Retention before VAT refers to an arrangement, commonly found in construction or service contracts, where a portion of the payment is withheld by the customer as a form of security to ensure that the contractor or supplier fulfills their obligations. The VAT treatment of retention can follow different approaches—either before or after VAT is applied—depending on the terms of the contract. This manual outlines the procedure for recording retention amounts where VAT is deferred i.e. retention is before VAT calculations.

• The retention is calculated on the net amount (before VAT).

• VAT is applied only to the amount paid or invoiced, not including the retention.

• The retained amount is usually paid at a later date, once agreed conditions are met (e.g. project completion or after a defect liability period).