Retention payments
in construction

Retention is common in construction contracts. The customer holds back a proportion of each payment, often a few percent, until the work is complete and any defects found shortly afterwards have been put right. It protects the customer. For a subcontractor on thin margins, the retention can be most of the profit on a job, so invoicing and chasing it properly matters.

How a retention works

A retention clause lets the customer keep part of the contract price once the work is done, pending confirmation that it was done properly. Typically part is released at practical completion and the rest after a defects period set in the contract. The contract, not the law, sets the percentage and the release dates, so read it before you price the job.

Invoicing the retention

Each interim or stage payment invoice shows the gross value of the work, the retention held back and the net amount due now. Keep a running total of retentions held on each contract. When a release date arrives, invoice the retention, referring to the contract and the earlier invoices it relates to. Do not wait for the customer to remember; they rarely do.

VAT on retentions

VAT Notice 708 gives retentions their own tax point rule. Under normal rules you would account for VAT on the whole contract when the work is done. For the retention element, the tax point is delayed until you either receive the retention payment or issue a VAT invoice for it, whichever occurs first. So you do not owe VAT on money the customer is still holding, as long as you have not invoiced it.

The rate is the same as the earlier payments: VAT Notice 708 says you apply the same VAT rate to retention payments as applied to previous payments under the contract.

If the domestic reverse charge applied to the earlier invoices, it applies to the retention invoice too, with the same wording. See reverse charge invoice wording.

CIS on retentions

CIS deductions are made when a contractor pays a subcontractor. When a retention is released and paid, the contractor makes the deduction from its labour element in the usual way and shows it on that month's payment and deduction statement. Keep your labour and materials split on the retention invoice so the deduction is right. The CIS calculator shows the figures.

Tracking retentions

Retentions go astray because they are paid months after the job, often to someone who has moved on. Keep a simple register: contract, customer, amount held, release events and dates. Diary each date. A month before release, confirm with the customer that the defects period is running normally.

When a retention is not released

If the release date passes, chase it like any overdue invoice, in writing, referring to the contract clause. If the customer is a business and the retention is contractually due, you may be able to claim interest under the contract or, if the contract sets no rate, statutory interest; the late payment interest calculator works out the figure. The guide on chasing an unpaid invoice sets out the steps.

Retentions and your accounts

Under the cash basis, a retention is income when it is paid to you. Under accruals, it counts when it is earned, which may be when the work is done even though you will not see the money for months. Your records should show both the invoiced work and the retention still outstanding.

A worked example

A subcontractor's contract is worth £40,000 with a 5% retention: £2,000. Half, £1,000, is due at practical completion and half after a 12-month defects period. The final retention is invoiced when the defects period ends; VAT on it becomes due at that invoice, at the contract's rate, not a year earlier.

How a retention builds up across a contract

Figures before VAT and CIS. CIS is deducted from the labour element of each payment when it is made.

Retentions and stage payments together

Most contracts with retentions also use stage payments or interim valuations. For construction services under such contracts, VAT Notice 708 says the tax point for each supply is the earlier of receiving payment or issuing a VAT invoice; there is no basic tax point at completion. So each valuation invoice creates a tax point for its net amount, and the retention's tax point waits until it is paid or invoiced. Keep the two separate on your invoices, so your VAT return picks up each at the right time.

Negotiating retentions

The retention percentage and the release terms are commercial terms, set before you sign. Points worth raising:

• The percentage. Ask whether it can be reduced for a small or short job.
• The release trigger. Tie release to a clear event, such as practical completion or the end of a stated defects period, not to the main contractor being paid by the client.
• A cap. Ask for the total retention to be capped at a fixed sum.
• Release in stages. Half at completion and half at the end of the defects period is common.
• Alternatives. Some contractors accept a retention bond instead of holding cash.

A contract that is silent or vague on release makes chasing much harder later.

When a retention is at risk

The biggest risk is the main contractor failing before the retention is released. A subcontractor who is owed a retention by an insolvent contractor usually ranks as an unsecured creditor. You cannot remove that risk entirely, but you can reduce it: keep retentions small, chase release promptly on the due date, and prefer contractors with a track record of releasing on time.

A simple retention register

A register takes minutes to set up and is the single best defence against forgotten retentions. One row per contract is enough.

Review it monthly. A month before each release date, contact the customer to confirm nothing is outstanding on the defects list, so the release is not held up by a snag you could have fixed in advance.

Retentions and your tax return

How a retention shows in your accounts depends on your accounting basis. Under the cash basis, which most sole traders use, income counts when it is received, so a retention released next year is next year's income. Under accruals, the full value of the work counts when you do it, and the retention sits in your accounts as money owed to you, part of your accounts receivable. If a retention is never paid and you are VAT registered, you may be able to claim VAT bad debt relief on any VAT you accounted for on it.

A retention invoice, line by line

Common questions

Do I charge VAT on a retention before it is paid? Not unless you issue a VAT invoice for it. The tax point is when you receive it or invoice it, whichever comes first.

Can I claim interest on a late retention? If it is contractually due and your customer is a business, you may claim under the contract or, if it sets no rate, statutory interest; the late payment interest calculator works it out.

Does the reverse charge apply to retentions? If it applied to the original invoices under the contract, it applies to the retention invoice too; see reverse charge invoice wording.

What if the customer says the defects are not fixed? Ask for a written list of the defects, fix what is genuinely yours to fix, and ask for sign-off. A clear record of what was put right, and when, is the evidence that releases the retention. If you disagree about a defect, the steps in invoice disputes apply, and how to chase an unpaid invoice covers escalation once the release is overdue.

Retentions are routine in construction, and handled well they are just delayed income. Handled carelessly, they are income you never see.