ZATCA Phase 2 for contractors: advance payments, progress invoices and retention

Published 16 October 2026 · Muqawil

Construction contracts mix down payments, monthly progress certificates and retention released after handover — and each follows a different VAT and e-invoicing rule. This guide sums up ZATCA's VAT Guideline for the Contracting Sector (second issue, May 2026) in practical terms.

Phase 2 in one minute

• B2B tax invoices are sent to ZATCA's Fatoora platform for clearance before you share them with the customer — and so are their credit and debit notes.
• B2C simplified invoices are reported to the platform within 24 hours of being issued.
• Wave 25 (announced 24 July 2026): taxpayers whose VAT-subject revenue was above SAR 187,500 in any year from 2022 to 2025 must integrate with Fatoora by 1 February 2027.

Advance payments: VAT on receipt

If you receive a down payment before the work is done, VAT is due on the amount received on the day you receive it, and you must issue a tax invoice for it no later than the 15th of the following month (VAT Implementing Regulations, Art. 53). ZATCA's example: a SAR 500,000 down payment means SAR 75,000 output VAT in that month's return.

On the e-invoice, the advance invoice uses document type 386; later invoices use type 388.

Progress certificates (mustakhlas): when is VAT due?

ZATCA treats construction as a continuous supply (Art. 20). Where the contract sets periodic payment dates, VAT is due at the earliest of the payment due date, actual payment or the invoice — and at least once every 12 months.

An approved progress certificate is not a tax invoice, but it shows that part of the work has been done. The safe practice: issue the tax invoice when the certificate is approved, and in any case by the 15th of the next month.

Deducting the advance on later invoices

• The later invoice references the advance invoice: its number, date, time and type 386.
• The amount deducted, including VAT, goes in the prepaid amount field (PrepaidAmount), with one line per VAT rate: taxable amount, tax, category and rate.
• Real-time checks are arithmetic only, but ZATCA later matches the deduction against the original advance invoice in its analytics — mismatches can lead to an audit.
• If the advance is larger than the invoice, deduct the full advance or only up to the invoice amount; if you refund the customer, a credit note is needed.

Retention: VAT on the full invoice

If you invoice the full amount due, VAT is due on the whole amount — including the part the customer holds back as retention. When the retention is released later, there is no new invoice and no further VAT (Contracting guideline, §5.2). Security deposits (Contracting guideline, §5.3): if the customer gives the contractor a deposit, VAT is deferred as long as it is held separately and the contractor cannot use it under the contract; a deposit or guarantee that is not consideration for any supply is outside VAT altogether.

If your company invoices net of retention, check the treatment with your tax adviser — the guideline does not cover that case directly.

Government projects

For contracts under the Government Tenders and Procurement Law, VAT is due at the earlier of the payment order or receipt of payment, to the extent received. This rule applies only to the main contractor contracting directly with the government entity, not to subcontractors (Art. 20(5); Contracting guideline, §4.2).

Delay penalties and price changes

Delay penalties deducted from the contract price reduce the consideration, so you issue a credit note with VAT, by the 15th of the following month. Compensation for damage to the client's property, or an amount set by a court, is not a price adjustment.

Fines

According to ZATCA's announcement (November 2021): not issuing e-invoices starts at SAR 5,000, deleting or changing an invoice after issue starts at SAR 10,000, and some violations start with a warning. A graduated schedule followed in 2022, so the current figures may differ — check ZATCA's site. On 29 June 2026 ZATCA extended the fines-cancellation initiative to 31 December 2026; it does not cover penalties on returns due after 30 June 2026.

Checklist for contractors

• A type 386 invoice for every advance, by the 15th of the next month.
• A tax invoice when each progress certificate is approved.
• Deduct the advance in PrepaidAmount and reference its invoice.
• VAT on retention with the full invoice; no invoice on release.
• A credit note for delay penalties.
• Check your wave and deadline on the Fatoora portal.

How Muqawil helps

Muqawil issues advance invoices and later invoices with the advance and retention deducted, is built to send them to Fatoora for clearance or reporting (tested on ZATCA's sandbox), and links every progress certificate to its project.

A summary for planning, not tax advice. Sources: ZATCA VAT Guideline for the Contracting Sector (second issue, May 2026), Guideline for Tax Invoicing and Records (v3, May 2026), E-Invoicing Detailed Guidelines and the VAT Implementing Regulations — all on zatca.gov.sa. Check the official text or your adviser before applying it.

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