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As filed with the Securities and Exchange Commission on June 27, 2003

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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549



---



FORM 20-F



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



For the fiscal year ended December 31, 2002



Commission file number __________________



---



Kowloon-Canton Railway Corporation

(Exact Name of Registrant as Specified in Its Charter)



Not Applicable.

(Translation of Registrants Name Into English)



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

(Jurisdiction of Incorporation or Organization)



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

(Address of Principal Executive Offices)



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



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



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



None.



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



None.



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, 2002

391,200 shares outstanding



Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.



Yes
x   No ____



Indicate by check mark which financial statement item the Registrant has elected to follow.



Item 17 x  Item 18 ____



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TABLE OF CONTENTS



|                                                                                       |  |     |  | Page
|-------------------------------------------------------------------------------------- |  | --- |  | ----
|GENERAL INFORMATION                                                                    |  | iii
|EXCHANGE RATE INFORMATION                                                              |  | iii
|FORWARD-LOOKING STATEMENTS                                                             |  | iii
|PART I                                                                                 |  |    
|ITEM 1.     IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS                      |  | 1  
|ITEM 2.     OFFER STATISTICS AND EXPECTED TIMETABLE                                    |  | 1  
|ITEM 3.     KEY INFORMATION                                                            |  | 1  
|ITEM 4.     INFORMATION ON THE CORPORATION                                             |  | 8  
|ITEM 5.     OPERATING AND FINANCIAL REVIEW AND PROSPECTS                               |  | 30 
|ITEM 6.     DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                 |  | 49 
|ITEM 7.     MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                          |  | 54 
|ITEM 8.     FINANCIAL INFORMATION                                                      |  | 56 
|ITEM 9.     THE OFFER AND LISTING                                                      |  | 57 
|ITEM 10.   ADDITIONAL INFORMATION                                                      |  | 57 
|ITEM 11.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS                 |  | 65 
|ITEM 12.   DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                      |  | 68 
|PART II                                                                                |  |    
|ITEM 13.   DEFAULT, DIVIDEND ARREARAGES AND DELINQUENCIES                              |  | 68 
|ITEM 14.   MATERIAL MODIFICATION TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS |  | 68 
|ITEM 15.   CONTROLS AND PROCEDURES                                                     |  | 68 
|ITEM 16.   [RESERVED]                                                                  |  | 69 
|PART III                                                                               |  |    
|ITEM 17.   FINANCIAL STATEMENTS                                                        |  | 69 
|ITEM 18.   FINANCIAL STATEMENTS                                                        |  | 69 
|ITEM 19.   EXHIBITS                                                                    |  | 69 
|SIGNATURES                                                                             |  | S-1
|CERTIFICATIONS                                                                         |  | S-2
|INDEX TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS                                     |  | F-1





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GENERAL INFORMATION



Except as
otherwise required by the context, references in this Annual Report to KCRC, Corporation or we refer to Kowloon-Canton Railway Corporation. The term you refers to holders of our 8% notes issued in
March 2000, due 2010 (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$7.7988 = 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, 2002. 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 dollars 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 effectively 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.



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;
|- |  | --------------------------------------------------------------------------------------------------------



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



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|· |  | 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 level and timing of imposition of the boundary facilities improvement tax;
|- |  | ------------------------------------------------------------------------------



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



|· |  | the decision of the Government on the merger between KCRC and MTR Corporation Limited;
|- |  | --------------------------------------------------------------------------------------



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



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



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



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







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PART I



ITEM 1.    IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS



Not applicable.



ITEM 2.    OFFER STATISTICS AND EXPECTED TIMETABLE



Not applicable.



ITEM 3.    KEY INFORMATION



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, 2000, 2001 and 2002 and Consolidated Balance Sheet Data as of December 31, 2001 and 2002 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. 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 42
to our audited consolidated financial statements for a summary of differences between HK GAAP and US GAAP applicable to us.



|                                              |  | Year Ended December 31,              |  
|--------------------------------------------- |  | ------------------------------------ | -
|                                              |  | 1998                                 |  
|                                              |  | HK$                                  |  
|                                              |  | (in millions, except per share data) |  
|Consolidated Income Statement Data:           |  |                                      |  
|HK GAAP:                                      |  |                                      |  
|Revenue                                       |  | 4,137                                |  
|Operating costs                               |  | (2,672                               | )
|                                              |  |                                      |  
|Operating profit before net investment income |  | 1,465                                |  
|Net investment income                         |  | 164                                  |  
|                                              |  |                                      |  
|Operating profit after net investment income  |  | 1,629                                |  
|Profit on property development                |  | 88                                   |  
|Share of profits/(losses) of associate        |  |                                     |  
|                                              |  |                                      |  
|Profit before taxation                        |  | 1,717                                |  
|Taxation                                      |  | (78                                  | )
|                                              |  |                                      |  
|Profit after taxation                         |  | 1,639                                |  
|                                              |  |                                      |  
|Dividend                                      |  |                                     |  
|                                              |  |                                      |  
|Earnings per share(10) Basic                 |  | 13,149                               |  
|Dividend per share                            |  |                                     |  
|US GAAP:                                      |  |                                      |  
|Net income                                    |  | 2,129                                |  
|                                              |  |                                      |  
|Earnings per share (10)                       |  | 17,080                               |  



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|                                 |  | As of December 31,                    
|-------------------------------- |  | --------------------------------------
|                                 |  | 1998                                  
|                                 |  | HK$                                   
|                                 |  | (in millions, except number of shares)
|Consolidated Balance Sheet Data: |  |                                       
|HK GAAP:                         |  |                                       
|Working capital(1)               |  | 8,663                                 
|Total assets                     |  | 31,945                                
|Long-term obligations(2)         |  |                                      
|Shareholders funds              |  | 30,253                                
|Issued and outstanding shares    |  | 166,200                               
|US GAAP:                         |  |                                       
|Total assets(3)                  |  | 33,398                                
|Long-term obligations(3)         |  | 951                                   
|Shareholders equity             |  | 30,021                                



|                                                         |  | Year Ended December 31,                                 |  
|-------------------------------------------------------- |  | ------------------------------------------------------- | -
|                                                         |  | 1998                                                    |  
|                                                         |  | HK$                                                     |  
|                                                         |  | (in millions, except ratios and railway operation data) |  
|Other Consolidated Financial Data:                       |  |                                                         |  
|HK GAAP:                                                 |  |                                                         |  
|Capital expenditures(4)                                  |  | 3,286                                                   |  
|Revenue per employee                                     |  | 0.987                                                   |  
|Total debt(2)                                            |  |                                                        |  
|Debt/equity ratio(2)                                     |  |                                                        |  
|Net cash inflow from operating activities(5)             |  | 1,977                                                   |  
|US GAAP:                                                 |  |                                                         |  
|Net cash provided by operating activities                |  | 2,553                                                   |  
|Railway Operation Data:                                  |  |                                                         |  
|Route kilometers (km):                                   |  |                                                         |  
|East Rail                                                |  | 34                                                      |  
|Light Rail                                               |  | 31.75                                                   |  
|Total number of passengers (in millions):                |  |                                                         |  
|East Rail(6)                                             |  | 269                                                     |  
|Light Rail                                               |  | 114                                                     |  
|Average fare revenue per passenger carried (HK$)         |  |                                                         |  
|East Rail(6)                                             |  | 10.74                                                   |  
|Light Rail                                               |  | 3.56                                                    |  
|Railway operating profit/(loss) per passenger carried(7) |  |                                                         |  
|East Rail(6)                                             |  | 4.49                                                    |  
|Light Rail                                               |  | (1.46                                                   | )

---

|(1) |  | 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 and accrual for capital expenditure.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Under HK GAAP, the long-term obligations include the interest-bearing borrowings, but not the commitments to making long-term lease payments arising from certain
leasing transactions as they are not recognized as obligations. See Note 42(h) to our audited consolidated financial statements. In June 2003, we launched a two-tranche HK$ retail bonds issue, including HK$300 million in principal amount of 3% notes
due 2008 and a HK$700 million in principal amount of 4.8% due 2013. We also issued HK$800 million in principal amount of 4.65% notes due 2013 under the US$3.0 billion Euro medium term note program.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





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|(3) |  | Total assets and long-term obligations in US GAAP are derived by adjusting the relevant items under Note 42 to our audited consolidated financial statements.
Long-term obligations in US GAAP include the interest-bearing borrowings and also the lease obligations of the lease out and lease back transactions. See Note 42(h) to our audited consolidated financial statements.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | The capital expenditure figure is presented on an accrual basis and a detailed breakdown of capital expenditures is depicted in the table on page 44.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Under HK GAAP, comparative figures in previous years have been restated as a result of the adoption of the newly revised Statement of Standard Accounting Practice
issued by the Hong Kong Society of Accountants (SSAP) 15 (Cash Flow Statement). See Note 4(d) to our audited consolidated financial statements.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) |  | Excluding through-train.
|--- |  | ------------------------

|(7) |  | The railway operating profit/(loss) per passenger carried is derived after depreciation and excluding net investment income. Retrospective adjustments to figures
from 1998 to 1999 have been made to include the cost of feeder bus in the operating costs of East Rail and Light Rail. Furthermore, fare revenue rather than total divisional revenue of both East Rail and Light Rail are used for calculating operating
profit/(loss) for consistency.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) |  | Solely for your convenience, we have translated certain Hong Kong dollar amounts into U.S. dollar amounts at the rate of HK$7.7988 = 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, 2002. The U.S. dollar amounts under Consolidated Income Statement Data and
Consolidated Balance Sheet Data are rounded to the nearest million.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(9) |  | Under HK GAAP, the prior period adjustments in 2001 are made as a result of the adoption of SSAP 34 (Employee Benefits) . See Note 4(a) to our audited consolidated
financial statements. Comparative figures before 2001 have not been restated because it is impractical to do so. Under US GAAP, the adoption of SSAP 34 with respect to the accrual of staffs annual leave and leave passage entitlements
represents a restatement for prior years. However, the amount of the restatement under US GAAP was not considered material to our results of operations or shareholders equity.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) |  | See Exhibit 6.1 for details of the computation of earnings per share information.
|---- |  | ---------------------------------------------------------------------------------



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 18, 2003, the noon buying rate for the Hong Kong dollar was HK$7.7989 = US$1.00.



|                       |  | Noon Buying Rate
|---------------------- |  | ----------------
|Year                   |  | Averagen (1)    
|1998                   |  | 7.7465          
|1999                   |  | 7.7599          
|2000                   |  | 7.7936          
|2001                   |  | 7.7996          
|2002                   |  | 7.7996          
|Months                 |  |                 
|2002                   |  |                 
|November               |  |                 
|December               |  |                 
|2003                   |  |                 
|January                |  |                 
|February               |  |                 
|March                  |  |                 
|April                  |  |                 
|May                    |  |                 
|June (through June 18) |  |                 

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





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RISK FACTORS



Because we are owned by the Government and substantially all of 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 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, and therefore 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. We have not raised fares for a fifth year in a row due to poor economic conditions. The Governments announcement of a moratorium on land sales in
2002 will lead to delay of our property development projects. The outbreak of atypical pneumonia in Hong Kong that began in March 2003 has led to lower ridership both within Hong Kong and between Hong Kong and mainland China, which has also been
dealing with this public health crisis. The 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.



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 Shatin 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 Shatin 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, any of which could give rise to delays or cost overruns.



For example, our development plan for the Lok Ma Chau spur
line project has been suspended due to the refusal by the Director of Environmental Protection (DEP) to issue an environmental permit to us, and the subsequent decision by the appeal board not to overturn the decision of the DEP. As a
result of the appeal boards decision, we announced a revised tunnel and viaduct scheme for the Lok Ma Chau spur line in September 2001. On November 30, 2001, we submitted a new environmental impact assessment report to the DEP for the revised
scheme and it was approved with conditions. In March 2002, we submitted a formal application for an environmental permit which was subsequently issued by DEP in April 2002. To comply with the conditions stipulated in the environmental permit, we
have set up an environmental committee to monitor the implementation of the proposed mitigation measures as set out in the habitat creation and management plan and the environmental impact assessment study.



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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, the Shatin to Central Link and the Kowloon Southern Link will have the scope
initially awarded. For more details on the project plans for West Rail Phase I, the East Rail Extensions, the Kowloon Southern Link and the Shatin to Central Link, see Item 4. Information on the CorporationRail OperationsWest Rail
Phase I, East Rail Extensions, Kowloon Southern Link and Shatin to Central Link. Furthermore, the 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, change 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 operators of road and sea transport. The lower capital cost 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 recent policy decision to open up the 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 will intensify the competition from cross-boundary bus services. As our profit depends heavily on
cross-boundary passenger services, the increase in the market share of our competitors might adversely affect our revenue growth and profitability.



West Rail Phase I is expected to go into revenue service in September 2003. Facing severe competition from road transport and a sluggish economy, we might
not be able to set fare levels for West Rail Phase I which makes it profitable.



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



Although we are empowered by the KCRC
Ordinance (as defined below) 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.



5



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##### Index to Financial Statements

Accidents and natural disasters could prevent operation 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, derailment and natural disasters, such as typhoons or floods. Natural disasters could interrupt our rail services leading to decreased revenues, increased
maintenance and higher engineering costs. Accidents could interrupt our rail services, subject us to increased liabilities or bring about pressure for greater regulation of our services. Although we have acquired insurance that is consistent with
industry practice against such risks, our insurance may not be sufficient to cover our losses or the losses of others, and the insurance may not continue to be available to us on a commercially reasonable basis.



We are regulated by the Government, which could modify the scope of our activities or
impose obligations on us or our customers, such as the proposed boundary facilities improvement tax, 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. The Government has
recently indicated its intention to implement a boundary facilities improvement tax in April 2004, which will increase the cost of crossing the boundary from Hong Kong to mainland China for our East Rail passengers. This may have a negative impact
on our cross-boundary ridership.



Since we are developing additional
large-scale infrastructure projects, such as the Kowloon Southern Link and the Shatin to Central Link, in parallel with the existing projects in West Rail Phase I and the East Rail Extensions, although not anticipated, we may encounter a shortage of
technical staff which could reduce our ability to complete the projects in a timely manner or increase the costs of the projects.



According to the current proposals for the Kowloon Southern Link and the Shatin to Central Link, it is expected that construction for the projects will
begin in 2004 following detailed environmental impact studies and design processes. Construction of the two projects 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 is largely limited to our employees and those of the MTR Corporation
Limited (the 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.



6



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##### Index to Financial Statements

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



We are currently in construction phase for a number of large-scale infrastructure projects, such as West Rail Phase I and the East Rail Extensions. In addition, we will start incurring material capital expenditures in
connection with the two new projects, the Kowloon Southern Link and the Shatin to Central Link, the total project cost of which is currently estimated to be at HK$10.3 billion and HK$33.2 billion, respectively, beginning in 2004, when construction
is expected to begin for both projects. The details on the capital expenditures related to the Kowloon Southern Link and the Shatin to Central Link are not final and even after the completion of the project agreements will be subject to change. 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 the Shatin to
Central Link. Given the fixed cost nature of our operations, we have in the past incurred, and may in the future incur, operating losses if our revenues do not adequately offset our capital expenditures. Our actual expenditures in connection with
the projects may exceed our planned expenditures due to a number of factors, including the following:



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



|· |  | 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 the inability to achieve projected revenues and limit the growth of our operations. For detailed discussion relating to our
capital commitments and resources for capital expenditures, see Item 5. Operating and Financial Review and ProspectsLiquidity and Capital Resources.



Because we are undertaking significant U.S. dollar denominated capital expenditures 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 expenditures, 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 of our revenues are denominated in Hong Kong dollars, any devaluation of the Hong Kong dollar may increase capital costs and related depreciation cost and increase Hong Kong dollar interest expense
on indebtedness in U.S. dollars, reducing our operating and net income, and may make 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.



7



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##### Index to Financial Statements

If the concept of a merger between us and MTRCL which has been publicly discussed by Government officials who have
proposed a feasibility study is implemented, its effects on our business, operations, financial results and financing capabilities are highly uncertain.



On June 25, 2002, the Government indicated that it was considering the possibility of a merger between us and the MTRCL.
Since details of the merger proposal are not available, 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.



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



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
northern-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 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 (the Secretary for Transport at the time of amendment) may authorize us to construct. The amendment in December 2001 provided for the separation of the functions and
duties of the Chairman from those of the Chief Executive Officer by creating the office of Chief Executive Officer. The Chief Executive Officer was also appointed as a member of the Managing Board.



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



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##### Index to Financial Statements

BUSINESS DEVELOPMENT



We are in the process of significantly expanding our rail operations by adding West Rail Phase I and the extensions of our East Rail line. We won the
Governments bid to build and operate the Shatin to Central Link, a 18 km long new railway line which includes the fourth rail harbor crossing. The Government also invited us to plan, build and operate the Kowloon Southern Link. We expect to
continue to devote a large percentage of our efforts in the next seven years to expand our rail network and monitor project development. We also expect to substantially expand our borrowings to meet part of the project costs in connection with the
construction of the Shatin to Central Link and the 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. As West Rail Phase I is not expected to commence operation until late 2003, the
three East Rail Extensions projects, TST Extension, Ma On Shan Rail and Lok Ma Chau spur line, until 2004, 2005 and 2007 respectively, the Kowloon Southern Link and the Shatin to Central Link until after 2008, the principal effects of these changes
should not occur until 2004. We expect that the new railway projects would have significant impact on our liquidity, capital expenditures and financing requirement in the next seven years.



CAPITAL EXPENDITURES



We had HK$12,308 million (US$1,578.2 million) in capital expenditure in 2002, of which HK$10,855 million (US$1,391.9
million) was incurred for the construction of West Rail Phase I and East Rail Extensions. This included expenditures 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$72 million (US$9.2 million) was spent on the study of new railway projects, including the Kowloon Southern Link, Shatin to Central Link, Port Rail Line and a freight distribution center in mainland China. The remainder was
spent on investments to increase passenger growth in the existing businesses and safety and environmental improvements. We financed our capital expenditures in 2002 by the equity injections from the Government, the export credit loan facilities with
the Japan Bank for International Cooperation and the Export Development Canada, issue of long-term bonds in 1999 and 2000, and surplus cash from operations.



Our capital expenditures for 2000 and 2001 were HK$10,829 million (US$1,388.5 million) and HK$14,595 million (US$1,871.4 million) respectively, which were
principally invested in West Rail Phase I, East Rail Extensions, refurbishment of existing rolling stock, purchase of new rolling stock and installation of the automatic train protection system. The capital expenditures in 2000 and 2001 were
principally financed by the equity injections of the Government, the export credit loan facilities with the Japan Bank for International Cooperation and the Export Development Canada, and surplus cash from operations.



Our capital expenditures for 2003 estimated at HK$14,868 million (US$1,906.4
million) include HK$6,691 million (US$858.0 million) for West Rail Phase I, HK$5,634 million (US$722.4 million) for East Rail Extensions, HK$118 million (US$15.1 million) for new East Rail rolling stock and HK$600 million (US$76.9 million) for Light
Rail expansion and safety works. Since the construction of the Kowloon Southern Link and the Shatin to Central Link is not expected to begin until 2004, we will not incur significant capital expenditures for the projects until then.



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##### Index to Financial Statements

BUSINESS OVERVIEW



We operate a commuter railway linking the suburban areas of Hong Kong with the urban areas. Our main line is the 34-kilometer East Rail line. It
comprises a total of 13 stations from Hung Hom, the main terminus in urban Kowloon, to Lo Wu, the terminus on the boundary with the mainland China. This line carries about 811,000 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. East Rail also operates intercity passenger services to Guangzhou on its own train and provides access for other intercity passenger trains running to and from 13 cities in mainland China,
including Dongguan, Guangzhou, Beijing and Shanghai. Our Light Rail system serves the north-west New Territories, by linking up the townships of Tuen Mun, Yuen Long and Tin Shui Wai. The system principally comprises tram-like vehicles which carry
about 313,000 passenger-trips a day. We also carry cargo, primarily textiles, foodstuff, metal, paper, chemicals and livestock on East Rail, and have feeder buses in our Light Rail network area as well as to and from East Rail stations.



In 2002, our railway network carried a total of 410 million passengers, or
an average of 1.1 million passengers per day, an increase of 0.2% over 2001. We supplement our railway revenues with revenues from property development, ownership and management, and commercial activities ancillary to our railway business, such as
pay phones and mobile phone transceivers.



Since we are
wholly-owned by the Government, our motivations 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 and equipment, service and repay debt and earn a reasonable rate of return for the Government.



We have five core operating divisions: East Rail, Light Rail,
Bus, Freight and Property. In addition, the West Rail, East Rail Extensions and New Railway Projects divisions are responsible for the planning and development of the West Rail Phase I, the East Rail Extensions, the Kowloon Southern Link, the Shatin
to Central Link and new projects respectively. The following table sets out the revenue and operating profit/(loss) after depreciation and before net investment income and tax for each of our five operating divisions for the periods indicated:



|                     |  | Year Ended December 31, | 
|-------------------- |  | ----------------------- | 
|                     |  | 2000                    | 
|                     |  | Revenues                | 
|                     |  | HK$                     | 
|                     |  | (in millions)           | 
|East Rail            |  | 3,438                   | 
|Light Rail           |  | 440                     | 
|Bus                  |  | 112                     | 
|Property Services(1) |  | 642                     | 
|Freight              |  | 99                      | 
|                     |  |                         | 
|Total                |  | 4,731                   | 
|                     |  |                         | 

---

|(1) |  | Including recurrent commercial, property ownership and management revenues from the Property division such as leasing, rental, advertising and estate management, but
excludes property development income.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | The prior period adjustments in 2001 are made as a result of the adoption of SSAP 34 (Employee Benefits) (see Note 4(a) of our audited consolidated financial
statements for the year ended 31 December 2002). Comparative figures before 2001 have not been restated because it is impractical to do so.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





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##### Index to Financial Statements

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 13 cities in mainland China, including Dongguan, Guangzhou, Shanghai
and Beijing. In October 1998, we commenced construction of West Rail Phase I, which will link the north-western New Territories to the Kowloon urban area. Two of the three East Rail Extensions projects, the Ma On Shan Rail and the TST Extension were
authorized by the Government in October 2000. The third East Rail Extension, 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 Shatin 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 design of the Kowloon Southern Link, which will join West Rail with East Rail
at Tsim Sha Tsui.



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 electric multiple unit trains of 12 car lengths. East Rail operates 37 12-car trains. With an average daily service of 540 trains per day in 2002, our performance indicators such
as punctuality rate of 99.7% and ticketing equipment availability rate of 99.9% in 2002 all exceeded our internal performance targets and published performance pledges.



In 2002, our East Rail operations accounted for 73.9% of the total revenue of KCRC and 86.1% of our operating profit before
net investment income (excluding profit on property development) of KCRC. Domestic passenger ridership decreased from 205 million in 2001 to 204 million in 2002 but cross-boundary passenger ridership increased from 87 million in 2001 to 92 million
in 2002. For 2002, total passengers carried increased 1.4% to 296 million as compared to 292 million in 2001. Peak days for cross-boundary ridership are very often associated with leisure trips. The observed ridership during weekends (excluding
public holidays) was on average 13% higher than the annual daily average of 251,600 in 2002.



The East Rail division is responsible for operating local, as well as cross-boundary, passenger services between Kowloon and Lo Wu. Our East Rail also operates through-train services to Guangzhou on our double deck
Ktt train and provides access for other intercity trains running to and from 13 cities in mainland China, including Dongguan, Guangzhou, Beijing and Shanghai. Through-train services allow passengers to go through customs and immigration
processing of Hong Kong prior to boarding rather than de-boarding or interchange at the boundary between Hong Kong and mainland China. Seven trains run between Kowloon and Guangdong in each direction per day of which two are our Ktt
train. Guangzhou Railway (Group) Corporation and other railway operators in its group operate the other five trains. To meet the increased demand experienced in 2001 and 2002, we plan to launch an additional pair of through-trains in 2003. These
trains will extend our service hours to the late afternoon so that passengers can enjoy more flexibility traveling to and from Guangzhou.



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. On October 21, 2001, journey times for Beijing and Shanghai through-trains were reduced to 27 hours and 24 hours from 28
hours after the tracks were upgraded. A new destination, Shijiazhuang, was added to the Beijing-Kowloon through-train route, and it has been in service since November 1, 2001.



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##### Index to Financial Statements

On June 28, 2001, we launched the Dongguan holiday through-train which runs in the evening from Friday to
Sunday and on public holidays. Due to the strong demand for through-train services to Dongguan, the service has been expanded commencing on January 2, 2003 to operate from Tuesdays to Sundays and on public holidays in Hong Kong and mainland China.



We engage in joint ticketing service 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. In the second half of 2003, the ticketing system will be enhanced to allow for real-time access
by KCRC and our counterparts in mainland China so that a common seat inventory may be maintained for through-train ticket sales.



To improve operations, we upgraded the existing automatic train protection system to a more sophisticated Automatic Train Operation (ATO)
System in December 2002. This fully automated signaling system will improve the reliability of East Rails operations and provide 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 for the expected growth of morning peak hour southbound passengers using the East Rail upon completion of the new Ma On Shan Rail in late 2004 and make
future system upgrades easier to implement. We brought eight new 12-car trains into service by the end of May 2002. The additional rolling stock has increased our carrying capacity by 28%.



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. By the end of 2002, we had completed noise barriers at 20 sites along the East Rail alignment. The planning of two more sites, namely Wo Liu Hang in Fo Tan
and Sheung Shui station, is in progress.



In the past
few years, we carried out a number of station improvement projects to increase the floor areas, construct new entrances and install/upgrade the facilities at 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 underground concourse at the Kowloon Tong station as well as a new 60-metre subway link to the existing MTR station began in 2001, and the
improvement project is expected to be completed by the end of 2003.



As a further improvement, we have placed orders for more user-friendly multi-ticket touch-screen machines to replace the existing ticket vending machines. These new machines are expected to enhance both the reliability and transaction
process of our automatic revenue collection system, and thus increase our customer satisfaction. The installation of the new ticket vending machines is expected to be completed by the end of 2003. New facilities have also been installed to cater for
the needs of our disabled passengers. We have introduced special voice announcement features and added in-train Braille signs for the visually impaired, and flap gates for wheelchair users.



Since a large portion of the cross-boundary passengers carry bulky luggage,
we plan to replace all the existing tripod turnstiles type ticket gates at Lo Wu Station with flap gates by the end of 2003. Upon the completion of the ticket gates replacement works, we expect the ticket gate throughput to increase by
50%.



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 because heavy smoke will hinder effective rescue and fire fighting. As part of the safety improvement plan for East Rail, we
have budgeted a 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 power supply, provision of fire detection system, diversion of existing services and
associated civil construction work. It is expected that upon the completion of the project in 2005, we would have fast and accurate detection of fires, thus preventing severe fatalities and enabling quick responses to incidents as well as a
smoke-free environment for passenger evacuation and fire fighting.



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##### Index to Financial Statements

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 that the number of travelers visiting Hong Kong from mainland China will increase dramatically in the long term and, as a result, the Lo Wu terminal will experience an unprecedented upsurge in
passenger flow. To alleviate the existing passenger congestion and also the expected increase in passenger demand, customs and immigration authorities on the Shenzhen side of the boundary have already completed the necessary improvements to increase
their exit processing capacity from 16,000 to 24,000 passengers per hour in 2002. On the Hong Kong side, the Government has also decided to increase the number of immigration counters in Lo Wu terminal. Accordingly, we commenced a new improvement
project at Lo Wu terminal in early 2002 to remodel the existing station operations by widening the passageways and waiting areas in the station concourse, improving public amenities, building a new train platform, and upgrading another three
existing platforms to free up passenger flows by segregating northbound and southbound passengers. With the expected completion of this project in 2004, the improved terminal facilities will not only enhance the quality of travel for our local and
foreign travelers, but also accommodate the expected increase in passenger demand.



As of December 31, 2002, East Rail has maintained a market share of more than 50% of the domestic passenger market for travel between the north-eastern New Territories and urban Kowloon. Our market share dropped from
51.2% in 2001 to approximately 50.1% in 2002. For the cross-boundary market, East Rails market share dropped from 76.8% in 2001 to approximately 74.5% in 2002. While East Rail faces competition from bus routes operating parallel to the
railway, 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.



The Financial Secretary of Hong Kong announced in March 1999 that the Government will implement a boundary facilities
improvement tax for boundary crossings by land from Hong Kong to mainland China, similar to the departure tax currently imposed on departures by air or sea. The Government has recently indicated its intention to implement this tax in April 2004 at
an assumed tax level of HK$18. Since a boundary facilities improvement tax will increase the cost of crossing the boundary from Hong Kong to mainland China for our East Rail passengers, it may have a negative impact on our ridership. However, the
degree of impact will depend on the actual level of the tax.



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.



In 2002 the daily patronage of through-trains was 6,290
passengers, an increase of 8% compared to 2001. The number of passengers traveling to mainland China on through-trains has been rising in 2001 and 2002. The number of passengers travelling to Lo Wu, and onward to mainland China by other means of
transport, has increased by 6.3% in 2002 compared to 2001. We are able to charge a premium fare on passengers travelling 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. We believe this combination of increased traffic and ability to charge a premium fare for travel to Lo Wu has resulted in revenue growth on East Rail of 2.4% in 2002 compared to 2001 despite the
sluggish economy in Hong Kong.



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##### Index to Financial Statements

The Government extended the boundary opening hours of the Lo Wu boundary crossing by 30 minutes effective
December 1, 2001. Although these interim measures have alleviated some of the congestion at Lo Wu terminal and helped us recapture market share, long-term relief (particularly during weekends and public holidays) will not occur until the Lok Ma Chau
spur line opens, which we expect will be in 2007 at the earliest. On January 27, 2003, the Government extended the boundary opening hours of the Lok Ma Chau-Huanggang boundary crossing to 24 hours. This will likely intensify the competition from
cross-boundary bus services, which may result in East Rail having a lower rate of annual growth for 2003 and beyond than the rates for 1998 to 2002 as set forth below.



|     |  | Cross-Boundary LoWu Ridership
|---- |  | -----------------------------
|     |  | DailyAveragePassengertrips   
|1998 |  | 178,802                      
|1999 |  | 206,481                      
|2000 |  | 229,120                      
|2001 |  | 236,800                      
|2002 |  | 251,600                      



West Rail Phase
I



In January 1995, the Government invited us to
submit a proposal to design, construct, finance and operate West Rail. West Rail is designed to resolve the long-standing transport problems for residents in the north-western New Territories by providing a direct link with urban Kowloon. The
population of the north-western New Territories is projected by the Government to grow from approximately 830,000 in 1996 to 1,430,000 in 2011. In response, we submitted a detailed feasibility study to the Government in November 1995. In December
1996, the Government announced that the West Rail route proposed by us should be adopted and that the proposal should be implemented in two phases. Phase I, which comprises 30.5 kilometers of domestic passenger line linking west Kowloon with Tuen
Mun in the western New Territories, will be built first. Phase I may be followed at a later date by Phase II, which would connect West Rail Phase I from Kam Tin to Lok Ma Chau, Sheung Shui and Lo Wu, and to provide the cross-boundary passenger and
freight services with west Kowloon. Phase II may be replaced by 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.



We signed the project agreement for West
Rail Phase I with the Government in October 1998. This agreement provided the basis for the project to progress from the technical study stage to the detailed design and construction stages, and the system is expected to commence operations in
September 2003. This agreement further provides that the source of financing for West Rail Phase I would comprise equity contribution from the Government of HK$29 billion, our internal funds to be accrued from property development profits in respect
of East Rail and Light Rail property developments, and commercial financing for the balance of the total project cost.



Based on the prices of contracts so far awarded, tender prices known to date and current estimates of land acquisition costs, the projected total project
cost as of December 2002 for West Rail Phase I is HK$46.4 billion. Contracts we have awarded and tendered as of December 31, 2002 represent approximately 96% of the total revised estimated construction costs of approximately HK$39.8 billion, which
excludes estimated land acquisition and financing costs of HK$6.0 billion and HK$0.6 billion, respectively.



We believe that our tendering and contract procurement procedures for West Rail Phase I follow fair, open and competitive tendering practices that mirror
those of the Government and conform with the World Trade Organizations Agreement on Government Procurement. Our contracts for West Rail Phase I can be separated into two main categories, civil construction contracts and operating systems
contracts. The civil construction contracts include two design/build contracts covering the tunnel sections and 18 construction-only contracts relating to the remainder of the line segments, railway stations, office building and the depot. There are
approximately 34 major contracts for the design, supply and installation, testing and commissioning of railway operation systems, including signaling, traction power, telecommunications, control systems, automatic revenue collection, platform screen
doors, permanent way, escalators, lifts, rolling stock, tunnel ventilation, signs and advertising facilities, spares, equipment and plants. The last three of such contracts for systems and plants will be awarded in 2003.



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##### Index to Financial Statements

In 2002, the Managing Board commissioned a review of payments to contractors for the West Rail Phase I,
which addressed, among other things, the Corporations tender evaluation, and contractual performance and monitoring systems with particular focus on three contracts. The review was undertaken by the international firm of accountants, Ernst
& Young. Ernst & Young established that while there were some areas where improvement could be made in respect of the Corporations monitoring and management procedures, the detailed systems for management of the West Rail Phase I
appeared to be of a high standard and reflected current industry norms and practice. The Managing Board has adopted the recommendations proposed by Ernst & Young.



West Rail Phase I and the East Rail Extensions are designed to be compatible with each other to facilitate future linkage of
West Rail with 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, the signaling
systems are different and some modification would have to be made for the two rail lines to be completely compatible.



In preparation for West Rail Phase Is opening, we have set up an Operational Readiness Steering Committee, chaired by the Chief
Executive Officer, and an Operational Readiness Working Group, co-chaired by the Director of West Rail and Director of Light Rail. The Working Group liaises with relevant government agencies and other internal and external bodies to oversee
activities that are not part of the project works but are necessary for successful start-up operation. These include the commissioning of public transport interchanges, staff recruitment and training, as well as public relations and marketing.



At the end of 2002, West Rail Phase I was 90% completed. The
civil engineering works were substantially finished. Among the many milestones we achieved during the year were the completion of structural work for all nine stations, the energisation of the first section of overhead line, and the occupation of
the West Rail Building and Pat Heung Maintenance Centre. With the end of the project in sight, in early 2002, we began the process of redeploying, recruiting and training the staff needed to operate and maintain the railway. Some staff have been
acquired through redeploying existing manpower from East Rail division and Light Rail division, and others through external recruitment.



The new trains required for West Rail Phase I started arriving in Hong Kong in April 2002. These 40-tonne, 25-metre long electrical multiple units
(EMUs) then underwent static and high-speed dynamic tests. A total of 154 EMUs will eventually be delivered to form 22 sets of 7-car trains for West Rail Phase I.



West Rail Phase I will be entering the final phase in 2003. Before going into revenue service, we will be carrying out
testing, commissioning of pre-revenue trial operations and additional staff recruitment and training. We will also step up public education, publicity and marketing activities so passengers become familiar with all aspects of the system.
Consultations will be held with the travelling public, as Light Rail and bus services will be restructured to tie in with the commissioning of the West Rail Phase I. We are on schedule for a targeted opening in September 2003.



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##### Index to Financial Statements

East Rail Extensions



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 Tsim Sha Tsui (the TST
Extension). This submission was followed by the Governments invitation to undertake detailed design with a view to completing the TST Extension and the Ma On Shan Rail in 2004. The Ma On Shan Rail will extend the East Rail from Tai Wai
to Ma On Shan, with stations along 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 Shatin 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 the TST Extension are viewed as a
combined project, in part, because the TST Extension will become critical as an alternative interchange into the Mass Transit Railway of the 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
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$22.6 billion will be construction costs, HK$1.6 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 construction of Ma On Shan Rail and TST Extension was received. We expect to complete the
construction of the TST Extension and the Ma On Shan Rail and bring them into operation by 2004 and 2005 respectively.



As at December 31, 2002, 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 Tai Wai Maintenance Centre. 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 at December 31, 2002, 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 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
depot. We would expect that third party developers would fund the costs of property developments, which are expected to comprise primarily residential developments.We would not expect any property development rights to generate any profits
until some time in 2008. We and the Government have agreed in principle that any property development profits from these sites in excess of a specified amount would generally be distributed to the Government as extraordinary dividends.



Both projects are on target for completion in 2004. As at March 31, 2003,
99% of the 8.2 kilometer Ma On Shan Rail viaduct has been erected, and the concrete structures for four out of nine stations were completed, and the 6.5-hectare Tai Wai Maintenance Center, which comprises an administration building and a main depot
building, was 91% complete. As at March 31, 2003, the modification of Hung Hom station to accommodate the new TST Extension has been completed, and the railway tunnel which runs from Hung Hom station along Salisbury Road to the new station in East
Tsim Sha Tsui was over 98% complete.



16



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##### Index to Financial Statements

To relieve the pressure on the Lo Wu station at the boundary with mainland China, where 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 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 DEP
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 the Corporation
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. From Chau Tau, the railway will rise gradually onto a viaduct and end at Lok Ma Chau Terminus. The spur line is targeted for opening by mid-2007. The project will be funded by internal resources at a cost of
approximately HK$10 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. All contract awards were the results of an open tendering process, which is in line with the World Trade
Organizations Agreement on Government Procurement. It is expected that the remaining civil construction contracts for the improvement works at Sheung Shui station will be awarded in mid 2003.



We signed the project agreement for the East Rail Extensions in February
2003. The project agreement provided for the financing, design, construction and operations of the East Rail Extensions and related services and facilities.



Light Rail Services



Our Light Rail system commenced operation in September 1988 and comprises 31.75 kilometers of double track with 57 stops. It is a regional mass
transit system utilizing vehicles which are similar to trams on tracks which run parallel to public roads. In 2002, 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 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 17 bus routes
including feeder bus routes, auxiliary routes and special bus routes linking various districts as at December 31, 2002. The five auxiliary routes are bus routes that supplement the Light Rail and to which the integrated fare system is not
applicable. The two special bus routes are stand-alone routes which charge a separate fare and to which the integrated fare system is not applicable. As of December 31, 2002, the Light Rail system had 119 light rail vehicles. The Light Rail vehicles
carried an average of 313,600 passenger-trips a day in 2002. The Light Rail division accounted for 8.7% of total revenue of KCRC and had an operating loss in 2002.



Light Rail has operated at a loss since the commencement of operations in 1988. The two principal factors contributing to
lower than expected ridership are slower population growth in the north-western New Territories than originally projected by the Government (and therefore lower than expected passenger ridership) and the partial relaxation of KCRCs mass
transit monopoly in the Light Rail operations area from 1993, when the Government removed the boarding and alighting restrictions on franchised bus operators for internal trips in the area. Light Rail also faces competition from other modes of
transport such as minibuses and taxis.



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##### Index to Financial Statements

In 2002 Light Rail continued to face increased competition from other modes of transport in the
north-western New Territories. As a result of this and the sluggish economy, revenue was down by 3.5% to HK$418 million. Despite these challenges, Light Rail was able to maintain a strong market position. It captured a 62.1% share of the
north-western New Territories public transport market in 2002, although this was down from 66.1% in 2001. The main reason for the decrease was that population growth for the region was largely in Tin Shui Wai North, where travel was largely by
public buses (including KCRC buses). The decrease in Light Rails market share was mostly offset by the increase in market share taken by Light Rail feeder buses in the north-western New Territories, which grew from 9% in 2001 to 12.7% in 2002.
For 2002, we experienced a 1.8% decrease in passengers carried on the Light Rail from 2001.



In 2002, the enhancement work of the platform announcement system significantly improved the clarity and quality of the announcements. Other service enhancements in the year included upgrading the existing in-train
announcement system to enable Light Rail route numbers to be broadcast inside train compartments, replacement of destination display panels with electronic display panels on all Light Rail vehicles and the installation of over 200 directional signs
near Light Rail stops.



In 2002, we continued on a HK$2.3
billion project that will enable Light Rail to integrate efficiently with West Rail Phase I when it opens for service in 2003. The project includes a 1.7-kilometre extension to Tin Shui Wai New 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. All construction contracts relating to this project have been awarded in early 2001. At
the end of 2002, about 80% of the works of the Tin Shui Wai extension have been completed. The grade separation at Pui To Road is about 70% completed, and grade separation at Tsing Lun Road is about 10% completed. The construction work was all
completed on time and within budget. Integration of the two railway networks directly linking the north-western New Territories to the Kowloon urban area is expected to enhance the competitiveness of Light Rail over other modes of transport in the
region, and, we believe, will constitute a key factor in improving the profitability of the Light Rail operations in the medium to long term.



With the commissioning of West Rail targeted in September 2003, we began the process of reconfiguring 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 a first-class feeder service to West Rail and, at the same time, maintain Light Rails role as the
major transport service provider in the north-western New Territories. We focus our restructuring to:



|· |  | accommodate the changes in travel patterns after the opening of West Rail Phase I and the completion of the new Tin Shui Wai Light Rail Extensions,
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

|
|

|· |  | introduce routings made possible by the grade separation works in Tuen Mun,
|- |  | ---------------------------------------------------------------------------

|
|

|· |  | minimize wasteful duplication of resources, and
|- |  | -----------------------------------------------

|
|

|· |  | encourage use of West Rail Phase I for internal and external journeys.
|- |  | ----------------------------------------------------------------------



A public consultation exercise for the service restructuring commenced towards the end of 2002 and will continue in 2003 to obtain public feedback. Our
bus services operating in the north-western New Territories will be similarly restructured.



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##### Index to Financial Statements

Shatin 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 Shatin to Central (the Shatin to Central Link). The MTRCL submitted a competing bid for the same project.



On June 25, 2002, the Government announced that we had won the bid to build and operate the Shatin to Central Link. In our bid proposal, the Shatin to
Central Link 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. Once completed, this new line will extend the KCRC network to Hong Kong Island for the first time. 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 Shatin to Central
Link, East Rail and West Rail.



In August 2002, the Managing
Board decided to construct an additional station at Tsz Wan Shan and to build a 1.6 km people-mover system connecting the Whampoa area to the Shatin to Central Link in response to a request from the Government. This 18-kilometer new line will have
11 stations, a rail harbor crossing and a maintenance depot at Kai Tak. Passengers will be able to interchange with the MTR network at Diamond Hill, Exhibition and Admiralty stations.



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$33.2 billion, we expect that HK$29.3 billion will be construction costs, HK$0.9 billion will be land acquisition costs and HK$3.0 billion will be financing costs. While the details on the capital
expenditures related to the Shatin to Central Link are still being reviewed and are subject to change, we expect to finance the project from internal resources and new debt.



For the detailed planning and design, we have assembled a core project team of engineers, planners, surveyors and architects
with extensive experience in building new railway lines. This team will receive support from professionals with expertise in environmental issues, land acquisition, safety and quality control. In 2002, we began preliminary site investigations,
topographical survey and environmental impact assessment studies. We initiated in 2003 schematic design consultancies in preparation for awarding design and construction contracts.



In the next few months, we will develop this new rail project with the
Government and expect to finalize the design by 2003. Subject to final agreement with the Government, construction is expected to begin in 2004 following completion of detailed environmental impact assessment studies and design processes. 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 2009.



Kowloon Southern Link



The Government invited us to submit a proposal to plan, build, operate and
finance the Kowloon Southern Link. We submitted a proposal for the Kowloon Southern Link to the Government in July 2001. On 24 September 2002, the Government invited us to design, build and operate the 3.7 kilometers Kowloon Southern Link, which is
planned for completion in 2008.



The Kowloon Southern Link will
run from Nam Cheong station, the southern terminus of West Rail, to Tsim Sha Tsui East station on East Rail, 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



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##### Index to Financial Statements

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$10.3 billion, we expect that HK$8.9 billion will be construction costs, HK$0.8 billion will be land acquisition costs and HK$0.6 billion will be financing costs. While the
details on the capital expenditures 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 have already begun preliminary site investigations, topographical surveys
and environmental impact assessment studies. We initiated in December 2002 schematic design in preparation for awarding design and construction contracts.



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 mid 2004 after the issue of an environment permit by the Environmental Protection Department and an approval by the Executive Council of Hong
Kong.



Bus Services



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 at December 31, 2002, we operated 17 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. Our bus operations accounted for 2.9% of our total revenue and 0.3% of our operating profit before net investment income (excluding profit on property development).



In 2002, we enhanced our bus services in Tin Shui Wai North to meet higher
demand resulting from population growth in this area. We also built four more bus shelters to improve the waiting environment for passengers. In preparation for West Rails opening, we began the process of reconfiguring the bus services in the
north-western New Territories to provide feeder bus service to West Rail.



We are not entitled to charge fares on our feeder bus services for 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 some of our feeder bus routes to Tai Po, Shatin 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 East Rail and, by indirectly benefiting from fuel tax concessions given to franchised bus operators such as Kowloon Motor Bus, to reduce costs.



The number of passenger trips on our buses, excluding the seven feeder routes for East Rail run by Kowloon Motor Bus, was
25.8 million, or a daily average of 71,450 in 2002. This represented an increase of 23.6% over 2001. Of these trips, 23.8 million were made on Light Rail feeder routes, an increase of 29.6% over 2001, and 2.0 million were on residential and express
routes, a decrease of 20.0% from 2001. As a result of the substantial increase in bus patronage, the market share of our buses in the north-western New Territories increased from 9.0% in 2001 to 12.7% in 2002. During the year bus revenue grew by
6.9% to HK$140 million, an increase of HK$9 million when compared with 2001.



Freight Services



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



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##### Index to Financial Statements

| | (1) |  | livestock;
| | --- |  | ----------



| | (2) |  | breakbulk, which comprises mainly textile fibers, foodstuffs, metals, paper and chemicals; and
| | --- |  | ----------------------------------------------------------------------------------------------



| | (3) |  | containers.
| | --- |  | -----------



The Freight Department now operates container services to a total of 45 cities and breakbulk services to a total of 58 cities in mainland China. We have set up 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. The Freight Department accounted for 1.8% of total revenue of KCRC and had an operating
loss in 2002.



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 potential competitors to Hong Kong transshipment services if Chinese exporters choose to export through these ports as they offer lower terminal
handling charges than Hong Kong. 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 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. Chinas Ministry of Railways has designated container shuttle services as a priority service for railways within mainland China. Furthermore, the Chinese government has in recent years targeted its economic development
plans for the interior provinces such as Sichuan and Kunming. We see opportunities to grow our container freight services to the Pearl River Delta and the interior provinces of mainland China.



To improve efficiency, financial control and customer service, the Freight
Department continues to integrate all of its electronic freight business systems and enhance its financial control and invoicing systems. Completion of the integration of the electronic freight business systems is expected by the end of 2003. We
have adopted Tradelink, Hong Kongs electronic data interchange system for trade documentation, and worked with Hong Kongs Customs & Excise Department towards the development of an electronic trade manifest system for rail-borne
cargo.



A new container shuttle service between Hong Kong and
Dongguan was introduced in 2002 as a result of the joint planning efforts of the Guangzhou Railway (Group) Corporation, Guangshen Railway Co. Ltd., mainland customs units and KCRC.



In June 2002, the Freight Department signed a Memorandum of Understanding with Shenzhens Sungang Customs Unit, which
is responsible for clearance of cross-boundary freight conveyed by rail between Hong Kong and mainland China. This Memorandum of Understanding is intended to improve the speed and efficiency of inspection and clearance of rail-borne freight being
transported between Hong Kong and mainland China in both directions.



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##### Index to Financial Statements

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 increase. 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.



From 1998 to 2002, we did not increase the fares of our passenger transport
networks after careful consideration of many factors which included the maintenance of competitiveness with other mass transit providers, which in general did not increase fares, and the hardship our passengers were experiencing as a result of the
prevailing sluggish economic situation in Hong Kong.



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, | 
|--------------------------------------------------------------------------- |  | ----------------------- | 
|                                                                            |  | 1998                    | 
|Annual average passenger fare increase (%)                                  |  |                         | 
|East Rail(1)                                                                |  | 0.00                    | 
|Light Rail                                                                  |  | 0.00                    | 
|Increase/(decrease) in CPI(2)(%)                                            |  | 2.60                    | 
|Average fare revenues per passenger carried (HK$)                           |  |                         | 
|East Rail(1)                                                                |  | 10.74                   | 
|Light Rail                                                                  |  | 3.56                    | 
|Increase/ (decrease) in average operating costs(3)per passenger carried (%) |  |                         | 
|East Rail(1)                                                                |  | 8.76                    | 
|Light Rail                                                                  |  | 10.00                   | 

---

|(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 expenditures of
HK$4,500 to HK$18,499 in 1999/2000, broadly equivalent to HK$4,300 to HK$17,500 at 2002 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). Retrospective adjustments to
figures for 1998 to 1999 have been made to include the cost of feeder bus in the operating costs of East Rail and Light Rail.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|
|





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##### Index to Financial Statements

The introduction of 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 East Rail, the Octopus Smart Card is used by approximately 91% of our
passengers in 2002. 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 the 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 will have the greatest impact on future railway development are the higher population projections in the 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 outlines 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 Shatin to Central Link, see Item 4. Information on the CorporationRail OperationsShatin 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.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Two |  | additional railway lines under consideration by the Government will proceed at later dates:
|--- |  | -------------------------------------------------------------------------------------------



|· |  | The Northern Link, which would join 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 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, East Rail and West Rail will form a massive single loop serving the New Territories and Kowloon.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Index to Financial Statements

|· |  | 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 just over 1 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.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Government announced its population policy in February 2003 and is expected to release towards the latter part of this year 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 impact on future railway development.



Property Development and Services



Our Property division consists of two departments, the first dealing with property development along the railway lines, and the second with commercial
activities, including leasing 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 2002, the Property division accounted for 12.7% of total revenue of KCRC and 20.2% of operating profit before net investment income (excluding profit on property development) of KCRC.



Property Development



We develop property for three main reasons: first, 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 been
involved in joint ventures 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 our joint venture partners for each development based on their development experience, track record and the terms and conditions of each joint venture proposed. In the case of property developments along the existing railway
lines, developers will be invited to form joint ventures with us before any work commences. Developers generally fund the cash 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 the Ma On Shan Rail, we may, in certain circumstances, undertake the necessary property development enabling works in conjunction with the railway works in order to preserve
the development potential above the new railway lines. Developers will then be solicited as joint venture partners to undertake the property developments. Profits from the developments, with the exception of West Rail Phase I property sites, after
reimbursement of development costs, are shared between KCRC and the developers. In certain instances, the minimum profit to us has been guaranteed by the parent holding company of our joint venture partner. 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 our
joint venture partner, but with KCRC making the final decision with a casting vote. We retain control over the disposal of properties completed by the joint ventures, including decisions regarding whether to sell or lease the properties, the offer
price and sale price if we decide to sell, and the lease terms if we decide to lease the properties.



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##### Index to Financial Statements

Completed property developments along the East Rail and Light Rail include Pierhead Garden, Sun Yuen Long
Centre, Manlai Court, Hanford Garden, Sun Tuen Mun Centre, 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. Properties development at Hung Hom Bay in
Kowloon, the Metropolis, provides 132,218 square meters of commercial floor area, including office, hotel, retail area and serviced apartments. The first phase of the Metropolis, comprising an office tower, a retail podium and a hotel, was completed
and sold in 2002. The second phase of the Metropolis, comprising two serviced apartment blocks, was also completed and is now being put up for sale.



For West Rail Phase I, we have identified thirteen sites with potential for property development along nine stations. We expect to provide a total gross
floor area of about 2,200,000 square meters, 91% of which would be for residential use and the remainder for commercial use. Under our current tentative plans, these projects would supply a total of about 30,000 flats during the period from 2008 to
2015. As part of its agreement to inject HK$29.0 billion of additional equity into us to help fund West Rail Phase I, the Government is to receive the net profits from development of these projects, net of contingent expenses, development costs and
other benefits to KCRC 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. In 2000, KCRC and the
Government formed a joint venture company for KCRC to act as the Governments property development agent of the 13 West Rail Phase I property sites.



Along the Ma On Shan Rail alignment of the East Rail Extensions, four sites have been identified for property development and these sites together with a
site at Ho Tung Lau on East Rail, are expected to provide a total gross floor area of about 936,000 square meters, of which 97% would be residential. These five sites are expected to generate some HK$2.0 billion profit, contributing towards debt
repayment for the new project. The five sites together are expected to generate about 12,600 flats from 2008 to 2011. We have recently awarded the tender for the property development at Ho Tung Lau to a subsidiary of Sino Land Company Limited. We
plan to solicit joint venture partners to undertake the property projects at Tai Wai, Yuen Long and Nam Cheong in 2004 when the Governments land sales moratorium is expected to be lifted. This land sales moratorium was imposed by the
Government in November 2002, whereby property development tender invitations have been suspended pending Governments decision to lift the control measures.



Commercial Activities, Leasing and Property Management



We own an aggregate of 27,485 square meters of commercial office space at
Citylink Plaza at Shatin station and 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 Centre, Citylink Plaza, Plaza Ascot, Manlai Court, Hanford Plaza
and Pierhead Plaza.



We manage a total retail area of over
11,500 square meters at East Rail stations providing a wide variety of commercial services to passengers. We devote considerable efforts to the development of associated commercial activities and property management along the railway lines of the
East Rail and Light Rail network with a view to generating ancillary income. These include the operation of carparks, duty free business and advertising at stations, licensing and leasing of space for offices, retail shops, restaurants, vending
machines, payphones, mobile phone equipment, exhibitions and sales kiosks along railway networks. In some cases, we have negotiated arrangements with the tenants of the shops and restaurants, and the operator of the carparks, to provide us a share
of the income and to provide commercial services to the traveling public. In terms of estate management, as of December 31, 2002, we were managing 9,832 residential flats, 3,588 carparking spaces and 91,600 square meters of commercial floor area
along the railway lines of the East Rail and Light Rail network. In 2002, despite the downturn in the Hong Kong property market, the average occupancy rate for commercial premises at our stations, commercial offices and shopping centers was
approximately 93%.



25



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##### Index to Financial Statements

The commercial portfolio will be increased substantially for the new railways scheduled to be
commissioned in late 2003 to 2005, i.e. West Rail Phase I, Ma On Shan Rail and TST Extension. These include a total of around 400 retail units for shops and restaurants. The scope of advertising display is also expected to be enhanced by 12,000
units for stations and inside new trains.



In the year ahead,
we plan to introduce multimedia advertising on board all trains to provide value-added services to passengers and generate additional advertising income. The audio-video infotainment programmes and advertisements will be shown on LCD screens.



A new revenue source along the East Rail network is the launch
in January 2003 of 15 self-service electronic kiosks selling travel insurance products. Further initiatives are in progress to expand the revenue sources through redevelopment of commercial opportunities in our existing property portfolio and
operating shopping centers in developments of new railway lines.



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 Light Rail system, 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 from trucks, ferries 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



The Government announced in March 1999 that the MTRC, the other railway
operator in Hong Kong, will be partially privatized, and it did so in October 2000 in connection with a global offering of shares and American Depositary Receipts. The Government has indicated that it was considering the possibility of a merger
between KCRC and MTRCL.



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.



26



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##### Table of Contents

##### Index to Financial Statements

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 one dividend payment in 1997 of HK$300 million, representing 9.75% of our 1996 profit after taxation, and have declared a dividend in 2003 of HK$620 million,
representing 23.3% of our 2002 profit after taxation.



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



We also interface with the Government 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.



ORGANIZATIONAL STRUCTURE



The Corporation has the following subsidiaries:



|Subsidiary Name                                    |  | Country   |  | Proportion ofownership |  
|-------------------------------------------------- |  | --------- |  | ---------------------- | -
|Manlai 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                     | %
|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                    | %
|West Rail Property Development Limited(1)          |  | Hong Kong |  | 51                     | %



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##### Index to Financial Statements

|Subsidiary Name                                              |  | Country   |  | Proportion ofownership |  
|------------------------------------------------------------ |  | --------- |  | ---------------------- | -
|Subsidiaries of West Rail Property Development Limited       |  |           |  |                        |  
|Kam Sheung Property Development Limited(1)                   |  | Hong Kong |  | 51                     | %
|Kwai Fong Property Development Limited(1)                    |  | Hong Kong |  | 51                     | %
|Long Ping Property Development Limited(1)                    |  | Hong Kong |  | 51                     | %
|Long Ping South Property Development Limited(1),(2)          |  | 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),
(2) |  | Hong Kong |  | 51                     | %
|Tsuen Wan West TW6 Property Development Limited(1),
(2)      |  | Hong Kong |  | 51                     | %
|Tsuen Wan West TW7 Property Development Limited(1),
(2)      |  | Hong Kong |  | 51                     | %
|Tuen Mun Property Development Limited(1)                     |  | Hong Kong |  | 51                     | %
|Yuen Long Property Development Limited(1)                    |  | Hong Kong |  | 51                     | %

---

|(1) |  | These subsidiaries are held by the Corporation 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 the Corporation has no effective control over or beneficial interests in the net assets of, other than the amount of capital provided to, these subsidiaries.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | The subsidiaries were incorporated subsequent to December 31, 2002.
|--- |  | -------------------------------------------------------------------



PROPERTY, PLANTS 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 or pursuant to grants by the Government in accordance with the KCRC Ordinance. Such grants will expire in 2047 pursuant to the Sino-British
Joint Declaration between the Government of the United Kingdom and the Government of Peoples Republic of China. 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 use the land for railway operations and ancillary purposes necessary for our railway operations. We are not allowed to assign, lease or otherwise dispose of an interest in the land for a period greater than 3 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.



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##### Index to Financial Statements

ENVIRONMENTAL MATTERS



We believe that our existing operations are in substantial compliance with applicable 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 environmental impacts. Currently, the core functions within our East Rail division and all functions of our Light Rail division have been certified under
the ISO 14001 standard. For projects under development, we are required to comply with the statutory processes prescribed by the Government, including submission of an environmental impact assessment to the Environmental Protection Department and
satisfactory conclusion of a public consultation period. We are also required to comply with the requirements of the environmental permits as a result of our environmental impact assessments and applicable environmental regulations in our
construction activities.



We are committed to construct West
Rail Phase I, the East Rail Extensions, the Kowloon Southern Link and the Shatin to Central Link in an environmentally responsible manner. A comprehensive environmental management system has been implemented for the construction of West Rail Phase I
and 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 final report of the environmental impact assessment for West Rail Phase I
was endorsed by the Advisory Council on the Environment in March 1998. The design and construction of West Rail Phase I takes account of the aesthetic and landscaping aspects to ensure the alignment and structures are visually pleasing. Noise impact
of the railway operation has been addressed by an integrated design approach, which includes skirts on the train body to trap noise, a noise and vibration absorption viaduct structure, noise barriers, plus noise and vibration absorption rubber
supports for the tracks. We expect when West Rail Phase I comes into operation, it will be one of the quietest railways in the world.



During 2002, 12 hectares of wetlands were recreated near the West Rail Phase I alignment for rare species of bird, frogs and other creatures.
Hydro-seeding and tree-planting also took place underneath the railway viaduct after the completion of construction, both to meet the requirements of the environment permit and to ensure maximum environmental friendliness.



The Environmental Protection Department approved the environmental impact
assessment for the Ma On Shan Rail and the TST Extension, and granted the respective environmental permits in January and May 2000, respectively.



The Environmental Protection Department approved the environmental impact assessment for the Lok Ma Chau spur line project with conditions in March 2002,
and granted an environmental permit in April 2002. We set up an Environmental Committee to monitor the implementation of proposed mitigation measures as set out in the habitat creation and management plan and the environmental impact assessment
study to meet the conditions of the environmental permit for the Lok Ma Chau spur line. This committee is chaired by the Senior Director of Capital Projects and composed of representatives from green groups, environmental experts and our senior
management.



In response to the Governments award of the
Kowloon Southern Link and the Shatin to Central Link, we prepared and submitted two project profiles to the Environmental Protection Department. The environmental impact assessment studies for the two projects started in June and November 2002,
respectively.



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##### Index to Financial Statements

Over the past years, we have invested substantially in measures designed to protect the environment. One
of the major initiatives undertaken by us in this respect is the noise mitigation project for East Rail. Designed to reduce the noise impact of trains running along the East Rail alignment, this project will eventually cost approximately HK$900
million, making it one of the largest single private investments in environmental improvement project in Hong Kong.



In November 2001, we placed an order for five quieter locomotives which are scheduled to be delivered in October 2003. After testing and commissioning,
these quieter locomotives may replace some of the existing locomotives currently used for hauling freight trains and engineering trains. We have also invested HK$3.1 billion in new environmentally-friendly rolling stock96 cars for East Rail
which have been put into service by the end of May 2002 and 154 cars for the introduction of the West Rail Phase I service later this year. These modern trains are quieter and more energy efficient due to their train skirts and their regenerative
braking system which saves traction power by regenerating and feeding energy back into the power system during braking. We are now undertaking a feasibility study on the installation of train skirts on the East Rails older trains and replacing
existing railway crossings with a quieter type.



All of our bus
fleet and diesel locomotives run on ultra-low sulphur diesel. 74 buses with pre-Euro standard engines have all been fitted with catalytic converters and 18 Euro I standard engine buses are scheduled to be retrofitted by the end of 2003.



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 appear 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.



CRITICAL ACCOUNTING POLICIES



Our significant accounting policies, including the assumptions and judgments underlying them, are disclosed in the Note 3 to the 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 2002, KCRC adopted three new or revised accounting policies in response to
the issuance by the SSAP 34 on employee benefits relating to the recognition of the annual leave and leave passage entitlement as at the balance sheet date, SSAP 15 on cash flow statements regrouping activities into operating, investing and
financing, and SSAP 1 relating to a new statement for changes in equity, which replaces the Consolidated Statement of Recognized Gains and Losses in previous financial statements. See Note 4 to our audited consolidated financial statements. In
January 2003, KCRC adopted a revised accounting policy relating to deferred taxation in order to comply with SSAP 12 on income taxes.



Detailed information in respect of US GAAP can be found in Note 42 to our audited consolidated financial statements.



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##### Index to Financial Statements

Impairment of assets



KCRC has complied 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 no longer exists or may have decreased.



If any such indication exists, we estimate the assets recoverable amount, which is calculated by discounting the estimated future cash flows. 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 the balance sheet date, no
such indication of impairment loss for KCRC existed.



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. For those costs incurred by KCRC in respect of feasibility studies on proposed railway related construction projects, they are charged to income statement when there is no certainty of the projects materializing. When the
proposed projects are viable, their 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, the management makes
an assessment on the feasibility of the projects from the technical and financial aspects which include the projection of cash flows and assumption on the pre-tax discount rate.



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, the management makes an
assessment on the feasibility of the projects from the technical and financial aspects which include the projection of cash flows and assumption on the pre-tax discount rate.



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



Provision for deferred taxation is calculated on the liability method at current taxation rate on timing differences to the extent that it is probable
that a liability will crystallize in the foreseeable future. We exercise 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.



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##### Index to Financial Statements

With effect from January 1, 2003, we adopted a revised accounting policy on deferred taxation in order to
comply with SSAP 12 relating to income taxes dealing with the recognition of deferred tax assets and deferred tax liabilities.



A deferred tax liability is recognized for all taxable temporary differences when the carrying amount of the asset at the net book value exceeds its tax
base at the tax written down value. On the other hand, a deferred tax asset is recognized for the carrying forward of unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available to be
utilized against the unused tax losses and unused tax credits.



SSAP 12 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, the opening balances of retained profits as at January
1, 2002 and 2003 have to be restated. In addition, the previously reported profit after taxation for the year ended December 31, 2002 will also be adjusted to reflect changes in provision for deferred taxation during the year. However, the
Corporation is currently assessing the effect that the adoption of SSAP 12 will have on its financial position and results of operations.



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 litigations, mainly relating to the construction of West Rail Phase I and East Rail Extensions. We will make a provision for the 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.



Recently Issued Accounting Standards of the United States of America



In June 2001, the Financial Accounting Standards
Board (FASB) in the United States of America issued Statement of Financial Accounting Standard (SFAS) No. 143 (Accounting for Asset Retirement Obligations). SFAS No. 143 requires the Corporation to record the fair value of an
asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development, and/or normal use of the assets.
The Corporation also records a corresponding asset that is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation will be adjusted at the end of each period to reflect the
passage of time and changes in the estimated future cash flows underlying the obligation. SFAS No. 143 took effect on January 1, 2003. The Corporation is currently assessing the effect that the application of SFAS No.143 will have on its financial
position and results of operations.



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##### Index to Financial Statements

In April 2002, the FASB issued SFAS No. 145 (Rescission of FASB Statements No. 4, 44 and 64, Amendment of
FASB Statement No. 13, and Technical Corrections). SFAS No. 145 amends existing guidance on reporting gains and losses on the extinguishment of debt to prohibit the classification of the gain or loss as extraordinary, as the use of such
extinguishments have become part of the risk management strategy of many companies. SFAS No. 145 also amends SFAS No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback
transactions. The provisions of SFAS No. 145 related to the rescission of Statement No. 4 is applied in fiscal years beginning after May 15, 2002. Earlier application of these provisions is encouraged. The provisions of SFAS No. 145 related to
Statement No. 13 were effective for transactions occurring after May 15, 2002, with early application encouraged. The Corporation does not expect the application of SFAS No.145 will have a significant effect on its financial position and results of
operations.



In June 2002, the FASB issued SFAS No. 146
(Accounting for Costs Associated with Exit or Disposal Activities). SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue
94-3 (Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity). The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002, with early
application encouraged. The Corporation does not expect the application of SFAS No. 146 will have a significant impact on its financial position and results of operations.



In November 2002, the FASB issued Interpretation No. 45 (Guarantors Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness to Others) (FIN No. 45), an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. FIN No. 45 elaborates on the disclosures to be made
by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. FIN No. 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The initial recognition and measurement provisions of FIN No. 45 are applicable to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual
periods ending after December 15, 2002. The Corporation has not issued any guarantees. The Corporation does not expect the application of FIN No. 45 will have a significant impact on its financial position and results of operations.



In November 2002, the 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. The Corporation is currently assessing the effect that the application of EITF 00-21 will have on its financial position and results of operations.



In December 2002, the FASB issued SFAS No. 148 (Accounting for Stock-Based
Compensation  Transition and Disclosure), an amendment of FASB Statement No. 123. SFAS No. 148 amends FASB Statement No. 123 (Accounting for Stock-Based Compensation), to provide alternative methods of transition for a voluntary change to the
fair value method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements. Certain of the
disclosure modifications are required for fiscal years ending after December 15, 2002 and are included in the notes to our audited consolidated financial statements. However, since the Corporation files Item 17 of Form 20-F, it is exempted from such
disclosure requirements. The application of SFAS No. 148 will not have any impact on the Corporations financial position and results of operations as the Corporation does not provide any stock-based compensation to its employees.



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##### Index to Financial Statements

In January 2003, the FASB issued Interpretation No. 46 (Consolidation of Variable Interest Entities), an
interpretation of ARB No. 51 (FIN No. 46). FIN No. 46 addresses the consolidation by business enterprises of variable interest entities as defined in the interpretation. FIN No. 46 applies immediately to variable interests in variable
interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. The interpretation applies in the first fiscal year or interim period beginning after June 15, 2003, to
variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. FIN No. 46 applies to public enterprises as of the beginning of the applicable interim or annual period, and it applies to
nonpublic enterprises as of the end of the applicable annual period. The Corporation is currently assessing the effect that the application of FIN No. 46 will have on its financial position and results of operations. FIN No. 46 requires certain
disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that the Corporation will consolidate or disclose information about variable interest entities when the interpretation becomes effective. However, since
the Corporation files Item 17 of Form 20-F, it is exempted from such disclosure requirements.



In April 2003, the FASB issued SFAS No. 149 (Amendment of Statement 133 on Derivative Instruments and Hedging Activities). SFAS No. 149 amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133 (Accounting for Derivative Instruments and Hedging Activities). SFAS No.
149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. All provisions of SFAS No. 149 will be applied prospectively. The Corporation is currently assessing the
effect that the application of SFAS No. 149 will have on its financial position and results of operations.



In May 2003, the FASB issued SFAS No. 150 (Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity). SFAS No. 150
establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity, and requires the classification of a financial instrument that is within its scope as a liability (or
an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The
Corporation is currently assessing the effect that the application of SFAS No. 150 will have on its financial position and results of operations.



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 to comply with the requirements of the US
Statement of Financial Accounting Standard 133Accounting for Derivative Instruments and Hedging Activities. We seek to reduce our foreign currency exposure in respect of debt obligations and capital expenditures by converting such obligations
into either Hong Kong dollars or U.S. dollars, and to maintain U.S. dollar exposure no greater than 30% of our total debt obligations. Moreover, we seek to limit our exposure to floating interest rate risk by maintaining at least 50% of the total
principal amount of our debt obligations at fixed interest rate for the duration of the debt obligations, regardless of maturity.



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##### Index to Financial Statements

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 populations 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 through increased ridership levels. The expansion in our portfolio of commercial properties over the past years has contributed to
increase revenues from property ownership and management and other property services. From 1988 to 1998, we have been able to achieve increase 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. Nevertheless, we are still able to achieve growth in profits and transport revenues in 2002 as a result of
increased patronage for cross-boundary and intercity through-train.



East
Rail



East Rail has contributed approximately 73% of our
revenues in each of 2000, 2001 and 2002, with ridership on our electric multiple unit trains increasing in each year. Efficiency on East Rail has been improved over this period. The electric multiple unit train refurbishment program has increased
carrying capacity by an additional 15% as of December 31, 2000. The additional rolling stock, which has all been put into service by the end of May 2002, increased the carrying capacity by 28%. These changes have increased the revenue generating
capacity of East Rail. Over the past years, we have also improved equipment and maintenance programs, which have reduced the number of breakdowns per vehicle kilometer. Over the period from 1993 to 2002, this has resulted in 36% decline in number of
breakdowns per million vehicle kilometer run and a 24% reduction in annual maintenance costs per million vehicle kilometer run. As a result of these factors, operating margins, defined as operating profit after depreciation as a percentage of total
revenue of East Rail, which fell from 43.0% in 1988 to 32.3% in 1992, have increased every year since 1993 to 47.5% in 2001 (restated as described in Note 4(a) to our audited consolidated financial statements for the year ended December 31, 2002),
but fell slightly to 46.7% in 2002.



East Rail passenger
revenues consist of the following:



|· |  | fares paid by passengers who travel between stations in Hong Kong, who constitute domestic passenger traffic;
|- |  | -------------------------------------------------------------------------------------------------------------

|
|

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

|
|

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

|
|



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. The Government has proposed to charge a boundary facilities improvement tax to individuals crossing into mainland China by foot, train or passenger vehicle similar to the departure tax currently charged to individuals
departing Hong Kong by airplane and ferry. When the boundary facilities improvement tax is imposed in April 2004, it may reduce our cross-boundary passenger volume. With the gradual opening up of 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 number of cross-boundary passengers grew by 6.3% during 2002. This rise in cross-boundary patronage can be attributed in large part to the relaxation
of visitor quotas and the introduction of multiple entry visas for travelers from mainland China coming to Hong Kong.



35



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##### Table of Contents

##### Index to Financial Statements

|     |  | Cross-Boundary LoWu Ridership
|---- |  | -----------------------------
|     |  | DailyAveragePassengertrips   
|1998 |  | 178,802                      
|1999 |  | 206,481                      
|2000 |  | 229,120                      
|2001 |  | 236,800                      
|2002 |  | 251,600                      



In 2002, East
Rails through-trains to mainland China continued to see an increase in patronage. In January 2003, we added more train services to Dongguan in mainland China.



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, which is non-recurring, 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 a one-time land premium 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 capitalized on our balance sheet.



In most cases, we contribute the site and receive a guaranteed minimum
profit, and our joint venture partners bear substantially all of the cash 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 joint venture partners in the form of upfront payments when the joint ventures are formed. 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.



We completed one major property development project at Hung Hom Bay in 2002. We have recently awarded the tender for the property development at Ho Tung
Lau to a subsidiary of Sino Land Company Ltd. As the Governments agent, we will be granted significant rights to develop additional properties in connection with the construction of West Rail Phase I. As part of the agreement to invest
additional capital, the Government will retain substantially all of the development profits from designated developments along West Rail Phase I. See Item 4. Information on the CorporationProperty Development and ManagementProperty
Development for a more detailed description of completed and proposed property development projects.



36



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##### Table of Contents

##### Index to Financial Statements

The amount and timing of property development related cash inflows and profits have fluctuated as various
properties have been developed. In 1997, profit on property development accounted for 63.4% of profit before taxation. In 2000, 2001 and 2002, profit on property development accounted for 3.8%, 1.0% and 3.5% respectively, of profit before taxation.
The reduction reflects the absence of new property developments available for sale during those years and the downturn in the Hong Kong real estate market.



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 2002, commercial activities, property ownership and management operations accounted for 12.7% of total
revenue of KCRC and 20.2% 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 and 2002. Revenues and profits depend on market conditions at the time leases are entered into and renewed.



Light Rail, Bus and Freight



Light Rail, bus and freight operations make up the remainder of our operations. We undertook Light Rail and associated bus operations in the late 1980s at
the request of the Government to support projected population growth in the north-west New Territories, on the understanding that competition from bus operators would be restricted and that certain Light Rail stations would be the only terminal for
bus service to urban areas. However, population growth in the Light Rail service area underperformed Government estimates and the Government has allowed a higher level of competition from other modes of transport in the region, which has reduced
passenger use of Light Rail. Primarily as a result of these factors, the Light Rail system has not been profitable since 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 East Rail stations in 1999. Previously, this service did not generate revenue.



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 package offered by operator 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 even as overall cross-boundary freight has increased. However, the percentage of higher value goods and
the number of containers carried by our freight services have increased significantly, with container volumes growing by almost 60% in 2002, more than offsetting the decline in breakbulk and livestock volumes. As a result, overall freight volume
rose by 10% in 2002. See Item 4. Information on the CorporationFreight Services.



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 have received an aggregate of HK$37
billion of contributions of capital from the Government. In addition to the US$1 billion of eurobonds in July 1999 and US$50 million private placement under our Euro medium term note programme in November 1999, we also issued US$1 billion notes in
March 2000. We had cash and interest paying investments of HK$24,693 million (US$3,166.3 million) as of December 31, 2002. We generated net investment income of HK$618 million (US$79.2 million) during 2002. This amount does not include investment
income of HK$975 million (US$125.0 million) and borrowing costs of HK$1,178 million (US$151.0 million) which were capitalized to the project costs of West Rail Phase I and East Rail Extensions. The capitalized amounts relate to capital contributions
and borrowings incurred for the purposes of those projects. We anticipate that we will continue to receive significant cash interest receipts in the next two years, which receipts are expected to be offset in part or in full by the higher interest
expense related to our increased borrowings. With respect to funds that are required for use on West Rail Phase I or the East Rail Extensions, 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 42 to our audited consolidated
financial statements for a summary of differences between HK GAAP and US GAAP applicable to us.



37



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##### Table of Contents

##### Index to Financial Statements

Operating Costs



Our principal operating costs are electricity and fuel costs, depreciation, and staff costs, which accounted for approximately 9.0%, 25.0% and 42.3%,
respectively, of total operating costs in 2002. Our staff costs are influenced by inflation, labor productivity, the relative supply and demand for labor in Hong Kong and other factors. Depreciation expense in 2002 increased by 9.7% as compared to
2001 mainly due to the growth in capital expenditure, such as commissioning of the new EMUs. 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.



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, |  
|------------------------------------------- |  | ----------------------- | -
|                                            |  | 2000                    |  
|                                            |  | HK$                     |  
|                                            |  | (in millions)           |  
|Revenue:                                    |  |                         |  
|East Rail                                   |  | 3,438                   |  
|Light Rail                                  |  | 440                     |  
|Freight                                     |  | 99                      |  
|                                            |  |                         |  
|Total railway operations                    |  | 3,977                   |  
|Bus                                         |  | 112                     |  
|Property Services                           |  | 642                     |  
|                                            |  |                         |  
|Total revenue                               |  | 4,731                   |  
|                                            |  |                         |  
|Operating Profit (Loss) After Depreciation: |  |                         |  
|East Rail                                   |  | 1,606                   |  
|Light Rail                                  |  | (116                    | )
|Freight                                     |  | (33                     | )
|                                            |  |                         |  
|Total railway operations                    |  | 1,457                   |  
|Bus                                         |  | (11                     | )
|Property Services                           |  | 455                     |  
|                                            |  |                         |  
|Total operating profit                      |  | 1,901                   |  
|Net investment income                       |  | 302                     |  
|Profit from property development            |  | 87                      |  
|Share of profit/(loss) of associate         |  | (1                      | )
|                                            |  |                         |  
|Profit before taxation                      |  | 2,289                   |  
|Taxation                                    |  | (1                      | )
|                                            |  |                         |  
|Profit after taxation                       |  | 2,288                   |  
|                                            |  |                         |  

---

|(1) |  | The prior period adjustments in 2001 are made as a result of the adoption of SSAP 34 (Employee Benefits). See Note 4(a) to our audited consolidated financial
statements for the year ended 31 December 2002. Comparative figures before 2001 have not been restated because it is impractical to do so.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



38



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##### Table of Contents

##### Index to Financial Statements

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:



|                         |  | Year EndedDecember 31, |  
|------------------------ |  | ---------------------- | -
|                         |  | 2000                   |  
|                         |  | %                      |  
|Revenue/Total Revenue:   |  |                        |  
|East Rail                |  | 72.6                   |  
|Light Rail               |  | 9.3                    |  
|Freight                  |  | 2.1                    |  
|                         |  |                        |  
|Total railway operations |  | 84.0                   |  
|Bus                      |  | 2.4                    |  
|Property Services        |  | 13.6                   |  
|                         |  |                        |  
|Total revenue            |  | 100.0                  |  
|                         |  |                        |  
|Operating Profit/(Loss): |  |                        |  
|East Rail                |  | 84.5                   |  
|Light Rail               |  | (6.1                   | )
|Freight                  |  | (1.7                   | )
|                         |  |                        |  
|Total railway operations |  | 76.7                   |  
|Bus                      |  | (0.6                   | )
|Property Services.       |  | 23.9                   |  
|                         |  |                        |  
|Total operating profit   |  | 100.0                  |  
|                         |  |                        |  



Operating Results



Year Ended December 31, 2002 Compared to Year Ended December 31,
2001



Total revenue from operations was HK$4,830
million (US$619.3 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$540.2 million) and a 6.2% decrease in property
services revenue to HK$617 million (US$79.1 million). Revenue from East Rail grew by 2.4% from HK$3,487 million for 2001 to HK$3,569 million (US$457.6 million) for 2002. This increase in East Rail revenue reflected a 1.4% overall increase in
passenger volume from 2002 compared with 2001. The overall fare paid per passenger increased 0.6% from 2001 to 2002 due to an increase in the proportion of cross-boundary passengers. Revenue from Light Rail decreased by 3.5% from HK$433 million for
2001 to HK$418 million (US$53.6 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$79.1 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. The Citylink Plaza renovation has been completed as of the end of April 2003 and is expected to generate better trade mix and higher revenue income. 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$11.0 million) for 2002.



39



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##### Table of Contents

##### Index to Financial Statements

Operating profit after depreciation and before net investment income increased by 1.2% to HK$1,934
million (US$248.0 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%
(restated as described in Note 4(a) of the audited consolidated financial statements for the year ended December 31, 2002) for 2001 to 40.0% for 2002. Operating costs (before net investment income) grew by 0.3% from HK$2,886 million (restated as
described in Note 4(a) of the audited consolidated financial statements for the year ended December 31, 2002) for 2001 to HK$2,896 million (US$371.3 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 more than offset decreases in staff costs which reduced by 3.9% to HK$1,226 million and energy and other expenses which reduced by 0.4% to HK$262 million. The net amount of
staff costs after capitalization for various capital projects was reduced mainly attributable to the reduction in staff benefits in 2002. See Note 5(b) to our audited consolidated financial statements for a breakdown of operating costs.



Net investment income increased from HK$490 million for 2001 to HK$618
million (US$79.2 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$125.0 million) and borrowing costs of HK$1,178 million (US$151.0 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 of HK$1 million for 2002 is the same as 2001, which represented the estimated assessable profits tax of the subsidiaries of the Corporation
for the year.



Year Ended December 31, 2001 Compared to
Year Ended December 31, 2000



Total revenue from
operations was HK$4,797 million (US$615.1 million) for 2001, a 1.4% increase from HK$4,731 million for 2000. This increase included a 1.2% increase in transportation (railway and bus operations) revenue to HK$4,139 million (US$530.7 million) and a
2.5% increase in property services revenue to HK$658 million (US$84.4 million). Revenue from East Rail grew by 1.4% from HK$3,438 million for 2000 to HK$3,487 million (US$447.1 million) for 2001. This increase in East Rail revenue reflected a 1.5%
overall increase in passenger volume from 2001 compared with 2000. The overall fare paid per passenger increased 0.1% from 2000 to 2001 due to an increase of cross-boundary passengers. Revenue from Light Rail decreased by 1.6% from HK$440 million
for 2000 to HK$433 million (US$55.5 million) for 2001, mainly due to competition from other modes of transport in the north-western New Territories. Revenue from property services increased by 2.5% from HK$642 million for 2000 to HK$658 million
(US$84.4 million) for 2001 principally as a result of higher revenue generated from rental and other revenue related to duty free operation. Revenue from bus operations increased by 17% from HK$112 million for 2000 to HK$131 million (US$16.8
million) for 2001. Revenue from freight services decreased 11.1% from HK$99 million for 2000 to HK$88 million (US$11.3 million) for 2001, due to lower breakbulk and livestock traffic.



Operating profit after depreciation and before net investment income increased by 0.5% 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) (US$245.0 million) for 2001, compared to HK$1,901 million for 2000. The operating margin decreased from 40.2% for 2000 to 39.8% (restated
as described in Note 4(a) to our audited consolidated financial statements for the year ended December 31, 2002) for 2001. Operating costs (before net investment income) grew by 1.9% from HK$2,830 million for 2000 to HK$2,886 million (US$370.1
million) (restated as described in Note 4(a) to our audited consolidated financial statements for the year ended December 31, 2002) for 2001, primarily because of increases in staff costs which grew by 5.5% to HK$1,276 million (restated as described
in Note 4(a) to our audited consolidated financial statements for the year ended December 31, 2002) and energy and other expenses grew by 6.1% to HK$663 million more than offset decreases in maintenance costs which decreased by 12.3% to HK$286
million and depreciation which fell by 1.3% to HK$661 million. The growth of staff costs was mainly due to the pay adjustment in July 2001, the full-year effect of new posts filled in 2000, and additional posts created and filled in 2001. See Note
5(b) to our audited consolidated financial statements for a breakdown of operating costs.



40



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##### Table of Contents

##### Index to Financial Statements

Net investment income increased from HK$302 million for 2000 to HK$490 million (US$62.8 million) for 2001
due principally to the additional investment of surplus funds from bond proceeds, equity injection and operations. Net investment income excluded investment income of HK$1,971 million (US$252.7 million) and borrowing costs of HK$1,325 million
(US$169.9 million) capitalized to construction in progress and deferred expenditures during 2001. Profits from property development decreased from HK$87 million for 2000 to HK$24 million (US$3.1 million) for 2001 mainly from the Royal Ascot property
development. Provision for profits taxes of HK$1 million for 2001 is the same as 2000 which represented the estimated assessable profits tax for the year of the subsidiaries of the Corporation.



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 four years, in light of the economic downturn in Asia and Hong Kong and other factors, we did not increase fares for both 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 2.8% in the Hong Kong Consumer Price Index (A) for the four years from 1999 to 2002. For the years 1999, 2000, 2001 and 2002, the Hong Kong Consumer Price Index (A) dropped
3.3%, 3.0%, 1.7% and 3.2% respectively representing deflation for four consecutive years. See Item 4. Information on the CorporationPricing of Rail Services.



EFFECTS OF INTEREST RATE AND FOREIGN EXCHANGE MOVEMENTS ON OUR BORROWINGS



We had HK$995.3 million (US$127.6 million) of floating rate debt as of
December 31, 2002. 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, the East Rail Extensions, the Kowloon Southern Link and the Shatin 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 floating rate risk by our policy to maintain at
least 50% of the total principal amount of our debt obligations at 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 of our revenues and operating expenses are
incurred in HK dollars. In addition, a substantial majority of the capital expenditures for West Rail Phase I and the East Rail Extensions will be incurred in HK dollars. However, we have raised significant borrowings in U.S. dollars. We have
reduced foreign exchange exposure relating to debt obligations and capital expenditures 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 U.S. dollar exposure no greater than 30% of our total borrowings.



In addition to U.S. dollar bond issue, we issued HK dollar bonds in June 2003 to finance Kowloon Southern Link and Shatin to Central Link to minimize our foreign exchange exposure.



41



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##### Table of Contents

##### Index to Financial Statements

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.



|                                          |  | As of or for Year Ended December 31,
|----------------------------------------- |  | ------------------------------------
|                                          |  | 2000                                
|                                          |  | HK$                                 
|                                          |  | (in millions)                       
|Profit after taxation in accordance with: |  |                                     
|HK GAAP                                   |  | 2,288                               
|US GAAP                                   |  | 4,113                               
|Shareholders funds in accordance with:   |  |                                     
|HK GAAP                                   |  | 48,901                              
|US GAAP                                   |  | 51,977                              

---

|(1) |  | The prior period adjustments in 2001 are made as a result of the adoption of SSAP 34 (Employee Benefits). See Note 4(a) to our audited consolidated financial
statements for the year ended 31 December 2002. Comparative figures before 2001 have not been restated because it is impractical to do so.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



See Note 42 to our audited consolidated financial statements for the reconciliation of profit after taxation and shareholders funds reported between
HK GAAP and US GAAP.



LIQUIDITY AND CAPITAL RESOURCES



Capital Commitments



The four largest capital projects we are currently developing are the West Rail Phase I, the East Rail Extensions, the
Kowloon Southern Link and the Shatin 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 four largest capital projects from project inception to the commencement of operations, including
financing costs during construction, as follows:



|                                  |  | West Rail Phase I |  | East Rail Extensions |  | KowloonSouthernLink |  | Shatin toCentral Link |  | Total
|--------------------------------- |  | ----------------- |  | -------------------- |  | ------------------- |  | --------------------- |  | -----
|                                  |  | HK$               |  | HK$                  |  | HK$                 |  | HK$                   |  | HK$  
|                                  |  | (in billions)    
|Anticipated development costs:    |  |                   |  |                      |  |                     |  |                       |  |      
|Construction costs                |  | 39.8              |  | 22.6                 |  | 8.9                 |  | 29.3                  |  | 100.6
|Land costs                        |  | 6.0               |  | 1.6                  |  | 0.8                 |  | 0.9                   |  | 9.3  
|Financing costs                   |  | 0.6               |  | 2.5                  |  | 0.6                 |  | 3.0                   |  | 6.7  
|                                  |  |                   |  |                      |  |                     |  |                       |  |      
|Total                             |  | 46.4              |  | 26.7                 |  | 10.3                |  | 33.2                  |  | 116.6
|                                  |  |                   |  |                      |  |                     |  |                       |  |      
|Anticipated financing sources(1): |  |                   |  |                      |  |                     |  |                       |  |      
|Government equity                 |  | 29.0              |  | 8.0                  |  |                    |  |                      |  | 37.0 
|KCRC debt                         |  | 5.5               |  | 12.7                 |  | 7.0                 |  | 22.6                  |  | 47.8 
|KCRC internal funds               |  | 11.9              |  | 6.0                  |  | 3.3                 |  | 10.6                  |  | 31.8 
|                                  |  |                   |  |                      |  |                     |  |                       |  |      
|Total                             |  | 46.4              |  | 26.7                 |  | 10.3                |  | 33.2                  |  | 116.6
|                                  |  |                   |  |                      |  |                     |  |                       |  |      

---

|(1) |  | As of December 31, 2002, total financing sources amounted to HK$53,870.9 million (US$6,907.5 million), consisting of HK$29,000 million (US$3,718.5 million) of
Government capital contributions for West Rail Phase I and an additional HK$8,000 million (US$1,025.8) for Ma On Shan Rail and TST Extension; HK$7,738.3 million (US$992.2 million) in net proceeds from the US$1 billion in principal amount of the
Notes; HK$8,149.3 million (US$1,044.9 million) in net proceeds from the 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; HK$824.6 million (US$105.7 million) from drawdowns under
our US$379.7 million export credit facilities; and HK$158.7 million (US$20.4 million) from deferred payment of long term credit facilities.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



42



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##### Table of Contents

##### Index to Financial Statements

As of December 31, 2002, we had an aggregate of approximately HK$6.8 billion in outstanding commitments
for capital expenditures for the development of West Rail Phase I. We had HK$10.3 billion in outstanding commitments for capital expenditures of the East Rail Extensions. We had an aggregate of approximately HK$2.5 billion in outstanding commitments
for capital expenditures relating to the existing East Rail, Light Rail operations and new railway projects.



For West Rail Phase I, we incurred a total cash outlay of HK$27.3 billion prior to 2002 and HK$7.2 billion in 2002. Based on our projected construction
schedule and the terms of the commitments for capital expenditures we have contracted to date for West Rail Phase I, the following is our estimated schedule of payments from 2003 onwards and the actual payments in 2002 for West Rail Phase I:



|                   |  | 2002          |  | 2003 |  | 2004 |  | 2005onwards |  | Total
|------------------ |  | ------------- |  | ---- |  | ---- |  | ----------- |  | -----
|                   |  | HK$           |  | HK$  |  | HK$  |  | HK$         |  | HK$  
|                   |  | (in billions)
|Construction costs |  | 6.9           |  | 6.8  |  | 0.8  |  | 1.6         |  | 16.1 
|Land costs         |  | 0.2           |  | 0.8  |  | 0.9  |  | 0.7         |  | 2.6  
|Financing costs    |  | 0.1           |  | 0.2  |  | 0.1  |  |            |  | 0.4  
|                   |  |               |  |      |  |      |  |             |  |      
|Total              |  | 7.2           |  | 7.8  |  | 1.8  |  | 2.3         |  | 19.1 
|                   |  |               |  |      |  |      |  |             |  |      



For East Rail
Extensions, we incurred a total cash outlay of HK$4.0 billion prior to 2002 and HK$3.5 billion in 2002. Based on our projected construction schedule and the terms of the commitments for capital expenditures we have contracted to date for East Rail
Extensions, the following is our estimated schedule of payments from 2003 onwards and the actual payments in 2002 for East Rail Extensions:



|                   |  | 2002          |  | 2003 |  | 2004 |  | 2005onwards |  | Total
|------------------ |  | ------------- |  | ---- |  | ---- |  | ----------- |  | -----
|                   |  | HK$           |  | HK$  |  | HK$  |  | HK$         |  | HK$  
|                   |  | (in billions)
|Construction costs |  | 3.2           |  | 5.2  |  | 5.4  |  | 5.5         |  | 19.3 
|Land costs         |  | 0.1           |  | 0.9  |  | 0.2  |  | 0.2         |  | 1.4  
|Financing costs    |  | 0.2           |  | 0.4  |  | 0.5  |  | 0.9         |  | 2.0  
|                   |  |               |  |      |  |      |  |             |  |      
|Total              |  | 3.5           |  | 6.5  |  | 6.1  |  | 6.6         |  | 22.7 
|                   |  |               |  |      |  |      |  |             |  |      



43



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##### Table of Contents

##### Index to Financial Statements

For Shatin to Central Link, we incurred a total cash outlay of HK$61 million in 2001 and HK$251 million
in 2002. Based on our projected construction schedule, the following is our estimated schedule of payments from 2003 onwards and the actual payments in 2002 for Shatin to Central Link:



|                   |  | 2002          |  | 2003 |  | 2004 |  | 2005onwards |  | Total
|------------------ |  | ------------- |  | ---- |  | ---- |  | ----------- |  | -----
|                   |  | HK$           |  | HK$  |  | HK$  |  | HK$         |  | HK$  
|                   |  | (in billions)
|Construction costs |  | 0.2           |  | 0.8  |  | 1.8  |  | 26.4        |  | 29.2 
|Land costs         |  |              |  |     |  |     |  | 0.9         |  | 0.9  
|Financing costs    |  |              |  |     |  | 0.1  |  | 2.9         |  | 3.0  
|                   |  |               |  |      |  |      |  |             |  |      
|Total              |  | 0.2           |  | 0.8  |  | 1.9  |  | 30.2        |  | 33.1 
|                   |  |               |  |      |  |      |  |             |  |      



For Kowloon Southern
Link, we incurred a total cash outlay of HK$11 million in 2001 and HK$37 million in 2002. Based on our projected construction schedule, the following is our estimated schedule of payments from 2003 onwards and the actual payments in 2002 for the
Kowloon Southern Link:



|                   |  | 2002          |  | 2003 |  | 2004 |  | 2005onwards |  | Total
|------------------ |  | ------------- |  | ---- |  | ---- |  | ----------- |  | -----
|                   |  | HK$           |  | HK$  |  | HK$  |  | HK$         |  | HK$  
|                   |  | (in billions)
|Construction costs |  |              |  | 0.2  |  | 0.7  |  | 8.0         |  | 8.9  
|Land costs         |  |              |  |     |  | 0.4  |  | 0.4         |  | 0.8  
|Financing costs    |  |              |  |     |  |     |  | 0.6         |  | 0.6  
|                   |  |               |  |      |  |      |  |             |  |      
|Total              |  |              |  | 0.2  |  | 1.1  |  | 9.0         |  | 10.3 
|                   |  |               |  |      |  |      |  |             |  |      



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 Shatin to Central Link and the Kowloon Southern Link include funds that the Corporation 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 set forth above.



The following table
sets out our capital expenditures for each of the three years ended December 31, 2002:



|                                                                                |  | Year Ended December 31,
|------------------------------------------------------------------------------- |  | -----------------------
|                                                                                |  | 2000                   
|                                                                                |  | HK$                    
|                                                                                |  | (in millions)          
|Railway related operational equipment(1)                                        |  | 11                     
|Assets under construction:(2)                                                   |  |                        
|West Rail Phase I                                                               |  | 9,034                  
|East Rail Extensions                                                            |  | 933                    
|Automatic Train Protection System                                               |  | 24                     
|Rolling Stock                                                                   |  | 415                    
|Others                                                                          |  | 132                    
|                                                                                |  |                        
|                                                                                |  | 10,538                 
|Others(3)                                                                       |  | 20                     
|                                                                                |  |                        
|Total railway assets                                                            |  | 10,569                 
|Investment property and buildings                                               |  |                       
|Assets under construction for investment property, leasehold land and buildings |  | 260                    
|                                                                                |  |                        
|Total capital additions(4)                                                      |  | 10,829                 
|                                                                                |  |                        



44



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##### Table of Contents

##### Index to Financial Statements

---

|(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 others and all capital expenditures 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 additions exclude capitalized investment income and borrowing costs. See Note 3(r) to our audited consolidated financial statements for accounting policy
on borrowing costs and investment income.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | The prior period adjustments in 2001 are made as a result of the adoption of SSAP 34 (Employee Benefits). See Note 4(a) to our audited consolidated financial
statements for the year ended 31 December 2002. Comparative figures before 2001 have not been restated because it is impractical to do so.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Resources for Capital Expenditures



Earnings.    Historically, we have generated our capital resources primarily through earnings. Earnings from railway
operations and property management have been supplemented by earnings from non-recurring property development. For the year ended December 31, 2002, net cash inflow from operating activities was HK$2,500 million (US$320.6 million), an increase of
HK$71 million (US$9.1 million) or 2.9%, from HK$2,429 million for the year ended December 31, 2001. The increase was mainly due to the increase in net cash inflow from operations, even though this increase was reduced by the increase in cash outflow
from property development of HK$402 million (US$51.5 million) in 2002, compared to HK$350 million (US$44.9 million) in 2001.



Currently, we are not subject to contractual restrictions on the payment of dividends under any of our borrowings. We declared a dividend payment of
HK$620 million in 2003. Dividend payments would reduce the funds available to meet capital expenditures and repay indebtedness.



Earnings will not be sufficient to fund the significant capital resources required to complete West Rail Phase I, the East Rail Extensions, the Kowloon
Southern Link and the Shatin 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 the Shatin to
Central Link projects, we expect to rely largely on borrowings. We currently expect borrowing costs to represent about 5.8% of project costs, and variations in costs could have a significant effect on the returns from these projects. In order to
reduce risk, we have decided to pre-fund a significant portion of our borrowings to lock in financing costs at fixed interest rates. We anticipate that the US$1 billion in eurobonds issued in July 1999 and the US$50 million private placement 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 the West Rail
Phase I and the East Rail Extensions projects. We expect to incur significant capital expenditures in connection with the Kowloon Southern Link and the Shatin to Central Link with material expenditures expected to begin in 2004, when construction is
expected to commence. While the details on the capital expenditures related to the Kowloon Southern Link and the Shatin 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 probably will be required to substantially expand our borrowings to meet part of the project costs for the construction of the Kowloon Southern Link and the Shatin to Central Link.



45



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##### Table of Contents

##### Index to Financial Statements

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 Ma On Shan Rail and TST Extension of East Rail Extensions. These equity injections received from the Government represent approximately 62.5% and 30.0% of the revised estimated
HK$46.4 billion and HK$26.7 billion aggregate project costs of West Rail Phase I and East Rail Extensions respectively. We do not expect any equity injections from the Government for the Kowloon Southern Link and the Shatin to Central Link.



Contractual Obligations and Commercial
Commitments.    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, 2002:



|                            |  | Payments Due by Period
|--------------------------- |  | ----------------------
|Contractual Obligations     |  | Lessthan1year         
|                            |  | HK$                   
|                            |  | (in millions)         
|Long-term Debt              |  | 310                   
|Capital Lease Obligations   |  | 504                   
|Operating Leases            |  | 148                   
|Other Long-term Obligations |  |                      
|                            |  |                       
|Total                       |  | 962                   
|                            |  |                       



|                                                   |  | Amount of Commitment Expiration Per Period
|-------------------------------------------------- |  | ------------------------------------------
|Other Commercial Commitments                       |  | Lessthan 1year                            
|                                                   |  | HK$                                       
|                                                   |  | (in millions)                             
|Short-term Uncommitted Revolving Credit Facilities |  | 2,250                                     
|Letter of Credit                                   |  | 3                                         
|Overdraft Facilities                               |  | 25                                        
|Medium Term Note Programme                         |  |                                          
|Letter of Credit for US Leverage Leases            |  | 110                                       
|Export Credit Loan Facilities                      |  |                                          
|Capital Commitments(1)                             |  | 11,414                                    
|Other Commercial Commitments                       |  |                                          
|                                                   |  |                                           
|Total                                              |  | 13,802                                    
|                                                   |  |                                           

---

|(1) |  | The capital commitments relate to the capital works contracted for and those authorized but not contracted for as at December 31, 2002. Since these works had
not been commenced as at December 31, 2002, they were not provided for in our financial statements. Besides, there is no breakdown for the commitments over one year in consideration of the uncertainties in estimating the works to be completed for
each contract for the years beyond one year.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





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##### Index to Financial Statements

Debt Facilities.    Under the KCRC Ordinance, the Corporation is
empowered to borrow or otherwise raise money and charge all or any part of our property as security for the borrowings and to create and issue bonds, notes or other securities which may be charged on the property, undertaking and revenue of the
Corporation or any part thereof. We may exercise such powers to provide us 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 and paying interest, premium or other charge on such money or repaying sums to the Government. Moodys Investors Services changed the outlook of our foreign currency rating A3 to positive from stable in mid February
2001. On April 17, 2003, Moodys Investors Services affirmed our Aa3 domestic and A3 foreign currency ratings, the outlook for our domestic currency rating as stable and the outlook for our foreign currency rating as
positive. Standard & Poors Rating Group, a division of McGraw-Hill, Inc., affirmed our AA- local and A+ foreign currency ratings as well as the stable outlook on our foreign currency rating on October 24, 2002, but
the agency revised the outlook on our local currency rating to negative from stable on the same day. These ratings are the sovereign ceiling of the Government. 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 the 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 at a floating rate at a margin over LIBOR and the loans are repayable in 17 semi-annual instalments
commencing in May 2004 or the seventh month after the date of final delivery of the equipment, whichever is earlier. As of December 31, 2002, we had completed drawdowns totaling US$22.4 million under this facility.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|· |  | In March 2000, we launched a US$1 billion in principal amount of 8% notes due in 2010 (the Notes). The Notes are unsecured senior obligations of KCRC and rate 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 Itochu-Kinki-Kawasaki Consortium for
the design, manufacture, supply, testing and commissioning of electric multiple unit trains for both the 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 at a floating rate at a margin over LIBOR. The loans are payable in 17 equal semi-annual instalments commencing in April 2003. As of June 19, 2002, we had completed drawdowns totaling US$290.2 million under this facility. We made a single
repayment of US$19.9 million in April 2003. We do not intend to make further drawdowns under this loan facility. A notice was served to cancel the undrawn balance of this loan facility with effect from June 30, 2003.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|· |  | 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 the Shatin 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 launched a two-tranche Hong Kong dollar retail bonds issue, 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.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





47



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##### Table of Contents

##### Index to Financial Statements

|· |  | In June 2003, we issued HK$800 million in principal amount of 4.65% notes due 2013 under the US$3.0 billion 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 HK dollars or U.S. dollars or hedged into these currencies. As of December 31, 2002, our cash, investments and
deposits with banks were HK$24,693 million (US$3,166.3 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 and US$50 million in principal amount of 7.77% notes due 2014 that we issued in November 1999. Of such HK$24.7 billion, over HK$12.2 billion of our investments were in bank deposits and certificates of deposit. HK$16.4 billion
were invested in unlisted fixed income securities, and over HK$17.0 billion of our investments were in obligations (or with institutions) rated in the top two rating categories of recognized international rating agencies. As of December 31, 2002,
over HK$16.8 billion represented HK 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 HK$1,397 million (US$179.1 million) as of December 31, 2002. Our need for operational working capital is limited, as our operating expenses are primarily funded through passenger fares paid on a current basis. We
believe that our cash investments will provide us with sufficient liquidity to fund capital costs for West Rail Phase I and the East Rail Extensions through 2003.



TREND INFORMATION



During 2002, substantial progress was made on our existing capital projectsWest Rail Phase I and the East Rail Extensions. In 2002, we were awarded
two new railway projects which will provide the vital links needed between West Rail and East Rail and more importantly, for the first time extend the KCRC network to Hong Kong Island.



When completed, the Shatin 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. Another project awarded to us in 2002 was the Kowloon Southern Link, which is a natural extension of our existing West Rail line. This will join West Rail with 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 East Rail.



The Kowloon Southern Link project, together with the Shatin to Central Link,
will add another HK$43,500 million to the HK$70,000 million in projects already underway. It will also realize our long term vision of connecting Hong Kong Island, urban Kowloon and the New Territories with a comprehensive railway network.



We realized a net profit of HK$94 million from our property
development at Hung Hom Bay in 2002. In support of the Governments announcement of a moratorium on land sales in November 2002, we have withheld inviting further tenders for our property development projects until the end of 2003 when a
decision to lift the control measures on land sales is expected to be made by the Government. We do not expect our income to be seriously affected by the Governments decision. Our main source of revenue has always been and will continue to be
fares. The receipts from property developments are one-off in nature and are not a dependable long-term stable source of revenue for us. Moreover, we will only obtain profits from those developments to be built along East Rail, Light Rail and the Ma
On Shan Rail.



48



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##### Table of Contents

##### Index to Financial Statements

In the case of the property sites along the alignment of West Rail Phase I, we will act only as the agent
of the Government in its development. Subsidiaries of West Rail Property Development Limited (WRPDL) have been formed to implement the property developments along West Rail Phase I route whereby the Government will receive the profits,
if any, from each development and we will earn management fees. In April 2003, we offered to our retail tenants whose business was badly hit by the outbreak of atypical pneumonia a rental concession of up to 50% for three months starting from May
2003. We estimate that the rental concession scheme would lead to a loss of rental revenue of up to HK$56 million. We expect our revenue from property ownership and management from 2003 to 2005 to be higher than 2002 due to additional income
generated from our commercial portfolio along West Rail, TST Extension and Ma On Shan Rail



Our fare revenue from our passenger services, as compared with the corresponding period in the previous year, has decreased from February 2003 to May 2003. The decrease was mainly attributable to the recent outbreak
of atypical pneumonia in Guangzhou and Hong Kong. As a consequence, the outbreak of atypical pneumonia is currently having a negative impact on patronage in 2003. Patronage is expected to gradually return to a level before the atypical pneumonia
outbreak after the effect of the outbreak has abated. We did not raise our fares in the last five years and do not expect to in 2003. Our fare revenue would be affected by the duration and severity of the atypical pneumonia crisis and our decision
not to raise fares.



The ridership of Light Rail is expected to
increase towards the end of 2003 when the extensions to Tin Shui Wai are open for service and when West Rail commences operations and the Light Rail becomes a major feeder to West Rail in north-western New Territories.



The Managing Board has decided to consolidate all transport operations into a
single Transport Division, which will be implemented in phases from the beginning of May 2003 and be completed in time for the commencement of West Rail operations. The restructuring is expected to meet changing operational requirements and enhance
cost efficiency.



Given our decision to freeze
fares in 2002, we have reduced expenditure to compensate for the loss of revenue such as reducing non-critical expenses and cut in staff remuneration and benefits. The scope for further cost cutting to hold down fares is, however, limited if
services and safety standards are not to be compromised, or the completion of new projects is not to be delayed.



ITEM 6.    DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES



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 the Corporation 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 the Corporation, and the Chairman leads
the Managing Board in addressing the strategic, policy and development issues of the Corporation. The Chairman and eight other members of our Managing Board do not have service contracts with us and do not have benefits upon termination of
appointment.



49



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##### Table of Contents

##### Index to Financial Statements

Several committees have been formed to assist the Board and supervise specific aspects of the
Corporation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.



During the year the
terms of appointment of six members expired, namely, Mr Denys Connolly, Mr Tim Chung Shui-ming, Mr Edmond Lau Ting-chung, Mr Vincent Cheng Hoi-chuen, Mr Vincent Lo Wing-sang and Mr Keith Lam Hon-keung. Mr Vincent Cheng Hoi-chuen and Mr Vincent Lo
Wing-sang were reappointed for a further two years from 16 November 2002 and 24 December 2002 respectively. Four new Members were appointed for a term of two years, namely, Mr Wan Man-yee from 16 November 2002, Mr Patrick B Paul and Mr Patrick Wang
Shui-chung, both from 24 December 2002, and Mr Victor So Hing-woh from 15 January 2003. The two ex-officio Members were also replaced as a result of the Government introducing the Principal Officials Accountability System on 24 June 2002. Miss
Denise Yue, the former Secretary for the Treasury, was replaced by Mr Frederick Ma Si-hang, the Secretary for Financial Services and the Treasury, and Mr Nicholas Ng Wing-fui, the former Secretary for Transport, was replaced by Dr Sarah Liao
Sau-tung, the Secretary for the Environment, Transport and Works.



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



|Members of the Managing Board                                                                                                                                                                                            |  | Principal Outside Functions                                                                                                                                                                                                                                                                                                                                                     |  | MemberSince |  | Current TermExpires
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------- |  | -------------------
|Michael P.S. Tien, BBS, JP(1)(2) Chairman Chairman of Strategic Human Resource
Committee                                                                                                                                 |  | Chairman of The G2000 Group since 1979, Chairman of the Standing Committee on Language Education and Research, and Chairman of the 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 December2003    
|K.Y. Yeung, CBE, JP(2)(3) Chief Executive Officer (Chairman and Chief Executive from
24 December 1996 to 23 December 2001) Member of Finance Committee Member of Capital Projects Committee Member of Property Committee |  | Member of the Advisory Board of the Hong Kong Red Cross Society, Director of the Community Chest of Hong Kong and Chairman of the Hong Kong Vocational Training Council.                                                                                                                                                                                                        |  | 1996        |  | 23 December2003    
|Vincent 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 November2004    



50



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##### Table of Contents

##### Index to Financial Statements

|Members of the Managing Board                                                                                                                   |  | Principal Outside Functions                                                                                                                                                                                                                                                                                                                                                                          |  | MemberSince |  | Current TermExpires
|----------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------- |  | -------------------
|Vincent 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, Member of the Consumer Legal Action Fund Management Committee, the Inland Revenue Appeal Board, the Red Cross Council and the Lotteries Fund Advisory Committee. |  | 1999        |  | 23 December2004    
|Patrick B. Paul, CBE(3) Chairman of Audit Committee Member of Strategic Human
Resource     Committee                                            |  | Director of Johnson Electric Holdings Ltd. and Kingway International Holdings Ltd.                                                                                                                                                                                                                                                                                                                   |  | 2002        |  | 23 December2004    
|Victor H.W. So, MBE, JP(2)(3) Member of Capital Projects Committee Member of Finance
Committee Member of Strategic Human Resource
    Committee |  | Executive Director of Sun Hung Kai Properties Ltd., Chairman of Housing Managers Registration Board, Council Member of Employers Federation of Hong Kong, Member of Corruption
Prevention Advisory Committee and Co-opted Member of Historical Buildings & Structures Committee of the Antiquities Advisory Board.                                                                                  |  | 2003        |  | 14 January2005     
|Patrick S.C. Wang, JP(2)                                                                                                                        |  | Chairman and Chief Executive of Johnson Electric Industrial Manufactory Ltd., Member of the Exchange Fund Advisory Committee, General Committee Member of The Hong Kong General
Chamber of Commerce, Council member of The Chinese University of Hong Kong and The University of Hong Kong.                                                                                                          |  | 2002        |  | 23 December2004    
|M.Y. Wan, BBS, JP(1)(2) Chairman of Capital Projects Committee Member of Audit
Committee Member of Property Committee                           |  | Director of M Y Wan and Associates Limited, Member of Hong Kong Housing Society Supervisory Board, Elderly Commission, Panel Member of Municipal Services Appeals Board, President of
Youth Outreach. Council Member of Hong Kong Federation of Youth Groups, Manager of Chi Lin Buddhist Secondary School (SOS).                                                                                    |  | 2002        |  | 15 November2004    
|Sarah S.T. Liao, JP(2) Member of Capital Projects Committee Member of Strategic
Human Resource     Committee                                    |  | Secretary for the Environment, Transport and Works, the Government of the Hong Kong Special Administrative Region (ex officio)                                                                                                                                                                                                                                                                       |  | 2002        |  | No expiry          



51



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##### Index to Financial Statements

|Members of the Managing Board                                                                                                                                                                     |  | Principal Outside Functions                                                                                                   |  | MemberSince |  | CurrentTermExpires
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------- |  | ----------- |  | ------------------
|Frederick S.H. Ma, JP(2) Member of Audit Committee 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        |  | Noexpiry          

---

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

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

|(3) |  | The abbreviation CBE means Commander of the Most Excellent Order of the British Empire, the abbreviation OBE means Officer of the Most
Excellent Order of the British Empire and the abbreviation of MBE means member 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.



|Members of Senior Management |  | Position                                                                                         |  | PositionHeldSince
|---------------------------- |  | ------------------------------------------------------------------------------------------------ |  | -----------------
|K.Y. Yeung, CBE, JP(1)(2)(a) |  | Chief Executive Officer (Chairman and
Chief Executive from 24 December 1996 to 23 December 2001) |  | 2001             
|James Blake, OBE, JP(1)(2)   |  | Senior Director, Capital Projects                                                                |  | 1997             
|Samuel M.H. Lai(b)           |  | Senior Director, Finance and Management                                                          |  | 2000             
|K.K. Lee                     |  | Director, East Rail Extensions                                                                   |  | 1999             
|Ian M. Thoms                 |  | Director, West Rail                                                                              |  | 1998             
|Jonathan H.G. Yu, JP.(2)     |  | Director, Light Rail                                                                             |  | 1989             
|Daniel C. Lam, BBS, JP(2)(3) |  | Director, Property                                                                               |  | 2000             
|Kenneth K. S. Leung, SBS(3)  |  | Director, New Railway Projects                                                                   |  | 2000             
|Y.T. Li(c)                   |  | Director, East Rail                                                                              |  | 2001             
|David A. Fleming             |  | Company Secretary                                                                                |  | 1997             

---

|(1) |  | 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.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | 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.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | 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) |  | Mr. K.Y. Yeung will proceed on end of contract leave on 24 October 2003.
|--- |  | ------------------------------------------------------------------------

|(b) |  | The Managing Board has decided, with the prior approval of the Chief Executive of Hong Kong,
to appoint Mr. Samuel M.H. Lai as the Acting Chief Executive Officer with effect from 24 October 2003, when Mr. K.Y. Yeung will proceed on end of contract leave. Also on 24 October 2003, the post of Senior Director, Finance and Management will be
vacated and a new post of Director, Finance and Management will be created.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(c) |  | The Managing Board has decided to consolidate all transport operations into a single
Transport Division. The restructuring will take effect in phases from the beginning of May 2003 and be completed in time for the commencement of West Rail operations. The post of the Head of Transport Division will be filled by Mr. Y.T. Li,
currently Director, East Rail, who will act as Senior Director, Transport until a further decision is taken by the Managing Board.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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.



COMPENSATION



The aggregate compensation paid by KCRC to all members of the Managing Board
and senior management as a group for 2002 was HK$41 million (US$5.3 million). There were no retirement or severance benefits for members of the Managing Board except for the Chief Executive Officer.



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. The Corporation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, Victor H.W. So, Fredrick S.H. Ma and K.Y. Yeung and the expert member is Alfred H.K. Li. This committee is
chaired by Vincent H.C. Cheng.



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 Frederick S.H. Ma. This committee is chaired by Patrick B. Paul.



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, Victor H.W. So, 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.



EMPLOYEES



We employed 5,510 total full-time staff as of December 31, 2002. We had 1,681 contract staff, generally with a contract term of two years, hired for West Rail Phase I and East Rail Extensions, the Kowloon Southern
Link and the Shatin 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 East Rail Extensions. We hired 569 new staff in 2002,
including 258 for the West Rail Division and 95 for the East Rail Extensions Division. Of a total of 1,715 operating staff, 797 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 Light Rail Division Staff 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.



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Our Human Resource Department continuously analyzes, improves and synchronizes our human resources
planning and practices with our business needs. We emphasize the importance of training and development, and endeavour 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 2002 was approximately 4.3%. 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



MAJOR SHAREHOLDER



The Government is our sole shareholder. As of December 31, 2002, the Financial Secretary Incorporated for and on behalf of the Government owns 391,200
shares of the Corporation, which represents 100% of our total shares outstanding.



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



RELATED PARTY
TRANSACTIONS



East Rail Extensions Project
Agreement



On February 28, 2003, we entered into the
above 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 the 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 the Ma On Shan Rail and to bring them into operation by 2004 and 2005 respectively.



The Government, subject to the final approval of the Chief Executive in Council or the Director of Lands, has agreed to grant us 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 depot. 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 rateable 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.



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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 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



We have made investments in debt securities issued by
the Government and Government-owned entities in Hong Kong with a total market value of HK$219 million as at December 31, 2002. In January 2002, the market value of the maximum investment balance in Government and Government-owned entities amounted
to HK$468 million. The market value of the unaudited investment balance as of May 22, 2003 amounted to HK$424 million. Interest income derived from these debt securities in 2002 amounted to HK$11 million. The unaudited interest income for the period
from January 1, 2003 to May 22, 2003 amounted to HK$6 million.



Octopus Cards Limited



In 2002, we made
payments of HK$30 million to Octopus Cards Limited, of which we hold 22.1% of its shares, in respect of transaction and interchange fees for handling of Octopus tickets. These payments were made based on the usage of and revenue generated from
Octopus tickets. No other charges were made or incurred by us in respect of the administration of the Octopus Cards system. We received HK$6 million from Octopus Cards Limited in respect of ticket loading agent fees for providing add-value amounts
on Octopus tickets.



Shareholding in and Loan to WRPDL



On February 24, 2000, we entered into a shareholding
agreement with the Government for the formation of a sub-group of the Corporation under an intermediate holding company, 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 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 the 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.



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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 the Corporation and the Government. In 2003, the Government has in principle agreed
to include such costs and the related accrued interest in the loan to WRPDL. However, the exact amount to be included in the loan account is still subject to finalization.



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.



ITEM 8.     FINANCIAL INFORMATION



See Item 17. Financial Statements and pages F-1 through F-52.



LEGAL PROCEEDINGS



At
as December 31, 2002, 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 at December 31, 2002. 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 40 to our audited consolidated financial
statements.



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 2003, we declared a dividend of HK$620 million, representing 23.3% of our 2002 profit after taxation.



SIGNIFICANT CHANGES



Our fare revenue from our passenger services, as compared with the
corresponding periods in the previous year, has decreased from February 2003 to May 2003. The decrease was mainly attributable to the recent outbreak of atypical pneumonia in Guangzhou and Hong Kong. As a consequence, the outbreak of atypical
pneumonia is currently having a negative impact on the patronage in 2003. Patronage is expected to gradually return to a level before the atypical pneumonia outbreak after the effect of the outbreak has abated.



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ITEM 9.    THE OFFER AND LISTING



LISTING DETAILS



The stock of KCRC is not listed on
any market.



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



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 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 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 the Corporation.



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 the Corporation
subject to the prior approval of the Chief Executive of Hong Kong.



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



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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 the Corporation. The Chief Executive Officer is responsible for the day to day management and operation of the
Corporation, and the Chairman leads the Managing Board in addressing the strategic, policy and development issues of the Corporation. 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 the Corporation or a subsidiary of the Corporation
which is brought up for consideration by the Corporation must disclose the nature of his interest at a meeting of the Corporation. The disclosure shall be recorded in the minutes of the Corporation, and the member shall not without the permission of
the Chairman take any part in any deliberation of the Corporation with respect to that contract and shall not in any event vote on any question concerning it.



Under the KCRC Ordinance, the Corporation may, as it thinks fit, borrow or otherwise raise money and charge all or any part of its property as
security. The Corporation may also create and issue bonds, notes or other securities which may be charged on the property, undertaking and revenue of the Corporation. The Managing Board is the governing body of the Corporation 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 the Corporation shall pay to the members of the Managing Board. The quorum of the Corporation 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 is no corporate or shareholder documents that set forth the voting rights of the shareholder or rights,
preferences and restrictions with respect to our shares.



Under
the KCRC Ordinance, the Financial Secretary of the Government may, after consulting the Corporation, increase the authorized capital of the Corporation. Shares in the authorized capital of the Corporation 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 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 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.



MATERIAL CONTRACTS



On January 18, 2001, the Corporation and Maeda Corporation entered into a
Civil Construction Contract (TCC-400) for the construction of the Tai Wai station included in the East Rail Extensions. The contractor agrees to execute the construction and the Corporation covenants to pay to the contractors the contract sums in
accordance with the contract. The contract price has been filed separately with the Commission pursuant to an application for confidential treatment.



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On January 18, 2001, the Corporation and NECSO Entrecanales Cubiertas, S.A. and China State Construction
Engineering Corporation entered into a Civil Construction Contract (TCC-200) for the construction of a railway from Tai Wai to Shek Mun included in the East Rail Extensions. The contractors agree to execute the construction and the Corporation
covenants to pay to the contractors the contract sums in accordance with the contract. The contract price has been filed separately with the Commission pursuant to an application for confidential treatment.



On January 18, 2001, the Corporation and NECSO Entrecanales Cubiertas, S.A.
and China State Construction Engineering Corporation entered into a Civil Construction Contract (TCC-300) for the construction of a railway from Shek Mun to Lee On included in the East Rail Extensions. The contractors agree to execute the
construction and the Corporation covenants to pay to the contractors the contract sums in accordance with the contract. The contract price has been filed separately with the Commission pursuant to an application for confidential treatment.



On January 18, 2001, the Corporation and Itochu Corporation,
The Kinki Sharyo Co. Ltd. and Kawasaki Heavy Industries, Ltd. entered into a Electric Multiple Units Contract (SP-1950) for the procurement of EMUs for the Ma On Shan Rail. Under the terms and conditions of the contract, the contractors have agreed
to manufacture, deliver and commission into service railway rolling stock consisting of EMUs for use on the Ma On Shan Rail. The contract price has been filed separately with the Commission pursuant to an application for confidential treatment.



Pursuant to a Letter of Acceptance dated January 16, 2001, the
Corporation accepted the tender submitted by Gammon Construction Limited for the construction of the Tai Wai Depot (TCC-500) included in the East Rail Extensions. Under the Letter of Acceptance, the contractor agrees to execute construction of the
project in accordance with the terms and conditions of the Letter of Clarification, General Conditions of Contract, Special Conditions of Contract, Articles of Agreement, Form of Tender, Drawings and Specification. The tender price has been filed
separately with the Commission pursuant to an application for confidential treatment.



Pursuant to a Letter of Acceptance dated January 19, 2001, the Corporation accepted the tender submitted by Leighton Contractors (Asia) Ltd. for the construction of permanent way, traction power and overhead line
system for the connection between the Light Rail system and West Rail Phase 1 (CC-230). Under the Letter of Acceptance, the contractor agrees to execute construction of the project in accordance with the terms and conditions of the Letter of
Clarification, General Conditions of Contract, Special Conditions of Contract, Articles of Agreement, Form of Tender, Drawings and Specification. The tender price has been filed separately with the Commission pursuant to an application for
confidential treatment.



Pursuant to a Letter of Acceptance
dated March 9, 2001, the Corporation accepted the tender submitted by Gammon Construction Limited and Nishimatsu Construction Co., Ltd. for the construction of the East Tsim Sha Tsui station included in the East Rail Extensions (HCC-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 tender price has been filed separately with the Commission pursuant to an application for confidential treatment.



Pursuant to a Letter of Acceptance dated March 9, 2001, the Corporation accepted the tender submitted by Gammon Construction
Limited for the construction of a tunnel between Hung Hom and Tsim Sha Tsui included in the East Rail Extensions (HCC-301). 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 tender price has been filed separately with the Commission pursuant to
an application for confidential treatment.



Pursuant to a
Letter of Acceptance dated March 9, 2001, the Corporation accepted the tender submitted by Gammon Construction Limited and Nishimatsu Construction Co., Ltd. for the construction of a pedestrian subway to MTR Tsim Sha Tsui station included in the
East Rail Extensions (HCC-302). 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 tender price has been filed separately with the Commission pursuant to an application for confidential treatment.



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Pursuant to a Letter of Acceptance dated March 21, 2001, the Corporation accepted the tender submitted by
Foxboro Australia Pty Limited for the installation of integrated control and communications systems for the East Rail Extensions (DB-1550). 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 tender price has been filed separately with the
Commission pursuant to an application for confidential treatment.



Pursuant to a Letter of Acceptance dated April 11, 2001, the Corporation accepted the tender submitted by Siemens Limited for the supply and installation of communications systems software for the stations and depots included in the East
Rail Extensions (DB-1552). 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 tender price has been filed separately with the Commission pursuant to an application for confidential treatment.



Pursuant to a Letter of Acceptance dated April 25, 2001, the Corporation
accepted the tender submitted by Alcatel Canada Inc. for the installation of signaling and train control equipment for the Ma On Shan Rail, which includes the main line and Tai Wai depot included in the East Rail Extensions (DB-1320). 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 tender price has been filed separately with the Commission pursuant to an application for confidential treatment.



Pursuant to a Letter of Acceptance dated April 25, 2001, the Corporation accepted the tender submitted by Chun Wo
Construction & Engineering Co., Ltd., Henryvicy Construction Company Limited and China Railway Construction Corporation for the construction of the East Rail Extension permanent way (CC-1850). The permanent way contract covers the track
installation along the three East Rail Extensions (Ma On Shan Rail, Lok Ma Chau spur line and TST Extension). 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 tender price has been filed separately with the Commission pursuant to an
application for confidential treatment.



Pursuant to a Letter
of Acceptance dated July 20, 2001, the Corporation accepted the tender submitted by Siemens Limited for the supply and installation of a new signaling system for the existing Light Rail network and the interchanges between Light Rail and West Rail
Phase I, which includes the extensions to Tin Shui Wai (DB-2040). 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 tender price has been filed separately with the Commission pursuant to an application for confidential treatment.



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Pursuant to the Deed of Vesting dated January 2, 2002, the Corporation acquired the Lo Wu Terminal
Building Stage III from the Government.



Pursuant to the East
Rail Extensions Project Agreement dated February 28, 2003, the Government awarded to the Corporation 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 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 depot. The
Government and the Corporation 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.



Pursuant to a Letter of Acceptance dated October 28, 2002, the Corporation
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, the Corporation
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 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, the Corporation
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 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.



Pursuant to a Letter of Acceptance dated October 30, 2002, the Corporation
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.



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Pursuant to a Letter of Acceptance dated December 17, 2002, the Corporation 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.



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.



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.



Hong Kong Taxation



Under Hong Kong law as in effect on the date of this
Annual Report, neither we nor any paying agent will be required to declare 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 or of any subsequent transfer, provided that
the Notes 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
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| | (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.
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



62



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##### Index to Financial Statements

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 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 purchased the Notes. The discussion does not address all aspects of U.S. federal income taxation that may be
relevant to a particular holder in light of their individual circumstances or to certain types of holders subject to special treatment, such as certain financial institutions, insurance companies, tax-exempt organizations, dealers, traders in
securities who elect to mark to market, or persons who hold the Notes as part of a hedging transaction, straddle, conversion or other integrated transaction.



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.



63



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##### Index to Financial Statements

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 par and, accordingly, the Notes 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.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



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 up to a maximum rate of 30% (subject to reduction through 2006). 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.



64



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##### Index to Financial Statements

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 rate and foreign exchange 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 contracts to reduce or eliminate interest rate and foreign exchange risks associated with changing cash flows and market interest rate and foreign exchange movements. Interest rate risk occurs when interest rate sensitive assets
and debts do not reprice simultaneously and in equal magnitude.



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



The following presents information regarding our market risk exposures as of December 31, 2002. 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, GBP are to the Pound Sterling, and NZD are to the New Zealand dollar.



65



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##### Index to Financial Statements

Interest Rate Risk



For investment securities and debt instruments, the following tables present principal cash flows and related weighted average interest rates by expected
maturity dates as of December 31, 2001 and 2002. The information is presented in Hong Kong dollars, which is our reporting currency. The instruments actual cash flows are denominated in the currencies indicated below.



|                        |  | As of December 31, 2002 Expected Maturity Date          |   |  | As of December 31,2001 |  
|----------------------- |  | ------------------------------------------------------- | - |  | ---------------------- | -
|                        |  | 2003                                                    |   |  | 2004                   |  
|                        |  | (HK$ equivalent in millions, other than interest rates) |  
|Investment securities:  |  |                                                         |   |  |                        |  
|Fixed rate:             |  |                                                         |   |  |                        |  
|Principal amount (HK$)  |  | 9,264                                                   |   |  | 1,243                  |  
|Average interest rate   |  | 4.4                                                     | % |  | 2.9                    | %
|Principal amount (US$)  |  | 4,551                                                   |   |  | 537                    |  
|Average interest rate   |  | 5.3                                                     | % |  | 5.4                    | %
|Principal amount (CAD)  |  |                                                        |   |  |                       |  
|Average interest rate   |  |                                                         |   |  |                        |  
|Principal amount (EUR)  |  |                                                        |   |  |                       |  
|Average interest rate   |  |                                                         |   |  |                        |  
|Variable rate:          |  |                                                         |   |  |                        |  
|Principal amount (HK$)  |  |                                                        |   |  |                       |  
|Average interest rate   |  |                                                         |   |  |                        |  
|Principal amount (US$)  |  | 205                                                     |   |  | 376                    |  
|Average interest rate   |  | 1.6                                                     | % |  | 1.8                    | %
|Debt instruments:       |  |                                                         |   |  |                        |  
|Fixed rate:             |  |                                                         |   |  |                        |  
|Medium term note        |  |                                                         |   |  |                        |  
|Principal amount(US$)   |  |                                                        |   |  |                       |  
|Average interest rate   |  |                                                         |   |  |                        |  
|Global note             |  |                                                         |   |  |                        |  
|Principal amount(US$)   |  |                                                        |   |  |                       |  
|Average interest rate   |  |                                                         |   |  |                        |  
|Export credit loan      |  |                                                         |   |  |                        |  
|Principal amount (US$)  |  |                                                        |   |  |                       |  
|Average interest rate   |  |                                                         |   |  |                        |  
|Variable rate:          |  |                                                         |   |  |                        |  
|Export credit loan      |  |                                                         |   |  |                        |  
|Principal amount (US$)  |  | (310                                                    | ) |  | (348                   | )
|Average interest rate   |  | 2.3                                                     | % |  | 2.2                    | %
|Interest rate swaps(1): |  |                                                         |   |  |                        |  
|Variable to fixed rate: |  |                                                         |   |  |                        |  
|Notional amount (HK$)   |  |                                                        |   |  |                       |  
|Interest pay rate       |  |                                                         |   |  |                        |  
|Interest receive rate   |  |                                                         |   |  |                        |  
|Fixed to variable rate: |  |                                                         |   |  |                        |  
|Notional amount (US$)   |  |                                                        |   |  |                       |  
|Interest pay rate       |  |                                                         |   |  |                        |  
|Interest receive rate   |  |                                                         |   |  |                        |  

---

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



66



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##### Index to Financial Statements

Foreign Exchange Risk



The tables below provide information about our investment securities, debt instruments and derivative financial instruments and presents such information
in Hong Kong dollars. The tables summarize information on investment securities, debt instruments and foreign exchange agreements that are sensitive to foreign currency exchange rates. For investment securities, the tables present principal cash
flows and related weighted average interest rates by expected maturity dates as of December 31, 2001 and 2002. For foreign currency exchange agreements, the tables present notional amounts and weighted average exchange rates by 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, 2002 Expected Maturity Date                             |   |  | As of December 31, 2001 |  
|------------------------------------- |  | -------------------------------------------------------------------------- | - |  | ----------------------- | -
|                                      |  | 2003                                                                       |   |  | 2004                    |  
|                                      |  | (HK$ equivalent in millions, other than interest rates and exchange rates) |  
|Investment securities:                |  |                                                                            |   |  |                         |  
|Fixed rate:                           |  |                                                                            |   |  |                         |  
|US$                                   |  |                                                                            |   |  |                         |  
|Principal amount                      |  | 4,551                                                                      |   |  | 537                     |  
|Average interest rate                 |  | 5.3                                                                        | % |  | 5.4                     | %
|CAD                                   |  |                                                                            |   |  |                         |  
|Principal amount                      |  |                                                                           |   |  |                        |  
|Average interest rate                 |  |                                                                            |   |  |                         |  
|EUR                                   |  |                                                                            |   |  |                         |  
|Principal amount                      |  |                                                                           |   |  |                        |  
|Average interest rate                 |  |                                                                            |   |  |                         |  
|Variable rate:                        |  |                                                                            |   |  |                         |  
|Principal amount                      |  | 205                                                                        |   |  | 376                     |  
|Average interest rate                 |  | 1.6                                                                        | % |  | 1.8                     | %
|Debt instruments:                     |  |                                                                            |   |  |                         |  
|Fixed rate:                           |  |                                                                            |   |  |                         |  
|Medium term note                      |  |                                                                            |   |  |                         |  
|Principal amount (US$)                |  |                                                                           |   |  |                        |  
|Average interest rate                 |  |                                                                            |   |  |                         |  
|Global note                           |  |                                                                            |   |  |                         |  
|Principal amount (US$)                |  |                                                                           |   |  |                        |  
|Average interest rate                 |  |                                                                            |   |  |                         |  
|Export credit loan                    |  |                                                                            |   |  |                         |  
|Principal amount (US$)                |  |                                                                           |   |  |                        |  
|Average interest rate                 |  |                                                                            |   |  |                         |  
|Variable rate:                        |  |                                                                            |   |  |                         |  
|Export credit loan                    |  |                                                                            |   |  |                         |  
|Principal amount (US$)                |  | (310                                                                       | ) |  | (348                    | )
|Average interest rate                 |  | 2.3                                                                        | % |  | 2.2                     | %
|Foreign exchange agreements:          |  |                                                                            |   |  |                         |  
|Receive AUD/pay HK$                   |  |                                                                           |   |  |                        |  
|Average contractual exchange rate     |  |                                                                            |   |  |                         |  
|Receive CAD/pay HK$                   |  | 0.8                                                                        |   |  |                        |  
|Average contractual exchange rate     |  | 5.0                                                                        |   |  |                         |  
|Receive CHF/pay HK$                   |  | 31.9                                                                       |   |  |                        |  
|Average contractual exchange rate     |  | 4.7                                                                        |   |  |                         |  
|Receive EUR/pay HK$                   |  | 126.1                                                                      |   |  | 21.8                    |  
|Average contractual exchange rate     |  | 7.1                                                                        |   |  | 7.5                     |  
|Receive GBP/pay HK$                   |  | 7.2                                                                        |   |  |                        |  
|Average contractual exchange rate     |  | 11.9                                                                       |   |  |                         |  
|Receive US$/pay HK$                   |  | 154.9                                                                      |   |  |                        |  
|Average contractual exchange rate     |  | 7.8                                                                        |   |  |                         |  
|Receive US$/pay CAD                   |  |                                                                           |   |  |                        |  
|Average contractual exchange rate     |  |                                                                            |   |  |                         |  
|Receive US$/pay EUR                   |  |                                                                           |   |  |                        |  
|Average contractual exchange rate     |  |                                                                            |   |  |                         |  
|Receive US$/pay NZD                   |  |                                                                           |   |  |                        |  
|Average contractual exchange rate     |  |                                                                            |   |  |                         |  
|Receive CAD/pay US$                   |  |                                                                           |   |  |                        |  
|Average contractual exchange rate     |  |                                                                            |   |  |                         |  
|Receive EUR/pay US$                   |  |                                                                           |   |  |                        |  
|Average contractual exchange rate     |  |                                                                            |   |  |                         |  
|Receive NZD/pay US$                   |  |                                                                           |   |  |                        |  
|Average contractual exchange rate     |  |                                                                            |   |  |                         |  
|Currency Swap                         |  |                                                                            |   |  |                         |  
|Notional amount (Receive US$/pay HK$) |  |                                                                           |   |  |                        |  
|Average interest rate                 |  |                                                                            |   |  |                         |  

---

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



67



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##### Index to Financial Statements

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 year end. 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. In 2002, we entered into currency swaps to hedge the currency exposure of the Notes, resulting in a material change in the foreign exchange exposure from currency swaps.



ITEM 12.    DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES



Not applicable.



PART II



ITEM 13.    DEFAULT, DIVIDEND ARREARAGES AND DELINQUENCIES



None.



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



None.



ITEM 15.    CONTROLS AND PROCEDURES



Our Chief Executive Officer and our Senior Director, Finance and Management, have 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) within 90 days of the filing date of this annual report. Based on the evaluation, under the supervision and with the participation of our management, they have concluded that these disclosure controls and
procedures are effective.



There were no significant changes in
our internal controls or other factors that could significantly affect these disclosure controls and procedures, nor were there any significant deficiencies or material weaknesses in our internal controls subsequent to the date our Chief Executive
Officer and our Senior Director, Finance and Management completed their evaluation. As a result, no corrective actions were required or undertaken.



68



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##### Index to Financial Statements

ITEM 16.    [RESERVED]



PART III



ITEM 17.    FINANCIAL STATEMENTS



See pages F-1 through F-52 incorporated herein by reference.



ITEM 18.    FINANCIAL STATEMENTS



The Corporation has responded to Item 17 in lieu of responding to this Item.



ITEM 19.    EXHIBITS



|       | 
|------ | 
|*1.1   | 
|       | 
|*1.2   | 
|       | 
|*1.3   | 
|       | 
|1.4    | 
|       | 
|***1.5 | 
|       | 
|*2.1   | 
|       | 
|**2.2  | 
|       | 
|**4.1 | 
|       | 
|**4.2 | 
|       | 
|**4.3 | 
|       | 
|**4.4 | 
|       | 
|**4.5 | 
|       | 
|**4.6 | 



69



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##### Index to Financial Statements

|         | 
|-------- | 
|**4.7   | 
|         | 
|**4.8   | 
|         | 
|**4.9   | 
|         | 
|**4.10  | 
|         | 
|**4.11  | 
|         | 
|**4.12  | 
|         | 
|**4.13  | 
|         | 
|***4.14 | 
|         | 
|***4.15  | 
|         | 
|4.16    | 
|         | 
|4.17    | 
|         | 
|4.18    | 
|         | 
|4.19    | 
|         | 
|4.20    | 
|         | 
|4.21    | 
|         | 
|6.1      | 
|         | 
|8.1      | 
|         | 
|99.1     | 
|         | 
|99.2     | 



70



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##### Index to Financial Statements

---

|* |  | 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)
|--- |  | --------------------------------------------------------------------------------------------------------------------

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







71



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##### Index to Financial Statements

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

OF

KOWLOON-CANTON RAILWAY CORPORATION



Audited Consolidated Financial Statements



|                                                                                                  | 
|------------------------------------------------------------------------------------------------- | 
|Independent Auditors Report                                                                      | 
|                                                                                                  | 
|Consolidated Income Statements for the years ended December 31, 2000, 2001 and 2002               | 
|                                                                                                  | 
|Consolidated Balance Sheets as of December 31, 2001 and 2002                                      | 
|                                                                                                  | 
|Consolidated Statements of Changes in Equity for the years ended December 31, 2000, 2001 and 2002 | 
|                                                                                                  | 
|Consolidated Cash Flow Statements for the years ended December 31, 2000, 2001 and 2002            | 
|                                                                                                  | 
|Notes to Audited Consolidated Financial Statements                                                | 



---

##### Table of Contents

##### Index to Financial Statements

INDEPENDENT AUDITORS REPORT



Members of the
Managing Board

Kowloon-Canton Railway Corporation:



We have audited the accompanying consolidated balance sheets of Kowloon-Canton Railway Corporation and its subsidiaries (the Group) as of
December 31, 2001 and 2002, the consolidated statements of changes in equity for the years ended December 31, 2001 and 2002, and the related consolidated income statements and cash flow statements for each of the years in the three-year period ended
December 31, 2002. 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 United States of America. 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, 2001 and 2002, and
the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in Hong Kong.



Accounting principles generally accepted in Hong Kong vary in certain
significant respects from accounting principles generally accepted in the United States of America. Application of accounting principles generally accepted in the United States of America would have affected the consolidated profit for each of the
years in the three-year period ended December 31, 2002 and shareholders funds as of December 31, 2001 and 2002, to the extent summarized in note 42 to the consolidated financial statements.



The accompanying consolidated financial statements as of and for the year
ended December 31, 2002 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(z) to the consolidated financial statements.



KPMG

Hong Kong

February 20, 2003



F-2



---

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##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



CONSOLIDATED INCOME STATEMENTS



|                                                     |  |      |     |  | Year Ended December 31, |  
|---------------------------------------------------- |  | ---- | --- |  | ----------------------- | -
|                                                     |  | Note |     |  | 2000                    |  
|                                                     |  |      |     |  |                         |  
|                                                     |  |      |     |  | HK$                     |  
|                                                     |  |      |     |  | (in millions)           |  
|Revenue                                              |  | 5    |     |  | 4,731                   |  
|Operating costs                                      |  | 5    |     |  | 2,830                   |  
|                                                     |  |      |     |  |                         |  
|Operating profit before net investment income        |  | 5    |     |  | 1,901                   |  
|Net investment income                                |  | 6    |     |  | 302                     |  
|                                                     |  |      |     |  |                         |  
|Profit after net investment income                   |  |      |     |  | 2,203                   |  
|Profit on property development                       |  | 7    |     |  | 87                      |  
|Share of (loss)/profit of associate                  |  |      |     |  | (1                      | )
|                                                     |  |      |     |  |                         |  
|Profit before taxation                               |  |      |     |  | 2,289                   |  
|Taxation                                             |  | 8    | (a) |  | (1                      | )
|                                                     |  |      |     |  |                         |  
|Profit after taxation                                |  | 9    |     |  | 2,288                   |  
|Transfer to development reserve                      |  | 30   |     |  | (87                     | )
|                                                     |  |      |     |  |                         |  
|Retained profit for the year                         |  |      |     |  | 2,201                   |  
|                                                     |  |      |     |  |                         |  
|Dividend attributable to the year:                   |  |      |     |  |                         |  
|Final dividend proposed after the balance sheet date |  | 10   |     |  |                        |  
|                                                     |  |      |     |  |                         |  



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



F-3



---

##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



CONSOLIDATED BALANCE SHEETS



|                                                    |  |      |  | As of December 31,
|--------------------------------------------------- |  | ---- |  | ------------------
|                                                    |  | Note |  | 2001              
|                                                    |  |      |  | Restated          
|                                                    |  |      |  | HK$               
|                                                    |  |      |  | (in millions)     
|Assets                                              |  |      |  |                   
|Fixed assets                                        |  |      |  |                   
|Investment properties                              |  | 12   |  | 940               
|Other properties, plant and equipment              |  | 12   |  | 12,805            
|                                                    |  |      |  |                   
|                                                    |  |      |  | 13,745            
|Construction in progress                            |  | 13   |  | 26,939            
|Deferred expenditure                                |  | 14   |  | 4,216             
|Properties under development                        |  | 15   |  | 739               
|Interest in associate                               |  | 17   |  | 23                
|Loan to subsidiary                                  |  | 18   |  | 1,316             
|Investments in securities                           |  | 19   |  | 27,752            
|Stores and spares                                   |  | 20   |  | 186               
|Properties held for resale                          |  | 41   |  | 11                
|Interest receivable                                 |  | 21   |  | 709               
|Other receivables                                   |  | 22   |  | 428               
|Cash and cash equivalents                           |  | 23   |  | 6,473             
|                                                    |  |      |  |                   
|                                                    |  |      |  | 82,537            
|                                                    |  |      |  |                   
|Liabilities                                         |  |      |  |                   
|Interest payable                                    |  | 24   |  | 436               
|Other payables                                      |  | 25   |  | 2,542             
|Accrued charges and provisions for capital projects |  | 26   |  | 2,694             
|Interest-bearing borrowings                         |  | 27   |  | 16,831            
|Deferred income                                     |  | 28   |  | 454               
|                                                    |  |      |  |                   
|                                                    |  |      |  | 22,957            
|                                                    |  |      |  |                   
|Net Assets                                          |  |      |  | 59,580            
|                                                    |  |      |  |                   
|Capital and Reserves                                |  |      |  |                   
|Share capital                                       |  | 29   |  | 39,120            
|Development reserve                                 |  | 30   |  | 6,441             
|Investment property revaluation reserve             |  | 31   |  | 176               
|Investment revaluation reserve                      |  | 32   |  | 133               
|Proposed dividend                                   |  | 10   |  |                  
|Retained profits                                    |  | 33   |  | 13,710            
|                                                    |  |      |  |                   
|                                                    |  |      |  | 59,580            
|                                                    |  |      |  |                   



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



F-4



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY



|                                                                                        |  |      |     |  | Year ended December 31, |  
|--------------------------------------------------------------------------------------- |  | ---- | --- |  | ----------------------- | -
|                                                                                        |  | Note |     |  | 2001                    |  
|                                                                                        |  |      |     |  | Restated                |  
|                                                                                        |  |      |     |  | HK$                     |  
|                                                                                        |  |      |     |  | (in millions)           |  
|Opening balanceTotal equity                                                            |  |      |     |  | 49,126                  |  
|Changes in accounting policy                                                            |  | 4    | (a) |  | (32                     | )
|                                                                                        |  |      |     |  |                         |  
|Restated balance                                                                        |  |      |     |  | 49,094                  |  
|                                                                                        |  |      |     |  |                         |  
|Deficit on revaluation of investment properties                                         |  | 31   |     |  | (66                     | )
|Surplus/(deficit) on revaluation of investments in securities                           |  | 32   |     |  | 131                     |  
|                                                                                        |  |      |     |  |                         |  
|Net gains/(losses) not recognized in the income statement                               |  |      |     |  | 65                      |  
|                                                                                        |  |      |     |  |                         |  
|                                                                                        |  |      |     |  | 49,159                  |  
|Revaluation deficit/(surplus) transferred to income statement on disposal of securities |  | 32   |     |  | (14                     | )
|Retained profit for the year                                                            |  |      |     |  |                         |  
|as previously reported                                                                 |  |      |     |  | 2,412                   |  
|prior period adjustment for change in accounting policy (note 4(a))                    |  |      |     |  | (1                      | )
|Retained profit for the year (2001: as restated)                                        |  |      |     |  | 2,411                   |  
|Transfer to development reserve                                                         |  | 30   |     |  | 24                      |  
|Issue of share capital                                                                  |  | 29   |     |  | 8,000                   |  
|                                                                                        |  |      |     |  |                         |  
|Closing balanceTotal equity                                                            |  |      |     |  | 59,580                  |  
|                                                                                        |  |      |     |  |                         |  



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



F-5



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



CONSOLIDATED CASH FLOW STATEMENTS



|                                                                                  |  |      |     |  | Year Ended December 31, |  
|--------------------------------------------------------------------------------- |  | ---- | --- |  | ----------------------- | -
|                                                                                  |  | Note |     |  | 2000                    |  
|                                                                                  |  |      |     |  | HK$                     |  
|                                                                                  |  |      |     |  | (in millions)           |  
|Operating activities                                                              |  |      |     |  |                         |  
|Net cash inflow from operations                                                   |  | 36   | (a) |  | 2,756                   |  
|Net cash inflow/(outflow) from property development                               |  | 36   | (b) |  | 97                      |  
|Hong Kong profits tax (paid)/refunded                                             |  |      |     |  | (5                      | )
|                                                                                  |  |      |     |  |                         |  
|Net cash inflow from operating activities                                         |  |      |     |  | 2,848                   |  
|                                                                                  |  |      |     |  |                         |  
|Investing activities                                                              |  |      |     |  |                         |  
|Decrease in deposits with banks with more than 3 months of maturity when placed   |  |      |     |  | 4,120                   |  
|Payments to acquire investments                                                   |  |      |     |  | (8,604                  | )
|Payments for capital expenditure                                                  |  |      |     |  |                         |  
|West Rail project                                                                |  |      |     |  | (8,438                  | )
|East Rail Extensions project                                                     |  |      |     |  | (597                    | )
|other capital projects and purchase of fixed assets                              |  |      |     |  | (838                    | )
|Loan repaid by associate                                                          |  |      |     |  |                        |  
|Loan to associate                                                                 |  |      |     |  | (7                      | )
|Interest received                                                                 |  |      |     |  | 1,712                   |  
|Receipt from disposal of shares in associate                                      |  |      |     |  |                        |  
|Payment for purchase of shares in associate                                       |  |      |     |  | (10                     | )
|Loan to subsidiary                                                                |  |      |     |  | (268                    | )
|Receipts from sale of fixed assets                                                |  |      |     |  |                        |  
|Receipts from redemption of investments                                           |  |      |     |  | 3,814                   |  
|Receipts from sale of investments                                                 |  |      |     |  | 310                     |  
|                                                                                  |  |      |     |  |                         |  
|Net cash outflow from investing activities                                        |  |      |     |  | (8,806                  | )
|                                                                                  |  |      |     |  |                         |  
|Net cash inflow/(outflow) before financing                                        |  |      |     |  | (5,958                  | )
|                                                                                  |  |      |     |  |                         |  
|Financing activities                                                              |  |      |     |  |                         |  
|Net proceeds on drawdown of loans                                                 |  |      |     |  | 8,071                   |  
|Proceeds of issue of share capital                                                |  |      |     |  |                        |  
|Interest paid                                                                     |  |      |     |  | (915                    | )
|Net income received /(expenses paid) on derivative instruments                    |  |      |     |  | (38                     | )
|Other borrowing costs paid                                                        |  |      |     |  | (4                      | )
|Amounts paid in respect of expenses for the issues of interest-bearing borrowings |  |      |     |  | (28                     | )
|                                                                                  |  |      |     |  |                         |  
|Net cash inflow/(outflow) from financing activities                               |  |      |     |  | 7,086                   |  
|                                                                                  |  |      |     |  |                         |  
|Increase/(Decrease) in cash and cash equivalents                                  |  |      |     |  | 1,128                   |  
|Cash and cash equivalents at January 1,                                           |  |      |     |  | 2,164                   |  
|                                                                                  |  |      |     |  |                         |  
|Cash and cash equivalents at December 31,                                         |  |      |     |  | 3,292                   |  
|                                                                                  |  |      |     |  |                         |  
|Analysis of the balances of cash and cash equivalents                             |  |      |     |  |                         |  
|Cash at bank and in hand                                                          |  | 23   | (a) |  | 56                      |  
|Deposits with banks within 3 months of maturity when placed                       |  | 23   | (a) |  | 3,236                   |  
|                                                                                  |  |      |     |  |                         |  
|                                                                                  |  |      |     |  | 3,292                   |  
|                                                                                  |  |      |     |  |                         |  



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



F-6



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS

December 31, 2000, 2001, 2002



|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 Hong Kong.



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 are 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 system; the development of associated ancillary commercial activities; the development of property; the operation of feeder bus services; the construction and subsequent operation of the West Rail system; and the planning and
detailed design of other railways or extensions as requested by the Government of the Hong Kong Special Administrative Region (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 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 December 31, 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 purposes 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 or beneficial interests in
the net assets of, other than the amount of capital provided, these subsidiaries.



F-7



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



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



A subsidiary is a company in which the Group, directly or indirectly, holds more than half of the issued share capital, or controls more than half of the
voting power, or controls the composition of the board of directors.



Investments in subsidiaries in the Corporations balance sheet are stated at cost less impairment losses (see note 3(h)).



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



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



Unless the interest in an associate is acquired and held
exclusively with a view to subsequent disposal in the near future, 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.



The results of the associates are included in the
Corporations income statement to the extent of dividends received and receivable, providing the dividend is in respect of a period ending on or before that of the Corporation and the Corporations right to receive the dividend is
established before the balance sheet date. In the Corporations balance sheet, its investments in associates are stated at cost less impairment losses (see note 3(h)).



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



| | (i) |  | Fixed assets are carried in the balance sheets 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 Corporation 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 qualified external
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:
| | ---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 investment property revaluation reserve.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-8



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



| |  |  | 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.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (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 Corporation, 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 owned 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 instalments 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   | %
|Rolling stock (diesel)                                             |  | 3-20  | %
|Lifts and escalators                                               |  | 5     | %
|Ballast replacement programs                                       |  | 8     | %
|Machinery and equipment                                            |  | 4-10  | %
|Telecommunication and signalling systems and airconditioning plant |  | 7-10  | %
|Fare collection system                                             |  | 7-10  | %
|Mobile phone system                                                |  | 20    | %
|Furniture and fixtures                                             |  | 7-33  | %
|Computer and office equipment (including computer software)        |  | 20-33 | %
|Buses                                                              |  | 6-10  | %
|Other motor vehicles                                               |  | 7-25  | %



F-9



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



| | (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); and
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | investments in subsidiaries and associate.
| | - |  | ------------------------------------------



If any such indication exists, the assets recoverable amount is estimated. An impairment loss is recognized to 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 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(r)) 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.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



Deferred expenditure represents advances, deposits, mobilization payments, design and construction costs made to 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



F-10



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



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 joint ventures. When the Corporation determines or reaches agreement with its joint
venture partner 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 property 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 joint venture 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) |  | Joint ventures
|--- |  | --------------



A joint venture is a contractual arrangement whereby the Corporation and at least one other party undertake an economic activity which is subject to joint
control and none of the parties involved unilaterally has control over the economic activity.



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 equity injection received and borrowings obtained specifically for the construction of West Rail and the East Rail Extensions before
the funds are used for such purpose (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.



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



F-11



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



derivative instruments for hedging against foreign currency investments and gains or losses arising from the disposal
of such investments, are capitalized to 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
| | ---- |  | -------------------------



| |  |  | on a straight-line basis over the periods of the respective leases and agreements.
| | - |  | ----------------------------------------------------------------------------------



| | (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) |  | Sale of properties
| | ---- |  | ------------------



Revenue arising from properties held for resale, upon the signing of the sale and purchase agreements or the issue of occupation permit, whichever is
later. Deposits held and instalments received on properties sold prior to the date of revenue recognition are included in the balance sheet under other payables.



| | (v) |  | 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 that 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 to 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, and 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. The net amounts of cash received by the
Corporation from the arrangements are accounted for as deferred income and are being amortized over the applicable lease terms of the transactions.



F-12



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|(p) |  | Properties held for resale
|--- |  | --------------------------



Properties held for resale are stated at the lower of cost and estimated net realisable value. Net realisable value represents the estimated selling price
less costs to be incurred in selling the property.



|(q) |  | 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.



|(r) |  | Borrowing costs and investment income
|--- |  | -------------------------------------



Borrowing costs incurred on borrowings during the period 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.



|(s) |  | 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(r).



|(t) |  | Deferred taxation
|--- |  | -----------------



Provision for deferred taxation is calculated on the liability method at current taxation rates on timing differences to the extent that it is probable
that a liability will crystallize in the foreseeable future.



A
deferred tax asset in respect of carried forward tax losses is only recognized if it is assured beyond reasonable doubt that the Corporation will have taxable profits sufficient to offset the available losses in the foreseeable future.



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



Provisions are recognized for liabilities of uncertain timing or amount when the Corporation or 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 expenditures 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.



F-13



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|(v) |  | 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.



|(w) |  | 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.



|(x) |  | 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.



|(y) |  | 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, and corporate and financing expenses.



|(z) |  | Translation of 2002 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 2002
consolidated financial statements have been translated into US Dollars at the specified rate below. These translations should not be construed as representations that the Hong Kong Dollars amounts actually represent such US Dollars 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$7.7988, 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, 2002.



F-14



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|4 |  | Change in accounting policies
|- |  | -----------------------------



|(a) |  | With effect from January 1, 2002, the Group has adopted a new accounting policy as set out in note 3(v) to provide for liabilities in respect of the annual leave and leave passage
entitlements of its staff in order to comply with the Statement of Standard Accounting Practice (SSAP) 34 (Employee Benefits). The adjustments made to the Groups financial statements as a result of the adoption of this accounting
policy are set out as follows:
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                      |  | December 31, 2000 |  | December 31, 2001 |   |  | December 31,2002 |   |  | December 31,2002 |  
|------------------------------------- |  | ----------------- |  | ----------------- | - |  | ---------------- | - |  | ---------------- | -
|                                      |  | HK$               |  | HK$               |   |  | HK$              |   |  | US$              |  
|                                      |  | (in millions)     | 
|Balance Sheet                         |  |                   |  |                   |   |  |                  |   |  |                  |  
|Increase in other payables           |  |                  |  | (52               | ) |  | (54              | ) |  | (7               | )
|Increase in construction in progress |  |                  |  | 13                |   |  | 21               |   |  | 3                |  
|Increase in deferred expenditure     |  |                  |  | 6                 |   |  | 1                |   |  |                 |  
|Decrease in retained profits         |  |                  |  | 33                |   |  | 32               |   |  | 4                |  
|                                      |  |                   |  |                  
|                                      |  | 2000              |  | 2001              |   |  | 2002             |   |  | 2002             |  
|                                      |  | HK$               |  | HK$               |   |  | HK$              |   |  | US$              |  
|                                      |  | (in millions)     | 
|Income statement                      |  |                   |  |                   |   |  |                  |   |  |                  |  
|Increase/(Decrease) in staff costs   |  |                  |  | 1                 |   |  | (1               | ) |  |                 |  



Comparative figures
before 2001 have not been restated because it is impractical to do so.



|(b) |  | 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(u) in order to comply
with Statement of Standard Accounting Practice 28 issued by the Hong Kong Society of Accountants. The effect of adopting the Statement is that the balance of insurance provision has been adjusted to the balance of retained profits at January 1,
2001. No restatement of comparative information is made.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(c) |  | In order to comply with the requirements of SSAP 1 (revised) (Preparation of Financial Statements), the Group has adopted the new statement Consolidated Statement of Changes
in Equity which replaces the Consolidated Statement of Recognized Gains and Losses included in previous financial statements. The new statement reconciles the movement of key components of the shareholders fund, including share capital,
reserves and retained profits, from the beginning to the end of a period.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(d) |  | The format of the Consolidated Cash Flow Statement has been revised to follow the new requirements of SSAP 15 (revised) (Cash Flow Statement).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------



F-15



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|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 during the year are as follows:
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                   |  | 2000          |  | 2001  |  | 2002  |  | 2002
|------------------ |  | ------------- |  | ----- |  | ----- |  | ----
|                   |  | HK$           |  | HK$   |  | HK$   |  | US$ 
|                   |  | (in millions)
|Passenger services |  | 3,990         |  | 4,051 |  | 4,127 |  | 529 
|Freight services   |  | 99            |  | 88    |  | 86    |  | 11  
|Property services  |  | 642           |  | 658   |  | 617   |  | 79  
|                   |  |               |  |       |  |       |  |     
|                   |  | 4,731         |  | 4,797 |  | 4,830 |  | 619 
|                   |  |               |  |       |  |       |  |     



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



|                                                                                                          |  | 2000          |   |  | 2001     |   |  | 2002  |   |  | 2002 |  
|--------------------------------------------------------------------------------------------------------- |  | ------------- | - |  | -------- | - |  | ----- | - |  | ---- | -
|                                                                                                          |  |               |   |  | Restated |   |  |       |   |  |      |  
|                                                                                                          |  | HK$           |   |  | HK$      |   |  | HK$   |   |  | US$  |  
|                                                                                                          |  | (in millions) |  
|Staff costs                                                                                               |  |               |   |  |          |   |  |       |   |  |      |  
|Gross amount including retirement costs of HK$129 million (2001: HK$123 million; 2000: HK$99 million)    |  | 1,932         |   |  | 2,094    |   |  | 2,140 |   |  | 274  |  
|Amount capitalized including retirement costs of HK$19 million (2001: HK$18 million; 2000: HK$7 million) |  | (723          | ) |  | (818     | ) |  | (914  | ) |  | (118 | )
|                                                                                                          |  |               |   |  |          |   |  |       |   |  |      |  
|                                                                                                          |  | 1,209         |   |  | 1,276    |   |  | 1,226 |   |  | 156  |  
|Electricity and fuel                                                                                      |  | 259           |   |  | 263      |   |  | 262   |   |  | 34   |  
|Stores and spares consumed                                                                                |  | 127           |   |  | 121      |   |  | 110   |   |  | 14   |  
|Material costs                                                                                            |  | 32            |   |  | 37       |   |  | 23    |   |  | 3    |  
|Repairs and maintenance                                                                                   |  | 167           |   |  | 128      |   |  | 144   |   |  | 18   |  
|Government rent and rates                                                                                 |  | 64            |   |  | 72       |   |  | 75    |   |  | 10   |  
|Octopus Cards transactions and interchange fees                                                           |  | 27            |   |  | 29       |   |  | 30    |   |  | 4    |  
|Cost of services acquired                                                                                 |  | 142           |   |  | 138      |   |  | 111   |   |  | 14   |  
|Property ownership and management expenses                                                                |  | 25            |   |  | 50       |   |  | 44    |   |  | 6    |  
|Depreciation                                                                                              |  |               |   |  |          |   |  |       |   |  |      |  
|assets held for use under operating leases                                                               |  | 17            |   |  | 17       |   |  | 17    |   |  | 2    |  
|other assets                                                                                             |  | 657           |   |  | 647      |   |  | 711   |   |  | 91   |  
|depreciation charged capitalized                                                                         |  | (4            | ) |  | (3       | ) |  | (3    | ) |  |     |  
|Others                                                                                                    |  | 108           |   |  | 111      |   |  | 146   |   |  | 19   |  
|                                                                                                          |  |               |   |  |          |   |  |       |   |  |      |  
|                                                                                                          |  | 2,830         |   |  | 2,886    |   |  | 2,896 |   |  | 371  |  
|                                                                                                          |  |               |   |  |          |   |  |       |   |  |      |  



F-16



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|5 |  | Revenue, operating costs and operating profit(Continued)
|- |  | ---------------------------------------------------------



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



|                                                                                                                                                       |  | 2000          |  | 2001 |   |  | 2002 |  | 2002
|------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- |  | ---- | - |  | ---- |  | ----
|                                                                                                                                                       |  | HK$           |  | HK$  |   |  | HK$  |  | US$ 
|                                                                                                                                                       |  | (in millions)
|Fixed assets written off                                                                                                                               |  | 1             |  | 5    |   |  | 27   |  | 3   
|Auditors remuneration                                                                                                                                 |  |               |  |      |   |  |      |  |     
|Audit services                                                                                                                                        |  | 2             |  | 2    |   |  | 2    |  |    
|Other services                                                                                                                                        |  | 1             |  | 1    |   |  | 3    |  |    
|Operating lease charges (minimum lease payments)                                                                                                       |  |               |  |      |   |  |      |  |     
|Hire of plant and machinery                                                                                                                           |  | 18            |  | 18   |   |  | 18   |  | 2   
|Rental of property                                                                                                                                    |  | 8             |  | 11   |   |  | 11   |  | 1   
|Remuneration of Members of the Managing Board including the Chief Executive Officer, and Executive Directors who are not Members
of the Managing Board |  | 36            |  | 41   | * |  | 38   |  | 5   
|                                                                                                                                                       |  |               |  |      |   |  |      |  |     
|and after crediting:                                                                                                                                   |  |               |  |      |   |  |      |  |     
|Gross and net rentals from operating leases (including contingent rentals of HK$26 million (2001: HK$43 million; 2000: HK$32
million))                 |  | 480           |  | 491  |   |  | 461  |  | 59  
|Gross and net rentals from investment properties                                                                                                       |  | 104           |  | 98   |   |  | 92   |  | 12  
|                                                                                                                                                       |  |               |  |      |   |  |      |  |     



|(d) |  | Remuneration of Members of the Managing Board including Executive Directors who are not Members of the Managing Board
|--- |  | ---------------------------------------------------------------------------------------------------------------------



The fees and emoluments during the year were:



|                                                                                                                                              |  | 2000          |  | 2001* |  | 2002 |  | 2002
|--------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- |  | ----- |  | ---- |  | ----
|                                                                                                                                              |  | HK$           |  | HK$   |  | HK$  |  | US$ 
|                                                                                                                                              |  | (in millions)
|Remuneration of Members of the Managing Board including 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                                  |  | 34            |  | 39    |  | 36   |  | 5   
|                                                                                                                                              |  |               |  |       |  |      |  |     
|                                                                                                                                              |  | 36            |  | 41    |  | 38   |  | 5   
|                                                                                                                                              |  |               |  |       |  |      |  |     



Emoluments include
salary, allowances, benefits-in-kind and accruals for gratuities and annual leave entitlement. Allowances and benefits-in-kind include housing, education and passage allowances.



F-17



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|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 individuals | 
|-------------------------------------------------------------- |  | ------------------ | 
|                                                               |  | 2000               | 
|Members of the Managing Board:                                 |  |                    | 
|Non-executive members including the Chairman                   |  |                    | 
|Below HK$250,000                                               |  | 8                  | 
|                                                               |  |                    | 
|Chief Executive Officer                                        |  |                    | 
|HK$5,500,001 - HK$6,000,000                                    |  |                   | 
|HK$6,000,001 - HK$6,500,000                                    |  | 1                  | 
|                                                               |  |                    | 
|Executive Directors who are not Members of the Managing Board: |  |                    | 
|HK$500,000 - HK$1,000,000                                      |  | 1@                 | 
|HK$1,500,001 - HK$2,000,000                                    |  | 1@                 | 
|HK$2,500,001 - HK$3,000,000                                    |  | 1@                 | 
|HK$3,000,001 - HK$3,500,000                                    |  | 1                  | 
|HK$3,500,001 - HK$4,000,000                                    |  | 2                  | 
|HK$4,000,001 - HK$4,500,000                                    |  | 1                  | 
|HK$4,500,001 - HK$5,000,000                                    |  | 2                  | 
|HK$5,000,001 - HK$5,500,000                                    |  |                   | 



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

---

|@ |  | Executive Directors who are not Members of the Managing Board appointed or left during the year.
|- |  | ------------------------------------------------------------------------------------------------

|* |  | Since the Group has adopted a new accounting policy to provide for liabilities in respect of gratuity, annual leave, leave passage and other benefits-in-kind of its staff in order
to comply with SSAP 34 (Employee Benefits) as described in note 4(a), certain comparative figures and information have been restated to conform to the current years presentation.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|# |  | 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 non-executive members on the Managing Board.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-18



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|6 |  | Net investment income
|- |  | ---------------------



|                                                               |  | 2000          |   |  | 2001   |   |  | 2002   |   |  | 2002 |  
|-------------------------------------------------------------- |  | ------------- | - |  | ------ | - |  | ------ | - |  | ---- | -
|                                                               |  | HK$           |   |  | HK$    |   |  | HK$    |   |  | US$  |  
|                                                               |  | (in millions) |  
|Gain on disposal of shares in associate                        |  |              |   |  | 3      |   |  |       |   |  |     |  
|Interest income from deposits with banks                       |  | 634           |   |  | 431    |   |  | 91     |   |  | 11   |  
|Interest income from investments                               |  | 1,904         |   |  | 1,887  |   |  | 1,301  |   |  | 167  |  
|Interest income from loan to subsidiary                        |  | 36            |   |  | 85     |   |  | 139    |   |  | 18   |  
|Interest income on other receivables (note 22)                 |  |              |   |  |       |   |  | 148    |   |  | 19   |  
|Net realized gain/(loss) on disposal of non-trading securities |  | 84            |   |  | 62     |   |  | (55    | ) |  | (7   | )
|Net exchange gain                                              |  | 12            |   |  |       |   |  |       |   |  |     |  
|                                                               |  |               |   |  |        |   |  |        |   |  |      |  
|                                                               |  | 2,670         |   |  | 2,468  |   |  | 1,624  |   |  | 208  |  
|* Less: Amount capitalized                                     |  | (2,368        | ) |  | (1,971 | ) |  | (975   | ) |  | (125 | )
|                                                               |  |               |   |  |        |   |  |        |   |  |      |  
|                                                               |  | 302           |   |  | 497    |   |  | 649    |   |  | 83   |  
|                                                               |  |               |   |  |        |   |  |        |   |  |      |  
|Interest expenses on other loans                               |  | 1,103         |   |  | 1,252  |   |  | 1,279  |   |  | 164  |  
|Net expenses/(income) from derivative instruments              |  | 97            |   |  | 24     |   |  | (90    | ) |  | (11  | )
|Other borrowing costs                                          |  | 9             |   |  | 18     |   |  | 17     |   |  | 2    |  
|Net exchange loss                                              |  |              |   |  | 38     |   |  | 3      |   |  |     |  
|                                                               |  |               |   |  |        |   |  |        |   |  |      |  
|                                                               |  | 1,209         |   |  | 1,332  |   |  | 1,209  |   |  | 155  |  
|# Less: Amount capitalized                                     |  | (1,209        | ) |  | (1,325 | ) |  | (1,178 | ) |  | (151 | )
|                                                               |  |               |   |  |        |   |  |        |   |  |      |  
|                                                               |  |              |   |  | 7      |   |  | 31     |   |  | 4    |  
|                                                               |  |               |   |  |        |   |  |        |   |  |      |  
|Net investment income                                          |  | 302           |   |  | 490    |   |  | 618    |   |  | 79   |  
|                                                               |  |               |   |  |        |   |  |        |   |  |      |  

---

|* |  | Interest income capitalized was earned at rates ranging between 3.98% (2001: 5.55%; 2000: 6.23%) and 5.84% (2001: 6.54%; 2000: 7.07%) per annum.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------

|# |  | Interest expenses capitalized were charged at rates ranging between 6.75% (2001: 7.40%; 2000: 7.97%) and 7.46% (2001: 8.25%; 2000: 8.26%) per annum.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



|7 |  | Profit on property development
|- |  | ------------------------------



|                              |  | 2000          |  | 2001 |  | 2002 |  | 2002
|----------------------------- |  | ------------- |  | ---- |  | ---- |  | ----
|                              |  | HK$           |  | HK$  |  | HK$  |  | US$ 
|                              |  | (in millions)
|Royal Ascot, Sha Tin          |  | 81            |  | 24   |  |     |  |    
|Mongkok Station Redevelopment |  | 6             |  |     |  |     |  |    
|Hung Hom Bay                  |  |              |  |     |  | 94   |  | 12  
|                              |  |               |  |      |  |      |  |     
|                              |  | 87            |  | 24   |  | 94   |  | 12  
|                              |  |               |  |      |  |      |  |     



Profit on property
development arises from the Groups interests in jointly controlled operations.



F-19



---

##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|8 |  | Taxation
|- |  | --------



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



|                                                                                            |  | 2000          |  | 2001 |  | 2002 |  | 2002
|------------------------------------------------------------------------------------------- |  | ------------- |  | ---- |  | ---- |  | ----
|                                                                                            |  | HK$           |  | HK$  |  | HK$  |  | US$ 
|                                                                                            |  | (in millions)
|Provision for Hong Kong profits tax at 16% on the estimated assessable profits for the year |  | 1             |  | 1    |  | 1    |  |    
|                                                                                            |  |               |  |      |  |      |  |     



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 substantial accumulated tax losses carried forward
of HK$2,570 million at December 31, 2002 (2001: HK$1,716 million) which are available to set off against future assessable profits.



|(b) |  | Taxation in the consolidated balance sheet represents:
|--- |  | ------------------------------------------------------



|                                                 |  | 2001          |   |  | 2002 |   |  | 2002
|------------------------------------------------ |  | ------------- | - |  | ---- | - |  | ----
|                                                 |  | HK$           |   |  | HK$  |   |  | US$ 
|                                                 |  | (in millions)
|Provision for Hong Kong profits tax for the year |  | 1             |   |  | 1    |   |  |    
|Provisional profits tax paid                     |  | (1            | ) |  | (1   | ) |  |    
|                                                 |  |               |   |  |      |   |  |     
|                                                 |  |              |   |  |     |   |  |    
|                                                 |  |               |   |  |      |   |  |     



|(c) |  | Deferred taxation
|--- |  | -----------------



The potential deferred tax liability of the Corporation and of the Group of HK$2,604 million (2001: HK$2,153 million) principally relates to depreciation
allowances in excess of related depreciation of HK$3,016 million (2001: HK$2,428 million) and estimated future benefit of HK$412 million (2001: HK$275 million) arising from tax losses. No provision for deferred taxation has been made as such
potential liability is not expected to crystallize in the foreseeable future. No deferred tax has been provided for on the revaluation surplus of the Groups investment properties as it does not constitute a timing difference.



|9 |  | Profit after taxation
|- |  | ---------------------



Of the consolidated profit after taxation, HK$2,644 million (2001(restated): HK$2,425 million; 2000: HK$2,288 million) has been dealt with in the
financial statements of the Corporation.



|10 |  | Proposed dividend
|-- |  | -----------------



|                                                                                                   |  | 2000         |  | 2001 |  | 2002 |  | 2002
|-------------------------------------------------------------------------------------------------- |  | ------------ |  | ---- |  | ---- |  | ----
|                                                                                                   |  | HK$          |  | HK$  |  | HK$  |  | US$ 
|                                                                                                   |  | ($ millions)
|Dividend attributable to the year:                                                                 |  |              |  |      |  |      |  |     
|Final dividend proposed after the balance sheet date of HK$ 1,584.87 dollars per share (2001: nil) |  |             |  |     |  | 620  |  | 79  
|                                                                                                   |  |              |  |      |  |      |  |     



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-20



---

##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



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



2002



Operating Results



|                                              |  | Passenger services |   |  |            |   |  |      |   |  | Consolidated Total |  
|--------------------------------------------- |  | ------------------ | - |  | ---------- | - |  | ---- | - |  | ------------------ | -
|                                              |  | East Rail          |   |  | Light Rail |   |  | Bus  |   |  | Total              |  
|                                              |  | HK$                |   |  | HK$        |   |  | HK$  |   |  | HK$                |  
|                                              |  | (in millions)      |  
|Revenue                                       |  | 3,569              |   |  | 418        |   |  | 140  |   |  | 4,127              |  
|Operating costs before depreciation           |  | (1,232             | ) |  | (387       | ) |  | (117 | ) |  | (1,736             | )
|Inter-segment charges(1)                      |  | 25                 |   |  | 2          |   |  | 2    |   |  | 29                 |  
|Depreciation                                  |  | (530               | ) |  | (101       | ) |  | (16  | ) |  | (647               | )
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  
|Resultsprofit/(loss)                         |  | 1,832              |   |  | (68        | ) |  | 9    |   |  | 1,773              |  
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  
|Unallocated Corporate expenses                |  |                    |   |  |            |   |  |      |   |  |                    |  
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  
|Operating profit before net investment income |  |                    |   |  |            |   |  |      |   |  |                    |  
|Net investment income                         |  |                    |   |  |            |   |  |      |   |  |                    |  
|Profit on property development                |  |                    |   |  |            |   |  |      |   |  |                    |  
|Share of profit of associate                  |  |                    |   |  |            |   |  |      |   |  |                    |  
|Taxation                                      |  |                    |   |  |            |   |  |      |   |  |                    |  
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  
|Profit after taxation                         |  |                    |   |  |            |   |  |      |   |  |                    |  
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  

---

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



Assets and Liabilities



|                             |  | Passenger services |  |            |  |     |  | Consolidated Total
|---------------------------- |  | ------------------ |  | ---------- |  | --- |  | ------------------
|                             |  | East Rail          |  | Light Rail |  | Bus |  | Total             
|                             |  | HK$                |  | HK$        |  | HK$ |  | HK$               
|                             |  | (in millions)     
|Segment assets               |  | 10,175             |  | 3,045      |  | 141 |  | 13,361            
|Properties under development |  |                   |  |           |  |    |  |                  
|Interest in associate        |  |                   |  |           |  |    |  |                  
|Unallocated assets#          |  |                   |  |           |  |    |  |                  
|                             |  |                    |  |            |  |     |  |                   
|                             |  | 10,175             |  | 3,045      |  | 141 |  | 13,361            
|                             |  |                    |  |            |  |     |  |                   
|Segment liabilities          |  | 215                |  | 146        |  | 6   |  | 367               
|Deferred income              |  | 252                |  | 78         |  |    |  | 330               
|Unallocated liabilities*     |  |                   |  |           |  |    |  |                  
|                             |  |                    |  |            |  |     |  |                   
|                             |  | 467                |  | 224        |  | 6   |  | 697               
|                             |  |                    |  |            |  |     |  |                   

---

|# |  | Including construction in progress for West Rail (HK$31,764 million), East Rail Extensions (HK$8,850 million) and Corporate (HK$15 million) and deferred expenditure for other
proposed railway projects (HK$156 million), Corporate assets (HK$468 million), investment 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$2,896 million) and other
payables (HK$1,461 million).
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-21



---

##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|11 |  | Segmental Reporting(Continued)
|-- |  | -------------------------------



Other Information



|                                 |  | Passenger services |  |            |  |     |  | Consolidated Total
|-------------------------------- |  | ------------------ |  | ---------- |  | --- |  | ------------------
|                                 |  | East Rail          |  | Light Rail |  | Bus |  | Total             
|                                 |  | HK$                |  | HK$        |  | HK$ |  | HK$               
|                                 |  | (in millions)     
|Capital Expenditure              |  |                    |  |            |  |     |  |                   
|Existing businesses             |  | 565                |  | 695        |  | 1   |  | 1,261             
|Railway under construction      |  |                   |  |           |  |    |  |                  
|Unallocated capital expenditure |  |                   |  |           |  |    |  |                  
|                                 |  |                    |  |            |  |     |  |                   
|                                 |  | 565                |  | 695        |  | 1   |  | 1,261             
|                                 |  |                    |  |            |  |     |  |                   



2001



Operating Results

(Restated)



|                                              |  | Passenger services |   |  |            |   |  |      |   |  | Consolidated Total |  
|--------------------------------------------- |  | ------------------ | - |  | ---------- | - |  | ---- | - |  | ------------------ | -
|                                              |  | East Rail          |   |  | Light Rail |   |  | Bus  |   |  | Total              |  
|                                              |  | HK$                |   |  | HK$        |   |  | HK$  |   |  | HK$                |  
|                                              |  | (in millions)      |  
|Revenue                                       |  | 3,487              |   |  | 433        |   |  | 131  |   |  | 4,051              |  
|Operating costs before depreciation           |  | (1,228             | ) |  | (422       | ) |  | (123 | ) |  | (1,773             | )
|Inter-segment charges(1)                      |  | 27                 |   |  | 1          |   |  | 2    |   |  | 30                 |  
|Depreciation                                  |  | (481               | ) |  | (92        | ) |  | (17  | ) |  | (590               | )
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  
|Resultsprofit/(loss)                         |  | 1,805              |   |  | (80        | ) |  | (7   | ) |  | 1,718              |  
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  
|Unallocated Corporate expenses                |  |                    |   |  |            |   |  |      |   |  |                    |  
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  
|Operating profit before net investment income |  |                    |   |  |            |   |  |      |   |  |                    |  
|Net investment income                         |  |                    |   |  |            |   |  |      |   |  |                    |  
|Profit on property development                |  |                    |   |  |            |   |  |      |   |  |                    |  
|Share of profit of associate                  |  |                    |   |  |            |   |  |      |   |  |                    |  
|Taxation                                      |  |                    |   |  |            |   |  |      |   |  |                    |  
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  
|Profit after taxation                         |  |                    |   |  |            |   |  |      |   |  |                    |  
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  

---

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



F-22



---

##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|11 |  | Segmental reporting(Continued)
|-- |  | -------------------------------



Assets and Liabilities

(Restated)



|                             |  | Passenger services |  |            |  |     |  | Consolidated Total
|---------------------------- |  | ------------------ |  | ---------- |  | --- |  | ------------------
|                             |  | East Rail          |  | Light Rail |  | Bus |  | Total             
|                             |  | HK$                |  | HK$        |  | HK$ |  | HK$               
|                             |  | (in millions)     
|Segment assets               |  | 10,111             |  | 2,439      |  | 155 |  | 12,705            
|Properties under development |  |                   |  |           |  |    |  |                  
|Interest in associate        |  |                   |  |           |  |    |  |                  
|Unallocated assets#          |  |                   |  |           |  |    |  |                  
|                             |  |                    |  |            |  |     |  |                   
|                             |  | 10,111             |  | 2,439      |  | 155 |  | 12,705            
|                             |  |                    |  |            |  |     |  |                   
|Segment liabilities          |  | 679                |  | 178        |  | 6   |  | 863               
|Deferred income              |  | 213                |  | 66         |  |    |  | 279               
|Unallocated liabilities*     |  |                   |  |           |  |    |  |                  
|                             |  |                    |  |            |  |     |  |                   
|                             |  | 892                |  | 244        |  | 6   |  | 1,142             
|                             |  |                    |  |            |  |     |  |                   

---

|# |  | Including construction in progress for West Rail (HK$25,543 million) and 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$379 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$2,133 million) and other
payables (HK$1,364 million).
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Other information

(Restated)



|                                 |  | Passenger services |  |            |  |     |  | Consolidated Total
|-------------------------------- |  | ------------------ |  | ---------- |  | --- |  | ------------------
|                                 |  | East Rail          |  | Light Rail |  | Bus |  | Total             
|                                 |  | HK$                |  | HK$        |  | HK$ |  | HK$               
|                                 |  | (in millions)     
|Capital Expenditure              |  |                    |  |            |  |     |  |                   
|Existing businesses             |  | 1,045              |  | 371        |  | 10  |  | 1,426             
|Railway under construction      |  |                   |  |           |  |    |  |                  
|Unallocated capital expenditure |  |                   |  |           |  |    |  |                  
|                                 |  |                    |  |            |  |     |  |                   
|                                 |  | 1,045              |  | 371        |  | 10  |  | 1,426             
|                                 |  |                    |  |            |  |     |  |                   



F-23



---

##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|11. |  | Segmental reporting(Continued)
|--- |  | -------------------------------



2000



Operating Results



|                                              |  | Passenger services |   |  |            |   |  |      |   |  | Consolidated Total |  
|--------------------------------------------- |  | ------------------ | - |  | ---------- | - |  | ---- | - |  | ------------------ | -
|                                              |  | East Rail          |   |  | Light Rail |   |  | Bus  |   |  | Total              |  
|                                              |  | HK$                |   |  | HK$        |   |  | HK$  |   |  | HK$                |  
|                                              |  | (in millions)      |  
|Revenue                                       |  | 3,438              |   |  | 440        |   |  | 112  |   |  | 3,990              |  
|Operating costs before depreciation           |  | (1,233             | ) |  | (417       | ) |  | (109 | ) |  | (1,759             | )
|Inter-segment charges(1)                      |  | 28                 |   |  | 1          |   |  | 4    |   |  | 33                 |  
|Depreciation                                  |  | (484               | ) |  | (97        | ) |  | (15  | ) |  | (596               | )
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  
|Resultsprofit/(loss)                         |  | 1,749              |   |  | (73        | ) |  | (8   | ) |  | 1,668              |  
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  
|Unallocated Corporate expenses                |  |                    |   |  |            |   |  |      |   |  |                    |  
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  
|Operating profit before net investment income |  |                    |   |  |            |   |  |      |   |  |                    |  
|Net investment income                         |  |                    |   |  |            |   |  |      |   |  |                    |  
|Profit on property development                |  |                    |   |  |            |   |  |      |   |  |                    |  
|Share of loss of associate                    |  |                    |   |  |            |   |  |      |   |  |                    |  
|Taxation                                      |  |                    |   |  |            |   |  |      |   |  |                    |  
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  
|Profit after taxation                         |  |                    |   |  |            |   |  |      |   |  |                    |  
|                                              |  |                    |   |  |            |   |  |      |   |  |                    |  

---

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



Assets and Liabilities



|                             |  | Passenger services |  |            |  |     |  | Consolidated Total
|---------------------------- |  | ------------------ |  | ---------- |  | --- |  | ------------------
|                             |  | East Rail          |  | Light Rail |  | Bus |  | Total             
|                             |  | HK$                |  | HK$        |  | HK$ |  | HK$               
|                             |  | (in millions)     
|Segment assets               |  | 9,496              |  | 2,164      |  | 157 |  | 11,817            
|Properties under development |  |                   |  |           |  |    |  |                  
|Interest in associate        |  |                   |  |           |  |    |  |                  
|Unallocated assets#          |  |                   |  |           |  |    |  |                  
|                             |  |                    |  |            |  |     |  |                   
|                             |  | 9,496              |  | 2,164      |  | 157 |  | 11,817            
|                             |  |                    |  |            |  |     |  |                   
|Segment liabilities          |  | 257                |  | 41         |  | 4   |  | 302               
|Deferred income              |  | 228                |  | 70         |  |    |  | 298               
|Unallocated liabilities*     |  |                   |  |           |  |    |  |                  
|                             |  |                    |  |            |  |     |  |                   
|                             |  | 485                |  | 111        |  | 4   |  | 600               
|                             |  |                    |  |            |  |     |  |                   

---

|# |  | Including construction in progress for West Rail (HK$16,491 million) and Corporate (HK$10 million), deferred expenditure for East Rail Extensions (HK$1,104 million), Corporate
assets (HK$485 million), investments in securities (HK$27,789 million), loan to subsidiary (HK$602 million), interest receivable (HK$886 million), and other receivables (HK$451 million), tax recoverable (HK$19 million) and cash and cash equivalents
(HK$8,597 million).
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|* |  | Including interest-bearing borrowings (HK$16,395 million), interest payable (HK$434 million), insurance provision (HK$225 million), accrual for capital expenditure (HK$2,307
million) and other payables (HK$1,013 million).
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-24



---

##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|11. |  | Segmental reporting(Continued)
|--- |  | -------------------------------



Other information



|                                 |  | Passenger services |  |            |  |     |  | Consolidated Total
|-------------------------------- |  | ------------------ |  | ---------- |  | --- |  | ------------------
|                                 |  | East Rail          |  | Light Rail |  | Bus |  | Total             
|                                 |  | HK$                |  | HK$        |  | HK$ |  | HK$               
|                                 |  | (in millions)     
|Capital Expenditure              |  |                    |  |            |  |     |  |                   
|Existing businesses             |  | 581                |  | 169        |  | 63  |  | 813               
|Railway under construction      |  |                   |  |           |  |    |  |                  
|Unallocated capital expenditure |  |                   |  |           |  |    |  |                  
|                                 |  |                    |  |            |  |     |  |                   
|                                 |  | 581                |  | 169        |  | 63  |  | 813               
|                                 |  |                    |  |            |  |     |  |                   



|12 |  | Fixed assets
|-- |  | ------------



Fixed assets comprise:



|                                       |  | Investment properties |   |  | Leasehold land and permanent way |  | Tunnels, bridges and roads |  | Buildings |   |  | Rolling stock |  | Other equipment |   |  | Total  |  
|-------------------------------------- |  | --------------------- | - |  | -------------------------------- |  | -------------------------- |  | --------- | - |  | ------------- |  | --------------- | - |  | ------ | -
|                                       |  | HK$                   |   |  | HK$                              |  | HK$                        |  | HK$       |   |  | HK$           |  | HK$             |   |  | HK$    |  
|                                       |  | (in millions)         |  
|Cost or valuation:                     |  |                       |   |  |                                  |  |                            |  |           |   |  |               |  |                 |   |  |        |  
|At January 1, 2002                     |  | 940                   |   |  | 1,644                            |  | 523                        |  | 5,014     |   |  | 5,264         |  | 5,932           |   |  | 19,317 |  
|Transfer from construction in progress |  | 2                     |   |  |                                 |  |                           |  | 18        |   |  | 870           |  | 189             |   |  | 1,079  |  
|Additions                              |  |                      |   |  |                                 |  |                           |  |          |   |  |              |  | 28              |   |  | 28     |  
|Disposals                              |  | (5                    | ) |  |                                 |  |                           |  | (27       | ) |  |              |  | (35             | ) |  | (67    | )
|Deficit on revaluation                 |  | (42                   | ) |  |                                 |  |                           |  |          |   |  |              |  |                |   |  | (42    | )
|                                       |  |                       |   |  |                                  |  |                            |  |           |   |  |               |  |                 |   |  |        |  
|At December 31, 2002                   |  | 895                   |   |  | 1,644                            |  | 523                        |  | 5,005     |   |  | 6,134         |  | 6,114           |   |  | 20,315 |  
|                                       |  |                       |   |  |                                  |  |                            |  |           |   |  |               |  |                 |   |  |        |  
|Aggregate Depreciation:                |  |                       |   |  |                                  |  |                            |  |           |   |  |               |  |                 |   |  |        |  
|At January 1, 2002                     |  |                      |   |  | 146                              |  | 74                         |  | 740       |   |  | 1,686         |  | 2,926           |   |  | 5,572  |  
|Charge for the year                    |  |                      |   |  | 25                               |  | 5                          |  | 111       |   |  | 151           |  | 436             |   |  | 728    |  
|Written back on disposals              |  |                      |   |  |                                 |  |                           |  | (6        | ) |  |              |  | (30             | ) |  | (36    | )
|                                       |  |                       |   |  |                                  |  |                            |  |           |   |  |               |  |                 |   |  |        |  
|At December 31, 2002                   |  |                      |   |  | 171                              |  | 79                         |  | 845       |   |  | 1,837         |  | 3,332           |   |  | 6,264  |  
|                                       |  |                       |   |  |                                  |  |                            |  |           |   |  |               |  |                 |   |  |        |  
|Net book value:                        |  |                       |   |  |                                  |  |                            |  |           |   |  |               |  |                 |   |  |        |  
|At December 31, 2002                   |  | 895                   |   |  | 1,473                            |  | 444                        |  | 4,160     |   |  | 4,297         |  | 2,782           |   |  | 14,051 |  
|                                       |  |                       |   |  |                                  |  |                            |  |           |   |  |               |  |                 |   |  |        |  
|At December 31, 2001                   |  | 940                   |   |  | 1,498                            |  | 449                        |  | 4,274     |   |  | 3,578         |  | 3,006           |   |  | 13,745 |  
|                                       |  |                       |   |  |                                  |  |                            |  |           |   |  |               |  |                 |   |  |        |  

---

|(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 Corporations leasehold land with a net book value of HK$587 million (2001: HK$600 million) is held in Hong Kong under long-term leases.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------



F-25



---

##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|12 |  | Fixed assets(Continued)
|-- |  | ------------------------



|(d) |  | The Corporation leases out investment properties and certain properties either used in or ancillary to the Corporation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. Lease payments are usually revised regularly to reflect market rentals. 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, 2002 by an independent firm of surveyors, FPDSavills (Hong Kong)
Limited, 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$42 million
(2001: surplus of HK$66 million) has been transferred to the investment properties revaluation reserve (see note 31).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



|                                     |  | Grosscarryingamount |  | Relatedaccumulateddepreciation |  | Grosscarryingamount |  | Relatedaccumulateddepreciation
|------------------------------------ |  | ------------------- |  | ------------------------------ |  | ------------------- |  | ------------------------------
|                                     |  | 2001                |  | 2001                           |  | 2002                |  | 2002                          
|                                     |  | HK$                 |  | HK$                            |  | HK$                 |  | HK$                           
|                                     |  | (in millions)      
|Goods Yard at Hung Hom Bay           |  | 148                 |  | 7                              |  | 148                 |  | 10                            
|Hung Hom Station Car Park            |  | 55                  |  | 20                             |  | 55                  |  | 21                            
|Offices at Hung Hom Station          |  | 31                  |  | 6                              |  | 31                  |  | 7                             
|Offices at Hung Hom freight building |  | 9                   |  | 1                              |  | 8                   |  | 1                             
|Citylink Plaza at Sha Tin Station    |  | 102                 |  | 49                             |  | 104                 |  | 54                            
|Goods Yard at Mongkok Station        |  | 45                  |  | 4                              |  | 45                  |  | 4                             
|Shops at stations                    |  | 282                 |  | 42                             |  | 262                 |  | 46                            
|                                     |  |                     |  |                                |  |                     |  |                               
|                                     |  | 672                 |  | 129                            |  | 653                 |  | 143                           
|                                     |  |                     |  |                                |  |                     |  |                               



Although these
properties are leased to tenants, they are either used in or are ancillary to the Corporation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:
|--- |  | -----------------------------------------------------------------------------------------------------------------



|                                |  | 2001          |  | 2002  |  | 2002
|------------------------------- |  | ------------- |  | ----- |  | ----
|                                |  | HK$           |  | HK$   |  | US$ 
|                                |  | (in millions)
|Within 1 year                   |  | 525           |  | 495   |  | 63  
|After 1 year but within 5 years |  | 288           |  | 1,239 |  | 159 
|After 5 years                   |  | 24            |  | 24    |  | 3   
|                                |  |               |  |       |  |     
|                                |  | 837           |  | 1,758 |  | 225 
|                                |  |               |  |       |  |     



F-26



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|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 and revenue collection equipment. Under each arrangement, the Group has leased the assets to an investor in United States (US investor), who has prepaid all the rentals in relation to a lease agreement.
Simultaneously, the Group has leased the assets back from the US 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 US investors
leasehold interest in the assets at a pre-determined date for a fixed amount. Part of the rental prepayments received from the US investor has been placed in deposits or debt securities 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.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



As
at December 31, 2002, a portion of the Groups assets with a total original cost of HK$8,132 million (2001: HK$6,477 million) and net book value of HK$5,524 million (2001: HK$4,203 million) is covered by seven arrangements, one of which was
concluded during the year. Five arrangements involve the rolling stock, with the basic lease terms ranging from 18 to 28 years. The remaining two arrangements, one on the signaling equipment and the other on the revenue collection system, have a
basic lease term of 15 years. Since the Group retains substantially all the risks and rewards incident to ownership of the underlying assets in respect of each arrangement and enjoys substantially the same rights to its use as before the
arrangement, no adjustment has been made to fixed assets. As a result of the seven arrangements, the Group has received cash of HK$9,100 million (2001: HK$7,478 million), and has committed to make long-term lease payments with a total estimated net
present value of HK$8,685 million (2001: HK$7,136 million) which have been defeased by payments of deposits totalling HK$8,685 million (2001: HK$7,136 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$19 million (2001: HK$19 million) recognized for the year has been included in the revenue of the income statement.



F-27



---

##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|13 |  | Construction in progress
|-- |  | ------------------------



Construction in progress comprises:



|                                            |  | Balance as at January 1, 2002 Restated |   |  | Costs incurred during the year |   |  | Transferfrom deferredexpenditure |   |  | Transfer to fixed assets |   |  | Reclassifications |   |  | Balance as at December 31, 2002 |  
|------------------------------------------- |  | -------------------------------------- | - |  | ------------------------------ | - |  | -------------------------------- | - |  | ------------------------ | - |  | ----------------- | - |  | ------------------------------- | -
|                                            |  | HK$                                    |   |  | HK$                            |   |  | HK$                              |   |  | HK$                      |   |  | HK$               |   |  | HK$                             |  
|                                            |  | (in millions)                          |  
|West Rail                                   |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|Main contracts                              |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|Civil works                                |  | 17,877                                 |   |  | 3,613                          |   |  |                                 |   |  |                         |   |  |                  |   |  | 21,490                          |  
|Plant and equipment                        |  | 1,251                                  |   |  | 1,668                          |   |  |                                 |   |  |                         |   |  |                  |   |  | 2,919                           |  
|                                            |  |                                        |   |  |                                |  
|Associated construction costs               |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|Feasibility studies                        |  | 219                                    |   |  |                               |   |  |                                 |   |  |                         |   |  |                  |   |  | 219                             |  
|Consultants fees                          |  | 4,448                                  |   |  | 492                            |   |  |                                 |   |  |                         |   |  | (49               | ) |  | 4,891                           |  
|                                            |  |                                        |   |  |                                |  
|Land & related costs                        |  | 3,878                                  |   |  | 344                            |   |  |                                 |   |  |                         |   |  | (449              | ) |  | 3,773                           |  
|                                            |  |                                        |   |  |                                |  
|Overheads                                   |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|Staff costs                                |  | 1,608                                  |   |  | 500                            |   |  |                                 |   |  |                         |   |  |                  |   |  | 2,108                           |  
|Others                                     |  | 796                                    |   |  | 103                            |   |  |                                 |   |  |                         |   |  |                  |   |  | 899                             |  
|On-cost recovery                           |  | (413                                   | ) |  | (183                           | ) |  |                                 |   |  |                         |   |  |                  |   |  | (596                            | )
|                                            |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|                                            |  | 29,664                                 |   |  | 6,537                          |   |  |                                 |   |  |                         |   |  | (498              | ) |  | 35,703                          |  
|Net borrowing costs/(net investment income) |  | (4,121                                 | ) |  | 182                            |   |  |                                 |   |  |                         |   |  |                  |   |  | (3,939                          | )
|                                            |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|                                            |  | 25,543                                 |   |  | 6,719                          |   |  |                                 |   |  |                         |   |  | (498              | ) |  | 31,764                          |  
|                                            |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|East Rail Extensions                        |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|Main contracts                              |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|Civil works                                |  |                                       |   |  |                               |   |  | 5,676                            |   |  |                         |   |  |                  |   |  | 5,676                           |  
|Plant and equipment                        |  |                                       |   |  |                               |   |  | 788                              |   |  |                         |   |  |                  |   |  | 788                             |  
|                                            |  |                                        |   |  |                                |  
|Associated construction costs               |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|Consultants fees                          |  |                                       |   |  |                               |   |  | 1,095                            |   |  |                         |   |  |                  |   |  | 1,095                           |  
|Land & related costs                        |  |                                       |   |  |                               |   |  | 451                              |   |  |                         |   |  |                  |   |  | 451                             |  
|                                            |  |                                        |   |  |                                |  
|Overheads                                   |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|Staff costs                                |  |                                       |   |  |                               |   |  | 774                              |   |  |                         |   |  |                  |   |  | 774                             |  
|Others                                     |  |                                       |   |  |                               |   |  | 186                              |   |  |                         |   |  |                  |   |  | 186                             |  
|On-cost recovery                           |  |                                       |   |  |                               |   |  | (221                             | ) |  |                         |   |  |                  |   |  | (221                            | )
|                                            |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|                                            |  |                                       |   |  |                               |   |  | 8,749                            |   |  |                         |   |  |                  |   |  | 8,749                           |  
|Net borrowing costs/(net investment income) |  |                                       |   |  |                               |   |  | 101                              |   |  |                         |   |  |                  |   |  | 101                             |  
|                                            |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|                                            |  |                                       |   |  |                               |   |  | 8,850                            |   |  |                         |   |  |                  |   |  | 8,850                           |  
|                                            |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|                                            |  |                                        |   |  |                                |  
|Other                                       |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|Buildings and other civil works             |  | 588                                    |   |  | 745                            |   |  |                                 |   |  | (22                      | ) |  |                  |   |  | 1,311                           |  
|Rolling stock                               |  | 612                                    |   |  | 387                            |   |  |                                 |   |  | (860                     | ) |  |                  |   |  | 139                             |  
|Other equipment                             |  | 162                                    |   |  | 221                            |   |  |                                 |   |  | (149                     | ) |  |                  |   |  | 234                             |  
|Net borrowing costs                         |  | 34                                     |   |  | 14                             |   |  |                                 |   |  | (48                      | ) |  |                  |   |  |                                |  
|                                            |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|                                            |  | 1,396                                  |   |  | 1,367                          |   |  |                                 |   |  | (1,079                   | ) |  |                  |   |  | 1,684                           |  
|                                            |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  
|                                            |  | 26,939                                 |   |  | 8,086                          |   |  | 8,850                            |   |  | (1,079                   | ) |  | (498              | ) |  | 42,298                          |  
|                                            |  |                                        |   |  |                                |   |  |                                  |   |  |                          |   |  |                   |   |  |                                 |  



F-28



---

##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|13 |  | Construction in progress(Continued)
|-- |  | ------------------------------------



|(a) |  | 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$67 million (2001: HK$112 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$97 million (2001: HK$74 million) for land resumption work undertaken on the West Rail project undertaken by the Government on behalf of the Corporation.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | HK$142 million (2001: HK$235 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.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(b) |  | Reclassifications of land and related costs represent the costs recoverable in respect of the property development along the West Rail, Phase I route (note 22 (a)).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(c) |  | Included in on-cost recovery credited during the year are amounts received and receivable in respect of the following:
|--- |  | ----------------------------------------------------------------------------------------------------------------------



| |  |  | HK$52 million (2001: HK$47 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$73 million (2001: HK$80 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 18).
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-29



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|14 |  | Deferred expenditure
|-- |  | --------------------



Deferred expenditure comprises:



|                                            |  | Balance as at January 1,2002 |   |  | Expenditure during theyear |   |  | Transferfrompropertiesunderdevelopment |  | Transferto incomestatement |   |  | Transfer toconstructionin progress |   |  | Balance as at December 31, 2002
|------------------------------------------- |  | ---------------------------- | - |  | -------------------------- | - |  | -------------------------------------- |  | -------------------------- | - |  | ---------------------------------- | - |  | -------------------------------
|                                            |  | HK$                          |   |  | HK$                        |   |  | HK$                                    |  | HK$                        |   |  | HK$                                |   |  | HK$                            
|                                            |  | (in millions)               
|East Rail Extensions Main contracts         |  |                              |   |  |                            |   |  |                                        |  |                            |   |  |                                    |   |  |                                
|Civil works                                |  | 2,560                        |   |  | 3,116                      |   |  |                                       |  |                           |   |  | (5,676                             | ) |  |                               
|Plant and equipment                        |  | 234                          |   |  | 554                        |   |  |                                       |  |                           |   |  | (788                               | ) |  |                               
|Associated construction costs               |  |                              |   |  |                            |   |  |                                        |  |                            |   |  |                                    |   |  |                                
|Consultants fee                           |  | 789                          |   |  | 306                        |   |  |                                       |  |                           |   |  | (1,095                             | ) |  |                               
|Land and related costs                      |  | 337                          |   |  | 114                        |   |  |                                       |  |                           |   |  | (451                               | ) |  |                               
|Overheads                                   |  |                              |   |  |                            |   |  |                                        |  |                            |   |  |                                    |   |  |                                
|Staff costs                                |  | 482                          |   |  | 292                        |   |  |                                       |  |                           |   |  | (774                               | ) |  |                               
|Others                                     |  | 121                          |   |  | 65                         |   |  |                                       |  |                           |   |  | (186                               | ) |  |                               
|On-cost recovery                           |  | (127                         | ) |  | (94                        | ) |  |                                       |  |                           |   |  | 221                                |   |  |                               
|                                            |  |                              |   |  |                            |   |  |                                        |  |                            |   |  |                                    |   |  |                                
|                                            |  | 4,396                        |   |  | 4,353                      |   |  |                                       |  |                           |   |  | (8,749                             | ) |  |                               
|Net borrowing costs/(net investment income) |  | (284                         | ) |  | 385                        |   |  |                                       |  |                           |   |  | (101                               | ) |  |                               
|                                            |  |                              |   |  |                            |   |  |                                        |  |                            |   |  |                                    |   |  |                                
|                                            |  | 4,112                        |   |  | 4,738                      |   |  |                                       |  |                           |   |  | (8,850                             | ) |  |                               
|Other proposed railway projects             |  | 104                          |   |  | 59                         |   |  | 13                                     |  | (20                        | ) |  |                                   |   |  | 156                            
|                                            |  |                              |   |  |                            |   |  |                                        |  |                            |   |  |                                    |   |  |                                
|                                            |  | 4,216                        |   |  | 4,797                      |   |  | 13                                     |  | (20                        | ) |  | (8,850                             | ) |  | 156                            
|                                            |  |                              |   |  |                            |   |  |                                        |  |                            |   |  |                                    |   |  |                                



|(a) |  | East Rail Extensions comprise Tsim Sha Tsui extension HK$2,119 million (2001 (restated) : HK$1,103 million), Ma On Shan Rail HK$5,115 million (2001 (restated) : HK$2,708 million)
and Lok Ma Chau Spur Line HK$1,616 million (2001 (restated) : HK$301 million).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(b) |  | 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$54 million (2001: HK$44 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$36 million (2001: HK$231 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.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(c) |  | Included in on-cost recovery credited during the year is an amount of HK$29 million (2001: HK$34 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.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(d) |  | As the project agreement of East Rail Extensions has been reached with the Government, the deferred expenditure for East Rail Extensions project is transferred to construction in
progress.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



F-30



---

##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|15 |  | Properties under development
|-- |  | ----------------------------



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



|                           |  | Balance as at January 1, 2002 |  | Expenditureduring theyear |  | Transfer toincomestatementduring theyear |   |  | Transfer todeferredexpenditure |   |  | Balance as at December 31, 2002
|-------------------------- |  | ----------------------------- |  | ------------------------- |  | ---------------------------------------- | - |  | ------------------------------ | - |  | -------------------------------
|                           |  | HK$                           |  | HK$                       |  | HK$                                      |   |  | HK$                            |   |  | HK$                            
|                           |  | (in millions)                
|Che Kung Temple            |  | 23                            |  | 7                         |  |                                         |   |  |                               |   |  | 30                             
|Ho Tung Lau                |  | 18                            |  | 1                         |  |                                         |   |  |                               |   |  | 19                             
|Hung Hom Bay               |  | 37                            |  |                          |  | (37                                      | ) |  |                               |   |  |                               
|Tai Wai Depot              |  | 557                           |  | 401                       |  |                                         |   |  |                               |   |  | 958                            
|Tai Wai Station            |  | 51                            |  | 26                        |  |                                         |   |  |                               |   |  | 77                             
|Wu Kai Sha                 |  | 32                            |  | 26                        |  |                                         |   |  |                               |   |  | 58                             
|Other property development |  | 21                            |  | 3                         |  |                                         |   |  | (13                            | ) |  | 11                             
|                           |  |                               |  |                           |  |                                          |   |  |                                |   |  |                                
|                           |  | 739                           |  | 464                       |  | (37                                      | ) |  | (13                            | ) |  | 1,153                          
|                           |  |                               |  |                           |  |                                          |   |  |                                |   |  |                                



On November 13, 2002,
the Government announced a moratorium on land supply including property sites along railway lines, as well as other policies in relation to the property market. Accordingly, the Group would further discuss with the Government on a time schedule on
property development consistent with the moratorium. Notwithstanding the introduction of the moratorium and other policies in relation to the property market, none of the expenditure incurred on the above property development projects is considered
to be irrecoverable.



F-31



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|16 |  | Investment in subsidiaries
|-- |  | --------------------------



|                         |  | Corporation  
|------------------------ |  | -------------
|                         |  | 2001         
|                         |  | HK$          
|                         |  | (in millions)
|Unlisted shares, at cost |  |             
|                         |  |              



Details of the
subsidiaries, which are incorporated and operate in Hong Kong, are as follows:



|Name of company                                    |  | Number ofissued andfully paidshares** |  | Parvalue ofshares |    | Percentageof sharesheld by theCorporation |     |   | Percentage of sharesheld bysubsidiary |     |   | Nature of business
|-------------------------------------------------- |  | ------------------------------------- |  | ----------------- | -- | ----------------------------------------- | --- | - | ------------------------------------- | --- | - | ------------------
|Manlai Court Property Management Company Limited   |  | 25,500A                             |  | HK$               | 1  |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  | 24,500B                             |  | HK$               | 1  |                                           | Nil |   |                                       | Nil |   |                   
|                                                   |  |                                       |  |                   |   
|Sun Tuen Mun Centre Management Company Limited     |  | 25,000A                             |  | HK$               | 1  |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  | 25,000B                             |  | HK$               | 1  |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  |                                       |  |                   |   
|Royal Ascot Management Company Limited             |  | 25,000A                             |  | HK$               | 1  |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  | 25,000B                             |  | HK$               | 1  |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  |                                       |  |                   |   
|Hanford Garden Property Management Company Limited |  | 10,000                                |  | HK$               | 1  |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  |                                       |  |                   |   
|Pierhead Garden Management Company Limited         |  | 25,000A                             |  | HK$               | 1  |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  | 25,000B                             |  | HK$               | 1  |                                           | Nil |   |                                       | 100 | % |                   
|                                                   |  |                                       |  |                   |   
|The Metropolis Management Company Limited          |  | 25,500A                             |  | HK$               | 1  |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  | 24,500B                             |  | HK$               | 1  |                                           | Nil |   |                                       | Nil |   |                   
|                                                   |  |                                       |  |                   |   
|Capital System Limited                             |  | 5,000                                 |  | HK$               | 1  |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  |                                       |  |                   |   
|Buoyant Asset Limited                              |  | 100                                   |  | HK$               | 10 |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  |                                       |  |                   |   
|Advanced Asset Limited                             |  | 100                                   |  | HK$               | 10 |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  |                                       |  |                   |   
|Quality Asset Limited                              |  | 100                                   |  | HK$               | 10 |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  |                                       |  |                   |   
|Kasey Asset Limited                                |  | 100                                   |  | HK$               | 10 |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  |                                       |  |                   |   
|Circuit Asset Limited                              |  | 100                                   |  | HK$               | 10 |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  |                                       |  |                   |   
|Shining Asset Limited                              |  | 100                                   |  | HK$               | 10 |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  |                                       |  |                   |   
|Fluent Asset Limited                               |  | 100                                   |  | HK$               | 10 |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  |                                       |  |                   |   
|*West Rail Property Development Limited            |  | 51A                                 |  | HK$               | 10 |                                           | 100 | % |                                       | Nil |   |                   
|                                                   |  | 49B                                 |  | HK$               | 10 |                                           | Nil |   |                                       | Nil |   |                   



F-32



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|16 |  | Investment in subsidiaries(Continued)
|-- |  | --------------------------------------



|Name of company                             |  | Number ofissued andfully paidshares** |  | Parvalue ofshares |    | Percentageof sharesheld by theCorporation |     | Percentage of sharesheld bysubsidiary |     |   | Nature of business
|------------------------------------------- |  | ------------------------------------- |  | ----------------- | -- | ----------------------------------------- | --- | ------------------------------------- | --- | - | ------------------
|*KamSheung PropertyDevelopment Limited      |  | 100                                   |  | HK$               | 10 |                                           | Nil |                                       | 100 | % |                   
|                                            |  |                                       |  |                   |   
|*Kwai Fong PropertyDevelopment Limited      |  | 100                                   |  | HK$               | 10 |                                           | Nil |                                       | 100 | % |                   
|                                            |  |                                       |  |                   |   
|*Long Ping PropertyDevelopment Limited      |  | 100                                   |  | HK$               | 10 |                                           | Nil |                                       | 100 | % |                   
|                                            |  |                                       |  |                   |   
|*Nam Cheong PropertyDevelopment Limited     |  | 100                                   |  | HK$               | 10 |                                           | Nil |                                       | 100 | % |                   
|                                            |  |                                       |  |                   |   
|*Pat Heung PropertyDevelopment Limited      |  | 100                                   |  | HK$               | 10 |                                           | Nil |                                       | 100 | % |                   
|                                            |  |                                       |  |                   |   
|*Tin Shui Wai PropertyDevelopment Limited   |  | 100                                   |  | HK$               | 10 |                                           | Nil |                                       | 100 | % |                   
|                                            |  |                                       |  |                   |   
|*Tsuen Wan West PropertyDevelopment Limited |  | 100                                   |  | HK$               | 10 |                                           | Nil |                                       | 100 | % |                   
|                                            |  |                                       |  |                   |   
|*Tuen Mun PropertyDevelopment Limited       |  | 100                                   |  | HK$               | 10 |                                           | Nil |                                       | 100 | % |                   
|                                            |  |                                       |  |                   |   
|*Yuen Long PropertyDevelopment Limited      |  | 100                                   |  | HK$               | 10 |                                           | Nil |                                       | 100 | % |                   

---

|* |  | 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 the consolidation as the Corporation has no effective control over or 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-33



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|17 |  | Interest in associate
|-- |  | ---------------------



The interest in associate is as follows:



|                         |  | 2001          |  | 2002 |  | 2002
|------------------------ |  | ------------- |  | ---- |  | ----
|                         |  | HK$           |  | HK$  |  | US$ 
|                         |  | (in millions)
|Unlisted shares, at cost |  |              |  |     |  |    
|Share of net assets      |  | 19            |  | 35   |  | 4   
|                         |  |               |  |      |  |     
|                         |  | 19            |  | 35   |  | 4   
|Loan to associate        |  | 4             |  |     |  |    
|                         |  |               |  |      |  |     
|                         |  | 23            |  | 35   |  | 4   
|                         |  |               |  |      |  |     



Details of the
associate, which is incorporated and operates in Hong Kong and provides the Octopus Cards system, are as follows:



|Name of company        |  | Number of issued and fully paid shares |  | Par value of shares |  | Percentage of shares held |   |  | Nature of business                               
|---------------------- |  | -------------------------------------- |  | ------------------- |  | ------------------------- | - |  | -------------------------------------------------
|*Octopus Cards Limited |  | 42,000,000 ordinary                    |  | HK$1                |  | 22.1                      | % |  | Development and operation of Octopus Cards system

---

|* |  | Formerly known as Creative Star Limited until January 2, 2002.
|- |  | --------------------------------------------------------------



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.



On the same day, the
Corporation signed a new Shareholders Agreement for Octopus Cards Limited by which the Corporation sold 1,092,000 shares in Octopus Cards Limited to KMB Public Bus Services Holdings Limited for a consideration of HK$4 million, together with a
deferred consideration to be received in the event of Octopus Cards Limited subsequently becoming a stock exchange listed company. The Corporations shareholding in Octopus Cards Limited was reduced to 22.1% after this transfer.



During the year, the Group made payments to Octopus Cards Limited amounting
to HK$30 million (2001: HK$29 million) in respect of transaction and interchange fees for the handling of Octopus tickets. These payments were made based on the usage of and revenue generated from Octopus tickets. No other charges were made or
incurred by the Group in respect of the administration of the Octopus Cards system. The Group received HK$6 million (2001: HK$6 million) from Octopus Cards Limited in respect of ticket loading agent fees for providing add-value amounts on Octopus
tickets.



|18 |  | 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% plus 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.



F-34



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|19 |  | Investments in securities
|-- |  | -------------------------



|(a) |  | Investments in securities comprise:
|--- |  | -----------------------------------



|                                  |  | 2001          |  | 2002   |  | 2002 
|--------------------------------- |  | ------------- |  | ------ |  | -----
|                                  |  | HK$           |  | HK$    |  | US$  
|                                  |  | (in millions)
|Non-trading securities            |  |               |  |        |  |      
|Managed by fund managers          |  |               |  |        |  |      
|Listed outside Hong Kong          |  | 2,943         |  | 1,217  |  | 156  
|Listed in Hong Kong               |  | 210           |  | 16     |  | 2    
|Unlisted investments              |  | 9,270         |  | 11,093 |  | 1,422
|Managed by the Corporation        |  |               |  |        |  |      
|Listed outside Hong Kong          |  | 2,059         |  | 1,377  |  | 177  
|Listed in Hong Kong               |  | 171           |  | 156    |  | 20   
|Unlisted investments              |  | 13,099        |  | 5,306  |  | 680  
|                                  |  |               |  |        |  |      
|Total market value of investments |  | 27,752        |  | 19,165 |  | 2,457
|                                  |  |               |  |        |  |      



Included in
investments in securities are debt securities issued by the Government and Government-owned entities in Hong Kong with a total market value of HK$219 million (2001: HK$479 million) as at December 31, 2002. Interest income derived from these debt
securities during the year amounted to HK$11 million (2001: HK$19 million).



|(b) |  | Investments in securities are expected to mature as follows:
|--- |  | ------------------------------------------------------------



|              |  | 2001          |  | 2002   |  | 2002 
|------------- |  | ------------- |  | ------ |  | -----
|              |  | HK$           |  | HK$    |  | US$  
|              |  | (in millions)
|Within 1 year |  | 20,492        |  | 16,612 |  | 2,130
|After 1 year  |  | 7,260         |  | 2,553  |  | 327  
|              |  |               |  |        |  |      
|              |  | 27,752        |  | 19,165 |  | 2,457
|              |  |               |  |        |  |      



|20 |  | Stores and spares
|-- |  | -----------------



Stores and spares are expected to be consumed as follows:



|              |  | 2001          |  | 2002 |  | 2002
|------------- |  | ------------- |  | ---- |  | ----
|              |  | HK$           |  | HK$  |  | US$ 
|              |  | (in millions)
|Within 1 year |  | 88            |  | 104  |  | 13  
|After 1 year  |  | 98            |  | 109  |  | 14  
|              |  |               |  |      |  |     
|              |  | 186           |  | 213  |  | 27  
|              |  |               |  |      |  |     



|21 |  | Interest receivable
|-- |  | -------------------



Interest receivable is expected to be recovered within 1 year.



F-35



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|22 |  | Other receivables
|-- |  | -----------------



|(a) |  | Other receivables comprise:
|--- |  | ---------------------------



|                                  |  | 2001          |  | 2002  |  | 2002
|--------------------------------- |  | ------------- |  | ----- |  | ----
|                                  |  | HK$           |  | HK$   |  | US$ 
|                                  |  | (in millions)
|Amount due from associate         |  |              |  | 1     |  |    
|Amount due from Government        |  | 229           |  | 298   |  | 38  
|Debtors, deposits and prepayments |  | 199           |  | 863   |  | 111 
|                                  |  |               |  |       |  |     
|                                  |  | 428           |  | 1,162 |  | 149 
|                                  |  |               |  |       |  |     



The amount due from
the Government represents HK$256 million (2001: HK$197 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$42 million (2001: HK$32 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 are
certain costs totalling HK$498 million (2001: nil) 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(b)), and the related accrued interest of
HK$148 million (2001: nil) (note 6). The amounts will be included in the balance of a loan to WRPDL pending agreement between the Corporation and the Government according to the provisions as set out in the Shareholding Agreement (note 18).



|(b) |  | Other receivables are expected to be recovered as follows:
|--- |  | ----------------------------------------------------------



|              |  | 2001          |  | 2002  |  | 2002
|------------- |  | ------------- |  | ----- |  | ----
|              |  | HK$           |  | HK$   |  | US$ 
|              |  | (in millions)
|Within 1 year |  | 337           |  | 479   |  | 61  
|After 1 year  |  | 91            |  | 683   |  | 88  
|              |  |               |  |       |  |     
|              |  | 428           |  | 1,162 |  | 149 
|              |  |               |  |       |  |     



|(c) |  | Included in other receivables are debtors with the following ageing analysis :
|--- |  | ------------------------------------------------------------------------------



|                           |  | 2001          |  | 2002  |  | 2002
|-------------------------- |  | ------------- |  | ----- |  | ----
|                           |  | HK$           |  | HK$   |  | US$ 
|                           |  | (in millions)
|Current                    |  | 280           |  | 1,026 |  | 132 
|Less than 1 month overdue  |  | 4             |  | 3     |  |    
|1 to 3 months overdue      |  | 2             |  | 2     |  |    
|More than 3 months overdue |  | 4             |  | 5     |  | 1   
|                           |  |               |  |       |  |     
|Total debtors              |  | 290           |  | 1,036 |  | 133 
|Deposits and prepayments   |  | 138           |  | 126   |  | 16  
|                           |  |               |  |       |  |     
|                           |  | 428           |  | 1,162 |  | 149 
|                           |  |               |  |       |  |     



For debtors of
commercial property leasing and franchise operation, no credit is allowed except for revenue sharing arrangements. For debtors of other business dealings, the normal credit period to customers is one month.



F-36



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|23 |  | Cash and cash equivalents
|-- |  | -------------------------



|(a) |  | Cash and cash equivalents comprise:
|--- |  | -----------------------------------



|                                                                          |  | 2001          |   |  | 2002  |   |  | 2002 |  
|------------------------------------------------------------------------- |  | ------------- | - |  | ----- | - |  | ---- | -
|                                                                          |  | HK$           |   |  | HK$   |   |  | US$  |  
|                                                                          |  | (in millions) |  
|Deposits with banks                                                       |  |               |   |  |       |   |  |      |  
|Within 3 months of maturity when placed                                  |  | 2,433         |   |  | 4,565 |   |  | 585  |  
|More than 3 months of maturity when placed                               |  | 4,009         |   |  | 943   |   |  | 121  |  
|Cash at bank and in hand                                                  |  | 31            |   |  | 20    |   |  | 3    |  
|                                                                          |  |               |   |  |       |   |  |      |  
|Cash and cash equivalents in balance sheet                                |  | 6,473         |   |  | 5,528 |   |  | 709  |  
|Less: deposits with banks with more than 3 months of maturity when placed |  | (4,009        | ) |  | (943  | ) |  | (121 | )
|                                                                          |  |               |   |  |       |   |  |      |  
|Cash and cash equivalents in cash flow statement                          |  | 2,464         |   |  | 4,585 |   |  | 588  |  
|                                                                          |  |               |   |  |       |   |  |      |  



|(b) |  | At December 31, 2002, the deposits with banks were placed to mature as follows:
|--- |  | -------------------------------------------------------------------------------



|              |  | 2001          |  | 2002  |  | 2002
|------------- |  | ------------- |  | ----- |  | ----
|              |  | HK$           |  | HK$   |  | US$ 
|              |  | (in millions)
|Within 1 year |  | 6,442         |  | 5,308 |  | 680 
|After 1 year  |  |              |  | 200   |  | 26  
|              |  |               |  |       |  |     
|              |  | 6,442         |  | 5,508 |  | 706 
|              |  |               |  |       |  |     



|24 |  | Interest payable
|-- |  | ----------------



Interest payable is expected to be settled within 1 year.



|25 |  | Other payables
|-- |  | --------------



|(a) |  | Other payables comprise:
|--- |  | ------------------------



|                              |  | 2001          |  | 2002  |  | 2002
|----------------------------- |  | ------------- |  | ----- |  | ----
|                              |  | Restated      |  |       |  |     
|                              |  | HK$           |  | HK$   |  | US$ 
|                              |  | (in millions)
|Deposits and advances         |  | 1,386         |  | 1,520 |  | 195 
|Creditors and accrued charges |  | 672           |  | 714   |  | 91  
|Amount due to Government      |  | 484           |  | 17    |  | 2   
|Amount due to subsidiaries    |  |              |  |      |  |    
|                              |  |               |  |       |  |     
|                              |  | 2,542         |  | 2,251 |  | 288 
|                              |  |               |  |       |  |     



The amount due to
Government represents HK$17 million (2001: nil) for land grant application for property development along the route of the East Rail Extensions in 2002. The balance as at December 31, 2001 represented HK$10 million for land resumption work
undertaken on the West Rail project and HK$474 million in respect of the consideration for the vesting of Lo Wu Terminal Building Stage III to the Corporation.



F-37



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|25 |  | Other payables(Continued)
|-- |  | --------------------------



|(b) |  | Other payables are expected to be settled as follows:
|--- |  | -----------------------------------------------------



|              |  | 2001          |  | 2002  |  | 2002
|------------- |  | ------------- |  | ----- |  | ----
|              |  | Restated      |  |       |  |     
|              |  | HK$           |  | HK$   |  | US$ 
|              |  | (in millions)
|Within 1 year |  | 1,121         |  | 1,063 |  | 136 
|After 1 year  |  | 1,421         |  | 1,188 |  | 152 
|              |  |               |  |       |  |     
|              |  | 2,542         |  | 2,251 |  | 288 
|              |  |               |  |       |  |     



|(c) |  | Included in other payables are creditors with the following ageing analysis:
|--- |  | ----------------------------------------------------------------------------



|                                |  | 2001          |  | 2002  |  | 2002
|------------------------------- |  | ------------- |  | ----- |  | ----
|                                |  | Restated      |  |       |  |     
|                                |  | HK$           |  | HK$   |  | US$ 
|                                |  | (in millions)
|Due within 1 month or on demand |  | 844           |  | 353   |  | 45  
|                                |  |               |  |       |  |     
|Total creditors                 |  | 844           |  | 353   |  | 45  
|Deposits and advances received  |  | 1,386         |  | 1,520 |  | 195 
|Accrued charges                 |  | 312           |  | 378   |  | 48  
|                                |  |               |  |       |  |     
|                                |  | 2,542         |  | 2,251 |  | 288 
|                                |  |               |  |       |  |     



|26 |  | 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$570 million (2001: HK$543 million) for amounts payable to the Government in respect of land resumption work undertaken on the West Rail and East Rail
Extensions projects.



Accrued charges and provisions for
capital projects of the Group and of the Corporation are all expected to be settled or utilized within 1 year.



F-38



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|27 |  | Interest-bearing borrowings
|-- |  | ---------------------------



Interest-bearing borrowings comprise:



|                                             |  | Balance as at December 31, 2001 |  | Balance as at December 31, 2002 |  | Balance as at December 31, 2002
|-------------------------------------------- |  | ------------------------------- |  | ------------------------------- |  | -------------------------------
|                                             |  | HK$                             |  | HK$                             |  | US$                            
|                                             |  | (in millions)                  
|Capital market instruments                   |  |                                 |  |                                 |  |                                
|US dollar Euro medium term notes due 2009(a) |  | 7,768                           |  | 7,769                           |  | 996                            
|US dollar Euro medium term notes due 2014(a) |  | 389                             |  | 388                             |  | 50                             
|US dollar Global notes due 2010(b)           |  | 7,790                           |  | 7,781                           |  | 998                            
|                                             |  |                                 |  |                                 |  |                                
|                                             |  | 15,947                          |  | 15,938                          |  | 2,044                          
|                                             |  |                                 |  |                                 |  |                                
|Bank loan                                    |  |                                 |  |                                 |  |                                
|Export credit loans(d)                       |  | 884                             |  | 1,815                           |  | 232                            
|                                             |  |                                 |  |                                 |  |                                
|                                             |  | 16,831                          |  | 17,753                          |  | 2,276                          
|                                             |  |                                 |  |                                 |  |                                

---

|(a) |  | The Corporation issued US$1 billion in principal amount of 7.25% notes due 2009 at a discount on July 27, 1999 and US$50 million in principal amount of 7.77% notes due 2014 at a
discount on November 17, 1999 under its US$3 billion Euro Medium Term Note program. All the notes issued are unsecured and wholly repayable on the respective due dates.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) |  | The Corporation issued US$1 billion in principal amount of 8.00% global notes due 2010 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 wholly repayable on the due date.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(c) |  | All the net proceeds received from the notes issued have been invested in fixed income instruments or placed on deposits with banks or issuers with triple B or above credit ratings
until they are required to meet development costs.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(d) |  | During the year, in addition to the amounts totalling US$102.1 million drawn down in previous years, an amount of US$107.4 million was drawn down by the Corporation under a US$338
million export credit loan facility for financing the purchase of rolling stock. Fifty per cent of the total loan balance bears interest at a rate of 5.6% per annum and the remaining 50% bears interest at a rate of LIBOR plus 0.5% per annum. The
loan is unsecured and repayable by seventeen semi-annual instalments commencing on April 21, 2003.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

During the year, in
addition to the amount of US$10.7 million drawn down in previous years, an amount of US$11.7 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 instalments commencing not later than May 1, 2004.

|(e) |  | At December 31, 2002, the interest-bearing borrowings were repayable as follows:
|--- |  | --------------------------------------------------------------------------------



|                                |  | Total 2001    |  | Capital marketinstruments 2002 |  | Bank loans 2002 |  | Total 2002 |  | Total 2002
|------------------------------- |  | ------------- |  | ------------------------------ |  | --------------- |  | ---------- |  | ----------
|                                |  | HK$           |  | HK$                            |  | HK$             |  | HK$        |  | US$       
|                                |  | (in millions)
|Within 1 year                   |  |              |  |                               |  | 310             |  | 310        |  | 40        
|After 1 year but within 2 years |  | 311           |  |                               |  | 350             |  | 350        |  | 45        
|After 2 year but within 5 years |  | 573           |  |                               |  | 548             |  | 548        |  | 70        
|After 5 years                   |  | 15,947        |  | 15,938                         |  | 607             |  | 16,545     |  | 2,121     
|                                |  |               |  |                                |  |                 |  |            |  |           
|                                |  | 16,831        |  | 15,938                         |  | 1,815           |  | 17,753     |  | 2,276     
|                                |  |               |  |                                |  |                 |  |            |  |           



F-39



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|28 |  | Deferred income
|-- |  | ---------------



|(a) |  | Movements on deferred income comprise:
|--- |  | --------------------------------------



|                                    |  | 2001          |   |  | 2002 |   |  | 2002 |  
|----------------------------------- |  | ------------- | - |  | ---- | - |  | ---- | -
|                                    |  | HK$           |   |  | HK$  |   |  | US$  |  
|                                    |  | (in millions) |  
|Balance at January 1,               |  | 444           |   |  | 454  |   |  | 58   |  
|Net amount received during the year |  | 36            |   |  | 140  |   |  | 18   |  
|Transfer to income statement        |  | (26           | ) |  | (160 | ) |  | (20  | )
|                                    |  |               |   |  |      |   |  |      |  
|Balance at December 31,             |  | 454           |   |  | 434  |   |  | 56   |  
|                                    |  |               |   |  |      |   |  |      |  



|(b) |  | Deferred income is expected to be recognized in the income statement as follows:
|--- |  | --------------------------------------------------------------------------------



|              |  | 2001          |  | 2002 |  | 2002
|------------- |  | ------------- |  | ---- |  | ----
|              |  | HK$           |  | HK$  |  | US$ 
|              |  | (in millions)
|Within 1 year |  | 159           |  | 27   |  | 4   
|After 1 year  |  | 295           |  | 407  |  | 52  
|              |  |               |  |      |  |     
|              |  | 454           |  | 434  |  | 56  
|              |  |               |  |      |  |     



F-40



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|29 |  | Share capital
|-- |  | -------------



|                          |  | 2000         |  | 2001         |  | 2002         |  | 2002        
|------------------------- |  | ------------ |  | ------------ |  | ------------ |  | ------------
|                          |  | No. ofshares |  | HK$          |  | No. ofshares |  | HK$         
|                          |  |              |  | (in million) |  |              |  | (in million)
|Share capital:            |  |              |  |              |  |              |  |             
|Authorized:               |  |              |  |              |  |              |  |             
|Shares of HK$100,000 each |  | 340,000      |  | 34,000       |  | 425,000      |  | 42,500      
|                          |  |              |  |              |  |              |  |             
|Issued and fully paid:    |  |              |  |              |  |              |  |             
|At January 1,             |  | 311,200      |  | 31,120       |  | 311,200      |  | 31,120      
|Issued during the year    |  |             |  |             |  | 80,000       |  | 8,000       
|                          |  |              |  |              |  |              |  |             
|At December 31,           |  | 311,200      |  | 31,120       |  | 391,200      |  | 39,120      
|                          |  |              |  |              |  |              |  |             



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 cash 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.



|30 |  | Development reserve
|-- |  | -------------------



The development reserve represents appropriations of all profits from property developments to retain reserves within the Corporation for railway capital
expenditure. Movements in the development reserve during the year were as follows:



|                               |  | 2000          |  | 2001  |  | 2002  |  | 2002
|------------------------------ |  | ------------- |  | ----- |  | ----- |  | ----
|                               |  | HK$           |  | HK$   |  | HK$   |  | US$ 
|                               |  | (in millions)
|Balance at January 1,          |  | 6,330         |  | 6,417 |  | 6,441 |  | 826 
|Transfer from income statement |  | 87            |  | 24    |  | 94    |  | 12  
|                               |  |               |  |       |  |       |  |     
|Balance at December 31,        |  | 6,417         |  | 6,441 |  | 6,535 |  | 838 
|                               |  |               |  |       |  |       |  |     



|31 |  | Investment property revaluation reserve
|-- |  | ---------------------------------------



The investment property revaluation reserve comprises:



|                                                                   |  | 2000          |  | 2001 |   |  | 2002 |   |  | 2002 |  
|------------------------------------------------------------------ |  | ------------- |  | ---- | - |  | ---- | - |  | ---- | -
|                                                                   |  | HK$           |  | HK$  |   |  | HK$  |   |  | US$  |  
|                                                                   |  | (in millions) | 
|Balance at January 1,                                              |  | 231           |  | 242  |   |  | 176  |   |  | 22   |  
|Surplus/(Deficit) arising on revaluation during the year (note 12) |  | 11            |  | (66  | ) |  | (42  | ) |  | (5   | )
|                                                                   |  |               |  |      |   |  |      |   |  |      |  
|Balance at December 31,                                            |  | 242           |  | 176  |   |  | 134  |   |  | 17   |  
|                                                                   |  |               |  |      |   |  |      |   |  |      |  



F-41



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|32 |  | Investment revaluation reserve
|-- |  | ------------------------------



The revaluation reserve arising on investments in securities comprises:



|                                                                  |  | 2000          |   |  | 2001 |   |  | 2002 |   |  | 2002 |  
|----------------------------------------------------------------- |  | ------------- | - |  | ---- | - |  | ---- | - |  | ---- | -
|                                                                  |  | HK$           |   |  | HK$  |   |  | HK$  |   |  | US$  |  
|                                                                  |  | (in millions) |  
|Balance at January 1,                                             |  | 2             |   |  | 16   |   |  | 133  |   |  | 17   |  
|                                                                  |  |               |   |  |      |   |  |      |   |  |      |  
|Surplus/(Deficit) arising on revaluation                          |  | 406           |   |  | 250  |   |  | (516 | ) |  | (66  | )
|Less: Amount capitalized                                          |  | (384          | ) |  | (119 | ) |  | 414  |   |  | 53   |  
|                                                                  |  |               |   |  |      |   |  |      |   |  |      |  
|                                                                  |  | 22            |   |  | 131  |   |  | (102 | ) |  | (13  | )
|                                                                  |  |               |   |  |      |   |  |      |   |  |      |  
|Deficit/(Surplus) realized on disposal                            |  | (44           | ) |  | (62  | ) |  | 55   |   |  | 7    |  
|Surplus/(Deficit) capitalized in prior year                       |  | 36            |   |  | 48   |   |  | (36  | ) |  | (5   | )
|                                                                  |  |               |   |  |      |   |  |      |   |  |      |  
|Deficit/(Surplus) transferred to the income statement on disposal |  | (8            | ) |  | (14  | ) |  | 19   |   |  | 2    |  
|                                                                  |  |               |   |  |      |   |  |      |   |  |      |  
|Balance at December 31,                                           |  | 16            |   |  | 133  |   |  | 50   |   |  | 6    |  
|                                                                  |  |               |   |  |      |   |  |      |   |  |      |  



|33 |  | Retained profits
|-- |  | ----------------



Profits are retained as follows:



|                                             |  | 2000          |  | 2001     |   |  | 2002   |   |  | 2002  |  
|-------------------------------------------- |  | ------------- |  | -------- | - |  | ------ | - |  | ----- | -
|                                             |  |               |  | Restated |   |  |        |   |  |       |  
|                                             |  | HK$           |  | HK$      |   |  | HK$    |   |  | US$   |  
|                                             |  | (in millions) | 
|Retained profits at January 1,               |  |               |  |          |   |  |        |   |  |       |  
|as previously reported                      |  | 8,905         |  | 11,106   |   |  | 13,743 |   |  | 1,762 |  
|prior period adjustment                     |  |               |  |          |   |  |        |   |  |       |  
|change in accounting policy (note 4(a))     |  |              |  | (32      | ) |  | (33    | ) |  | (4    | )
|change in accounting policy (note 4(b))     |  |              |  | 225      |   |  |       |   |  |      |  
|                                             |  |               |  |          |   |  |        |   |  |       |  
|Retained profits at January 1, (as restated) |  | 8,905         |  | 11,299   |   |  | 13,710 |   |  | 1,758 |  
|Retained profit for the year                 |  | 2,201         |  | 2,411    |   |  | 2,567  |   |  | 329   |  
|                                             |  |               |  |          |   |  |        |   |  |       |  
|Retained profits at December 31,             |  | 11,106        |  | 13,710   |   |  | 16,277 |   |  | 2,087 |  
|                                             |  |               |  |          |   |  |        |   |  |       |  
|Representing:                                |  |               |  |          |   |  |        |   |  |       |  
|Proposed dividend (note 10)                  |  |              |  |         |   |  | 620    |   |  | 79    |  
|Retained profits after proposed dividend     |  | 11,106        |  | 13,710   |   |  | 15,657 |   |  | 2,008 |  



Included in the
retained profits is an amount of HK$26 million (2001: HK$10 million; 2000: accumulated loss of HK$1 million), being the retained profit attributable to an associate.



F-42



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|34 |  | 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
West Rail, Phase I and the 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, 18, 22, 25, 26 and 29 to the financial
statements. In addition, the Corporation has made investments in debt securities issued by the Government and Government-owned entities and these are disclosed in note 19 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 transaction and interchange fees from the Corporation and paid a ticket loading agent fee to
the Corporation. Details of the transactions are disclosed in note 17 to the financial statements.



|35 |  | Outstanding commitments
|-- |  | -----------------------



(a)    Commitments outstanding at December 31, 2002 in respect of capital expenditure not provided for in the financial statements were as follows:



|                                                                        |  | 2001          |  | 2002        
|----------------------------------------------------------------------- |  | ------------- |  | ------------
|                                                                        |  | Total         |  | Within1 year
|                                                                        |  | HK$           |  | HK$         
|                                                                        |  | (in millions)
|Contracted for                                                          |  |               |  |             
|Noise abatement program                                                 |  | 21            |  | 20          
|Acquisition & implementation of computer systems                        |  | 33            |  | 1           
|Construction & improvement works at various stations, stops & terminals |  | 16            |  | 158         
|New railway projects                                                    |  | 7             |  | 36          
|Improvement works on vehicles & equipment                               |  | 48            |  | 9           
|Purchase of eight 12-car Electric Multiple Units                        |  | 237           |  | 9           
|Light Rail Extension to Tin Shui Wai                                    |  | 320           |  | 167         
|Grade Separation at LRT junction                                        |  | 356           |  | 135         
|Replacement of LRT vehicle information system                           |  | 197           |  | 184         
|Southern subway & concourse at Kowloon Tong Station                     |  | 147           |  | 67          
|Replacement of three diesel locomotives                                 |  | 44            |  | 5           
|Light Rail integration project with West Rail                           |  | 127           |  | 25          
|East Rail Extensions project:                                           |  |               |  |             
|Consultants fees                                                       |  | 684           |  | 295         
|Construction works                                                      |  | 6,417         |  | 3,520       
|Staff cost                                                              |  | 1,397         |  | 250         
|Land acquisition cost                                                   |  | 502           |  | 520         
|Others                                                                  |  | 48            |  | 31          
|                                                                        |  |               |  |             
|                                                                        |  | 9,048         |  | 4,616       
|West Rail project:                                                      |  |               |  |             
|Consultants fees                                                       |  | 921           |  | 487         
|Construction works                                                      |  | 6,676         |  | 2,665       
|Staff cost                                                              |  | 1,271         |  | 369         
|Land acquisition cost                                                   |  | 337           |  | 150         
|Others                                                                  |  | 53            |  | 42          
|                                                                        |  |               |  |             
|                                                                        |  | 9,258         |  | 3,713       
|Other projects                                                          |  | 34            |  | 30          
|                                                                        |  |               |  |             
|                                                                        |  | 19,893        |  | 9,175       
|                                                                        |  |               |  |             



F-43



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|35 |  | Outstanding commitments(Continued)
|-- |  | -----------------------------------



|                                                                          |  | 2001          |  | 2002        
|------------------------------------------------------------------------- |  | ------------- |  | ------------
|                                                                          |  | Total         |  | Within 1year
|                                                                          |  | HK$           |  | HK$         
|                                                                          |  | (in millions)
|Authorized but not contracted for                                         |  |               |  |             
|Upgrade of signalling system                                              |  | 39            |  | 3           
|Noise abatement program                                                   |  | 185           |  | 34          
|PRC Through Train development                                             |  | 52            |  | 17          
|Electric Multiple Units refurbishment                                     |  | 46            |  | 31          
|Installation & replacement of escalators at stations                      |  | 12            |  | 9           
|Acquisition and implementation of computer systems                        |  | 75            |  | 36          
|Construction & improvement works at various stations, stops and terminals |  | 87            |  | 56          
|Improvement works on vehicles & equipment                                 |  | 111           |  | 92          
|Purchase of eight 12-car Electric Multiple Units                          |  | 363           |  | 142         
|Light Rail Extension to Tin Shui Wai                                      |  | 82            |  |            
|Replacement of LRT vehicle information system                             |  | 70            |  |            
|Installation of training information system                               |  |              |  | 15          
|Southern subway & concourse at Kowloon Tong Station                       |  | 62            |  | 27          
|Replacement of ARC equipment at all stations                              |  | 64            |  | 27          
|Replacement of three diesel locomotives                                   |  | 98            |  | 79          
|Train-borne Infotainment system                                           |  |              |  | 49          
|New railway projects                                                      |  | 17            |  | 259         
|Renovation of Government & commercial office                              |  | 18            |  | 13          
|East Rail Extensions project:                                             |  |               |  |             
|Consultants fees                                                         |  | 31            |  | 9           
|Construction works                                                        |  | 175           |  | 41          
|Staff cost                                                                |  |              |  | 68          
|Land acquisition cost                                                     |  | 21            |  | 3           
|Others                                                                    |  | 4             |  | 6           
|                                                                          |  |               |  |             
|                                                                          |  | 231           |  | 127         
|West Rail project:                                                        |  |               |  |             
|Consultants fees                                                         |  | 46            |  |            
|Construction works                                                        |  | 423           |  |            
|Land acquisition cost                                                     |  | 2,266         |  | 629         
|Others                                                                    |  | 638           |  | 542         
|                                                                          |  |               |  |             
|                                                                          |  | 3,373         |  | 1,171       
|Other projects                                                            |  | 54            |  | 52          
|                                                                          |  |               |  |             
|                                                                          |  | 5,039         |  | 2,239       
|                                                                          |  |               |  |             



(b) As December 31, 2002, the total
future minimum lease payments under non-cancellable operating leases on property are payable as follows:



|                                |  | 2001          |  | 2002 |  | 2002
|------------------------------- |  | ------------- |  | ---- |  | ----
|                                |  | HK$           |  | HK$  |  | US$ 
|                                |  | (in millions)
|Within 1 year                   |  | 134           |  | 148  |  | 19  
|After 1 year but within 5 years |  | 176           |  | 125  |  | 16  
|                                |  |               |  |      |  |     
|                                |  | 310           |  | 273  |  | 35  
|                                |  |               |  |      |  |     



The operating leases
are mainly related to work areas used for construction of new railways.



F-44



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|36 |  | Notes to the consolidated cash flow statement
|-- |  | ---------------------------------------------



|(a) |  | Reconciliation of operating profit before net investment income to net cash inflow from operations:
|--- |  | ---------------------------------------------------------------------------------------------------



|                                                                                                                       |  | 2000          |   |  | 2001     |   |  | 2002  |   |  | 2002 |  
|---------------------------------------------------------------------------------------------------------------------- |  | ------------- | - |  | -------- | - |  | ----- | - |  | ---- | -
|                                                                                                                       |  |               |   |  | Restated |   |  |       |   |  |      |  
|                                                                                                                       |  | HK$           |   |  | HK$      |   |  | HK$   |   |  | US$  |  
|                                                                                                                       |  | (in millions) |  
|Operating profit before net investment income                                                                          |  | 1,901         |   |  | 1,911    |   |  | 1,934 |   |  | 248  |  
|Increase in insurance provision                                                                                        |  | 10            |   |  |         |   |  |      |   |  |     |  
|Depreciation                                                                                                           |  | 670           |   |  | 661      |   |  | 725   |   |  | 93   |  
|Fixed assets written off                                                                                               |  | 1             |   |  | 5        |   |  | 27    |   |  | 3    |  
|Decrease/(Increase) in stores and spares                                                                               |  | 8             |   |  | (15      | ) |  | (27   | ) |  | (3   | )
|Increase in interest receivable and other receivables                                                                  |  | (354          | ) |  | (264     | ) |  | (539  | ) |  | (69  | )
|Increase in interest payables, other payables, accrued charges and provisions for capital projects and deferred
income |  | 520           |   |  | 463      |   |  | 783   |   |  | 100  |  
|                                                                                                                       |  |               |   |  |          |   |  |       |   |  |      |  
|                                                                                                                       |  | 2,756         |   |  | 2,761    |   |  | 2,903 |   |  | 372  |  
|                                                                                                                       |  |               |   |  |          |   |  |       |   |  |      |  



|(b) |  | Reconciliation of profit on property development to net cash inflow/(outflow) from property development:
|--- |  | --------------------------------------------------------------------------------------------------------



|                                                            |  | 2000          |   |  | 2001 |   |  | 2002 |   |  | 2002 |  
|----------------------------------------------------------- |  | ------------- | - |  | ---- | - |  | ---- | - |  | ---- | -
|                                                            |  | HK$           |   |  | HK$  |   |  | HK$  |   |  | US$  |  
|                                                            |  | (in millions) |  
|Profit on property development                              |  | 87            |   |  | 24   |   |  | 94   |   |  | 12   |  
|Decrease in property development debtors                    |  | 10            |   |  |     |   |  |     |   |  |     |  
|Decrease/(Increase) in property under development           |  | 1             |   |  | (383 | ) |  | (577 | ) |  | (73  | )
|Decrease/(Increase) in properties held for resale           |  |              |   |  | (11  | ) |  | 11   |   |  | 1    |  
|(Decrease)/Increase in deferred property development income |  | (1            | ) |  | 20   |   |  | 70   |   |  | 9    |  
|                                                            |  |               |   |  |      |   |  |      |   |  |      |  
|                                                            |  | 97            |   |  | (350 | ) |  | (402 | ) |  | (51  | )
|                                                            |  |               |   |  |      |   |  |      |   |  |      |  



F-45



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|37 |  | Retirement benefit scheme
|-- |  | -------------------------



The Kowloon-Canton Railway Corporation Retirement Benefit Scheme (the Scheme) was established on February 1, 1983 under trust. With effect from November
16, 1994, the Scheme has been registered under Section 18 of the Occupational Retirement Schemes Ordinance.



Prior to January 1, 2000, the Scheme was a defined benefit retirement scheme which provided benefits for all eligible employees of the Corporation.
Benefits were calculated by reference to the unit price, accrued service, salary and number of accumulated units of a member. With effect from January 1, 2000, a new defined contribution section was 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 from the Scheme are defined contributions and are calculated by reference to the
Corporations contributions and members 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 for non-management staff and management staff.



On July 17, 2000, the Scheme was granted an exemption certificate by the Mandatory Provident Fund Schemes Authority under Section 5 of the Mandatory
Provident Fund Schemes Ordinance. This means that all potential future members of the Scheme must be given a one-off opportunity to elect to join either the Scheme or an MPF Scheme. As of December 31, 2001, most of the eligible members of the Scheme
opted to join the Scheme.



Where there are employees who leave
the Scheme prior to their entitlement vesting fully to all or part of the Corporations contributions, 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, 2002 amounted to HK$110 million (2001: HK$105 million) net of capitalized amount of HK$19 million (2001: HK$18 million), after a forfeiture of HK$4 million (2001: HK$8 million) unvested contributions.



F-46



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|38 |  | Loan facilities
|-- |  | ---------------



Total undrawn loan facilities available to the Corporation comprise:



|                                                                                                                     |  | 2000          |  | 2001   |  | 2002   |  | 2002 
|-------------------------------------------------------------------------------------------------------------------- |  | ------------- |  | ------ |  | ------ |  | -----
|                                                                                                                     |  | HK$           |  | HK$    |  | HK$    |  | US$  
|                                                                                                                     |  | (in millions)
|HK$2,250 million (2001: HK$2,650 million; 2000: HK$2,150 million) short-term uncommitted revolving credit
facilities |  | 2,150         |  | 2,650  |  | 2,250  |  | 289  
|HK$20 million (2001: HK$20 million; 2000: HK$20 million) letters of credit                                           |  | 20            |  | 20     |  | 3      |  |     
|HK$25 million (2001: HK$25 million; 2000: HK$25 million) overdraft facilities                                        |  | 25            |  | 25     |  | 25     |  | 3    
|Nil (2001: Nil; 2000: HK$10,000 million) note issuance program                                                       |  | 10,000        |  |       |  |       |  |     
|US$3,000 million (2001: US$3,000 million; 2000: US$3,000 million) Euro medium term program                           |  | 15,269        |  | 15,264 |  | 15,266 |  | 1,957
|US$236 million (2001: US$188 million; 2000: US$174 million) letters of credit for US leverage leases                 |  | 1,362         |  | 1,472  |  | 1,848  |  | 237  
|US$380 million (2001: US$380 million; 2000: US$380 million) export credit loan facilities                            |  | 2,523         |  | 2,088  |  | 1,157  |  | 149  
|                                                                                                                     |  |               |  |        |  |        |  |      
|                                                                                                                     |  | 31,349        |  | 21,519 |  | 20,549 |  | 2,635
|                                                                                                                     |  |               |  |        |  |        |  |      



|39 |  | 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, 2002, the Corporation has outstanding derivative instruments in the notional amount of HK$19,830 million comprising:



|                                   |  | 2001          |  | 2002   |  | 2002 
|---------------------------------- |  | ------------- |  | ------ |  | -----
|                                   |  | HK$           |  | HK$    |  | US$  
|                                   |  | (in millions)
|Interest rate swaps                |  | 5,871         |  | 3,914  |  | 502  
|Cross currency swaps               |  | 11,673        |  | 15,573 |  | 1,997
|Foreign exchange forward contracts |  | 1,033         |  | 343    |  | 44   
|                                   |  |               |  |        |  |      
|                                   |  | 18,577        |  | 19,830 |  | 2,543
|                                   |  |               |  |        |  |      



|40 |  | Contingent liabilities
|-- |  | ----------------------



At December 31, 2002, 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, 2002. The Group is in the process of resolving these claims and the amounts of the Groups obligations, if
any, cannot be estimated reliably.



|41 |  | Properties held for resale
|-- |  | --------------------------



All properties held for resale were disposed as at December 31, 2002.



F-47



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|42 |  | Summary of differences between accounting principles generally accepted in Hong Kong and the United States of America
|-- |  | ---------------------------------------------------------------------------------------------------------------------



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 of America (US GAAP). The significant
differences relate principally 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$764 million and HK$761 million at December 31, 2001 and December 31, 2002, 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(r)) 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.



|(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
also 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 is recognized on a percentage-of-completion basis.



In 1997, the Corporation 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 given up. Under US GAAP, the cost of the acquired properties should be stated at the cost of the properties
being disposed of as the transaction was considered an exchange of similar productive assets. Accordingly, an adjustment of HK$61 million was made to net assets to restate the cost of properties acquired under US GAAP.



|(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.



|(e) |  | Income taxes
|--- |  | ------------



The Groups deferred taxation is calculated under the liability method in respect of the taxation effect arising from all timing differences which
are expected with reasonable probability to become payable in the foreseeable future. With respect to deferred tax provision, HK GAAP includes recognition criteria providing for deferred taxation to be probable of crystallization in the foreseeable
future. Based on these recognition criteria, as disclosed in note 8(c), the Group had an unrecognized deferred tax liability at December 31, 2002 and December 31, 2001.



US GAAP requires that full provision be 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.



F-48



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|42 |  | Summary of differences between accounting principles generally accepted in Hong Kong and the United States of America(Continued)
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------



|(f) |  | Capitalized interest and foreign exchange gains and losses
|--- |  | ----------------------------------------------------------



Under HKGAAP, 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 became similar to US GAAP.



Further, under HK GAAP, foreign exchange differences are capitalized to the extent that they are regarded as an adjustment to interest costs. Under US GAAP, foreign exchange differences are not capitalized.



|(g) |  | 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.



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



Under HK GAAP, where commitments by the Corporation 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 Corporation (see note 3(o)). Under US GAAP, the security deposits placed consist of cash lease
deposits and cannot be used to offset the obligations. As such, under US GAAP, the deposits paid and the commitments to make long-term lease payments would be reflected separately in the balance sheets.



|(i) |  | Pension costs
|--- |  | -------------



Prior to April 1, 2000, the provision for the defined benefit element of the Kowloon-Canton Railway Corporation Retirement Benefit Scheme (the
Scheme) was generally based on the contributions made to the Scheme under HK GAAP. Such contributions were determined with reference to an Actuarial Valuation. Under US GAAP, the defined benefit element of the Scheme is recognized as a
charge to income over the employees approximate service period, in accordance with United States Statement of Financial Accounting Standards (SFAS) 87, Employers Accounting for Pensions. SFAS 87 focuses on the
Schemes benefit formula as the basis for determining the benefit earned, and therefore the cost incurred, in each year. The determination of the benefit earned is actuarially determined and includes components for service cost, time value of
money, return on plan assets and gains or losses from changes in previous assumptions.



With effect from April 1, 2000, the Groups retirement scheme has been changed from a defined benefit plan to a defined contribution plan. Under HK GAAP, the accounting policy for a defined contribution plan is
similar to US GAAP.



F-49



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|42 |  | Summary of differences between accounting principles generally accepted in Hong Kong and the United States of America(Continued)
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------



|(j) |  | Insurance Provision
|--- |  | -------------------



Prior to January 1, 2001, the Group maintained a provision for insurance 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. Under US GAAP, the Groups provision for insurance does not meet the US GAAP liability accrual requirement that a loss be probable in
order for a provision to be established.



With effect from
January 1, 2001, the Groups accounting policy under HK GAAP for the recognition of provision for losses and contingent liabilities is similar to US GAAP. The effect of adopting this policy resulted in an increase of HK$225 million to the
balance of shareholders funds as of January 1, 2001, and accordingly, the prior year US GAAP adjustment to shareholders funds for insurance provision has been eliminated.



|(k) |  | Reconciliation of consolidated profit after taxation to US GAAP
|--- |  | ---------------------------------------------------------------



|                                                                           |  | Note |      |  | Year ended December 31, |           
|-------------------------------------------------------------------------- |  | ---- | ---- |  | ----------------------- | ----------
|                                                                           |  |      | 2000 |  |                         | 2001(Note)
|                                                                           |  |      |      |  |                         |           
|                                                                           |  |      |      |  | HK$                     |           
|                                                                           |  |      |      |  | (in millions)           |           
|Consolidated profit after taxation for the year in accordance with HK GAAP |  |      |      |  | 2,288                   |           
|Adjustments required under US GAAP                                         |  |      |      |  |                         |           
|Depreciation on investment properties                                      |  | 42   | (a)  |  | (14                     | )         
|Investment securities                                                      |  | 42   | (b)  |  | 36                      |           
|Investment income capitalized under HK GAAP                                |  | 42   | (b)  |  | 2,320                   |           
|Revenue recognition of property development                                |  | 42   | (c)  |  |                        |           
|Capitalization of certain costs net of related depreciation                |  | 42   | (d)  |  | (44                     | )         
|Difference in periodic pension cost                                        |  | 42   | (i)  |  | (27                     | )         
|Deferred tax accounting                                                    |  | 42   | (e)  |  | (357                    | )         
|Amortization of capitalized interest                                       |  | 42   | (f)  |  | (27                     | )         
|Capitalized net foreign exchange gain/(loss)                               |  | 42   | (f)  |  | 12                      |           
|Insurance provision                                                        |  | 42   | (j)  |  | 10                      |           
|Derivative instruments                                                     |  | 42   | (g)  |  |                        |           
|Tax effect of above adjustments                                            |  |      |      |  | (84                     | )         
|                                                                           |  |      |      |  |                         |           
|Consolidated net income for the year in accordance with US GAAP            |  |      |      |  | 4,113                   |           
|                                                                           |  |      |      |  |                         |           

---

Note:

Under HK GAAP, the Group adopted SSAP 34 (Employee Benefits) on January 1, 2002. As a result of the adoption of SSAP 34, the Group recognises liabilities
for certain employee benefits in the accounting period in which the obligations arise, including staffs annual leave balance and leave passage entitlements. Under HK GAAP, SSAP 34 was adopted retrospectively, resulting in the restatement of
certain prior year balances as set out in note 4(a) of the financial statements. Under US GAAP, the adoption of SSAP 34 with respect to the accrual of staffs annual leave and leave passage entitlements represents a restatement for prior years.
However, the amount of the restatement under US GAAP was not considered material to the Groups results of operations or shareholders equity.



F-50



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|42 |  | Summary of differences between accounting principles generally accepted in Hong Kong and the United States of America(Continued)
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------



|(l) |  | Reconciliation of consolidated shareholders funds to US GAAP
|--- |  | -------------------------------------------------------------



|                                                                        |  | Note |            |  | As of December 31, |     
|----------------------------------------------------------------------- |  | ---- | ---------- |  | ------------------ | ----
|                                                                        |  |      | 2001(Note) |  |                    | 2002
|                                                                        |  |      |            |  | Restated           |     
|                                                                        |  |      |            |  | HK$                |     
|                                                                        |  |      |            |  | (in millions)      |     
|Consolidated shareholders funds in accordance with HK GAAP             |  |      |            |  | 59,580             |     
|Adjustments required under US GAAP                                      |  |      |            |  |                    |     
|Accumulated depreciation on investment properties                       |  | 42   | (a)        |  | (95                | )   
|Asset revaluation reserve                                               |  | 42   | (a)        |  | (176               | )   
|Valuation of investment portfolio                                       |  | 42   | (b)        |  | 463                |     
|Investment income capitalized under HK GAAP                             |  | 42   | (b)        |  | 6,678              |     
|Revenue recognition on property development                             |  | 42   | (c)        |  | 12                 |     
|Capitalization of certain costs net of related depreciation             |  | 42   | (d)        |  | (381               | )   
|Deferred tax accounting                                                 |  | 42   | (e)        |  | (2,153             | )   
|Amortization of capitalized interest                                    |  | 42   | (f)        |  | 259                |     
|Capitalized net foreign exchange loss                                   |  | 42   | (f)        |  | (39                | )   
|Derivative instruments including cumulative effect of adopting SFAS 133 |  | 42   | (g)        |  | (152               | )   
|Lease obligations                                                       |  | 42   | (h)        |  | (7,709             | )   
|Lease deposits                                                          |  | 42   | (h)        |  | 7,709              |     
|Tax effect of above adjustments                                         |  |      |            |  | (218               | )   
|                                                                        |  |      |            |  |                    |     
|Consolidated shareholders equity in accordance with US GAAP            |  |      |            |  | 63,778             |     
|                                                                        |  |      |            |  |                    |     

---

Note:

Under HK GAAP, the Group adopted SSAP 34 (Employee Benefits) on January 1, 2002. As a result of the adoption of SSAP 34, the Group recognizes liabilities
for certain employee benefits in the accounting period in which the obligations arise, including staffs annual leave balance and leave passage entitlements. Under HK GAAP, SSAP 34 was adopted retrospectively, resulting in the restatement of
certain prior year balances as set out in note 4(a) of the financial statements. Under US GAAP, the adoption of SSAP 34 with respect to the accrual of staffs annual leave and leave passage entitlements represents a restatement for prior years.
However, the amount of the restatement under US GAAP was not considered material to the Groups results of operations or shareholders equity.



F-51



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##### Table of Contents

##### Index to Financial Statements

KOWLOON-CANTON RAILWAY CORPORATION



NOTES TO THE FINANCIAL STATEMENTS(Continued)

December 31, 2000, 2001, 2002



|42 |  | 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, |  
|----------------------------------------- |  | ------------------ | -
|                                          |  | 2000               |  
|                                          |  | HK$                |  
|                                          |  | (in millions)      |  
|Net cash provided/(used) by:              |  |                    |  
|Operating activities                      |  | 3,603              |  
|Investing activities                      |  | (10,518            | )
|Financing activities                      |  | 8,043              |  
|                                          |  |                    |  
|Change in cash and cash equivalents       |  | 1,128              |  
|Cash and cash equivalents at January 1,   |  | 2,164              |  
|                                          |  |                    |  
|Cash and cash equivalents at December 31, |  | 3,292              |  
|                                          |  |                    |  



F-52



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##### Table of Contents

##### Index to Financial Statements

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 Corporation





By:/s/ K.Y.
Yeung

K.Y. Yeung

Chief Executive Officer



Date: June 27, 2003





S-1



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##### Table of Contents

##### Index to Financial Statements

CERTIFICATION



I, K.Y. Yeung, certify that:



|1. |  | I have reviewed this annual report on Form 20-F of Kowloon-Canton Railway Corporation.;
|-- |  | ---------------------------------------------------------------------------------------



|2. |  | Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light
of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition,
results of operations and cash flows of the registrant as of, and for, the period presented in this annual report;
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14
and 15d-14) for the registrant and have:
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this annual report is being prepared;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the
Evaluation Date); and
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) |  | presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of
registrants board of directors (or persons performing the equivalent function);
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) |  | all significant deficiencies in the design or operation of internal controls which would adversely affect the registrants ability to record, process, summarize and report
financial data and have identified for the registrants auditors any material weakness in internal controls; and
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Date: June 27, 2003



/s/ K.Y.
Yeung

K.Y. Yeung

Chief Executive Officer



S-2



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##### Table of Contents

##### Index to Financial Statements

CERTIFICATION



I, Samuel M.H. Lai, certify that:



|1. |  | I have reviewed this annual report on Form 20-F of Kowloon-Canton Railway Corporation;
|-- |  | --------------------------------------------------------------------------------------



|2. |  | Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light
of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|3. |  | Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition,
results of operations and cash flows of the registrant as of, and for, the period presented in this annual report;
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14
and 15d-14) for the registrant and have:
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this annual report is being prepared;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the
Evaluation Date); and
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) |  | presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of
registrants board of directors (or persons performing the equivalent function);
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) |  | all significant deficiencies in the design or operation of internal controls which would adversely affect the registrants ability to record, process, summarize and report
financial data and have identified for the registrants auditors any material weakness in internal controls; and
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) |  | any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Date: June 27, 2003



/s/ Samuel M.H.
Lai

Samuel M.H. Lai

Senior Director, Finance and Management





S-3