Retention in Accounting and Taxes
A Comprehensive Guide to Risks and Best Practices
Are you figuring out how to properly account for a retention fee in a contract for work? Are you unsure about its impact on VAT and income tax? This article will provide you with clear and practical answers. We will guide you through the pitfalls of accounting procedures, tax obligations, and legal risks, so you can protect your finances and prevent costly disputes.
Key takeaways
Retention Money: More Than Just a Deferred Payment
A fundamental mistake many companies make is to view retention money as a mere deferral of payment. However, the case law of the Czech Supreme Court repeatedly confirms that it is something entirely different. A retention agreement is an arrangement where the right to the final payment for the work itself only arises after a specific, contractually defined condition has been met.
Therefore, until the given condition is met (for example, the expiry of the warranty period without defects), the contractor's claim for this amount does not legally exist. This conflict between common business practice, which perceives retention as "money that will come later," and the strict legal reality is a source of significant risks related to the statute of limitations and insolvency.
This legal nature of retention money also changes the perception of risk. For the contractor, it is not just about the client's payment discipline. They must now address the risk associated with their own ability to meet the conditions and their precise contractual definition. For the client, it is crucial not to abuse this powerful tool and expose themselves to the risk of a dispute over the wrongful withholding of funds.
How to Account for Retention Money Correctly? A Guide for Suppliers and Customers
Although the payment of retention money is deferred, Czech accounting standards require the application of the accrual principle. This means that revenues and costs must be accounted for in the period to which they relate in time and substance, regardless of the actual cash flow. The entire value of the work thus enters the accounts immediately.
Procedure for the Supplier (Contractor)
Issue an invoice for the total value of the work (e.g., CZK 1,000,000). Clearly state the amount of the retention money and the conditions for its release on the invoice.
Record the entire revenue and receivable, for example, to accounts 311 / 60x.
For clarity, immediately separate the portion of the receivable corresponding to the retention money into a separate analytical account (e.g., 311.200 – Long-term receivables from retentions).
Record the payment received (excluding retention) to the standard receivables account (e.g., 221 / 311.100).
After the conditions are met and the retention money is paid, record the remaining payment to the retention analytical account (e.g., 221 / 311.200).
Procedure for the Customer (Client)
Record the received invoice in its full amount as an expense (5xx account group) or as an asset acquisition (0xx account group) against the liabilities account 321.
Just like the supplier, you should also separate the portion of the liability corresponding to the retention money into an analytical account (e.g., 321.200 – Long-term liabilities from retentions).
Pay the amount excluding the retention money (e.g., 321.100 / 221).
After the conditions are met and the retention is released, pay the remaining part of the liability from the analytical account (e.g., 321.200 / 221).
Correct accounting procedures are the foundation of financial stability. The lawyers at ARROWS can provide expert training for your finance and accounting teams to ensure your internal processes are always in compliance with current legislation and legal practice. For an immediate solution to your situation, write to us at consultation@arws.cz.
Tax Implications of Retention Money: Don't Be Caught Off Guard by the Tax Authority
The tax implications of retentions are an area where frequent and costly mistakes occur. It is crucial to distinguish between the VAT regime and the income tax regime, as well as between different legal forms of business.
For VAT, the situation is clear. Retention money has no effect on VAT and is considered merely a deferral of the invoice payment. The supplier is obliged to declare and pay VAT on the entire invoiced amount in the tax return for the period in which the taxable supply occurred (date of taxable supply).
For suppliers, especially small and medium-sized enterprises, this represents a significant burden on cash flow. They must pay VAT to the tax authority even on money they will physically receive several years later. In effect, they are lending to the state, which can threaten their liquidity if they have multiple projects.
While the procedure for VAT is uniform, for income tax, it depends on whether you keep double-entry books or tax records.
Legal entities (s.r.o., a.s.) and natural persons keeping double-entry books: The accrual principle applies. The entire invoiced amount (excluding VAT) enters the supplier's revenues and the customer's costs (or asset value) at the time the work is completed. Income tax is therefore paid on the full amount immediately, regardless of when the retention money is paid. The corporate income tax rate for 2024 is 21%.
Natural persons keeping tax records (self-employed individuals): Here, the cash principle applies. Income is taxed only when it is actually received. The amount paid immediately after invoicing is taxable income right away. The retention amount becomes taxable income only in the year it is actually paid. This represents a significant tax and cash flow advantage.
The different tax regimes should be a strategic factor when deciding on the legal form of a business or the structure of a specific project. It is not just about tax liability, but a key financial decision with which our tax and legal experts can assist you.
Risks and Penalties | How ARROWS Helps |
Late payment of VAT on the full amount. Risk of late payment interest and a penalty for late filing of the tax return. | We provide legal consultations and tax advisory to ensure the correct determination of the date of taxable supply and timely fulfillment of tax obligations. |
Incorrect inclusion in the income tax base for a limited liability company (s.r.o.). Additional tax assessment, penalties, and late payment interest from the tax authority. | We will prepare expert opinions and internal guidelines for your accounting department to prevent errors in the tax base. |
Incorrect application of costs by the customer. Disallowance of the tax deductibility of the cost and subsequent additional tax assessment. | We will review your contracts and accounting procedures to ensure maximum tax optimization and compliance with the law. |
A Legal Minefield: The Biggest Risks of Retentions and How to Avoid Them
Incorrectly structured or managed retentions can lead to fatal financial losses. These are not theoretical risks; they are real threats confirmed by extensive case law from the Czech Supreme Court.
The greatest danger for the contractor is the statute of limitations on the claim for payment of the retention money. The general limitation period is three years. However, the key is to determine when it begins to run. A landmark judgment by the Czech Supreme Court confirmed that the period does not start from the invoice due date, but from the day following the day the conditions for the release of the retention were met (see Supreme Court judgment file no. 31 Cdo 3125/2022).
Therefore, if the condition is the expiry of a five-year warranty period, the three-year limitation period begins the day after it ends, regardless of whether you have even requested payment. Your passivity and waiting for a call from the client can lead to a complete and irreversible loss of your claim to the retained money.
The insolvency of a contractual partner dramatically changes the situation, and without a high-quality contract, you can find yourself in a very disadvantageous position.
Insolvency of the contractor: For the client, the so-called insolvency clause is key. It stipulates that in the event of the contractor's insolvency, the price of the work is automatically reduced by the amount of the retention. The Czech Supreme Court has confirmed the validity of such clauses. Without it, you risk the insolvency administrator demanding payment of the retention into the insolvency estate without anyone guaranteeing the performance of warranty repairs (see Supreme Court judgment file no. 29 Cdo 561/2017).
Insolvency of the client: If the conditions for the release of the retention were not met before the commencement of insolvency proceedings, your claim does not legally exist. You must register it as a claim subject to a condition precedent, which significantly worsens your position and chances of satisfaction.
Vague formulations like "release upon proper completion of the work" are an invitation to a dispute. The contract must contain objective, measurable, and verifiable conditions. For international projects, which are often governed by standards such as FIDIC, specific rules apply to the release of retentions (Clause 14.9) and the option to replace them with a bank guarantee.
Our specialists will help you
Thanks to our ARROWS International network, we handle contracts with an international element daily and can protect your interests both under Czech law and in accordance with international standards.
Risks and Penalties | How ARROWS Helps |
Statute of limitations on the claim for payment of retention due to inactivity after conditions are met. Loss of the entire retained amount. | Preparation or revision of work contracts with clearly defined milestones and a proactive notification system. |
Invalid or missing insolvency clause. In case of the contractor's insolvency, you must pay the retention to the insolvency administrator without any guarantee of repairs. | Drafting of bulletproof contractual documentation that will protect you from the risks of the counterparty's insolvency. |
Vaguely defined conditions for the release of retention. Leads to expensive and lengthy court disputes over whether the right to final payment ever arose. | Representation in courts and before administrative authorities. We have extensive experience in resolving disputes from work contracts and will protect your financial interests. |
Deliberate frustration of the fulfillment of conditions by the client, who tries to avoid payment (e.g., refuses to accept corrected defects). | Legal consultation and dispute management strategy. We will advise you on how to proceed and use the legal fiction of the fulfillment of a condition (Section 549 of the Czech Civil Code) to your advantage. |
How We at ARROWS Can Help You
As is clear, managing retentions is not just an accounting operation. It is a complex discipline at the intersection of contract law, tax regulations, and financial management, where any mistake can mean a significant financial loss. At ARROWS, we approach this issue comprehensively and offer integrated services to protect your business.
Our experts will provide you with:
Preparation and revision of contracts with precisely defined conditions and bulletproof insolvency clauses.
Tax advisory to ensure compliance with legislation and optimize your cash flow.
Representation in disputes before courts and administrative authorities to protect your financial interests.
Expert training for your management and finance teams to help them prevent risks.
Drafting of legal opinions to assess the validity of your claims and risks.
Our portfolio includes more than 150 joint-stock companies, 250 limited liability companies, and 51 municipalities and regions. We pride ourselves on speed, high quality, and experience from long-term cooperation with our clients. Moreover, we can connect our clients if they have interesting investment or business opportunities. We would be happy to hear your business idea as well.
Whether you are a supplier protecting your cash flow or a client demanding a quality guarantee, the correct setup of retentions is key. Connect with us at consultation@arws.cz and get a tailor-made legal solution that will protect your finances and support your growth.
About the author
Disclaimer:
The information contained in this article is for general informational purposes only and serves as a basic guide to the issue as of 2026. Although we strive for maximum accuracy, laws and their interpretation evolve over time. We are ARROWS Law Firm, a member of the Czech Bar Association (our supervisory authority), and for the maximum security of our clients, we are insured for professional liability with a limit of CZK 350,000,000. To verify the current wording of the regulations and their application to your specific situation, it is necessary to contact ARROWS Law Firm directly (consultation@arws.cz). We are not liable for any damages arising from the independent use of the information in this article without prior individual legal consultation.