By Liz Hoffman 

Avago Technologies Ltd. said the Internal Revenue Service has declined to assure that its pending $37 billion takeover of Broadcom Corp. will be tax-free to that company's shareholders, highlighting an unusual consequence of some cross-border deals.

Singapore-based Avago and California-based Broadcom said in May, when they announced their tie-up, that they would seek an IRS ruling that the deal qualified as a tax-free reorganization. They also included a fallback that would let Broadcom investors--including its co-founders, who own 8.6% of the company--defer any tax hit were the deal to end up taxable.

At issue for tax purposes is the two companies' relative size. If Avago is larger when the deal closes, the transaction will be tax-free under IRS rules that apply to foreign takeovers of U.S. companies. If Broadcom is larger, investors will owe taxes on the newly issued stock they receive. Either way, shareholders will owe taxes on the cash portion of the deal, which makes up less than half of the total payment.

Avago had sought the IRS's blessing based on the status quo when the deal was struck, when Avago was significantly bigger. The gap has since narrowed: Avago's current market capitalization is $33 billion, versus $31 billion for Broadcom.

Should the deal end up being taxable, Avago has said it is prepared to offer Broadcom investors tax-deferring partnership units in lieu of stock, which would let Broadcom shareholders decide when to make their tax payments. Broadcom negotiated for the partnership units with the co-founders in mind, a person familiar with the matter earlier said.

The IRS has historically granted requests for such rulings, making its decision here unusual, independent tax expert Robert Willens said. He said Avago's rapid growth through acquisitions over the past few years could cloud the picture, as the IRS has a three-year "lookback" window when determining company size in such situations.

Write to Liz Hoffman at liz.hoffman@wsj.com

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