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How do you account for Construction Retentions?

Fotolia_46578927_XS home off

It’s a very common question, the client pays you and keeps a retention of 5% reducing to 2.5% on completion  to be released after the end of the defects period.

You do the same with your sub-contractors.

The retentions need to be held in balance sheet accounts as they can’t be invoiced to client and aren’t due to the sub-contractors. But they should be included within sales and sub-contract costs.

HMRC’s guidance is in BIM51520

In the construction industry it is a common feature of construction contracts for the customer to retain part of the contract fee over a maintenance period pending the satisfactory completion of any remedial work required by the contractor. Typically this may be for a 12-month period between a Certificate of Completion being given and the issue of a Maintenance Certificate.

In their accounts, builders will generally deal with retentions in one of the following ways:

  • include retentions within turnover, provide for the estimated cost of remedial work, and make provision for any debt impairment (see BIM42700 onwards), or
  • defer recognition of retentions until their receipt becomes virtually certain.

Each of the above accords with generally accepted accounting practice and should be followed for tax purposes unless an unrealistically conservative view has been taken.

In recent years, construction industry customers have become increasingly reluctant to pay retention monies, irrespective of whether there are defects to be made good. It is now common for such monies never to get paid. Consequently, it will often be the case that, whichever of the above approaches is adopted, there will be little or no difference in the figure of net profit.

A challenge will only be appropriate in worthwhile cases. For example, where retentions are only recognised on receipt but, in practice, a large proportion is in fact consistently paid over to the builder and there is a significant tax effect (compared with the alternative provisions method).

There is guidance on VAT in VATTOS5170

……the tax point for retentions is delayed until either a VAT invoice is issued or payment of the retention is received, whichever is the earlier. It must be stressed that this only applies to the retained element of the contract price. The rest of the supply is subject to the normal tax point rules.

Should a subcontractor Zero Rate supplies to a housing main contractor?

Percentage Sign and Quesiton Mark - Searching for Best Rate

This question comes up on a regular basis because it has cash flow implications for the main contractor.

If a contractor constructs a new building they will normally have to charge VAT at the standard rate. The contractor may, however, be able to zero-rate your supply if they are involved in constructing a qualifying building. A qualifying building can be:

  • a building ‘designed as a dwelling’ ;
  • a building that will be used solely for a ‘relevant residential purpose’ ; or
  • a building that will be used solely for a ‘relevant charitable purpose’ (for non-business use or as a village hall).

If the building qualifies the client issues a certificate to the Main Contractor (section 17 of Notice 708)

This certificate has the force of law.
Certificate for zero-rated and reduced-rated building work.
1. Address of the building:
2. Name and address of organisation receiving the building work:
VAT Registration number (if registered):
Charity registration (if registered):
3. Date of completion (or estimated date of completion) of
the work:
Value (or estimated value) of the supply: £
Name, address and VAT registration number of building contractor:
4. I have read the relevant parts of Notice 708 Buildings and construction and certify that this organisation (in conjunction with any other organisation where applicable) will use the building, or the part of the building, for which zero-rating or reduced-rating is being sought solely for (tick as appropriate ):
a relevant charitable purpose, namely by a charity in either or both of the following ways:
otherwise than in the course or furtherance of business or
as a village hall or similarly in providing social or recreational facilities for a local community
a relevant residential purpose, namely as:
(a) a home or other institution providing residential accommodation for children
(b) a home or other institution providing residential accommodation with personal care for persons in need of personal care by reason of old age, disablement, past or present dependence on alcohol or drugs or past or present mental disorder
a hospice
residential accommodation for students or school pupils
residential accommodation for members of any of the armed forces
a monastery, nunnery or similar establishment or
an institution which is the sole or main residence of at least 90 per cent of its residents
and will not be used as a hospital, prison or similar institution or an hotel, inn or similar establishment.
5 I certify that the information given is complete and accurate and acknowledge that if the building, or the part of the building, for which zero-rated supplies have been obtained, within a period of 10 years from the date of its completion:

  • ceases to be used solely for a relevant residential purpose and/or a relevant charitable purpose;
  • is no longer used to the same extent for a relevant residential purpose and/or a relevant charitable purpose decreases; or
  • is disposed of,

a taxable supply will have been made, on which this organisation will have to account for VAT at the standard rate. .
Name (print):
Position held:

General warning
1. HMRC reserves the right to alter the format of the certificate through the publication of a new notice. You must ensure that the certificate used is current at the time of issue.
Warnings for the issuer
2. You may be liable to a penalty if you issue a false certificate.
3. You are responsible for the information provided on the completed certificate.
Warnings for the contractor
4. You must take all reasonable steps to check the validity of the declaration given to you on this certificate.
5. This certificate does not automatically confer zero-rating or reduced-rating on your supplies. You must check that you meet all the conditions for zero-rating or reduced-rating your supply – see Notice 708 Buildings and construction.


However, the main contractor can not issue certificates to its subcontractors…

16.4 Should subcontractors accept certificates?

No. If you are a contractor working to a main contractor, you should not be issued with a certificate. You must always standard-rate your supply when working on a certificated building.

This means the Main Contractor has to pay the VAT to the subcontractors and then recover the VAT on its next VAT return which for smaller Main Contractors can cause problems.

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