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to agree to the exclusion of these receipts from the revenue subject to assessment. In anticipation of their agreement, the Governor is being instructed that the system of crediting these overpayments to revenue should be introduced as proposed.

G. Waterworks.-Sir Philip Cunliffe-Lister does not wish to dispute the principle that, where the gross revenue of a productive undertaking was included in the revenue of the Colony at the time the percentage was fixed, it is theoretically improper that such revenue should now be treated on a net receipts basis without an alteration of the percentage. He considers, however, that a clear distinction should be drawn between the waterworks existing on the island of Hong Kong and in Kowloon in 1896, and any later extensions of these waterworks, and the quite separate waterworks which have been constructed subsequently in the New Territories. These New Territory waterworks should, in his opinion, be regarded as a separate productive undertaking, and in accordance with the first proviso of Section 3 of the Hong Kong Defence Contribution Ordinance, 1901, be assessed on a net receipts basis. The New Territories were not a part of the Colony when the percentage was fixed, having been acquired by lease from China in 1898. If the Army Council are prepared to agree in principle that the waterworks constructed in the New Territories should be treated as a separate undertaking, it will be necessary to obtain from the Governor of Hong Kong details of the revenue which can be allocated to them and of the expenditure which should be deducted.

Sir Philip Cunliffe-Lister will be glad to learn whether the Army Council agree in principle in order that these details may be ascertained.

Apart from the treatment of the New Territory works it appears that, under the second proviso to the Hong Kong Defence Contribution Ordinance, 1901 (as amended) the Hong Kong Government are entitled to deduct from the gross revenue from the waterworks an allowance in respect of capital expenditure met from revenue upon these undertakings. This proviso was added to the Ordinance by Ordinance No. 45 of 1911, the draft of which was concurred in by the War Office and the Treasury, and Sir Philip Cunliffe-Lister is advised that the second proviso is not limited in its operation to the productive undertakings referred to in the first proviso. He would be glad to learn that the Army Council agree to a deduction being made in future, i.e., for a period of 50 years from 1932, in respect of the capital expenditure met from revenue on extensions and new constructions of waterworks since 1896, at the rate of 4 per cent in respect of expenditure before 1915 and at the rate of 6 per cent in respect of expenditure from and after 1915.

There remains for consideration the exemption conferred by Ordinance 14 of 1927, of sums sufficient to provide for the service of so much of the Public Works Loan of 1927 as was used for expenditure on waterworks.

Sir Philip Cunliffe-Lister considers that such deductions are justifiable, following the precedent of the River and Harbour Improvements in the Straits Settlements in 1906, when it was agreed that the revenues raised to meet the cost of this undertaking should be exempted from military contribution. In both cases, the effect of the expenditure is to increase the revenue of the Colony, and Sir Philip Cunliffe-Lister considers that it would be only fair that the cost of ensuring that increased revenue should be deducted from it. In the circumstances he does not see his way to suggest to the Government of Hong Kong that Section 15 of the Ordinance in question should be repealed.

H. Treatment of Profits on the Sale of Securities.-The Government of Hong Kong, like most Colonial Governments, periodically invests surplus revenue and later sells the investments as money is required. On such sales, profits or losses may be realized, according as the investments have appreciated or depreciated, and, in the case of sterling investments made by the Hong Kong Government, according to changes in the sterling. value of the Hong Kong dollar. The accounting treatment of such profits or losses has varied from time to time, but the present practice is that such investments are valued annually, and the book profit or loss is shown as revenue or expenditure in the accounts of the Colony. The Army Council will appreciate that although changes in the value of investments due either to general appreciation or depreciation or to exchange differences tend to cancel out in the long run, they do not generally cancel out within any period of twelve months, and if during that period there has been a considerable depreciation of the Hong Kong dollar, a large profit may be shown which will probably later be compensated by a book loss when the exchange moves in the opposite direction. If therefore the Colonial Government were expected to pay military contribution on the revenue represented by such book profits in years when such profits accrue, while not being entitled to deduct book losses in estimating the revenue in years when such losses accrue, the result would clearly be to impose an inequitable burden on the Colony.

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Sir Philip Cunliffe-Lister therefore considers that the fair way of treating these transactions would be on a net receipts basis, and the best practical way of doing so would appear to be, while including book profits of the nature described in the revenue for purposes of assessment, to allow a deduction from that revenue in respect of similar 'book losses. Alternatively the transactions could be wholly excluded in the calculation

of military contribution.

A further consideration arises, however, in this connexion. The Hong Kong Government has obtained a considerable revenue in past years from land sales. In some Colonies, such revenue is treated separately from the general revenue of the Colony, and is invested in a separate fund. Land sales are not included in Hong Kong revenue for the purpose of assessment of military contribution; if the proceeds of such sales had been isolated and invested in a separate fund, Sir Philip Cunliffe-Lister considers that the income of such a fund should logically have been exempted from assessment, and he has no doubt that the Army Council would have agreed. In fact, the revenue from land sales, which has amounted since 1896 to approximately $24,450,000, very considerably exceeds the amount of the investments at present held by the Hong Kong Government. Sir Philip Cunliffe-Lister therefore considers that these investments could reasonably be regarded as having been wholly made out of the proceeds of land sales, and that income from them might reasonably be regarded as wholly exempt from military contribution. He would be glad to know whether the Army Council agree.

In this, as in the matter of the treatment as a separate undertaking of the New Territory waterworks and of the deduction of an allowance on capital expenditure on waterworks met from revenue, Sir Philip Cunliffe-Lister considers that the Hong Kong Government could very well have made out a case for concessions many years ago. He does not now wish to put forward any retrospective claims, but he would suggest that the Army Council should take that fact into consideration. He would accordingly urge that the proposals now submitted for calculating the Hong Kong military contribution may be considered in a sympathetic and accommodating spirit. In this connexion he desires to draw the attention of the Army Council to the view expressed by Lord Haliburton, who acted as Chairman of the Interdepartmental Committee of 1895. In a memorandum dated the 8th of June, 1899, he included the following expression of opinion: "If we wish to preserve the contributions, we should now, having established our right after great controversy, exercise it with very great moderation, and should meet the Colonies with every concession that is consistent with the preservation of the contributions." Sir Philip Cunliffe-Lister feels no doubt that it will be possible to reach agreement on all these questions if they are considered in the spirit of that quotation.

A copy of this letter has been sent to the Treasury for the information of the Lords Commissioners.

C. 82756/31 [No. 20].

(Confidential.)

SIR,

No. 74.

HONG KONG.

THE GOVERNOR

to

THE SECRETARY OF STATE.

(Received 30th November, 1931.)

I am, &c.,

H. R. COWELL.

Government House, Hong Kong, 26th October, 1931.

I have the honour to acknowledge the receipt of your telegram No. 110 of the 11th of September, 1981*, on the subject of overpayments recovered and to confirm my reply No. 190 of the 2nd of October reading as follows:-

Your telegram [see No. 72]. explain this."

2. I enclose a list showing the principal receipts from this source during the current year. It is, of course, inevitable that overpayments of this nature should occur from time to time and that in a number of cases the excess should not be recovered until after the end of the financial year in which the original payments were made. In Hong Kong

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. PUBLIC RECORD OFFICE

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