Contract analysis

I. Executive Summary Calderwood & Harkness LLP ("C&H") was retained on June 2, 2022, to represent Penterra Pharmaceuticals Corp. ("PPC" or the "Company") in connection with an examination opened by the Internal Revenue Service Large Business & International Division ("LB&I") on May 16, 2022. The examination was initiated by Letter 2205-A and has been assigned Exam Team ID LB&I-NE-TP-2022-00641. The examination covers

II. Background — PPC's Corporate Structure and IP Arrangements A. Corporate Structure Overview Penterra Pharmaceuticals Corp. is a corporation organized under the laws of the State of Delaware and publicly traded on the Nasdaq Stock Market under the ticker symbol PPCA. PPC's principal executive offices are located at 2200 Independence Boulevard, Princeton Junction, New Jersey 08550. PPC is a specialty pharmaceutical

III. Scope and Posture of the IRS Examination A. Examination Opening and Team The IRS opened the examination by issuing Letter 2205-A, dated May 16, 2022, notifying PPC that its consolidated federal income tax returns for Tax Years 2017, 2018, 2019, and 2020 had been selected for examination. The examination has been assigned to the LB&I Northeast Transfer Pricing Practice, with Team ID LB&I-NE-TP-2022-00641. The IRS

1. PCT Valuation. The IRS is likely to scrutinize whether the $312 million PCT payment made by PBI to PPC on July 1, 2012, adequately compensated PPC for the pre-existing intellectual property transferred to PBI at the inception of the CSA. Although Tax Year 2012 is beyond the four-year examination window, the IRS may use any perceived PCT undervaluation as a basis for challenging the ongoing CSA economics during the

2. CSA Cost-Sharing Ratios. The IRS is likely to challenge whether PBI's cost-sharing percentages (38.2% in 2017 rising to 42.7% in 2020) accurately reflect PBI's reasonably anticipated benefits from the intangible development activities funded by the CSA. The IRS may argue that PPC's RAB projections overstate PBI's anticipated share of benefits and correspondingly understate PPC's share, resulting in an allocation o

3. Legacy IP Royalty Rate. The IRS is likely to challenge whether the 4.5% royalty rate on legacy compound non-Americas net sales represents arm's-length compensation for the use of PPC's intangible property. In recent transfer pricing examinations of pharmaceutical companies, the IRS has consistently asserted that royalty rates in the range of 4%–5% substantially understate the arm's-length rate for pharmaceutical I

4. PBI Economic Substance / DEMPE Functions. The IRS may challenge whether PBI has sufficient economic substance and performs adequate Development, Enhancement, Maintenance, Protection, and Exploitation ("DEMPE") functions to justify its role as the IP-holding company and CSA participant for the non-Americas territory. If the IRS can establish that critical development and enhancement functions — particularly core R&

IV. Assessment of PPC's Transfer Pricing Positions A. Cost-Sharing Arrangement — Cost-Sharing Ratios

1. PPC's Position PPC's position is that PBI's cost-sharing percentages are based on a reasonable and consistently applied methodology for measuring PBI's reasonably anticipated benefits from the intangible development activities funded by the CSA. The RAB methodology employed by PPC uses projected revenue splits between the Americas territory (PPC's area) and the non-Americas territory (PBI's area) as the allocation

2. Potential IRS Challenge We anticipate that the IRS will challenge PPC's RAB methodology and the resulting cost-sharing percentages on one or more of the following grounds: (a) Revenue Projections. The IRS may argue that PPC's revenue projections for the non-Americas territory were overstated, resulting in an inflated RAB percentage for PBI and correspondingly understated cost-sharing payments. The IRS may point to

3. Assessment of Defensibility PPC's RAB methodology is consistent with the regulatory framework established by Treasury Regulation § 1.482-7 and is supported by contemporaneous documentation prepared by Crestfield. Revenue-based RAB is a widely accepted methodology in the pharmaceutical industry, and PPC's use of this methodology is not inherently vulnerable to challenge. The progressive increase in PBI's cost-shari

1. PPC's Position PPC's position is that the 4.5% royalty rate on legacy compound non-Americas net sales represents arm's-length compensation for PBI's use of PPC's intangible property, consistent with the standards of Treasury Regulation § 1.482-4. The royalty rate was established at the inception of the license agreement based on a comparable uncontrolled transaction ("CUT") analysis performed by Crestfield. The CU

2. Potential IRS Challenge The IRS is likely to assert that the 4.5% royalty rate substantially understates the arm's-length royalty for pharmaceutical IP of this nature and value. In recent transfer pricing examinations of pharmaceutical companies, the IRS has consistently challenged royalty rates in the 4%–6% range as below arm's length, proposing rates in the range of 10%–15% for pharmaceutical IP with characteris

3. Assessment of Defensibility The CUT analysis will be a central battleground in this examination. The defensibility of PPC's 4.5% royalty rate depends critically on the comparability and quality of the CUT agreements used in Crestfield's analysis, and on PPC's ability to demonstrate that its selected comparables are more reliable and probative than any alternative comparables the IRS may identify. CUT analyses are

1. PPC's Position On July 1, 2012, PBI made a lump-sum PCT payment of $312 million to PPC as consideration for a buy-in to PPC's pre-existing pharmaceutical IP portfolio for the non-Americas territory. The PCT was valued at the time of the transaction using an income method / Discounted cash flow ("DCF") approach, consistent with the methodologies prescribed in Treasury Regulation § 1.482-7(g)(4) for valuing platform

2. Potential IRS Challenge Although Tax Year 2012 falls outside the four-year examination window, the IRS may use a PCT undervaluation theory to challenge the ongoing CSA economics for Tax Years 2017–2020. This approach has been employed by the IRS in several recent examinations and litigated cases, and is based on the theory that an understated PCT payment creates a systemic distortion in the CSA that persists throu

3. Assessment of Defensibility The PCT valuation will require a thorough re-examination using the data available at the time of the 2012 transaction, as well as an analysis of how the PCT valuation interacts with the ongoing CSA cost-sharing adjustments for the 2017–2020 period. The key variables in the DCF analysis are the discount rate (WACC) applied and the revenue projections used. C&H has directed Whitmore to pr

1. PPC's Position PPC's position is that PBI has substantial economic substance in Ireland and performs key DEMPE functions that justify its role as the IP-holding company and CSA participant for the non-Americas territory. The factual evidence supporting PBI's substance and functional contributions includes the following: • Personnel: PBI employed 185 individuals as of December 31, 2020, a significant increase from

2. Potential IRS Challenge The IRS may argue that PBI's claimed substance and functional contributions are insufficient to justify its role as IP owner and CSA participant, and that the critical Development and Enhancement functions — particularly core R&D, clinical trials management, and strategic IP portfolio decisions — remained in the United States under PPC's control throughout the examination period. The IRS's

3. Assessment of Defensibility This is an area where PPC has strong factual defenses, but the evidence must be carefully marshaled and presented. The growth in PBI's headcount from 52 employees at incorporation to 185 employees by 2020 demonstrates a substantial and sustained investment in building operational capabilities in Ireland. The 42 board meetings held in Dublin during the four-year examination period, the €

V. Preliminary Exposure Quantification A. Potential Adjustment Ranges Based on C&H's experience with similar IRS transfer pricing examinations of pharmaceutical companies and our preliminary analysis of PPC's positions, we estimate the following potential adjustment ranges for the four examination years: CSA Cost-Sharing Adjustments. If the IRS proposes increasing PBI's cost-sharing percentage by approximately 10 per