Broadcom: How to Buy a Company 7 Months Post Spin

By Stuart E. Leblang, Michael J. Kliegman and Amy S. Elliot 

News reports state that Broadcom Inc. (NASDAQ:  AVGO) (Broadcom) is well along in negotiations to acquire VMware, Inc. (NYSE:  VMW) (VMware) in a cash-and-stock deal expected to be valued at approximately $60 billion. ¹ While not unprecedented, the proximity of this transaction to the spin-off of VMware by Dell Technologies Inc. (NYSE:  DELL) (Dell) at the end of October ² presents a useful opportunity to review the rules of the road that apply to post-spin acquisitions from a tax standpoint.

Whatever the precise terms of the deal, it raises a question as to whether it could result in a corporate level tax on Dell as a result of the so-called anti-Morris Trust rules of Section 355(e) of the Internal Revenue Code (IRC).  Under that statutory provision, generally, if a tax-free spin-off occurs as part of a plan with one or more other transactions resulting in the Parent’s shareholders owning 50 percent or less of both the Parent and Spinco, then the transaction results in taxable gain to the Parent.  Under the statute, a transaction (e.g., corporate acquisition) occurring within two years of the spin-off is presumed to be part of a plan.³  

In fact, regulations promulgated by the Internal Revenue Service (IRS) have provided far more generous guidance as to the existence of a “plan” than what is in the statute.^[4]In addition to fleshing out how the core “facts and circumstances” test is to be applied (outlining specific plan and non-plan factors), the regulations provide several safe harbors for ensuring that certain post-spin acquisitions will not be considered to be part of a plan (allowing taxpayers to avoid the catastrophic tax consequences that result when such acquisitions are part of a plan).

Tax advisers commonly discuss with potential suitors of a prospective post-spin Target what rules to follow, such as when and how it may be safe to engage in discussions with Parent or Spinco management.  Probably the most broadly useful safe harbor under the regulations is Safe Harbor I, which is also presumably the one being relied on by Broadcom and VMware, with the following requirements: ⁵ 

• The spin-off was motivated by a business purpose not involving a corporate acquisition;
• The acquisition occurs more than six months after the spin-off; and
• There is no agreement, understanding, arrangement or substantial negotiations concerning the acquisition during the period beginning one year before the spin-off and ending six months after.

While there are important nuances in the definitions of agreement, understanding, etc. in the final prong, the takeaway from Safe Harbor I is that, assuming a prospective buyer can comfortably establish that there were no discussions about a possible deal prior to the spin-off, then the buyer need only defer initiating discussions with Parent/Spinco management for six months following the spin-off.  Given that most spin-off transactions have a long gestation period between announcement and completion, waiting until six months after a spin-off may involve a much longer waiting period if interest in an acquisition begins closer to when a spin- off is first announced.  (For example, Dell announced its planned spin of VMware in April 2021.) ⁶ 

In addition to the substantive tax rules, there are ordinarily contractual restrictions that must be navigated.  In the case of the Dell-VMware spin-off, the Tax Matters Agreement ⁷ provides generally that each party will be responsible for any spin-off taxes brought about by its breach of contractual obligations, and particularly its taking any action that jeopardizes the tax-free nature of the spin-off.  Section 5.02(c) prohibits VMware from engaging in a number of different transactions, including a merger, during the two-year period following the spin-off, unless it either obtains an IRS ruling or an opinion from tax counsel that the proposed action will not cause the spin-off to be taxable.  We expect that the merger agreement between Broadcom and VMware will provide that obtaining such a ruling or opinion will be a condition of the merge

^{[1] Cara Lombardo and Dana Cimilluca, Broadcom in Talks to Pay About $60 Billion for VMware, Wall St. J., May 23, 2022 (https://www.wsj.com/articles/broadcom-discussing-paying-around-140-a-share-for-vmware-people-say-11653334946).}

^{[2] Press Release, Dell, Dell Technologies Announces Completion of VMware Spin-off (Nov. 1, 2021) (https://investors.delltechnologies.com/news-releases/news-release-details/dell-technologies-announces-completion-vmware- spin).}

^{[3] IRC §355(e)(2)(B).}

^{[4] Treas. Reg. §1.355-7.}

^{[5] Treas. Reg. §1.355-7(d)(1).}

^{[6] Press Release, Dell, Dell Technologies Announces Planned VMware Spin-Off (April 14, 2021) (https://www.dell.com/en- us/dt/corporate/newsroom/announcements/detailpage.press-releases~usa~2021~04~april-14th-2021-announcement.htm).}

^{[7] Tax Matters Agreement, Exhibit E of Separation and Distribution Agreement between Dell and VMware dated April 14, 2021, filed April 14, 2021 (https://www.sec.gov/Archives/edgar/data/0001571996/000119312521116271/d142017dex21.htm).}