Tax treatment of long term construction contracts


Draft ruling TR2017/D8 explains the methods acceptable by the ATO for returning income derived and recognising expenses incurred in long term construction projects.


A long term construction contract refers to contracts under which construction work extends beyond one year of income. A construction contract which runs for less than twelve months, but straddles two or more income years is therefore regarded as a long term construction contract.


The principles in this ruling recognise two different approaches for tax purposes:

  • The basic approachAll progress and final payments received in a year are to be included in assessable income and costs are deductible to the extent permitted by law (they have been incurred).
  • The Estimated Profits BasisA method of accounting which has the effect of allocating, on a fair and reasonable basis, the ultimate profit or loss on a contract over the years taken to complete the contract.

Unacceptable methods

Neither the completed contracts basis nor emerging profits basis (which both return profits and losses on completion of a contract) are acceptable method for determining taxable income from long term construction contracts. This is because income tax liabilities are to be determined annually.

The specific details of each method are detailed below:


The basic approach

  • Progress and final payments - Assessable income arising from long term construction contracts includes not only progress and final payments actually received in a year but also amounts billed or billable to customers in a year for work carried out and certified as acceptable for payment by the appropriate person authorised to do so in the contract. 
  • Up-front payments - As a general rule an up-front payment or advance progress payment should be recognised as assessable income between its receipt and when the next progress payment is due.
  • Retention Clauses - amounts retained under a retention clause should not be included in assessable income until the taxpayer either receives them or is entitled to receive them from the customer. Symmetrically, if the taxpayer, being a contractor, retains amounts from sub-contractors, the amounts so retained are not deductible until such time as they are due to the sub-contractors.
  • Work-in-progress - Work-in-progress in this case is not treated as on hand as is the case with trading stock. The property concerned would normally belong to the client or customer, with the contractor having rights to sue for work done.
  • Costs - Only losses and outgoings which are incurred during an income year may be allowed as deductions. 

Estimated Profits Basis

  • Accounting standards - The estimated profits basis is similar to the accounting standard AASB 15 Revenue from Contracts with Customers but is appropriately adjustment for income tax purposes. Revenue is recognised when performance milestones are performed and goods are effectively transferred to the customer.
  • Costs taken into account - Only costs that are identified as likely to be incurred over the period of the contract and which are properly deductible are taken into account in calculating notional taxable income. These costs are estimated relying upon the taxpayer's experience in the construction industry and using sound commercial or business principles. The estimations must be well documented and can vary from year to year.
  • Tender Costs - Tender costs are not taken into account in the estimated profits basis. Although tender costs are attributable to the construction contract, they are severable from it and occur at a time before the beginning of the contract.
  • Methods of allocating notional taxable income - There are a number of acceptable methods of allocating notional taxable income over the years taken to complete a long term construction contract. They each seek to recognise notional taxable income in a manner that reflects the progress of a contract. The particular method used will depend upon the nature of a contract, be it a cost plus contact or a fixed price contract.
  • Recognising a loss - An estimated contract loss is to be spread over the period taken to complete the contract in a manner that reflects the progress of the contract.
  • Changes over the contract period - In many cases, particularly where the contract price is fixed, the notional taxable income will not remain the same over the life of the contract. Hence the profit recognised may varying each year over the life of the contract.

If you are in the building and construction industry and would like some more detailed information on the income recondition features of long term contract. Please contact a partner or manager at Goodwin Chivas & Co for more information.




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