Retentions are common across the construction industry and, unfortunately, quite hard to avoid. Knowing how to manage retentions properly, especially with the Construction Industry Scheme (CIS), could make a big difference to cash flow and tax obligations.
What are Retentions?
A retention is a portion of a subcontractor’s payment that a contractor holds back, usually around 5% of the contract value. The contractor withholds this amount to cover any potential snagging or defects in the work. They then release the retained funds once they confirm that the work meets the required standard. This often happens after a defect liability period, which can last for months or even years.
Retentions should provide contractors with a safety net. If any issues arise in the workmanship or materials used, the contractor can use this withheld money to fix them without having to chase the subcontractor.
CIS and Retentions
Under CIS, the contractor only deducts tax when the subcontractor receives payment. This means the contractor does not calculate CIS deductions on the retained portion until they actually pay it to the subcontractor. Here’s what matter most:
- CIS tax applies to the money you receive, not the amount you invoice
- When contractors pay retentions, they apply CIS applies based on the subcontractor’s tax status at that time
This can work in the favour of subcontractors if their tax status improves. However, it also means they will need to stay on top of their tax verification and ensure their records are up-to-date. If the subcontractor’s status changes before the contractor pays the retention, the contractor must use the updated status to calculate deductions. The contractor cannot rely on the status from the time of the original work.
Contractors must also verify the subcontractor’s payment status before making the retention payment. If they fail to do this, it can lead to complications or incorrect tax deductions.
How to Account for CIS Retentions
Corporation Tax
You must account for the full contract amount in your business’s income when completing the job, even if you have not received the retention. This means you could be paying Corporation Tax on money you haven’t yet received.
To stay on top of this, use a separate code in your Balance Sheet to track unpaid retentions. This helps keep your debtor list tidy and gives you a clearer picture of what money is still outstanding.
If it becomes clear that the contractor will not pay the retention, whether they have gone out of business or refuse to release the funds, you can potentially write it off as a bad debt. This removes the unpaid income from your tax liability.
VAT
VAT works differently. The VAT point for retentions happens when either:
- A VAT invoice is issued for the retention
- The retention is actually paid
This means you do not pay VAT to HMRC on the retention until one of those two events occurs. It’s a small relief, especially when you’re already dealing with Corporation Tax on money you haven’t received.
If you are under the Domestic Reverse Charge rules for construction, you will not need to worry about charging VAT anyway. The contractor handles that part, so it’s one less thing on your plate.
How to Structure Your Invoice
To account for a retention properly, your invoice should reflect the deduction clearly. Here’s an example invoice layout:
| £ | ||
| Gross Payment: | Labour | 20,000 |
| Materials | 15,000 | |
| 35,000 | ||
| Retention @ 5% | (1,750) | |
| Subtotal | 33,250 | |
| VAT @ 20% | 6,650 | |
| CIS Tax Deduction | (3,800) | |
| Payment to Account | 36,100 |
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