Index linkage and VAT in a construction contract: base index, determining index and linkage differences in the account
Index linkage is how a construction contract deals with price changes over the course of the project: the contract sum is set according to a base index, and each account is updated by the change in the index up to the determining index. In Israeli construction contracts the accepted index is the construction inputs index for residential building, which the Central Bureau of Statistics publishes once a month. VAT is added after the linkage, on the amount payable. I have experience in calculating index linkage in interim payment applications and in final accounts, from the contractor's side and from the checker's side.
Base index, determining index and the index linkage formula
Three concepts are enough to understand any account. The base index is the index set in the contract as the starting point, usually according to the date of the tender or of signing. The determining index is the index by which a particular account is updated, and the contract defines which one: the index known on the day the account is submitted, or the index of the month in which the work was done. The known index is the last index published.
The formula: the linkage differences equal the amount, times the determining index divided by the base index, minus one. In words: if the index rose by 3%, the linkage differences are 3% of the amount. The amounts in the account stay at base prices, and the linkage is calculated in a separate line, so that it can be checked.
The difference between the known index and the index of the month of work matters in practice: the index for a given month is published only after the month is over. A contract that links to the index of the month of work means waiting for publication, or paying by the known index and making up the difference in the next account.
A worked example in an interim payment application
As an illustration, a period amount of 200,000 shekels excluding VAT, a base index of 130.0 points and a determining index of 133.9 points. The numbers are an example, not a real index.
| Step | Calculation | Amount |
|---|---|---|
| Period amount before linkage | At contract prices | 200,000 |
| Index ratio | 133.9 divided by 130.0 | 1.03 |
| Linkage differences | 200,000 times 0.03 | 6,000 |
| Amount after linkage | 200,000 plus 6,000 | 206,000 |
| VAT 18% | 206,000 times 0.18 | 37,080 |
| Payable including VAT | 243,080 |
A quick check anyone can do: if the index rose 3%, the linkage differences should be 3% of the period amount, no more. How the calculation fits into the rest of the account, with retention and the advance recovery, is on the page interim payment application.
Index linkage in a cumulative account: each period by its own index
In cumulative accounts, under the method usual in many contracts, each period is linked to its own determining index, and not the whole cumulative amount to the latest index. As an illustration, three accounts with a base index of 130.0 points:
| Account | Period amount | Determining index | Change | Linkage differences |
|---|---|---|---|---|
| 1 | 150,000 | 131.3 | 1% | 1,500 |
| 2 | 120,000 | 132.6 | 2% | 2,400 |
| 3 | 200,000 | 133.9 | 3% | 6,000 |
| Total | 470,000 | 9,900 |
Whoever links the full 470,000 shekels to the latest index gets 14,100, that is 4,200 more. The gap comes from extra linkage on work that was already paid at its own index. Before arguing about the number, check what the contract says and which method was used in the first account.
When index linkage is partial, and what happens when the index falls
Not every contract links the whole amount. The common options, all of them set in the contract:
- Full linkage: the whole amount is updated by the change in the index.
- Partial linkage: only part of the amount is linked, for example 80%, and the rest is fixed.
- Threshold: linkage starts only after a certain change, for example above 2%.
- Cap: linkage is limited to a maximum rate for the whole project.
- A fall in the index: in some contracts a fall reduces the payment, and in others linkage works only upwards.
For variations, it is worth agreeing in advance on the base index of a new price: the contract index, or the index of the date on which the price was set. Without that, the same variation can get double linkage. More on variations on the page submitting variation claims.
VAT in accounts: excluding VAT, including VAT, and input tax
Bills of quantities and price lists are priced excluding VAT. The VAT rate in Israel currently stands at 18%, and it is advisable to check the rate on the date the invoice is issued. VAT is calculated on the total amount, including the linkage differences. A private client actually pays the VAT; a registered business offsets it as input tax. The term is sometimes confused with the construction inputs index, but there is no connection between the two. Inputs in the sense of resources are covered on the page construction inputs.
The order of calculation: first quantities times prices, then linkage, then retention and deductions according to the contract, and VAT at the end. A different order gives a different number, and a good supervisor will check exactly that.
Linkage and VAT are calculated on the amount, but the amount itself rests on a quantity takeoff. A quantity surveyor who checks the account starts from the quantities, because an error in the quantity takeoff grows with every linkage.
Frequently asked questions
Where do you find the index?
On the website of the Central Bureau of Statistics, which publishes it once a month. It is worth keeping the indices used in each account together with the account.
What is the difference between the construction inputs index and the consumer price index?
The first measures construction costs: materials, labour and equipment. The second measures consumer prices. In construction contracts the first is the usual one, because it is closer to the contractor's costs.
Is VAT added to the linkage differences too?
Yes, in most cases VAT is calculated on the total amount, after index linkage.
Who checks that the calculation is right?
The supervisor, and on many projects also a quantity surveyor for construction projects acting for the client. Since the method is fixed, the check is quick when the account is orderly. The effect of indices on a cost estimate is explained on the page construction cost estimate.
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Contact me for a quote* Created with AI for marketing, for illustration only. Not reviewed by Yaakov Avital and not professional advice. Every project must be checked on its own by a professional quantity surveyor and an engineer.