If Distributor sold the product at P105, the impact on cash flow is shown below:

Cash Flows on VAT payments	Old VAT Law	R.A. 9337
	No cap	70% cap
Output VAT	10.50	10.50
Input VAT	( 10.00)	(7.35)
Amount to be paid to BIR	0.50	3.15
Increase in payment under RA 9337		2.65

         








The Distributor’s financial statements (below) will show a net loss because the additional VAT paid under the E-VAT law will wipe out its profit and working capital:

Income Statement	Old VAT Law	R.A. 9337
	No Cap	70% Cap
Sales	105.00	105.00
Cost of product sold	100.00	100.00
Gross Margin	5.00	5.00
Input tax expense (Note 1)		(2.65)
Gross Profit	5.00	2.35
less: selling and admin expenses	3.00	3.00
net profit/(loss)	2.00	(0.65)

Note 1: According to external auditors, the excess input VAT that we accumulate should be written off because we will not be able to apply the excess input VAT in the foreseeable future unless we claim a tax refund upon dissolution of the business or dramatically increase our margins.
                             
The foregoing illustrations clearly show that under the E-VAT law, the distributor will always incur losses if his margins are low. The above figures do not include yet the effect of the input taxes on consumable goods and services (for operating expenses) which definitely will also be deferred and added to the net loss.  Moreover, the provision will even have a multiplier effect as goods and services move across the VAT chain.

1.2    The 70% limitation will unnecessarily increase prices exponentially which causes the overall demand for goods and services to go down resulting to lower revenues.

Considering the significant financial drain that businesses would incur due to the 70% cap, the only logical recourse for businesses (starting from the supplier down to manufacturers and the retailer of goods) would be to recover the unutilized input VAT by increasing their prices to maintain their financial viability. This input tax recovery has compounded effect where the total increase in price may be about 10 or 13% depending on the industry and the number of entities as businesses try to ensure the same profitability as before the EVAT law:
         

To illustrate, a supplier with 95% input VAT level vs. output VAT will increase its price by 2.5% due to the 70% cap to achieve the same profit of P50 under the old law:

Supplier's Income Statement	Old VAT Law	R.A. 9337
	No cap	70% cap
Sales	1000	1025
Cost of product Sold	950	950
Gross Margin	50	75
Input Tax expense w/ 70% cap (95-71.75)		(23.25)
Gross Profit	50	51.75

Note 1: The gross profit under R.A. 9337 is not exactly equal to that under old law because this assumes that the supplier will round off price increases to  the nearest 50 basis points (at 2.5% mark-up).
                 
While increase in prices may be an option, such increase is not without limitation as it will affect the demand side.  Once demand goes down, production slows down; thus, resulting in increase in unemployment. All these will adversely affect the productivity and consumption in the Philippines.  Eventually, because of decrease in sales, tax revenue will likewise go down, hence, defeating the purpose of the law to increase revenue collection.

Indeed, the immediate effect of the 70% cap is huge tax collection but this would only be short term because of lack of business growth and investments. The biggest impact will be on the small-scale and medium-sized industries which cannot afford to stay in business while paying the VAT.  In the long term, the 70% cap will not promote investments in the Philippines, but it will result in the financial ruin of businesses, and will lead to a high inflation rate.