- Sec 89 withholding on contracts over Rs 50,000
- 1.5%
- Sec 89 rate on non-resident contract payments
- 5%
- Rs threshold that triggers withholding
- 50,000
- months the IRD generally has to amend an assessment
- 4
A contracting business looks profitable on the completed-job list and still runs out of cash, because three things are routinely mismatched: the job is 70% built but only 50% billed, the client is holding back 5 to 10% as retention until the defect period ends, and the payer has withheld tax that never gets reconciled against the contractor's own return. None of these are unusual. All three are manageable once they are tracked separately instead of blended into one number called "contract revenue."
This guide sets out how a Nepali construction or engineering contractor should account for a long-running contract under NFRS, how retention money should be treated, and how the Section 89 withholding on contract payments actually works. The rules described apply as of FY 2083/84 (2026/27); Finance Acts change withholding rates and thresholds from year to year, so confirm the current year's schedule before relying on any single figure here.
How should revenue on a construction contract be recognised?
A construction or installation contract is almost always a single performance obligation satisfied over time under NFRS 15, Revenue from Contracts with Customers, not a sale recognised at one point. That matters because it changes when revenue, and the related tax exposure, is actually recognised:
Over time, by progress. Where the customer controls the asset as it is built, or the work has no alternative use and the contractor has an enforceable right to payment for work done to date, revenue is recognised as the work progresses, measured by an input method (cost incurred relative to total expected cost) or an output method (surveyed physical progress, milestones completed).
Not by invoice or certification date. The bill a client's engineer certifies is a cash-flow and billing event, not the revenue recognition trigger. A job that is 60% physically complete but has only had 40% of its value certified for billing has under-billed revenue sitting as a contract asset, not a nil position.
Costs follow the same logic. Direct materials, labour and site overhead incurred on the contract are expensed as the related revenue is recognised, not when the client eventually pays.
| Situation | What it means in the accounts |
|---|---|
| Work certified exceeds revenue recognised to date | Contract liability (billed in advance of progress) |
| Revenue recognised exceeds amount certified for billing | Contract asset (unbilled progress, sometimes called "work in progress" commercially) |
| Retention withheld by the client pending defect liability | Still a receivable of the contractor, not written off or expensed |
What is retention money, and how should it be treated?
Most construction and supply contracts in Nepal hold back 5 to 10% of each certified bill as retention, released in two tranches: part on practical completion of the works, and the remainder after the defect liability period (commonly 12 months) expires without a defect claim. The contract itself fixes the percentage and the release conditions, so the first step on any job is reading those clauses, not assuming a standard figure.
The accounting question is whether retention is simply a late payment or a separate financing arrangement. On the facts of a typical Nepali construction contract, retention exists to give the client security against defects, not to finance the contractor, so the retained amount should ordinarily be recognised as part of contract revenue when the related work is performed, and carried as a receivable (a specific, trackable one, not merged into general trade debtors) until released. It is not a cost, a bad debt, or a reduction of revenue, and it should not be written off simply because its release sits many months in the future.
Two practical consequences follow for a contractor managing cash:
Retention is working capital, not profit leakage. A contractor financing retention through overdraft facilities is paying interest on money that is legally owed to it; building the retention schedule into the cash flow forecast, by client and by expected release date, is a basic discipline that most disputes with banks trace back to skipping.
Retention disputes need the same documentation as the main contract. If a client tries to withhold retention beyond the agreed defect period, or against defects unrelated to the contractor's work, the contractor's position rests on the same site records, variation orders and completion certificates used to support revenue recognition in the first place.
How does TDS on contract and construction payments work?
To check the rate on any specific payment, use our TDS rate calculator.
Section 89 of the Income Tax Act, 2058 governs withholding on payment of a "deed or contract," a term the Act defines to include a contract for the supply of goods, labour, or the construction, installation or establishment of tangible property or structure. This is the specific provision for construction and contracting payments; it sits alongside, and is distinct from, the Section 88 withholding that applies to interest, royalties and most service fees.
| Payer and payee | Rate | Threshold |
|---|---|---|
| Resident payer to a resident contractor | 1.5% of the payment | Payments exceeding Rs 50,000 |
| Resident payer to a non-resident contractor | 5% of the payment | No stated minimum in the general rule |
| Payment for a consumer committee's work | 1.5% of the payment | Payments exceeding Rs 50 lakh |
Three points matter in practice:
The withholding is a credit, not a cost. Tax withheld under Section 89 is advance tax paid on the contractor's behalf. It must be set against the contractor's own income tax liability for the year, supported by the withholding certificate the payer is required to issue. A contractor who does not collect and reconcile certificates from every client is simply giving up a tax credit it already paid for.
VAT and TDS are separate questions. Where a contractor is VAT-registered and the amount is billed with VAT, the 1.5% withholding is generally applied to the amount excluding VAT, since the Section 89 base is the contract payment for the work, not the VAT collected on behalf of the tax authority. Confirm the treatment your payer is applying against your own invoice, since getting this wrong either way understates or overstates the credit available.
The payer, not the contractor, carries the compliance burden of deducting and depositing. But the contractor carries the burden of reconciling what was actually deducted against what was recorded, because a mismatch only surfaces when the contractor's own return is assessed, often years later.
A worked example
A contractor completes NPR 10 million of certified work on a single job in a tax year, is paid in full by a resident client, and is VAT-registered.
| Line | Calculation | NPR |
|---|---|---|
| Certified value (excl. VAT) | 10,000,000 | |
| VAT at 13% | 13% x 10,000,000 | 1,300,000 |
| Gross invoice | 11,300,000 | |
| Section 89 withholding | 1.5% x 10,000,000 (VAT excluded) | 150,000 |
| Retention held (assume 5%) | 5% x 10,000,000 | 500,000 |
| Cash received this year | 11,300,000 − 150,000 − 500,000 | 10,650,000 |
The contractor's revenue for the year is the full NPR 10,000,000 of work performed, regardless of how much cash was actually collected. The NPR 150,000 withheld is a tax credit to claim against the contractor's assessment, supported by the withholding certificate. The NPR 500,000 retained is a receivable, not a loss, and should appear on the contractor's books until the defect period runs and the client releases it; only then does it convert to cash.
What do contractors get wrong most often?
Recognising revenue only on certified amounts. This understates progress-based revenue and can make a genuinely profitable job look like it is losing money mid-contract, which damages the contractor's standing with its own bank.
Writing off retention as a cost when cash is tight. Retention is a receivable with a contractual release date, not a bad debt, unless there is an actual defect dispute. Writing it off prematurely misstates both the balance sheet and taxable income.
Losing withholding certificates. Without the certificate, the credit is difficult to substantiate at assessment. See our guide on how the IRD selects companies for tax audit for how discrepancies between what a payer reports and what a contractor claims can trigger exactly this kind of review.
Confusing VAT treatment with TDS treatment. They are governed by different provisions and calculated on different bases; treating them as one number produces an incorrect credit claim in either direction.
Not tracking retention by job and by release date. Where a contractor runs several jobs at once, retention balances that are not broken out by job and expected release date become invisible in a single "trade receivables" line, and cash planning suffers as a result.
Frequently asked
Is retention money taxable when it is withheld, or only when it is received?
Retention relates to work already performed, so the revenue it represents is recognised as that work is done under NFRS 15, in line with the contractor's normal progress-based recognition; the retained cash is a receivable, not a separate later sale. Confirm the specific tax timing position with your own filing position, since the accounting recognition point and the income tax treatment are related but separate questions.
What rate of TDS applies to a construction payment in Nepal?
Under Section 89 of the Income Tax Act, 2058, a resident payer withholds 1.5% of the contract payment where it exceeds Rs 50,000, and 5% where the contractor is non-resident. Finance Acts can revise these rates, so check the current year's schedule.
Does TDS apply to the VAT portion of a contractor's invoice?
The withholding base is generally the contract payment for the work, excluding VAT charged on top of it, since VAT is collected on the tax authority's behalf rather than being part of the contractor's own income. Confirm this against the specific invoice and payer practice.
Can a contractor recognise profit on a job before the client has certified the final bill?
Yes, where the contract gives the contractor an enforceable right to payment for work performed to date and the customer effectively controls the asset as it is built, NFRS 15 requires revenue to be recognised by progress, not only when a bill is certified.
What happens if a client never releases retention after the defect period ends?
That is a contract enforcement issue, not an accounting write-off. The contractor's position depends on the same records (completion certificates, defect notices, correspondence) that supported the original revenue recognition, so keeping that documentation intact matters well beyond the tax return.
How Veritas supports contracting businesses
We set up contract-by-contract revenue schedules under NFRS, build retention trackers tied to each client's defect liability period, and reconcile Section 89 withholding certificates against filed returns so the credit is not lost at assessment. Explore our NFRS and financial reporting capability or see our note on whether your company needs NFRS if you are not yet sure your business is in scope.
*General information only, not advice. Rates, thresholds and standards change with each Finance Act and ASB Nepal pronouncement; confirm the current position before acting.*
