Our ‘IFRS Viewpoint’ series provides insights from our global IFRS team on applying IFRSs in challenging situations. Each edition will focus on an area where the Standards have proved difficult to apply or lack guidance.
What's the issue?
When should a purchase of investment property (or properties) be accounted for as a business combination, and when as a simple asset purchase? This is an important issue because the IFRS accounting requirements for a business combination are very different from asset purchases.
Distinguishing business combinations and asset purchases can also be challenging for many other types of transaction and judgement is often required. This is particularly the case when investing in assets that generate cash flows on a standalone basis such as retail outlets and hotels. We focus here on investment property but the underlying arguments apply more broadly.
Our view
A purchase of investment property is considered a business combination if it meets IFRS 3’s definition of a business, which includes ‘inputs’, ‘processes’, and ‘outputs’. The property itself is always an input, and if there are in-place tenants or leases, the output (rental income) is also met. Even without leases, a property that is ready for letting can generate rental income. Determining whether the purchase constitutes a business combination depends on whether any processes are transferred, and the nature and significance of those processes.
When an investment property has tenants, various services must also be provided, some of which may be specified in the leases. These and other services (or contracts for services outsourced to third parties) may be transferred to the buyer on purchase, in which case they are part of the acquired set. In our view, however, many basic services commonly associated with investment property are administrative functions that do not meet the definition of processes (IFRS 3.B7). Examples include: rent collection, basic tenant administration, basic maintenance, security and cleaning.
By contrast services that go beyond administrative matters are likely to be ‘processes’. Processes typically involve specific knowledge or skills and can be significant to the decision to purchase the property(ies) and/or its value. The presence of processes in the acquired set is indicative of a business. However, the presence of a relatively unimportant process may not be enough – for example if other, more important processes are excluded.
Accordingly, in our view the transfer of some services does not necessarily mean that the acquired set is a business. As a general indication, our preferred view is that:
However, we also acknowledge that some commentators interpret IFRS 3’s definition of a business in such a way that each of these scenarios could be a business combination. This is explained further in the full report available to the right hand side of this page.
