MGS Private

MGS Private provides advice as to the structures and advantages of using the different methods under a long-term construction contract.

Taxation Ruling TR 2018/3 considers the income tax treatment of long-term construction contracts.

The ruling applies to “long term construction contracts”, i.e., contracts under which construction work extends beyond one year of income. This includes construction contracts that run for less than 12 months, but straddle two or more income years (see also withdrawn TD 92/186). It does not apply to contracts for the sale and supply of what may ordinarily be regarded as the sale of trading stock, for example, it does not include a contract for the supply and installation of office furniture in a new building, even though the furniture may need to be assembled upon delivery.
The word “construction” takes its ordinary meaning. Income from long term construction contracts would include income from construction of buildings, bridges, dams, pipelines, tunnels and other civil engineering projects; income from related activities such as demolition, dredging, heavy earth moving projects, etc; and income from the construction of major plant items including ships and transport vessels. It may also include income from similar contracts in associated fields depending on the facts and circumstances (that is, the contract and substance of the agreement), like air conditioning contracts, major electrical wiring or rewiring contracts, major refurbishment of hotels, stores, etc, major construction management contracts.

Applicable methods

The Commissioner accepts the following methods to recognise, for income tax purposes, income derived from, and expenses incurred in long term construction contracts:

1. the basic approach, i.e., all progress and final payments received in a year are to be included in assessable income and income tax deductions allowed for losses and outgoings, to the extent permitted by law, or
2. the estimated profits basis, i.e., any 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,

provided the method adopted is to be applied consistently to all years during which the particular contract runs and to all similar contracts entered into by the entity. For this purpose, service of maintenance contracts, being the provision of services rather than construction, are not within TR 2018/3 and are therefore not similar contracts. Each of the above methods are further explained below.

The Commissioner has expressly said in TR 2018/3 that the completed contracts method is unacceptable. In other words, in contracts which extend beyond one income year, it is not permissible to defer the bringing of profits or losses to account until the contract is completed. The “emerging profits basis” is also unacceptable.
By way of rationale, liability to income tax has to be determined annually. In the case of long-term construction projects, it is the position at the end of each year that has to be taken into account. Section 170(9) of the ITAA 1936 is the mechanism provided in the income tax law to ensure that, in the end result, there is not an over assessment of income tax liability.

MGS Private can provide advice on the structure of entities to take advantage of long-term construction contracts.