Three different securities
A works contract usually ties up a contractor's money in three ways, and they are often confused:
- Earnest money deposit (EMD) or bid security: given with the bid, returned once the successful bidder furnishes the performance guarantee. See EMD, BG and PBG.
- Performance guarantee (PG, also performance security or PBG): furnished once, at the start, usually as a bank guarantee, for proper performance of the contract.
- Security deposit or retention money: deducted from each running bill and held until the defect liability period is over.
The PG protects the owner during construction. The retention protects the owner after completion, when defects show up. In private contracts the two are often merged into a single "retention" clause; government contracts usually keep them separate.
How CPWD handles them
| Point | Performance guarantee (clause 1) | Security deposit (clause 1A) |
|---|---|---|
| Amount | Percentage of tendered amount in Schedule E; the GCC 2023 proforma shows 5% | 2.5% of the gross amount of each running and final bill, until 2.5% of the tendered amount is held |
| When | Within the period in Schedule F from the letter of acceptance | Deducted from each bill |
| Form | Insurance surety bond, demand draft, fixed deposit receipt or bank guarantee from a commercial bank | Cash deduction; can be released against a bank guarantee once ₹5 lakh has accumulated |
| Validity | Stipulated completion date plus at least 6 months, extended if time is extended | Held until refund |
| Return | 80% on the provisional completion certificate; the rest after the completion certificate | Under clause 17: not before 12 months after completion (6 months for works of ₹10 lakh or less, except road work), or until the final bill is passed, whichever is later |
A few details in the CPWD GCC 2023 that are easy to miss:
- Where the contract includes maintenance after construction, 50% of the PG is retained as security deposit and returned year by year.
- Bank guarantees against the security deposit must each be at least ₹5 lakh, except the last one, and their validity follows clause 17, extended whenever time is extended under clauses 2 and 5.
- The department can recover any compensation or other sum due from the contractor out of the security deposit, and the contractor must make good the shortfall within 10 days.
- For road work, the Engineer-in-Charge can refund half of the security deposit after six months if half is enough to cover the contractor's liabilities.
- Under clause 41, the security deposit is refunded only if no labour complaint has been received from the labour officer by the due date; if one is, the amount needed to settle it is deducted first.
Outside CPWD, the General Financial Rules 2017 (Rule 171) ask for performance security of 3% to 10% of the contract value, as stated in the bid documents, after a Department of Expenditure amendment of 29 December 2023. State PWDs, PSUs and private owners set their own percentages, so take the figure from your agreement.
Defect liability period and release
The defect liability period (DLP) starts from the date of completion recorded by the owner. Under CPWD clause 17, if any defect, shrinkage or other fault appears within twelve months (six months for works costing ₹10 lakh or less, except road work) after the completion certificate, arising from defective materials or workmanship, the contractor must make it good at its own cost on written notice. If it does not, the Engineer-in-Charge can get the work done by others and recover the cost from the contractor's dues or the security deposit.
To get the retention back on time:
- Get the completion certificate recorded, and keep a copy with its date.
- Attend to every defect notice within the DLP and get each closure signed.
- Close the final bill: under CPWD the deposit is held until the final bill is passed if that is later than the end of the DLP.
- Clear labour dues and any complaints, and keep the evidence.
- Apply in writing for the refund and the return of any bank guarantees, with the dates above.
Replacing cash retention with a bank guarantee
Retention held in cash is working capital that earns nothing. Where the contract allows it, swapping it for a bank guarantee releases cash at the cost of the bank's commission and the margin the bank holds. Before you do it, compare:
- The guarantee commission for the remaining period, plus any processing charges.
- The cash margin or fixed deposit the bank asks for, and the interest that earns.
- The effect on your sanctioned non-fund limits, which you may need for the next bid.
The bank guarantee cost calculator works out the cost, and the EMD and performance security calculator works out the amounts a tender asks for.
Worked example
Illustrative figures on CPWD terms. ABC Infra Private Limited wins a ₹4 crore building contract.
| Stage | Performance guarantee | Security deposit held |
|---|---|---|
| Letter of acceptance | BG of ₹20,00,000 (5%) | Nil |
| RA bills totalling ₹2,00,00,000 | ₹20,00,000 | ₹5,00,000 (2.5% of bills) |
| Contractor gives a ₹5,00,000 BG against the deposit | ₹20,00,000 | ₹5,00,000 as BG, cash refunded |
| RA bills totalling ₹4,00,00,000 | ₹20,00,000 | ₹10,00,000 (limit of 2.5% of ₹4 crore reached) |
| Provisional completion certificate | ₹4,00,000 (80% returned) | ₹10,00,000 |
| Completion certificate | Returned in full | ₹10,00,000 |
| 12 months after completion and final bill passed | Nil | Refunded, less any recoveries |
Once the ₹10,00,000 limit is reached, no further security deposit is deducted from bills. The final bill and any extra items may change the tendered-amount base; follow the department's working.
Accounting and tax basics
In the contractor's books, retention is part of the revenue for work done. It is shown as a receivable, or as a contract asset where it becomes due only on a future condition, such as the end of the DLP. Under Ind AS 115, a retention held to protect the customer against non-completion is not normally treated as a financing component. Review old retentions for recoverability; a deposit stuck for years behind an unclosed final bill may need a provision.
Income tax. Income Computation and Disclosure Standard III (construction contracts), notified under the 1961 Act, includes retentions in contract revenue, so retention is generally taxed as the work is done, not when it is released. The Income-tax Act 2025 says the same in s.57(3)(a) ("contract revenue shall include retention money"), and s.536(2)(j) keeps the earlier notifications in force where they are consistent with it. Income-tax TDS under s.393 [194C] is deducted on the amount credited or paid; where the full bill is credited to the contractor's account, TDS is on the gross amount including the part retained.
GST. Retention is part of the consideration for the works contract, not a discount. GST is charged on the full value of the bill, at the time of supply, even though part of it is paid later. The same applies to GST TDS under s.51, which is worked on the taxable value of the bill.
In the owner's books, retention is a liability to the contractor until it is released. An amount forfeited for an unremedied defect is set against the cost of remedying it.
K-Projects holds work orders with their retention and advance terms and shows each contractor's running bills with retention and advance recovery, and what is still owed.
Common questions
What is the difference between retention money and a performance guarantee?
A performance guarantee is furnished once at the start, usually as a bank guarantee, to secure performance during the contract. Retention or security deposit is deducted from each running bill and held until the defect liability period is over.
How much security deposit does CPWD deduct?
Under clause 1A of the CPWD General Conditions of Contract 2023, 2.5% of the gross amount of each running and final bill, until the total reaches 2.5% of the tendered amount. The performance guarantee is separate, at the percentage in Schedule E.
When is the security deposit refunded in a CPWD contract?
Under clause 17, not before 12 months after the completion certificate (6 months for works costing ₹10 lakh or less, except road work), or until the final bill is passed, whichever is later, and only if no labour complaint is pending.
Can retention money be replaced by a bank guarantee?
Under CPWD clause 1A, yes, once ₹5 lakh has accumulated, with each guarantee at least ₹5 lakh except the last. Other contracts allow it only if their clause says so.
Is retention money taxable when it is deducted or when it is released?
Under ICDS III, notified under the 1961 Act, retentions form part of contract revenue, so they are generally taxed as the work is done. GST is charged on the full bill value including the retained part. Confirm the treatment under the Income-tax Act 2025 with your CA.