The construction industry has special rules found in almost no other sector: Sometimes the customer owes the VAT, payments to subcontractors may be subject to withholding tax, and contracts are billed in installments over several months. Here, we explain what bookkeeping looks out for and what the tax advisor clarifies.
Why construction has its own rules
The legislature has established several special rules for the construction industry, primarily to prevent tax revenue losses. In an industry with many subcontractors, chains of subcontractors, and large sums of money, there is a high risk that VAT will be charged but not paid to the tax office, or that wages will be paid under the table.
For construction companies and trades businesses, this means additional obligations. If you know them and build them into your processes, they take little effort. If you overlook them, you risk paying taxes twice or being held liable for the taxes and contributions of others.
Reverse charge under § 13b UStG
Normally, a business charges VAT on its invoices and pays it to the tax office. With construction services, it can be the other way around: If a business provides a construction service to another business that itself regularly provides construction services, the client owes the VAT. The contractor then invoices net.
Construction services are work done to build, repair, maintain, alter, or demolish structures. Supplies of materials alone are not included, nor are planning and supervision services.
In practice, a certificate from the tax office can prove whether the client regularly provides construction services themselves. This certificate is valid for a limited time, so make sure you have a valid certificate for each client when you invoice net.
- As a contractor: invoice without VAT, with the note “Steuerschuldnerschaft des Leistungsempfängers,” the German wording for reverse charge
- As a client: report the VAT on the service received yourself and, under certain conditions, deduct it as input VAT
- In both cases: keep all certificates and invoices on file
The tax advisor assesses whether the reverse charge applies in an individual case. If the invoice is wrong, the tax may be owed twice: by the contractor, because they showed it on the invoice, and by the client, because they owe it by law.
Construction withholding tax and exemption certificate
The second special rule concerns payments to subcontractors. Any business that commissions construction services must withhold 15% of the payment and pay it to the tax office. This is known as construction withholding tax. It does not apply if the subcontractor presents a valid exemption certificate, or if payments to that subcontractor in the calendar year stay below a threshold, usually 5,000 euros.
The exemption certificate is issued by the subcontractor’s tax office. Its validity can be verified online with the Federal Central Tax Office. If the construction withholding tax is not withheld even though it was due, the client is liable for it.
For bookkeeping, this means one simple rule: Do not make any payment to a subcontractor without a verified, valid exemption certificate in the portal. Certificates are valid for a limited time, so you also need a list of expiration dates. If construction withholding tax does become due, it must be reported and paid by the 10th of the following month.
Progress invoices and final invoice
Construction contracts run for weeks or months and are billed in installments. An important VAT rule applies here: For down payments and progress payments, VAT becomes due as soon as the money comes in, not only when the work is completed. Progress payments must therefore appear in the advance VAT return for the month in which they were paid.
The final invoice shows the total work with the total VAT and deducts the progress payments already made, along with the tax on them. If this deduction is missing or wrong, VAT is shown twice. In the books, progress payments are tracked by contract and offset against the final invoice.
In addition, there are cash discounts, deductions made by the client, change orders, and partial acceptances. Each of these changes affects revenue and VAT and must be allocated to the correct contract.
Retentions
Clients often withhold a portion of the final invoice as security for warranty claims, frequently for several years. This amount is an outstanding receivable that is carried on the books until it is paid or until the retention period expires. If it is never paid, it must be written off.
Retentions place a strain on liquidity: money that has been earned is not available. Many businesses therefore replace retentions with a warranty bond. Whether VAT can be temporarily adjusted for retentions is a matter for the tax advisor.
Work in progress at year-end
As of the balance sheet date, contracts are often underway but have not yet been accepted. These work-in-progress items are recorded and valued in the annual financial statements, generally excluding the profit, which is recognized only upon acceptance. The tax advisor is responsible for the valuation.
For this, bookkeeping provides the tax advisor with the costs to date for materials, labor, and subcontractors for each contract, the progress payments received, and the status of the work. If you post to cost centers per construction site, you already have these figures. If they are missing, the status must be estimated after the fact, and that is rarely more accurate than site-by-site bookkeeping kept up to date.
Construction wages and liability for subcontractors
Payroll in the construction industry is a discipline in its own right. Many businesses are bound by collective agreements with wage groups, hardship premiums, and travel allowances, and there are the construction industry’s social funds, SOKA-BAU, with their own filings and contributions for vacation pay and vocational training. In the bad-weather season, seasonal short-time work benefits also come into play. The construction industry is also subject to the immediate notification requirement for new employees.
If you, as a general contractor, pass on work to subcontractors, you may be liable for their social security contributions above certain contract values and, regardless of that, for the minimum wage of their employees. Prequalification or certificates of good standing from the health insurance funds and the Berufsgenossenschaft, the statutory accident insurer, can limit this risk. Collect these documents together with the exemption certificate for each subcontractor.
Common mistakes in the construction industry
Most problems identified during audits in the construction industry stem from a few recurring errors:
- Invoicing net without a valid certificate from the client: the contractor may then have to pay the VAT after all
- Showing VAT even though the client owes it: the tax is owed twice
- Taxing progress payments only with the final invoice: VAT is due as soon as the payment comes in
- Final invoice without deducting progress payments: VAT is shown twice
- Paying subcontractors without an exemption certificate: liability for construction withholding tax
- Overlooking expired certificates: what was valid in the spring may no longer be valid in the fall
- Forgetting the immediate notification: a fine if there is an inspection on site
Even smaller trades businesses that primarily work for private clients are affected as soon as they hire subcontractors themselves or work for other construction companies. A simple process involving a list of certificates and a review before each payment prevents most of these errors.
Construction company bookkeeping in practice
- Contracts: progress payments, partial invoices, and final invoices per contract, by cost center on request
- Outgoing invoices: standard taxation or reverse charge, matching the client’s certificate
- Subcontractors: exemption certificates with expiration dates, payments only after verification
- Retentions and discounts: tracked as open items until payment or write-off
- Materials and equipment: purchases, rentals, and leases by construction site
- Wages: collectively agreed rates, premiums, SOKA-BAU, and immediate notification
- Year-end: list of work in progress with costs and progress payments
You can find out how we organize this for construction companies and trades businesses on the construction and trades page. We also handle payroll with construction wages; see payroll.
Sources
Laws and bodies named in the article. The legal texts link to gesetze-im-internet.de, in German.
- § 13b UStG: recipient of the service as the person liable for the tax
- Federal Central Tax Office: construction withholding tax and exemption certificates
This article is for general informational purposes only and does not constitute tax or legal advice in specific cases. A tax advisor is responsible for tax-related questions.