Should the purchase of an investment property be accounted for as a business combination or as an asset purchase?
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.
The purchase of investment property (or properties) is a business combination if the acquired set of assets and activities meets IFRS 3’s definition of a business (IFRS 3 Appendix A and supporting guidance). That guidance explains that a business consists of ‘inputs’ and ‘processes’ applied to those inputs that together have the ability to create ‘outputs’ (IFRS 3.B7). Determining whether a purchase of investment property is a business combination therefore requires a careful evaluation of the transaction and of what has been acquired (the ‘acquired set’). This often requires judgement. When purchasing an investment property the ‘input’ part of the definition is always met because the property itself is an input. If the property has in-place tenants and leases, the ‘outputs’ part is also met because rental is an output. Even with no in-place leases at the purchase date, a property that is substantially complete and available for letting may have the ability to earn rentals and therefore be capable of creating outputs. In these situations, deciding whether the acquired set is a business depends on whether any ‘processes’ are transferred and, if so, their nature and significance.
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:
- the purchase of a property or properties with or without tenants in which no services are transferred should be accounted for as an asset purchase
- the purchase of a property or properties with tenants and with the transfer of only administrative-type services should also be accounted for as an asset purchase
- the purchase of a property or properties with tenants and more sophisticated services/activities should generally be accounted for as a business combination (in accordance with IFRS 3).
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.