Construction Holdback: What You Need to Know
Do you work or own a company in the construction industry? Maybe a general contractor or specialty trade? Chances are, you most likely heard of ‘Holdback’. Do you know what it actually means and the implications it has on your projects and company?
If you haven’t seen my previous blog posts on the WIP report, please check it out here. In that post, I talk about the various types of stakeholders that require the WIP report, why the WIP report is crucial for you as the business owner and the different components that make up this report.
Let’s get started!
Types of Holdback
Before we define what Holdback is, it’s good to know that there are actually three types of holdback:
Basic Holdback
Separate Holdback for Finishing Work
Other Holdback
The first two are defined in the Construction Act while the third is not. For the third, I created this name to account for all other holdback specifically excluded from the two above.
Basic Holdback
In Part IV section 22(1) of the Construction Act, Basic Holdback is defined like this: “Each payer upon a contract or subcontract under which a lien may arise shall retain a holdback equal to 10 per cent of the price of the services or materials as they are actually supplied under the contract or subcontract until all liens that may be claimed against the holdback have expired or been satisfied, discharged or otherwise provided for under this Act.” (here is the link to the legislation Construction Act, R.S.O. 1990, c. C.30 (ontario.ca)
In layman’s terms, it means 10% of the price of services should be withheld until all liens have expired, satisfied or discharged for a particular contract. It’s also known as Statutory Holdback.
Separate Holdback for Finishing Work
In Part IV section 22(2) of the Construction Act, Separate Holdback for Finishing Work is defined like this: “Where the contract has been certified or declared to be substantially performed but services or materials remain to be supplied to complete the contract, the payer upon the contract, or a subcontract, under which a lien may arise shall retain, from the date certified or declared to be the date of substantial performance of the contract, a separate holdback equal to 10 per cent of the price of the remaining services or materials as they are actually supplied under the contract or subcontract, until all liens that may be claimed against the holdback have expired or been satisfied, discharged or otherwise provided for under this Act.” (here is the link to the legislation Construction Act, R.S.O. 1990, c. C.30 (ontario.ca)
In layman’s terms, it means 10% of the price of services should be withheld if there is work to be completed from after substantial performance to project completion until all liens have expired, satisfied or discharged for a particular contract. It’s also known as Statutory Holdback.
Other Holdback
This is not defined in the Construction Act (I made this term up) because the Act only specifies the minimum requirements according to legislation. Based on my experience, some municipalities or owners may specify in the contracts for an additional holdback such as Maintenance Holdback, Finishing Holdback or another type of holdback. It could be expressed as a percentage or dollar amount (I’ve seen both). Other owners may just stick with the required 10%.
What Happens to the Holdback?
According to the above, a minimum of 10% should be withheld from the price of services. If you are submitting progress billings monthly, then 10% of your monthly invoice will be deducted. After you reach Substantial Performance and if all liens have expired, satisfied or discharged, then the accumulated holdback will be released to you.
How Does This Affect Your Business?
Now onto the meat and potatoes of this blog. What no one really talks about is the effect on your business. Holdback is only a cash flow related item. Repeat that last sentence and let it sink in.
Here’s what it doesn’t affect:
How much you bill the client
How much your subcontractor bills you
How much you earn
Yes, I know what you’re thinking. I just told you earlier that 10% should be withheld from the price of services and now I mentioned that it doesn’t affect how much you will bill your clients and how much your subcontractor bills you. You’re in the right place because it’s extremely important.
Quick Accounting Lesson
Holdback is a cash flow related item so it actually doesn’t affect your revenue/sales or cost. Usually, you would have a software that does all this in the back end, assuming it was set up properly in the first place.
For example, let’s say the contract with your client is $10,000. By the way, holdback is not incorporated in this number. In month #1, you completed $1,000 worth of services or work so you bill $1,000 to your client. According to the holdback provisions above, 10% should be withheld from the price of services. That means it’s a deduction of $100, however that doesn’t mean you are billing $900. You are still billing $1,000 because that’s how much service you have provided.
Your invoice should look like this or something similar depending on the format your software uses or the Excel template you use.
Gross Billing $1,000 (which is treated as Revenue/Sales)
Less: Holdback $100 (which is treated as a Holdback Receivable)
Net $900 (this is not actually posted into your software)
Now let’s say you have a contract with your subcontractor for $10,000. In month #1, they completed $1,000 worth of services so they invoice you for $1,000. According to the holdback provisions above, 10% should be withheld from the price of services. That means it’s a deduction of $100, however that doesn’t mean they are invoicing you for $900. They are still invoicing you $1,000 because that’s how much service they have provided (ie. Your cost)
Cost $1,000 (which is treated as cost)
Less: Holdback $100 (which is treated as Holdback Payable)
Net $900 (this is not posted into your software)
Best Practice with Subcontractor Invoices
I’ve seen where subcontractors will invoice you the cost without taking the holdback off and then before you paying them, you deduct 10% or they will deduct 10% off the invoice. In the former, it actually causes issues with your reports, tax implications, high chance of error and major tracking issues. I won’t get into the tax implications of Holdback in this blog but it’s something CRA looks at.
The best practice is to get your subcontractor to deduct 10% off their invoice. It will help you keep track of holdback payable properly, cleaner paperwork and less hassle for you.
What does this all mean?
Just to quickly recap what happened above, holdback is a cash flow related item only and doesn’t affect your billing or cost. In my previous blog posts, I mentioned that cash flow is one of the most important metrics to monitor. Cliché alert but cash is king or queen.
General Contractor and Client
10% holdback is reduced off your billing to the client and 10% holdback is reduced off your subcontractor’s billing. From a cash flow perspective, you are receiving 10% less in cash but you are paying 10% less in cash. Your cash flow is still positive because the difference would essentially be your profit.
Subcontractor and General Contractor
If you don’t have any subcontractors that work for you, that means 10% of your holdback is reduced off your billing to the general contractor. From a cash flow perspective, you are receiving 10% less in cash but you are paying out in full. For example, wages or materials. This will cause your cash flow to go negative. How do you deal with negative cash flow situations? You are financing the project using your own corporate funds.
Your Turn
In your own organization, do you have visibility into the numbers and is Holdback being tracked and accounted for correctly? If you’re not sure or have no idea, it’s time to look for a solution that can help you bridge the gap. If you currently don’t have something like this but would be interested in setting something up, make sure to reach out to an accountant who knows the industry.
Here’s where you can find out more:
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At JTL CPA, our founder has just over nine years of experience in the construction industry (at the time of writing this article) with various general contractors and specialty trades, all the way to senior management. Our approach is unique because our solutions give you the ability to make sound decisions from good data. Check out our website here: www.jtlaccounting.com.
Thank you for making it to the end of the blog post. If there are topics that you would like to learn more about in the future, please let us know down in the comments.
Until then, see you next time!
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