(TAX UPDATE) Public Ruling 5/2025 on Construction Contracts: The 12-Month CPC Rule and Other Tax Changes Contractors Must Know

Introduction

If you are a contractor or project owner dealing with construction contracts, this is one update you cannot ignore.

LHDN (IRBM) has released Public Ruling No. 5/2025 – Construction Contracts, replacing the older Public Ruling 2/2009 of the same title. It introduces legislative updates, clarifications, and new examples.

The practical impact is simple: your tax calculations now follow stricter timing, stricter loss rules, and stricter documentation expectations.

Key Summary for SMEs

1) Mandatory profit recognition within 12 months after CPC (YA 2023 onwards)

From Year of Assessment 2023, when a contract is treated as completed but the final account is only finalised later, the contractor must determine and recognise the actual gross profit or loss based on the earlier of:

12 months after the date of completion (CPC), or
the date when the final account is agreed between contractor and client.

This is a major change for contractors who used to let “final account pending” drag for a long time.

2) Income must be recognised as work progresses (stage of completion)

Income from construction contracts must be recognised as the work progresses, based on the stage of completion at the statement of financial position date.

Meaning: you cannot wait until the end of the job and recognise everything only when you feel “project finish already”.

3) Stricter rules on estimated losses (no more “easy offset”)

One of the biggest tightening points is this:

Estimated losses from one or more contracts cannot be set off against the actual gross profit of other contracts.

In practical terms:

Estimated loss can only offset estimated profits (within the rules),
but it cannot reduce actual profits already earned from other contracts.

This affects instalment tax planning, budgeting, and how you explain the numbers during a tax review.

4) Revision of estimated gross profit is allowed but must be supported

Contractors may revise estimated gross profit for the basis period or immediately following basis periods if any of these happens:

estimated gross profit is reduced
estimated gross profit becomes estimated loss
estimated gross profit is increased

But the revision must be based on revised contract value and revised construction cost, supported by real changes and proper documents not just a year-end “balancing figure”.

5) Clear tax treatment for retention sums, LAD, and defect liability

These three items are common trouble areas because they sit between “accounting provision” and “tax timing”.

Based on the key changes highlighted:

Retention sums: treated as income when billed.
LAD (Liquidated Ascertained Damages): provision is not deductible until the actual amount is agreed/confirmed.
Defect liability costs: must follow specific rules on when it is deductible, including situations involving carry-back / timing conditions.

This matters because many SMEs book provisions and assume tax will follow the same timing. Under PR 5/2025 direction, that assumption is risky.

6) Contract splitting or combining: must follow commercial reality

For projects with multiple LOA, variation orders, or separate packages, the ruling introduces clearer criteria for when contracts should be treated as:

separate contracts, or
one combined contract

The key message: the treatment must follow how the job is negotiated, priced, and structured not simply arranged to make tax computation nicer.

7) Enhanced documentation requirements (the “audit-ready” pressure)

Contractors should maintain clear records such as:

Letter of Award / contract documents
CPC and completion-related documents
progress billings and progress claims
final accounts and agreement evidence
cost details and supporting documents

In other words: if your records are messy, your tax risk becomes bigger.

SME Implications (How this impacts your business)

1) Earlier tax exposure if final accounts are delayed

The 12-month rule means you can’t keep profit recognition “pending” for too long after CPC. If your QS and finance team are slow to finalise, tax timing may still move forward.

2) Your progress claims must align with tax recognition

If your accounts recognise progress one way, but your tax computation is done differently, the gap becomes a risk point during review.

3) Less room for “estimated loss planning”

SMEs who rely heavily on estimates to smooth tax numbers will feel this change. LHDN is clearly tightening this area.

4) More disputes around retention, LAD and defect costs

These items now require stronger evidence and clearer timing. Provisions alone are usually not enough. Expect more internal back-and-forth between project team, QS, finance, and tax agent.

5) Documentation becomes your “insurance policy”

If an officer reviews your case, documents decide whether your position is accepted quickly or becomes a long fight.

KTP’s View (Our advice to clients)

From what we see in practice, most construction SMEs do not get into trouble because they want to evade tax.

They get into trouble because:

projects run long,
paperwork is scattered,
final accounts are delayed,
and tax is computed too late, too fast.

PR 5/2025 is basically LHDN saying:

“We want your tax position to follow project progress, supported by proper documents, and closed within a reasonable timeline.”

So our practical advice is:

Start a project-by-project tax folder (digital is fine) from Day 1.
Track stage of completion, estimated vs actual, and CPC date like a compliance deadline.
For retention, LAD and defect costs: keep a clean trail (billing, confirmation, agreement, evidence).
Do a quarterly review with your tax agent, not only at year end.

Call to Action

If your company handles construction contracts … main contractor, subcontractor, M&E, design & build, or developer-side project management. This is a good time to do a quick health check.

KTP can help you:

map your contracts to PR 5/2025 requirements,
review your progress recognition and “final account pending” exposure,
tighten documentation so your file is audit-ready,
and reduce the risk of future adjustments and penalties.

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