Office of Tax Analysis

U.S. Treasury Department

Washington, D. C. 20220 

Issued: January 1977 

TAX BARRIERS TO 

TECHNOLOGY TRANSFERS 

G. N. Carlson 

G. C. Hufbauer 

U. S. Treasury Department 

OTA Paper 16 November, 1976 
TABLE OF CONTENTS 

I . Introduction .................. 1 

I1 . International Dialogue on Technology Transfer . 2 

A . UNCTAD ................... 2 

B . OECD .................... 4 

C . Meeting of Foreign Ministers ........ 4 

D . Eminent Persons Report ........... 5 

I11 . Tax Treatment of Technology Transfers ..... 7 

A . Tax Policy in Developed Countries ..... 7 

B . Tax Policy in Developing Countries ..... 8 

C . Taxation as a Barrier to Technology Transfer 13 
I. INTRODUCTION 

Technology transfer is high on the agenda of 

international issues for developing countries. The 

developing countries have two goals: to accelerate the 

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rate of technology transfer and to reduce its cost. 

Unfortunately these goals may conflict with each other. 

The developed countries realize the importance of 

making more technology available to the developing 

countries. This is particularly true since developed 

countries conduct more than 95 percent of the world's 

research and development. But the developed countries 

cannot simply mandate that privately held technology be 

made freely available. As with any other good or service, 

the holders of technology will be willing to sell if they 

receive an attractive rate of return. The rate of return 

in developing countries may be unattractive for a variety 

of reasons: exchange controls, potential patent infringements, fear of expropriation, or high taxes. The conflict 

between the goals of developing countries and the capabilities 

of developed countries has been discussed in numerous 

international groups. 
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11. INTERNATIONAL DIALOGUE ON TECHNOLOGY TRANSFER 

The developing countries want access to the technology 

of the developed countries at reduced or zero cost. The 

developed countries respond that they cannot accommodate 

this demand because the technology is privately held and 

national governments cannot dictate the price at which it 

is sold. But developed nations are willing to support 

a declaration that technology should be made available to 

the developing countries at fair, reasonable, and equitable 

rates. Discussion of these topics has taken place in 

several international groups. 

A. UNCTAD. Within the United Nations Conference on 

Trade and Development (UNCTAD) I the developing countries, 

acting in the guise of the Group of 77, have proposed a code 

of conduct regulatingthetransfer of technology. One section 

of the code declares that all countries have the right to 

technology. Therefore, it concludes, all countries should 

promote the transfer of technology at prices favorable to 

the developing countries. A favorable price would presumably 

be lower than the market price. The Manila Declaration, 

adopted by the Group of 77 in February 1976, states: "The 

developed countries should grant the developing countries 

unrestricted access to existing technology irrespective of 

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the ownership of such technology." 
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In those instances where payments are made for 

technology, the code proposed by the Group of 77 would 

encourage countries to treat payments for technology as 

distributions of profits whenever close economic relations 

exist between a buyer and a seller. This treatment would 

mean that royalties would be taxed as profits at the 

corporate level and then further subject to a withholding 

tax when paid to the licensor. 

The developed countries responded with an alternative 

code of conduct. The alternative code suggests that 

transfers of technology will be best encouraged by a system 

which allows the source and recipient enterprises to negotiate 

freely the terms of the transfer. Taking direct issue with 

the code proposed by the Group of 77, the developed countries 

contend that, while private owners of technology should 

license enterprises within developing countries on reasonable terms, they cannot be expected to serve as instruments 

of foreign aid. 

U.S. Secretary of State Kissinger echoed these 

sentiments in his Nairobi speech before UNCTAD IV. He noted 

that technology resides primarily in the private sector and 

that the developed and developing countries should work 

together toward creating an environment conducive to its 

transfer. He then proposed "that voluntary guidelines be 
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developed that set forth the conditions and standards of 

technology transfer which encourage, facilitate, and 

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maximize the orderly transfer of technology." 

B. -OECD. Members of the Organization for Economic

Cooperation and Development (OECD) have tentatively agreed 

on a set of guidelines for multinational enterprises that 

contain a section on transfers of technology. Since the 

OECD is composed primarily of developed countries, it is 

understandable that the guidelines stress proprietary 

rights tempered by reasonable licensing terms. The guidelines provide that enterprises should: 

(1) endeavour to ensure that their activities 

fit satisfactorily into the scientific and technological policies and plans of the countries 

in which they operate, and contribute to the 

development of national scientific and technological capacities, including as far as 

appropriate the establishment and improvement 

in host countries of their capacity to innovate; 

(2) to the fullest extent practicable, adopt

in the course of their business activities 

practices which permit the rapid diffusion of 

technologies with due regard to the protection 

of industrial and intellectual property rights; 

(3) when granting licenses for the use of 

industrial property rights or when otherwise 

transferring technology do so on reasonable 

terms and conditions. -4/ 

C. Meeting of Foreign Ministers. The Working Group on 

Transnational Enterprises of the Meeting of Foreign Ministers 

is made up of representatives of Latin American nations plus 
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the United States. The Latin American group proposed on 

the one hand that transnational enterprises make no charge 

for technology transferred between a subsidiary and the 

home country, and in the alternative, that only competitive, 

market prices be charged. The U.S. responded by pointing 

out that, since costs are associated both with the 

development of teahnology and its transfer, it is appropriate 

that a price be charged on licenses between a parent firm 

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and its subsidiary. 

D. Eminent 

- Persons Report. The United Nations eminent

persons report on multinational corporations reviews the 

positions of the developing and developed countries on the 

technology transfer issue. Developing countries, it notes, 

feel that technology should be made available at a very low 

charge because the transfer supposedly does not involve 

extra costs. "Developing countries argue that the technology 

provided by multinational corporations has already been 

produced and that the corporations have already derived 

The developed countries, the report continues, feel 

that this argument misses the point. Research and development is a risky business; some projects succeed, others 

fail. The successful ones must bear the costs of the 
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unsuccessful projects in addition to their own. Thus, it 

is incorrect to conclude that no charge should be made for 

the transfer of a successful technological venture merely 

because its costs have more or less been written off. 

In additioq, it should be mentioned that the developing 

countries often fail to recognize the concept of opportunity 

costs. The owner of technology is foregoing alternatives 

when he makes technology more widely available. As technology 

is disseminated, it loses its scarcity value. This 

reduction in value is clearly a cost and it is appropriate 

that the owner charge for it. 
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111. TAX TWATMENT OF TECHNOLOGY TRANSFERS 

The developing countries want technology made widely 

available at preferential rates enforced by government 

regulation, while the developed countries prefer to rely 

on market forces. While this impasse will be difficult 

to resolve, interim steps can be taken to accelerate the 

flow of technology. The tax rates which developing countries 

apply to royalty income often impede the transfer of 

technology. Modification of these tax rates could 

remove an important barrier to the inflow of technology 

to developing countries. 

A. Tax Policy in Developed Countries. The tax treatment 

of royalties in the developed countries can be used as a 

point of reference for evaluating the tax policies of 

developing countries. There are two tax issues: whether 

royalties paid by the recipient of the technology are a 

deductible expense of doing business, and the rate of withholding tax levied by the country paying for the technology. 

The non-discrimination article of the revised OECD 

model income tax treaty provides that "royalties ... paid 

by an enterprise of a Contracting State to a resident of 

the other Contracting State shall, for the purpose of 

determining the taxable profits of such enterprise, be 

deductible under the same condition as if they had been paid 
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7/ 

to a resident of the first-mentioned State." - The 

deduction is, however, limited to an arm's length amount. 

The developed countries tend to follow this approach. Since 

royalties paid to residents are generally deductible, they 

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also are deductible when paid to non-residents. 

The royalty article of the revised OECD nodel income 

tax treaty provides that "royalties arising in a Contracting 

State and paid to a resident of the other Contracting State 

shall be taxable only in that other State if such resident 

9/

is the beneficial owner of the royalties." - Payments for 

technology made by a subsidiary corporation to its parent, 

or by an unrelated corporation to a foreign licensor, are 

characterized as royalties. Many of the income tax treaties 

between developed countries follow the OECD principle of 

assigning exclusive taxation of royalties to the State of 

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the recipient's residence. Table 1, shows the withholding 

rates on royalties provided by tax treaties between the 

United States and a number of developed countries. Most 

rates are zero, with the exception of the treaties with 

Canada, France, and Japan which provide that the State where 

royalties arise may levy a low withholding tax. 

B. Tax Policy in Developing Countries. By contrast, 

the developing countries tend to restrict the deductibility 

of royalty payments. These countries view royalties as 
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Table 1 

I/

Withholding Tax Rates on Royalties- Stipulated

in Income Tax Treaties between the 

United States and Selected Developed Countries 

Treaty Withholding

U.S. Treaty with: : Rate on Industrial Royalties 

(Percent) 

Austria 

Belgium

Canada 

Denmark 

France 

Germany (Federal Republic)

Italy

Japan 

Luxembourg

Netherlands 

Norway 

Sweden 

Switzerland 

United Kingdom 

0 

0 

15 

0 

5 

0 

0 

10 

0 

0 

0 

0 

0 

0 

June 28, 1976 

-1/ Rate at which a country may tax royalties paid to a 

resident of the other country. 

Source: Tax Treaties, Commerce Clearing House, Inc., Table 

entitled Withholding Under Tax Treaties, p. 169. 
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thinly veiled profit distributions rather than legitimate 

expenses of acquiring technology. Accordingly, three 

different approaches are used: deductibility of royalty 

payments is denied; it is limited; or it is dependent on 

government approval of the technology transfer agreement. 

The approaches followed by selected countries are illustrated 

in Table 2. 

Because they need tax revenue, and because technology 

is largely a one-way flow from developed countries, developing nations are often unwilling to follow the OECD treaty 

model which grants the exclusive right to tax royalties 

to the residence country of the licensor. For example, 

in the model treaty developed by members of the Andean Pact 

(Bolivia, Columbia, Ecuador, Peru, and Venezuela), the 

OECD principle is just reversed and the sole right to tax 

royalties paid for technology is reserved to the country 

c11/

where the technology is used. In practice, most developing 

countries levy some withholding tax on royalties arising 

within their borders that are paid to residents of other 

States. The term "withholding" is something of a misnomer, 

since the withholding tax is a final tax on distributions 

to foreign recipients which is additional to any tax levied 

on profits at the corporate level. Two approaches are used: 

the withholding tax may be levied on gross royalties or it 

may be levied on gross royalties less some allowance for 

expenses. The approaches are illustrated in Table 3. 
paid 

-- 

-- 

-- 

Table 2 

Deductibility of Royalty Payments in Selected 

Countries When Paid to Nonresidents 

Deductibility Limited 

Deductibility Denied : Deductibility Limited : and Depends on Government 

:Approval of Transfer Agreement 

Brazil -- if nonresident is Brazil -- limited to 5 percent Mexico -- limited to 1.5 to

or 

controlling interest corporation to of a sales principal if not share- sales 3.0 percent of net ~~ 

holder 

Argentina -- if nonresident is India limited to 5 percent 

a related party Argentina -- limited to an of sales if not paid for

arm's length the acquisition of I 

amount if not paid capital rights I--1 

to a related 

PartY 

r

Guatemala limited to 15 

percent of gross

Philippines deductible if sales

not excessive 

Ghana -- limited to a fair and 

reasonable amount 

June 15, 1976 

Source: Tax Treaties Between Developed and Developing Countries, United Nations Department

of Economic and Social Affairs, 1969 and 1972. 

Cahiers De Droit Fiscal International, Studies on International Fiscal Law,

International Fiscal Association, Volume LXa, Premier Sujet, 1975, 1 and 11. 

I 
Table 3 

Withholding Tax Treatment of Royalties Arising in Selected Developing Countries and 

Paid to Nonresidents not Maintaining a Permanent Establishment in the Developing Country 

Tax on Tax on Gross Royalty Country Gross Royalty Less Expense Deduction 

Brazil 25.0% 

Chile 37.5 

India 1/ 40.0 

Israel - 2/ 25.0

Mexico w - 5.0 to 42.0

Pakistan 60.0 

Peru 37.0 

Philippines 35.0 

Argentina 41.0%, with expense deduction of 50% of royalty

Ghana 50.0%, with deduction for reasonable expenses

Panama 45.0%, with expense deduction of 50% of royalty 

uruguay 38.0% rate reduced to 19.0% if expenses incurred 

directly associated with royalty 

Venezuela 15.0% to 50.0%, with expense deduction of 20.0% A of royalty h, 

June 16, 1976 

1/ India taxes royalties paid to foreign companies under approved agreements made after March 31, 1975. 

A recently signed treaty between the U.S. and Israel provides for a rate of 15 percent on 

industrial royalties. The treaty has not yet been ratified. 

2' plus a sales tax of 4% of gross royalty. 

Sources: Cahiers De Droit Fiscal International, Studies on International Fiscal Law, International 

Fiscal Associaton, Volume LXa, Premier Sujet, 1975, 11. 

Tax Treaties between Developed and Developing Countries, United Nations Department of 

Economic and Social Affairs, 1972. 

"Arrangements for the Transfer of Operative Technology to the Developing Countries",

Division of Public Finance and Financial Institutions of the United Nations Secretariat, 

1971. 

"Brief Resume of Taxation of Investment Income of Nonresidents"; Government of India 

memorandum, unpublished. 

I 
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C. Taxation as a Barrier to Technology Transfer. The tax 

policies which restrict or prohibit the deduction of royalties 

or levy a high withholding tax on royalty income paid to nonresidents can significantly retard the transfer of technology. 

Since the withholding taxes are assessed on gross income with 

only a limited deduction for expenses, the tax liability may 

be a very large portion of net royalty income. For example, 

Mexico levies a tax as high as 42 percent on gross royalty 

income paid to nonresidents. It is difficult to determine the 

expenses associated with the generation and transmission of 

technology, but if expenses are 50 percent of the gross royalty 

income, the tax liability works out to 84 percent of net 

income. 

Table 4 illustrates the effective royalty tax rates, defined 

as tax liability as a percent of net royalty income. Various 

levels of expense (25, 50, and 75,percent)are assumed in 

computing net royalty income. Each country's corporate tax 

(if any) on royalty income, plus its withholding tax, 

taking into account any allowable expense deductions, are 

then expressed as a percent of net royalty income. In many 

instances the effective tax exceeds 50 percent. This i.s 

high in the sense that 50 percent is greater than the rate 
Table 4 

Effective Tax Rates-I/ $n Selected Developing 

Countries on Net Royalty Income 

Country : Irktual Expensesp as a Percent of the Gross Royalty Are: 

25% 50% 75% 

Argentina -2/ 

Brazil -3/ 

Chile 

Ghana 51 

India 

Israel 

Mexico -

5/ 

Pakistan 

Panama 

Peru 

Philippines 

Uruguay 

Venezuela -

6/ 

82.0% 123.0% 246.0% 

73.3 110.0 220.0 

50.0 75.0 150.0 

33.0 50.0 100.0 

53.3 80.0 160.0 

33.3 50.0 100.0 

56.0 84.0 168.0 

80.0 120.0 240.0 

30.0 ' 45.0 90.0 

49.3 74.0 148.0 

46.7 70.0 140 .O 

25.3 38.0 76.0 

53.3 80.0 160.0 

Liability as a percent of actual net royalty income. 

Includes the taxes on royalties at the corporate level as profits due to 

denying the deductibility of royalties paid to foreign controlling shareholders. 

If expense deduction of 50% of royalty allowed for tax purposes. 

1/ Assumes the maximum rate of 42 percent.

F;/ Assumes the maximum rate of 50 percent. 

Source: Refer to the sources of Tables 2 and 3, 
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at which either the developed or developing countries 

customarily tax ordinary business income. There are even 

instances where effective rates may exceed 100 percent. 

Such tax rates may well frustrate the goal of easier 

access to technology. High taxation clearly acts as a 

barrier to the importation of technology from countries such 

as France and the Netherlands which customarily exempt 

foreign income from domestic taxation. In these cases, 

the high taxation imposed by developing countries simply 

erodes the after-tax earnings of French and Dutch sellers 

of technology. What is not so widely recognized is that 

high taxation of royalty income also acts as a barrier to 

the importation of technology from countries such as the 

United States, the United Kingdom, Japan, and West Germany 

which provide a foreign tax credit. Depending on the 

country, the amount of foreign royalty income will be 

measured either on a net or on a gross basis for purposes 

of calculating the foreign tax credit limit. If foreign

royalty income is measured on a net basis (after related 

expenses), the taxes imposedbydeveloping countries may easily 

exceed the creditable limit. Particular companies may have 

excess foreign tax credits from other types of foreign source 

income which can be used to "shield" royalty income from 
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taxation by the home government. Thus, if developing countries 

reduced their withholding taxes on royalties, this would not 

so much transfer revenue to the treasuries of the developed 

countries, as it would reduce the overall tax burden on the 

sellers of technology. 

Sooner or later, the suggestion is likely to be made 

that the developed countries provide tax relief or incentives 

for industrial royalties received from developing nations. 

At some stage, this suggestion might be seriously entertained. 

But clearly the developing nations themselves are responsible 

for the firststep in moderating the taxation of royalty 

income. 
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FOOTNOTES 

The authors are associated with the Office of International 

Tax Affairs of the U. S. Treasury Department. The views 

expressed are the personal opinions of the authors and do 

not represent the views of the Treasury Department. 

New York Times, "Poor Nations Demand Change in Getting

Technology of Rich", June 24, 1976. 

Declaration and Prosram of Action of the Group of SeventySeven, "Transfer of Technology", Article I, Paragraph C(4). 

Speech before the Fourth Ministerial Meeting of the United 

Nations Conference on Trade and Development, Nairobi, Kenya,

May 6, 1976. 

"Guidelines for Multinational Enterprises", OECD, Committee 

on International Investment and Multinational Enterprises. 

Indeed, section 482 of the United States Internal Revenue 

Code requires that, for tax purposes, either the parties 

enter into a prior cost sharing agreement, or an arm's length

charge be made for such transfers. 

"The Impact of Multinational Corporations on the Development

Process and on International Relations", Report of the Group

of Eminent Persons to Study the Role of Multinational 

Corporations on Development and on International Relations,

United National Economic and Social Council, May 1974, p. 56. 

Some developing countries point to the commentary on the 

business profits article of the OECD draft as evidence 

that royalties should not be deductible. The business 

profits article provides that expenses, wherever incurred, 

on behalf of a permanent establishment shall be deductible 

in determining the taxable profits of the permanent

establishment. A foreign permanent establishment is 

essentially a foreign branch of a parent corporation. The 

commentary suggests that royalty payments by a permanent

establishment to its head office should not be allowed as 

deductions in computing the permanent establishment's taxable 

profits. It seems, however, that this is merely advising that 

a royalty account does not need to be set up between a home 

office and a branch since, pursuant to the business profits

article, a portion of the research expenses incurred to produce 

the technology presumably was already charged against the 

foreign branch income. 
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-

9/Double Taxation of Income and Capital: Revised Texts of Certain 

Articles of the 1963 OECD Draft Convention and of the Economic 

Commentary Thereon, Organization for Economic Cooperation and 

Development, 1974, p. 21. 

g/This is true even though the country's internal tax code may

provide for a royalty withholding tax. The U.S. statute,

for example, in the absence of a treaty, calls for a 30 percent

withholding tax to be levied on royalty payments to nonresidents. 

GICahiers De Droit Fiscal International, Studies on International 

Fiscal Law, International Fiscal Assocation. Volume LXa. 

Premier Sujet, 1975, I, 14.