As part of its activities, the European Securities and Markets Authority (ESMA) organizes a forum of enforcers from 38 different European jurisdictions, all of whom carry out monitoring and review programs similar to those carried out here by the Canadian Securities Administrators. ESMA a while ago published some extracts from its confidential database of enforcement decisions on financial statements, covering eight cases arising in the period from December 2023 to February 2025, to “enhance supervisory convergence and inform issuers, auditors and users about the correct application of IFRS.” There’s no way of knowing whether these are purely one-off issues or more widespread, but some of them certainly have some relevance to matters discussed within Canadian entities once in a while.

One of the cases relates to IFRS 3 Business combinations, in particular to the concept of a business as “an integrated set of activities and assets (that) must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output.” One of the situations in which a process is considered to be substantive arises when a set of activities and assets has outputs at the acquisition date, and an acquired process (or group of processes), when applied to an acquired input or inputs, is critical to the ability to continue producing outputs, and the inputs acquired include an organized workforce with the necessary skills, knowledge, or experience.

The facts are as follows:

• The issuer is a real estate investment firm that primarily operates logistics properties in several European countries. In 2022 it acquired another listed real estate investment firm (‘the Acquiree’)…Because the issuer considered that the assets acquired did not constitute a business, it accounted for the acquisition as an asset acquisition…
• …While the issuer identified inputs and outputs resulting from the activities carried out by the Acquiree, it was of the opinion that no substantive processes were acquired. The issuer identified four processes that required further analysis as to whether they were substantive or not: (i) strategic management, (ii) accounting, (iii) property management and (iv) lease management.
• Applying the guidance in paragraph B12C of IFRS 3 the issuer concluded that:
  • No organized workforce in the Acquiree was acquired, since the management board, that was responsible for all strategic and operational decision making and therefore critical to the management of the entity as a business, left per the terms of the transaction.
  • Although some of the processes (property management and lease management) could be considered as ‘significantly contributing to the ability to continue producing outputs’, these processes were outsourced, not unique nor scarce and could be readily replaced without significant cost…

The enforcer (as ESMA likes to term it) disagreed with the issuer’s analysis, concluding that all three elements of a business in IFRS 3 were met and the issuer should have accounted for the acquisition of the investment firm as a business combination. The enforcer noted that while strategic management left under the terms of the transaction, the issuer should have considered the conditions that existed in the Acquiree at the time of acquisition (and not subsequently). In that context, key observations include:

• None of the parties involved in the outsourcing contracts could unilaterally cease operations at the time of acquisition and/or denounce the contracts without incurring significant costs…
• In addition to the day-to-day management of the portfolio (rent collection, annual rent increase, small maintenance, etc.), the outsourcing contracts also covered the acquisition of new tenants, short and mid-term maintenance and refurbishment planning as well as strategic advice…In fact, all important business processes were performed by the outsourcing partner; the board of the Acquiree (which stepped down at the acquisition date) had the final say only regarding major strategic choices.

ESMA’s description of the issue seems to include differing accounts of the terms of the outsourcing contracts, indicating that the issuer represented the contracts could be terminated giving three months’ notice with no termination costs (and were in fact “terminated and replaced by the issuer’s internal processes without difficulties one year after the acquisition date”), whereas in fact they could only be terminated approximately two years after the acquisition date, unless the issuer paid an early termination fee. It’s not clear to me whether this should be taken as an indication that the issuer misrepresented the terms of the contracts, or that it didn’t fully understand them, or whether there’s some other explanation. But in any event, the broad point is clear. IFRS 3 notes that “difficulties in replacing an acquired organized workforce may indicate that the acquired organized workforce performs a process that is critical to the ability to create outputs.” But that doesn’t mean that a relative lack of difficulty in replacing such a workforce indicates a process that isn’t critical in this respect. The focus, in general terms, should be on whether the acquisition is of something that history demonstrates to be greater than the sum of its parts; if so, it’s most likely an acquisition of a business, regardless that the acquiree isn’t interested in preserving all of those parts…

The opinions expressed are solely those of the author.