Retentions

To ensure that a Contractor in the Building and Construction Industry performs in accordance with the signed Contract, the Principal typically requests an appropriate form of guarantee from the Contractor or they deduct retentions from the payments they make..

Bank Guarantees or Retentions

The forms of guarantee that are most common are Retentions and Bank Guarantees. The Bank Guarantee or Security option requires the subcontractor to have equity in property that they are prepared to provide to their Bank so that a security amount typically equal to 5% of the Contract Sum is held as security in two equal parts.

Retentions (or Retainings as they are sometimes called) refers to the money withheld from the progress payments made to the Contractor. The total Retentions would equal a percentage of the Contract Sum - again, normally not exceeding 5%.

In fact the Retention rates are more usually described as “10% to 5%” as there is a loading on the early payments made to a subcontractor to help build a Retention reserve. So the Retention is calculated at 10% of each progress payment until the total retained is equal to 5% of the Contract Sum.

Bank Guarantees are better for Subcontractors while Retentions are more beneficial for the Construction Company – the reason is cash-flow. Further information on Bank Guarantees is available in our INDUSTRY DOCUMENTATION SECTION.

The Principal's right to retain amounts from progress payments, and the Contractor's entitlement to the release of the retention money is generally outlined in the agreement between the parties. A Contractor may be entitled to the release of part of the retention amounts held upon practical completion of the construction, and the release of the balance upon expiration of a defects liability period.

Most agreements allow the Principal recourse to the retention monies in the event that the Contractor is liable to the Principal for a default under the contract. The Contractor may default by failing to complete work to a required standard or by failing to rectify defects.

Retention amounts may therefore be used to offset the liability of the Contractor. As such the Contractor may not receive the full amount retained from the progress payments. For example, if a Contractor fails to rectify certain defects, the Principal may pay a third party to do so, using part of the retained amounts.

Standard Retention Rates

Muli Software is supplied with a pre-loaded Retention Rate table that can be modified by the user. The standard data has 12 rates and covers all possibilities. There are the common percentage rates and it even includes codes for “No Retentions” and “Bank Guarantee”.

The table allows for a Maximum Rate % and a Maximum Retention %. The ten percentage rates that are included start with "2.5%", "5% to 2.5%", "5%", "7.5% to 5%" etc, plus of course the most commonly employed rate of “10% to 5%”.

Muli will automatically apply the rate selected in a subcontract and calculate the retention required when processing a progress claim.  If an amendment is made to the total contract sum then Muli will take this into account when next calculating the retention.

Australian Taxation Office Rulings on Retentions and Goods & Services Tax (GST)

When the Retention amounts are released to the Contractor, GST is applied the same as it is during the processing of progress claims.

Refer Paragraphs 172 to 189 of RULING 20

Refer Paragraphs 121 to 123 of RULING 35 

Refer Paragraphs   37 to   43 of RULING 18  

EXAMPLE

The following example shows the calculation of Subcontractor Retentions and the appropriate GST:-

A builder may engage an air-conditioning subcontractor to supply and install a system for a total of $200,000.

During the installation the subcontractor makes a progress claim of $50,000 based on an assessment of work to date. The builder agrees with the figure but contractually needs to retain 5% of the $200,000 against satisfactory completion.

The agreement quotes a retention rate of "10% to 5%" so to build a retention reserve the builder would retain 10% of the first claim. Therefore the builders records would show:

Invoice Value                          $50,000

Less Retention                        $  5,000

Value approved for payment  $45,000

Plus GST                                 $  4,500

Cheque Amount                     $49,500

Liability on completion          $  5,000 (and the GST on this amount will be levied at some time in the future when the retention monies are released to the subcontractor) 

Accounts Payable? Accounts Receivable? Maybe Both?

The example above shows how retentions are handled in an Accounts Payable system - when you pay your subcontractors.

However if you are a General Contractor or the Construction Company, then in addition to engaging Subcontractors you will also have retentions withheld from your payments by your client - so it affects your Accounts Receivable.

Visibility of Retentions improves Liquidity and Profitability 

You don't want to be using accounting software that uses "work-arounds" like Negative Inventory to handle Retentions.

You do want:

• Retentions rate table stored and user maintainable
• Retentions visible and automatically calculated when processing Subcontractor Progress Claims
• Retentions able to be input in Client Progress Claims
• Retentions rolled over to the new financial year
• Retentions clearly visible in all Accounts Receivable, Accounts Payable and Project Review reports.

Without visibility you will become one of the contractors who "forfeit" their retentions through neglect.