Introduction
Every incorporated contractor in Ontario operating under the Construction Act is familiar with holdbacks — the 10% retained from each progress draw, held until the lien period expires. What is less consistently understood is how holdbacks affect the contractor's tax obligations: when the holdback must be included in income, how it affects HST, and what documentation the CRA expects.
What Is the Holdback?
Under Ontario's Construction Act, the owner of a project is required to retain 10% of the value of each progress payment (and each subcontract payment, with the holdback cascading down the construction pyramid) until the lien period expires. The standard holdback period is 60 days from the date of last supply, though this can vary based on the nature of the project and whether a proper notice of completion has been published.
The holdback exists to protect subcontractors, suppliers, and workers who may have lien rights. It is not the contractor's money until the lien period expires and the holdback is properly released.
Income Recognition: When Is the Holdback Income?
For an incorporated contractor, the timing of income recognition depends on the accounting method the corporation uses.
Accrual basis: On a strict accrual basis, revenue is recognised when it is earned — when the right to receive payment arises. Under this approach, the holdback receivable may be included in income in the year the work is performed and the progress draw is certified, even though the 10% is not yet released. The logic is that the amount is owed; collection is expected.
Completed contract method: Some construction companies recognise income only on contract completion. Under this approach, income from a project — including holdbacks — is recognised only when the contract is substantially complete. This is permissible under ASPE for certain types of construction contracts.
Percentage of completion: For longer-term contracts, income is recognised proportionally as work is completed — with holdbacks included as part of the recognised revenue as the percentage of completion advances.
The CRA's position is that income from a construction contract should be recognised in a manner consistent with generally accepted accounting principles, applied consistently year over year. The holdback receivable — once the right to it has been established — is generally considered part of earned income, even before it is physically received.
Practical implication: A contractor with significant outstanding holdbacks at fiscal year end may be including income in their T2 return that they have not yet collected in cash. This creates a potential cash flow mismatch between reported taxable income and available cash to pay the resulting tax.
HST on Holdbacks
For HST purposes, the timing of HST obligations on holdback amounts is specifically addressed in the Excise Tax Act. HST on a holdback amount is generally not due until the holdback is released and paid. The CRA's administrative position allows contractors to delay reporting HST on holdback amounts until the holdback is actually paid out.
This means that for HST purposes, a contractor can defer the collection and remittance of HST on the 10% holdback until the lien period expires and the holdback is released — even if the holdback amount has been included in income for corporate income tax purposes.
This separation — income tax inclusion in one period, HST remittance in another — requires careful tracking. The holdback should be tracked separately from the regular progress draw amounts to ensure HST is accounted for correctly in the right reporting period.
Documenting Holdbacks
Holdback receivables should be tracked on the balance sheet as a separate receivable category — not grouped with general trade accounts receivable. This separation makes the year-end review of outstanding holdbacks straightforward, supports the income recognition analysis, and provides clear documentation if the CRA requests supporting records.
For each project, the contractor should maintain records of progress draw amounts, the 10% holdback retained, the date of last supply, the lien period expiry, and the date the holdback was released and received.
When to Speak With a CPA
For contractors with multiple ongoing projects, the interaction between income recognition, outstanding holdbacks, and HST timing can create complexity in the year-end tax position. A CPA familiar with construction accounting can review the holdback position before year end and ensure the income recognition and HST treatment are correctly applied.