Retention Payments and VAT: What Contractors Must Know Under Bahraini Law
Retention payments are a standard feature in Bahrain’s construction industry. Developers withhold a percentage of contract payments (usually 5% to 10%) until project completion or the defects liability period has ended. While retention protects developers from incomplete or defective work, it creates unique challenges under Value Added Tax (VAT) rules.
Many contractors mistakenly believe that VAT applies only when retention money is released. In fact, Bahraini law requires VAT to be accounted for at the time of invoicing, even if payment is delayed. Misunderstanding these rules can trigger penalties, reassessments, and legal disputes. Consulting an experienced lawyer in Bahrain ensures compliance and prevents costly mistakes.
Explore our Legal services in tax compliance and disputes in Bahrain.
How Retention Payments Work in Construction
- Retention Percentage
- Typically 5–10% of the contract value is withheld by the developer.
- Defects Liability Period
(DLP)
- Retention is usually released after the DLP ends, ensuring defects are repaired.
- Final Release
- Retention may be released in stages, e.g., 50% at practical completion and the rest after the DLP.
These practices are standard worldwide, but under Bahraini VAT law, they carry immediate tax implications.
VAT Treatment of Retention Payments
1. VAT Applies on Invoice, Not Release
Under Bahraini VAT law, VAT is due when the invoice is issued, even if part of the payment (retention) is delayed. Contractors must include VAT on the full contract value, not just the amount received.
2. Risk of Double Taxation
If contractors fail to account for VAT at invoicing and later pay VAT again at release, they risk double taxation — and the NBR is unlikely to refund without proper evidence.
3. Subcontractor Retentions
Main contractors must also ensure subcontractors apply VAT correctly on their invoices, or liability can shift upward.
4. Variation Orders and Retentions
Changes in scope that affect contract value also affect retention amounts and their VAT treatment.
Legal Risks of Mismanaging VAT on Retention
- NBR Reassessments
- The National Bureau for Revenue may reassess VAT returns, leading to unexpected liabilities.
- Penalties and Fines
- Incorrect VAT treatment may result in financial penalties and interest charges.
- Criminal Liability
- Intentional underreporting may be prosecuted as tax evasion.
- Cash Flow Problems
- Contractors may face sudden tax demands if retention VAT was not accounted for earlier.
- Reputation Risks
- Developers may lose confidence in contractors who mishandle tax obligations.
An experienced advocate in Bahrain can defend contractors during audits and minimize penalties.
Consult the Best Advocate in Bahrain for tax-related matters.
How Contractors Can Protect Themselves
1. Draft Contracts with VAT Clauses
Clearly state how VAT applies to retentions, advances, and variation orders. A law firm in Bahrain can draft contracts that allocate responsibility fairly.
2. Maintain Detailed Records
Keep complete documentation of invoices, retention amounts, and payment schedules to defend against NBR inquiries.
3. Train Finance and Project Teams
Ensure accounting staff and project managers understand that VAT applies at invoicing, not at retention release.
4. Conduct Internal Reviews
Pre-audit checks by legal and tax experts can detect errors before the NBR does.
5. Seek Legal Guidance for Disputes
If retention VAT is challenged, consult a lawyer in Bahrain immediately to manage investigations and appeals.
Role of Legal Services in Retention VAT Issues
Professional legal services in Bahrain help contractors and developers by:
- Advising on VAT treatment of retentions and variation orders.
- Drafting contracts with clear VAT allocation clauses.
- Representing clients in NBR audits and disputes.
- Acting as advocates in Bahrain to challenge reassessments or penalties.
- Supporting compliance through tailored VAT training and internal reviews.
By working with a trusted law firm in Bahrain, contractors can manage VAT risks proactively and avoid disputes with developers and regulators.
In Bahrain’s construction industry, retention payments create complex VAT challenges. Contractors who fail to account for VAT at invoicing risk audits, penalties, and even criminal liability.
The solution lies in prevention — through strong contracts, accurate accounting, and professional legal support. By partnering with an experienced lawyer in Bahrain and engaging professional legal services in Bahrain, contractors and developers can manage VAT obligations confidently and protect their financial interests.
At Manal Dhahi Legal Consultants, Attorney & Private Notary, our skilled advocates in Bahrain specialize in construction and tax law. We ensure contractors and developers remain fully compliant with VAT rules while defending their rights in disputes with the NBR.
