Critical to a country’s tax revenue base is taxpayer compliance, with Allingham and Sandmo’s model of tax compliance predicting that if detection is likely and penalties are severe, people will be more compliant. However, the mixed evidence about the deterrent effect has been attributed to factors such as low penalties and corruption. Given the importance of a value added tax (‘VAT’) for developing nations, this study explores the extent to which there is a deterrent effect to improve compliance with VAT law in such a country. In particular, this article reports the findings from focus groups and a survey of 240 small and medium enterprises (‘SMEs’) in Bangladesh. The results indicate that there is a greater deterrent effect for SME taxpayers who have a compliant history compared to non-compliant taxpayers. These results are consistent over a number of measures of deterrence, including the likelihood of audits and penalties. Part of the reason for the reduced deterrence for non-compliant SME taxpayers appears to be due to Tax Officers being ‘managed’ through bribes. The findings demonstrate that for a deterrent effect through audits and penalties to lead to greater compliance in a developing country, it is essential that the issue of corruption is addressed.