Tax treatment of long-term construction contracts

Draft Taxation Ruling TR 2017/D8 explains the methods that taxpayers can use to return income derived, and recognise expenses incurred, in long-term construction projects (that is, projects that straddle two or more income years). TR 2017/D8 is a “refresh” of IT 2450 (the original ruling on this matter) and makes no changes to the ATO’s views.

One of two methods of accounting may be adopted.

The first method is the basic approach, which is essentially the accruals method. Under this method, assessable income for an income year includes all progress and final payments received in the year, plus any amounts billed or billable to customers in the year for work carried out and certified as acceptable for payment. 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. Losses or outgoings incurred during the income year are deductible to the extent permitted by law.

The second method is the estimated profits basis. This method is similar to the one laid out in AASB 15 Revenue from Contracts with Customers, which will be compulsory from 1 January 2018. Under the estimated profits basis, the ultimate profit or loss on a project can be spread over the years required to complete the contract. However, the ATO requires the basis of spreading to be fair and reasonable and in accordance with accepted accountancy practices. The “ultimate profit or loss” is in effect the notional taxable income expected to arise under the contract, which can be adjusted from year to year according to expectations existing at the close of each income year. Only those costs that are identified as likely to be incurred over the period of the contract and which are properly deductible may be taken into account in calculating notional taxable income.

Once a particular method is chosen, the ATO expects the taxpayer to apply it consistently for the duration of the contract. The same method should also be applied to all similar contracts that the taxpayer enters into.

Accounting methods that are not acceptable to the Commissioner include the “completed contracts” basis (which brings profits and losses to account on completion of a contract) and the “emerging profits” basis.

If you would like to know more please contact one of our accountants on 07 4639 1099 or come in and see us at 14 Russell Street Toowoomba.