Is an advance payment made by the employer to the contractor after a construction contract is signed a loan from the employer to the contractor or the contractor’s income? This question persists unanswered on the mind of many. Typically, an advance payment is limited by a ceiling not to exceed 15% of the contract price, no matter whether it is a public-sector contract or a private one, with the ceiling in the public sector regulated by a Ministry of Finance regulation. The employer will only make an advance payment after it has received an advance payment bond issued by a bank operating in Thailand. A new regulation for an international bidding allows the bank bond to be issued by a bank overseas.
The bank bond is to secure the contractor’s obligation to repay the advance payment in full in the form of work performance.
Lopsided form of advance payment bond
A construction contract generally says that when the contractor completes the work for each instalment, such as a monthly instalment, and the employer inspects and has accepted the delivery of the work for such instalment, the employer will issue a certificate of payment to the contractor, which entitles the contractor to receive the amount of a construction service fee stated in the certificate.
10 percent of the amount in the payment certificate will be deducted by the employer for a repayment by the contractor of the advance payment. This deduction and repayment highlights the character of the advance payment as a loan. The 10% deduction keeps going for 10 instalments until all the advance payment is fully repaid.
7 days after the full repayment, the original advance payment bond will be returned by the employer to the contractor signifying the completion of the latter’s repayment obligation.
A point to watch: A government form of advance payment guarantee sometimes provides that the employer will not return the bond “until all obligations of the contractor have been fulfilled.” This unnecessarily expands beyond the fundamental purpose of an advance payment guarantee against the contractor’s obligation to repay the advance payment to widely cover all obligations of the contractor under the contract, already secured separately by another bond, the performance guarantee.
The provision will let the government employer hold the bond until eternity, without having to return it, even though the repayment of the advance payment has been made in full. If you encounter this standard form, make a point to argue with it. Don’t let it pass.
Advance payment as a loan
Contractually, an advance payment is an “advance,” that is a loan that the contractor takes out from the employer to fund its construction work. The repayment is made in kind, not in cash, by the contractor carrying out the construction work, except when the construction contract is terminated abruptly over the contractor’s fault. In an event of termination, the repayment schedule of the 10% monthly deductions will be accelerated by the employer to become immediately due and payable and the contractor is required to repay the remaining advance payment right away in one bullet payment.
Another point to watch: A contract drafter often overlooks the acceleration of the advance payment repayment schedule and often forgets to demand a full repayment of the advance payment upon termination of the contract on top of other damages.
If the contract does not expressly specify the right of the employer to accelerate the repayment schedule, a dispute will arise whether or not the advance payment is a loan and whether the contractor is bound to repay it in full, when the 10% monthly deduction is disrupted by the termination.
Academically, a construction contract is governed by the Civil and Commercial Code (CCC) and is classified as a “hire of work” contract. The terms, “employer” and “contractor” are the official names that the CCC calls both parties to a construction contract.
Advance payment as taxable income
Regardless of what the construction contract says, under the Revenue Code, a separate piece of law independent from the CCC, an advance payment will always be treated as a taxable income of the contractor, not a loan debt. In whichever accounting year the advance payment is received by the contractor, it must be included in the calculation of income for that year, along with the monthly construction service fee accruing for the monthly instalments of progress of work for the same accounting period.
In respect of the regular instalment progress work service fee during the construction period, the fee is deemed to accrue, and considered a taxable income on an accrual basis, when the employer issues the payment certificate upon delivery of the instalment work, although that payment certificate remains undue and unpaid.
This is because upon the payment certificate being issued, the right of the contractor to receive a payment under the certificate accrues or comes into being, forming the foundation of the contractor’s obligation to pay corporate tax on that income.
Withholding tax
Withholding tax is corporate income tax imposed on payments of the construction service fee, either payable as an advance payment or regular instalment progress payments. If the employer is the government, it is required to withhold 1% of each payment to the contractor.
In the case that the employer is a private-sector company and the contractor is also a private-sector legal entity, the withholding tax rate is 3%.
The amount of tax withheld can be credited by the contractor against the total corporate income tax calculation for the same tax year.
Value added tax
The contractor is liable to pay the value added tax (VAT) at the rate of 7% on the construction fee. A question is often asked as to when this liability arises: Upon the payment certificate being issued by the employer? Upon the contractor issuing an invoice? Or when the contractor actually receives the service fee? Related questions ensue: Can an invoice be issued as a single document that also serves as a tax invoice? Must a tax invoice be issued as a standalone document or can it be issued by the contractor in the same document as a receipt?
According to the tax law, the liability of the contractor to pay the VAT arises when he actually receives a payment of the service fee, a totally different concept from the accrual basis of the corporate income tax.
The corporate income tax is based on the accrual or the happening of the contractor’s right to receive an income, although the income has not been received, while the VAT is based on an actual receipt of that income.
Together with the liability to pay the VAT, the contractor is obligated to issue a tax invoice and a receipt to the employer upon receipt of payment of the service fee.
Invoice, tax invoice, receipt
An invoice or a commercial invoice is a commercial and accounting document that the Revenue Code does not require the contractor to issue. Therefore, it does not matter whether it will be incorporated as a single document with a tax invoice, or issued independently as is the choice by most companies. When the employer pays the invoice, the contractor can then issue them a tax invoice.
A tax invoice is a legal document that the contractor must issue every time it receives payment of the service fee from the employer. The document must show the amount of the service fee, other expenses, and the amount of the VAT that is calculated on the combination of the service fee and the expenses.
A receipt is also a required document that the contractor must issue and deliver to the employer in exchange for payment.
The tax law allows a convenience of both the tax invoice and the receipt to be issued independently of each other, or issued in combination as a single document, whichever the contractor chooses.
The VAT the contractor is liable to pay is in fact the amount of VAT that the contractor must collect from the employer. This is the contractor’s output tax that the contractor must add up to other amounts of output tax for the calendar month to get a total output tax for that month. It will have to calculate a total of all amounts of its input tax for the month in the same manner. If the total output tax exceeds the total input tax for the month, the contractor pays the balance to the tax man.
Stamp duty
It is common for contractors to omit to pay a stamp duty of 0.1% of the contract price, as required by law within 15 days of signing the construction contract. The payment has been regulated to be paid in cash, practically by a cashier’s check issued by a bank in Thailand payable to the Revenue Department, instead of physically affixing all the stamps onto the back of the contract.
Some contractors, who are late to pay, would avoid a hefty penalty by purchasing the real stamps and affix them to the contract. This ancient physical method has been outlawed and invalidated for nearly three decades in respect of a construction contract worth 200,000 baht or more for a government contract, and 1,000,000 baht for a private-sector contract.
The stamp duty liability can be substantial. A construction contract, with the contract price of 1 billion baht, can attract as high a stamp duty as 1 million baht.
A failure to pay the stamp duty on time can result in the contract being inadmissible as evidence in civil litigation in court. If the failure is found in a tax audit or someone accuses the contractor or notifies and tips off the tax man of such failure, the contractor could be liable for a heavy surcharge of 600% of the original stamp duty amount. Coupled with the original basic amount, the contractor could end up paying 700%. If a contractor deliberately avoids paying a stamp duty of 1,000,000 baht, he could ultimately be forced to pay 7,000,000 baht in the end.
Wirot Poonsuwan is a practicing attorney and can be reached at [email protected].
