Avago’s Pending Broadcom Purchase Taps Arcane Tax Structure
Avago Technologies Ltd.’s pending takeover of Broadcom Corp. taps an arcane tax structure that has being dusted off amid a rise in cross-border mergers.
Avago said it is prepared to offer Broadcom shareholders special partnership units that would defer any taxes triggered by the $37 billion tie-up, which was announced Thursday. The cross-border nature of the deal–Avago is based in Singapore, while Broadcom is in California–might otherwise generate tax bills for Broadcom investors.
The partnership arrangement would give those shareholders–including Broadcom’s two co-founders, who collectively own about 8.6% of the company–flexibility in deciding when to take their tax hit. Broadcom negotiated for the partnership units with the founders in mind, said a person familiar with the deal.
At issue is the relative size of the two companies, experts say. Stock mergers of two U.S. companies are typically tax-free to shareholders. But under Internal Revenue Service rules that govern cross-border mergers, if Broadcom is larger than Avago by the time the deal closes, the transaction could be taxable to Broadcom’s U.S. shareholders, though the IRS could issue a waiver.
As of Tuesday’s close, before The Wall Street Journal first reported the negotiations, Avago had a market value of $34 billion, while Broadcom had a market value of $28 billion. But by Thursday trading, the gap had narrowed, with Avago worth about $36.7 billion and Broadcom worth about $34.6 billion.
The issue arose several times last year, when overseas deals known as inversions were in vogue. Those deals, in which a U.S. acquirer buys a foreign target and redomiciles into a lower-tax venue, generally prompted taxes for the U.S. shareholders, often without generating much, if any, cash to cover the bill.
Indeed, the special partnership units under consideration in the Avago-Broadcom deal were offered to shareholders of Burger King Worldwide Inc. and Tim Hortons Inc. in the two restaurant chains’ 2014 merger, an inversion in which the combined entity domiciled in lower-tax Canada.
With Avago and Broadcom, the partnership units, which would not be publicly traded, are a backup plan should the IRS deem the transaction taxable, Avago said. If that happens, Broadcom investors could still choose to receive a mix of common stock and cash and owe taxes immediately on their gains. Or they could elect to receive partnership units and defer those payments until they convert the units to Avago common stock, which they couldn’t do for at least a year.
The setup can enable “tax-free treatment, albeit at the cost of holding an illiquid, quirky security,” independent tax expert Robert Willens said in an email.
The deferral could make a big difference to Broadcom’s co-founders, Henry Nicholas and Henry Samueli, who own shares worth about $3 billion at Broadcom’s current price.
Deferrals enable taxpayers to time their hit, for example to offset future losses, or to put the money to work in investments.
“Deferral is everything,” said Robert Holo, a tax partner at law firm Simpson Thacher & Bartlett LLP who isn’t involved in the deal.
Broadcom doesn’t expect most of its investors would choose to take the units, the person familiar with the deal said. For example, mutual funds–which own about 25% of Broadcom’s stock, according to FactSet–are typically judged by their pretax performance and thus are unlikely to try to minimize or defer taxes, experts say.
The Burger King deal also involved big inside shareholders. In the fast-food tie-up, 3G Capital Partners LP owned about 70% of Burger King and would have owed taxes on the gains when the Tim Hortons acquisition closed, but for the partnership units.