Construction & Retentions GST NZ: Avoid the Cashflow Trap
Construction & Retentions GST NZ
Retention money withheld under a construction contract isn’t subject to GST until it’s actually paid or payable — not when the underlying work is done. The trap: if you issue a tax invoice for the full contract value (including the retention) upfront, you owe GST on the whole amount immediately, even though you might not receive the retention for 12 months or more.
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What Is a Retention, and Why Does It Exist?
A retention is a percentage — commonly 5–10% — that a principal or head contractor withholds from each progress payment to a subcontractor, as security against defective or incomplete work. It’s typically released in two parts: half at practical completion, and the remainder at the end of the defects liability period, often 12 months later. Retentions are a standard feature of construction contracts under the Construction Contracts Act 2002, which also sets rules for how retentions must be held (in trust, for contracts entered into after specific 2023 amendments) to protect subcontractors if a head contractor becomes insolvent.
The Core GST Rule — “Time of Supply”
GST is triggered by the time of supply rule: generally the earlier of the invoice date or the payment date. For most progress claims, this is straightforward — you issue an invoice, GST applies to that invoice. Retentions break this simplicity, because IRD treats withheld retention money as not yet supplied until it’s actually paid or becomes payable — meaning the GST liability on the retention portion is genuinely deferred, not just administratively delayed.
The Cashflow Trap — And How to Avoid It
This is the single most costly mistake in construction industry GST, and it happens because of a document mix-up between two genuinely different things:
| Document | What it does | Triggers GST? |
|---|---|---|
| Payment Claim | A request for payment under the Construction Contracts Act, typically marked “This is not a tax invoice” | No |
| Payment Schedule | The payer’s response, certifying the amount they agree to pay (after deducting retention) | No — it’s the payer’s response, not your invoice |
| Tax Invoice | The actual GST-triggering document | Yes, on invoice basis, for whatever amount it states |
The trap: if you issue a tax invoice for the full contract amount, including the retention, you owe IRD GST on the entire figure in your next return — even though the retention itself might sit unpaid for a full year. You’ve effectively paid GST out of pocket on money you haven’t received, sometimes for months.
The fix — a 4-step sequence:
- Issue a Payment Claim for the work completed (not a tax invoice — no GST triggered).
- Receive the Payment Schedule from the payer, certifying the amount they’ll actually release now (after their retention deduction).
- Issue a Tax Invoice only for the certified amount being paid now — not the full claim value.
- Issue a separate Tax Invoice for the retention amount only when it’s actually released — often 12 months later, at the end of the defects liability period.
Worked Example
Tama, a GST-registered electrical subcontractor, completes $50,000 (GST-exclusive) of work on a commercial fit-out. The head contract specifies a 10% retention.
| Stage | Amount (GST-excl.) | What happens |
|---|---|---|
| Payment Claim issued | $50,000 | No GST triggered — not a tax invoice |
| Payment Schedule received | $45,000 certified for release now | Payer has deducted $5,000 (10%) retention |
| Tax Invoice #1 — issued for certified amount | $45,000 + $6,750 GST = $51,750 | GST triggered here: $6,750, declared in this period’s return |
| (12 months later) Retention released | $5,000 | Retention finally paid |
| Tax Invoice #2 — issued for retention | $5,000 + $750 GST = $5,750 | GST triggered here: $750, declared in the period the retention was actually released |
Total GST across both invoices: $7,500 — identical to 15% of the full $50,000 contract — but spread across two GST periods, matching when the money actually arrives, rather than front-loaded into a single period where Tama would have been $750 out of pocket for up to a year.
Buyer-Created Tax Invoices (BCTIs) — Common in Construction
In many construction supply chains, the main contractor issues the tax invoice on the subcontractor’s behalf — this is a Buyer-Created Tax Invoice (BCTI), a recognised, IRD-compliant arrangement rather than an irregularity. It’s common because head contractors often control the certification process (via the Payment Schedule) and find it more efficient to generate the corresponding tax invoice directly, rather than waiting on each subcontractor to issue their own. If you’re a subcontractor receiving payments this way, confirm in writing whether a BCTI arrangement is in place — you shouldn’t also issue your own competing tax invoice for the same supply, since that risks double-counting GST.
Does Your GST Accounting Basis Change Any of This?
Yes, meaningfully. If you’re on payments basis rather than invoice basis, this entire trap is largely sidestepped — GST is triggered only when payment is actually received, so retention money simply isn’t counted until it lands in your account, regardless of what any invoice says. This is a major reason many smaller subcontractors and tradies specifically choose payments basis (available if turnover is $2 million or under) — it naturally aligns GST timing with real cashflow on exactly this kind of contract structure.
How This Interacts With Schedular Payments and Withholding Tax
Construction labour is a standard schedular payment activity, meaning subcontractors are often also dealing with withholding tax on top of GST, deducted by the head contractor under an IR330C-declared rate. The same GST-exclusive calculation rule applies here as elsewhere: withholding tax is calculated on the certified, GST-exclusive payment amount only — never on the GST component, and never on money still held as retention that hasn’t been certified for payment yet.
(See our full GST for Contractors NZ guide for the complete withholding tax mechanics and a worked example of the GST-exclusive calculation.)
Frequently Asked Questions
Do I have to pay GST on retention money before I receive it?
No. Retention money isn’t subject to GST until it’s actually paid or becomes payable — provided you haven’t issued a tax invoice for the full amount (including the retention) upfront.
What’s the difference between a Payment Claim and a Tax Invoice in construction?
A Payment Claim is a request for payment under the Construction Contracts Act and does not trigger GST. A Tax Invoice is the document that actually triggers your GST liability, and should only be issued for the amount actually being certified and paid, not the full claim including retention.
What happens if I invoice for the full contract amount including retention?
You’ll owe GST on the entire amount in your next GST return, even though you may not receive the retention portion for 12 months or more — creating a genuine, avoidable cashflow problem.
What is a Buyer-Created Tax Invoice (BCTI)?
An arrangement where the buyer, usually a head contractor, issues the tax invoice on behalf of the supplier or subcontractor. It’s a recognised, compliant practice in construction, but subcontractors should confirm in writing whether a BCTI arrangement applies before issuing their own competing invoice.
Does my GST accounting basis affect how retentions are treated?
Yes. On payments basis, GST is only triggered when payment is actually received, which naturally avoids the retention cashflow trap. On invoice basis, careful invoice timing (claim, then certified amount, then retention separately) is required to achieve the same result.
When should I issue the second tax invoice for a retention?
Only when the retention is actually released — commonly at the end of the defects liability period, often around 12 months after the certified progress payment was made.
