Contract analysis

I. Executive Summary This memorandum analyzes the U.S. federal income tax, Delaware state tax, and Irish tax treatment of the two categories of payments that Solstice will make to Apex Surgical Innovations, Inc. ("Apex") under the proposed settlement of Apex Surgical Innovations, Inc. v. Solstice Biomedical, Inc., Case No. 1:24-cv-00587-RGA (D. Del.) (the "Litigation"). The two payment categories are: (a) The lump-su

1. Lump-Sum Payment — U.S. Federal Deductibility. The lump-sum payment of $8,750,000 is likely deductible for U.S. federal income tax purposes as an ordinary and necessary business expense under IRC § 162(a), to the extent it is properly allocable to the settlement of past infringement damages. Any portion allocable to the acquisition of the prospective non-exclusive patent license may be subject to capitalization an

2. Running Royalty Payments — U.S. Federal Deductibility. The running royalty payments of 3.75% of Net Sales are deductible as ordinary and necessary business expenses under IRC § 162(a) in the taxable year in which they accrue. There is no capitalization issue with respect to periodic royalty payments for ongoing use of the licensed technology.

3. Withholding Tax and U.S.-Ireland Treaty. Because both the direct payor (Solstice US) and the payee (Apex) are U.S. domestic corporations, no U.S. withholding tax applies to the settlement or royalty payments. However, if any portion of the settlement cost is economically borne or reimbursed by the Irish Parent through intercompany arrangements, the U.S.-Ireland Income Tax Treaty (Article 12, Royalties) may be rele

4. Irish Corporation Tax Treatment. If the settlement costs are borne at the U.S. Subsidiary level, there are no direct Irish corporation tax consequences. If the Irish Parent funds, reimburses, or is recharged for any portion of the settlement costs, the deductibility of such amounts will depend on whether the expenditure qualifies as "wholly and exclusively laid out for the purposes of the trade" under Section 81 o

5. Transfer Pricing. Any intercompany allocation of the settlement costs between the Irish Parent and the U.S. Subsidiary must comply with the arm's-length principle under both IRC § 482 and Part 35A of the Taxes Consolidation Act 1997 (as amended by Finance Act 2019). Contemporaneous documentation should be prepared to support the allocation rationale. We strongly recommend that Solstice coordinate with its auditors

II. Background and Settlement Payment Structure A. The Litigation and Settlement Context On May 9, 2024, Apex Surgical Innovations, Inc. filed a complaint for patent infringement in the United States District Court for the District of Delaware, Case No. 1:24-cv-00587-RGA, before the Honorable Richard G. Andrews, United States District Judge. The complaint alleges that Solstice Biomedical, Inc.'s PrecisionEdge™ line o

III. U.S. Federal Income Tax Treatment A. Characterization of the Lump-Sum Payment

1. General Principles — Deductibility of Litigation Settlement Payments. Under Section 162(a) of the Internal Revenue Code ("IRC"), a taxpayer may deduct "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." Litigation settlement payments are generally deductible under this provision, provided that the underlying litigation arises out of and is connec

2. Capitalization vs. Expensing Analysis. Although the lump-sum payment is deductible in principle under § 162(a), an important subsidiary question is whether any portion of the payment must be capitalized rather than currently expensed. Under IRC § 263(a), amounts paid to acquire, produce, or improve tangible or intangible property must be capitalized. The Supreme Court in INDOPCO, Inc. v. Commissioner, 503 U.S. 79

Section 197 vs. Section 167 Analysis. If any portion of the lump-sum is capitalized as a cost of acquiring the non-exclusive patent license, the applicable amortization provision must be determined. IRC § 197 generally requires that the cost of certain intangible assets — including "any license, permit, or other right granted by a governmental unit or an agency or instrumentality thereof" — be amortized ratably over

3. Timing of Deduction. Solstice Biomedical, Inc. is a Delaware C-corporation and, based on its revenue level and corporate structure, is required to use the accrual method of accounting for federal income tax purposes. Under the accrual method, a deduction is allowable in the taxable year in which all events have occurred that establish the fact of the liability, the amount of the liability can be determined with re

1. Deductibility. The running royalty payments of 3.75% of Net Sales of Licensed Products are ordinary and necessary business expenses deductible under IRC § 162(a). Royalties paid for the right to use patented technology in the taxpayer's trade or business are a paradigmatic example of currently deductible business expenses. See Treas. Reg. § 1.162-1(a) (listing "rentals or other payments required to be made as a co

2. Timing. Under the accrual method of accounting, the running royalty payments are deductible in the taxable year in which they accrue. The Patent License Agreement provides for quarterly reporting periods (as specified in Exhibit D, the Form of Royalty Report), and royalties accrue based on Net Sales during each quarterly period. The all-events test is satisfied at the end of each quarter when the Net Sales figures

IV. U.S. Withholding Tax Analysis A. Domestic Payment Scenario (Solstice US to Apex) Both Solstice Biomedical, Inc. and Apex Surgical Innovations, Inc. are U.S. domestic corporations organized under the laws of Delaware. Payments made by one U.S. domestic corporation to another U.S. domestic corporation are not subject to U.S. withholding tax. IRC §§ 1441 and 1442, which impose withholding obligations on payments of

Article 12 — Royalties. Article 12 of the Treaty provides that royalties arising in a Contracting State (i.e., the United States) and paid to a resident of the other Contracting State (i.e., Ireland) may be taxed in the state of residence. Article 12(1) further provides that such royalties may also be taxed in the Contracting State in which they arise, but the tax shall not exceed the rate specified in the Treaty. Fo

Article 23 — Limitation on Benefits (LOB). The Treaty contains a limitation on benefits ("LOB") clause in Article 23, which is designed to prevent "treaty shopping" — that is, the use of the Treaty by persons who are not genuine residents of Ireland. To claim treaty benefits, Solstice Biomedical Devices Ltd. must satisfy one of the qualifying tests under Article 23. The relevant tests include: (a) Ownership and Base

V. Irish Tax Treatment A. Irish Corporation Tax on the Lump-Sum Payment Under Irish tax law, the applicable corporation tax rate depends on the characterization of the income or expense at issue. Trading income of an Irish-resident company is taxed at the standard rate of 12.5%. Non-trading (passive) income — including investment income, rental income, and certain categories of foreign-source income — is taxed at the

VI. Transfer Pricing Considerations A. Intercompany Allocation of Settlement Costs Solstice Biomedical Devices Ltd. (Irish Parent) and Solstice Biomedical, Inc. (U.S. Subsidiary) are "associated enterprises" within the meaning of both U.S. and Irish transfer pricing rules. They are members of the same multinational enterprise group, with the Irish Parent holding 100% of the shares of Solstice US. Accordingly, all int

VII. Specific Structural Recommendations Based on the analysis set forth above, we recommend the following specific actions to optimize the tax treatment of the settlement and royalty payments. A. Allocation of the Lump-Sum Payment in the Definitive Settlement Agreement We recommend that the Definitive Settlement Agreement include explicit language characterizing the lump-sum payment of $8,750,000 as compensation for

1. Avoidance of U.S. withholding tax complexity. If the payments are routed through or made by the Irish Parent, the payments may be subject to U.S. withholding tax analysis under IRC §§ 1441 and 1442, requiring the filing of treaty claims and IRS Forms W-8BEN-E. By routing all payments from Solstice US (a U.S. domestic corporation) to Apex (another U.S. domestic corporation), the payment remains entirely within the

2. Alignment of deduction with revenue. Solstice US generates the U.S. revenue from the accused PrecisionEdge™ products. Allowing Solstice US to deduct the settlement and royalty payments against its U.S. revenue produces the most efficient tax result, because the deduction offsets income taxed at the 21% U.S. corporate rate.

3. Simplicity and audit trail. Direct payment from Solstice US to Apex through the Tidewater escrow account provides a clean audit trail and minimizes the complexity of intercompany flows. To implement this recommendation: • All wire transfers to the escrow account at Tidewater Fiduciary Services, Inc. should originate from Solstice Biomedical, Inc.'s U.S. bank accounts. • The wire transfer instructions letter to Jen

VIII. Impact on Insurance and Covered Costs The $8,750,000 lump-sum settlement payment and all running royalty payments under the proposed settlement are explicitly not covered by Solstice's intellectual property insurance policy maintained with Halcyon Specialty Insurance Co. (Policy No. HSI-IP-2023-04891). The Halcyon policy provides coverage only for defense fees and costs incurred in connection with the defense o