What Is a Retention Payment?
Retention Payment

Retentions are a fixture of UK construction. A main contractor holds back part of each payment to its subcontractors, and a client often does the same to its main contractor, as security that the work has been done properly and that any defects appearing soon after completion will be fixed. For the business owed the retention, it is earned income that arrives months, sometimes more than a year, after the work, and it is easy to lose track of in the meantime.

How a retention works

The percentage, any cap, the defects period and the release triggers are all set by the contract, not by law. Read them before you sign, and price the job knowing some of your money will wait, sometimes well beyond the end of the job itself.

VAT on retentions

Under normal rules, VAT would be due on the whole contract at the basic tax point. For retentions, VAT Notice 708 gives a special rule: the tax point for the retention element is delayed until you either receive the retention payment or issue a VAT invoice for it, whichever comes first. So a VAT-registered business does not pay VAT on money it has not yet received and has not invoiced. The rate is the same as the earlier payments under the contract.

Where the domestic reverse charge applied to the contract, the retention invoice carries the same reverse charge wording as the earlier invoices.

CIS on retentions

CIS deductions are taken from payments to a subcontractor. When a retention is released and paid, the contractor makes the deduction from its labour element, and it appears on that month's payment and deduction statement. Keep labour and materials separate on the retention invoice so the deduction is right; the CIS calculator shows the figures.

Invoicing a retention

When a release date arrives, invoice the retention. Refer to the contract, the site and the invoices it was held from, and say which release it is: "Release of retention, 2.5% on completion of the 12-month defects period, Unit 4 fit-out, valuations INV-0188 to INV-0201". Give it the next number in your normal sequence and a due date under the contract's payment terms. Do not wait for the customer to remember; they rarely do.

Why retentions go unpaid

Retentions are lost for predictable reasons. The release date passes and nobody invoices. The contact who managed the job has moved on. The customer claims defects that were never reported. Or, worst of all, the customer becomes insolvent before release, leaving the subcontractor as an unsecured creditor for money it earned long ago. A little discipline prevents most of these: a register of every retention, a diary entry for each release date, a check-in with the customer a month before release, and prompt invoicing on the day.

Planning cash flow around retentions

A retention is profit you have earned but cannot spend yet. On thin construction margins, a 5% retention can be most of the profit on a job, which means a subcontractor can be busy, profitable on paper and short of cash all at once. Plan for it: when you price a job, assume the retention will arrive late, and do not count it towards next month's bills. Track the total held across all contracts; once it reaches a meaningful share of your annual profit, it is worth managing as actively as your unpaid invoices.

The defects period in practice

The defects period, sometimes called the rectification or defects liability period, is the time after completion during which the customer can report defects in your work and ask you to put them right. It is set by the contract, often six or twelve months. At the end, if defects have been fixed, the final part of the retention is released. Keep a record of every defect reported, when you fixed it and who signed it off. A customer cannot fairly hold a retention for defects that were never reported, or were reported and fixed, and your records are how you show it.

Retention bonds

On larger contracts, some customers accept a retention bond instead of holding cash. A bond is a guarantee, usually from an insurer or bank, that pays the customer if the contractor fails to fix defects. The contractor pays a fee for the bond but receives the full payment for each valuation, with nothing held back. For businesses with many retentions outstanding, bonds can free a significant amount of cash. They are a commercial product, so compare the cost with the value of having the money now.

The customer's side

If you are a contractor holding retentions from your own subcontractors, remember they are money you owe. Record them as liabilities, diary the release dates, and release them promptly when due. Holding retentions beyond the contract terms damages relationships with the subcontractors you rely on, and a subcontractor owed a contractually due retention can pursue it as a debt.

Negotiating retentions

Retention terms are commercial and negotiable before signing. Points to raise: a lower percentage for a small or short job; a cap on the total held; release tied to your own work's completion rather than the whole project's; a defined, short defects period; and, for larger jobs, a retention bond in place of cash. Terms that make release depend on the main contractor being paid by its client push the risk down to you, so push back on them.

Retentions and your accounts

Under the cash basis, a retention is income when you receive it, which may be in the next tax year. Under accruals, the full value of the work counts when it is done, and the unpaid retention sits in your accounts receivable. If a retention proves unrecoverable and you are VAT registered, VAT bad debt relief may return VAT you accounted for on it, subject to the conditions.

A worked example

A plastering subcontractor completes a £40,000 package with a 5% retention. Across four monthly valuations, £2,000 is held back. At practical completion, £1,000 is released; she invoices it the same week, with VAT at the contract's rate. A year later, at the end of the defects period, her register flags the release date. She confirms with the contractor that no defects are outstanding, invoices the final £1,000, and is paid within the contract's terms. Because the tax point for each retention was its invoice, she paid VAT on each part only when she invoiced it.

When a retention is late

If a retention is contractually due and unpaid, chase it like any overdue invoice, in writing, citing the contract clause. For a business customer, interest may be claimable under the contract or, if the contract sets no rate, as statutory interest; the late payment interest calculator works out the figure.

Retentions and payment notices

Construction contracts are subject to the Housing Grants, Construction and Regeneration Act 1996, which requires contracts to set out how and when payments fall due and the notices that go with them. Retention releases are payments like any other under the contract, so the same notice and due date mechanics usually apply to them. When a release falls due, check what your contract says about applications and notices, and follow it, so there is no procedural reason for the release to be delayed.

Common mistakes

• Forgetting to invoice the release. The most common reason retentions are never paid.
• Charging VAT too early. The retention's tax point is when it is paid or invoiced, not when the work is done.
• Using a different VAT rate. The retention takes the contract's rate.
• Not recording defects and fixes. Without records, a customer's defect claim is hard to answer.
• Signing up to release terms tied to someone else's payment. Negotiate release on your own work's completion.

Related terms

For VAT on the release invoice, see VAT invoice; for the domestic reverse charge on construction work, see reverse charge invoice wording.

Retentions are usually held from stage payments. The guide on retention payments in construction goes further on invoicing, VAT and negotiation, and CIS invoice requirements covers the deduction on each payment.

The short version

A retention is your money, earned and held for you. Know the percentage and release dates before you sign, record every retention in a register, fix and record any defects promptly, and invoice each release on the day it falls due. Account for VAT only when you invoice or are paid, at the contract's rate, and expect CIS to come off the labour element.