Holdbacks: Are You Paying Tax and HST on Money You Haven’t Collected Yet?
Holdbacks: Are You Paying Tax and HST on Money You Haven’t Collected Yet?
If you own a construction company, here’s a question worth asking your accountant before year-end - how are we treating holdbacks?
Most owners assume the answer is obvious. It usually isn’t. Depending on how your invoices are written, how your bookkeeper codes the entries, and how your accountant has set up the year-end, you may be paying corporate income tax on holdback income you don’t yet have a legal right to collect, and remitting HST on holdbacks months before the law requires you to. Both cost you working capital.
The good news is that the Income Tax Act and the Excise Tax Act both give construction businesses real flexibility on holdbacks, and the rules are well-settled. This post walks through what those rules are and where the cash is hiding.
The framing: holdbacks are a timing question
Every dollar of holdback eventually shows up in your income, your deductions, or your HST remittance.
The question is not whether, the question is when. And in construction, the timing answer can be meaningfully different from what your accounting system defaults to.
There are three buckets to think about: holdbacks receivable from your customers (income tax), holdbacks payable to your subcontractors (income tax), and HST on holdbacks.
Each has its own rule.
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Income tax: holdbacks receivable from your customers
The general rule in the Income Tax Act is paragraph 12(1)(b): you include amounts receivable in income in the year you’ve earned them, whether or not you’ve been paid. That’s accrual accounting, and most contractors are used to it.
Construction holdbacks are a recognized exception. The key concept here is what tax law calls a “legal right to enforce payment.” An amount is only receivable for tax purposes once you have a clear, enforceable legal right to demand payment, not just an expectation that you’ll eventually be paid.
Where your contract gives the customer the right to retain a holdback pending architect or engineer certification, or pending expiry of the statutory lien period, the courts have long held that your right to that money is “precarious” until those conditions are satisfied. You can’t sue for it. It’s not due.
And until it is due, it doesn’t have to be in your income.
That gives you two practical options.
The first option: Exclude qualifying holdbacks from income until they become legally receivable.
You include the progress billing in income at the net-of-holdback amount, and you pick up the holdback later, when the architect signs off, when the lien period runs out, or when the customer is otherwise legally required to pay.
This is the approach most mid-market construction companies should be using.
The second option: Include all billings, including the holdback, as billed.
Some contractors prefer the simpler bookkeeping, and the CRA accepts that method too, but with two important constraints.
First, the method has to apply across all your contracts. You don’t get to use the defer-until-receivable method on a contract where it helps your tax position and the include-all-billed method on a contract where it doesn’t.
The CRA expects the method to be applied globally to your business, not cherry-picked contract by contract.
Second, once you pick a method, you have to use it consistently year over year.
Canadian courts have specifically held that a contractor who has consistently reported uncertified holdback billings as income is not allowed to switch methods retroactively when it would reduce tax owing.
The same logic applies in the other direction: you don’t get to toggle annually based on what’s most favorable.
Neither of these is an “election” you file with your return. There is no special form. But the choice should be documented in your year-end working papers, and your accountant should be applying it consistently.
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For a contractor doing $15 million in revenue with average holdbacks running $1.5 million at any given time, deferring that income for an average of 8-12 months past year-end can shift roughly $300,000 of corporate tax (at typical Ontario active-business rates) into the next fiscal year.
That is real cash in your operating account.
A side note on non-arm’s-length contracts, say, you’re billing a related real-estate company. The deferral is still available, but the CRA will examine whether the holdback structure reflects the genuine legal terms between the two related parties, or whether it’s a manufactured arrangement.
Importantly, you cannot defer income simply because the related party hasn’t been paid by its own end-customer. The obligation between you and the related party has to be independently contingent under your own contract with them.
Keep the paperwork tight.
Income tax: holdbacks payable to your subcontractors
Here’s the side of the ledger that catches owners off guard. If you withhold a holdback from a subcontractor pending certification or lien expiry, that amount is what tax law calls a contingent liability, you don’t yet owe it at law, because the obligation depends on a condition that hasn’t happened yet.
And contingent liabilities are not deductible.
You deduct the subcontractor holdback when it becomes a fixed legal liability, when the work is certified, when the lien period expires, when you’re contractually on the hook to pay no matter what happens next.
This applies even if the arrangement with your sub is verbal or based on industry custom rather than a tightly-drafted written agreement. Canadian courts have held that even a verbal understanding or established industry practice to withhold payment until the prime contractor is paid can be enough to render the debt contingent and non-deductible.
Informal documentation does not unlock an earlier deduction.
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The asymmetry, and why it matters in dollars
Here’s where the math actually lands. Take a contractor with $1.5 million of uncertified holdbacks receivable from customers and $1 million of holdbacks payable to subs at year-end.
On the books, those two numbers usually appear symmetrically, $1.5 million of revenue accrued and $1 million of subcontractor cost accrued, leaving roughly $500,000 of gross profit on the holdback portion of the work.
For tax purposes, both sides come off:
• The $1.5 million of customer holdbacks is excluded from income (defer-until-receivable
method).
• The $1 million of subcontractor holdbacks is not deductible (contingent liability).
So the net taxable-income deferral is the $500,000 of gross profit, the piece that would otherwise be taxable this year if both sides were currently recognized. At a typical Ontario active-business rate, that’s roughly $132,500 of cash tax kept in your operating account until the holdbacks crystallize.
The trap is when accounting accrues both sides symmetrically as normal AR/AP, and the tax return follows the books, deferring the $1.5 million of receivable income (right) and deducting the $1 million of payables (wrong).
That overstates deductions by $1 million, which translates into roughly $265,000 of corporate tax that shouldn’t have been saved.
It’s a real exposure on CRA review or audit.
HST on holdbacks: the quiet rule that helps construction businesses
This is where the legislation actively does construction businesses a favour.
The Excise Tax Act’s subsection 168(7) creates a special timing rule for construction holdbacks. Where part of the consideration on a written contract for the construction, renovation, alteration, or repair of real property is held back pending satisfactory performance, either under provincial lien legislation or under the contract itself, then HST on that holdback only becomes payable on the earlier of:
1. the day the holdback is actually paid out, or
2. the day the holdback period expires.
Translation: the HST clock doesn’t start running on the holdback portion of your invoice until the holdback is released or the lien period ends. Even though you’ve already invoiced and collected HST on the rest of the contract, the HST on the holdback portion can sit on the sidelines.
You have two invoicing approaches.
The first is to invoice and collect HST on the full contract amount up front, including the holdback.
If you do this, you have to remit that HST in the reporting period you collected it. Subsection 168(7) gives you the right to defer, but if you choose to collect early, the deferral is gone.
The second is to invoice HST only on the non-holdback portion initially, and separately invoice the HST on the holdback when the holdback period ends or the holdback is paid.
This is the approach that actually captures the cash-flow benefit of the section.
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Workable Example
Take a $2 million construction job, with a 10% statutory holdback held for 60 days past substantial completion.
The non-holdback portion of $1.8 million attracts $234,000 of HST at 13%. The holdback of $200,000 carries $26,000 of HST.
If you invoice the holdback HST up front along with everything else, that $26,000 lands in your next HST return and gets remitted out the door. If you invoice it later under subsection 168(7), the $26,000 stays in your bank account until the holdback is released.
That’s one $2 million job. A contractor doing $20 million in revenue across a dozen jobs a year can easily have $200,000-$300,000 of HST timing float sitting on the table, money that’s currently working for the CRA instead of you.
Two important limitations:
First, the special rule under subsection 168(7) only applies if the holdback is required by law (Provincial Construction Act / lien legislation) or by a qualifying written construction contract. Informal or verbal holdbacks don’t qualify.
The ordinary “earlier of paid or invoiced” HST rule under subsection 168(1) applies in that case, and there is no deferral.
Second, this is a deferral, not a forgiveness. The HST on the holdback is still owed, just later.
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Is there a formal election to file?
This is the question we get most often. The short answer is no.
There is no general “construction holdback election.” The income tax choice, defer or include-all-billed, is a reporting method, not a statutory election. The HST treatment under subsection 168(7) is automatic if the conditions are met; what you control is how your invoices are written.
There is one election worth flagging in passing: subsection 12(2.2) of the Income Tax Act. This is not a holdback election. It applies when your business receives certain government or industry assistance, inducements, reimbursements, contributions, that would otherwise be picked up as income under paragraph 12(1)(x).
The election lets you reduce the related expenditure instead of recognizing income, and it must be filed by your corporate return’s filing-due date for the year the expense was incurred.
It can matter to construction companies that receive infrastructure grants or program funding, but it has nothing to do with normal contractual holdbacks.
Three practical Tax and HST Holdback takeaways
ONE
Ask your accountant which method is being used for holdbacks receivable. If the answer is “we include everything as billed,” ask whether the defer-until-receivable method would be a better fit for your cash flow. For most contractors in the $2 million to $25 million range, deferring holdback income produces meaningfully better timing, and it’s a method the CRA accepts.
TWO
Look at how subcontractor holdbacks payable are being treated. If your year-end is picking those up as deductions while they’re still contingent, your tax return may be overstating deductions.
That’s a real exposure on review or audit.
THREE
Look at your invoice template.
Many construction companies are quietly remitting HST on holdbacks months earlier than required because the standard invoice billed the full HST up front.
Restructuring the invoice to bill HST on the holdback portion only when the holdback period ends, under subsection 168(7), is one of the cheapest cash-flow improvements available to a construction business.
Where ARC-CPA fits in
These are exactly the kinds of issues we work through with construction-company clients. If you’re not certain your current holdback treatment is the right one, or if you’d like a second opinion on how your year-end working papers handled holdbacks last year, we’d be happy to take a look.
Book a 30-minute discovery call.
Bring your last year-end working papers and one recent HST return, and we’ll tell you plainly where the timing is working in your favour and where it isn’t.
This article is general information, not specific tax advice. Holdback treatment depends on your contracts, your
provincial lien legislation, and your specific facts. Talk to your accountant before changing how you report.
Source references
• Income Tax Act, paragraph 12(1)(b), subsection 12(2), subsection 12(2.2)
• Excise Tax Act, subsections 168(1) and 168(7)
• MNR v. John Colford Contracting Co. Ltd. meaning of “receivable”
• Wilchar Construction Ltd. v. The Queen, consistency in reporting methods
• Ellis Construction Ltd. v. MNR, contingent holdbacks payable
• CRA External T.I. 2007-0228811E5, Holdbacks Receivable
• CRA External T.I. 2002-0121835, section 85(1) and Holdbacks Payable
• CRA Internal T.I. 1999-0015087, Construction Contractors
• CRA GST/HST Interpretation 25508, Construction Contracts and Holdbacks
• CRA GST/HST Interpretation 13611/HQC0004892, Construction Holdbacks and Invoices