Broadcom Back in the U.S.A.

By Stuart E. Leblang Michael J. Kliegman and Amy S. Elliott

Broadcom’s announced intention to reincorporate from Singapore to the United States after having shed its U.S. tax domicile in 2016 when it was acquired by Avago Technologies Ltd. shines a spotlight on its tax position. In our view:

• The decision by Broadcom to move back to the United States is unusual and was motivated by non-tax considerations;
• Because a “majority of [Broadcom’s] consolidated assets are located outside the United States” and because many of its operations are located in Singapore and Malaysia so as to “maximize the benefit from various tax incentives and tax holidays,”¹ Broadcom’s effective tax rate would likely not change much under current law as long as it keeps its earnings from those foreign operations offshore;
• If Broadcom does redomicile, U.S. tax reform could actually cause its tax rate to increase relative to current U.S. tax laws. The benefit of a possible 15 percentage point corporate rate reduction and a move to a territorial system of taxation whereby foreign earnings could be repatriated tax-free would be more than offset by increased taxes levied as part of the anti-base erosion measures (including the global minimum tax) being drafted by Congress.

Standing next to President Trump at a news conference in the Oval Office on November 2, CEO Hock Tan of Broadcom Ltd. (Broadcom) (NASDAQ: AVGO) announced that the company would be changing its place of incorporation from Singapore to Delaware. On November 6, confirming rumors, Broadcom offered to purchase Qualcomm Inc. (Qualcomm) (NASDAQ: QCOM) for $103 billion in cash and stock.²Qualcomm, on the other hand, should see a meaningful change in its effective tax rate as a result of tax reform. Both companies design and sell (but outsource the manufacturing of) semiconductors.

Announcement of Broadcom’s redomiciliation to the United States came only a day after release by House Ways and Means Committee Chairman Kevin Brady (R-TX) of the draft “Tax Cuts and Jobs Act” (H.R. 1) (the Brady Bill), introducing among other things, radical changes to the taxation of businesses. It is, therefore, tempting to interpret the decision to bring Broadcom into the United States as both an endorsement of pending tax changes and, correspondingly, dependent on those changes being successfully enacted.

We will not purport to divine the motivation of Hock Tan, but based in part on his own statements, it is clear that while he has nice things to say about the direction of tax reform, plans for the move to the United States will proceed regardless of how that goes, and there is more behind the move than taxes. For one thing, it has been reported that Broadcom’s aggressive M&A strategy has been stalled by reviews of at least one pending transaction by the Committee on Foreign Investment in the United States (CFIUS), the government agency responsible for screening foreign investments in national security-sensitive U.S. industries. ³ Given that Broadcom has a predominantly U.S. shareholder base, becoming a U.S. company would presumably eliminate this impediment. ⁴ 

Coming back to our own wheelhouse of tax law, we offer a few observations about how a company such as Broadcom may fare as a U.S.-parented company compared to a company incorporated in a relatively tax-friendly jurisdiction such as Singapore.

First, Broadcom is the result of a 2016 merger inversion of Singapore-based Avago Technologies Ltd. (Avago) and U.S.-based Broadcom Corp. It is unclear to what extent tax efficiencies have thus far been implemented in connection with the inversion. In view of the fact that the inversion occurred following the issuance of IRS notices severely limiting access to much of the low-hanging fruit from such transactions, ⁵ the expected tax benefits from the inversion were more likely of a longer term nature. Generally speaking, Broadcom’s structure, like that of most inverted companies, superimposes the foreign (in this case, Singapore) parent company at the top of a multinational group of companies, leaving the U.S.-parented old Broadcom Corp. group in place beneath it, along with other legacy subsidiaries of Avago.

While Singapore has a statutory corporate tax rate of 17 percent, the company has benefitted from several years of tax incentives there and in Malaysia that have reduced the effective tax rate very substantially. It is important to note that, regardless of the tax rate of the Singapore parent, the main driver of the group’s tax rate is the mix of rates in the primary jurisdictions where it does business around the world, including the United States.

On Broadcom’s March 1, 2017, earnings call, CFO Tom Krause said that the company has a “sustainable tax rate of 4.5 percent,” ⁶ but it was unclear if that correlated with its global effective cash tax rate. A year earlier, on its March 3, 2016, earnings call, company representatives cited a slightly higher number for the tax rate—5 percent—which was “a bit lower than our guidance at 5.5 percent.” ⁷ 

Taxation Under Current U.S. Tax System

After Broadcom becomes a Delaware corporation, the status quo income taxation of the group’s companies could remain substantially intact. This is because while the U.S. statutory rate is high—35 percent—this rate is generally only applied to income generated by U.S. companies, including earnings of foreign subsidiaries that are repatriated back to the U.S. parent. Thus, absent such repatriation, the 35 percent tax rate need not be incurred at the parent-company level.

Turning attention to the potential Qualcomm acquisition, this would further increase the overall mix of U.S. operations in the Broadcom whole, likely increasing the overall tax rate regardless of whether the parent was U.S. or Singapore resident. Details are starting to be reported about how Broadcom would finance the $103 billion transaction, of which approximately $85 billion would be cash. Under current U.S. tax laws, there are few limitations on deductibility of interest from third-party lenders to finance corporate acquisitions.

Qualcomm’s effective tax rate in 2017 was 18 percent, which reportedly reflected an increase in Qualcomm’s Singapore tax rate because certain of its tax incentives expired in March 2017. The company said its Singapore rate will go up again in 2027 when its remaining incentives expire. ⁸ 

Taxation Under Brady Bill

What would change under the draft legislation? We highlight three items: The reduced rate; the change to territorial international taxation, including important exceptions; and limitations on interest deductions.

#1:       Statutory Rate

Without doubt, reduction in the statutory federal income tax rate from 35 percent to 20 percent should on its own have a favorable, pervasive impact on the long-term effective tax rate of a domesticated Broadcom, all the more so if it expands in the United States through the acquisition of Qualcomm.

#2:       International Taxation

As noted above, the current U.S. tax system generally takes a hands-off approach to income earned by foreign subsidiaries. However, when those earnings are repatriated, the 35 percent rate comes directly into play, subject to a credit for taxes paid to the foreign jurisdiction. Related to that, certain kinds of income earned overseas may be subjected to deemed dividend treatment under the Subpart F regime.

Under the Brady Bill, dividends from foreign subsidiaries will generally be exempted from U.S. taxation through the mechanism of a deduction equal to the foreign-source dividend. The most important consequence of this is that under the new law, U.S. taxation of foreign earnings income will be the same regardless of whether those earnings are repatriated, either for investment in the United States or to make distributions to shareholders.

There are two flies in this ointment, however: the major one is the minimum tax on “high returns” of foreign subsidiaries; the likely less significant one is the excise tax on certain intercompany transactions. As to the first, the Brady Bill imposes a 10 percent minimum tax on foreign subsidiaries’ income in excess of a prescribed level (plus some additional tax to account for the foreign tax credit limitation). Designed to capture overseas income attributed to intangibles rather than tangible invested capital, the tax is imposed on income exceeding a prescribed return on tangible business property.

Of the $50 billion of assets on Broadcom’s October 31, 2016, balance sheet, $40 billion consists of goodwill and other intangibles, with property, plant and equipment only $2.5 billion. Based on a market capitalization of $111 billion reported on November 8, 2017, the implied economic return on intangible value is a great deal higher. As a result, we would expect the minimum tax to be imposed on a fairly large portion of Broadcom’s income earned outside the United States.

The new excise tax targets cross-border intercompany transactions where a U.S. company makes payments to foreign affiliates that generate either a U.S. income tax deduction or tax basis in inventory or depreciable or amortizable assets. Although it could end up being relevant to Broadcom, it is currently undergoing significant revision in the House and could very well not even end up in the Senate’s proposal. ⁹ 

#3: Limitation on Interest Deductions

The Brady Bill contains an across-the-board limitation on a U.S. group’s net interest deductions to 30 percent of something similar to EBITDA (earnings before interest, taxes, depreciation and amortization) (revised Section 163(j). In addition, it reworks the current law interest expense limitation (new Section 163(n)) to take into account the overall leverage of the worldwide group. That provision limits the ability of the U.S. group to deduct net interest expense that exceeds 110 percent of the U.S. group’s share of net interest expense calculated by reference to the U.S. group’s share of global group’s earnings. The U.S. group is forced to apply whichever—Section 163(j) or Section 163(n)—denies the greater interest expense deduction. This could potentially limit the deductibility of interest on debt incurred to finance the Qualcomm purchase.

^{[1] See Broadcom’s 2016 Form 10-K, https://www.sec.gov/Archives/edgar/data/1649338/000164933816000151/avgo-10302016x10k.htm.}

^{[2] https://blogs.wsj.com/cio/2017/11/06/the-morning-download-broadcom-proposes-acquisition-of-qualcomm/}

^{[3] See, e.g., Ezequiel Minaya, Oct. 3, 2017, “Broadcom, Brocade Push Back Merger Deadline,” The Wall Street Journal (https://www.wsj.com/articles/broadcom-brocade-push-back-merger-deadline-1507042190).}

^{[4] See Zeke Miller and Matt O’Brien, Nov. 2, 2017, “Trump Announces Semiconductor Company’s Return to US,” The Washington Post/Associated Press (https://www.washingtonpost.com/politics/white-house-announces-companys-return-to-us/2017/11/02/b5de48f8-bfea-11e7-9294-705f80164f6e_story.html?utm_term=.bceacbb23fc1).}

^{[5] See Notice 2015-79, 2015-49 IRB 375 (11/20/2015); Notice 2014-52, 2014-42 IRB 712 (9/22/2014) .}

^{[6] https://seekingalpha.com/article/4051269-broadcoms-avgo-ceo-hock-tan-q1-2017-results-earnings-call-transcript}

^{[7] https://seekingalpha.com/article/3954116-broadcom-avgo-hock-e-tan-q1-2016-results-earnings-call-transcript}

^{[8] https://www.sec.gov/Archives/edgar/data/804328/000123445217000190/qcom10-k2017.htm}

^{[9] The excise tax is imposed at the full 20 percent corporate income tax rate, and is only avoided if the foreign affiliate treats the amounts it receives as subject to U.S. corporate income tax as if they were effectively connected income (ECI). The provision was amended on November 6 and again on November 9 to allow the foreign corporation to reduce its taxes due if it makes the ECI election by both providing a deduction for some deemed expenses (but without a routine return mark-up) and providing a credit for 80 percent of certain foreign taxes paid. As of publication, the Senate had not yet released its detailed plan.}