platform. The construction contract for the stage one installation works was
awarded in April 2004 with the contract for stage two installation works
anticipated to be awarded by early 2005 for completion in 2006. During the
year, we also successfully completed the testing for the East Rail of five
environmentally-friendly diesel locomotives, which are much quieter and less
polluting. These locomotives will be used to operate freight trains and night
trains. In the past few years, we carried out a number of station improvement
projects to increase the floor area, 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 passenger demands. The design and construction of a new
18,000 square metre underground concourse at the Kowloon Tong station as well
as a new 60-metre 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
expand 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. With mainland Chinas accession to the World Trade Organization in
November 2001 and the opening of Disneyland in Hong Kong scheduled for 2005, we
expect the number of travelers visiting Hong Kong from mainland China to
increase in the long term and, as a result, the Lo Wu terminal is expected to
experience a growth in passenger flow despite keen competition from
cross-boundary bus services. To alleviate the existing passenger congestion
and also to meet the expected increase in passenger demand, we made further
improvements to the Lo Wu station to assist passenger movement, such as the
completion of a new passenger platform, the widening of existing passenger
platforms, installation of additional escalators and new ticket flap gates. We
also segregated the boarding and 13




---



##### Table of Contents



alighting of passengers to facilitate better passenger flow. We believe that
these improved terminal facilities will not only enhance the quality of travel
for our local and foreign travelers which in turn will improve our
competitiveness against cross-boundary bus services, but will also accommodate
the expected growth in passenger volume resulting from the Individual Visitor
Scheme. We completed the remodeling works at the Hung Hom station in mid-December
2003. The remodeling works allowed the East Rail to increase train speeds and
service frequency in this section of the alignment, and will facilitate the
integration of the East Rail with the TST Extension, which is planned for the
end of 2004. In preparation for the construction of the Lok Ma Chau spur line, we
completed the Sheung Shui down and up track temporary diversion in October 2003
and January 2004 respectively. We also opened the extended concourse of the
Tai Wai station (an interchange station between the East Rail and Ma On Shan
Rail) for public use on December 24, 2003, and installed new ticket flap gates
at the station to promote improved passenger flow. As a further improvement, we simplified the East Rail ticketing system,
with the number of single ride ticket types reduced from eight to four. In
December 2003, we introduced new ticket vending machines with touch screens,
which allow passengers to purchase different types and varying quantities of
single ride tickets at one time. To assist our visually impaired passengers,
in addition to our special voice announcement features and added in-train
Braille signs, some of these ticket machines are also equipped with Braille
signage and audio devices. The Beacon Hill Tunnel built in 1980 was not equipped with a smoke
extraction system. Should a fire occur inside the tunnel, smoke will
accumulate and lead to severe fatalities 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 fire detection
system, diversion of existing services and associated civil construction work.
The contract for the construction work is expected to be awarded in August
2004. It is expected that upon the completion of the project in 2005, we will
have fast and accurate detection of fires, 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. As part of our business contingency operational plan, we completed the
construction of the Fall Back Control Center, which was put into operation on
August 15, 2003. The Fall Back Control Center will provide a back-up location
for normal train service should the main East Rail Control Center need to be
evacuated. During the SARS outbreak in 2003, we implemented contingency plans and
were the first public transport operator in Hong Kong to provide free face
masks to the public. We further stepped up cleaning and disinfections of
stations, trains and other facilities while increasing the air filter
replacement frequency for the ventilation system. However, notwithstanding the
SARS outbreak and the ongoing improvement and construction works throughout the
year, the East Rail maintained a train service delivery rate of 99.9%, and a
train punctuality rate of 99.7%. Both exceeded the target rates of 99.7% and
99.4%, respectively. The East Rail also significantly improved train
reliability with a record low of only one failure per 953,565 car-kilometres,
which represents an increase of 53.0% over 2002. Further, the customer
satisfaction index for overall service was maintained at 92.0%, and the number
of complaints per million passengers dropped to 2.32 in 2003 from 2.75 in 2002. 14




---



##### Table of Contents



Several safety improvement works were carried out during the year,
including the installation of bollards at the entry landings of escalators at
the Hung Hom and Mongkok stations to prevent passengers from carrying bulky
luggage onto the escalators, the installation of signs with flashing lights to
encourage the use of lifts by passengers carrying luggage and others in need,
and the conduct of drills and joint exercises with the police, fire services
department and other emergency services to promote coordination and
communication during rescue operations. This resulted in a reduction in
safety-related accidents, with the number of escalator incidents reducing by
8.0%, and the passenger accident rate not exceeding the targeted benchmark rate
of 0.65 per million passengers. Significant improvement was recorded in
operational safety with the staff injury rate dropping from 9.21 accidents per
1,000 employees in 2002 to 6.8 in 2003, reflecting a reduction of 28.0%. 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 line on the same day. The discount scheme, which ran from
April 2003 to September 2003, has been extended to September 30, 2004. As of December 31, 2003, the East Rail had maintained a market share of
50.1% of the domestic passenger market for travel between the north-eastern New
Territories and urban Kowloon. For the cross-boundary market, East Rails
market share dropped from 74.5% in 2002 to approximately 68.6% in 2003. While
East Rail faces competition from bus routes operating parallel to the railway
line, we believe that our East Rail service is generally regarded as safer and
more reliable, factors which give it a competitive advantage compared to bus
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 enjoyed the benefits of increasing cross-boundary traffic over recent
years. Lo Wu, directly across the boundary from Shenzhen, is the more
convenient boundary crossing for travelers to Shenzhen on business or for
retail shopping, a leisure activity for Hong Kong residents that has seen an
increase in popularity in recent years. We are able to charge a premium fare
on passengers traveling to Lo Wu. The current fare from the Hung Hom terminus
in Kowloon to Sheung Shui (the last station before Lo Wu) is HK$9 one way,
compared to the fare of HK$33 from Hung Hom to Lo Wu. In 2003, the Government
proposed the introduction of a boundary facilities improvement tax, which would
have increased the cost for passengers traveling to Lo Wu. However, in February
2004, the Financial Secretary of Hong Kong announced that due to the status of
the Hong Kong economy, the Government would not implement the proposed boundary
facilities improvement tax for boundary crossings by land from Hong Kong to
mainland China. In 2003 the daily patronage of through-trains was 5,870 passengers, a
decrease of 6.7% compared to 2002. The number of passengers traveling to
mainland China on through-trains rose in 2001 and 2002, but decreased in 2003.
The number of passengers traveling to Lo Wu, and onward to mainland China
decreased by 10.8% in 2003 compared to 2002, and market share of cross-boundary
passenger traffic decreased by 5.9% to 68.6%. This decrease in passenger
volume was largely due to the reluctance of the public to travel due to the
SARS outbreak in the early half of 2003, and both passenger volume and market
share were adversely affected by severe competition from cross-boundary coach
operators. On January 27, 2003, the Government extended the boundary opening hours of
the Lok Ma Chau-Huanggang boundary crossing to 24 hours. This resulted in
intensified competition from cross-boundary bus services, thus contributing to
the decreased patronage on the East Rail for 2003. Given the lower fare
structure of the coach operations, it will be a challenge for us to maintain a
premium on fares for cross-boundary passengers. Coach operations at the Lok Ma
Chau boundary directly impacted our cross-boundary patronage at Lo Wu. The
gradual opening up of previously restricted areas near the boundary with
mainland China to road transport will result in more competition for our
cross-boundary service. It is likely that this increased competition will
continue to erode the market share and revenues of the East Rail going forward.
Also, the effect on the level of competition from the bus operators due to the 15




---



##### Table of Contents



Governments recent decision to legalize and regulate all currently operating
cross-boundary bus services, which were previously operating without
authorization from the Government, is presently uncertain. Cross-Boundary Lo Wu RidershipDaily Average Passenger trips
    
    Year on year Growth (%)1999
    
    
    206,481
    
    
    
    15.52000
    
    
    229,120
    
    
    
    10.92001
    
    
    236,800
    
    
    
    3.42002
    
    
    251,600
    
    
    
    6.32003
    
    
    224,500
    
    
    
    (10.8
    )
 West Rail Phase I 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 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 commenced trial operations on June 17, 2003 through the
final quarter of 2003. Problems with the train control and signaling system
were discovered during the trial runs, which were rectified through a series of
software and hardware upgrades. As part of our publicity programs to
familiarize the public with the West Rail Phase I services, we carried out
several publicity events prior to the official commencement of West Rail Phase
I services, including station open days whereby the public was invited to visit
the West Rail Phase I stations and try out facilities such as the ticket
vending machines and entry and exit gates with retractable flaps. 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 17 electric multiple unit trains of seven-car
lengths 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. We anticipate that West Rail Phase I will not meet its
forecasted ridership figures for 2004. See Item 5. Operating and Financial
Review and Prospects  Trend Information for details on West Rail Phase Is
below forecast ridership. To assess commuters feedback on the West Rail Phase I service, we
conducted two passenger surveys in 2003. Passenger surveys have indicated that
most passengers consider the current fares for West Rail Phase I to be
competitive with those for road-based public transport. We are focusing on
improving the connectivity and accessibility of the West Rail Phase I stations.
West Rail Phase I is connected to the Mass Transit Railway 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 are evaluating proposals for the provision of more footbridges
and pedestrian crossings for passengers, and we have commenced free feeder bus
services to increase the accessibility of the West Rail Phase I stations. We
anticipate that West Rail will be an important service 16




---



##### Table of Contents



link for passengers upon the completion of the Kowloon Southern Link, which is
anticipated to be completed in early 2009, when passengers will be able to
transit through Tsim Sha Tsui to Hung Hom station. The total project cost as of March 2004 for West Rail Phase I was HK$40.5
billion. The budgeted total project cost for West Rail Phase I was HK$46.4
billion. We are currently subject to claims by contractors in connection with
the West Rail Phase I project, and discussions are currently on-going with the
contractors to clarify the exact basis and amount of these claims. We have
retained a program reserve within the West Rail Phase I total projected cost
budget and we anticipate that any additional payment to contractors in addition
to that already budgeted will be covered by that program reserve. West Rail Phase I and the East Rail Extensions are designed to be
compatible with each other to facilitate future linkage of the West Rail with
the East Rail. As an illustration, the new rolling stock ordered from the
Itochu-Kinki-Kawasaki Consortium for the projects will be identical and the
electric voltage is the same for the two operating systems. However, while the
signaling systems on West Rail Phase I are compatible with those on the Ma On
Shan Rail, the signaling systems on the East Rail and TST Extension, which are
compatible with each other, are not compatible with the West Rail Phase I and
Ma On Shan Rail signaling systems. Upon the completion of the Kowloon Southern
Link, we intend to replace the signaling systems on the East Rail and TST
Extension with one compatible with West Rail Phase I, the Ma On Shan Rail and
the Kowloon Southern Link system. East Rail Extensions Ma On Shan Rail and TST Extension In June 1998, in response to the Governments invitation, we forwarded our
proposals to the Secretary for Transport for the construction and operation, as
a combined project, of the 11.4-kilometer link between Ma On Shan and Tai Wai
station (the Ma On Shan Rail) and the one-kilometer extension of East Rail
from Hung Hom to the new East Tsim Sha Tsui station (the TST Extension).
This submission was followed by the Governments invitation for us to undertake
detailed design with a view to completing the TST Extension and Ma On Shan Rail
in 2004. The Ma On Shan Rail will extend the East Rail from Tai Wai to Ma On
Shan, with nine stations located within walking distance of several large
residential complexes, including City One, Chevalier Garden and Heng On. As is
the case with West Rail Phase I, each station has been designed to have
passenger transport interface with buses, minibuses and taxis. The Sha Tin and
Ma On Shan area to be served by East Rail and Ma On Shan Rail had a population
of 629,000 in 2001 and is expected to grow to about 690,000 by 2011. The Ma On
Shan Rail and TST Extension are viewed as a combined project, in part, because
the TST Extension will become critical as an alternative interchange into the
MTR of MTRCL to relieve the current dedicated Kowloon Tong interchange, which
is expected to overload in capacity when the Ma On Shan Rail comes into
operation. The Ma On Shan Rail will increase the capacity of external public
transport services for Ma On Shan New Town by approximately 34%. Upon its
opening, scheduled for the end of 2004, we expect to run a four-car train every
2.5 minutes during peak hours, which may be increased to longer trains of up to
eight cars at two minute intervals, should demand grow. The Environmental Protection Department approved the environmental impact
assessment for the Ma On Shan Rail and granted an environmental permit in
January 2000. For the TST Extension, the Environmental Protection Department
approved the environmental impact assessment and granted an environmental
permit in May 2000. Of the estimated HK$26.7 billion in aggregate costs for the East Rail
Extensions, we expect HK$22.9 billion will be construction costs, HK$1.3
billion will be land acquisition costs, and HK$2.5 billion will be financing
costs. In October 2000, the Chief Executive of Hong Kong approved both railway
proposals. In March 2001, an equity injection of HK$8 billion from the
Government for the 17




---



##### Table of Contents



construction of the Ma On Shan Rail and TST Extension was received. We expect
to complete the construction of the TST Extension and Ma On Shan Rail and bring
them into operation by the end of 2004. As of December 31, 2003, nine major civil construction contracts have been
awarded, with a combined total value of HK$8.1 billion. Four of the contracts
are for the construction of the 11.4-kilometer Ma On Shan Rail including the
Tai Wai Maintenance Center. The other five contracts are for the construction
of the TST Extension including the modification that will be needed on the
existing Hung Hom Station prior to the construction of the one-kilometer long
underground extension from Hung Hom to Tsim Sha Tsui. As of December 31, 2003,
all ten major railway systems contracts have been awarded at a combined value
of about HK$1.6 billion. All contract awards were made through an open
tendering process, which we believe to be in line with the World Trade
Organizations Agreement on Government Procurement. The Government, subject to the final approval of the Chief Executive in
Council or the Director of Lands, has agreed to grant to us 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. We have offered to relinquish the property development
rights of the four sites along the Ma On Shan Rail in exchange for the
Governments firm commitment that these four sites would be developed first
when the current land-sale moratorium is lifted. Following further discussions
with the Government, it was agreed that we would not need to hand over such
rights to the Government. By the end of 2003, both projects were approximately 87% completed, and
are on target for completion at the end of 2004. As of December 31, 2003, the
tracks for the entire alignment from Tai Wai to Wu Kai Sha for the Ma On Shan
Rail had been laid. The concrete structures were substantially completed, the
last segment of the 8.4-kilometre viaduct was laid in April 2003, and the
remaining five out of nine stations were completed. Eight of the 18 trains
required for the Ma On Shan Rail were delivered from Japan to Hong Kong during
the year. The new trains have undergone static tests on the maintenance track
at the Ho Tung Lau Maintenance Center, as well as performance and reliability
tests at the East Rail main line. The remaining trains have been delivered as
of May 2004. Construction of the TST Extension has also made significant progress, and
like the Ma On Shan Rail, most of its concrete structures were completed in
December 2003. The railway tunnels along Salisbury Road were completed in
April 2003, and the electrical and mechanical works were completed in May 2004.
Backfilling of the tunnels was substantially completed as of December 2003,
allowing most of Salisbury Road to be reopened to traffic. A track improvement
project to remodel the track layout and reduce the number of rail crossings was
completed in December 2003 at the Hung Hom station. Over 90% of the tracks for
the TST Extension have been laid. The concrete structures of the subway
systems along Mody Road and Middle Road were completed, with backfilling and
reinstatement works began in October 2003, and progress being made on building
services installation. The structure of the East Tsim Sha Tsui Station,
including the installation of building services and railway systems, was
substantially completed, with only a small section adjacent to the overrun
tunnel outstanding. In preparation for the opening of the Ma On Shan Rail and TST Extension in
2004, we have set up an Operational Readiness Steering Committee to lead and
monitor the activities required for a successful Day One operation. These
activities include discussions with government departments for obtaining the
necessary statutory approvals, a review of train services and station
operation, staff recruitment and training, and public relations and marketing.
We also formulated a recruitment plan for operations and maintenance staff and
seconded a considerable number of East Rail operations staff to the East Rail
Extensions to assist in the opening. 18




---



##### Table of Contents



As of this date, most civil, electrical and mechanical installation works
for the Ma On Shan Rail have been completed, and testing and commissioning of
the systems have commenced. We anticipate that full-scale trial runs will be
conducted in the last quarter of 2004. The East Tsim Sha Tsui Station on the
TST Extension will be completed for trial operations to begin in the third
quarter of 2004, and the entire extension from the existing Hung Hom station to
East Tsim Sha Tsui station is expected to be completed by the end of 2004. Lok Ma Chau Spur Line To relieve the pressure on the Lo Wu station at the boundary with mainland
China, where the East Rails current capacity of approximately 80,000
passengers per hour exceeds the current immigration processing capacity, the
Government invited us to deliver proposals for the construction and operation
of the 7.4-kilometer Lok Ma Chau spur line from Sheung Shui station on the East
Rail line to the Lok Ma Chau station at the boundary with mainland China. We
submitted our proposal for the Lok Ma Chau spur line to the Government in March
1999. We were granted an environmental permit for the Lok Ma Chau spur line by
the Department of Environmental Protection in April 2002. As required by the
environmental permit, we have set up an environmental committee to monitor the
implementation of the mitigation measures and compliance with the conditions
stipulated in the permit. On June 14, 2002, the Chief Executive of Hong Kong authorized KCRC to
proceed with the construction of the Lok Ma Chau spur line. The final scheme
is based on a tunnel and viaduct approach. The 7.4-kilometre spur line will
branch off the existing East Rail line north of Sheung Shui station and then
proceed underground until it reaches Chau Tau, with two stations. From Chau
Tau, the railway will rise gradually onto a viaduct and end at the Lok Ma Chau
Terminus. The project will be funded by internal resources at a cost of
approximately HK$12 billion. Major civil construction contracts, including those for the construction
of the tunnels, viaduct and terminus at Lok Ma Chau, were awarded by the end of
2002. The civil construction contracts for the improvement works at the Sheung
Shui station were awarded in June 2003, and preliminary works commenced at the
end of 2003. All contract awards were the results of an open tendering
process, which we believe to be in line with the World Trade Organizations
Agreement on Government Procurement. Major civil construction of the Lok Ma Chau Spur Line started in January
2003, and by December 2003, all scheduled milestones had been achieved.
Excavation of the launching shaft for the tunnel boring machine started in
early 2003. By December 2003, 17% of the total boring length of the 6.4
kilometre tunnels had been excavated. In order to make room for the section of
the Lok Ma Chau Spur Line just north of Sheung Shui Station, by September 2003,
the Dongjiang raw water supply mains was diverted, and a section of the
southbound track north of Sheung Shui Station had been temporarily relocated.
Work on the viaduct section from Chau Tau to Lok Ma Chau began in January 2003,
and by December 2003, 67% of the bored piling works had been completed, with 11
out of 54 viaduct piers built and the first viaduct span erected. By December
2003, bored piling for the Lok Ma Chau Station was substantially completed, and
site formation works for the Immigration Hall were in progress. By the end of 2003, civil construction works for the Lok Ma Chau Spur Line
were 29% complete. We anticipate that by the end of 2004, the first of the two
bored tunnels should be excavated, and work should be ready to begin on the
second tunnel, with the viaduct section and superstructure of the terminus
building to be approximately 90% and 80% completed, respectively. The Lok Ma
Chau spur line is on target for completion by late 2006. 19




---



##### Table of Contents



Light Rail Services During 2003, we conducted a reorganization of the Light Rail and bus
services in order to provide a more efficient feeder service to increase public
accessibility 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.
Based on passenger surveys conducted in 2003, we are currently studying
proposals to strengthen the feeder services provided by the Light Rail and
buses. We are in the process of reconfiguring the Light Rail and our bus services
so that residents of the north-western New Territories can make the best use of
the improved transport infrastructure. Through this restructuring, we aim to
provide an efficient feeder service to West Rail Phase I and, at the same time,
maintain the Light Rails role as the major transport service provider in the
north-western New Territories. We have held public consultations with the
public throughout the period leading to the service restructuring. During the
consultations, members of the public expressed their support for the
restructuring. However, they also voiced concerns about the planned
cancellation of two inter-town Light Rail routes which overlapped West Rail
Phase Is service coverage. We are continuing to monitor passenger traveling
behavior after the opening of West Rail to determine the timing of these
proposed changes. Our Light Rail system commenced operation in September 1988 and with the
opening of the new Tin Shui Wai Extension in December 2003, comprises 36.15
kilometers of double track with 68 stops. It is a regional mass transit system
utilizing vehicles which are similar to trams on tracks which run parallel to
public roads. Since 2003, the Light Rail has also been functioning as a feeder
system for West Rail Phase I, which came into operation in December 2003. In
2003, the Light Rail vehicles recorded a punctuality rate of 99.0% and a ticket
equipment availability rate of 99.9%, which equaled or exceeded our internal
performance targets. The Light Rail system operates within the area of Tuen Mun, Yuen Long and
Tin Shui Wai in the north-western New Territories, providing an integrated
transport system with eight Light Rail routes, and a total of 16 bus routes
including feeder bus routes, auxiliary routes and special bus routes linking
various districts as of December 31, 2003. 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, 2003, 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 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 combined Light Rail and feeder bus patronage experienced a decrease of
6.0% over the year. The Light Rail and bus services combined accounted for
HK$468 million of total revenue of KCRC, and showed a decrease of 16.1% from
2002. As of December 31, 2003, the Light Rail system had 119 light rail
vehicles. The Light Rail vehicles carried an average of 291,400
passenger-trips a day in 2003, representing a decrease of 7.1% over the
previous year. Fare revenue of the Light Rail system decreased by 7.2% in the
year 2003. Both 20




---



##### Table of Contents



patronage and fare revenue for the Light Rail were lower than forecasted for
2003. This was mainly attributable to the SARS outbreak, which forced school
closures in March and April of 2003. During the outbreak, the Light Rail
patronage dropped by more than 20.0%. However, the drop in the Light Rail
patronage was offset by the increase in market share of the Light Rail feeder
buses in the north-western New Territories. The number of passenger trips on our buses, excluding the seven feeder
routes for the East Rail run by Kowloon Motor Bus, was 26 million, or a daily
average of 72,230 in 2003. This represented an increase of 1.1% over 2002. Of
these trips, 24 million were made on the Light Rail feeder routes and 2 million
were on residential and express routes, which were substantively the same as in
2002. The Light Rail maintained a 60.7% 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 62.1% in 2002, 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.
The market share of the Light Rail feeder buses grew from 12.7% in 2002 to
14.0% in 2003. During 2003, we completed most of the HK$2.3 billion project to transform
the Light Rail into a feeder system for West Rail Phase I. The project
includes a 1.7-kilometre extension to Tin Shui Wai Town, a 2.7-kilometre
extension to Tin Shui Wai North, the installation of a new signaling system for
the existing network and the new extensions, and grade separation at four Light
Rail road junctions in Tuen Mun. The Tin Shui Wai extension project consisted of 11 stops along a 1.7
kilometre extension in Tin Shui Wai Town and a 2.7 kilometre extension in Tin
Shui Wai North. Both were opened on December 7, 2003. These extension routes,
which connect areas of new development in Tin Shui Wai with the Light Rail
network, will benefit the approximately 200,000 residents along the alignment
who could previously only rely on buses. The cost of the project was
approximately HK$570 million. In August 2003, we completed the HK$471 million grade separation and
viaduct project at Pui To Road. The 1.2 kilometre viaduct, which crosses over
the busiest road in Tuen Mun, will save passengers about one to two minutes of
traveling time, enhance operating safety and increase the capacity of the
junctions along Pui To Road. Improvement works for the four Light Rail and West Rail interchange stops
were completed during the year. The signaling system for the new extension was
successfully installed by the end of 2003, and the installation of this new
system for the existing network will continue and is projected to be completed
by mid-2005. As of December 2003, approximately 60% of the grade separation project at
Tsing Lun Road was completed, and is targeted for completion in May 2005. The
project will cost about HK$115 million. Upon the conclusion of these projects, the Light Rail network will have
expanded by 4.4 kilometres to a total route length of 36.15 kilometres. Passenger and public injuries per million passengers carried was 0.25
against a target of 0.45, an improvement over 0.29 in 2002. 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. The Light Rails occupational safety record
for 2003 was only 5.59 accidents per 1,000 employees, against a target of 8. 21




---



##### Table of Contents



Sha Tin to Central Link In July 2001, in response to the Governments invitation, 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 kilometre rail system, and will be connected with the Ma On Shan
Rail at Ma On Shan, allowing passengers from Ma On Shan to travel to and from
Central without interchange, and passengers traveling on the East Rail to
interchange with this new line either at Tai Wai or Hung Hom. Passengers will
be able to interchange with the MTRCL network at the Diamond Hill, Exhibition
and Admiralty stations. Once completed, this new line will extend the KCRC
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
KCRC 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, the East Rail and West Rail Phase I. Although all estimates of cost are preliminary and subject to the final
project agreement and market conditions at the time, of the current total
estimated project cost of HK$43.3 billion, we expect that HK$34.6 billion will
be construction costs, HK$0.9 billion will be land acquisition costs and HK$7.8
billion will be financing costs. While the details on the capital expenditure
related to the Sha Tin to Central Link are still being reviewed and are subject
to change, we expect to finance the project from internal resources and new
debt. In January 2003, we awarded seven scheme design consultancy contracts. By
the end of 2003, the consultants had completed all design works based on the
initial project scheme and are now carrying out further studies based on newly
proposed options. Site investigation and topographical surveys were
essentially completed in early 2004. From the geotechnical and topographical
data obtained to date, the consultants are evaluating cost-saving options and
alternative schemes, such as extending the East Rail across Victoria Harbour to
Hong Kong Island. The proposed Sha Tin to Central line will have nine
stations, in addition to a reconfigured Hung Hom Station and a new maintenance
depot at Kai Tak. Two people-mover systems are being considered to link
passengers in the Tsz Wan Shan and Whampoa areas to the Sha Tin to Central Link
in response to a request by the public. We have been maintaining close contact with the Government in order to map
out the most efficient and beneficial alignment to meet the needs of Hong Kong.
While the project completion date was originally scheduled to be around 2008,
currently we are reviewing the construction program with the Government in
light of the delay in the Governments decision on the bid and it is likely the
project completion date will be delayed to 2011 or 2012. The Gazetted Scheme
under the Railways Ordinance is planned to be issued for public consultation in
2004 or 2005, with construction scheduled to commence in late 2005, subject to
full authorization by the Governments Executive Council. We commenced our own Environmental Impact Assessment (EIA) studies for
the Sha Tin to Central Link in November 2002. The EIA studies will evaluate
the projects impact on the environment and identify appropriate mitigation
measures during the construction phase and the subsequent railway operations.
We anticipate completing the EIA studies around December 2004. In April 2004,
we submitted an application to the Environmental Protection Department to start
the Environmental Impact Assessment by the Government. To oversee the planning, design and implementation of the Sha Tin to
Central Link, we are in the process of assembling a dedicated project
management team. At the end of 2003, this team had 61 professionals and
support staff, and are fully supported by external consultants and contractors,
who in turn employ some 600 professional staff and workers for the scheme
design of the project. 22




---



##### Table of Contents



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
early 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 the 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$8.9 billion, HK$8.1 billion will be
construction costs, HK$0.2 billion will be land acquisition costs and HK$0.6
billion will be financing costs. While the details on the capital expenditure
related to the Kowloon Southern Link are still being reviewed and are subject
to change, we expect to finance the project from internal resources and new
debt. We completed the preliminary design study for the Kowloon Southern Link in
2003. 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 the 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. The Kowloon Southern Link will be submitted to the Executive
Council for approval after the period for public consultation has ended. We
anticipate that the gazetting process will be completed by the end of 2004. We
also intend to commence the Environmental Impact Assessment Ordinance process
by mid 2004, and to start awarding construction contracts in late 2004. We are
currently negotiating the details of this project with the Government and
expect to finalize the definitive terms in a project agreement to be executed
in 2004. Subject to final agreement with the Government, construction is
expected to begin in 2005 after the issuance of an environment permit by the
Environmental Protection Department and an approval by the Executive Council of
Hong Kong, with a forecast completion date of early 2009. Freight Services Freight services, operating on the same track as the East Rail passenger
services, convey cargo by rail between Hong Kong and mainland China. We also
provide forwarding and terminal services. We carry three main types of cargo:  (1)
    
    livestock;(2)
    
    breakbulk, which consists mainly of textile fibers, foodstuffs, metals
and chemicals and(3)
    
    containers. We operate container services to a total of 42 cities and breakbulk
services to a total of 60 cities in mainland China. We have seven
representative offices in Shenzhen, Dongguan, Wuhan, Chengdu, Kunming, Xian and
Changsha in mainland China to facilitate liaison with our freight business
associates and customers and for services promotion. Freight revenue decreased
by 14.0% to HK$74 million from HK$86 million in 2002, mainly due to the
decreased breakbulk traffic from northern and central China and decreased
livestock traffic. After allocation of corporate expenses, the operating loss
of HK$36 million in 2003 was 33.3% higher than that of HK$27 million in 2002.
Freight Services accounted for 23




---



##### Table of Contents



1.7% of total revenue of KCRC for 2003. In light of the continued operating
losses of our freight services, we are currently evaluating our options
concerning our continued involvement in the freight business. Rail-borne freight, both breakbulk and containerized, either originates in
Guangdong Province or reaches Guangdong Province mainly from the interior
provinces of mainland China. From Pinghu in mainland China, rail-borne freight
is distributed to Yantian and Shekou in Guangdong and Hong Kong. Yantian and
Shekou, which are container terminals near the boundary in mainland China, are
competitive threats to our Hong Kong transshipment services as Chinese
exporters have been choosing road freight or river freight services and
exporting through these ports as they offer lower terminal handling charges
than Hong Kong and have a shorter transit time. However, the lack of
infrastructural support 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 away from breakbulk freight services and in favor of containerized
freight services, which are more attractive to customers. Our container rail
freight business is growing steadily in line with this trend, except for the
set back in 2003 due to the SARS outbreak. Through a partnership formed with
Guangshen Railway Co. Ltd. in 2003, we started the Dongguan Block Train which
links Hong Kong with the key manufacturing hub of Dongguan. 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 information relating to wagon and container tracking
status, sales booking orders, quotations, and the handling of licensed goods
and chemicals. We were selected as the Best Rail Operator  Asia in the Asian Freight &
Supply Chain Awards in April 2003 and the Rail Freight Operator of the Year in
the Asia Logistics Award 2003 in November 2003. 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 the 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 2003, 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 24




---



##### Table of Contents



providers, which in general did not increase their fares, and the hardship our
passengers were experiencing as a result of the prevailing economic recession
in Hong Kong. We have experienced significant pricing problems as a result of
public opinion, with the result that we have committed to a 20% discount of our
targeted West Rail Phase I fares, and we have extended the second trip
discount scheme on the East Rail for another year until September 2004. 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 31,1999
    
    2000
    
    2001
    
    2002
    
    2003Annual average passenger fare increase (%)East
Rail(1)
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.00Light Rail
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.00West
Rail(4)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Increase/(decrease) in CPI(2) (%)
    
    
    (3.30
    )
    
    
    (3.00
    )
    
    
    (1.70
    )
    
    
    (3.20
    )
    
    
    (2.10
    )Average fare revenues per passenger carried (HK$)East Rail(1)
    
    
    11.29
    
    
    
    11.65
    
    
    
    11.66
    
    
    
    11.73
    
    
    
    11.22Light Rail
    
    
    3.58
    
    
    
    3.59
    
    
    
    3.56
    
    
    
    3.53
    
    
    
    3.52West Rail(4)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Increase/
(decrease) in average operating costs(3) per passenger carried (%)East Rail(1)
    
    
    (2.07
    )
    
    
    (4.01
    )
    
    
    (1.54
    )
    
    
    (1.56
    )
    
    
    3.17Light Rail
    
    
    0.76
    
    
    
    (3.26
    )
    
    
    2.07
    
    
    
    (7.61
    )
    
    
    (2.20
    )West Rail(4)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
   (1)
    
    Excluding through-train.(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 2003 prices. Source: Census and
Statistics Department of the Government.(3)
    
    The average operating costs per passenger carried are derived before
depreciation and net investment income/(net borrowing costs). The cost of
the feeder bus service is included in the operating costs of the East
Rail and the Light Rail.(4)
    
    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. 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. For the East Rail, the Octopus
Smart Card was used by approximately 92% of our passengers in 2003. 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 franchise 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. The changes which 25




---



##### Table of Contents



will have the greatest impact on future railway development are the higher
population projections in light of the 1996 Population By-Census, the
development of strategic growth areas in the northern New Territories, reduced
reclamation and hence development in the inner harbor areas, the replacement of
port facilities on North Lantau Island by the Disney Theme Park and the
continuing growth in cross-boundary passenger traffic. As a result of these
changes, the Government commissioned the preparation of the second railway
development study in March 1998 to re-examine the rail proposals recommended in
the first railway development study, investigate other new proposals and
recommend a railway network which is designed to relieve bottlenecks in the
existing railway lines, facilitate timely accessibility to strategic growth
areas for housing and economic development and stimulate further developments
along rail corridors, and meet cross-boundary passenger and freight demands and
ensure increased compatibility and integration with the railway systems in
mainland China. 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Rail OperationsKowloon Southern Link
    
    The Sha Tin to Central Link, see Item 4. Information on the
CorporationRail Operations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, which would join the East Rail and West Rail Phase
I at the northern section. It will provide a much needed railway
corridor between the north-east and north-west districts of the New
Territories, as well as connection to the Lok Ma Chau and Lo Wu
stations for cross-boundary passengers. It will open up a new
corridor for new strategic growth areas now under study by the
Government and promote rail as the preferred mode of cross-boundary
travel. The likely completion timing for the Northern Link is between
2011 and 2016 depending on the development programme of strategic
growth areas and the growth of the cross-boundary traffic. Upon
completion of the Northern Link, the East Rail and West Rail will form
a massive single loop serving the New Territories and Kowloon.
    
    The Regional Express Line, which would be an express rail link for
suburban and intercity train services between Hong Kong and mainland
China from the proposed Mass Transportation Center in Hung Hom. This
new line will potentially permit journey times of under 15 minutes
through Hong Kong and around one hour to Guangzhou in mainland China.
Its implementation timing depends on cross-boundary traffic build-up
and the integration of the economic activities between Hong Kong and
the Pearl River Delta. In November 2003, the Government indicated that it was considering a
bridge link between Hong Kong, Zhuhai and Macau to address the anticipated
increase in traffic. Whether this would be a road and rail bridge or road only
bridge has yet to be decided by the Government. The Government announced its population policy in February 2003 and is
expected to release towards the later part of 2004 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 would have an impact on
future railway development. 26




---



##### Table of Contents



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 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 2003, the Property
division accounted for 13.7% of total revenue of KCRC and 25.0% of operating
profit before net investment income (excluding profit on property development)
of KCRC. Property Development We develop property for three main reasons: firstly, to generate income
that can be used for the continuous improvement of our railway networks in
order to keep them efficient, modern and competitive; secondly, to contribute
towards the capital costs of new railway projects; and finally, to secure a
permanent and increasing flow of passengers for our railway services. 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
the West Rail Phase I and 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 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. Completed property developments along the East Rail and Light Rail include
Pierhead Garden, Sun Yuen Long Center, Manlai Court, Hanford Garden, Sun Tuen
Mun Center, Royal Ascot and Mong Kok station, which provide 761,336 square
meters of residential floor area and 213,074 square meters of commercial floor
area, and the Metropolis, jointly developed by KCRC and Cheung Kong Holdings
Ltd., which provides 132,218 square meters of commercial floor area, including
office, hotel, retail area and 662 serviced apartments. The office, hotel and
retail areas were sold to affiliates of Cheung Kong (Holdings) Limited, while
all serviced apartments were sold pursuant to public sales launched in 2003. 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 27




---



##### Table of Contents



SARS outbreak in 2003. Ho Tung Lau (Site A) will provide 120,900 square metres
of residential floor areas, and 2,000 square metres of commercial floor area. 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 2,245,183 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 2009 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 benefits 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 19 to our audited consolidated financial statements. We
anticipate that we will start to seek 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. We have made progress on the designs and project briefs for the
formulation of tender invitations for nine property development projects with a
total land area of more than 62 hectares, in phases, from April 2005 onwards,
namely Tsuen Wan West (comprising four sites with a total area of 9.41
hectares), Yuen Long (3.46 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), Pak
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. Along the Ma On Shan Rail alignment of the East Rail Extensions, 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. We intend to invite tenders for the four sites along the Ma On
Shan Rail alignment from property developers during and after 2005 under a
revised master property development program. 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 metres
of gross floor areas to be built on these four sites. In accordance with the
Governments property stabilization measures announced in October 2003, the
residential developments at the Tai Wai station and maintenance center would
not be completed earlier than 2008. During the year, the Property division developed several Public Transport
Interchanges (PTI) in conjunction with property enabling works on a number of
sites along the Ma On Shan Rail and West Rail Phase I. The 11,247 square
meters PTI at the Tsuen Wan Station was completed in 2003, while the PTI at Tai
Wai and Wu Kai Sha along Ma On Shan Rail are targeted for completion by the end
of 2004. We also examined the redevelopment opportunities in relation to the Hung
Hom station and the commercial area shared by the Sha Tin Station and Citylink
Plaza in order to realize the property development potential of KCRCs vested
land assets. 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 18,540 square meters at the
East Rail and West Rail Phase I stations, an aggregate of 21,909 square meters
of 28




---



##### Table of Contents



commercial office space at Citylink Plaza at the Sha Tin station, 5,576 square
metres 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, 2003, we
manage 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 2003, despite the negative impact of the SARS outbreak and the
depressed performance of the retail sector, the average occupancy rate for
commercial premises at our stations, commercial offices and shopping centers
remained at 93.31%. This was largely due to our flexible leasing strategy and
promotional activities. During the period from May to July 2003, we provided
rent cuts of up to 50% to tenants whose sales were affected by SARS. We devote considerable efforts to the development of commercial activities
along the railway lines of the East Rail and West Rail Phase I networks with a
view to maximizing ancillary income. In 2003, we set up new commercial
facilities such as sales carts at the Mong Kok and Sha Tin stations and a
visitor information counter at the Lo Wu Station. We also arranged to have
more than 20 self-service electronic kiosks selling travel insurance products,
drinks and other consumables installed for the convenience of passengers. To
meet the needs of advertising clients, new advertising media were introduced
such as backdrop advertising at the Hung Hom and Sha Tin stations. To prepare
for the inauguration of West Rail Phase I in December 2003, we had started
pre-leasing of the 235 shops in the nine West Rail Phase I stations since 2002.
However, due to the lower than forecasted ridership, some tenants faced
financial difficulties. In early 2004, we granted a six-month rent free period
to all tenants to ease their financial difficulties. Citylink Plaza at the Sha Tin Station underwent a major refurbishment
program in 2003. After its completion, the shopping center was able to attract
a more diverse selection of clients with improved trade mix including
restaurants as well as beauty and fitness centers, and has increased its
revenue generation by over 100%. In order to improve business and traffic flows at the various KCRC
shopping centers, we conducted intensive marketing campaigns after the SARS
outbreak. Promotional activities included cash coupon giveaways, dance
competitions, food tasting and variety shows. In 2003, in partnership with the Chinese University of Hong Kong and with
the support of the University of Hong Kong, we undertook a multi-faceted
research study as part of its effort to promote sustainable property
development. The 24-month project, which involves household surveys by social
scientists, commenced in September 2003, and is targeted for completion in
September 2005. In 2004, as a result of the station improvement works at the Kowloon Tong
and Lo Wu stations, more than ten new station trading areas will be available
at these two stations. Further, with the TST Extension and Ma On Shan Rail
scheduled for completion by the end of 2004, we are planning a leasing and
marketing program for the pre-letting of 148 retail units for shops and
restaurants. The number of advertising displays is also expected to be
increased by 3,800 sites at stations and inside new trains. At the Tai Wai
station, which is the interchange station for the Ma On Shan Rail and East
Rail, a total of 47 new and refurbished station shops will be offered. Out of
these 47 shops, 15 were made available in early 2004 and 14 of them have been
leased. We have commenced commercial space planning and layout design for the
Lok Ma Chau Spur Line, Kowloon Southern Link and Sha Tin to Central Link. 29




---



##### Table of Contents



To explore new non-fare revenue sources, we plan to introduce real-time
passenger information displays on board all trains to generate additional
advertising revenue by selling air-time. LCD screens have been installed on
the East Rail, West Rail and Ma On Shan Rail trains for the planned broadcast
of real-time public information, multimedia infotainment programs and
advertising. New outdoor advertising will also be placed outside the East Rail
and West Rail Phase I stations. 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 buses, minibuses,
shuttle buses, taxis and private cars in our passenger operations within Hong
Kong, and from buses, tour coaches, ferries 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, ferries 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. 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 has a 76.3%
shareholding as of December 31, 2003. KCRC and MTRCL are to submit to the
Government the outcome of the negotiations, including preliminary transaction
terms and the framework of a draft operating agreement with key terms on
operational matters, including but not limited to the fare adjustment
mechanism, and safeguards and measures to deal with service disruption. The
Government would then determine the way forward. The negotiations are to be
conducted under the following parameters set by the Government:  
    
    Adoption of a more objective and transparent fare adjustment mechanism;
    
    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 the front line staff of both corporations at the time of the merger;
    
    Provision of seamless interchange arrangements in the long run; and
    
    Conclusion of negotiations by August 31, 2004. 30




---



##### Table of Contents



The Government has indicated that it hopes to achieve certain benefits
from the proposed merger, such as the following:  
    
    To achieve a more objective and transparent fare adjustment mechanism;
    
    To maximize synergies through integrated headquarters and support functions, a fully integrated rail network and economies
of scale viz-a-viz suppliers.
    
    Abolition of second boarding charges at interchange points;
    
    Reduction of duplication of networks for future railway projects, and early resolution of interchange arrangements for new
railway development projects;
    
    Removal of rail to rail competition to focus on competition with other modes of transport within the transport sector;
    
    Comprehensive contingency measures in the event of service disruption and station closures;
    
    Streamlining of staff and management; and
    
    Improved valuation of the railway corporations, with a view to evaluate further privatization through public share
offerings by the merged entity. 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 three 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)
and HK$620 million in 2004 (representing 44.9% of our 2003 profit after
taxation). 31




---



##### Table of Contents



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. Although we
believe we have made major contributions to the direction of railway and
transportation policy in this manner, 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. 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.
Currently, the core functions of what was previously known as our East Rail
Division and all functions of our previous Light Rail Division are certified to
the ISO 14001 standard. Pursuant to our restructuring, a new Transport
Division was formed in December 2003 which comprised the East Rail, Light Rail
and West Rail operating divisions. With the addition of West Rail, we are in
the process of expanding the scope of our ISO 14001 certification to cover the
whole of the new Transport Division by early 2005. In addition, in late 2003,
we gained another ISO 14001 certificate in relation to our New Railway Projects
Division. For projects under development, we are required to comply with the
statutory processes prescribed by the Government, including submission of an
EIA 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 the East Rail Extensions, Kowloon Southern
Link and Sha Tin to Central Link in an environmentally responsible manner. A
comprehensive environmental management system has been implemented for the
construction of the East Rail Extensions. This system consists of a three-tier
approach to the management of construction impacts on the environment to ensure
that contractors comply with all relevant environmental laws and requirements.
The Kowloon Southern Link and the Sha Tin to Central Link projects are at their
early stages in development and their EIA studies are scheduled to be completed
by early 2005. For the Lok Ma Chau Spur Line, an Environmental Committee has been set up
as part of the environmental permit conditions. It will advise on, and monitor
the implementation of, the proposed mitigation measures for the habitat
creation and management plan and the EIA. The committee comprises senior KCRC
members, members of green groups and other experts. We are also improving the environmental habitat around the Lok Ma Chau
station terminus area, where 37 hectares of fish ponds, reed beds and marshland
has been recreated and improved. These works 32




---



##### Table of Contents



are scheduled for completion in late 2006. At Kam Tin, near the West Rail
Phase I alignment, we have recreated 12 hectares of wetland. The work was
substantially completed in September 2003. We have substantially completed the noise mitigation project for the East
Rail which was designed to reduce the noise impact of trains running along the
East Rail alignment. All of our bus fleet and diesel locomotives run on
ultra-low sulphur diesel. In September 2003, we took delivery of five new
diesel locomotives which are substantial improvements on the old locomotives
they replace, as they generate 17dBA less noise and cut smoke emissions by 20%.
They will enter commercial service later in 2004 after being fully tested.
Our 18 Euro I standard engine buses are also scheduled for retrofitting in
2004. 4.C      ORGANIZATIONAL STRUCTURE We have the following subsidiaries: Jurisdiction of
    
    Proportion ofincorporation
    
    ownershipSubsidiary nameManlai Court Property Management Company Limited
    
    Hong Kong
    
    
    51
    %Sun Tuen Mun Centre 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 LimitedKam
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
    %
 33




---



##### Table of Contents



(1)
    
    These subsidiaries are held by us for the sole purposes 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
the consolidation as we have no effective control over or beneficial
interests in the net assets of, other than the amount of capital provided,
these subsidiaries. 4.D      PROPERTY, PLANT AND EQUIPMENT A 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 special 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 3 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. In 2003, we adopted revised accounting policies
in response to the issuance of SSAP 12 (Income Taxes) (revised) on income taxes
relating to the recognition of the deferred tax assets and liabilities as at
the balance sheet date. See Note 4 to our audited consolidated financial
statements. Impairment of assets 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 an impairment loss previously
recognized may no longer exist or may have decreased. 34




---



##### Table of Contents



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
assumption on 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. As of December 31, 2003, no such indication of impairment
loss for KCRC existed. Accordingly, no provision for impairment losses of
fixed assets or reversal of impairment of fixed assets has been made during the
year ended December 31, 2003. Construction in progress Assets under construction and capital works for the operating railway are
stated at cost. 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,
such as the projection of cash flows. Deferred expenditure Deferred expenditure represents advances, deposits, mobilization payments,
design and construction costs incurred for our committed projects. 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 on the feasibility of the projects from the
technical and financial aspects, such as the projection of cash flows. Depreciation All fixed assets, except investment properties, 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. 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 the depreciation amount will be
charged to the income statement for the year, and vice versa. Deferred taxation 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 35




---



##### Table of Contents



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 adequacy of the future taxable profits to utilize the unused tax losses,
which substantiate 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. 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 litigation, mainly relating to the construction of
the West Rail Phase I and 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. In addition to the claims arising from construction contracts, we have
incurred other liabilities in relation to lease arrangements entered into for
certain assets such as rolling stock, signaling equipment, revenue collection
equipment and railway infrastructure, which may be subject to termination upon
the occurrence of certain specified events or circumstances. Management has
considered the likelihood of such events occurring and has concluded that there
is a possibility that one of the lease arrangements entered in 2003 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 KCRC and its subsidiaries after deduction of the transaction
benefit is estimated to be approximately HK$65 million at December 31, 2003
representing compensation that KCRC and its subsidiaries may have to bear
should the termination occur. Recently Issued Accounting Standards of the United States In November 2002, the Emergence Issues Task Force (EITF) reached a
consensus on Issue No. 00-21 (Revenue Arrangements with Multiple Deliverables).
EITF 00-21 provides guidance on how to account for arrangements that involve
the delivery or performance of multiple products, services and/or rights to use
assets. The provisions of EITF 00-21 will apply to revenue arrangements
entered into in
fiscal periods beginning after June 15, 2003. We do not expect the EITF will
have any material impact on our financial position and results of operations. In December 2003, the Financial Accounting Standards Board (FASB) in
United States issued the revised FASB Interpretation No. 46 (FIN 46R)
(Consolidation of Variable Interest Entities), which addresses how a business
enterprise should evaluate whether it has a controlling financial interest in
an entity through means other than voting rights and accordingly should
consolidate the entity. FIN 46R applies to variable interests in Variable
Interest Entities (VIE) created after December 31, 2003 for a 36




---



##### Table of Contents



non-public entity, like KCRC, which is referred to and defined under Statement of
Financial Accounting Standard (SFAS) No. 123 (Accounting for Stock-Based
Compensation). For variable interests in VIEs created before January 1, 2004,
the interpretation will be applied beginning on January 1, 2005. Under the
disclosure requirements, the consolidating enterprise shall disclose the
following when it does not hold a majority voting interest in the VIE: (a) the
nature, purpose, size, and activities of the VIE; (b) the carrying amount and
classification of consolidated assets that are collateral for the VIEs
obligations; and (c) lack of recourse if creditors (or beneficial interest
holders) of a consolidated VIE have no recourse to the general credit of the
consolidating enterprise. We are currently assessing the effect that the
application of FIN 46R may have on our financial position and results of
operations. However, since we file under Item 17 of Form 20-F, we are exempted
from such disclosure requirements. Policy on Derivative Instruments We manage our currency and interest rate exposures by using 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 U.S. dollar exposure in debt obligations 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 for the
duration of the debt obligations, regardless of maturity. 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 five years. In 2003, both transport and recurrent revenues were down
compared to 2002, which was mainly attributable to the impact of the SARS
outbreak on passenger revenues and revenues derived from our property tenants.
Nevertheless, we remained profitable despite another year of fare freezes. East Rail The East Rail contributed HK$3,266 million (US$420.7 million) or
approximately 74% of our revenues in 2003, and HK$1,353 million (US$174.3
million) or approximately 87% of our total operating profit. During the year,
the East Rail continued to improve its productivity with cash operating costs
before depreciation reduced from HK$1.29 billion (US$0.2 billion) to HK$1.28
billion (US$0.2 billion), representing a reduction of 0.8%. Over the past
years, we have improved the efficiency on the East Rail. The electric multiple
unit train refurbishment program increased carrying capacity by an additional
15% as of December 31, 2000. The additional rolling stock, which was put into
service by the end of May 2002, increased the carrying capacity by 28%. These
changes have increased the revenue generating capacity of the East Rail. We
have also improved equipment and maintenance programs, which have 37




---



##### Table of Contents



reduced the
number of breakdowns per vehicle kilometer. Over the period from 1999 to 2003,
this has resulted in a 34.2% decline in the number of breakdowns per million
vehicle kilometers run and a 4.2% reduction in annual maintenance costs per
million vehicle kilometers run. As a result of these factors, operating
margins, defined as operating profit after depreciation as a percentage of
total revenue of the East Rail, have increased every year since 1993 to 46.7%
in 2002, but fell slightly to 41.4% in 2003. The 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
crossing from the Lo Wu station, we have historically been able to charge
relatively higher fares for cross-boundary passengers. With the gradual
opening up of previously restricted areas near the boundary with mainland China
to road transport, which will result in more competition, 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 cross-boundary passengers fell 10.8% during 2003. This
decrease in cross-boundary patronage can be attributed in large part to the
SARS outbreak, intense competition and the continuing contraction of the
economy. Cross-Boundary Lo Wu ridership
    
    Daily average passenger trips
    
    Year on year growth (%)1999
    
    
    206,481
    
    
    
    15.52000
    
    
    229,120
    
    
    
    10.92001
    
    
    236,800
    
    
    
    3.42002
    
    
    251,600
    
    
    
    6.32003
    
    
    224,500
    
    
    
    (10.8
    )
 In 2003, the East Rails through-trains to mainland China experienced a
decrease in patronage of 6.7% compared to 2002. This decrease was largely
because of the reluctance of the public to travel because of the SARS outbreak
in the early half of 2003. Light Rail, Bus and Freight The Light Rail, bus and freight operations make up the remainder of our
operations. 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. 38




---



##### Table of Contents



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 14.0% in 2003 mainly due to the decreased
breakbulk traffic from northern and central China and decreased livestock
traffic. See Information on the CorporationFreight Services. West Rail West Rail Phase I commenced services on December 20, 2003, and as such
does not yet have a history of revenue generation. It is anticipated that the
West Rail Phase I may continue to incur an operational loss for the coming
years. See Item 5. Operating and Financial Review and Prospects  Trend
Information for details on the below forecast ridership of West Rail Phase I.
We intend to put as a priority the completion of the development of the West
Rail property sites as soon as practicable, as we believe that the future
residents of these sites may contribute significantly to the growth of the West
Rail Phase I ridership. We also anticipate that ridership will increase upon
the completion of the Kowloon Southern Link in early 2009, as this will enable
the East Rail and West Rail to form an integrated transportation network. 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 developments undertaken jointly with
major Hong Kong property development companies. We are not required to 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. 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 in similar locations. Land
premium payments that we make 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 land premium involved in building
high-rise residential and commercial buildings on either an elevated base above
the relevant portion of railway 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 39




---



##### Table of Contents



profits in 2003. The last property development project we
undertook before the moratorium was the Ho Tung Lau (Site A) project in late
2002 and we expect the next property development project to commence 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 2003,
commercial activities, property ownership and management operations accounted
for 13.7% of total revenue of KCRC and 25.0% of operating profit before net
investment income (excluding profit on property development). 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.
Revenues and profits depend on market conditions at the time leases are entered
into and renewed. Investment Income Historically, net investment income has not been material to us, as we
have been investing the majority of our available cash in our operations and
expansion projects. From 1998 to 2001, we received an aggregate of HK$37
billion of contributions of capital from the Government. We issued US$1
billion of eurobonds in July 1999, US$50 million private placement under our
Euro medium term note program in November 1999 and US$1 billion notes in March
2000. We had cash and interest paying investments of HK$14,921 million
(US$1,921.8 million) as of December 31, 2003. We generated net investment
income of HK$353 million (US$45.5 million) during 2003. This amount does not
include investment income of HK$292 million (US$37.6 million) and borrowing
costs of HK$1,211 million (US$156.0 million) which were capitalized to the
project costs of West Rail Phase I, the East Rail Extensions, the Sha Tin to
Central Link and the Kowloon Southern Link. The capitalized amounts relate to
capital contributions and borrowings incurred for the purposes of those
projects. With respect to funds that are required for use on West Rail Phase
I, the East Rail Extensions, the Sha Tin to Central Link or the Kowloon
Southern Link, under HK GAAP, we capitalize both the investment income earned
on such funds and the borrowing costs attributed to related borrowings. As a
result, the net investment income reported in the income statement does not
include interest earned or interest paid with respect to such amounts for HK
GAAP purposes. See Note 43 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 41.7%, 26.0% and 9.4%,
respectively, of total operating costs in 2003. 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 2003 increased by 3.2%
as compared to 2002 mainly due to the depreciation of the assets associated
with West Rail Phase I following its
commencement of commercial operations in December 2003. 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 Note 5(b) to our audited consolidated
financial statements for a breakdown of operating costs. 40




---



##### Table of Contents



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 31,2001
    
    2002 restated
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Revenue :Passenger
Services(1)East Rail
    
    
    3,487
    
    
    
    3,569
    
    
    
    3,266
    
    
    
    421Light
Rail(2)
    
    
    564
    
    
    
    558
    
    
    
    468
    
    
    
    60West Rail
    
    
    
    
    
    
    
    
    
    
    11
    
    
    
    1Total passenger services
    
    
    4,051
    
    
    
    4,127
    
    
    
    3,745
    
    
    
    482Freight
    
    
    88
    
    
    
    86
    
    
    
    74
    
    
    
    10Property Services
    
    
    658
    
    
    
    617
    
    
    
    607
    
    
    
    78Total revenue
    
    
    4,797
    
    
    
    4,830
    
    
    
    4,426
    
    
    
    570Operating Profit (Loss) After Depreciation:Passenger ServicesEast Rail
    
    
    1,658
    
    
    
    1,666
    
    
    
    1,353
    
    
    
    174Light
Rail(2)
    
    
    (133
    )
    
    
    (95
    )
    
    
    (94
    )
    
    
    (12
    )West Rail
    
    
    
    
    
    
    
    
    
    
    (61
    )
    
    
    (8
    )Total passenger services
    
    
    1,525
    
    
    
    1,571
    
    
    
    1,198
    
    
    
    154Freight
    
    
    (29
    )
    
    
    (27
    )
    
    
    (36
    )
    
    
    (5
    )Property Services
    
    
    415
    
    
    
    390
    
    
    
    387
    
    
    
    50Total operating profit
    
    
    1,911
    
    
    
    1,934
    
    
    
    1,549
    
    
    
    199Net investment income
    
    
    490
    
    
    
    618
    
    
    
    353
    
    
    
    45Profit from property development
    
    
    24
    
    
    
    94
    
    
    
    
    
    
    
    Share of profit/(loss) of associate
    
    
    11
    
    
    
    16
    
    
    
    8
    
    
    
    1Profit before taxation
    
    
    2,436
    
    
    
    2,662
    
    
    
    1,910
    
    
    
    245Taxation(3)
    
    
    (1
    )
    
    
    (452
    )
    
    
    (529
    )
    
    
    (67
    )Profit after taxation
    
    
    2,435
    
    
    
    2,210
    
    
    
    1,381
    
    
    
    178
   (1)
    
    Our East Rail, Light Rail and Bus operations were restructured into a
single transport division as of December 12, 2003.(2)
    
    Starting from 2003, bus operations have been grouped under Light Rail in
segmental reporting. Revenues and operating profit/(loss) after
depreciation for 2001 and 2002 have, accordingly, been restated. See
Note 11 to our audited consolidated financial statements.(3)
    
    Under HK GAAP, comparative figures for 2002 have been restated as a
result of the adoption in 2003 of the SSAP 12 (Income Taxes) (revised)
issued by the Hong Kong Society of Accountants. See Note 4(a) to our
audited consolidated financial statements. Comparative figures for 2001
and prior years have not been restated because it would be impractical to
do so. Contribution of Major Business Activities The following table sets forth by category of major business activities
for the periods indicated our (1) revenue as a percentage of total revenue and
(2) operating profit/(loss) as a percentage of total operating profit: 41




---



##### Table of Contents



Year Ended December 31,2001
    
    2002
    
    2003%
    
    %
    
    %Revenue/Total Revenue:East Rail
    
    
    72.7
    
    
    
    73.9
    
    
    
    73.8Light
Rail(1)
    
    
    11.7
    
    
    
    11.6
    
    
    
    10.6West Rail
    
    
    
    
    
    
    
    
    
    
    0.2Total passenger services
    
    
    84.4
    
    
    
    85.5
    
    
    
    84.6Freight
    
    
    1.8
    
    
    
    1.8
    
    
    
    1.7Property Services
    
    
    13.8
    
    
    
    12.7
    
    
    
    13.7Total revenue
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Operating Profit/(Loss):East Rail
    
    
    86.8
    
    
    
    86.1
    
    
    
    87.3Light
Rail(1)
    
    
    (6.9
    )
    
    
    (4.9
    )
    
    
    (6.1
    )West Rail
    
    
    
    
    
    
    
    
    
    
    (3.9
    )Total passenger services
    
    
    79.9
    
    
    
    81.2
    
    
    
    77.3Freight
    
    
    (1.5
    )
    
    
    (1.4
    )
    
    
    (2.3
    )Property Services
    
    
    21.6
    
    
    
    20.2
    
    
    
    25.0Total operating profit
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.00
   (1)
    
    Starting from 2003, bus operations have been grouped under Light Rail in
segmental reporting. Revenue and operating profit/(loss) for 2001 and
2002 have, accordingly, been restated. See Note 11 to our audited
consolidated financial statements. Results of Operations Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 Total revenue from operations was HK$4,426 million (US$570.1 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 (US$482.4 million), a 14.0% decrease in freight revenue to
HK$74 million (US$9.5 million), and a 1.6% decrease in property services
revenue to HK$607 million (US$78.2 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 (US$420.7 million) for 2003. This decrease in the
East Rail 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 bus operators.
Revenues from the Light Rail and bus, both fare and non-fare, decreased 16.1%
to HK$468 million (US$60.3 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
(US$78.2 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 (US$9.5 million) in 2003 from
HK$86 million in 2002, mainly due to decreased breakbulk traffic from northern
and central China, and decreased livestock traffic. Operating profit before net investment income (before tax) declined by
19.9% to HK$1,549 million (US$199.5 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 declined by 0.7% to HK$2,877 million (US$370.6
million) from HK$2,896 million in 2002. Despite increases in expenses such as
depreciation which increased by 3.2% to HK$748 million (US$96.3 million), and
costs of materials and stores and spares consumed which rose by 12.0% to HK$149
million (US$19.2 million), 42




---



##### Table of Contents



the overall operating costs are reduced mainly
attributable to the reduction in staff costs which decreased by 2.0% to
HK$1,201 million (US$154.7 million), maintenance costs which reduced by 7.6% to
HK$133 million (US$17.1 million), and electricity and fuel and other expenses
(excluding depreciation) which decreased by 3.3% to HK$646 million (US$83.2
million). Net investment income declined by 42.9% to HK$353 million (US$45.5
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 (US$1.0 million) was recognized in 2003, compared with HK$16 million in
2002, representing a decrease of 50.0%. Net deferred tax in the amount of
HK$528 million (US$68.0 million) was recognized in 2003, compared with the
restated amount of HK$451 million in 2002, representing an increase of 17.1%,
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 (US$489.4 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. Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 Total revenue from operations was HK$4,830 million (US$622.1 million) for
2002, a 0.7% increase from HK$4,797 million for 2001. This increase included a
1.8% increase in transportation (railway and bus operations) revenue to
HK$4,213 million (US$542.6 million) and a 6.2% decrease in property services
revenue to HK$617 million (US$79.5 million) for 2002 compared with that of
2001. Revenue from the East Rail grew by 2.4% from HK$3,487 million for 2001
to HK$3,569 million (US$459.7 million) for 2002. This increase in the East
Rail revenue reflected a 1.4% overall increase in passenger volume from 2002
compared with 2001. The overall fares paid per passenger increased 0.6% from
2001 to 2002 due to an increase in the proportion of cross-boundary passengers.
Revenue from the Light Rail decreased by 3.5% from HK$433 million for 2001 to
HK$418 million (US$53.8 million) for 2002, mainly due to fewer optional trips
being taken, stiff competition from other modes of transport and the closure of
the Kin On Section of Pui To Road to make way for grade separation works.
Revenue from station commercial activities and property ownership decreased by
6.2% from HK$658 million for 2001 to HK$617 million (US$79.5 million) for 2002
partly as a result of government departments vacating several floors in
Citylink Plaza from June 2002 and the vacated area was under renovation.
Revenue from bus operations increased by 6.9% from HK$131 million for 2001 to
HK$140 million (US$18.0 million) for 2002, mainly due to service improvements
and steady growth in patronage on the three interim Light Rail bus routes in
Tin Shui Wai and one in Tuen Mun. Revenue from freight services decreased 2.3%
from HK$88 million for 2001 to HK$86 million (US$11.1 million) for 2002. Operating profit after depreciation and before net investment income
increased by 1.2% to HK$1,934 million (US$249.1 million) for 2002, compared to
HK$1,911 million (restated as described in
Note 4(a) to our audited consolidated financial statements for the year ended
December 31, 2002) for 2001. The operating margin increased from 39.8% for
2001 to 40.0% for 2002. Operating costs (before net investment income) grew by
0.3% from HK$2,886 million for 2001 to HK$2,896 million (US$373.0 million) for
2002, primarily because of increases in maintenance costs which increased by
12.5% to HK$144 million and depreciation which increased by 9.7% to HK$725
million, which together more than offset decreases in stores and spares
consumed and costs of materials, which reduced by 15.8% to 43




---



##### Table of Contents



HK$133 million,
staff costs which reduced by 3.9% to HK$1,226 million, and electricity and fuel
which reduced by 0.4% to HK$262 million. The net amount of staff costs after
capitalization for various capital projects was reduced mainly due to the
reduction in staff benefits in 2002. Net investment income increased from HK$490 million for 2001 to HK$618
million (US$79.6 million) for 2002 due principally to the recognition of the
interest income on other receivables in relation to the property development
along the West Rail Phase I. Net investment income excluded investment income
of HK$975 million (US$125.6 million) and borrowing costs of HK$1,178 million
(US$151.7 million) capitalized to construction in progress and deferred
expenditures during 2002. Profits from property development increased from
HK$24 million for 2001 to HK$94 million (US$12.1 million) for 2002 mainly from
Hung Hom Bay property development. Provision for profits taxes has been
restated in accordance with SSAP 12 (Income Taxes) (revised) to be HK$452
million as described in Note 4(a) of our audited consolidated financial
statements for 2003. Without taking SSAP 12 (Income Taxes) (revised) into
consideration, provision for profits taxes for 2002 was the same as 2001 at
HK$1 million. Inflation Historically, we have increased our scheduled fares at a rate in line with
inflation. Because the rate of inflation has declined significantly in the
past five years, in light of the economic downturn in Asia and Hong Kong and
other factors, we have not increased fares for both the East Rail and Light
Rail since 1998. The economic downturn has to some extent triggered the
deflation in Hong Kong which is reflected by an average annual decrease of
2.7% in the Hong Kong Consumer Price Index (A) for the five years from 1999 to
2003. For the years ended December 31, 1999, 2000, 2001, 2002 and 2003, the
Hong Kong Consumer Price Index (A) dropped 3.3%, 3.0%, 1.7%, 3.2% and 2.1%,
respectively, representing deflation for five consecutive years. See Item 4.
Information on the CorporationPricing of Rail Services. Effects of Interest Rate and Foreign Exchange Movements on Our Borrowings After converting part of our fixed rate debts into floating rate debts by
means of interest rate swaps, we had HK$6,832 million (US$880.0 million) of
floating rate debts as of December 31, 2003. We anticipate that an increased
portion of our future borrowings will bear interest at floating rates. Changes
in prevailing market rates of interest may therefore affect our liquidity. As
a result of borrowings to finance the West Rail Phase I development, East Rail
Extensions, Kowloon Southern Link and Sha Tin to Central Link, our interest and
financing charges are also expected to increase in the future. An increase in
interest rates or higher volatility in currency exchange rates between the Hong
Kong dollar and other currencies 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 to maintain between 30% and 75% of the
total principal amount of our debt obligations at a fixed interest rate for the
duration of the debt obligations, regardless of maturity. 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 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 no greater than 30% of our total borrowings. In June 2003, we issued 4.65% notes due 2013 in principal amount of HK$800
million (US$103.0 million) to institutional investors under our US$3.0 billion
medium-term note program. In the same month, we also issued a two-tranche Hong
Kong dollar retail bond, comprising 3% notes due 2008 in a principal amount of
HK$300 million (US$38.6 million) and 4.8% notes due 2013 in a principal amount
of HK$700 million (US$90.2 million). A total of HK$1,823 million (US$234.8
million) was raised through 44




---



##### Table of Contents



both bond issuances to finance the construction of
the Kowloon Southern Link and Sha Tin to Central Link. US GAAP Reconciliation We prepare our consolidated financial statements in accordance with HK
GAAP, which differ in certain material respects from US GAAP. The following
table sets forth a comparison of our profit after taxation, or net income
after taxation under US GAAP, and shareholders funds, or shareholders
equity under US GAAP, in accordance with HK GAAP and US GAAP. 2001
    
    2002 restated
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Profit after taxation in accordance with:HK
GAAP(1)
    
    
    2,435
    
    
    
    2,210
    
    
    
    1,381
    
    
    
    178US
GAAP(2)
    
    
    3,792
    
    
    
    2,951
    
    
    
    1,512
    
    
    
    195Shareholders funds in accordance with:HK
GAAP(1)
    
    
    59,580
    
    
    
    59,512
    
    
    
    60,205
    
    
    
    7,754US
GAAP(2)
    
    
    63,778
    
    
    
    66,205
    
    
    
    66,743
    
    
    
    8,596
   (1)
    
    Under HK GAAP, comparative figures for 2002 have been restated as a
result of the adoption in 2003 of the SSAP 12 (Income Taxes) (revised)
issued by the Hong Kong Society of Accountants. See Note 4(a) to our
audited consolidated financial statements. Comparative figures for 2001
and prior years have not been restated because it would be impractical to
do so.(2)
    
    See Note 43 to our audited consolidated financial statements for the
reconciliation of profit after taxation and shareholders funds reported
between HK GAAP and US GAAP. 5.B      LIQUIDITY AND CAPITAL RESOURCES Capital Commitments The three largest capital projects we are currently developing are the
East Rail Extensions, the Kowloon Southern Link and the Sha Tin to Central
Link. 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 three largest capital
projects from project inception to the commencement of operations, including
financing costs during construction, as follows: Kowloon
    
    Sha TinEast Rail
    
    Southern
    
    to CentralExtensions
    
    Link
    
    Link
    
    Total
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in billions)Anticipated development costs:Construction costs
    
    
    22.9
    
    
    
    8.1
    
    
    
    34.6
    
    
    
    65.6
    
    
    
    8.5Land costs
    
    
    1.3
    
    
    
    0.2
    
    
    
    0.9
    
    
    
    2.4
    
    
    
    0.3Financing costs
    
    
    2.5
    
    
    
    0.6
    
    
    
    7.8
    
    
    
    10.9
    
    
    
    1.4Total
    
    
    26.7
    
    
    
    8.9
    
    
    
    43.3
    
    
    
    78.9
    
    
    
    10.2Anticipated
financing sources:(1)Government equity
    
    
    8.0
    
    
    
    
    
    
    
    
    
    
    
    8.0
    
    
    
    1.0KCRC debt
    
    
    12.6
    
    
    
    6.7
    
    
    
    32.6
    
    
    
    51.9
    
    
    
    6.8
 45




---



##### Table of Contents



Kowloon
    
    Sha TinEast Rail
    
    Southern
    
    to CentralExtensions
    
    Link
    
    Link
    
    Total
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in billions)KCRC internal funds
    
    
    6.1
    
    
    
    2.2
    
    
    
    10.7
    
    
    
    19.0
    
    
    
    2.4Total
    
    
    26.7
    
    
    
    8.9
    
    
    
    43.3
    
    
    
    78.9
    
    
    
    10.2
   (1)
    
    As of December 31, 2003, total financing sources amounted to HK$22,311.5
million (US$2,873.7 million), consisting of HK$8,000 million (US$1,030.4
million) of capital contributions from the Hong Kong Government for the Ma
On Shan Rail and TST Extension; HK$7,738 million (US$996.7 million) in net
proceeds from the US$1 billion in principal amount of the Notes; HK$4,503
million (US$580.0 million) in net proceeds from the US$1 billion in
principal amount of 7.25% notes due 2009, US$50.0 million in principal
amount of 7.77% notes due 2014; HK$800 million (US$103.0 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$90.2 million) at a premium in
principal amount of 4.8% notes due 2013; and HK$270.5 million (US$34.8
million) from deferred payment of long term credit facilities. For the East Rail Extensions, we incurred a total cash outlay of HK$8.1
billion (US$1.0 billion) prior to 2003 and HK$5.6 billion (US$0.7 billion) in
2003. Based on our projected construction schedule, the following is our
estimated schedule of payments from 2004 onwards and the actual payments in
2003 for the East Rail Extensions: 2003
    
    2004
    
    2005
    
    2006 onwards
    
    Total
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in billions)Construction costs
    
    
    4.8
    
    
    
    5.3
    
    
    
    2.3
    
    
    
    3.9
    
    
    
    16.3
    
    
    
    2.1Land costs
    
    
    0.4
    
    
    
    0.3
    
    
    
    0.2
    
    
    
    0.1
    
    
    
    1.0
    
    
    
    0.1Financing costs
    
    
    0.4
    
    
    
    0.4
    
    
    
    0.3
    
    
    
    0.2
    
    
    
    1.3
    
    
    
    0.2Total
    
    
    5.6
    
    
    
    6.0
    
    
    
    2.8
    
    
    
    4.2
    
    
    
    18.6
    
    
    
    2.4
 For the Sha Tin to Central Link, we incurred a total cash outlay of HK$113
million (US$14.6 million) prior to 2003 and HK$458 million (US$59.0 million) in
2003. Based on our projected construction schedule, the following is our
estimated schedule of payments from 2004 onwards and the actual payments in
2003 for the Sha Tin to Central Link: 2003
    
    2004
    
    2005
    
    2006 onwards
    
    Total
    
    TotalHK$
    
    HK$
    
    
    
    
    
    HK$
    
    HK$
    
    US$(in billions)Construction costs
    
    
    0.4
    
    
    
    1.1
    
    
    
    1.0
    
    
    
    32.0
    
    
    
    34.5
    
    
    
    4.4Land costs
    
    
    
    
    
    
    
    
    
    
    0.3
    
    
    
    0.6
    
    
    
    0.9
    
    
    
    0.1Financing costs
    
    
    
    
    
    
    0.1
    
    
    
    0.2
    
    
    
    7.5
    
    
    
    7.8
    
    
    
    1.1Total
    
    
    0.4
    
    
    
    1.2
    
    
    
    1.5
    
    
    
    40.1
    
    
    
    43.2
    
    
    
    5.6
 For the Kowloon Southern Link, we incurred a total cash outlay of HK$42
million (US$5.4 million) prior to 2003 and HK$107 million (US$13.8 million) in
2003. Based on our projected construction schedule, the following is our
estimated schedule of payments from 2004 onwards and the actual payments in
2003 for the Kowloon Southern Link: 46




---



##### Table of Contents



2003
    
    2004
    
    2005
    
    2006 onwards
    
    Total
    
    TotalHK$
    
    HK$
    
    
    
    
    
    HK$
    
    HK$
    
    US$(in billions)Construction costs
    
    
    0.1
    
    
    
    0.2
    
    
    
    1.8
    
    
    
    6.0
    
    
    
    8.1
    
    
    
    1.0Land costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.2
    
    
    
    0.2
    
    
    
    Financing costs
    
    
    
    
    
    
    
    
    
    
    0.1
    
    
    
    0.5
    
    
    
    0.6
    
    
    
    0.1Total
    
    
    0.1
    
    
    
    0.2
    
    
    
    1.9
    
    
    
    6.7
    
    
    
    8.9
    
    
    
    1.1
 As of December 31, 2003, we had an aggregate of approximately HK$2,951
million (US$380.1 million) in outstanding commitments for capital expenditure
for the development of West Rail Phase I. We had HK$6,382 million (US$822.0
million) in outstanding commitments for capital expenditure of the East Rail
Extensions. We had an aggregate of approximately HK$3,972 million (US$511.6
million) in outstanding commitments for capital expenditure relating to the
existing East Rail and Light Rail operations and new railway projects. 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 West Rail Phase I, the East Rail Extensions, the Sha Tin to Central
Link and the 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, 2001, 2002 and 2003: Year Ended December 31,2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Railway
related operational equipment(1)
    
    
    13
    
    
    
    14
    
    
    
    15
    
    
    
    2Assets under
construction:(2)West Rail Phase I
    
    
    9,653
    
    
    
    6,503
    
    
    
    4,803
    
    
    
    619East Rail Extensions
    
    
    3,133
    
    
    
    4,352
    
    
    
    4,559
    
    
    
    587Kowloon Southern Link/Sha Tin to Central Link
    
    
    95
    
    
    
    61
    
    
    
    732
    
    
    
    94Automatic Train Protection System
    
    
    34
    
    
    
    
    
    
    
    
    
    
    
    Rolling Stock
    
    
    591
    
    
    
    387
    
    
    
    89
    
    
    
    11Others
    
    
    140
    
    
    
    232
    
    
    
    226
    
    
    
    2913,646
    
    
    
    11,535
    
    
    
    10,409
    
    
    
    1,340Others(3)
    
    
    20
    
    
    
    14
    
    
    
    3
    
    
    
    Total railway assets
    
    
    13,679
    
    
    
    11,563
    
    
    
    10,427
    
    
    
    1,342Investment property and buildings
    
    
    485
    
    
    
    
    
    
    
    
    
    
    
    Assets under construction for investment property, leasehold land and
buildings
    
    
    431
    
    
    
    745
    
    
    
    695
    
    
    
    91Total
capital expenditure(4)
    
    
    14,595
    
    
    
    12,308
    
    
    
    11,122
    
    
    
    1,433
   (1)
    
    Includes signaling system, telecommunication equipment, automatic revenue
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 and the East Rail Extensions.(3)
    
    Includes lifts, escalators, mobile phone communication equipment,
air-conditioning plant, furniture and fixture, electronic data processing
equipment, computer software, office equipment, buses, motor vehicles,
company boats and tools.(4)
    
    The capital expenditure excludes capitalized investment income and
borrowing costs. See Note 3(q) to our audited consolidated financial
statements for our accounting policy on borrowing costs and investment
income. 47




---



##### Table of Contents



Resources for Capital Expenditure Earnings.Historically, we have generated our capital resources primarily
through earnings. However, for the year ended December 31, 2003, the
contribution to capital resources by earnings from railway operations was
reduced as the net cash inflow from operating activities was HK$1,870 million
(US$240.9 million), a decrease of HK$630 million (US$81.1 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$620 million (US$79.9 million) in April 2004. 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 West Rail Phase I, the East Rail Extensions, the
Kowloon Southern Link and the Sha Tin to Central Link. 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 and Sha Tin to Central Link projects, we expect to rely largely on
borrowings. We currently expect borrowing costs to represent about 9.1% of
project costs in respect of all the above four projects, and variations in
costs could have a significant effect on the returns from these projects. We
anticipate that the US$1 billion in eurobonds issued in July 1999, and the
US$50 million private placement made in 1999 under our Euro medium term note
program, together with the net proceeds from the US$1 billion in principal
amount of the Notes and other debt facilities (see - Debt Facilities below),
will provide all the debt financing required for West Rail Phase I and the East
Rail Extensions projects. We expect to incur significant capital expenditure
in connection with the Kowloon Southern Link and Sha Tin to Central 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 and Sha Tin to Central Link are still being negotiated
and are subject to change, we expect to finance the projects from internal
resources and new debt. We will likely be required to substantially expand our
borrowings to meet part of the project costs for the construction of the
Kowloon Southern Link and Sha Tin to Central Link. 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 TST Extension of the East Rail
Extensions. These equity injections received from the Government represent
approximately 62.5% and 30.0% of the revised estimated project costs of HK$46.4
billion and HK$26.7 billion of West Rail Phase I and the East Rail Extensions,
respectively. 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. In October 2002,
Standard & Poors Rating Group, a division of McGraw-Hill, Inc. (Standard &
Poors) affirmed our AA- local and A+ foreign currency ratings. At the
same time, Standard & Poors affirmed the stable outlook on our foreign
currency rating but revised the outlook on our local currency rating to
negative from stable. On June 29, 2004, Standard &
Poors revised its outlook on our local currency rating from
negative to stable, and affirmed our foreign currency rating of
A+. In September 2003, Fitch Ratings assigned us, on an
unsolicited basis, ratings of AA- for our senior unsecured foreign currency
debt, AA for our senior unsecured local currency debt and F1+ for our short
term debt obligations with a negative outlook on long term ratings. In May
2004, Fitch Ratings 48




---



##### Table of Contents



affirmed its ratings on us but revised the outlook to
stable. In June 2004, Fitch Ratings revised our local currency outlook from
stable to negative, but affirmed our local currency rating at AA. In October
2003, Moodys Investors Services (Moodys) upgraded our foreign currency
rating from A3 to A1, reflecting the upgrade of Hong Kongs foreign currency
country ceilings with a stable outlook, and affirmed our domestic currency
rating at Aa3 with a stable outlook. The ratings assigned by
Moodys and Standard
& Poors are the sovereign ceiling of the Government of Hong
Kong Special Administrative Region. With respect to our required debt financing
for West Rail Phase I and the East Rail Extensions, we have implemented a
borrowing strategy designed to diversify funding sources and reduce financing
costs. We have developed the following funding sources:  
    
    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. 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 or the seventh
month after the date of final delivery of the equipment, whichever is
earlier. In addition to the US$22.4 million drawn down in previous
years, an amount of US$13.1 million was drawn down during the year.
    
    In March 2000, we issued US$1 billion in principal amount of 8% notes
due in 2010 (the Notes). The Notes are unsecured senior obligations
of KCRC and are rated equally with all of our other unsecured senior
indebtedness.
    
    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$253.6 million as of December
31, 2003, 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$36.6 million by KCRC. The loans are unsecured and
repayable in 17 semi-annual installments commencing in April 2003. As
of December 31, 2003, approximately 57% of the total loan balance
bears interest at a rate of 5.6% per annum and the remaining 43% bears
interest at LIBOR plus a margin.
    
    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 US$1 billion in
principal amount of 7.25% notes due 2009 and US$50 million in
principal amount of 7.77% notes due 2014, respectively, under this
program. With respect to our required debt financing for the Kowloon Southern Link
and Sha Tin to Central Link, we intend to implement a borrowing strategy
designed to diversify funding sources and reduce financing costs. We have
utilized the following funding sources:  
    
    In June 2003, we issued a two-tranche Hong Kong dollar retail bonds
issuance, including HK$300 million in principal amount of 3% notes due
2008 and HK$700 million in principal amount of 4.8% notes due 2013. 49




---



##### Table of Contents




    
    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. Investments Our Managing Board has adopted a set of guidelines governing the
investment of resources intended to regulate our credit risk exposure as well
as currency exposure. Currently, all our investments must be in Hong Kong
dollars or U.S. dollars or hedged into these currencies. As of December 31,
2003, our cash, investments and deposits with banks were HK$14,921 million
(US$1,921.8 million) after investment of the net proceeds of the US$1 billion
in principal amount of the Notes that we issued in March 2000, US$1 billion in
principal amount of 7.25% notes due 2009 that we issued in July 1999, US$50
million in principal amount of 7.77% notes due 2014 that we issued in November
1999, HK$300 million in principal amount of 3% notes due 2008, HK$700 million
in principal amount of 4.8% notes due 2013 and the HK$800 million in principal
amount of 4.65% notes due 2013 that we issued in June 2003. Of such HK$14.9
billion, over HK$7.3 billion was in bank deposits and certificates of deposit.
HK$7.0 billion was invested in unlisted fixed income securities. Over HK$11.3
billion of our investments was in obligations (or with institutions) rated in
the top two rating categories of recognized international rating agencies. As
of December 31, 2003, over HK$8.9 billion represented Hong Kong dollar
obligations. 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$748 million (US$96.3
million) as of December 31, 2003. This was mainly attributable to the decrease
in the balance of cash and cash equivalents as a result of 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
liquidation of our investments with external investment managers will allow us
to meet these payments in 2004. 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 In 2003, our ridership was impacted by the SARS outbreak and increased
competition. Our ridership recorded a 6% decrease in overall patronage to
1,132,000 passenger trips a day on average for the year, due to intense
competition from the cross-boundary coach operators. Since then, our market
share in the transport market in both percentage terms and absolute passenger
numbers have not recovered to pre-SARS levels. The monthly ridership figures
for the last six months of 2003 indicate a worsening downward trend, with
passenger numbers from July to December 2003 being over 8% down compared with
the same period in 2002. The latest in passenger ridership figures of 2004 do
not indicate
that this trend will reverse in the immediately foreseeable future. In
comparison, the cross-boundary coach operators increased their market share as
they took advantage of the further opening of the closed areas near the
boundary. The effect of the Governments recent decision to legalize and
regulate the cross-boundary bus services, which were previously operating
without authorization from the Government on competition in the cross-boundary
market is uncertain. The opening of the Lok Ma Chau 50




---



##### Table of Contents



Spur Line in late 2006
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. At present, mainland China authorities and the Transport Department of the
Government are discussing ways to regulate the coaches operating between Hong
Kong and Huanggang. The outcome of such discussions between the two authorities
could have a significant impact on our cross-boundary business. For the first five months of 2004, West Rail Phase I daily patronage, at
around 103,200, was 47.7% below the budget figure of 197,200. The reasons for
this below budget ridership include lower population growth in the
north-western New Territories than that forecasted by the Government, which is
in part due to the suspension of planned real property development along West
Rail, and a higher level of competition due to fewer bus routes being cancelled
than expected. West Rail Phase I ridership is anticipated to grow to approximately
140,000 by the end of 2004, giving a total ridership of less than 50% of our
forecast. This anticipated growth is based on our assumption that we will
implement a number of improvement measures in 2004, such as Light Rail and Bus
route rationalization, the provision of a West Rail feeder service at Tsuen Wan
and enhanced advertising and promotion, including, continuation of the free
ride promotion. If these improvement measures fail to increase ridership, the
shortfall in passenger numbers between the actual and forecasted figures will
be greater. If we fail to increase our ridership levels, the profitability of
West Rail Phase I would be adversely affected. However, we anticipate that
ridership will increase upon the completion of the Kowloon Southern Link in
early 2009. We have withheld inviting further tenders for our property development
projects until the end of 2004, based on our agreement with the Government to
help stabilize the property market. We intend to put as a priority the
completion of the development of West Rail property sites as soon as
practicable, as we believe that the future residents of these sites may
contribute significantly to the growth of the West Rail Phase I ridership.
However, our main source of revenue has always been and will continue to be
fares. The receipts from property developments are not a regular source of
revenue and are not a dependable long-term stable source of revenue for us. In
any event, we are only entitled to profits from those developments to be built
along the East Rail, Light Rail and Ma On Shan Rail, and all profits arising
from developments built along West Rail Phase I will belong to the Government. In relation to West Rail Phase I, which has been in commercial operation
since December 2003, we have granted a six-month rent-free period to all
tenants and will continually review the rental concessions. However, due to
the lower than forecasted ridership, some tenants are in financial difficulty.
The commercial revenue arising from West Rail Phase I commercial property
portfolio will be adversely affected. In view of the low patronage, ancillary
revenue from West Rail Phase I is expected to remain low until 2008, when our
joint venture property developments are expected to be completed. We expect
property revenues to increase in 2005, 2006 and 2007 due to the expanded
property portfolio along the Ma On Shan Rail, TST Extension and Lok Ma Chau
Spur Line. On February 24, 2004, the Government announced that KCRC and MTRCL were
invited to commence negotiations on a possible merger. KCRC and MTRCL are to
submit to the Government the outcome of the negotiations, including preliminary
transaction terms and the framework of a draft
operating agreement with key terms on operational matters, including but
not limited to the fare adjustment mechanism and safeguards and measures to
deal with service disruption. The Government would then determine the way
forward. The negotiations are to be conducted under the following parameters
set by the Government: 51




---



##### Table of Contents




    
    Adoption of a more objective and transparent fare adjustment mechanism;
    
    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 the front line staff of both corporations at the time of the merger;
    
    Provision of seamless interchange arrangements in the long run; and
    
    Conclusion of negotiations by August 31, 2004. 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, 2003, a portion of our assets with a total original cost of
HK$11,836 million (US$1,524.5 million) and net book value of HK$8,300 million
(US$1,069.0 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 43(j) to
our audited consolidated financial statements. See Note 3(o) and 12(h) to our
audited consolidated financial statements for descriptions of the accounting
treatment under HK GAAP and Note 43(h) 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. 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 as of December 31, 2003: Payments Due by PeriodLess than
    
    1-3
    
    4-5
    
    After 5Contractual Obligations
    
    1 year
    
    years
    
    years
    
    years
    
    Total
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in millions)Interest-bearing borrowings
    
    
    297
    
    
    
    597
    
    
    
    912
    
    
    
    18,207
    
    
    
    20,013
    
    
    
    2,578Capital lease obligations(1)
    
    
    671
    
    
    
    1,328
    
    
    
    1,718
    
    
    
    9,783
    
    
    
    13,500
    
    
    
    1,739Operating leases
    
    
    87
    
    
    
    45
    
    
    
    8
    
    
    
    
    
    
    
    140
    
    
    
    18Total
    
    
    1,055
    
    
    
    1,970
    
    
    
    2,638
    
    
    
    27,990
    
    
    
    33,653
    
    
    
    4,335
 52




---



##### Table of Contents



Amount of Commitment Expiration Per PeriodLess than
    
    1-3
    
    4-5
    
    After 5Other Commercial Commitments
    
    1 year
    
    years
    
    years
    
    Years
    
    Total
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in millions)Short-term
uncommitted revolving credit facilities
    
    
    2,350
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,350
    
    
    
    303Letter of credit
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20
    
    
    
    3Overdraft facilities
    
    
    25
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25
    
    
    
    3Medium term note program
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,399
    
    
    
    14,399
    
    
    
    1,854Letter of credit for US
leveraged leases
    
    
    265
    
    
    
    927
    
    
    
    920
    
    
    
    164
    
    
    
    2,276
    
    
    
    293Export credit loan facilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    51
    
    
    
    51
    
    
    
    7Purchase commitmentsCapital
expenditure(2)
    
    
    7,960
    
    
    
    3,855
    
    
    
    785
    
    
    
    705
    
    
    
    13,305
    
    
    
    1,713Recurrent expenditure
    
    
    978
    
    
    
    138
    
    
    
    
    
    
    
    
    
    
    
    1,116
    
    
    
    144Total
    
    
    11,598
    
    
    
    4,920
    
    
    
    1,705
    
    
    
    15,319
    
    
    
    33,542
    
    
    
    4,320
   (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 28 to our audited consolidated financial
statements) and those not recognized as obligations in the balance sheet
under HK GAAP (see Note 43(h) 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, 2003. Since these works had not
commenced as of December 31, 2003, they were not provided for in our
audited consolidated financial statements. 
 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. In 2003, the terms of appointment of two members expired, namely, Mr.
Michael P.S. Tien and Mr. K.Y. Yeung. Mr. Michael P.S. Tien was reappointed as
the Chairman for a term of two years from 53




---



##### Table of Contents



December 24, 2003. Mr. K.Y. Yeung
retired as the Chief Executive Officer and Member of the Managing Board on
December 31, 2003. Mr. Samuel M.H. Lai succeeded Mr. K.Y. Yeung as Chief
Executive Officer (Acting) on January 1, 2004. Mr. Patrick S.C. Wang and Mr.
Victor H.W. So resigned from the Board on January 31, 2004. Two new members,
Mr. Abraham L.H. Shek and Professor Richard Y.C. Wong, were appointed to the
Managing Board for a term of two years commencing February 1, 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
    
    Member Since
    
    Current Term ExpiresMichael P.S. Tien, BBS, JP(1)(2)
Chairman
Chairman of Strategic Human
Resource Committee
Member of Capital Projects
Committee
Member of Property Committee
    
    Chairman of The G2000 Group since 1979, Chairman
of the Standing Committee on Language Education
and Research, and Chairman of the Privatisation
Sub-group of the Business Advisory Group, Vice
Chairman of the Employee Retraining Board, Member
of the Education Commission, Manpower Development
Committee and Guangdong Chinese Peoples Political
Consultative Conference.
    
    
    2001
    
    
    23 December 2005Samuel M.H. Lai
Chief Executive Officer (Acting)
Member of Finance Committee
Member of Capital Projects
Committee
Member of Property Committee
    
    Member of the Hong Kong Management Associations
Membership Committee
    
    
    2004
    
    
    No ExpiryVincent H.C. Cheng, OBE, JP(2)(3)
Chairman of Finance Committee
Member of Strategic Human
Resource Committee
    
    Executive Director of The Hongkong and Shanghai
Banking Corporation Limited, Vice Chairman and
Chief Executive of Hang Seng Bank Limited,
Director of Great Eagle Holdings Ltd. and Chairman
of Process Review Panel for the Securities and
Futures Commission.
    
    
    1997
    
    
    15 November 2004Vincent W.S. Lo, JP(2)
Chairman of Property Committee
Member of Capital Projects
Committee
    
    Senior Partner, Gallant Y.T. Ho & Co., Director
of BOC China Fund Ltd., GZITIC Hualing Holdings
Ltd., and 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 Consumer Legal Action Fund
Management Committee and the Lotteries Fund
Advisory Committee.
    
    
    1999
    
    
    23 December 2004Patrick B. Paul, CBE(3)
Chairman of Audit Committee
Member of Strategic Human
Resource Committee
    
    Non-executive Director of Johnson Electric
Holdings Ltd. and Kingsway International Holdings
Ltd.
    
    
    2002
    
    
    23 December 2004M.Y. Wan, BBS, JP(1)(2)
Chairman of Capital Projects
Committee
Member of Audit Committee
    
    Director of M Y Wan and Associates Limited, Member
of Elderly Commission, Panel Member of Municipal
Services Appeals Board, President of Youth
Outreach. Council Member of Hong Kong
    
    
    2002
    
    
    15 November 2004
 54




---



##### Table of Contents



Members of the Managing Board
    
    Principal Outside Functions
    
    Member Since
    
    Current Term ExpiresMember of Property Committee
    
    Federation
of Youth Groups, Manager of Chi Lin Buddhist
Secondary School (SOS).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, Executive
Director of Styletec Building Materials Limited and
Wellco Holdings Limited, Director of
Shakespeare4all Company Limited, Non-Executive
Director of Midas International Holdings Limited,
Paliburg Holdings Limited and Sino Elite Ltd.
    
    
    2004
    
    
    31 January, 2006Richard Y.C. Wong, SBS, JP(1)(2)
Member of Property Committee
Member of Finance Committee
    
    Professor of Economics, Dean of the Faculty of
Business and Economics of the University of Hong
Kong, Non-Executive Director of Great Eagle
Holdings Ltd., ICBC (Asia) Ltd., CK Life Sciences
International (Holdings) Ltd. and Orient Overseas
(International) Ltd.
    
    
    2004
    
    
    31 January, 2006Sarah 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 expiryFrederick 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 and the abbreviation OBE means Officer of the Most
Excellent Order of the British Empire. These titles and honors are
awarded by the British monarch. One member of our Managing Board is affiliated with The Hongkong and
Shanghai Banking Corporation Limited. Vincent H.C. Cheng is the Vice-Chairman
of Hang Seng Bank Limited, which is 62% owned by The Hongkong and Shanghai
Banking Corporation Limited. Sarah Liao and Frederick Ma were appointed by our
sole shareholder, the Government. Members of Senior Management
    
    Position
    
    Position Held SinceSamuel M.H. Lai
    
    Chief Executive Officer (Acting)
    
    
    2004Y.T. Li
    
    Senior Director, Transport
    
    
    2003K.K. Lee
    
    Senior Director, Capital Projects
    
    
    2004Ian M. Thoms
    
    Director, West Rail
    
    
    1998Jonathan H.G. Yu, JP(1)
    
    Director, Operations(a)
    
    
    1989
 55




---



##### Table of Contents



Members of Senior Management
    
    Position
    
    Position Held SinceDaniel
C. Lam, BBS, JP(1)(2)
    
    Director, Property
    
    
    2000Kenneth
K. S. Leung, SBS(2)
    
    Director, New Railway Projects
    
    
    2000Lawrence C.P. Li
    
    Director, Finance
    
    
    2004Mimi Cunningham
    
    Director, Human Resource
    
    
    2004David A. Fleming
    
    Company Secretary
    
    
    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 SBS means Silver Bauhinia Star and the abbreviation
BBS means Bronze Bauhinia Star. The honors are awarded by the Hong Kong
Special Administrative Region.(a)
    
    Director, Light Rail was retitled to Director, Operations in 2003. 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. 6.B      COMPENSATION The aggregate compensation paid by KCRC to all members of the Managing
Board and senior management as a group for 2003 was HK$45 million (US$5.8
million). Members of the Managing Board are entitled to receive fees, and
members of senior management receive compensation in the form of salaries,
allowances, benefits-in-kind, gratuities and payment in lieu of annual leave.
The Chief Executive Officer (Acting), while he was the Senior Director, Finance
and Management, was paid a special allowance in recognition of his additional
responsibilities arising from the gradual take-over of the responsibilities of
the Chief Executive Officer. There were no retirement or severance benefits
granted to members of the Managing Board, except for a payment to the previous
Chief Executive Officer upon his departure from KCRC on December 31, 2003 as a
result of his entitlement to long service payment under the Employment
Ordinance. We have paid HK$137 million (US$17.6 million) being retirement
costs for our employees for the year 2003, as compared to HK$129 million
(US$16.6 million) in 2002 and HK$123 million (US$15.8 million) in 2001. Please
see Note 39 of our audited consolidated financial statements. 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 expect to launch the variable pay scheme to the
top three tiers of management in the second half of 2004. 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 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 Vincent H.C. Cheng, Richard Y.C. Wong, Fredrick
S.H. Ma and Samuel M.H. Lai and the expert member is Alfred H.K. Li. This
committee is chaired by Vincent H.C. Cheng. 56




---



##### Table of Contents



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 and external
auditors. 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. On January 21, 2003, the former Committee on Senior Executive Remuneration
was renamed as the Strategic Human Resource Committee. This 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, Vincent H.C. Cheng, 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. 6.D      EMPLOYEES We employed a total of 5,871 full-time staff as of December 31, 2003. We
had 1,470 contract staff, generally with a contract term of two years, hired
for West Rail Phase I and the East Rail Extensions, the Kowloon Southern Link
and the Sha Tin to Central Link projects. Staffing levels have increased at an
accelerated pace during the last three years to meet additional manpower
requirements of West Rail Phase I and the East Rail Extensions. We hired 898
new staff in 2003, including 102 for the East Rail Extensions Division. 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. We have not experienced any organized
labor disputes since KCRC was formed. At December 31, 2002 and 2001, we had
5,510 and 5,170 employees, respectively. Our Human Resource Division continuously analyzes, improves and
synchronizes our human resources planning and practices 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 our current and
anticipated needs. We believe that our relations with our employees are good,
and we regularly consult with our employees when formulating staff policies.
Employee turnover in 2003 was approximately 9.4%. 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 opportunities for internal promotion
among our existing technical staff. 
 ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 7.A      MAJOR SHAREHOLDER The Government is our sole shareholder. As of December 31, 2003, 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. 57




---



##### Table of Contents



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 Ma On Shan Rail and TST Extension in March 2001. We
expect to finance the balance of the cost for the project from commercial
financing and internal resources. We expect to design and complete the
construction of the TST Extension and Ma On Shan Rail and to bring them into
operation by 2004. 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 the
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. Investments in Debt Securities Issued by the Government Since December 15, 2003, we have not held any investments in debt
securities issued by the Government and Government-owned entities in Hong Kong.
Interest income derived from our investment in these debt securities during
2003 amounted to HK$11 million. Octopus Cards Limited In 2003, we made payments of HK$29 million to Octopus Cards Limited, of
which we hold 22.1% of its shares, 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$7
million from Octopus Cards Limited in ticket loading agent fees for providing
add-value amount on Octopus cards. 58




---



##### Table of Contents



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. As of December 31, 2002, included in other receivables as noted in our
audited consolidated financial statements are certain costs relating to the
property development along the West Rail Phase I route amounting to HK$498
million (US$63.9 million). Pursuant to the terms of the shareholding
agreement, the above amount together with the related accrued interest of
HK$148 million (US$19.0 million) will be aggregated together with the balance
of the outstanding loan granted to WRPDL, pending agreement between KCRC and
the Government. The amounts have been included in the balance of loan to WRPDL
at December 31, 2003 upon agreement between KCRC and the Government according
to the provisions as set out in the Shareholding Agreement. See Notes 19 and
23 to our audited consolidated financial statements. 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-54. Legal Proceedings As of December 31, 2003, the Group 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 projects for which no provisions
have been made in the financial statements as of December 31, 2003. The Group
is in the process of resolving these claims and the amounts of the Groups
obligations, if any, cannot be estimated reliably. See Note 42 to our audited
consolidated financial statements. 59




---



##### Table of Contents



We are not party to any legal 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. 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 2004, we declared and paid a dividend of HK$620 million (US$79.9
million), representing 44.9% of our 2003 profit after taxation. Significant Changes The lower than forecasted ridership on the West Rail Phase I is likely to
affect our profitability. For details, see Item 5  Operating and Financial
Review and Prospects  Trend Information. Also, our profitability is likely
to be affected by increased competition from cross-boundary operators. The
impact of the Governments recent decision to legalize and regulate all
previously unauthorized cross-boundary bus operators on the growth in numbers
of such cross-boundary bus operators is uncertain. 
 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 08371001-000-12-99-3. 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 60




---



##### Table of Contents



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. 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 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 of Conduct for Corporation Business govern
the proceedings of the Managing Board. 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 KCRC shall be five. 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. 61




---



##### Table of Contents



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. 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 TST Extension and Ma On Shan Rail. 10.C      MATERIAL CONTRACTS Pursuant to the Deed of Vesting dated January 2, 2002, KCRC acquired the
Lo Wu Terminal Building Stage III from the Government. Pursuant to a Letter of Acceptance dated October 28, 2002, KCRC accepted
the tender submitted by Balfour Beatty Group Limited and Lam Construction
Company Limited for the construction of the Lok Ma Chau Terminus and associated
works included in the East Rail Extensions (LCC-300). Under the Letter of
Acceptance, the contractor agrees to execute construction of the project in
accordance with the terms and conditions of the Articles of Agreement, Letter
of Clarification, General Conditions of Contract, Special Conditions of
Contract, Form of Tender, Drawings and Specifications. The components of the
contract cost for the project and the payment terms have been filed separately
with the Commission pursuant to an application for confidential treatment. Pursuant to a Letter of Acceptance dated October 29, 2002, KCRC accepted
the tender submitted by Chun Wo Construction & Engineering Co., Ltd. for the
construction of a public transport interchange and property development
enabling works at the Tai Wai station (PCC-TWS). Under the Letter of
Acceptance, the contractor agrees to execute construction of the project in
accordance with the terms and conditions of the Articles of Agreement, Letter
of Clarification, General Conditions of Contract, Special Conditions of
Contract, Form of Tender, Drawings and Specifications. The components of the
contract cost for the project and the payment terms have been filed separately
with the Commission pursuant to an application for confidential treatment. Pursuant to a Letter of Acceptance dated October 29, 2002, KCRC accepted
the tender submitted by Chun Wo Construction & Engineering Co., Ltd. for the
construction of a public transport interchange and property development
enabling works at the Wu Kai Sha station (PCC-WKS). Under the Letter of
Acceptance, the contractor agrees to execute construction of the project in
accordance with the terms and conditions of the Articles of Agreement, Letter
of Clarification, General Conditions of Contract, Special Conditions of
Contract, Form of Tender, Drawings and Specifications. The components of the
contract cost for the project and the payment terms have been filed separately
with the Commission pursuant to an application for confidential treatment. 62




---



##### Table of Contents



Pursuant to a Letter of Acceptance dated October 30, 2002, KCRC accepted
the tender submitted by Dragages Et Travaux Publics (HK) Ltd. and Bouygues
Travaux Publics S.A. for the construction of the Sheung Shui to Chau Tau
tunnels included in the East Rail Extensions (LDB-201). Under the Letter of
Acceptance, the contractor agrees to execute construction of the project in
accordance with the terms and conditions of the Articles of Agreement, Letter
of Clarification, General Conditions of Contract, Special Conditions of
Contract, Form of Tender, Drawings and Specifications. This contract created
by the Letter of Acceptance was amended by an Agreement Under Hand dated
December 19, 2002. The components of the contract cost for the project and the
payment terms have been filed separately with the Commission pursuant to an
application for confidential treatment. Pursuant to a Letter of Acceptance dated December 17, 2002, KCRC accepted
the tender submitted by Maeda Corporation for the construction of the west
section alignment and associated works included in the East Rail Extensions
(LCC-202). Under the Letter of Acceptance, the contractor agrees to execute
construction of the project in accordance with the terms and conditions of the
Articles of Agreement, Letter of Clarification, General Conditions of Contract,
Special Conditions of Contract, Form of Tender, Drawings and Specifications.
The components of the contract cost for the project and the payment terms have
been filed separately with the Commission pursuant to an application for
confidential treatment. 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 includes 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 centre. 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. The capital cost estimate, the amount payable to or by the
Government in consideration for the rental of land and the agreed allocation of
property development profits from these sites have been filed separately with
the Commission pursuant to an application for confidential treatment. 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. 63




---



##### Table of Contents



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 64




---



##### Table of Contents



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. 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 minimisdiscount 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. Gain 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. 65




---



##### Table of Contents



Information Reporting and Backup Withholding Payments in respect of 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 66




---



##### Table of Contents



exposures for approval by
our Managing Board. Adherence to these policies is monitored by our finance
division on an ongoing basis. The following presents information regarding our market risk exposures as
of December 31, 2003. References in the following tables to AUD are to the
Australian dollar, CAD are to the Canadian dollar, CHF are to the Swiss
Franc, 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, 2002 and 2003. 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, 2003Expected Maturity Date
    
    As of December 31, 2002Aggregate
    
    
    
    
    
    Aggregate2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Thereafter
    
    Total
    
    Fair Value(1)
    
    Total
    
    Fair Value(1)(HK$ equivalent in millions, other than interest rates)Investment securities:Fixed rate:Principal amount (HK$)
    
    
    3,892
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,892
    
    
    
    3,841
    
    
    
    10,565
    
    
    
    10,687Average interest rate
    
    
    2.4
    %Principal amount (US$)
    
    
    2,731
    
    
    
    387
    
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,126
    
    
    
    3,162
    
    
    
    5,249
    
    
    
    5,335Average interest rate
    
    
    2.4
    %
    
    
    5.0
    %
    
    
    2.9
    %Principal amount (EUR)
    
    
    166
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    166
    
    
    
    169
    
    
    
    
    
    
    
    Average interest rate
    
    
    4.2
    %Variable rate:Principal amount (HK$)
    
    
    30
    
    
    
    
    
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    50
    
    
    
    50
    
    
    
    
    
    
    
    Average interest rate
    
    
    0.6
    %
    
    
    
    
    
    
    0.7
    %Principal amount (US$)
    
    
    349
    
    
    
    317
    
    
    
    264
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    930
    
    
    
    931
    
    
    
    632
    
    
    
    632Average interest rate
    
    
    1.4
    %
    
    
    1.3
    %
    
    
    1.4
    %Debt instruments:Fixed rate:Medium term notePrincipal amount(US$)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,152
    )
    
    
    (8,152
    )
    
    
    (9,452
    )
    
    
    (8,189
    )
    
    
    (9,649
    )Average interest rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7.4
    %Principal amount(HK$)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (800
    )
    
    
    (800
    )
    
    
    (787
    )
    
    
    
    
    
    
    Average interest rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4.7
    %Global note (the Note)Principal amount(US$)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,764
    )
    
    
    (7,764
    )
    
    
    (9,344
    )
    
    
    (7,799
    )
    
    
    (9,560
    )Average interest rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8.2
    %Export credit loanPrincipal amount US$)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (199
    )
    
    
    (265
    )
    
    
    (663
    )
    
    
    (1,127
    )
    
    
    (1,198
    )
    
    
    (817
    )
    
    
    (881
    )Average interest rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5.7
    %
    
    
    5.7
    %
    
    
    5.7
    %Retail bondPrincipal amount (HK$)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (300
    )
    
    
    (700
    )
    
    
    (1,000
    )
    
    
    (1,000
    )
    
    
    
    
    
    
    Average interest rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.0
    %
    
    
    4.9
    %Variable rate:Export credit loanPrincipal amount US$)
    
    
    (298
    )
    
    
    (297
    )
    
    
    (298
    )
    
    
    (103
    )
    
    
    (38
    )
    
    
    (84
    )
    
    
    (1,118
    )
    
    
    (1,118
    )
    
    
    (992
    )
    
    
    (992
    )Average interest rate
    
    
    1.8
    %
    
    
    1.8
    %
    
    
    1.8
    %
    
    
    1.8
    %
    
    
    1.9
    %
    
    
    1.9
    %Interest
rate swaps(1):Fixed to variable rate:Notional amount (US$)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,882
    
    
    
    3,882
    
    
    
    561
    
    
    
    3,899
    
    
    
    678Interest pay rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2.2
    %Interest receive rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7.7
    %Notional amount (HK$)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    300
    
    
    
    1,500
    
    
    
    1,800
    
    
    
    (32
    )
    
    
    
    
    
    
    Interest pay rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.2
    %
    
    
    0.7
    %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




---



##### Table of Contents



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, 2002 and 2003. 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, 2003Expected Maturity Date
    
    As of December 31, 2002Aggregate
    
    
    
    
    
    Aggregate2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Thereafter
    
    Total
    
    Fair Value(1)
    
    Total
    
    Fair Value(1)(HK$ equivalent in millions, other than interest rates and exchange rates)Investment securities:Fixed rate:Principal amount
(US$)
    
    
    2,731
    
    
    
    387
    
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,126
    
    
    
    3,162
    
    
    
    5,249
    
    
    
    5,335Average interest
rate
    
    
    2.4
    %
    
    
    5.0
    %
    
    
    2.9
    %Principal amount
(EUR)
    
    
    166
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    166
    
    
    
    169
    
    
    
    
    
    
    
    Average interest
rate
    
    
    4.2
    %Variable rate:Principal amount
(US$)
    
    
    349
    
    
    
    317
    
    
    
    264
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    930
    
    
    
    931
    
    
    
    632
    
    
    
    632Average interest
rate
    
    
    1.4
    %
    
    
    1.3
    %
    
    
    1.4
    %Debt instruments:Fixed rate:Medium term notePrincipal amount
(US$)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,152
    )
    
    
    (8,152
    )
    
    
    (9,452
    )
    
    
    (8,189
    )
    
    
    (9,649
    )Average interest
rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7.4
    %Global note (the Note)Principal amount
(US$)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7,764
    )
    
    
    (7,764
    )
    
    
    (9,344
    )
    
    
    (7,799
    )
    
    
    (9,560
    )Average interest
rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8.2
    %Export credit loanPrincipal amount
(US$)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (199
    )
    
    
    (265
    )
    
    
    (663
    )
    
    
    (1,127
    )
    
    
    (1,198
    )
    
    
    (817
    )
    
    
    (881
    )Average interest
rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5.7
    %
    
    
    5.7
    %
    
    
    5.7
    %Variable rate:Export credit loanPrincipal
amount(US$)
    
    
    (298
    )
    
    
    (297
    )
    
    
    (298
    )
    
    
    (103
    )
    
    
    (38
    )
    
    
    (84
    )
    
    
    (1,118
    )
    
    
    (1,118
    )
    
    
    (992
    )
    
    
    (992
    )Average interest
rate
    
    
    1.8
    %
    
    
    1.8
    %
    
    
    1.8
    %
    
    
    1.8
    %
    
    
    1.9
    %
    
    
    1.9
    %Foreign exchange agreements:Receive CAD/pay HK$
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.8
    
    
    
    Average contractual
exchange rateReceive CHF/pay HK$
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31.9
    
    
    
    6.7Average contractual
exchange rateReceive EUR/pay HK$
    
    
    29.4
    
    
    
    11.8
    
    
    
    2.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    43.2
    
    
    
    8.5
    
    
    
    147.9
    
    
    
    18.8Average contractual
exchange rate
    
    
    7.8
    
    
    
    9.0
    
    
    
    8.8Receive GBP/pay HK$
    
    
    10.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10.0
    
    
    
    1.1
    
    
    
    7.2
    
    
    
    0.3Average contractual
exchange rate
    
    
    12.4Receive US$/pay HK$
    
    
    2,060.6
    
    
    
    1,307.6
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,368.2
    
    
    
    (6.9
    )
    
    
    154.9
    
    
    
    Average contractual
exchange rate
    
    
    7.8
    
    
    
    7.7Receive US$/pay EUR
    
    
    159.2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    159.2
    
    
    
    (13.7
    )
    
    
    
    
    
    
    Average contractual
exchange rate
    
    
    1.2
 68




---



##### Table of Contents



As of December 31, 2003Expected Maturity Date
    
    As of December 31, 2002Aggregate
    
    
    
    
    
    Aggregate2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Thereafter
    
    Total
    
    Fair Value(1)
    
    Total
    
    Fair Value(1)(HK$ equivalent in millions, other than interest rates and exchange rates)Currency SwapNotional amount (Receive US$/
pay HK$)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,184
    
    
    
    15,184
    
    
    
    (497.1
    )
    
    
    15,184
    
    
    
    (241.3
    )Average interest rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.7
    %
   (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. 
 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, 2003. 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 69




---



##### Table of Contents



occurred during the fiscal
year ended December 31, 2003 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 attached as
Exhibit 11.1. Our Code of Ethics is also 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 the appointed auditors
in 2002 and 2003 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 for its
leasing arrangements. Percentage ofServices DeliveredFees
    
    Fees
    
    Percentage of
    
    by Part-time Stafffor
    
    for
    
    Services Approved
    
    of the Accounting2003
    
    2002
    
    for 2003
    
    Firm(HK$ million)Audit services
    
    
    3
    
    
    
    3
    
    
    
    100
    %
    
    
    Audit-related services
    
    
    1
    
    
    
    
    
    
    
    100
    %
    
    
    Tax services
    
    
    6
    
    
    
    2
    
    
    
    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 the appointed auditor 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 external auditor 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 auditor except for those services prescribed in
Section 14B of the KCRC Ordinance. Procedures In order to give effect to the Audit Committees Policy in regard to the
pre-approval of services provided by KCRCs external auditor, the following
procedures have been adopted: 70




---



##### Table of Contents




    
    The external auditor 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 auditor 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 external auditor for audit
services rendered pursuant to Section 14B of the KCRC Ordinance but will
consider any submissions made by the external auditor in this regard and make
recommendations to the Managing Board. 
 ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES None. 
 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-54 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 of Conduct for Corporation Business (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 Programme.
 71




---



##### Table of Contents



***4.1
    
    Deed of Vesting dated January 2, 2002 between KCRC and Government of the Hong Kong Special Administration Region of the
Peoples Republic of China.****4.2
    
    Civil Construction Contract (LCC-300) for the Lok Ma Chau Terminus and
associated works dated October 28, 2002 between KCRC and Balfour Beatty
Group Limited and Lam Construction Company Limited.****4.3
    
    Civil Construction Contract (PCC-TWS) for the construction of a public
transport interchange and property development enabling works at Tai Wai
Station dated October 29, 2002 between KCRC and Chun Wo Construction &
Engineering Co., Ltd.****4.4
    
    Civil Construction Contract (PCC-WKS) for the construction of a public
transport interchange and property development enabling works at Wu Kai
Sha Station dated October 29, 2002 between KCRC and Chun Wo Construction &
Engineering Co., Ltd.****4.5
    
    Civil Construction Contract (LDB-201) for the construction of the
Sheung Shui to Chau Tau tunnels dated October 30, 2002 between KCRC and
Dragages Et Travaux Publics (HK) Ltd and Bouygues Travaux Publics S.A.****4.6
    
    Civil Construction Contract (LCC-202) for the construction of the west
section alignment and associated works included in the East Rail
Extensions dated December 17, 2002 between KCRC and Maeda Corporation.****4.7
    
    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.6.1
    
    Computation of Earnings per Share.8.1
    
    Subsidiaries of the Registrant: See
Item 4. Information on KCRC  Organizational Structure.11.1
    
    Code of Ethics.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)**
    
    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




---



##### Table of Contents



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 30, 2004 S-1




---



##### Table of Contents



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
OF
KOWLOON-CANTON RAILWAY CORPORATION Audited Consolidated Financial StatementsReport of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Income Statements for the years ended December 31, 2001, 2002 and 2003
    
    
    F-3Consolidated Balance Sheets as of December 31, 2002 and 2003
    
    
    F-4Consolidated Statements of Changes in Equity for the years ended December 31, 2002 and 2003
    
    
    F-5Consolidated Cash Flow Statements for the years ended December 31, 2001, 2002 and 2003
    
    
    F-6Notes 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, 2002 and 2003, the consolidated statements of
changes in equity for the years ended December 31, 2002 and 2003, and the
related consolidated income statements and cash flow statements for each of the
years in the three-year period ended December 31, 2003. 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, 2002 and 2003, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in Hong Kong. As discussed in note 4(a) to the consolidated financial statements, the
Group adopted with effect from January 1, 2003 a new accounting policy for
deferred tax in order to comply with the revised Statement of Standard
Accounting Practice 12, Income Taxes issued by the Hong Kong Society of
Accountants. 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 43 to the consolidated financial
statements. The accompanying consolidated financial statements as of and for the year
ended December 31, 2003 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
3(y) to the consolidated financial statements. KPMG
Hong Kong
March 1, 2004 F-2




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATIONCONSOLIDATED INCOME STATEMENTS Year Ended December 31,Note
    
    2001
    
    2002
    
    2003
    
    2003RestatedHK$
    
    HK$
    
    HK$
    
    US$(in millions)Revenue
    
    
    5
    
    
    
    4,797
    
    
    
    4,830
    
    
    
    4,426
    
    
    
    570Operating costs
    
    
    5
    
    
    
    2,886
    
    
    
    2,896
    
    
    
    2,877
    
    
    
    371Operating profit before net investment income
    
    
    
    
    
    
    1,911
    
    
    
    1,934
    
    
    
    1,549
    
    
    
    199Net investment income
    
    
    6
    
    
    
    490
    
    
    
    618
    
    
    
    353
    
    
    
    45Profit after net investment income
    
    
    
    
    
    
    2,401
    
    
    
    2,552
    
    
    
    1,902
    
    
    
    244Profit on property development
    
    
    7
    
    
    
    24
    
    
    
    94
    
    
    
    
    
    
    
    Share of profit of associate
    
    
    
    
    
    
    11
    
    
    
    16
    
    
    
    8
    
    
    
    1Profit before taxation
    
    
    
    
    
    
    2,436
    
    
    
    2,662
    
    
    
    1,910
    
    
    
    245Income tax
    
    
    8
    (a)
    
    
    (1
    )
    
    
    (452
    )
    
    
    (529
    )
    
    
    (67
    )Profit after taxation
    
    
    9
    
    
    
    2,435
    
    
    
    2,210
    
    
    
    1,381
    
    
    
    178Transfer to development reserve
    
    
    32
    
    
    
    (24
    )
    
    
    (94
    )
    
    
    
    
    
    
    Retained profit for the year
    
    
    
    
    
    
    2,411
    
    
    
    2,116
    
    
    
    1,381
    
    
    
    178Dividend attributable to the year:Final dividend proposed after the
balance sheet date
    
    
    10
    
    
    
    
    
    
    
    620
    
    
    
    620
    
    
    
    80
 The accompanying notes are an integral part of these financial statements. F-3




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATIONCONSOLIDATED BALANCE SHEETS As of December 31,Note
    
    2002
    
    2003
    
    2003RestatedHK$
    
    HK$
    
    US$(in millions)AssetsFixed assets Investment properties
    
    
    12
    
    
    
    895
    
    
    
    878
    
    
    
    113 Other properties, plant and equipment
    
    
    12
    
    
    
    13,156
    
    
    
    50,979
    
    
    
    6,56614,051
    
    
    
    51,857
    
    
    
    6,679Construction in progress
    
    
    13
    
    
    
    42,298
    
    
    
    15,101
    
    
    
    1,945Deferred expenditure
    
    
    14
    
    
    
    156
    
    
    
    900
    
    
    
    116Properties under development
    
    
    15
    
    
    
    1,153
    
    
    
    1,448
    
    
    
    187Interest in associate
    
    
    17
    
    
    
    35
    
    
    
    42
    
    
    
    5Loan receivable
    
    
    18
    
    
    
    
    
    
    
    774
    
    
    
    100Loan to subsidiary
    
    
    19
    
    
    
    2,048
    
    
    
    3,232
    
    
    
    416Investments in securities
    
    
    20
    
    
    
    19,165
    
    
    
    12,244
    
    
    
    1,577Stores and spares
    
    
    21
    
    
    
    213
    
    
    
    254
    
    
    
    33Interest receivable
    
    
    22
    
    
    
    299
    
    
    
    63
    
    
    
    8Other receivables
    
    
    23
    
    
    
    1,162
    
    
    
    612
    
    
    
    79Cash and cash equivalents
    
    
    24
    
    
    
    5,528
    
    
    
    2,677
    
    
    
    34586,108
    
    
    
    89,204
    
    
    
    11,490LiabilitiesInterest payable
    
    
    25
    
    
    
    443
    
    
    
    474
    
    
    
    61Other payables
    
    
    26
    
    
    
    2,251
    
    
    
    2,098
    
    
    
    270Accrued charges and provisions for capital projects
    
    
    27
    
    
    
    3,111
    
    
    
    1,782
    
    
    
    230Lease payable
    
    
    28
    
    
    
    
    
    
    
    758
    
    
    
    98Interest-bearing borrowings
    
    
    29
    
    
    
    17,753
    
    
    
    20,013
    
    
    
    2,578Deferred income
    
    
    30
    
    
    
    434
    
    
    
    743
    
    
    
    96Deferred tax liabilities
    
    
    8(
    d)
    
    
    2,604
    
    
    
    3,131
    
    
    
    40326,596
    
    
    
    28,999
    
    
    
    3,736Net Assets
    
    
    
    
    
    
    59,512
    
    
    
    60,205
    
    
    
    7,754Capital and ReservesShare capital
    
    
    31
    
    
    
    39,120
    
    
    
    39,120
    
    
    
    5,039Development reserve
    
    
    32
    
    
    
    6,535
    
    
    
    6,535
    
    
    
    841Investment property revaluation reserve
    
    
    33
    
    
    
    134
    
    
    
    117
    
    
    
    15Investment revaluation reserve
    
    
    34
    
    
    
    50
    
    
    
    (1
    )
    
    
    Proposed dividend
    
    
    10
    
    
    
    620
    
    
    
    620
    
    
    
    80Retained profits
    
    
    35
    
    
    
    13,053
    
    
    
    13,814
    
    
    
    1,77959,512
    
    
    
    60,205
    
    
    
    7,754
 The accompanying notes are an integral part of these financial statements. F-4




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATIONCONSOLIDATED STATEMENTS OF CHANGES IN EQUITY Year ended December 31,Note
    
    2002
    
    2003
    
    2003RestatedHK$
    
    HK$
    
    US$(in millions)Opening balance  Total equity as previously reported
    
    
    
    
    
    
    59,580
    
    
    
    59,512
    
    
    
    7,665 prior period adjustment arising from change in accounting
policy for deferred tax
    
    
    4(a) & 35
    
    
    
    (2,153
    )
    
    
    
    
    
    
     as restated
    
    
    
    
    
    
    57,427
    
    
    
    59,512
    
    
    
    7,665Deficit on revaluation of investment properties
    
    
    33
    
    
    
    (42
    )
    
    
    (17
    )
    
    
    (2
    )Deficit on revaluation of investments in securities
    
    
    34
    
    
    
    (102
    )
    
    
    (76
    )
    
    
    (10
    )Net losses not recognized in the income statement
    
    
    
    
    
    
    (144
    )
    
    
    (93
    )
    
    
    (12
    )57,283
    
    
    
    59,419
    
    
    
    7,653Revaluation deficit transferred to income statement on disposal of
securities
    
    
    34
    
    
    
    19
    
    
    
    25
    
    
    
    3Retained profit for the year as previously reported
    
    
    
    
    
    
    2,567 prior period adjustment arising from change in accounting
policy for deferred tax
    
    
    4(a) & 35
    
    
    
    (451
    ) Retained profit for the year (2002: as restated)
    
    
    
    
    
    
    2,116
    
    
    
    1,381
    
    
    
    178Transfer to the development reserve
    
    
    32
    
    
    
    94
    
    
    
    
    
    
    
    Dividend paid during the year
    
    
    10
    
    
    
    
    
    
    
    (620
    )
    
    
    (80
    )Closing balance  Total equity
    
    
    
    
    
    
    59,512
    
    
    
    60,205
    
    
    
    7,754
 The accompanying notes are an integral part of these financial statements. F-5




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATIONCONSOLIDATED CASH FLOW STATEMENTS Year Ended December 31,Note
    
    2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Operating activitiesNet cash inflow from operations
    
    
    38
    (a)
    
    
    2,761
    
    
    
    2,903
    
    
    
    2,179
    
    
    
    281Net cash outflow from property development
    
    
    38
    (b)
    
    
    (350
    )
    
    
    (402
    )
    
    
    (308
    )
    
    
    (40
    )Hong Kong profits tax (paid)/refunded
    
    
    
    
    
    
    18
    
    
    
    (1
    )
    
    
    (1
    )
    
    
    Net cash inflow from operating activities
    
    
    
    
    
    
    2,429
    
    
    
    2,500
    
    
    
    1,870
    
    
    
    241Investing activitiesDecrease in deposits with banks with more than
3 months of maturity when placed
    
    
    
    
    
    
    1,296
    
    
    
    3,066
    
    
    
    743
    
    
    
    96Payments to acquire investments
    
    
    
    
    
    
    (2,951
    )
    
    
    (4,328
    )
    
    
    
    
    
    
    Payments for capital expenditure West Rail project
    
    
    
    
    
    
    (10,225
    )
    
    
    (7,049
    )
    
    
    (5,367
    )
    
    
    (691
    ) East Rail Extensions project
    
    
    
    
    
    
    (2,636
    )
    
    
    (3,449
    )
    
    
    (5,282
    )
    
    
    (680
    ) other capital projects and purchase of fixed
assets
    
    
    
    
    
    
    (1,050
    )
    
    
    (2,008
    )
    
    
    (1,587
    )
    
    
    (204
    )Loan repaid by associate
    
    
    
    
    
    
    3
    
    
    
    4
    
    
    
    
    
    
    
    Interest received
    
    
    
    
    
    
    1,820
    
    
    
    1,813
    
    
    
    725
    
    
    
    93Receipt from disposal of shares in associate
    
    
    
    
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    Receipts from sale of fixed assets
    
    
    
    
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    Loan to subsidiary
    
    
    
    
    
    
    (511
    )
    
    
    (512
    )
    
    
    (382
    )
    
    
    (49
    )Receipts from redemption of investments
    
    
    
    
    
    
    3,468
    
    
    
    12,376
    
    
    
    6,783
    
    
    
    873Receipts from sale of investments
    
    
    
    
    
    
    412
    
    
    
    
    
    
    
    
    
    
    
    Net cash outflow from investing activities
    
    
    
    
    
    
    (10,370
    )
    
    
    (81
    )
    
    
    (4,367
    )
    
    
    (562
    )Net cash inflow/(outflow) before financing
    
    
    
    
    
    
    (7,941
    )
    
    
    2,419
    
    
    
    (2,497
    )
    
    
    321Financing activitiesNet proceeds on drawdown of loans
    
    
    
    
    
    
    433
    
    
    
    928
    
    
    
    2,271
    
    
    
    293Dividend paid
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (620
    )
    
    
    (80
    )Proceeds of issue of share capital
    
    
    
    
    
    
    8,000
    
    
    
    
    
    
    
    
    
    
    
    Interest paid
    
    
    
    
    
    
    (1,250
    )
    
    
    (1,256
    )
    
    
    (1,329
    )
    
    
    (171
    )Net income/(expenses) from derivative
instruments
    
    
    
    
    
    
    (61
    )
    
    
    60
    
    
    
    111
    
    
    
    14Other borrowing costs paid
    
    
    
    
    
    
    (9
    )
    
    
    (30
    )
    
    
    (37
    )
    
    
    (5
    )Amounts paid in respect of expenses for the
issue of interest-bearing borrowings
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7
    )
    
    
    (1
    )Net cash inflow/(outflow) from financing activities
    
    
    
    
    
    
    7,113
    
    
    
    (298
    )
    
    
    389
    
    
    
    50Increase/(decrease) in cash and cash equivalents
    
    
    
    
    
    
    (828
    )
    
    
    2,121
    
    
    
    (2,108
    )
    
    
    (271
    )Cash and cash equivalents at January 1,
    
    
    
    
    
    
    3,292
    
    
    
    2,464
    
    
    
    4,585
    
    
    
    590Cash and cash equivalents at December 31,
    
    
    
    
    
    
    2,464
    
    
    
    4,585
    
    
    
    2,477
    
    
    
    319Analysis of the balances of cash and cash
equivalentsCash at bank and in hand
    
    
    24
    (a)
    
    
    31
    
    
    
    20
    
    
    
    54
    
    
    
    7Deposits with banks within 3 months of
maturity when placed
    
    
    24
    (a)
    
    
    2,433
    
    
    
    4,565
    
    
    
    2,423
    
    
    
    3122,464
    
    
    
    4,585
    
    
    
    2,477
    
    
    
    319
 The accompanying notes are an integral part of these financial statements. F-6




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATIONNOTES TO THE FINANCIAL STATEMENTS
December 31, 2001, 2002, 2003 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  Principal activities The principal activities of the Corporation are the operation of East Rail
domestic passenger, cross-boundary passenger and freight traffic; the operation
of the Light Rail domestic passenger and, since 20 December 2003, West Rail
domestic passenger traffic; the development of associated ancillary commercial
activities; the development of property; the operation of feeder bus services;
the construction and subsequent operation of West Rail system; and the planning
and detailed design of other railways or extensions as requested by the
Government of the HKSAR (the Government). The principal activities of the
subsidiaries are set out in note 16. 3  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
Society of 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 in securities 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, other than the amount of capital provided,
these subsidiaries. F-7




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATIONNOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003 (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
investments in securities. 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, 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)  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 and impairment losses (see
note 3(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 assets expenditure is capitalized subject to a minimum cost
level of HK$20,000 per item.  
    
    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: F-8




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATIONNOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  
    
    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.  (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 3(g). Impairment
losses are accounted for in accordance with the accounting
policy, as set out in note 3(h). Revenue arising from operating
leases is recognized in accordance with the Groups revenue
recognition policies, as set out in note 3(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 Corporation and the Group do 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 signalling systems and airconditioning plant
    
    
    7-10
    %Fare collection system
    
    
    7-10
    %
 F-9




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATIONNOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003 Mobile phone system
    
    
    10-14
    %Furniture and fixtures
    
    
    7-33
    %Computer and office equipment (including computer software)
    
    
    20-33
    %Buses
    
    
    6-10
    %Other motor vehicles
    
    
    7-25
    %
  (iv)
    
    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. (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:  
    
    property, plant and equipment (other than investment
properties carried at revalued amounts) 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 railway are
stated at cost. Costs comprise direct costs of construction, such as
materials, staff costs and overheads, as well as net borrowing costs/investment
income (see note 3(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 policy detailed in
note 3(g). Costs incurred by the Corporation 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 being materialized, the costs concerned are
written off to the income statement.  
    
    where the proposed projects, having demonstrated an
acceptable financial viability and having obtained the Managing
Boards approval to proceed further, are at the detailed study
stage, 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-10




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATIONNOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003 (j)  Deferred expenditure Deferred expenditure represents advances, deposits, mobilization payments
and design and construction costs in respect of committed projects of the
Corporation. Such expenditure is capitalized and deferred only when projects
are clearly defined, the expenditure is separately identifiable and there is
reasonable certainty that the projects are technically feasible and financially
viable. Project development expenditure which does not meet these criteria is
expensed when incurred. Deferred expenditure on projects is transferred to construction in
progress after the relevant project agreements are reached with the Government. (k)  Property development The Corporation is involved in a number of property development projects.
When the Corporation 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 and other costs are
transferred to properties under development until such time that profit on the
development is recognized by the Corporation. Profits on property development are recognized in the income statement as
follows:  
    
    where the Corporation 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 Corporation.  
    
    where the Corporation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 Corporations profit is based on the retention of
certain properties from the development: when the properties
retained are ready for use by the Corporation after taking into
account outstanding risks, if any, retained by the Corporation in
connection with the development. The profit recognized is measured
at the fair value of the properties retained less any costs
incurred by the Corporation thereon. (l)  Jointly controlled operations Assets that the Corporation 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
Corporation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 Corporation,
as applicable. (m)  Investments in securities Investments in non-trading securities of the Corporation comprise:  (i)
    
    Temporary investment in securities of funds from the equity
injection received and borrowings obtained specifically for the
construction of the West Rail, East Rail Extensions, Kowloon
Southern Link and Sha Tin to Central Link before the funds are used
for such purposes (pre-funding investments in securities); and  (ii)
    
    Investment in securities of surplus funds from the
Corporations operations (other investments in securities). All investments in non-trading securities are stated in the balance sheet
at their fair value. F-11




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATIONNOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003 Changes in fair value of pre-funding investments in securities, together
with all income generated from the investments including interest income,
exchange gains or losses, gains or losses arising from transactions in
derivative instruments for hedging against foreign currency investments and
gains or losses arising from the disposal of such investments, are capitalized
as construction in progress and deferred expenditure. Changes in fair value of other investments in securities are recognized in
the investment revaluation reserve until the security is sold, collected or
otherwise disposed of or until there is objective evidence that the security 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 in securities 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 securities. (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 licence 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. Rent free periods
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 non-trading 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. (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 Corporation.
The arrangements do not, in substance, involve a lease under the Statement of
Standard Accounting Practice (SSAP) 14 (Leases) since the Corporation 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 Corporation 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 Corporation. In the case F-12




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATIONNOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003 where the Corporation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 net amounts received by the
Corporation from the arrangements 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 investment 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 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 instruments for hedging against foreign currency
investments, gains or losses on disposals of investments and exchange
differences arising from investments. Investment 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 and
deferred expenditure. (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 3(q). (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 it is 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. F-13




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATIONNOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  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. (u)  Employee benefits Obligations for contributions to the defined contribution scheme operated
by the Corporation 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 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. F-14




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATIONNOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003 (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 2003 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 2003 consolidated financial statements have been translated into US
Dollar 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$7.764, which was the noon buying rate in New York City for cable
transfer in Hong Kong Dollars as certified for customs purposes by the Federal
Reserve Bank of New York on December 31, 2003. F-15




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES
TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2003, 2003  4
    
    Change in accounting policies(a)
    
    In August 2002 the Hong Kong Society of 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 3(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,
    
    December 31,
    
    December 31,
    
    December 31,2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Balance Sheet Increase in deferred
tax liabilities
    
    
    
    
    
    
    2,604
    
    
    
    3,131
    
    
    
    403 Decrease in retained
profits
    
    
    
    
    
    
    (2,604
    )
    
    
    (3,131
    )
    
    
    (403
    )
 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Income statement Increase in income
tax
    
    
    
    
    
    
    451
    
    
    
    527
    
    
    
    68
  Retained profits at January 1, 2002 have decreased by HK$2,153 million as
a result of the retrospective application of SSAP 12 (revised).Comparative figures for 2001 and prior years have not been restated as it
would be impractical to do so.(b)
    
    With effect from January 1, 2002, the Group adopted a new accounting
policy as set out in note 3(u) to provide for liabilities in respect of
the annual leave and leave passage entitlements of its staff in order to
comply with the SSAP 34, Employee benefits. The adjustments made to the
balance of retained profit at January 1, 2001 and the retained profit for
the year ended December 31, 2001 as a result of the adoption of this
accounting policy as set out in note 35.No restatement of comparative figures for years prior to 2001 was made
because it would be impractical to do so. F-16




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES
TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2003, 2003  4
    
    Change in accounting policies (continued)(c)
    
    In prior years, the Corporations insurance arrangements included a
provision for insurance. The provision was maintained to provide cover
for losses up to the deductible levels of the Corporations external
insurance policies with increases in the provision being charged to the
income statement. With effect from January 1, 2001, the Group adopted the
accounting policy as set out in note 3(t) in order to comply with SSAP 28,
Provisions, contingent libilities and contingent assets. The effect of
adopting the statement was that the balance of insurance provision was
adjusted to the balance of retained profits at January 1, 2001 as set out
in note 35. No restatement of comparative figures for years prior to 2001
was made. F-17




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES
TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2003, 2003  5
    
    Revenue, operating costs and operating profit(a)
    
    Revenue represents the revenue from passenger, freight and property
services after eliminating inter-company transactions. The amounts of
each significant category of revenue recognized in revenue during the year
are as follows: 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Passenger services
    
    
    4,051
    
    
    
    4,127
    
    
    
    3,745
    
    
    
    482Freight services
    
    
    88
    
    
    
    86
    
    
    
    74
    
    
    
    10Property services
    
    
    658
    
    
    
    617
    
    
    
    607
    
    
    
    784,797
    
    
    
    4,830
    
    
    
    4,426
    
    
    
    570
  (b)
    
    Operating costs comprise the following: 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Staff costs Gross amount including retirement costs of
HK$137 million (US$18 million) (2002: HK$129
million; 2001: HK$123 million)
    
    
    2,094
    
    
    
    2,140
    
    
    
    2,262
    
    
    
    291 Amount capitalized including retirement
costs of HK$29 million (US$4 million) (2002: HK$19 million; 2001: HK$18 million)
    
    
    (818
    )
    
    
    (914
    )
    
    
    (1,061
    )
    
    
    (137
    )1,276
    
    
    
    1,226
    
    
    
    1,201
    
    
    
    154Electricity and fuel
    
    
    263
    
    
    
    262
    
    
    
    271
    
    
    
    35Stores and spares consumed
    
    
    121
    
    
    
    110
    
    
    
    115
    
    
    
    15Material costs
    
    
    37
    
    
    
    23
    
    
    
    34
    
    
    
    4Repairs and maintenance
    
    
    128
    
    
    
    144
    
    
    
    133
    
    
    
    17Government rent and rates
    
    
    72
    
    
    
    75
    
    
    
    64
    
    
    
    8Octopus cards usage fees
    
    
    29
    
    
    
    30
    
    
    
    29
    
    
    
    4Cost of services acquired
    
    
    138
    
    
    
    111
    
    
    
    105
    
    
    
    14Property ownership and management expenses
    
    
    50
    
    
    
    44
    
    
    
    56
    
    
    
    7Depreciation assets held for use under operating leases
    
    
    17
    
    
    
    17
    
    
    
    17
    
    
    
    2 other assets
    
    
    647
    
    
    
    711
    
    
    
    735
    
    
    
    95 depreciation charged capitalized
    
    
    (3
    )
    
    
    (3
    )
    
    
    (4
    )
    
    
    Others
    
    
    111
    
    
    
    146
    
    
    
    121
    
    
    
    162,886
    
    
    
    2,896
    
    
    
    2,877
    
    
    
    371
 F-18




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES
TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2003, 2003  5
    
    Revenue, operating costs and operating profit (continued)(c)
    
    Operating profit before net investment income is arrived at after
charging: 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Fixed assets written off
    
    
    5
    
    
    
    27
    
    
    
    9
    
    
    
    1Auditors remuneration Audit services
    
    
    3
    
    
    
    3
    
    
    
    4
    
    
    
     Tax compliance services
    
    
    
    
    
    
    1
    
    
    
    1
    
    
    
     Other services (net of HK$5 million (US$1
million) (2002 and 2001: HK$ nil) deferred)
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    Operating lease charges (minimum lease payments) Hire of plant and machinery
    
    
    18
    
    
    
    18
    
    
    
    21
    
    
    
    3 Rental of property
    
    
    11
    
    
    
    11
    
    
    
    14
    
    
    
    2Remuneration of Members of the Managing Board
and Executive Directors who are not Members of the
Managing Board
    
    
    41
    
    
    
    38
    
    
    
    42
    
    
    
    5and after crediting:Rentals receivable from operating leases less direct
outgoings of HK$13 million (US$2 million)
(2002: HK$12 million; 2001: HK$11 million) (including contingent rentals
of HK$20 million (US$3 million) (2002: HK$26 million;
2001: HK$42 million))
    
    
    480
    
    
    
    449
    
    
    
    449
    
    
    
    58Rentals receivable from investment properties less
direct outgoings of HK$16 million (US$2 million) (2002: HK$21 million; 2001: HK$26 million)
    
    
    72
    
    
    
    71
    
    
    
    68
    
    
    
    9
  (d)
    
    Remuneration of Members of the Managing Board and Executive Directors who
are not Members of the Managing BoardThe fees and emoluments during the year were: 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Remuneration of Members of the Managing
Board and Executive Directors who are
not Members of the Managing Board Fees for Members of the
Managing Board including the
Chairman but excluding Chief
Executive Officer
    
    
    1
    
    
    
    1
    
    
    
    1
    
    
    
     Contributions to retirement
benefit scheme for the Chief
Executive Officer and Executive
Directors who are not Members of
the Managing Board
    
    
    1
    
    
    
    1
    
    
    
    1
    
    
    
     Emoluments of the Chief
Executive Officer and Executive
Directors who are not Members of
the Managing Board
    
    
    39
    
    
    
    36
    
    
    
    40
    
    
    
    541
    
    
    
    38
    
    
    
    42
    
    
    
    5
  Emoluments include salaries, allowances, benefits-in-kind and accruals
for gratuities and annual leave entitlement. Allowances and
benefits-in-kind include housing, education and passage allowances. F-19




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES
TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2003, 2003  5
    
    Revenue, operating costs and operating profit (continued) The numbers of Members of the Managing Board and Executive Directors who
are not Members of the Managing Board whose remuneration fell within the
following bands were: No. of individuals2001
    
    2002
    
    2003Members of the Managing Board:The Chairman and other members excluding the
Chief Executive OfficerBelow HK$250,000
    
    
    9
    
    
    
    15
    #
    
    
    10Chief Executive OfficerHK$5,500,001  HK$6,000,000
    
    
    
    
    
    
    1
    
    
    
    HK$6,000,001  HK$6,500,000
    
    
    1
    
    
    
    
    
    
    
    1
    *Executive Directors who are not Members of the Managing Board:HK$3,000,001  HK$3,500,000
    
    
    
    
    
    
    1
    
    
    
    HK$3,500,001  HK$4,000,000
    
    
    3
    
    
    
    4
    
    
    
    3
    *HK$4,000,001  HK$4,500,000
    
    
    3
    
    
    
    2
    
    
    
    3
    *HK$4,500,001  HK$5,000,000
    
    
    
    
    
    
    1
    
    
    
    HK$5,000,001  HK$5,500,000
    
    
    2
    
    
    
    
    
    
    
    2
    *
 The above includes the remuneration of the five highest paid employees.  #
    
    During the year, the terms of appointment of some Members
expired and new Members were appointed in their place, as explained
in the Report of the Members of the Managing Board. At any one
time, there was a total of nine members on the Managing Board,
excluding the Chief Executive Officer.*
    
    During the year, there were larger than normal accruals of
annual leave in respect of the Chief Executive Officer and some
executive directors, who are not Members of the Managing Board, due
to the need to prepare for the opening of West Rail. In addition,
there was a payment to the Chief Executive Officer upon his
departure from the Corporation on December 31, 2003 as a result of
his entitlement to long service payment under the Employment
Ordinance. The Senior Director, Finance and Management was also paid
a special allowance in recognition of his additional
responsibilities arising from the gradual take-over of the
responsibilities of the Chief Executive Officer. Other than these
accruals and payments, there was no upward adjustment of the
remuneration of the Chief Executive Officer and relevant executive
directors in 2003. F-20




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  6
    
    Net investment income 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Gain on disposal of shares in associate
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    Interest income from deposits with banks
    
    
    431
    
    
    
    91
    
    
    
    50
    
    
    
    7Interest income from investments
    
    
    1,887
    
    
    
    1,301
    
    
    
    510
    
    
    
    66Interest income on loan receivable
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    Interest income from loan to subsidiary
    
    
    85
    
    
    
    139
    
    
    
    211
    
    
    
    27Interest income on other receivables (note 23)
    
    
    
    
    
    
    148
    
    
    
    
    
    
    
    Net realized gain/(loss) on disposal of non-trading securities
    
    
    62
    
    
    
    (55
    )
    
    
    (60
    )
    
    
    (8
    )2,468
    
    
    
    1,624
    
    
    
    714
    
    
    
    92*Less: Amount capitalized
    
    
    (1,971
    )
    
    
    (975
    )
    
    
    (292
    )
    
    
    (38
    )497
    
    
    
    649
    
    
    
    422
    
    
    
    54Interest expense on lease payable
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    Interest expenses on other loans
    
    
    1,252
    
    
    
    1,279
    
    
    
    1,355
    
    
    
    174Net expenses/(income) from derivative instruments
    
    
    24
    
    
    
    (90
    )
    
    
    (143
    )
    
    
    (18
    )Other borrowing costs
    
    
    18
    
    
    
    17
    
    
    
    37
    
    
    
    5Net exchange loss
    
    
    38
    
    
    
    3
    
    
    
    28
    
    
    
    41,332
    
    
    
    1,209
    
    
    
    1,280
    
    
    
    165#Less: Amount capitalized.
    
    
    (1,325
    )
    
    
    (1,178
    )
    
    
    (1,211
    )
    
    
    (156
    )7
    
    
    
    31
    
    
    
    69
    
    
    
    9Net investment income.
    
    
    490
    
    
    
    618
    
    
    
    353
    
    
    
    45
 *
    
    Interest income capitalized was earned at rates ranging between 2.20%
(2002: 3.98%; 2001: 5.55%) and 4.04% (2002: 5.84%; 2001: 6.54%) per
annum.#
    
    Interest expenses capitalized were charged at rates ranging between
6.10% (2002: 6.75%; 2001: 7.40%) and 6.75% (2002: 7.46%; 2001:
8.25%) per annum.
  7
    
    Profit on property development 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Royal Ascot, Sha Tin
    
    
    24
    
    
    
    
    
    
    
    
    
    
    
    Hung Hom Bay
    
    
    
    
    
    
    94
    
    
    
    
    
    
    
    24
    
    
    
    94
    
    
    
    
    
    
    
    
  Profit on property development arises from the Groups interests in
jointly controlled operations. F-21




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  8
    
    Income tax(a)
    
    Income tax in the consolidated income statement represents: 2001
    
    2002Restated
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Current taxProvision for Hong Kong profits tax at 17.5% (2002 and
2001: 16%) of the estimated assessable profits for the
year
    
    
    1
    
    
    
    1
    
    
    
    1
    
    
    
    Deferred taxOrigination and reversal of temporary differences
    
    
    
    
    
    
    451
    
    
    
    283
    
    
    
    36Effect of increase in tax rate on deferred tax balances
at January 1
    
    
    
    
    
    
    
    
    
    
    244
    
    
    
    31
    
    
    
    451
    
    
    
    527
    
    
    
    67Share of associates deferred tax
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    1
    
    
    
    452
    
    
    
    529
    
    
    
    67
 Comparative figures for 2001 and prior years have not been restated as a
result of change in accounting policy for deferred tax as set out in note 4(a)
because it would be impractical to do so. 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 and
2001: 16%) of the estimated assessable profits for the year. 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$3,800 million at
December 31, 2003 (2002: approximately HK$2,600 million; 2001: HK$1,700
million) which are available to set off against future assessable profits.  (b)
    
    Reconciliation between tax expense and accounting profit at applicable tax rates: 2002Restated
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Profit before tax.
    
    
    2,662
    
    
    
    1,910
    
    
    
    246Tax on accounting profit before tax
    
    
    426
    
    
    
    334
    
    
    
    43Tax effect of non-deductible expenses
    
    
    13
    
    
    
    13
    
    
    
    2Tax effect of non-taxable revenue
    
    
    13
    
    
    
    (10
    )
    
    
    (1
    )Tax effect of non-deductible expenses
overstated in prior years
    
    
    
    
    
    
    (52
    )
    
    
    (8
    )Effect on opening deferred tax balances resulting from an
increase in tax rate during the year
    
    
    
    
    
    
    244
    
    
    
    31Actual tax expense
    
    
    452
    
    
    
    529
    
    
    
    67
 As comparative figures for 2001 and prior years have not been restated as a
result of change in accounting policy for deferred tax as set out in note 4(a),
a reconciliation for 2001 is not presented.  (c)
    
    Current tax in the balance sheet represents: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Provision for Hong Kong profits tax for the year
    
    
    1
    
    
    
    1
    
    
    
    Provisional profits tax paid
    
    
    (1
    )
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
 F-22




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  8
    
    Income tax (continued)(d)
    
    Deferred tax assets and liabilities of the Group recognized: The components of deferred tax (assets) / liabilities of the Group and the
Corporation recognized in the Groups balance sheets and the movements during
the year are as follows: DepreciationFuture
    
    allowances inbenefit
    
    excess ofof tax
    
    the relatedlosses
    
    depreciation
    
    Total
    
    TotalHK$
    
    HK$
    
    HK$
    
    US$(in millions)At January 1, 2002
    
    
    (275
    )
    
    
    2,428
    
    
    
    2,153
    
    
    
    277Charged / (credited) to
the consolidated
income statement
    
    
    (137
    )
    
    
    588
    
    
    
    451
    
    
    
    58At December 31, 2002
    
    
    (412
    )
    
    
    3,016
    
    
    
    2,604
    
    
    
    335At January 1, 2003
    
    
    (412
    )
    
    
    3,016
    
    
    
    2,604
    
    
    
    335Charged / (credited) to
the consolidated
income statement
    
    
    (253
    )
    
    
    780
    
    
    
    527
    
    
    
    68At December 31, 2003
    
    
    (665
    )
    
    
    3,796
    
    
    
    3,131
    
    
    
    403
 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Deferred tax assets likely to be recovered after
more than 12 months
    
    
    (412
    )
    
    
    (665
    )
    
    
    (86
    )Deferred tax liabilities likely to be settled after more than 12 months
    
    
    3,016
    
    
    
    3,796
    
    
    
    4892,604
    
    
    
    3,131
    
    
    
    403
  9
    
    Profit after taxation Of the consolidated profit after taxation, HK$1,376 million (US$177
million) (2002 (restated): HK$2,193 million; 2001: HK$2,425 million) has been
dealt with in the financial statements of the Corporation.  10
    
    Proposed dividend 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)(a)
    
    Dividend attributable to the year:Final dividend proposed after the balance sheet date of HK$1,584.87 per share (2002: HK$1,584.87 per
share; 2001: HK$nil per share)
    
    
    
    
    
    
    620
    
    
    
    620
    
    
    
    80
 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. F-23




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  10
    
    Proposed dividend (continued) 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)(b)
    
    Dividend 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$1,584.87 per share
(2002 and 2001: HK$nil per
share)
    
    
    
    
    
    
    
    
    
    
    620
    
    
    
    80
  11
    
    Segmental reporting Business segment information is chosen as the primary reporting format
because this is more relevant to the Groups internal financial reporting.
Starting from 2003, bus operations are grouped under Light Rail in segmental
reporting and 2002 figures have been restated for comparison purposes. The bus
operations are essentially a feeder service to support railway businesses. The
operating costs of bus, net of bus revenue received from non-rail users, are
fully charged to the railway businesses on a cost recovery basis with no
markup. The associated risks and rewards of bus operations are therefore not
distinguishable from the railway businesses. The bus operations are not
considered as a business segment for reporting purposes according to the
Groups accounting policy and SSAP 26, Segment reporting. As bus operations
are under the management of Light Rail, therefore, they are grouped under Light
Rail in segmental reporting starting from 2003. No geographical segment information is shown as virtually all of the
turnover and operating profit is derived from activities in Hong Kong. 2003 Operating results Passenger servicesEast
    
    Light
    
    West
    
    
    
    
    
    
    
    
    
     
    
    
    
    ConsolidatedRail
    
    Rail
    
    Rail
    
    Total
    
    Freight
    
    Property
    
    Total
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in millions)Revenue
    
    
    3,266
    
    
    
    468
    
    
    
    11
    
    
    
    3,745
    
    
    
    74
    
    
    
    607
    
    
    
    4,426
    
    
    
    570Operating costs before
depreciation
    
    
    (1,204
    )
    
    
    (476
    )
    
    
    (35
    )
    
    
    (1,715
    )
    
    
    (64
    )
    
    
    (121
    )
    
    
    (1,900
    )
    
    
    (245
    )Inter-segment charges (1)
    
    
    (12
    )
    
    
    45
    
    
    
    (5
    )
    
    
    28
    
    
    
    (7
    )
    
    
    (21
    )
    
    
    
    
    
    
    Depreciation
    
    
    (549
    )
    
    
    (95
    )
    
    
    (30
    )
    
    
    (674
    )
    
    
    (24
    )
    
    
    (24
    )
    
    
    (722
    )
    
    
    (93
    )Results  profit/(loss)
    
    
    1,501
    
    
    
    (58
    )
    
    
    (59
    )
    
    
    1,384
    
    
    
    (21
    )
    
    
    441
    
    
    
    1,804
    
    
    
    232Unallocated corporate
Expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (255
    )
    
    
    (33
    )Operating profit before
net investment income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,549
    
    
    
    199Net investment income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    353
    
    
    
    45Share of profit of
associate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8
    
    
    
    1Income tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (529
    )
    
    
    (67
    )Profit after taxation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,381
    
    
    
    178
 (1)
    
    Inter-segment charges represent cost recoveries from other segments
for services rendered.
 F-24




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  11
    
    Segmental reporting (continued) Assets and liabilities Passenger servicesEast
    
    Light
    
    West
    
    
    
    
    
    
    
    
    
    
    
    
    
    ConsolidatedRail
    
    Rail
    
    Rail
    
    Total
    
    Freight
    
    Property
    
    Total
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in millions)Segment assets
    
    
    10,062
    
    
    
    3,632
    
    
    
    36,875
    
    
    
    50,569
    
    
    
    710
    
    
    
    1,462
    
    
    
    52,741
    
    
    
    6,793Properties under
development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,448
    
    
    
    1,448
    
    
    
    187Interest in associate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    42
    
    
    
    5Unallocated assets #
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    34,973
    
    
    
    4,50510,062
    
    
    
    3,632
    
    
    
    36,875
    
    
    
    50,569
    
    
    
    710
    
    
    
    2,910
    
    
    
    89,204
    
    
    
    11,490Segment liabilities
    
    
    268
    
    
    
    130
    
    
    
    1,092
    
    
    
    1,490
    
    
    
    9
    
    
    
    529
    
    
    
    2,028
    
    
    
    261Deferred income
    
    
    272
    
    
    
    126
    
    
    
    231
    
    
    
    629
    
    
    
    
    
    
    
    114
    
    
    
    743
    
    
    
    96Unallocatedliabilities *
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26,228
    
    
    
    3,379540
    
    
    
    256
    
    
    
    1,323
    
    
    
    2,119
    
    
    
    9
    
    
    
    643
    
    
    
    28,999
    
    
    
    3,736
 #
    
    Including construction in progress for East Rail Extensions (HK$14,091 million
(US$1,815 million)) and Corporate (HK$12 million (US$2 million)) and
deferred expenditure for other proposed railway projects (HK$900 million
(US$116 million)), Corporate assets (HK$471 million (US$61 million)),
investments in securities (HK$12,244 million (US$1,577 million)), loan
receivable (HK$774 million (US$100 million)), loan to subsidiary (HK$3,232
million (US$416 million)), interest receivable (HK$63 million (US$8
million), other receivables (HK$509 million (US$65 million)) and cash and
cash equivalents (HK$2,677 million (US$345 million)).*
    
    Including interest-bearing borrowings (HK$20,013 million (US$2,578 million),
interest payable (HK$474 million (US$61 million)), accrued charges and
provisions for capital projects (HK$896 million (US$116 million)), lease
payable (HK$758 million (US$98 million)), other payables (HK$956 million
(US$123 million)) and deferred tax liabilities (HK$3,131 million (US$403
million)).
 Other information Passenger servicesEast
    
    Light
    
    West
    
    
    
    
    
    
    
    
    
    
    
    
    
    ConsolidatedRail
    
    Rail
    
    Rail
    
    Total
    
    Freight
    
    Property
    
    Total
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$Capital expenditure Existing businesses
    
    
    402
    
    
    
    536
    
    
    
    4,804
    
    
    
    5,742
    
    
    
    2
    
    
    
    70
    
    
    
    5,814
    
    
    
    750 Railway under
construction
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,290
    
    
    
    681 Unallocated capital
expenditure
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18
    
    
    
    2402
    
    
    
    536
    
    
    
    4,804
    
    
    
    5,742
    
    
    
    2
    
    
    
    70
    
    
    
    11,122
    
    
    
    1,433
 F-25




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  11
    
    Segmental reporting (continued) 2002 Operating results (restated) Passenger servicesEast
    
    Light
    
    West
    
    
    
    
    
    
    
    
    
    
    
    
    
    ConsolidatedRail
    
    Rail
    
    Rail
    
    Total
    
    Freight
    
    Property
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$(in millions)Revenue
    
    
    3,569
    
    
    
    558
    
    
    
    
    
    
    
    4,127
    
    
    
    86
    
    
    
    617
    
    
    
    4,830Operating costs before
depreciation
    
    
    (1,232
    )
    
    
    (504
    )
    
    
    
    
    
    
    (1,736
    )
    
    
    (71
    )
    
    
    (112
    )
    
    
    (1,919
    )Inter-segment charges(1)
    
    
    25
    
    
    
    4
    
    
    
    
    
    
    
    29
    
    
    
    (7
    )
    
    
    (22
    )
    
    
    Depreciation
    
    
    (530
    )
    
    
    (117
    )
    
    
    
    
    
    
    (647
    )
    
    
    (24
    )
    
    
    (28
    )
    
    
    (699
    )Results  profit/(loss)
    
    
    1,832
    
    
    
    (59
    )
    
    
    
    
    
    
    1,773
    
    
    
    (16
    )
    
    
    455
    
    
    
    2,212Unallocated corporate
expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (278
    )Operating profit
before net investment
income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,934Net investment income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    618Profit on property
development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    94Share of profit of
associate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16Income tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (452
    )Profit after taxation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,210
 (1)
    
    Inter-segment charges represent cost recoveries from other segments for
services rendered.
 Assets and liabilities (restated) Passenger servicesEast
    
    Light
    
    West
    
    
    
    
    
    
    
    
    
    
    
    
    
    ConsolidatedRail
    
    Rail
    
    Rail
    
    Total
    
    Freight
    
    Property
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$(in millions)Segment assets
    
    
    10,175
    
    
    
    3,186
    
    
    
    31,764
    
    
    
    45,125
    
    
    
    730
    
    
    
    1,427
    
    
    
    47,282Properties under
development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,153
    
    
    
    1,153Interest in associate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35Unallocated assets #
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    37,63810,175
    
    
    
    3,186
    
    
    
    31,764
    
    
    
    45,125
    
    
    
    730
    
    
    
    2,580
    
    
    
    86,108Segment liabilities
    
    
    215
    
    
    
    152
    
    
    
    1,944
    
    
    
    2,311
    
    
    
    7
    
    
    
    631
    
    
    
    2,949Deferred income
    
    
    252
    
    
    
    78
    
    
    
    
    
    
    
    330
    
    
    
    
    
    
    
    104
    
    
    
    434Unallocated liabilities *
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23,213467
    
    
    
    230
    
    
    
    1,944
    
    
    
    2,641
    
    
    
    7
    
    
    
    735
    
    
    
    26,596
 #
    
    Including 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).*
    
    Including 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).
 F-26




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  11
    
    Segmental reporting (continued) Other information (restated) Passenger servicesEast
    
    Light
    
    West
    
    
    
    
    
    
    
    
    
    
    
    
    
    ConsolidatedRail
    
    Rail
    
    Rail
    
    Total
    
    Freight
    
    Property
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$(in millions)Capital expenditure Existing businesses
    
    
    565
    
    
    
    696
    
    
    
    6,537
    
    
    
    7,798
    
    
    
    
    
    
    
    63
    
    
    
    7,861 Railway under
construction
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,318 Unallocated
capital expenditure
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    129565
    
    
    
    696
    
    
    
    6,537
    
    
    
    7,798
    
    
    
    
    
    
    
    63
    
    
    
    12,308
 2001 Operating results Passenger servicesEast
    
    Light
    
    West
    
    
    
    
    
    
    
    
    
    
    
    
    
    ConsolidatedRail
    
    Rail
    
    Rail
    
    Total
    
    Freight
    
    Property
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$(in millions)Revenue
    
    
    3,487
    
    
    
    564
    
    
    
    
    
    
    
    4,051
    
    
    
    88
    
    
    
    658
    
    
    
    4,797Operating costs before
depreciation
    
    
    (1,228
    )
    
    
    (545
    )
    
    
    
    
    
    
    (1,773
    )
    
    
    (76
    )
    
    
    (127
    )
    
    
    (1,976
    )Inter-segment charges(1)
    
    
    27
    
    
    
    3
    
    
    
    
    
    
    
    30
    
    
    
    (8
    )
    
    
    (22
    )
    
    
    Depreciation
    
    
    (481
    )
    
    
    (109
    )
    
    
    
    
    
    
    (590
    )
    
    
    (24
    )
    
    
    (22
    )
    
    
    (636
    )Results  profit/(loss)
    
    
    1,805
    
    
    
    (87
    )
    
    
    
    
    
    
    1,718
    
    
    
    (20
    )
    
    
    487
    
    
    
    2,185Unallocated corporate
expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (274
    )Operating profit before
net investment income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,911Net investment income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    490Profit on property
development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24Share of loss of
associate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11Income tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )Profit after taxation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,435
 (1)
    
    Inter-segment charges represent cost recoveries from other segments for
services rendered.
 Assets and liabilities Passenger servicesEast
    
    Light
    
    West
    
    
    
    
    
    
    
    
    
    
    
    
    
    ConsolidatedRail
    
    Rail
    
    Rail
    
    Total
    
    Freight
    
    Property
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$(in millions)Segment assets
    
    
    10,111
    
    
    
    2,594
    
    
    
    25,770
    
    
    
    38,475
    
    
    
    758
    
    
    
    1,400
    
    
    
    40,633Properties under
development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    739
    
    
    
    739Interest in associate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23Unallocated assets #
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    41,14210,111
    
    
    
    2,594
    
    
    
    25,770
    
    
    
    38,475
    
    
    
    758
    
    
    
    2,139
    
    
    
    82,537Segment liabilities
    
    
    679
    
    
    
    184
    
    
    
    2,387
    
    
    
    3,250
    
    
    
    12
    
    
    
    864
    
    
    
    4,126Deferred income
    
    
    213
    
    
    
    66
    
    
    
    
    
    
    
    279
    
    
    
    
    
    
    
    175
    
    
    
    454Unallocated liabilities *
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,377892
    
    
    
    250
    
    
    
    2387
    
    
    
    3,529
    
    
    
    12
    
    
    
    1,039
    
    
    
    22,957
 F-27




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  11
    
    Segmental reporting (continued) #
    
    Including construction in progress for Corporate (HK$80 million), deferred
expenditure for East Rail Extensions (HK$4,112 million) and other proposed
railway projects (HK$104 million), Corporate assets (HK$444 million),
investment in securities (HK$27,752 million), loan to subsidiary (HK$1,316
million), interest receivable (HK$709 million), other receivables (HK$152
million) and cash and cash equivalents (HK$6,473 million).*
    
    Including interest-bearing borrowings (HK$16,831 million), interest payable
(HK$436 million), accrued charges and provisions for capital projects
(HK$591 million) and other payables (HK$519 million).
 Other information Passenger servicesEast
    
    Light
    
    West
    
    
    
    
    
    
    
    
    
    
    
    
    
    ConsolidatedRail
    
    Rail
    
    Rail
    
    Total
    
    Freight
    
    Property
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$(in millions)Capital expenditure Existing businesses
    
    
    1,045
    
    
    
    381
    
    
    
    9,651
    
    
    
    11,077
    
    
    
    1
    
    
    
    198
    
    
    
    11,276 Railway under
construction
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,132 Unallocated
capital expenditure
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1871,045
    
    
    
    381
    
    
    
    9,651
    
    
    
    11,077
    
    
    
    1
    
    
    
    198
    
    
    
    14,595
 F-28




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  12
    
    Fixed assetsFixed assets comprise: Leaseholdland and
    
    Tunnels,Investment
    
    permanent
    
    bridges
    
    
    
    
    
    Rolling
    
    Otherproperties
    
    way
    
    and roads
    
    Buildings
    
    stock
    
    equipment
    
    Total
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in millions)Cost or valuation:At January 1, 2003
    
    
    895
    
    
    
    1,644
    
    
    
    523
    
    
    
    5,005
    
    
    
    6,134
    
    
    
    6,114
    
    
    
    20,315
    
    
    
    2,617Transfer from
construction in
progress
    
    
    
    
    
    
    7,902
    
    
    
    10,292
    
    
    
    15,292
    
    
    
    1,921
    
    
    
    3,159
    
    
    
    38,566
    
    
    
    4,967Additions
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18
    
    
    
    18
    
    
    
    2Disposals
    
    
    
    
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (294
    )
    
    
    (300
    )
    
    
    (39
    )Deficit on revaluation
    
    
    (17
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (17
    )
    
    
    (2
    )At December 31, 2003
    
    
    878
    
    
    
    9,540
    
    
    
    10,815
    
    
    
    20,297
    
    
    
    8,055
    
    
    
    8,997
    
    
    
    58,582
    
    
    
    7,545Accumulated depreciation:At January 1, 2003
    
    
    
    
    
    
    171
    
    
    
    79
    
    
    
    845
    
    
    
    1,837
    
    
    
    3,332
    
    
    
    6,264
    
    
    
    807Charge for the year
    
    
    
    
    
    
    24
    
    
    
    11
    
    
    
    125
    
    
    
    168
    
    
    
    424
    
    
    
    752
    
    
    
    97Written back on disposal
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (291
    )
    
    
    (291
    )
    
    
    (38
    )At December 31, 2003
    
    
    
    
    
    
    195
    
    
    
    90
    
    
    
    970
    
    
    
    2,005
    
    
    
    3,465
    
    
    
    6,725
    
    
    
    866Net book value:At December 31, 2003
    
    
    878
    
    
    
    9,345
    
    
    
    10,725
    
    
    
    19,327
    
    
    
    6,050
    
    
    
    5,532
    
    
    
    51,857
    
    
    
    6,679At December 31, 2002
    
    
    895
    
    
    
    1,473
    
    
    
    444
    
    
    
    4,160
    
    
    
    4,297
    
    
    
    2,782
    
    
    
    14,051
    
    
    
    1,810
  (a)
    
    Permanent way includes 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
signalling systems, machinery, furniture and fixtures, motor
vehicles, computer and office equipment.(c)
    
    The Groups leasehold land with a net book value of HK$6,832 million
(US$880 million) (2002: HK$587 million) is held in Hong Kong under
long-term leases.(d)
    
    The Group leases out investment properties and certain properties
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, 2003 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 deficit of HK$17
million (US$2 million) (2002: deficit of HK$42 million) has been
transferred to the investment property revaluation reserve (see note
33). F-29




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  12
    
    Fixed assets (continued)  (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: Gross
    
    Related
    
    Gross
    
    Related
    
    Gross
    
    Relatedcarrying
    
    accumulated
    
    carrying
    
    accumulated
    
    carrying
    
    accumulatedamount
    
    depreciation
    
    amount
    
    depreciation
    
    amount
    
    depreciation2002
    
    2002
    
    2003
    
    2003
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$
    
    US$(in millions)Goods Yard at
Hung Hom Bay
    
    
    148
    
    
    
    10
    
    
    
    131
    
    
    
    12
    
    
    
    17
    
    
    
    2Hung Hom Station
Car Park
    
    
    55
    
    
    
    21
    
    
    
    55
    
    
    
    22
    
    
    
    7
    
    
    
    3Offices at Hung
Hom Station
    
    
    31
    
    
    
    7
    
    
    
    21
    
    
    
    5
    
    
    
    3
    
    
    
    1Offices at Hung
Hom freight
building
    
    
    8
    
    
    
    1
    
    
    
    8
    
    
    
    1
    
    
    
    1
    
    
    
    Citylink Plaza at
Sha Tin Station
    
    
    104
    
    
    
    54
    
    
    
    104
    
    
    
    58
    
    
    
    13
    
    
    
    7Goods Yard at
Mongkok Station
    
    
    45
    
    
    
    4
    
    
    
    45
    
    
    
    5
    
    
    
    6
    
    
    
    1Shops at stations
    
    
    262
    
    
    
    46
    
    
    
    545
    
    
    
    52
    
    
    
    70
    
    
    
    6653
    
    
    
    143
    
    
    
    909
    
    
    
    155
    
    
    
    117
    
    
    
    20
  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.(g)
    
    The Groups total future minimum lease payments under non-cancellable
operating leases are receivable as follows: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Within 1 year
    
    
    495
    
    
    
    596
    
    
    
    77After 1 year but within 5 years
    
    
    1,239
    
    
    
    1,171
    
    
    
    151After 5 years
    
    
    24
    
    
    
    108
    
    
    
    141,758
    
    
    
    1,875
    
    
    
    242
 F-30




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  12
    
    Fixed assets (continued)  (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, signalling 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, 2003, a portion of the Groups assets with a total
original cost of HK$11,836 million (US$1,524 million) (2002: HK$8,132
million) and net book value of HK$8,300 million (US$1,069 million)
(2002: HK$5,524 million) is covered by nine arrangements, two of which
were concluded during the year. Six arrangements involve rolling
stock, with basic lease terms of 15 to 28 years. Two arrangements,
one involving signalling 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$1,727 million) (2002: HK$9,100 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$1,633 million)
(2002: HK$8,685 million), which obligations are expected to be funded
with the proceeds of existing deposits and investments totalling
HK$11,923 million (US$1,536 million) (2002: HK$8,685 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$23 million (US$3 million)
(2002: HK$19 million) recognized for the year has been included in
turnover in the income statement.(i)
    
    During the year, an extensive review was undertaken of the useful
lives of all major fixed asset categories. Effective from January 1,
2003, the estimated useful lives of the following assets were
revised after taking into consideration the actual condition of the
assets and planned asset replacement programs. Management considers
that the revised useful lives better reflect the period over which
the related assets will contribute to the Group. Details of the
assets affected and the resultant financial effect are as follows: Increase /
    
    Increase /(decrease) in
    
    (decrease) inOriginal
    
    Revised
    
    depreciation
    
    depreciationuseful life
    
    useful life
    
    charge for
    
    charge forAsset category
    
    (Years)
    
    (Years)
    
    the year
    
    the yearHK$
    
    US$(in millions)Rolling stock (electrical)
    
    
    40
    
    
    
    30-40
    
    
    
    11
    
    
    
    1Mobile phone system
    
    
    5
    
    
    
    7
    
    
    
    (3
    )
    
    
    Office fixtures
    
    
    10
    
    
    
    15
    
    
    
    (3
    )
    
    
    Ballast replacement
    
    
    12
    
    
    
    15
    
    
    
    (5
    )
    
    
    (1
    )
    
    
    
    
 F-31




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  13
    
    Construction in progressConstruction in progress comprises: Balance
    
    Costs
    
    
    
    
    
    Balance
    
    Balanceas at
    
    incurred
    
    Transfer to
    
    as at
    
    as atJanuary 1,
    
    during
    
    fixed
    
    December 31,
    
    December 31,2003
    
    the year
    
    assets
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$West RailMain contracts Civil works
    
    
    21,490
    
    
    
    2,040
    
    
    
    (23,436
    )
    
    
    94
    
    
    
    12 Plant and equipment
    
    
    2,919
    
    
    
    1,473
    
    
    
    (4,246
    )
    
    
    146
    
    
    
    19Associated construction costs Feasibility studies
    
    
    219
    
    
    
    
    
    
    
    (219
    )
    
    
    
    
    
    
     Consultants fees
    
    
    4,891
    
    
    
    355
    
    
    
    (5,246
    )
    
    
    
    
    
    
    Land and related costs
    
    
    3,773
    
    
    
    282
    
    
    
    (4,055
    )
    
    
    
    
    
    
    Overheads Staff costs
    
    
    2,108
    
    
    
    591
    
    
    
    (2,699
    )
    
    
    
    
    
    
     Others
    
    
    899
    
    
    
    165
    
    
    
    (1,019
    )
    
    
    45
    
    
    
    6 On-cost recovery
    
    
    (596
    )
    
    
    (102
    )
    
    
    694
    
    
    
    (4
    )
    
    
    (1
    )35,703
    
    
    
    4,804
    
    
    
    (40,226
    )
    
    
    281
    
    
    
    36Net borrowing costs/(net investment income)
    
    
    (3,939
    )
    
    
    314
    
    
    
    3,652
    
    
    
    27
    
    
    
    431,764
    
    
    
    5,118
    
    
    
    (36,574
    )
    
    
    308
    
    
    
    40East Rail ExtensionsMain contracts Civil works
    
    
    5,676
    
    
    
    2,797
    
    
    
    
    
    
    
    8,473
    
    
    
    1,091 Plant and equipment
    
    
    788
    
    
    
    887
    
    
    
    
    
    
    
    1,675
    
    
    
    216Associated construction costs Consultants fee
    
    
    1,095
    
    
    
    286
    
    
    
    
    
    
    
    1,381
    
    
    
    177Land and related costs
    
    
    451
    
    
    
    264
    
    
    
    
    
    
    
    715
    
    
    
    92Overheads Staff costs
    
    
    774
    
    
    
    352
    
    
    
    
    
    
    
    1,126
    
    
    
    146 Others
    
    
    186
    
    
    
    54
    
    
    
    
    
    
    
    240
    
    
    
    31 On-cost recovery
    
    
    (221
    )
    
    
    (78
    )
    
    
    
    
    
    
    (299
    )
    
    
    (39
    )8,749
    
    
    
    4,562
    
    
    
    
    
    
    
    13,311
    
    
    
    1,714Net borrowing costs
    
    
    101
    
    
    
    679
    
    
    
    
    
    
    
    780
    
    
    
    1018,850
    
    
    
    5,241
    
    
    
    
    
    
    
    14,091
    
    
    
    1,815OtherBuildings and other civil works
    
    
    1,311
    
    
    
    695
    
    
    
    (1,633
    )
    
    
    373
    
    
    
    48Rolling stock
    
    
    139
    
    
    
    89
    
    
    
    (113
    )
    
    
    115
    
    
    
    14Other equipment
    
    
    234
    
    
    
    226
    
    
    
    (246
    )
    
    
    214
    
    
    
    281,684
    
    
    
    1,010
    
    
    
    (1,992
    )
    
    
    702
    
    
    
    9042,298
    
    
    
    11,369
    
    
    
    (38,566
    )
    
    
    15,101
    
    
    
    1,945
 F-32




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  13
    
    Construction in progress (continued)West Rail  (i)
    
    Included in land and related costs incurred during the year
are amounts paid and payable to the Government by the Corporation
in respect of the following:  
    
    HK$51 million (US$7 million) (2002: HK$67 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 Corporation
and/or its contractors.
    
    HK$40 million (US$5 million) (2002: HK$97 million) for
land resumption work on the West Rail project undertaken by the
Government on behalf of the Corporation.
    
    HK$181 million (US$23 million) (2002: HK$142 million)
for compensation accepted by the owners of resumed land in
respect of the West Rail project paid by the Government on
behalf of the Corporation. The Corporation is obligated to
reimburse such compensation paid to the Government.  (ii)
    
    Included in on-cost recovery credited during the year are amounts
received and receivable in respect of the following:  
    
    HK$39 million (US$5 million) (2002: HK$52 million)
from the Government for certain essential public infrastructure
works and other works along the West Rail, Phase I route
undertaken by the Corporation on its behalf pursuant to the
entrustment agreements in respect of such entrustment works.
    
    HK$35 million (US$5 million) (2002: HK$73 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 Corporation
and the Government (see note 19).  (iii)
    
    Costs included in construction in progress at December 31, 2003
relating to the West Rail project represent costs incurred to date
in respect of certain individual projects which were not complete
at December 31, 2003. Upon completion of the projects the relevant
costs will be transferred to fixed assets.  East Rail Extensions  (i)
    
    East Rail Extensions comprise the Tsim Sha Tsui extension
HK$3,243 million (US$418 million) (2002: HK$2,119 million), the Ma
On Shan Rail HK$6,958 million (US$896 million) (2002: HK$5,115
million) and the Lok Ma Chau Spur Line HK$3,890 million (US$501
million) (2002: HK$1,616 million).(ii)
    
    Include in land and related costs incurred during the year
are amounts paid and payable to the Government by the Corporation
in respect of the following:  
    
    HK$52 million (US$7 million) (2002: HK$54 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
Corporation and/or its contractors.
    
    HK$170 million (US$22 million) (2002: HK$36 million)
for land resumption work undertaken by the Government and
compensation accepted by the owners of resumed land paid by the
Government on behalf of the Corporation in respect of the East
Rail Extensions project. The Corporation is obligated to
reimburse such sums to the Government.  (iii)
    
    Included in on-cost recovery credited during the year is an amount
of HK$52 million (US$7 million) (2002: HK$29 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 Corporation on its behalf pursuant to
the entrustment agreements in respect of such entrustment works. F-33




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  14
    
    Deferred expenditureDeferred expenditure comprises: Balance
    
    
    
    
    
    
    
    
    
    Balance
    
    Balanceas at
    
    Expenditure
    
    Net
    
    as at
    
    as atJanuary 1,
    
    during the
    
    borrowing
    
    December 31,
    
    December 31,2003
    
    year
    
    costs
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in millions)Sha Tin to Central Link
    
    
    113
    
    
    
    609
    
    
    
    9
    
    
    
    731
    
    
    
    94Kowloon Southern Link
    
    
    43
    
    
    
    123
    
    
    
    3
    
    
    
    169
    
    
    
    22156
    
    
    
    732
    
    
    
    12
    
    
    
    900
    
    
    
    116
  Included in expenditure incurred during the year are amounts paid and
payable to the Government by the Corporation in respect of the following:  
    
    HK$5 million (US$1 million) (2002: HK$ nil) for land resumption
work on the Sha Tin to Central Link project undertaken by the
Government on behalf of the Corporation.
    
    HK$2 million (US$ nil) (2002: HK$ nil) for land resumption work
on the Kowloon Southern Link project undertaken by the Government on
behalf of the Corporation.  15
    
    Properties under developmentProperties under development held in Hong Kong under long-term leases
comprise: Balance
    
    
    
    
    
    Transfer
    
    Balance
    
    Balanceas at
    
    Expenditure
    
    from
    
    as at
    
    as atJanuary 1,
    
    during the
    
    deferred
    
    December 31,
    
    December 31,2003
    
    year
    
    income
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in millions)Che Kung Temple
    
    
    30
    
    
    
    
    
    
    
    
    
    
    
    30
    
    
    
    4Ho Tung Lau
    
    
    19
    
    
    
    
    
    
    
    (19
    )
    
    
    
    
    
    
    Tai Wai Maintenance
Centre
    
    
    958
    
    
    
    85
    
    
    
    
    
    
    
    1,043
    
    
    
    134Tai Wai Station
    
    
    77
    
    
    
    144
    
    
    
    
    
    
    
    221
    
    
    
    29Wu Kai Sha
    
    
    58
    
    
    
    81
    
    
    
    
    
    
    
    139
    
    
    
    18Other property
developments
    
    
    11
    
    
    
    4
    
    
    
    
    
    
    
    15
    
    
    
    21,153
    
    
    
    314
    
    
    
    (19
    )
    
    
    1,448
    
    
    
    187
  To strengthen the measures on stabilization of property prices, the
Secretary for Housing, Planning and Lands announced on October 15, 2003
that the Government and the Corporation have agreed not to invite
expression of interests for the property projects at Tai Wai Maintenance
Centre and Tai Wai Station until 2005, with the first phase of these two
developments to be completed no earlier than 2008. Development schedules
for the remaining property sites at Wu Kai Sha and Che Kung Temple of the
Ma On Shan Rail will not be put to tender before 2005. F-34




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  16
    
    Investment in subsidiaries Details of the subsidiaries are as follows: Number of
    
    
    
    Percentage
    
    PercentagePlace of
    
    issued and
    
    
    
    of shares
    
    of sharesincorporation
    
    fully paid
    
    Par value
    
    held by the
    
    held byName of company
    
    and operation
    
    shares**
    
    of shares
    
    Corporation
    
    subsidiary
    
    Nature of businessManlai Court Property
    
    Hong Kong
    
    
    25,500A
    
    
    HK$1
    
    
    100
    %
    
    Nil
    
    Property managementManagement Company Limited
    
    
    
    
    24,500B
    
    
    HK$1
    
    Nil
    
    NilSun Tuen Mun Centre
    
    Hong Kong
    
    
    25,000A
    
    
    HK$1
    
    
    100
    %
    
    Nil
    
    Property managementManagement Company Limited
    
    
    
    
    25,000B
    
    
    HK$1
    
    
    100
    %
    
    NilRoyal Ascot Management
    
    Hong Kong
    
    
    25,000A
    
    
    HK$1
    
    
    100
    %
    
    Nil
    
    Property managementCompany Limited
    
    
    
    
    25,000B
    
    
    HK$1
    
    
    100
    %
    
    NilHanford Garden PropertyManagement Company Limited
    
    Hong Kong
    
    
    10,000
    
    
    HK$1
    
    
    100
    %
    
    Nil
    
    Property managementPierhead Garden Management
    
    Hong Kong
    
    
    25,000A
    
    
    HK$1
    
    
    100
    %
    
    Nil
    
    Property managementCompany Limited
    
    
    
    
    25,000B
    
    
    HK$1
    
    Nil
    
    
    100
    %The Metropolis Management
    
    Hong Kong
    
    
    25,500A
    
    
    HK$1
    
    
    100
    %
    
    Nil
    
    Property managementCompany Limited
    
    
    
    
    24,500B
    
    
    HK$1
    
    Nil
    
    NilCapital System Limited
    
    Hong Kong
    
    
    5,000
    
    
    HK$1
    
    
    100
    %
    
    Nil
    
    Investment holdingBuoyant Asset Limited
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    
    100
    %
    
    Nil
    
    Rolling stock leasing facilitationAdvanced Asset Limited
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    
    100
    %
    
    Nil
    
    Signalling system leasing facilitationQuality Asset Limited
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    
    100
    %
    
    Nil
    
    Signalling system leasing facilitationKasey Asset Limited
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    
    100
    %
    
    Nil
    
    Rolling stock leasing facilitationCircuit Asset Limited
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    
    100
    %
    
    Nil
    
    Rolling stock leasing facilitation
 F-35




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  16
    
    Investment in subsidiaries (continued) Number of
    
    
    
    Percentage
    
    PercentagePlace of
    
    issued and
    
    
    
    of shares
    
    of sharesincorporation
    
    fully paid
    
    Par value
    
    held by the
    
    held byName of company
    
    and operation
    
    shares**
    
    of shares
    
    Corporation
    
    subsidiary
    
    Nature of businessShining Asset Limited
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    
    100
    %
    
    Nil
    
    Revenue collection system leasing facilitationFluent Asset Limited
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    
    100
    %
    
    Nil
    
    Rolling stock leasing facilitationKudos Asset Limited
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    
    100
    %
    
    Nil
    
    Rolling stock leasing facilitationUnique Asset Limited
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    
    100
    %
    
    Nil
    
    Rolling stock leasing facilitationBowman Asset Limited
    
    Cayman Islands
    
    
    1,000
    
    
    US$1
    
    
    100
    %
    
    Nil
    
    Railway infrastructure leasing facilitationStatesman Asset Limited
    
    Cayman Islands
    
    
    1,000
    
    
    US$1
    
    
    100
    %
    
    Nil
    
    Railway infrastructure leasing facilitationInterwind Asset Limited
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    
    100
    %
    
    Nil
    
    Railway equipment leasing facilitationV-Connect Limited
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    
    100
    %
    
    Nil
    
    Mobile communication system operation*West Rail Property
    
    Hong Kong
    
    
    51A
    
    
    HK$10
    
    
    100
    %
    
    Nil
    
    Property developmentDevelopment Limited
    
    
    
    
    49B
    
    
    HK$10
    
    Nil
    
    Nil*Kam Sheung Property
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    Nil
    
    
    100
    %
    
    Property developmentDevelopment Limited*Kwai Fong Property
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    Nil
    
    
    100
    %
    
    Property developmentDevelopment Limited*Long Ping Property
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    Nil
    
    
    100
    %
    
    Property developmentDevelopment Limited*Long Ping South Property
    
    Hong Kong
    
    
    100
    
    
    HK$10
    
    Nil
    
    
    100
    %
    
    Property developmentDevelopment Limited
 F-36




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  16
    
    Investment in subsidiaries (continued) Number of
    
    
    
    Percentage
    
    PercentagePlace of
    
    issued and
    
    
    
    of shares
    
    of sharesincorporation
    
    fully paid
    
    Par value
    
    held by the
    
    held byName of company
    
    and operation
    
    shares**
    
    of shares
    
    Corporation
    
    subsidiary
    
    Nature of business*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-37




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  17
    
    Interest in associateThe interest in associate is as follows: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Share of net assets
    
    
    35
    
    
    
    42
    
    
    
    5
 Details of the associate, which is incorporated and operates in Hong Kong and
provides the Octopus cards system are as follows: Numberof issuedand fully
    
    Par value
    
    Percentage ofName of company
    
    paid shares
    
    of shares
    
    shares held
    
    Nature of businessOctopus 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$29 million (US$4 million) (2002: HK$30 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$7 million (US$1 million) (2002: HK$6 million)
from Octopus Cards Limited in respect of ticket loading agent fees for
providing add-value amounts on Octopus cards.  18
    
    Loan receivable 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Loan receivable
    
    
    
    
    
    
    774
    
    
    
    100
 Under one of these lease arrangements entered into by the Group as
referred to in note 12(h), the lease payments are ultimately funded by the
repayment of a corresponding loan made by the Group to an unrelated party. The
loan receivable represents the outstanding loan made by the Group to an
unrelated party pursuant to these arrangements. The interest rate implicit in
the lease arrangement equals the interest rate receivable by the Group under
the loan, which is 6.96% per annum. The loan will be repayable by installments over the duration of the lease
arrangement until its expiry in 2018. Repayments are due, under the terms of
the lease arrangement as follows: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Within 1 year
    
    
    
    
    
    
    42
    
    
    
    6After 1 year
    
    
    
    
    
    
    732
    
    
    
    94
    
    
    
    774
    
    
    
    100
 F-38




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  19
    
    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 will earn management
fees.  20
    
    Investments in securities(a)
    
    Investments in securities comprise: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Non-trading securitiesManaged by fund managersListed Outside Hong Kong
    
    
    1,217
    
    
    
    1,165
    
    
    
    150 In Hong Kong
    
    
    16
    
    
    
    5
    
    
    
    1Unlisted Quoted in Hong Kong
    
    
    7,020
    
    
    
    4,182
    
    
    
    539 Quoted outside Hong Kong
    
    
    1,572
    
    
    
    1,596
    
    
    
    205Interest-bearing deposits
    
    
    2,501
    
    
    
    4,106
    
    
    
    529Managed by the CorporationListed Outside Hong Kong
    
    
    1,377
    
    
    
    
    
    
    
     In Hong Kong
    
    
    156
    
    
    
    
    
    
    
    Unlisted Quoted in Hong Kong
    
    
    5,306
    
    
    
    1,190
    
    
    
    153Total fair value of investments
    
    
    19,165
    
    
    
    12,244
    
    
    
    1,577Total market value of listed investments
    
    
    2,766
    
    
    
    1,170
    
    
    
    151
 Included in investments in securities are debt securities issued by the
Government and Government-owned entities in Hong Kong with a total fair value
of HK$ nil (US$ nil) (2002: HK$219 million) as at December 31, 2003. Interest
income derived from these debt securities during the year amounted to HK$11
million (US$1 million) (2002: HK$11 million).  (b)
    
    Investments in securities are expected to mature as follows: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Within 1 year
    
    
    16,612
    
    
    
    11,231
    
    
    
    1,447After 1 year
    
    
    2,553
    
    
    
    1,013
    
    
    
    13019,165
    
    
    
    12,244
    
    
    
    1,577
 F-39




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  21
    
    Stores and sparesStores and spares are expected to be consumed as follows: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Within 1 year
    
    
    104
    
    
    
    124
    
    
    
    16After 1 year
    
    
    109
    
    
    
    130
    
    
    
    17213
    
    
    
    254
    
    
    
    33
  22
    
    Interest receivableInterest receivable is expected to be recovered within 1 year.23
    
    Other receivables(a)
    
    Other receivables comprise: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Amount due from associate
    
    
    1
    
    
    
    3
    
    
    
    Amount due from the Government
    
    
    298
    
    
    
    393
    
    
    
    51Debtors, deposits and prepayments
    
    
    863
    
    
    
    216
    
    
    
    281,162
    
    
    
    612
    
    
    
    79
 The amount due from the Government represents HK$341 million (US$44
million) (2002: HK$256 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$52 million (US$7 million) (2002: HK$42 million) for
on-costs charged to the Government in respect of such entrustment works. Included in debtors, deposits and prepayments as at December 31, 2002 were
certain costs totalling HK$498 million (US$64 million) identified during the
year as relating to the property development along the West Rail, Phase I route
and transferred from construction in progress (note 13), and the related
accrued interest of HK$148 million (US$19 million) (note 6). The amounts have
been included in the balance of loan to WRPDL at December 31, 2003 upon
agreement between the Corporation and the Government according to the
provisions as set out in the Shareholding Agreement (note 19).  (b)
    
    Other receivables are expected to be recovered as follows: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Within 1 year
    
    
    479
    
    
    
    585
    
    
    
    75After 1 year
    
    
    683
    
    
    
    27
    
    
    
    41,162
    
    
    
    612
    
    
    
    79
  (c)
    
    Included in other receivables are debtors with the following ageing analysis: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Current
    
    
    1,026
    
    
    
    526
    
    
    
    68Less than 1 month overdue
    
    
    3
    
    
    
    8
    
    
    
    11 to 3 months overdue
    
    
    2
    
    
    
    14
    
    
    
    2More than 3 months overdue
    
    
    5
    
    
    
    11
    
    
    
    1Total debtors
    
    
    1,036
    
    
    
    559
    
    
    
    72Deposits and prepayments
    
    
    126
    
    
    
    53
    
    
    
    71,162
    
    
    
    612
    
    
    
    79
 F-40




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003 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.  24
    
    Cash and cash equivalents(a)
    
    Cash and cash equivalents comprise: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Deposits with banks Within 3 months of maturity when placed
    
    
    4,565
    
    
    
    2,423
    
    
    
    312 More than 3 months of maturity when placed
    
    
    943
    
    
    
    200
    
    
    
    26Cash at bank and in hand
    
    
    20
    
    
    
    54
    
    
    
    7Cash and cash equivalents in the balance sheets
    
    
    5,528
    
    
    
    2,677
    
    
    
    345Less: deposits with banks with more than 3 months
of maturity when placed
    
    
    (943
    )
    
    
    (200
    )
    
    
    (26
    )Cash and cash equivalents in the cash flow statement
    
    
    4,585
    
    
    
    2,477
    
    
    
    319
  (b)
    
    At December 31, 2003, the deposits with banks were placed to mature as follows: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Within 1 year
    
    
    5,308
    
    
    
    2,623
    
    
    
    338After 1 year
    
    
    200
    
    
    
    
    
    
    
    5,508
    
    
    
    2,623
    
    
    
    338
  25
    
    Interest payableInterest payable is expected to be settled within 1 year.26
    
    Other payables(a)
    
    Other payables comprise: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Deposits and advances
    
    
    1,520
    
    
    
    1,326
    
    
    
    171Creditors and accrued charges
    
    
    714
    
    
    
    770
    
    
    
    99Amount due to the Government
    
    
    17
    
    
    
    2
    
    
    
    2,251
    
    
    
    2,098
    
    
    
    270
 The amount due to the Government represents HK$2 million (US$ nil) (2002:
HK$17 million) for land grant applications for property development along the
route of East Rail Extensions. F-41




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  26
    
    Other payables (continued)  (b)
    
    Other payables are expected to be settled as follows: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Within 1 year
    
    
    1,063
    
    
    
    1,138
    
    
    
    146After 1 year
    
    
    1,188
    
    
    
    960
    
    
    
    1242,251
    
    
    
    2,098
    
    
    
    270
  (c)
    
    Included in other payables are creditors with the following ageing analysis: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Due within 1 month or on demand
    
    
    353
    
    
    
    265
    
    
    
    34Total creditors
    
    
    353
    
    
    
    265
    
    
    
    34Deposits and advances received
    
    
    1,520
    
    
    
    1,326
    
    
    
    171Accrued charges
    
    
    378
    
    
    
    507
    
    
    
    652,251
    
    
    
    2,098
    
    
    
    270
  27
    
    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. Included in accrued charges for capital projects is an amount of HK$383
million (US$49 million) (2002: HK$570 million) for amounts payable to the
Government in respect of land resumption work undertaken on 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.  28
    
    Lease payable Lease payable is expected to be repayable as follows: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Within 1 year
    
    
    
    
    
    
    42
    
    
    
    6After 1 year
    
    
    
    
    
    
    716
    
    
    
    92
    
    
    
    758
    
    
    
    98
 The lease payable arises from the lease arrangement disclosed in note 18. The
payments are to be funded by repayment of the loan receivable as discussed in
note 18 in accordance with the terms of the lease arrangement. F-42




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  29
    
    Interest-bearing borrowings Interest-bearing borrowings comprise: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Capital market instrumentsUS dollar Euro medium
term notes due 2009
(a)
    
    
    7,769
    
    
    
    7,770
    
    
    
    1,001HK dollar medium term
notes due 2013 (a)
    
    
    
    
    
    
    800
    
    
    
    103US dollar Euro medium
term notes due 2014
(a)
    
    
    388
    
    
    
    388
    
    
    
    50US dollar Global
notes due 2010 (b)
    
    
    7,781
    
    
    
    7,780
    
    
    
    1,002HK dollar Retail
notes due 2008 and
2013 (c)
    
    
    
    
    
    
    1,023
    
    
    
    13215,938
    
    
    
    17,761
    
    
    
    2,288Bank loanExport credit loans
(e)
    
    
    1,815
    
    
    
    2,252
    
    
    
    29017,753
    
    
    
    20,013
    
    
    
    2,578
  (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.  (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, in addition to the amounts totalling US$209.5 million
drawn down in previous years, an amount of US$80.7 million was drawn down
by the Corporation under a US$337.7 million export credit loan facility
for financing the purchase of rolling stock. The total amount of the
facility was reduced to US$253.6 million as at December 31, 2003 following
the cancellation of the undrawn amount of US$47.5 million of the facility
with effective from June 30, 2003 and the subsequent repayment of US$36.6
million by the Corporation. The loan is unsecured and repayable by
seventeen semi-annual installments commencing on April 21, 2003. As at
December 31, 2003, about 57% of the total loan balance bears interest at a
rate of 5.6% per annum and the remaining 43% bears interest at a rate of
LIBOR plus 0.5% per annum.  During the year, in addition to the amount of US$22.4 million drawn down
in previous years, an amount of US$13.1 million was drawn down by the
Corporation under a US$42 million export credit loan facility for
financing the purchase of the train control and signalling system of West
Rail. The loan balance bears interest at a rate of LIBOR plus 0.6% per
annum and is unsecured and repayable by seventeen semi-annual
installments commencing not later than May 1, 2004. F-43




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  29
    
    Interest-bearing borrowings (continued)  (f)
    
    At December 31, 2003, the interest-bearing borrowings were repayable as
follows: CapitalmarketTotal
    
    instruments
    
    Bank loans
    
    Total
    
    Total2002
    
    2003
    
    2003
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in millions)Within 1 year
    
    
    310
    
    
    
    
    
    
    
    297
    
    
    
    297
    
    
    
    38After 1 year but
within 2 years
    
    
    350
    
    
    
    
    
    
    
    298
    
    
    
    298
    
    
    
    38After 2 year but
within 5 years
    
    
    548
    
    
    
    304
    
    
    
    907
    
    
    
    1,211
    
    
    
    156After 5 years
    
    
    16,545
    
    
    
    17,457
    
    
    
    750
    
    
    
    18,207
    
    
    
    2,34517,753
    
    
    
    17,761
    
    
    
    2,252
    
    
    
    20,013
    
    
    
    2,577
  30
    
    Deferred income  (a)
    
    Movements on deferred income comprise: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Balance at January 1,
    
    
    454
    
    
    
    434
    
    
    
    56Net amount accrued during the year
    
    
    
    
    
    
    18
    
    
    
    2Net amount received during the year
    
    
    140
    
    
    
    337
    
    
    
    43Transfer to properties under development
    
    
    
    
    
    
    (19
    )
    
    
    (2
    )Transfer to the income statement
    
    
    (160
    )
    
    
    (27
    )
    
    
    (3
    )434
    
    
    
    743
    
    
    
    96
  (b)
    
    Deferred income is expected to be recognized in the income statement as
follows: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Within 1 year
    
    
    27
    
    
    
    48
    
    
    
    6After 1 year
    
    
    407
    
    
    
    695
    
    
    
    90434
    
    
    
    743
    
    
    
    96
  31
    
    Share capital 2001
    
    2002
    
    2003
    
    2003No. of
    
    HK$
    
    No. of
    
    HK$
    
    No. of
    
    HK$
    
    US$shares
    
    (in millions)
    
    shares
    
    (in millions)
    
    shares
    
    (in millions)
    
    (in millions)Share capital:Authorized:Shares of HK$100,000
each
    
    
    425,000
    
    
    
    42,500
    
    
    
    425,000
    
    
    
    42,500
    
    
    
    425,000
    
    
    
    42,500
    
    
    
    5,474Issued and fully paid:At January 1,
    
    
    311,200
    
    
    
    31,120
    
    
    
    391,200
    
    
    
    39,120
    
    
    
    391,200
    
    
    
    39,120
    
    
    
    5,039Issued during the
year
    
    
    80,000
    
    
    
    8,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    At December 31,
    
    
    391,200
    
    
    
    39,120
    
    
    
    391,200
    
    
    
    39,120
    
    
    
    391,200
    
    
    
    39,120
    
    
    
    5,039
 F-44




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  31
    
    Share capital (continued) Pursuant to the Kowloon-Canton Railway (Increase in Authorized Capital)
Order 2001 effective on March 2, 2001, the authorized capital of the
Corporation 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 the same day, 80,000 shares of HK$100,000 each were issued to the
Financial Secretary Incorporated for and on behalf of the Government for each
at par, being the equity injection money received from the Government for the
construction of the Tsim Sha Tsui extension and Ma On Shan Rail.  32
    
    Development reserve The development reserve represents appropriations of all profits from
property developments to retained reserves within the Corporation. The
development reserve will be utilized for future railway capital expenditure
upon approval of the Managing Board. Movements in the development reserve
during the year were as follows: 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Balance at January 1,
    
    
    6,417
    
    
    
    6,441
    
    
    
    6,535
    
    
    
    841Transfer from the income statement
    
    
    24
    
    
    
    94
    
    
    
    
    
    
    
    Balance at December 31,
    
    
    6,441
    
    
    
    6,535
    
    
    
    6,535
    
    
    
    841
  33
    
    Investment property revaluation reserve The investment property revaluation reserve comprises: 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Balance at January 1,
    
    
    242
    
    
    
    176
    
    
    
    134
    
    
    
    17Deficit arising on revaluation
during the year (note 12)
    
    
    (66
    )
    
    
    (42
    )
    
    
    (17
    )
    
    
    (2
    )Balance at December 31,
    
    
    176
    
    
    
    134
    
    
    
    117
    
    
    
    15
  34
    
    Investment revaluation reserve The revaluation reserve arising on investments in securities comprises: 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Balance at January 1,
    
    
    16
    
    
    
    133
    
    
    
    50
    
    
    
    7Surplus/(Deficit) arising on
revaluation
    
    
    250
    
    
    
    (516
    )
    
    
    (197
    )
    
    
    (25
    )Less: Amount capitalized
    
    
    (119
    )
    
    
    414
    
    
    
    121
    
    
    
    15131
    
    
    
    (102
    )
    
    
    (76
    )
    
    
    (10
    )Deficit/(Surplus) realized on
disposal
    
    
    (62
    )
    
    
    55
    
    
    
    60
    
    
    
    8Surplus/(Deficit) capitalized in
prior years
    
    
    48
    
    
    
    (36
    )
    
    
    (35
    )
    
    
    (5
    )Deficit/(Surplus) transferred to
the income statement on disposal
    
    
    (14
    )
    
    
    19
    
    
    
    25
    
    
    
    3Balance at December 31,
    
    
    133
    
    
    
    50
    
    
    
    (1
    )
    
    
    
 F-45




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  35
    
    Retained profits Profits are retained as follows: 2001
    
    2002
    
    2003
    
    2003RestatedHK$
    
    HK$
    
    HK$
    
    US$(in millions)Retained profits at January 1, as previously reported
    
    
    11,106
    
    
    
    13,710
    
    
    
    16,277
    
    
    
    2,096  prior period adjustment  change in accounting policy (note
4(a))
    
    
    
    
    
    
    (2,153
    )
    
    
    (2,604
    )
    
    
    (335
    )  change in
accounting policy (note
4(b))
    
    
    (32
    )  change in
accounting policy (note
4(c))
    
    
    225  as restated
    
    
    11,299
    
    
    
    11,557
    
    
    
    13,673
    
    
    
    1,761Dividend approved in respect of the
previous year (note 10)
    
    
    
    
    
    
    
    
    
    
    (620
    )
    
    
    (80
    )Retained profit for the year  as previously reported
    
    
    2,412
    
    
    
    2,567  prior period adjustment  change in accounting policy (note
4(a))
    
    
    
    
    
    
    (451
    )  change in accounting policy (note
4(b))
    
    
    (1
    )  as restated
    
    
    2,411
    
    
    
    2,116
    
    
    
    1,381
    
    
    
    178Retained profits at December 31,
    
    
    13,710
    
    
    
    13,673
    
    
    
    14,434
    
    
    
    1,859Representing:Proposed dividend (note 10)
    
    
    
    
    
    
    620
    
    
    
    620
    
    
    
    80Retained profits after proposed dividend
    
    
    13,710
    
    
    
    13,053
    
    
    
    13,814
    
    
    
    1,779
 Included in the retained profits of the Group is an amount of HK$33
million (US$4 million) (2002: HK$26 million; 2001: HK$10 million), being the
retained profits attributable to an associate. Comparative figures for 2002 have been restated as a result of the change
in accounting policy for deferred tax as set out in note 4(a). However,
comparative figures for 2001 and prior years have not been restated because it
would be impractical to do so.  36
    
    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, 3(c), 13, 14, 16, 19, 23, 26, 27 and 31 to
the financial statements. In addition, the Corporation had made investments in
debt securities issued by the Government and Government-owned entities during
the year. Details of the interest income derived therefrom are disclosed in
note 20 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 5 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 17 to the
financial statements. F-46




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  37
    
    Outstanding commitments  (a)
    
    Commitments outstanding at December 31, 2003 in respect of capital
expenditure not provided for in the financial statements were as follows: 2002
    
    2003Total
    
    Within 1 year
    
    After 1 year
    
    Total
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in millions)Contracted forNoise abatement program
    
    
    20
    
    
    
    5
    
    
    
    
    
    
    
    5
    
    
    
    1Construction and improvement works at various
stations, stops and terminals
    
    
    165
    
    
    
    
    
    
    
    10
    
    
    
    10
    
    
    
    1New railway projects
    
    
    36
    
    
    
    296
    
    
    
    70
    
    
    
    366
    
    
    
    47Improvement works on vehicles and equipment
    
    
    31
    
    
    
    7
    
    
    
    7
    
    
    
    14
    
    
    
    2Purchase of eight 12-car electric multiple
units
    
    
    9
    
    
    
    14
    
    
    
    2
    
    
    
    16
    
    
    
    2Light Rail Extension to Tin Shui Wai
    
    
    167
    
    
    
    7
    
    
    
    
    
    
    
    7
    
    
    
    1Grade separation at LRT junction
    
    
    171
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Replacement of LRT vehicle information
system
    
    
    185
    
    
    
    3
    
    
    
    
    
    
    
    3
    
    
    
    Southern subway and concourse at KowloonTong Station
    
    
    74
    
    
    
    1
    
    
    
    11
    
    
    
    12
    
    
    
    1Light Rail
integration projects with West Rail
    
    
    26
    
    
    
    4
    
    
    
    
    
    
    
    4
    
    
    
    1East Rail Extensions project:Consultants fees
    
    
    613
    
    
    
    255
    
    
    
    111
    
    
    
    366
    
    
    
    47Construction works
    
    
    7,607
    
    
    
    3,162
    
    
    
    1,424
    
    
    
    4,586
    
    
    
    591Staff costs
    
    
    790
    
    
    
    166
    
    
    
    67
    
    
    
    233
    
    
    
    30Land acquisition costs
    
    
    892
    
    
    
    231
    
    
    
    155
    
    
    
    386
    
    
    
    50Others
    
    
    63
    
    
    
    14
    
    
    
    19
    
    
    
    33
    
    
    
    49,965
    
    
    
    3,828
    
    
    
    1,776
    
    
    
    5,604
    
    
    
    722West Rail project:Consultants fees
    
    
    616
    
    
    
    239
    
    
    
    16
    
    
    
    255
    
    
    
    33Construction works
    
    
    2,789
    
    
    
    407
    
    
    
    
    
    
    
    407
    
    
    
    53Staff costs
    
    
    476
    
    
    
    162
    
    
    
    9
    
    
    
    171
    
    
    
    22Land acquisition costs
    
    
    191
    
    
    
    131
    
    
    
    
    
    
    
    131
    
    
    
    17Others
    
    
    54
    
    
    
    110
    
    
    
    2
    
    
    
    112
    
    
    
    144,126
    
    
    
    1,049
    
    
    
    27
    
    
    
    1,076
    
    
    
    139Other projects
    
    
    36
    
    
    
    22
    
    
    
    12
    
    
    
    34
    
    
    
    415,011
    
    
    
    5,236
    
    
    
    1,915
    
    
    
    7,151
    
    
    
    921
 F-47




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION
NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  37
    
    Outstanding commitments (continued) 2002
    
    2003Total
    
    Within 1 year
    
    After 1 year
    
    Total
    
    TotalHK$
    
    HK$
    
    HK$
    
    HK$
    
    US$(in millions)Authorized but not contracted forNoise abatement program
    
    
    151
    
    
    
    
    
    
    
    150
    
    
    
    150
    
    
    
    19PRC through train development
    
    
    28
    
    
    
    1
    
    
    
    25
    
    
    
    26
    
    
    
    4Electric multiple units refurbishment
    
    
    31
    
    
    
    5
    
    
    
    20
    
    
    
    25
    
    
    
    3Acquisition and implementation of computer
systems
    
    
    51
    
    
    
    2
    
    
    
    24
    
    
    
    26
    
    
    
    3Construction and improvement works at various
stations, stops and terminals
    
    
    86
    
    
    
    4
    
    
    
    50
    
    
    
    54
    
    
    
    7Improvement works on vehicles and equipment
    
    
    115
    
    
    
    4
    
    
    
    104
    
    
    
    108
    
    
    
    14Purchase of eight 12-car electric multiple
units
    
    
    267
    
    
    
    2
    
    
    
    133
    
    
    
    135
    
    
    
    17Light Rail Extension to Tin Shui Wai
    
    
    
    
    
    
    30
    
    
    
    
    
    
    
    30
    
    
    
    4Replacement of LRT vehicle information
system
    
    
    
    
    
    
    79
    
    
    
    5
    
    
    
    84
    
    
    
    11Installation of training information system
    
    
    32
    
    
    
    1
    
    
    
    31
    
    
    
    32
    
    
    
    4Southern subway and concourse at Kowloon Tong
Station
    
    
    48
    
    
    
    9
    
    
    
    24
    
    
    
    33
    
    
    
    4Replacement of ARC equipment at all stations
    
    
    50
    
    
    
    2
    
    
    
    21
    
    
    
    23
    
    
    
    3Replacement of three diesel locomotives
    
    
    99
    
    
    
    26
    
    
    
    
    
    
    
    26
    
    
    
    3Train-Borne Infotainment system
    
    
    219
    
    
    
    5
    
    
    
    124
    
    
    
    129
    
    
    
    17New railway projects
    
    
    264
    
    
    
    307
    
    
    
    1,954
    
    
    
    2,261
    
    
    
    291Renovation of Government and commercial
office
    
    
    13
    
    
    
    1
    
    
    
    1
    
    
    
    2
    
    
    
    East Rail Extensions project:Consultants fees
    
    
    56
    
    
    
    42
    
    
    
    19
    
    
    
    61
    
    
    
    8Construction works
    
    
    77
    
    
    
    183
    
    
    
    1
    
    
    
    184
    
    
    
    24Staff costs
    
    
    207
    
    
    
    125
    
    
    
    343
    
    
    
    468
    
    
    
    60Land acquisition costs
    
    
    6
    
    
    
    4
    
    
    
    
    
    
    
    4
    
    
    
    Others
    
    
    7
    
    
    
    33
    
    
    
    28
    
    
    
    61
    
    
    
    8353
    
    
    
    387
    
    
    
    391
    
    
    
    778
    
    
    
    100West Rail project:Land acquisition costs
    
    
    2,068
    
    
    
    1,686
    
    
    
    120
    
    
    
    1,806
    
    
    
    233Others
    
    
    629
    
    
    
    69
    
    
    
    
    
    
    
    69
    
    
    
    92,697
    
    
    
    1,755
    
    
    
    120
    
    
    
    1,875
    
    
    
    242Other projects
    
    
    72
    
    
    
    104
    
    
    
    253
    
    
    
    357
    
    
    
    464,576
    
    
    
    2,724
    
    
    
    3,430
    
    
    
    6,154
    
    
    
    792
  (b)
    
    As December 31, 2003, the total future minimum lease payments under
non-cancellable operating leases on property are payable as follows: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Within 1 year
    
    
    148
    
    
    
    87
    
    
    
    11After 1 year but within 5 years
    
    
    125
    
    
    
    53
    
    
    
    7273
    
    
    
    140
    
    
    
    18
 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$105 million (US$14 million) (2002: HK$115 million) were
capitalized as part of construction in progress and deferred expenditure. F-48




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  38
    
    Notes to the consolidated cash flow statement  (a)
    
    Reconciliation of operating profit before net investment income to net
cash inflow from operations: 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Operating profit before net
investment income
    
    
    1,911
    
    
    
    1,934
    
    
    
    1,549
    
    
    
    200Depreciation
    
    
    661
    
    
    
    725
    
    
    
    748
    
    
    
    96Fixed assets written off
    
    
    5
    
    
    
    27
    
    
    
    9
    
    
    
    1Increase in stores and spares
    
    
    (15
    )
    
    
    (27
    )
    
    
    (41
    )
    
    
    (5
    )Increase in other receivables
    
    
    (264
    )
    
    
    (539
    )
    
    
    (69
    )
    
    
    (9
    )Increase/(decrease) in other
payables and deferred income
    
    
    463
    
    
    
    783
    
    
    
    (17
    )
    
    
    (2
    )2,761
    
    
    
    2,903
    
    
    
    2,179
    
    
    
    281
  (b)
    
    Reconciliation of profit on property development to net cash outflow from
property development: 2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Profit on property development
    
    
    24
    
    
    
    94
    
    
    
    
    
    
    
    Increase in properties under
development
    
    
    (383
    )
    
    
    (577
    )
    
    
    (308
    )
    
    
    (40
    )Decrease/(Increase) in properties
held for resale
    
    
    (11
    )
    
    
    11
    
    
    
    
    
    
    
    Increase in deferred property
development income
    
    
    20
    
    
    
    70
    
    
    
    
    
    
    
    (350
    )
    
    
    (402
    )
    
    
    (308
    )
    
    
    (40
    )
  39
    
    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. F-49




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  39
    
    Retirement benefit scheme (continued) 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, 2003 amounted to HK$108 million (US$14 million)
(2002: HK$110 million; 2001: HK$105 million) net of a capitalized amount of
HK$29 million (US$4 million) (2002: HK$19 million; 2001: HK$18 million), after
a forfeiture of unvested contributions of HK$2 million (US$ nil) (2002: HK$4
million; 2001: HK$8 million).  40
    
    Loan facilities Total undrawn loan facilities available to the Corporation comprise: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)HK$2,350 million (US$303 million) (2002: HK$2,250
million) short-term uncommitted revolving credit
facilities
    
    
    2,250
    
    
    
    2,350
    
    
    
    303HK$20 million (US$3 million) (2002: HK$20 million) letters
of credit
    
    
    3
    
    
    
    20
    
    
    
    3HK$25 million (US$3 million) (2002: HK$25 million)
overdraft facilities
    
    
    25
    
    
    
    25
    
    
    
    3US$3,000 million (2002: US$3,000 million) Euro medium
term note program
    
    
    15,266
    
    
    
    14,399
    
    
    
    1,854US$292 million (2002: US$236 million) letters of credit
for leveraged leases
    
    
    1,848
    
    
    
    2,276
    
    
    
    293US$296 million (2002: US$380 million) export credit loan
facilities
    
    
    1,157
    
    
    
    51
    
    
    
    720,549
    
    
    
    19,121
    
    
    
    2,463
  41
    
    Off-balance sheet financial instruments The Corporation uses off-balance sheet derivative 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 Corporation solely for hedging
purposes. The Corporation does not engage in the trading or speculation of
derivative instruments. As at December 31, 2003, the Corporation has
outstanding derivative instruments in the notional amount of HK$24,850 million
(US$3,201 million) (2002: HK$19,830 million) comprising: 2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Interest rate swaps
    
    
    3,914
    
    
    
    5,697
    
    
    
    734Cross currency swaps
    
    
    15,573
    
    
    
    15,573
    
    
    
    2,006Foreign exchange forward contracts
    
    
    343
    
    
    
    3,580
    
    
    
    46119,830
    
    
    
    24,850
    
    
    
    3,201
  42
    
    Contingent liabilities At December 31, 2003, 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 for which no provisions have
been made in the financial statements as at December 31, 2003. The Group is in
the process of resolving these claims and the amounts of the Groups
obligations, if any, cannot be estimated reliably. F-50




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  42
    
    Contingent liabilities (continued) The lease arrangements referred to in note 12(h) are subject to certain
terms and conditions under the related agreements whereby one of the lease
arrangements entered in 2003 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$65 million (US$8 million) at December 31, 2003 representing compensation
that the Group may have to bear should the mandatory termination occur.  43
    
    Summary of differences between accounting principles generally accepted
in Hong Kong and the United States The Groups 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 significant differences relate to the
following items and the adjustments considered necessary to reconcile
consolidated profit after taxation and consolidated shareholders funds in
accordance with US GAAP are shown in the following tables.  (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.
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 (US$98 million) and HK$761 million (US$98 million) at December
31, 2002 and December 31, 2003, respectively.  (b)
    
    Investments Under HK GAAP, investment securities are stated in the balance sheet at
fair value. Changes in fair value of pre-funding investments in securities (see
note 3(m)) are capitalized to construction in progress and deferred
expenditure. Additionally, interest earned and realized gains and losses on
pre-funding investments in securities are credited (see note 3(q)) to
construction in progress and deferred expenditure. 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 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. Under both HK GAAP and US GAAP, no provision for or reversal of impairment
of investment securities has been made for the year ended December 31, 2003.  (c)
    
    Revenue recognition on property development Under HK GAAP, the Group recognizes its profit on the receipt of
non-refundable advance payments from developers after issue of the occupation
permit and taking into account outstanding risks, if any, retained by the Group
in connection with the development. Under US GAAP, profit on the receipt of
non-refundable advance payments from developers would be recognized on a
percentage-of-completion basis. 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) was
made to net assets to restate the cost of properties acquired under US GAAP.
This adjustment will be reversed upon disposal of the related properties. In 2002, under HK GAAP the Group recognized property development profits
amounting to HK$94 million (US$12 million) of which an amount of HK$73 million
(US$9 million) was recognized in 2001 on a percentage of completion basis under
US GAAP. Accordingly, an adjustment of HK$73 million (US$9 million) was made
to the consolidated net income under US GAAP for the year ended December 31,
2002. F-51




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  43
    
    Summary of differences between accounting principles generally accepted
in Hong Kong and the United States (continued)  (d)
    
    Capitalization of certain costs Under HK GAAP, certain costs of a non-incremental nature are capitalized
relative to 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. The related
depreciation charges in respect of capitalized non-incremental costs amounted
to HK$14 million (US$2 million) and HK$15 million (US$2 million) for the year
ended December 31, 2002 and December 31, 2003 respectively.  (e)
    
    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 expenditures for the asset exceed 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 as all borrowings
are specifically related to the acquisition or construction of an asset. 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.  (f)
    
    Income taxes Prior to January 1, 2003, under HK GAAP the Groups deferred tax
liabilities were calculated 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 and were provided to the
extent that it is probable that such liabilities were expected to crystallize
in the foreseeable future. Deferred tax assets were only recognized if their
realization was assured beyond reasonable doubt. Under US GAAP full provision is made for all deferred taxes as they arise,
except that a valuation allowance is provided on deferred tax assets to the
extent that it is not more likely than not that such deferred tax assets will
be realized. Under US GAAP, more likely than not is defined as a likelihood
of more than 50 percent. 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 3(s) is similar to
US GAAP except that under HK GAAP, deferred tax assets are recognized only to
the extent that it is probable that sufficient future taxable profits will be
generated to utilize such assets. As shown in note 35, the effect of adopting
this policy resulted in a decrease of HK$2,604 million (US$335 million) to the
balance of the shareholders funds as of January 1, 2002 and, accordingly, the
US GAAP adjustment to the shareholders funds arising in 2002 for deferred tax
accounting has been eliminated.  (g)
    
    Derivative instruments 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, derivative instruments are not required to be recorded on
the balance sheet. F-52




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  43
    
    Summary of differences between accounting principles generally accepted
in Hong Kong and the United States of America (continued)  (h)
    
    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 under the
lease out and lease back transactions as described in note 12(h), those
commitments and deposits are not recognized as obligations and assets of the
Group. In the case where the Corporation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 (see note 3(o)). Under US GAAP, cash deposits cannot be used to offset obligations if there
is no legal right to offset. The security deposits placed 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 to defease the
lease obligations and the related commitments to make long-term lease payments
would be reflected separately in the balance sheet.  (i)
    
    Reconciliation of consolidated profit after taxation to US GAAP Year ended December 31,Note
    
    2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Consolidated profit after taxation for the year in
accordance with HK GAAP
    
    
    
    
    
    
    2,435
    
    
    
    2,210
    
    
    
    1,381
    
    
    
    178Adjustments
required under US GAAPDepreciation on investment properties
    
    
    43
    (a)
    
    
    (14
    )
    
    
    (12
    )
    
    
    (15
    )
    
    
    (2
    )Investment income capitalized under HK GAAP
    
    
    43
    (b)
    
    
    1,971
    
    
    
    975
    
    
    
    292
    
    
    
    38Revenue recognition of property development
    
    
    43
    (c)
    
    
    73
    
    
    
    (73
    )
    
    
    
    
    
    
    Capitalization of certain costs net of related
depreciation
    
    
    43
    (d)
    
    
    (48
    )
    
    
    (112
    )
    
    
    (119
    )
    
    
    (15
    )Amortization of capitalized interest
    
    
    43
    (e)
    
    
    (27
    )
    
    
    (10
    )
    
    
    (9
    )
    
    
    (1
    )Capitalized net foreign exchange gains/(losses)
    
    
    43
    (e)
    
    
    (32
    )
    
    
    1
    
    
    
    (19
    )
    
    
    (3
    )Deferred tax accounting
    
    
    43
    (f)
    
    
    (484
    )
    
    
    
    
    
    
    
    
    
    
    Derivative instruments
    
    
    43
    (g)
    
    
    (5
    )
    
    
    (3
    )
    
    
    24
    
    
    
    3Tax effect of the above adjustments
    
    
    
    
    
    
    (77
    )
    
    
    (25
    )
    
    
    (23
    )
    
    
    (3
    )Consolidated net income for the year in accordance with
US GAAP
    
    
    
    
    
    
    3,792
    
    
    
    2,951
    
    
    
    1,512
    
    
    
    195
  (j)
    
    Reconciliation of consolidated shareholders funds to US GAAP As of December 31,Note
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    US$(in millions)Consolidated shareholders funds
in accordance with HK GAAP
    
    
    
    
    
    
    59,512
    
    
    
    60,205
    
    
    
    7,754Adjustments required under US GAAPAccumulated depreciation on
investment properties
    
    
    43
    (a)
    
    
    (107
    )
    
    
    (122
    )
    
    
    (16
    )Asset revaluation reserve
    
    
    43
    (a)
    
    
    (134
    )
    
    
    (117
    )
    
    
    (15
    )Valuation of investment
portfolio
    
    
    43
    (b)
    
    
    85
    
    
    
    (1
    )
    
    
    Investment income capitalized
under HK GAAP
    
    
    43
    (b)
    
    
    7,653
    
    
    
    7,945
    
    
    
    1,023Revenue recognition on
property development
    
    
    43
    (c)
    
    
    (61
    )
    
    
    (61
    )
    
    
    (8
    )Capitalization of certain
costs net of related
depreciation
    
    
    43
    (d)
    
    
    (493
    )
    
    
    (612
    )
    
    
    (79
    )Capitalization of interest
net of related amortization
    
    
    43
    (e)
    
    
    249
    
    
    
    240
    
    
    
    31Capitalized net foreign
exchange losses
    
    
    43
    (e)
    
    
    (38
    )
    
    
    (57
    )
    
    
    (7
    )Derivative instruments
    
    
    43
    (g)
    
    
    (218
    )
    
    
    (497
    )
    
    
    (64
    )Lease obligations
    
    
    43
    (h)
    
    
    (9,370
    )
    
    
    (12,742
    )
    
    
    (1,641
    )Lease deposits
    
    
    43
    (h)
    
    
    9,370
    
    
    
    12,742
    
    
    
    1,641Tax effect of above
adjustments
    
    
    
    
    
    
    (243
    )
    
    
    (180
    )
    
    
    (23
    )Consolidated shareholders equity
in accordance with US GAAP
    
    
    
    
    
    
    66,205
    
    
    
    66,743
    
    
    
    8,596
 F-53




---



##### Table of Contents



KOWLOON-CANTON RAILWAY CORPORATION NOTES TO THE FINANCIAL STATEMENTS  (Continued)
December 31, 2001, 2002, 2003  43
    
    Summary of differences between accounting principles generally accepted
in Hong Kong and the United States of America (continued)  (k)
    
    Statement of cash flows Following the adoption of SSAP 15 (revised) (Cash Flow Statement) under HK
GAAP, the Group presents its cash flows for: (a) operating activities; (b)
investing activities; and (c) financing activities. Under HK GAAP, interest
received is included in investing activities while interest paid and financing
expenses are included in financing activities. Under US GAAP, interest
received, interest paid and financing expenses paid are all included in the
operating activities. Under US GAAP, 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: As of December 31,2001
    
    2002
    
    2003
    
    2003HK$
    
    HK$
    
    HK$
    
    US$(in millions)Net cash provided/(used) by:Operating activities
    
    
    2,929
    
    
    
    3,087
    
    
    
    1,333
    
    
    
    172Investing activities
    
    
    (12,190
    )
    
    
    (1,894
    )
    
    
    (5,092
    )
    
    
    (656
    )Financing activities
    
    
    8,433
    
    
    
    928
    
    
    
    1,651
    
    
    
    213Change in cash and cash equivalents
    
    
    (828
    )
    
    
    2,121
    
    
    
    (2,108
    )
    
    
    (271
    )Cash and cash equivalents at
January 1,
    
    
    3,292
    
    
    
    2,464
    
    
    
    4,585
    
    
    
    590Cash and cash equivalents at
December 31,
    
    
    2,464
    
    
    
    4,585
    
    
    
    2,477
    
    
    
    319
  (l)
    
    Comprehensive income The comprehensive income for the years ended December 31, 2002 and
December 31, 2003 amounted to HK$2,427 million (US$313 million) and HK$1,158
million (US$149 million) respectively. F-54