VAT on Retention money6 min read

Retention Money

Retention money is referred to as the sum of money held by the employer as a safeguard for any defects or non-conforming work by the contractor.

Treatment of Retention Money

Retention money in business and contracting refers to a percentage of the contract value that is withheld by the client or customer for a specified period after the completion of a project. The purpose of retention is to ensure that the contractor fulfills all contractual obligations, including addressing any defects or issues that may arise after project completion. Here’s how retention money is typically treated:

1. Withholding During the Project:

   – The client withholds a percentage of the contract value (often around 5-10%) during the project.

   – This withheld amount is usually released upon substantial completion of the project but may continue to be retained until final completion.

2. Release Conditions:

   – Retention is often released in stages based on project milestones, such as achieving substantial completion or passing inspections.

   – Some contracts may release a portion of the retention after a certain period following substantial completion, with the remainder released at final completion.

3. Defects Correction Period:

   – The retention period serves as a defects liability period during which the contractor is responsible for rectifying any defects or issues that arise.

   – If defects are identified during this period, the client can use the retained funds to cover the cost of necessary corrections.

4. Interest on Retention:

   – In some cases, clients may be required to pay interest on the retained amount, especially if the retention period extends beyond a specified timeframe.

5. Agreements and Contracts:

   – The treatment of retention money is typically outlined in the construction contract or agreement between the parties.

   – The contract specifies the percentage of retention, conditions for release, and any penalties or interest associated with late release.

6. Release Certificate:

   – Upon meeting the conditions for release, the contractor may submit a formal request for the release of retention money.

   – The client issues a release certificate, and the funds are then released to the contractor.

7. Accounting Treatment:

   – Contractors often account for retention as a liability on their balance sheets until it is released.

   – Once released, the liability is reduced, and the corresponding revenue or income is recognized.

Properly managing retention is essential for maintaining positive contractor-client relationships and ensuring that the project’s contractual requirements are met satisfactorily. The specific details of retention treatment can vary based on the terms outlined in the contract.

VAT on retention money

The treatment of Value Added Tax (VAT) on retention money can vary based on the jurisdiction and the specific regulations in place. In many VAT systems, the general principle is that VAT is due when a taxable supply of goods or services occurs. Here are some considerations regarding VAT on retention money:

1. Timing of VAT Liability:

   – In some jurisdictions, VAT may be triggered when the retention money is invoiced or received, depending on the tax point rules.

   – Other jurisdictions may require VAT to be accounted for when the actual supply of goods or services takes place, which might be upon project completion.

2. Consideration as a Deposit:

   – Some tax authorities consider retention money as a deposit rather than a payment for goods or services. In such cases, VAT may not be immediately due on the retention amount.

3. Release of Retention and VAT:

   – When retention money is released to the contractor, VAT may become payable, especially if the release is considered a separate taxable supply.

   – The timing of when VAT becomes due upon the release of retention can vary based on local regulations.

4. Interest and Penalties:

   – Late payment or non-payment of VAT on retention money may attract interest or penalties, so it’s important for businesses to adhere to VAT regulations and timelines.

5. Documentation and Invoices:

   – Proper documentation, including invoices and contractual agreements, is essential for determining the correct VAT treatment on retention money.

   – Invoices should clearly state the VAT implications, and contracts should specify the timing and conditions under which VAT becomes due.

6. Consultation with Tax Advisors:

   – Due to the complexity of VAT regulations and variations between jurisdictions, businesses are advised to consult with tax advisors or local tax authorities to ensure compliance.

It’s crucial for businesses to stay informed about the specific VAT rules in their jurisdiction and to adapt their practices accordingly. The treatment of VAT on retention money may also be influenced by the nature of the contract, the industry, and the legal framework governing VAT in a particular region.

VAT on retention money in UAE

There are specific guidelines in the United Arab Emirates (UAE) follows a VAT (Value Added Tax) system, regarding the treatment of VAT on retention money. However, tax regulations are subject to change, and it’s essential to refer to the most recent and relevant sources or consult with tax professionals for the latest information.

As a general guideline based on previous information:

1. Retention Money as Consideration:

   – In the UAE, if retention money is considered as part of the consideration for a taxable supply of goods or services, VAT may be applicable.

2. Timing of VAT Liability:

   – VAT liability is generally triggered when a taxable supply occurs. In the context of retention money, this may be when the supply of goods or services, for which the retention is held, is completed.

3. Release of Retention and VAT:

   – The release of retention money may be considered a separate taxable supply. VAT could be applicable when the retention money is released, depending on the specific circumstances and the nature of the underlying supply.

4. Documentation and Invoices:

   – Proper documentation, including invoices and contractual agreements, is crucial for determining the correct VAT treatment on retention money in the UAE. Invoices should clearly indicate the VAT implications.

5. Consultation with Tax Authorities:

   – Businesses operating in the UAE are encouraged to consult with the Federal Tax Authority (FTA) or seek advice from tax professionals to ensure compliance with the latest VAT regulations.

It’s important to note that tax regulations are subject to updates and amendments. Therefore, businesses should stay informed about any changes to VAT rules in the UAE and adjust their practices accordingly. Always refer to the latest information from official tax authorities or seek guidance from tax experts for the most accurate and up-to-date advice.

Dates to be considered

VAT shall be due on the retention amount at the earliest of the following dates:

  • Payment of retention
  • Work signed off as complete
  • Issue of tax invoice