Tax policy can significantly influence the incentives of multinationals to move their capital and technology across national borders. This paper examines policy options to induce foreign investment and technology transfer from the perspective of Korea as the host country.

The transfer of technology via multinational investment typically takes two forms: the subsidiary either imports technology from its related parties of develop its own technology through R & D activities in the host country. The latter choice tends to generate more technology-transmission effects in the host country. Evidence based on U.S. government sources indicates that U.S. multinationals tend to rely more on technology imports than local R & D for their investment in Korea compared to their activities in other countries.

Since Korea is a relatively low-tax country, foreign firms may face a less incentive to generate technology-related expenses. Rather extensive technology incentives may be needed to induce more technology activities by foreign firms. In addition, these incentives can be most effectively provided if foreign firms are discriminated based on their nationalities. This is because the final effect of local tax policy on the behavior of foreign firms is partly determined by tax policy in the home countries of these firms.

Negotiating bilateral tax treaties is a more efficient method of accommodating differential tax incentives among foreign firms than providing unilateral tax incentives to these firms. The witholding tax rate for royalties can also be used to affect the mix of technology import and local R & D. In addition, technology transfer via Korean firms investment abroad needs to be subsidized through tax incentives and deregulation.