(TAX UPDATE) Retention Sums in Contract Accounts

(TAX UPDATE) Retention Sums in Contract Accounts

Why SMEs keep “missing” the tax treatment, and why LHDN now expects cleaner retention tracking

Last month, I was at a site meeting. The boss opened his laptop, showed me the contract account, and said:
“Boss, retention not yet receive. So this part not taxable yet, right?”

I told him, half-joking:

“By your logic ah… I should also tell you my tax bill is not taxable yet.
Because I know you will ask for discount, then drag payment for x months.”

He just stared at me.

On the screen, the Retention Sum was sitting there quietly in the account.
But in a tax review, this “quiet account” is often the first place LHDN finds a timing gap.

Executive Summary

Retention sums are commonly excluded from contract income computations because SMEs treat them as “not yet earned” until released. This approach is high risk.

LHDN’s latest Public Ruling No. 5/2025 : Construction Contracts defines progress billings to include retention sums, and this affects stage-of-completion computations.

Separately, Income Tax Act 1967, Section 24(1) taxes business gross income based on debt owing / receivable timing.

What LHDN Says

1) “Progress billings” includes retention sums

PR 5/2025 defines progress billings as amounts billed for work performed “including retention sums”.
(For reference, PR 2/2009 used the same wording on progress billings and retention sums.)

2) Section 24(1): tax timing follows “debt owing”

Section 24(1) provides that where a debt owing arises in the relevant period, the amount of the debt is treated as gross income for that relevant period.

SME translation :
If your progress claim is certified/billed and creates a receivable, the tax question usually starts there, not only when the customer finally releases cash.

Why SMEs Keep Missing It

(A) Accounting ledger follows cash, not certification

Many book progress claims net of retention because that is what the customer pays. The retention portion is “parked” in retention receivable and forgotten during tax computation.

(B) QS documents are not tied into tax working papers

Progress Billing Certificate / interim cert exists, but no structured reconciliation to:

  • invoices/claims raised, and

  • contract account used for tax computation.

(C) Year-end contract account prepared late

When contract profits are computed as a year-end balancing figure, retention often gets excluded because nobody prepares a proper retention schedule by project.

(D) Subcontractor behaviour

Subcontractors commonly record only what they receive (net), especially when payment advice is net of retention.

Key risk areas we see during LHDN review

Understatement of contract income due to excluding retention sums from progress billings computations.

Mismatch between certificates vs contract account vs tax computation (project-by-project).

Weak audit trail (no schedule to explain opening retention, current year withheld, release, closing balance).

Double counting later when retention is released (some SMEs bring it as “new income” again without checking prior-year tax treatment).

Practical guidance

Step 1: Implement a Retention Control Schedule (project-by-project)

Minimum fields:

  • contract sum

  • cumulative certified work / progress billings (gross)

  • cumulative retention withheld

  • retention released (by date, amount, certificate reference)

  • retention outstanding (aging)

Step 2: Perform a 3-way reconciliation at year-end

Reconcile each project between:

  1. Progress billing certificates / certifications (QS / architect / engineer)

  2. Invoices / progress claims issued

  3. Ledger balances (revenue + retention receivable)

Step 3: Document the basis clearly in the tax file

PR 5/2025 places strong emphasis on documentation support (certificates, final account, completion evidence).

KTP’s View

Retention sums are not the “small leftover amount”.
It is a timing item that can move profit across years. When you have multiple projects rolling forward, that timing difference becomes material fast.

If your retention schedule is clean, your contract income story becomes clean.
And when LHDN asks, you can answer in 10 minutes instead of 10 days.

Sources :

LHDN Public Ruling No. 5/2025 – Construction Contracts (definition of progress billings includes retention sums).

LHDN Public Ruling No. 2/2009 – Construction Contracts (historical reference; similar concept).

Income Tax Act 1967, Section 24 (basis period for business gross income; debt owing concept).

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