10 The status of the retained earnings and reserves accumulated since 1960 must be regarded also in another light, that is, in relation to carnings. It is clearly objectionable that the shareholder should receive a return on capital raised from the consumer through excess profits. So far as future accretions are concerned, the scheme of control meets this point, but does not do so in relation to existing resources. It is stated in paragraph 6 above that the forecast rate of return on shareholders' equity is 13 to 14%. This is so, however, in the case of China Light only if the return is related to a total equity which includes the whole existing retained earnings and reserves of $149 million. It would be more correct in Government's view to regard only $75 million of this (i, e. what could have accrued to shareholders if the proposed scheme were approved retrospectively) as eligible to earn profits. On this basis the rate of return to China Light is of the order of 17% on existing equity, not 14%. (Earlier proposals gave an even higher return but certain downward adjustments were made). This may be considered excessive and is certainly a considerably higher return than is likely to have been agreed if control had been imposed on CLF alone. It is now difficult, because of complicated inter-relationships between parts of the scheme, to make further adjustments without a complete revision of the basis of the scheme. It may therefore be considered that the scheme is acceptable in the cir- cumstances.
Further Points
11
Cne not altogether desirable feature of the Scheme should be noted. The profits generated for the Development Fund are liable to profits tax, so that the consumer is, in effect, taxed for the privilege of supplying capital. This has, of course, been happening in recent years. The problem is not very significant in the period 1964-68 as the total tax involved in this period is about $13 1/2 million. It seems unlikely that exemption from tax can be accorded but if necessary some adjustment might be made later through the tax on fuel. No action seems necessary at present, particularly as it has not yet been possible to consider Hong Kong Electric's position in this respect.
12
The Electricity Commission proposed and CLP agreed in connection with the abortive merger that interest should be paid on consumers' deposits. These amounted to $34 million at 30 September 1963 and are an important source of working capital. The present proposals by the companies do not include this but it is Government's intention to require it. It is believed that the companies will not object. This will reduce total profits by about $1 million a year at first, reducing by that amount the surplus available for the Development Fund.
13
It is proposed that the arrangement remain in force for fifteen years, negotiations for its renewal, with whatever modifications are found necessary, to start after 12 years.
14
It is to be noted that, if there were a change of policy in China Light, and a substantial proportion of capital for expansion were to be raised by borrowing, the proposed 13 1/2% return on net fixed assets might generate a considerably larger profit on shareholders' equity than is forecast. The companies are prepared to review the scheme of control with Government if the pattern of capital receipts is substantially modified from the present intention.
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