An entity can provide ancillary services, such as maintenance and security, to the third-party occupants of a property owned by the entity. Services that are an insignificant element of the whole arrangement do not affect the classification of the property as an investment property.

An owner-managed hotel is regarded as an owner-occupied property rather than an investment property. The property is being used to a significant extent for the supply of goods and services.

Judgement involved in ancillary services It might be difficult to determine whether ancillary services are so significant that the property does not qualify as investment property – for example, a hotel where the management function and provision of services are not carried out by the owner but by a third party to whom the owner has transferred those responsibilities under a management contract. Such contracts vary considerably and, at one extreme, the owner might in substance be a passive investor, whilst at the other extreme the owner might have outsourced certain functions, but retained significant exposure to variations in cash flows from the operation of the hotel. In the former case, the hotel might be treated as an investment property, but in the latter case it would be treated as an owner-occupied property.

Entities should disclose the criteria used in assessing whether something is an investment property or owner-occupied property where this involves judgement.

Services provided by the owner of an office building For example, if the owner of an office building provides cleaning services for the lessees of the building and these services are ‘insignificant’ in the context of the total arrangement, the building is classified and accounted for as an investment property. It would be unusual for cleaning services to be so material that they would prevent a property from being classified as an investment property. A similar conclusion is likely for security and maintenance services. At the other extreme, some entities rent out fully furnished offices including a whole range of services such as IT systems and secretarial services. Such arrangements are in the nature of the rendering of a service rather than property investment and the property would be classified as owner-occupied and accounted for under IAS 16. However, there are many instances in between these extremes for which the appropriate classification can only be determined based on a detailed assessment of the arrangements and whether or not the services provided are judged to be insignificant. The determination as to whether ancillary services are significant (thus excluding the property from the scope of IAS 40) requires the exercise of judgement. The Standard considers the case of hotels and acknowledges the variety of arrangements that may exist. For example, the owner of a hotel property may transfer some responsibilities to third parties under a management contract. The terms of such contracts vary widely. The owner’s role may be restricted to that of a passive investor, in which case the property would be more likely to qualify as investment property. At the other extreme, the contract may simply result in the outsourcing of some day-to-day responsibilities, while the owner retains significant exposure to variations in the cash flows generated by the operation of the hotel. In the latter case, the contract has little effect on the substance of the owner’s interest and the property is likely to be classified as owner-managed.

---

Hotel property as investment property – example A hotel operator owns a significant number of buildings. The hotel operator seeks to maximise revenue by selling room occupancy. It is not acceptable for the hotel operator to classify these buildings as investment properties. The properties are used by the hotel operator in the normal course of business and, therefore, are not investment properties. IAS 40 cites the direct provision of services to hotel guests as services that will generally be considered to be ‘significant’. Although the hotel operator may hold the buildings for long-term appreciation, that is not the principal reason for holding them.

Property leased to other group members

If an entity owns a property that is leased to, and occupied by, another group member (e.g. a parent or another subsidiary), the property is not recognised as an investment property in the consolidated financial statements because it will be treated as owner-occupied from the perspective of the group. However, from an individual-entity perspective, the property is treated as an investment property if it meets the definition in IAS 40.

Classification of properties subject to inter-group rental agreements It is not necessary for the intra-group rental agreement to meet the definition of a lease under IFRS 16 in order for the property to be classified as investment property in the individual-entity financial statements. This is because IAS 40 defines an investment property as a property that is held to earn rentals, for capital appreciation or both. In order for the property to be classified as investment property, there is no requirement that the rental arrangement qualify as a lease under IFRS 16 and/or that the rental payments qualify as lease payments under IFRS 16. For example, a parent may own a building and rent out the space to its subsidiaries but in accordance with the contract terms, retain the right to change the assignment of the space between the subsidiaries. This arrangement may not qualify as a lease as defined in IFRS 16 if such right gives the parent a substantive substitution right. Even though the arrangement may not qualify as a lease, when the parent is preparing its separate financial statements, it would not be precluded from classifying the building as an investment property in accordance with IAS 40.

---

Property accepted as loan settlement – example Entity A, a financial institution, provides mortgage loans to individuals and corporate entities to finance the acquisition of properties. The terms of these mortgage loans require the property to be pledged as collateral for the loan. If a counterparty defaults under the terms of a mortgage loan and is no longer entitled to redeem the collateral, Entity A accepts the property as settlement of the loan receivable. The former owner ceases to have any rights over the property or over the income that it generates. The derecognition criteria in IFRS 9 (or, for entities that have not yet adopted IFRS 9, IAS 39) are met and Entity A derecognises the loan receivable, and recognises the property as its asset, initially measured at fair value. The appropriate classification of the property depends on Entity A’s intended use of the property and the definition in the applicable Standards which may include IAS 2, IAS 16, IAS 40, or IFRS 5 if appropriate. For example, if the entity intends to hold the property to earn rentals or for capital appreciation (or both), the property would meet the definition of an investment property and should be accounted for under IAS 40. If the entity intends to sell the asset in the ordinary course of business, it would be accounted for as inventories under IAS 2.

---

Group of assets leased under a single operating lease – example IAS 40 states that “in determining the carrying amount of investment property under the fair value model, an entity does not double-count assets or liabilities that are recognised as separate assets or liabilities. For example: 1.      (a) equipment such as lifts or air-conditioning is often an integral part of a building and is generally included in the fair value of the investment property, rather than recognised separately as property, plant and equipment. 2.      (b) if an office is leased on a furnished basis, the fair value of the office generally includes the fair value of the furniture, because the rental income relates to the furnished office. When furniture is included in the fair value of investment property, an entity does not recognise that furniture as a separate asset”. Consider the following example: a lessor leases out a farm for the purpose of earning rentals; the farm is made up of the following assets: (1) land and agricultural buildings, and (2) agricultural fittings, fixtures and machinery that are an integral part of the agricultural buildings; the lease agreement meets the definition of an operating lease for the lessor; and the lessor measures investment property after initial recognition at fair value. The lessor should account for all the assets included in the operating lease agreement as a unique investment property and, as a consequence, measure it using the fair value model. Although agricultural fittings, fixtures and machinery do not meet the definition of an investment property in their own right, the lessor should follow the requirements in IAS 40 to determine the fair value of its investment property, including the other assets that form part of the lease agreement. In the above example, the lease agreement includes all the assets (i.e. land and agricultural buildings and fittings, fixtures and machinery) that are an integral part of the farm and are necessary for operating the farm. Therefore, the rental income reflects the right to use of the complete set of assets. Consequently, the lessor should recognise investment property comprising all the assets (i.e. the land and agricultural buildings and the agricultural fittings, fixtures and machinery), measured in accordance with IAS 40. Specific facts and circumstances should be considered by the lessor in each operating lease agreement covering a piece of land or a building, or part of a building, or both, together with property, plant and equipment items held to earn rentals, in order to establish which assets covered by the agreement should be regarded as investment property.

---