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PRIVILEGED & CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT

MEMORANDUM

TO: Special Committee of the Board of Directors of Penterra Pharmaceuticals Corp. Diane Prescott, Chair James Okafor Dr. Helen Ng

FROM: Sophie Tremblay, Calderwood & Harkness LLP

DATE: August 15, 2023

RE: Tax Structure and Considerations — Proposed Acquisition of Caliston BioSciences, Inc. by Penterra Pharmaceuticals Corp. (Project Coriander)

C&H Matter No.: 1025-00006

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I. Executive Summary

This memorandum has been prepared by Calderwood & Harkness LLP ("C&H") at the request of the Special Committee of the Board of Directors of Penterra Pharmaceuticals Corp. ("Penterra" or the "Company") in connection with Penterra's proposed acquisition of one hundred percent (100%) of the outstanding equity of Caliston BioSciences, Inc. ("Caliston"), referred to internally as "Project Coriander." The purpose of this memorandum is to analyze the material federal and state income tax consequences of the proposed transaction for both Penterra and the stockholders of Caliston, and to identify structuring considerations and potential areas of exposure that should inform the Special Committee's decision-making and the negotiation of the definitive merger agreement.

As currently structured, Penterra proposes to acquire Caliston through a one-step merger of Caliston with and into Penterra, with Penterra as the surviving corporation. The aggregate equity value of the transaction is Nine Hundred Twenty-Five Million Dollars ($925,000,000). The consideration mix consists of approximately seventy-five percent (75%) cash, in the amount of Six Hundred Ninety-Three Million Seven Hundred Fifty Thousand Dollars ($693,750,000), and approximately twenty-five percent (25%) newly issued Penterra common stock, valued at Two Hundred Thirty-One Million Two Hundred Fifty Thousand Dollars ($231,250,000), based on a thirty-day volume-weighted average price ("VWAP") of $39.17 per share as of June 1, 2023, implying the issuance of approximately 5,903,497 shares of Penterra common stock (NYSE ticker: PPHR).

In addition to the upfront merger consideration, the transaction provides for contingent value rights ("CVRs") payable to former Caliston stockholders in an aggregate amount of up to One Hundred Twenty-Five Million Dollars ($125,000,000) upon the achievement of a specified regulatory milestone — namely, receipt of approval from the United States Food and Drug Administration ("FDA") for CLT-4019 on or before December 31, 2026. If both the upfront equity consideration and the maximum CVR payment are taken into account, the maximum aggregate transaction value is One Billion Fifty Million Dollars ($1,050,000,000).

Key Conclusion. The seventy-five percent (75%) cash / twenty-five percent (25%) stock consideration mix fails the continuity of interest ("COI") requirement necessary for tax-free reorganization treatment under Section 368 of the Internal Revenue Code of 1986, as amended (the "Code" or "IRC"). Under established administrative guidance and judicial precedent, the COI safe harbor requires that at least approximately forty percent (40%) of the total merger consideration consist of acquiror stock. Because the stock component of the proposed transaction represents only twenty-five percent (25%) of the aggregate equity consideration (and approximately twenty-two percent (22%) if the CVR maximum is included in the denominator), the transaction falls well short of the COI threshold. Accordingly, the merger will be treated as a fully taxable acquisition for Caliston stockholders, and each such stockholder will recognize gain or loss upon the exchange of Caliston shares for the merger consideration.

This memorandum additionally addresses the following topics of significance to the Special Committee:

• The treatment of the CVRs under the open transaction and closed transaction doctrines, including installment sale considerations and original issue discount ("OID") implications;

• The application of Section 280G of the Code to payments made to Caliston employees and equity holders in connection with the change of control, including the availability of the private company stockholder vote exception;

• State income tax consequences for material Caliston stockholders and post-closing state tax nexus implications for Penterra; and

• Structuring observations and recommendations for the definitive merger agreement and the proxy statement.

Our analysis and recommendations are set forth in detail below.

II. Proposed Transaction Structure — Summary

The proposed acquisition of Caliston by Penterra is structured as a one-step merger of Caliston with and into Penterra, pursuant to which Caliston will cease to exist as a separate legal entity and Penterra will be the surviving corporation. The merger will be effected under Section 251 of the Delaware General Corporation Law ("DGCL"), which governs the statutory merger of two Delaware corporations.

A. The Parties

Caliston BioSciences, Inc. Caliston is a corporation organized under the laws of the State of Delaware, with its principal office located at 88 Harbor Point Road, Cambridge, Massachusetts 02142. Caliston's Employer Identification Number is 84-4219063. Caliston is a privately held clinical-stage biopharmaceutical company focused on the development of novel therapeutics targeting autoimmune and inflammatory diseases. Caliston's lead product candidate, CLT-4019, is currently in Phase 2 clinical trials, and its pipeline additionally includes CLT-5227 and CLT-6034, both in earlier stages of development. Caliston currently employs ninety-four (94) individuals, substantially all of whom are based at its Cambridge, Massachusetts facility.

Penterra Pharmaceuticals Corp. Penterra is a corporation organized under the laws of the State of Delaware, with its headquarters located at 400 Innovation Drive, Suite 1200, Princeton, New Jersey 08540. Penterra's Employer Identification Number is 22-3847195. Penterra is a publicly traded specialty pharmaceutical company, with its common stock listed on the New York Stock Exchange under the ticker symbol "PPHR." Penterra's current market capitalization, as of the reference date used for the transaction, supports the issuance of the stock component of the merger consideration without requiring stockholder approval under NYSE listing rules, subject to final confirmation.

B. Consideration. The merger consideration to be paid to Caliston stockholders consists of the following components:

1. Cash Consideration: Six Hundred Ninety-Three Million Seven Hundred Fifty Thousand Dollars ($693,750,000), representing approximately seventy-five percent (75%) of the aggregate equity value. The cash component is expected to be funded from (a) approximately Four Hundred Million Dollars ($400,000,000) of cash on hand on Penterra's balance sheet, and (b) a draw of approximately Two Hundred Ninety-Three Million Seven Hundred Fifty Thousand Dollars ($293,750,000) on Penterra's existing $1.5 billion revolving credit facility maintained with Greystone National Bank, N.A. (priced at SOFR plus 150 basis points).

2. Stock Consideration: Two Hundred Thirty-One Million Two Hundred Fifty Thousand Dollars ($231,250,000) in newly issued shares of Penterra common stock, representing approximately twenty-five percent (25%) of the aggregate equity value. The per-share value of Penterra stock is based on the thirty-day VWAP of $39.17 per share as of June 1, 2023, implying the issuance of approximately 5,903,497 shares.

3. Contingent Value Rights (CVRs): Up to One Hundred Twenty-Five Million Dollars ($125,000,000) in aggregate milestone payments payable to former Caliston stockholders upon FDA approval of CLT-4019 on or before December 31, 2026. The CVRs will be administered by Columnar Trust Services, Inc., as trustee, pursuant to a Contingent Value Rights Agreement to be executed at closing. As currently contemplated, the CVRs will be non-transferable and will not be listed on any securities exchange.

The aggregate equity value of the transaction, excluding the CVRs, is $925,000,000. The maximum aggregate transaction value, including the CVRs, is $1,050,000,000.

C. Caliston Capitalization

Based on information provided by Caliston and its counsel, the capitalization of Caliston and the implied economics to its stockholders are summarized as follows:

The founders and management pool includes Dr. Nadia Sorensen (CEO), holding 14.2% ($131,350,000 implied proceeds), Dr. Raj Malhotra (CSO), holding 9.8% ($90,650,000 implied proceeds), and other management and employees, collectively holding 6.5% ($60,125,000 implied proceeds). These figures are on a fully diluted basis and are subject to adjustment based on the final capitalization table delivered at closing.

Caliston completed its most recent financing round, a Series C preferred stock offering, in October 2021 at a post-money valuation of $680,000,000. The proposed merger consideration of $925,000,000 represents a premium of approximately 36.03% over the Series C post-money valuation. Total equity capital raised by Caliston to date across all financing rounds is approximately $347,000,000.

D. Governing Law

The merger will be governed by the DGCL, and specifically Section 251 thereof, which provides the statutory framework for the merger of two or more domestic corporations. Both Penterra and Caliston are incorporated in Delaware, and accordingly the merger does not implicate the provisions of DGCL Section 252 (merger of domestic and foreign corporations). The definitive merger agreement and all ancillary transaction documents will be governed by Delaware law.

III. Federal Income Tax Analysis — Taxable vs. Tax-Free Reorganization

The central tax question presented by the proposed transaction is whether the merger can qualify as a tax-free reorganization under Section 368 of the Code, such that Caliston stockholders would be entitled to defer recognition of gain on the portion of their Caliston shares exchanged for Penterra stock. As detailed below, the proposed consideration mix does not satisfy the applicable requirements, and the transaction will be treated as fully taxable.

A. Tax-Free Reorganization Framework

Under Section 368(a)(1)(A) of the Code, a statutory merger or consolidation may qualify as a tax-free "Type A" reorganization. A Type A reorganization is the most flexible of the reorganization forms, as it permits the use of a mix of consideration, including cash, stock, and other property, subject to certain judicially and administratively developed requirements. The merger of Caliston with and into Penterra, as a statutory merger under DGCL Section 251, would satisfy the statutory form requirement for a Type A reorganization.

We note that Section 368(a)(2)(E) of the Code provides for forward subsidiary mergers, in which a target merges into a subsidiary of the acquiring corporation. That provision is not applicable here, as no merger subsidiary is being used; the transaction is structured as a direct merger of Caliston into Penterra itself. Accordingly, the analysis proceeds solely under Section 368(a)(1)(A).

Even where the statutory form requirement is met, a transaction must additionally satisfy certain judicial and administrative requirements to qualify as a tax-free reorganization. The two most significant of these requirements are:

Continuity of Interest ("COI"). The COI doctrine, codified in Treasury Regulation Section 1.368-1(e), requires that a substantial part of the value of the proprietary interests in the target be preserved through an equity interest in the acquiring corporation. In practical terms, a sufficient proportion of the merger consideration must consist of stock of the acquiring corporation to ensure that the former target stockholders maintain a meaningful continuing equity stake in the combined enterprise. IRS Revenue Procedure 77-37 historically established that the IRS would issue a favorable advance ruling on COI where at least fifty percent (50%) of the total consideration consisted of acquiror stock, though the IRS subsequently indicated in practice that it would not rule adversely where the stock component was at least forty percent (40%). Although Revenue Procedure 77-37 was superseded for purposes of advance rulings, the forty percent (40%) threshold has been widely adopted by practitioners and courts as a general safe harbor for COI purposes. Case law and Treasury Regulation Section 1.368-1(e)(2)(v), Example 1 confirm that the proprietary interest requirement is satisfied where the target stockholders receive stock of the issuing corporation equal to at least forty percent (40%) of the total consideration.

Continuity of Business Enterprise ("COBE"). Treasury Regulation Section 1.368-1(d) requires that the acquiring corporation either (a) continue the target's historic business, or (b) use a significant portion of the target's historic business assets in a business. In the present transaction, Penterra has indicated that it intends to continue the development of CLT-4019 and the Caliston pipeline following the closing, which would satisfy the COBE requirement. Accordingly, COBE is not a concern with respect to the proposed transaction, and the analysis below focuses on the COI requirement.

B. Application to Proposed Transaction

Applying the COI framework to the proposed merger, the stock component of the merger consideration constitutes only twenty-five percent (25%) of the aggregate equity value:

Stock Consideration / Aggregate Equity Value = $231,250,000 / $925,000,000 = 25.0%

This ratio falls substantially below the forty percent (40%) safe harbor threshold. The shortfall is significant — the stock component would need to increase to at least $370,000,000 (40% of $925,000,000) to meet the safe harbor, representing an increase of approximately $138,750,000 in acquiror stock issuance and a corresponding reduction in the cash component.

Moreover, if the CVR payments are included in the denominator of the COI calculation — as they should be to the extent they are treated as additional merger consideration — the stock ratio drops even further:

Stock Consideration / Maximum Total Consideration = $231,250,000 / $1,050,000,000 ≈ 22.0%

Under this calculation, the stock component would need to increase to approximately $420,000,000 (40% of $1,050,000,000) to satisfy COI, representing an increase of approximately $188,750,000 in stock issuance.

Even if the COI analysis were conducted excluding the CVRs from the denominator entirely (on the theory that the CVRs are sufficiently contingent to be disregarded for COI purposes), the 25% stock ratio remains well below the 40% threshold.

Conclusion. The merger, as currently structured, does not qualify as a tax-free reorganization under Section 368(a)(1)(A) of the Code. It will be treated as a fully taxable acquisition for all Caliston stockholders. Each Caliston stockholder will recognize gain or loss upon the exchange of Caliston shares for the merger consideration, as discussed in Section III.C below.

Note on Restructuring. Restructuring the transaction to achieve tax-free reorganization treatment would require increasing the stock component of the consideration to approximately $370,000,000 to $420,000,000, depending on the treatment of the CVRs. Such a restructuring would increase the number of newly issued Penterra shares from approximately 5.9 million to approximately 9.4 to 10.7 million shares, significantly increasing dilution to existing Penterra shareholders and fundamentally altering the negotiated economic terms of the transaction. Based on our discussions with the deal team, such a restructuring is not contemplated and would likely be unacceptable to Penterra's Board of Directors and stockholders. Accordingly, this memorandum proceeds on the assumption that the transaction will be treated as taxable.

C. Tax Consequences to Caliston Stockholders

Because the merger will be treated as a fully taxable acquisition, each Caliston stockholder will recognize gain or loss upon the exchange of its Caliston shares for the merger consideration. The amount of gain or loss recognized by each stockholder will equal the difference between:

(a) the "amount realized" by such stockholder, which consists of the sum of (i) the cash received, (ii) the fair market value of the Penterra common stock received, and (iii) the fair market value of the CVRs received (if any, as discussed in Section IV below); and

(b) the stockholder's adjusted tax basis in the Caliston shares surrendered in the merger.

For the vast majority of Caliston stockholders, the amount realized will substantially exceed the stockholder's adjusted tax basis, resulting in recognition of gain. The character of such gain will generally be capital gain, and will be long-term capital gain for any stockholder who has held its Caliston shares for more than one year at the time of the merger closing. The applicable federal tax rates are as follows:

• Individual stockholders: Long-term capital gains are currently subject to a maximum federal tax rate of twenty percent (20%), plus the 3.8% net investment income tax ("NIIT") imposed under Section 1411 of the Code, for a combined maximum federal rate of 23.8%.

• Corporate stockholders: Capital gains recognized by corporations are subject to tax at the regular corporate income tax rate, currently twenty-one percent (21%) under Section 11 of the Code.

• Pass-through entities: Gain recognized by pass-through entities (such as partnerships, limited partnerships, and limited liability companies taxed as partnerships) is not subject to entity-level federal income tax. Instead, the gain flows through to the individual partners or members of the entity, who report and pay tax on their respective allocable shares of the gain at the applicable individual rates.

To illustrate the magnitude of the tax exposure for the principal Caliston stockholders:

Dr. Marcus Hale. Dr. Hale holds a 28.5% equity interest in Caliston, which he acquired through a personal investment of approximately $42,000,000. At the proposed merger consideration of $925,000,000, Dr. Hale's implied proceeds are approximately $263,625,000 (28.5% × $925,000,000), resulting in an implied gain of approximately $221,625,000 ($263,625,000 minus $42,000,000 adjusted basis). Assuming long-term capital gain treatment and a combined federal rate of 23.8%, Dr. Hale's federal income tax liability on the merger would be approximately $52,746,750. State income tax consequences for Dr. Hale are discussed in Section VI.A below.

Ridgeline Ventures, LP and Meridian Life Sciences Fund III, LP. These institutional investors are organized as limited partnerships and are treated as pass-through entities for federal income tax purposes. Their respective shares of the merger consideration — approximately $206,375,000 (22.3%) for Ridgeline Ventures and approximately $172,975,000 (18.7%) for Meridian Life Sciences Fund III — will flow through to their individual partners and members. The tax consequences to each partner will depend on the partner's allocable share of gain, adjusted tax basis in the partnership interest, and individual tax circumstances (including residency and applicable state tax rates).

Dr. Nadia Sorensen and Dr. Raj Malhotra. These founders hold equity interests of 14.2% and 9.8%, respectively, with implied proceeds of approximately $131,350,000 and $90,650,000. Their tax consequences will depend on their individual adjusted tax bases in their Caliston shares (which may be nominal if shares were acquired upon founding or through the exercise of stock options at low exercise prices). Additionally, a portion of their proceeds may be attributable to the accelerated vesting of unvested equity awards, which may be characterized as ordinary income rather than capital gain and may implicate Section 280G, as discussed in Section V below.

Penterra Stock Received. Each Caliston stockholder who receives shares of Penterra common stock as part of the merger consideration will take a fair market value basis in such Penterra shares, equal to the fair market value of the Penterra shares on the date of the merger closing. Because the transaction is taxable, there is no carryover or substituted basis. The holding period for the Penterra shares received will begin on the date of the merger closing; Caliston stockholders will not be permitted to tack their holding period in Caliston shares to the Penterra shares received.

D. Tax Consequences to Penterra

Because the merger is treated as a taxable acquisition, Penterra will acquire Caliston's assets with a "stepped-up" cost basis equal to the purchase price paid for the Caliston equity, adjusted for Caliston's liabilities assumed in the merger. The purchase price will be allocated among Caliston's assets in accordance with the residual method prescribed by Section 1060 of the Code and the asset class allocation methodology set forth in Treasury Regulation Section 1.338-6.

Under this methodology, the purchase price is allocated first to Class I assets (cash and cash equivalents), then to Class II assets (actively traded personal property, certificates of deposit, and foreign currency), then to Class III assets (accounts receivable, mortgages, and credit card receivables), then to Class IV assets (inventory), then to Class V assets (all other assets not in Class I through IV or Classes VI and VII), then to Class VI assets (Section 197 intangibles other than goodwill and going concern value), and finally to Class VII assets (goodwill and going concern value).

Given that Caliston is a clinical-stage biopharmaceutical company, a significant portion of the $925,000,000 purchase price (plus assumed liabilities, if any) is expected to be allocable to Class VI intangible assets — specifically, in-process research and development ("IPR&D") associated with CLT-4019, CLT-5227, and CLT-6034 — and to Class VII goodwill. Under Section 197 of the Code, amortizable Section 197 intangibles (including goodwill, going concern value, and certain other intangible assets acquired in connection with the acquisition of a trade or business) are amortized on a straight-line basis over a fifteen (15)-year period. The amortization deductions arising from the stepped-up basis in these intangible assets will provide a meaningful tax benefit to Penterra over the amortization period, partially offsetting the premium paid in the transaction.

It is important to note that in a tax-free reorganization under Section 368, the acquiring corporation would take a carryover basis in the target's assets, equal to the target's historic tax basis. Because the transaction is taxable, Penterra benefits from the step-up in basis but forgoes the potential benefit of any net operating losses ("NOLs") or other tax attributes of Caliston that might have been preserved in a tax-free reorganization (subject to the limitations of Section 382 of the Code). However, as a clinical-stage company with limited or no taxable income, Caliston's NOLs and other tax attributes may have had limited value in any event.

IV. Contingent Value Rights — Tax Treatment

A. Overview of CVR Structure

As described in Section II.B above, the merger consideration includes CVRs providing for an aggregate contingent payment of up to One Hundred Twenty-Five Million Dollars ($125,000,000) to former Caliston stockholders, payable upon FDA approval of CLT-4019 on or before December 31, 2026. The CVRs will be issued pursuant to a Contingent Value Rights Agreement (the "CVR Agreement") to be entered into at the closing of the merger among Penterra, Columnar Trust Services, Inc. (as trustee), and a representative of the former Caliston stockholders.

The CVRs are expected to be non-transferable — that is, they may not be sold, assigned, pledged, or otherwise transferred by the holders thereof, except by operation of law (e.g., upon the death of a holder or by a partnership or trust to its partners or beneficiaries). The CVRs will not be registered under the Securities Act of 1933, as amended, and will not be listed or traded on any securities exchange or over-the-counter market. The non-transferable nature of the CVRs is relevant to the tax analysis, as discussed below.

The CVR payment, if earned, would be distributed pro rata to former Caliston stockholders in proportion to their ownership of Caliston shares immediately prior to the closing. For example, Dr. Hale, as a 28.5% stockholder, would be entitled to receive 28.5% of the CVR payment, or approximately $35,625,000 (28.5% × $125,000,000) upon achievement of the milestone.

B. Open Transaction vs. Closed Transaction Reporting

The tax treatment of the CVRs raises the question of whether the transaction should be reported under the "open transaction" doctrine or the "closed transaction" doctrine. The distinction between these two approaches is significant:

Closed Transaction Method. Under the installment sale rules of Section 453 of the Code and the contingent payment sale regulations of Treasury Regulation Section 15a-453-1, a transaction is generally treated as "closed" if the maximum amount of consideration is determinable at the time of the sale. Here, the maximum CVR payment is fixed at $125,000,000 — only the occurrence of the contingency (FDA approval of CLT-4019 by December 31, 2026) is uncertain, not the amount payable if the contingency occurs. Because the maximum consideration is determinable, the transaction is generally treated as a closed transaction under the regulatory framework.

Under closed transaction treatment, the CVRs are valued at their fair market value as of the closing date, and that fair market value is included in the "amount realized" by each Caliston stockholder at the time of the merger closing. This means that a portion of the Caliston stockholder's gain is recognized at closing based on the imputed fair market value of the CVR, even though the CVR payment has not yet been received and may never be received.

The fair market value of the CVRs at closing will depend on a probability-weighted assessment of the likelihood that CLT-4019 will receive FDA approval on or before December 31, 2026. This assessment should take into account, among other factors, the current stage of clinical development of CLT-4019, the historical probability of success for drug candidates in the relevant therapeutic area and development stage, the remaining development timeline, and regulatory risk factors. We understand that Thorngate Partners, Penterra's financial advisor on this transaction, has conducted a risk-adjusted analysis of the CLT-4019 program, and Caliston's auditor, Brentmoor Advisors LLP, may have relevant valuation data. These analyses will be critical inputs into the determination of fair market value of the CVRs for tax reporting purposes.

Consequences of Closed Transaction Treatment. If the CVRs are valued at an amount less than the $125,000,000 maximum at closing (reflecting the uncertainty of the contingency), and the full $125,000,000 is subsequently paid upon FDA approval of CLT-4019, the excess of the actual payment over the fair market value initially included in the amount realized will constitute additional capital gain recognized by the Caliston stockholders in the taxable year in which the CVR payment is received. Conversely, if the CVR lapses worthless (i.e., FDA approval is not obtained by December 31, 2026, and no payment is made), each Caliston stockholder may be entitled to recognize a capital loss equal to the fair market value of the CVR that was included in the amount realized at closing. The character of any such loss (long-term versus short-term) will depend on the stockholder's holding period for the CVR, measured from the closing date.

Open Transaction Method. Under the open transaction doctrine, the CVRs would not be valued at closing, and the Caliston stockholder would recover its adjusted basis first and recognize gain only when and to the extent the aggregate consideration received (including any CVR payment) exceeds the stockholder's basis. However, the open transaction doctrine is disfavored by the IRS and is available only in "rare and extraordinary" circumstances where the fair market value of the contingent right is not reasonably ascertainable. See Burnet v. Logan, 283 U.S. 404 (1931); Treas. Reg. §15a-453-1(d)(2)(iii). Given that the maximum CVR amount is fixed at $125,000,000 and the probability of the milestone can be estimated with reasonable accuracy based on available clinical data, we do not believe the open transaction doctrine would be sustained for the CVRs in this transaction. Accordingly, closed transaction treatment is the appropriate reporting method.

C. Installment Sale Considerations

Section 453 of the Code generally provides for installment sale treatment of gains from the sale of property where at least one payment is received after the close of the taxable year in which the sale occurs. However, several considerations are relevant here:

Exclusion for Publicly Traded Stock. Section 453(f)(3) provides that installment sale treatment is not available for sales of stock traded on an established securities market. This exclusion does not apply to the sale of Caliston stock, as Caliston is privately held and its shares are not traded on any exchange or market. Accordingly, this exclusion does not preclude installment sale reporting for the CVR component of the transaction.

Fixed Maximum Amount. Because the maximum CVR payment is fixed at $125,000,000, Treasury Regulation Section 15a-453-1(c) governs the installment reporting methodology. Under this regulation, the taxpayer's basis is recovered ratably over the maximum period during which payments may be received, using a fraction in which the numerator is the taxpayer's basis and the denominator is the maximum aggregate consideration (including the CVR maximum). This ensures that basis is allocated across the upfront consideration and the potential CVR payment proportionally.

Practical Application. In practice, each Caliston stockholder would allocate its adjusted tax basis in its Caliston shares across the total potential consideration (upfront cash + fair market value of Penterra stock + $125,000,000 maximum CVR), and would recognize gain at closing to the extent the amount realized (including the fair market value of the CVR) exceeds the allocated basis. If the CVR is later paid, additional gain would be recognized to the extent the actual payment exceeds the fair market value attributed to the CVR at closing.

Recommendation. We recommend that C&H and the Company engage experienced tax advisors to determine the appropriate fair market value of the CVRs at closing and to advise on the specific reporting method to be adopted. The selected reporting method and the tax treatment of the CVRs should be disclosed in the proxy statement to be furnished to Caliston stockholders in connection with the merger, along with a recommendation that each stockholder consult its own tax advisor with respect to its individual circumstances.

D. Imputed Interest / OID Considerations

If the CVR payment is characterized as a deferred payment of purchase price, the original issue discount ("OID") rules of Sections 1272 through 1275 of the Code and the imputed interest rules of Sections 483 and 1274 of the Code could potentially apply to treat a portion of the deferred payment as imputed interest income rather than additional purchase price.

Under Section 483, if a deferred payment exceeds the present value of such payment (Discounted at the applicable federal rate), the excess is recharacterized as imputed interest, which is ordinary income to the recipient and deductible by the payor. Similarly, under Section 1274, deferred payment obligations that do not provide for adequate stated interest may give rise to OID.

However, in the context of the proposed CVRs, the practical impact of these provisions is likely minimal for the following reasons:

(i) The CVR payment is contingent upon an uncertain regulatory milestone (FDA approval of CLT-4019 by December 31, 2026). Because the payment is not a fixed obligation — and may never be made at all — the imputed interest and OID rules are generally inapplicable to contingent payments that are truly uncertain in both amount and timing.

(ii) The CVR Agreement should be structured so that the CVR payment, if earned, is payable within thirty (30) days of achievement of the FDA approval milestone, rather than on a fixed future date. This structure emphasizes the contingent nature of the obligation and further supports the position that the payment is additional purchase price, not deferred consideration subject to imputed interest.

We recommend that the CVR Agreement be drafted to include provisions that minimize the risk of OID characterization, including specifying prompt payment following milestone achievement and avoiding language that could be construed as creating a fixed obligation to pay on a date certain.

V. Section 280G — Parachute Payment Analysis for Caliston Employees

A. Overview of Section 280G

Sections 280G and 4999 of the Code impose significant tax penalties on certain compensation payments that are contingent on a change in ownership or control of a corporation. Specifically:

• Section 280G disallows the corporate income tax deduction for "excess parachute payments." An "excess parachute payment" is the portion of any "parachute payment" that exceeds the recipient's "base amount." A "parachute payment" is any payment in the nature of compensation to (or for the benefit of) a "disqualified individual" that is contingent on a change in the ownership or effective control of the corporation (or in the ownership of a substantial portion of the assets of the corporation), where the aggregate present value of all such payments equals or exceeds three times the recipient's base amount. The "base amount" is the individual's average annualized compensation includible in gross income for the five most recent taxable years ending before the date of the change of control (generally, the five-year average of W-2 compensation).

• Section 4999 imposes a nondeductible twenty percent (20%) excise tax on the recipient of any excess parachute payment. This excise tax is in addition to regular federal income tax and is not creditable against the recipient's regular tax liability.

The term "disqualified individual" includes any individual who, with respect to the corporation undergoing the change of control, is (a) an officer, (b) a shareholder holding more than one percent (1%) of the outstanding stock of the corporation (by fair market value), or (c) a "highly compensated individual" (defined as an individual who is, or would be, among the highest-paid one percent (1%) of the employees of the corporation, or, if less, the highest-paid 250 employees).

B. Application to Caliston Employees

Caliston currently has ninety-four (94) employees. Based on information available to C&H, the following individuals are likely to be classified as "disqualified individuals" for purposes of Section 280G:

(i) Dr. Nadia Sorensen, Chief Executive Officer and holder of a 14.2% equity stake in Caliston. As an officer and a greater-than-1% stockholder, Dr. Sorensen is a disqualified individual.

(ii) Dr. Raj Malhotra, Chief Scientific Officer and holder of a 9.8% equity stake in Caliston. As an officer and a greater-than-1% stockholder, Dr. Malhotra is a disqualified individual.

(iii) Dr. Evan Whitmore, Head of Clinical Development and a member of the Caliston board of directors. As an officer and director, Dr. Whitmore is a disqualified individual.

(iv) Other officers and highly compensated employees of Caliston who may be classified as disqualified individuals based on their compensation levels and/or equity holdings.

The types of payments that are contingent on, or proximate to, the change of control and must be included in the parachute payment calculation include:

• Accelerated vesting of unvested equity awards (stock options, restricted stock, restricted stock units) triggered by the merger closing;

• Transaction bonuses payable upon or in connection with the closing of the merger;

• Severance benefits payable upon termination of employment following the change of control;

• The value of any non-competition consideration (for example, the non-competition agreement to be entered into by Dr. Sorensen in connection with the merger); and

• Any other payments in the nature of compensation that are contingent on the change of control.

All such payments must be aggregated for each disqualified individual and compared to the three-times-base-amount threshold. If the aggregate present value of a disqualified individual's parachute payments equals or exceeds three times the individual's base amount, the entire amount in excess of the base amount (not merely the excess over three times the base amount) is treated as an excess parachute payment, subject to the Section 4999 excise tax and the Section 280G deduction disallowance.

With respect to Dr. Sorensen, it is important to distinguish between payments that constitute merger consideration for her vested Caliston equity interest and payments that constitute compensation in the nature of parachute payments. Dr. Sorensen's 14.2% equity stake in Caliston implies merger proceeds of approximately $131,350,000 (14.2% × $925,000,000). To the extent these proceeds represent the fair market value of Dr. Sorensen's vested equity, they should not be treated as parachute payments, because they are consideration for the sale of a capital asset rather than compensation contingent on the change of control. However, any proceeds attributable to the accelerated vesting of unvested equity awards (which acceleration is triggered by the merger closing) would be treated as compensation and included in the parachute payment calculation.

A detailed analysis of each disqualified individual's base amount, parachute payments, and potential excise tax exposure should be conducted as promptly as practicable. This analysis will require access to the employment agreements, offer letters, equity award agreements, change-of-control severance plans, and historical W-2 compensation data for each affected individual.

C. Caliston as a Private Company — Stockholder Vote Exception

Section 280G(b)(5)(B) of the Code provides an important exception for privately held corporations. Under this provision, the parachute payment rules of Section 280G do not apply if both of the following conditions are met:

(i) The payment is approved by a vote of the persons who owned, immediately before the change of control, more than seventy-five percent (75%) of the outstanding stock of the corporation entitled to vote (determined by value), after adequate disclosure to all such stockholders of all material facts concerning the payments; and

(ii) The disqualified individual whose payments are being voted upon does not participate in the vote with respect to his or her own payments (i.e., the individual's shares are excluded from both the numerator and denominator of the vote calculation).

Because Caliston is a privately held corporation, this exception is potentially available to eliminate Section 280G exposure for the transaction. However, the practical feasibility of obtaining the required stockholder approval must be carefully evaluated.

Practical Analysis. Based on the Caliston capitalization table, the stockholders who are not disqualified individuals (or whose shares are not required to be excluded from a particular vote) include Dr. Marcus Hale (28.5%), Ridgeline Ventures, LP (22.3%), Meridian Life Sciences Fund III, LP (18.7%), and potentially other stockholders in the founders/management pool who are not themselves disqualified individuals. Caliston stockholders holding approximately 69.5% of the outstanding equity are expected to execute the written consent to approve the merger itself. However, the Section 280G stockholder vote requires approval by holders of more than 75% of the outstanding shares entitled to vote (by value), with the disqualified individual's own shares excluded from the vote.

For example, in a vote on Dr. Sorensen's parachute payments, her 14.2% stake would be excluded, and the vote would be conducted among holders of the remaining 85.8% of the outstanding equity. To satisfy the 75% threshold within this adjusted pool, affirmative votes representing more than approximately 64.35% of total outstanding equity (75% × 85.8%) would be required. This threshold is potentially achievable if the institutional investors (Ridgeline Ventures and Meridian III, together holding 41.0%) and Dr. Hale (28.5%) support the vote, as their combined holdings (69.5%) would exceed the required threshold.

Similar calculations would need to be performed for each disqualified individual whose payments are subject to the vote, excluding that individual's shares from the denominator in each case.

Recommendation. We recommend that the Section 280G stockholder vote be pursued for each disqualified individual whose parachute payment exposure is material. If the vote fails with respect to any disqualified individual, that individual would bear the 20% excise tax under Section 4999, and Penterra would lose the deduction under Section 280G for the excess parachute payment. Accordingly, the consequences of a failed vote should be considered in negotiating the treatment of parachute payments in the merger agreement.

We further recommend that the merger agreement include a covenant requiring Caliston to use commercially reasonable efforts to obtain a Section 280G stockholder vote prior to closing. The vote should be structured in accordance with the requirements of Section 280G(b)(5)(B) and the applicable Treasury Regulations, including full and adequate disclosure to all Caliston stockholders of all material facts concerning the parachute payments.

D. Deductibility Impact on Penterra

If excess parachute payments are made to Caliston disqualified individuals in connection with the merger and the Section 280G stockholder vote exception is not obtained, the tax consequences to Penterra are as follows:

• Penterra, as the surviving corporation, will be disallowed a deduction under Section 280G for the "excess parachute payment" portion of each such payment. The lost deduction, at Penterra's marginal federal corporate income tax rate of twenty-one percent (21%), could be material depending on the aggregate amount of excess parachute payments. For example, if the aggregate excess parachute payments across all disqualified individuals total $50,000,000, the lost deduction would result in an incremental federal tax cost to Penterra of approximately $10,500,000 (21% × $50,000,000).

• In addition, to the extent Caliston employment agreements or equity plans contain "gross-up" provisions — that is, provisions obligating the employer to reimburse the employee for the Section 4999 excise tax — the cost of the gross-up payments themselves would be subject to the same Section 280G deduction disallowance and would further increase the aggregate cost of the parachute payments to Penterra. Gross-up provisions effectively "cascade," as the gross-up payment is itself an excess parachute payment, requiring an additional gross-up, and so on. We recommend that all Caliston employment agreements, change-of-control provisions, and equity plans be reviewed for the existence of gross-up provisions, and that consideration be given to negotiating "best net" or "cutback" provisions as alternatives.

Under a "best net" or "cutback" approach, the disqualified individual's parachute payments would be reduced (if necessary) to the largest amount that would not trigger the Section 280G excise tax, but only if the after-tax benefit to the individual from the reduced payment exceeds the after-tax benefit from receiving the full payment and bearing the excise tax. This approach eliminates the gross-up exposure entirely and reduces the overall cost to Penterra.

VI. State Income Tax Considerations

A. Caliston Stockholder State Tax

In addition to federal income tax, Caliston stockholders will be subject to state income tax on the gain recognized in the merger, to the extent such gain is subject to tax in the stockholder's state of residence (for individuals) or the state or states in which the stockholder has nexus (for entities).

Massachusetts. Individual Caliston stockholders who are residents of Massachusetts will be subject to Massachusetts income tax on their capital gains from the merger. Massachusetts currently imposes a flat income tax rate of five percent (5%) on most categories of income, including capital gains. Effective January 1, 2023, the "Fair Share Amendment" (Article 44 of the Amendments to the Massachusetts Constitution) imposes an additional four percent (4%) surtax on taxable income in excess of One Million Dollars ($1,000,000), bringing the total Massachusetts income tax rate on gains above the threshold to nine percent (9%). Given the magnitude of the gains expected to be realized by the principal Caliston stockholders, substantially all of their merger gain would be subject to the 9% combined Massachusetts rate.

Dr. Marcus Hale — New Jersey. Dr. Hale is a resident of New Jersey. New Jersey does not provide preferential tax rates for capital gains; instead, capital gains are taxed as ordinary income under the New Jersey Gross Income Tax. The top marginal rate under the New Jersey Gross Income Tax is currently ten and three-quarters percent (10.75%) on income in excess of $1,000,000. Given Dr. Hale's implied gain of approximately $221,625,000, substantially all of his gain will be subject to the top New Jersey rate.

The combined federal and New Jersey tax burden on Dr. Hale's gain from the merger is estimated as follows:

This estimate is approximate and does not take into account potential credits for state taxes paid (the deduction for state and local taxes is limited to $10,000 per year for individual taxpayers under Section 164(b)(6) of the Code, as amended by the Tax Cuts and Jobs Act of 2017), the alternative minimum tax, or other individual-specific adjustments. Dr. Hale should be advised to consult with his personal tax advisors regarding his specific situation.

Partnership / LP Investors. The gain recognized by Ridgeline Ventures, LP and Meridian Life Sciences Fund III, LP will flow through to their respective partners and members. The state income tax consequences for each partner will depend on the partner's state of residency or domicile. To the extent the partnership has nexus in a state (for example, through the partnership's own activities or through the location of the assets giving rise to the gain), the state may impose a filing obligation on the partnership and/or its partners even if the partners are not residents of that state. Ridgeline Ventures and Meridian III should consult their own tax advisors regarding the state tax consequences to their partners.

B. Penterra State Tax and Nexus

Current Filing Profile. Penterra is headquartered in New Jersey and currently files state income tax returns in multiple states in which it has nexus through employees, offices, or business activities.

New Nexus in Massachusetts. The acquisition of Caliston will likely create new nexus for Penterra in the Commonwealth of Massachusetts, given Caliston's principal office and substantially all of its employees (94) are located in Cambridge, Massachusetts. Post-closing, Penterra will be required to assess whether it has a Massachusetts corporate excise tax filing obligation, taking into account the combined reporting rules applicable in Massachusetts. Massachusetts imposes a corporate excise tax on corporations with nexus in the state, consisting of an income component (currently 8% of net income apportioned to Massachusetts) and a non-income component (based on property or net worth).

Asset Step-Up Amortization Deductions. The availability of amortization deductions on the stepped-up basis in Caliston's intangible assets (discussed in Section III.D) will vary by state. Certain states decouple from the federal Section 197 amortization provisions or impose limitations on the recognition of amortization deductions arising from asset step-ups in acquisitions. For example, some states require the use of the target's historical tax basis for purposes of computing state taxable income, effectively denying the benefit of the step-up at the state level. Penterra's state tax advisors should conduct a state-by-state analysis of the availability of the amortization deductions.

Post-Closing Integration. We recommend that Penterra's tax department conduct a comprehensive state tax nexus analysis following the closing of the merger, taking into account the addition of Caliston's employees, facilities, and business activities to Penterra's operations. This analysis should address filing obligations, apportionment of income, and the potential availability or limitation of amortization deductions in each relevant state.

C. Delaware Considerations

Both Penterra and Caliston are incorporated in the State of Delaware. Delaware does not impose a corporate income tax on corporations that are merely incorporated in Delaware but do not conduct business within the state. To the extent Penterra and Caliston maintain their Delaware incorporation solely for legal and governance purposes and do not conduct business activities in Delaware (other than maintaining a registered agent), the Delaware holding company exemption should shield the entities from Delaware income tax.

However, Delaware does impose an annual franchise tax on domestic corporations incorporated in the state. The franchise tax is calculated based on either the authorized shares method or the assumed par value capital method, whichever results in a lower tax. Following the merger, the surviving entity (Penterra) will continue to be subject to Delaware franchise tax obligations, and the obligation should be reflected in post-closing budgeting and compliance planning.

VII. Structuring Observations and Recommendations

Based on the analysis set forth above, we offer the following observations and recommendations for the Special Committee's consideration:

A. Taxable Structure — Cost-Benefit Summary

The taxable treatment of the proposed merger has both advantages and disadvantages relative to a potential tax-free reorganization structure:

Advantages of Taxable Treatment:

• Purchase price step-up and amortization. Penterra will acquire Caliston's assets with a stepped-up cost basis equal to the purchase price, generating significant Section 197 amortization deductions over fifteen (15) years. This benefit is not available in a tax-free reorganization, where the acquiror takes a carryover basis in the target's assets.

• Structural simplicity. A taxable acquisition does not require satisfaction of the COI or COBE requirements, eliminating the risk that the IRS could challenge the tax-free treatment of the transaction and impose tax retroactively on Caliston stockholders.

• Flexibility in consideration mix. Penterra retains full flexibility to determine the cash/stock ratio without regard to the 40% stock threshold required for COI. This permits Penterra to minimize dilution to its existing stockholders.

Disadvantages of Taxable Treatment:

• Immediate tax recognition for Caliston stockholders. Each Caliston stockholder will recognize gain on the merger at closing, rather than deferring gain on the stock component (as would be the case in a tax-free reorganization where stock received qualifies for nonrecognition under Section 354 of the Code).

• No deferral benefit for stock consideration. In a tax-free reorganization, the 25% stock component ($231,250,000) would have been received on a tax-deferred basis, with gain recognized only upon a subsequent disposition of the Penterra stock. In the proposed taxable structure, Caliston stockholders will pay tax on the full fair market value of the Penterra stock received at closing.

Conclusion on Structure. Given the negotiated 75% cash / 25% stock consideration mix, taxable treatment is effectively locked in. Restructuring the transaction to achieve tax-free treatment would require increasing the stock component to approximately $370,000,000 to $420,000,000 (depending on CVR treatment), which would significantly increase dilution to Penterra shareholders, alter the negotiated economic terms, and likely require renegotiation of the transaction. We do not recommend pursuing a restructuring for this purpose.

B. CVR Valuation

We recommend that Penterra engage a qualified independent valuation firm to establish the fair market value of the CVRs at closing for tax reporting purposes. Alternatively, Thorngate Partners (Penterra's financial advisor) or Brentmoor Advisors LLP (Caliston's auditor) may be in a position to provide a probability-weighted valuation of the CVRs based on their analysis of the CLT-4019 development program and the probability of FDA approval by December 31, 2026.

The valuation should be completed prior to or concurrent with the closing of the merger, as the fair market value of the CVRs will directly affect the amount realized by each Caliston stockholder and the gain or loss recognized at closing. The proxy statement to be furnished to Caliston stockholders should describe the tax treatment of the CVRs, including the closed transaction reporting methodology, and should advise each stockholder to consult its own tax advisor regarding the individual impact.

C. Section 280G Mitigation

We recommend the following steps to mitigate Section 280G exposure in connection with the transaction:

1. Merger Agreement Covenant. Include a covenant in the merger agreement requiring Caliston to use commercially reasonable efforts to obtain a stockholder vote satisfying Section 280G(b)(5)(B) of the Code prior to the closing of the merger. The covenant should specify that Caliston will prepare and distribute the required disclosure materials to its stockholders and solicit the required votes for each disqualified individual.

2. Quantification of Exposure. Promptly review all Caliston employment agreements, offer letters, change-of-control severance plans, equity award agreements (including stock option agreements and restricted stock unit agreements), and any other arrangements that could give rise to parachute payments. Quantify the potential parachute payment exposure for each disqualified individual, including Dr. Sorensen, Dr. Malhotra, Dr. Whitmore, and any other affected employees.

3. Gross-Up Provisions. Identify any gross-up provisions in existing Caliston employment agreements or plans that would obligate Caliston or Penterra to reimburse affected employees for the Section 4999 excise tax. Consider negotiating the elimination of gross-up provisions and replacing them with "best net" or "cutback" provisions, which would reduce the aggregate cost to Penterra while potentially leaving the affected employee in a comparable or better after-tax position.

D. Withholding and Reporting Obligations

Penterra (or the exchange agent appointed in connection with the merger) will have the following withholding and reporting obligations with respect to the merger consideration:

Form 1099-B Reporting. Cash consideration paid to Caliston stockholders in exchange for their Caliston shares is subject to information reporting on IRS Form 1099-B. Penterra or the exchange agent must furnish Form 1099-B to each Caliston stockholder (other than corporate or exempt recipients) and file copies with the IRS. Backup withholding at the rate of twenty-four percent (24%) may apply if a stockholder fails to provide a valid taxpayer identification number (TIN) or is subject to backup withholding for other reasons.

Penterra Stock. Shares of Penterra common stock issued as merger consideration are not subject to withholding, but the fair market value of the shares must be reported as part of the merger consideration on Form 1099-B.

FIRPTA Considerations. If any Caliston stockholders are non-U.S. persons (i.e., nonresident alien individuals, foreign corporations, foreign partnerships, or other foreign entities), withholding under Section 1445 of the Code (the Foreign Investment in Real Property Tax Act, or "FIRPTA") may apply. Under FIRPTA, a transferee of a "United States real property interest" ("USRPI") is generally required to withhold fifteen percent (15%) of the amount realized by the transferor. A USRPI includes stock in a "United States real property holding corporation" ("USRPHC"), which is any domestic corporation in which the fair market value of United States real property interests equals or exceeds fifty percent (50%) of the aggregate fair market value of the corporation's worldwide real property interests plus other assets used or held for use in a trade or business. Given that Caliston is a clinical-stage biopharmaceutical company whose assets consist primarily of intellectual property, clinical data, and cash, it is unlikely that Caliston would qualify as a USRPHC. Nevertheless, a FIRPTA analysis should be conducted as part of the pre-closing due diligence, and appropriate certifications should be obtained from Caliston or its stockholders.

VIII. Summary of Key Tax Conclusions

For the convenience of the Special Committee, the principal tax conclusions of this memorandum are summarized below:

1. Fully Taxable Transaction. The proposed merger is a fully taxable transaction for Caliston stockholders. The 75% cash / 25% stock consideration mix falls well below the 40% continuity of interest threshold required for tax-free reorganization treatment under Section 368 of the Code. Each Caliston stockholder will recognize gain or loss upon the exchange of Caliston shares for the merger consideration.

2. CVR Treatment. The CVRs should be treated under the closed transaction method, based on the fixed maximum of $125,000,000. The fair market value of the CVRs at closing should be formally determined by a qualified independent valuation firm and included in the amount realized by each Caliston stockholder.

3. Section 280G Exposure. Section 280G parachute payment exposure exists for Caliston disqualified individuals, including Dr. Sorensen, Dr. Malhotra, and Dr. Whitmore, among others. The private company stockholder vote exception under Section 280G(b)(5)(B) should be pursued as a mitigation strategy, and a covenant to that effect should be included in the merger agreement.

4. State Income Tax Implications. State income tax consequences are material for high-gain individual stockholders. Dr. Hale faces a combined federal and New Jersey effective tax rate of approximately 34.55% on his implied gain of $221,625,000. Massachusetts residents face a combined state rate of up to 9% on gains above $1,000,000 due to the recently enacted surtax. Partnership investors should consult their own advisors regarding flow-through state tax implications.

5. Penterra Benefits from Step-Up. Penterra will benefit from a stepped-up cost basis in Caliston's assets, including significant Section 197 intangible assets (IPR&D and goodwill), amortizable on a straight-line basis over fifteen (15) years. The amortization deductions will partially offset the premium paid in the transaction over the amortization period.

6. Proxy Statement Disclosure. These conclusions should be reflected in the tax disclosure section of the proxy statement to be prepared in connection with the merger. The proxy statement should advise Caliston stockholders that the transaction is taxable, describe the treatment of the CVRs, and recommend that each stockholde

PRIVILEGED & CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT
MEMORANDUM
TO: Special Committee of the Board of Directors of Penterra Pharmaceuticals Corp. Diane Prescott, Chair James Okafor Dr. Helen Ng
FROM: Sophie Tremblay, Calderwood & Harkness LLP
DATE: August 15, 2023
RE: Tax Structure and Considerations — Proposed Acquisition of Caliston BioSciences, Inc. by Penterra Pharmaceuticals Corp. (Project Coriander)
C&H Matter No.: 1025-00006
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I. Executive Summary
This memorandum has been prepared by Calderwood & Harkness LLP ("C&H") at the request of the Special Committee of the Board of Directors of Penterra Pharmaceuticals Corp. ("Penterra" or the "Company") in connection with Penterra's proposed acquisition of one hundred percent (100%) of the outstanding equity of Caliston BioSciences, Inc. ("Caliston"), referred to internally as "Project Coriander." The purpose of this memorandum is to analyze the material federal and state income tax consequences of the proposed transaction for both Penterra and the stockholders of Caliston, and to identify structuring considerations and potential areas of exposure that should inform the Special Committee's decision-making and the negotiation of the definitive merger agreement.
As currently structured, Penterra proposes to acquire Caliston through a one-step merger of Caliston with and into Penterra, with Penterra as the surviving corporation. The aggregate equity value of the transaction is Nine Hundred Twenty-Five Million Dollars ($925,000,000). The consideration mix consists of approximately seventy-five percent (75%) cash, in the amount of Six Hundred Ninety-Three Million Seven Hundred Fifty Thousand Dollars ($693,750,000), and approximately twenty-five percent (25%) newly issued Penterra common stock, valued at Two Hundred Thirty-One Million Two Hundred Fifty Thousand Dollars ($231,250,000), based on a thirty-day volume-weighted average price ("VWAP") of $39.17 per share as of June 1, 2023, implying the issuance of approximately 5,903,497 shares of Penterra common stock (NYSE ticker: PPHR).
In addition to the upfront merger consideration, the transaction provides for contingent value rights ("CVRs") payable to former Caliston stockholders in an aggregate amount of up to One Hundred Twenty-Five Million Dollars ($125,000,000) upon the achievement of a specified regulatory milestone — namely, receipt of approval from the United States Food and Drug Administration ("FDA") for CLT-4019 on or before December 31, 2026. If both the upfront equity consideration and the maximum CVR payment are taken into account, the maximum aggregate transaction value is One Billion Fifty Million Dollars ($1,050,000,000).
Key Conclusion. The seventy-five percent (75%) cash / twenty-five percent (25%) stock consideration mix fails the continuity of interest ("COI") requirement necessary for tax-free reorganization treatment under Section 368 of the Internal Revenue Code of 1986, as amended (the "Code" or "IRC"). Under established administrative guidance and judicial precedent, the COI safe harbor requires that at least approximately forty percent (40%) of the total merger consideration consist of acquiror stock. Because the stock component of the proposed transaction represents only twenty-five percent (25%) of the aggregate equity consideration (and approximately twenty-two percent (22%) if the CVR maximum is included in the denominator), the transaction falls well short of the COI threshold. Accordingly, the merger will be treated as a fully taxable acquisition for Caliston stockholders, and each such stockholder will recognize gain or loss upon the exchange of Caliston shares for the merger consideration.
This memorandum additionally addresses the following topics of significance to the Special Committee:
• The treatment of the CVRs under the open transaction and closed transaction doctrines, including installment sale considerations and original issue discount ("OID") implications;
• The application of Section 280G of the Code to payments made to Caliston employees and equity holders in connection with the change of control, including the availability of the private company stockholder vote exception;
• State income tax consequences for material Caliston stockholders and post-closing state tax nexus implications for Penterra; and
• Structuring observations and recommendations for the definitive merger agreement and the proxy statement.
Our analysis and recommendations are set forth in detail below.
II. Proposed Transaction Structure — Summary
The proposed acquisition of Caliston by Penterra is structured as a one-step merger of Caliston with and into Penterra, pursuant to which Caliston will cease to exist as a separate legal entity and Penterra will be the surviving corporation. The merger will be effected under Section 251 of the Delaware General Corporation Law ("DGCL"), which governs the statutory merger of two Delaware corporations.
A. The Parties
Caliston BioSciences, Inc. Caliston is a corporation organized under the laws of the State of Delaware, with its principal office located at 88 Harbor Point Road, Cambridge, Massachusetts 02142. Caliston's Employer Identification Number is 84-4219063. Caliston is a privately held clinical-stage biopharmaceutical company focused on the development of novel therapeutics targeting autoimmune and inflammatory diseases. Caliston's lead product candidate, CLT-4019, is currently in Phase 2 clinical trials, and its pipeline additionally includes CLT-5227 and CLT-6034, both in earlier stages of development. Caliston currently employs ninety-four (94) individuals, substantially all of whom are based at its Cambridge, Massachusetts facility.
Penterra Pharmaceuticals Corp. Penterra is a corporation organized under the laws of the State of Delaware, with its headquarters located at 400 Innovation Drive, Suite 1200, Princeton, New Jersey 08540. Penterra's Employer Identification Number is 22-3847195. Penterra is a publicly traded specialty pharmaceutical company, with its common stock listed on the New York Stock Exchange under the ticker symbol "PPHR." Penterra's current market capitalization, as of the reference date used for the transaction, supports the issuance of the stock component of the merger consideration without requiring stockholder approval under NYSE listing rules, subject to final confirmation.
B. Consideration. The merger consideration to be paid to Caliston stockholders consists of the following components:
1. Cash Consideration: Six Hundred Ninety-Three Million Seven Hundred Fifty Thousand Dollars ($693,750,000), representing approximately seventy-five percent (75%) of the aggregate equity value. The cash component is expected to be funded from (a) approximately Four Hundred Million Dollars ($400,000,000) of cash on hand on Penterra's balance sheet, and (b) a draw of approximately Two Hundred Ninety-Three Million Seven Hundred Fifty Thousand Dollars ($293,750,000) on Penterra's existing $1.5 billion revolving credit facility maintained with Greystone National Bank, N.A. (priced at SOFR plus 150 basis points).
2. Stock Consideration: Two Hundred Thirty-One Million Two Hundred Fifty Thousand Dollars ($231,250,000) in newly issued shares of Penterra common stock, representing approximately twenty-five percent (25%) of the aggregate equity value. The per-share value of Penterra stock is based on the thirty-day VWAP of $39.17 per share as of June 1, 2023, implying the issuance of approximately 5,903,497 shares.
3. Contingent Value Rights (CVRs): Up to One Hundred Twenty-Five Million Dollars ($125,000,000) in aggregate milestone payments payable to former Caliston stockholders upon FDA approval of CLT-4019 on or before December 31, 2026. The CVRs will be administered by Columnar Trust Services, Inc., as trustee, pursuant to a Contingent Value Rights Agreement to be executed at closing. As currently contemplated, the CVRs will be non-transferable and will not be listed on any securities exchange.
The aggregate equity value of the transaction, excluding the CVRs, is $925,000,000. The maximum aggregate transaction value, including the CVRs, is $1,050,000,000.
C. Caliston Capitalization
Based on information provided by Caliston and its counsel, the capitalization of Caliston and the implied economics to its stockholders are summarized as follows:
The founders and management pool includes Dr. Nadia Sorensen (CEO), holding 14.2% ($131,350,000 implied proceeds), Dr. Raj Malhotra (CSO), holding 9.8% ($90,650,000 implied proceeds), and other management and employees, collectively holding 6.5% ($60,125,000 implied proceeds). These figures are on a fully diluted basis and are subject to adjustment based on the final capitalization table delivered at closing.
Caliston completed its most recent financing round, a Series C preferred stock offering, in October 2021 at a post-money valuation of $680,000,000. The proposed merger consideration of $925,000,000 represents a premium of approximately 36.03% over the Series C post-money valuation. Total equity capital raised by Caliston to date across all financing rounds is approximately $347,000,000.
D. Governing Law
The merger will be governed by the DGCL, and specifically Section 251 thereof, which provides the statutory framework for the merger of two or more domestic corporations. Both Penterra and Caliston are incorporated in Delaware, and accordingly the merger does not implicate the provisions of DGCL Section 252 (merger of domestic and foreign corporations). The definitive merger agreement and all ancillary transaction documents will be governed by Delaware law.
III. Federal Income Tax Analysis — Taxable vs. Tax-Free Reorganization
The central tax question presented by the proposed transaction is whether the merger can qualify as a tax-free reorganization under Section 368 of the Code, such that Caliston stockholders would be entitled to defer recognition of gain on the portion of their Caliston shares exchanged for Penterra stock. As detailed below, the proposed consideration mix does not satisfy the applicable requirements, and the transaction will be treated as fully taxable.
A. Tax-Free Reorganization Framework
Under Section 368(a)(1)(A) of the Code, a statutory merger or consolidation may qualify as a tax-free "Type A" reorganization. A Type A reorganization is the most flexible of the reorganization forms, as it permits the use of a mix of consideration, including cash, stock, and other property, subject to certain judicially and administratively developed requirements. The merger of Caliston with and into Penterra, as a statutory merger under DGCL Section 251, would satisfy the statutory form requirement for a Type A reorganization.
We note that Section 368(a)(2)(E) of the Code provides for forward subsidiary mergers, in which a target merges into a subsidiary of the acquiring corporation. That provision is not applicable here, as no merger subsidiary is being used; the transaction is structured as a direct merger of Caliston into Penterra itself. Accordingly, the analysis proceeds solely under Section 368(a)(1)(A).
Even where the statutory form requirement is met, a transaction must additionally satisfy certain judicial and administrative requirements to qualify as a tax-free reorganization. The two most significant of these requirements are:
Continuity of Interest ("COI"). The COI doctrine, codified in Treasury Regulation Section 1.368-1(e), requires that a substantial part of the value of the proprietary interests in the target be preserved through an equity interest in the acquiring corporation. In practical terms, a sufficient proportion of the merger consideration must consist of stock of the acquiring corporation to ensure that the former target stockholders maintain a meaningful continuing equity stake in the combined enterprise. IRS Revenue Procedure 77-37 historically established that the IRS would issue a favorable advance ruling on COI where at least fifty percent (50%) of the total consideration consisted of acquiror stock, though the IRS subsequently indicated in practice that it would not rule adversely where the stock component was at least forty percent (40%). Although Revenue Procedure 77-37 was superseded for purposes of advance rulings, the forty percent (40%) threshold has been widely adopted by practitioners and courts as a general safe harbor for COI purposes. Case law and Treasury Regulation Section 1.368-1(e)(2)(v), Example 1 confirm that the proprietary interest requirement is satisfied where the target stockholders receive stock of the issuing corporation equal to at least forty percent (40%) of the total consideration.
Continuity of Business Enterprise ("COBE"). Treasury Regulation Section 1.368-1(d) requires that the acquiring corporation either (a) continue the target's historic business, or (b) use a significant portion of the target's historic business assets in a business. In the present transaction, Penterra has indicated that it intends to continue the development of CLT-4019 and the Caliston pipeline following the closing, which would satisfy the COBE requirement. Accordingly, COBE is not a concern with respect to the proposed transaction, and the analysis below focuses on the COI requirement.
B. Application to Proposed Transaction
Applying the COI framework to the proposed merger, the stock component of the merger consideration constitutes only twenty-five percent (25%) of the aggregate equity value:
Stock Consideration / Aggregate Equity Value = $231,250,000 / $925,000,000 = 25.0%
This ratio falls substantially below the forty percent (40%) safe harbor threshold. The shortfall is significant — the stock component would need to increase to at least $370,000,000 (40% of $925,000,000) to meet the safe harbor, representing an increase of approximately $138,750,000 in acquiror stock issuance and a corresponding reduction in the cash component.
Moreover, if the CVR payments are included in the denominator of the COI calculation — as they should be to the extent they are treated as additional merger consideration — the stock ratio drops even further:
Stock Consideration / Maximum Total Consideration = $231,250,000 / $1,050,000,000 ≈ 22.0%
Under this calculation, the stock component would need to increase to approximately $420,000,000 (40% of $1,050,000,000) to satisfy COI, representing an increase of approximately $188,750,000 in stock issuance.
Even if the COI analysis were conducted excluding the CVRs from the denominator entirely (on the theory that the CVRs are sufficiently contingent to be disregarded for COI purposes), the 25% stock ratio remains well below the 40% threshold.
Conclusion. The merger, as currently structured, does not qualify as a tax-free reorganization under Section 368(a)(1)(A) of the Code. It will be treated as a fully taxable acquisition for all Caliston stockholders. Each Caliston stockholder will recognize gain or loss upon the exchange of Caliston shares for the merger consideration, as discussed in Section III.C below.
Note on Restructuring. Restructuring the transaction to achieve tax-free reorganization treatment would require increasing the stock component of the consideration to approximately $370,000,000 to $420,000,000, depending on the treatment of the CVRs. Such a restructuring would increase the number of newly issued Penterra shares from approximately 5.9 million to approximately 9.4 to 10.7 million shares, significantly increasing dilution to existing Penterra shareholders and fundamentally altering the negotiated economic terms of the transaction. Based on our discussions with the deal team, such a restructuring is not contemplated and would likely be unacceptable to Penterra's Board of Directors and stockholders. Accordingly, this memorandum proceeds on the assumption that the transaction will be treated as taxable.
C. Tax Consequences to Caliston Stockholders
Because the merger will be treated as a fully taxable acquisition, each Caliston stockholder will recognize gain or loss upon the exchange of its Caliston shares for the merger consideration. The amount of gain or loss recognized by each stockholder will equal the difference between:
(a) the "amount realized" by such stockholder, which consists of the sum of (i) the cash received, (ii) the fair market value of the Penterra common stock received, and (iii) the fair market value of the CVRs received (if any, as discussed in Section IV below); and
(b) the stockholder's adjusted tax basis in the Caliston shares surrendered in the merger.
For the vast majority of Caliston stockholders, the amount realized will substantially exceed the stockholder's adjusted tax basis, resulting in recognition of gain. The character of such gain will generally be capital gain, and will be long-term capital gain for any stockholder who has held its Caliston shares for more than one year at the time of the merger closing. The applicable federal tax rates are as follows:
• Individual stockholders: Long-term capital gains are currently subject to a maximum federal tax rate of twenty percent (20%), plus the 3.8% net investment income tax ("NIIT") imposed under Section 1411 of the Code, for a combined maximum federal rate of 23.8%.
• Corporate stockholders: Capital gains recognized by corporations are subject to tax at the regular corporate income tax rate, currently twenty-one percent (21%) under Section 11 of the Code.
• Pass-through entities: Gain recognized by pass-through entities (such as partnerships, limited partnerships, and limited liability companies taxed as partnerships) is not subject to entity-level federal income tax. Instead, the gain flows through to the individual partners or members of the entity, who report and pay tax on their respective allocable shares of the gain at the applicable individual rates.
To illustrate the magnitude of the tax exposure for the principal Caliston stockholders:
Dr. Marcus Hale. Dr. Hale holds a 28.5% equity interest in Caliston, which he acquired through a personal investment of approximately $42,000,000. At the proposed merger consideration of $925,000,000, Dr. Hale's implied proceeds are approximately $263,625,000 (28.5% × $925,000,000), resulting in an implied gain of approximately $221,625,000 ($263,625,000 minus $42,000,000 adjusted basis). Assuming long-term capital gain treatment and a combined federal rate of 23.8%, Dr. Hale's federal income tax liability on the merger would be approximately $52,746,750. State income tax consequences for Dr. Hale are discussed in Section VI.A below.
Ridgeline Ventures, LP and Meridian Life Sciences Fund III, LP. These institutional investors are organized as limited partnerships and are treated as pass-through entities for federal income tax purposes. Their respective shares of the merger consideration — approximately $206,375,000 (22.3%) for Ridgeline Ventures and approximately $172,975,000 (18.7%) for Meridian Life Sciences Fund III — will flow through to their individual partners and members. The tax consequences to each partner will depend on the partner's allocable share of gain, adjusted tax basis in the partnership interest, and individual tax circumstances (including residency and applicable state tax rates).
Dr. Nadia Sorensen and Dr. Raj Malhotra. These founders hold equity interests of 14.2% and 9.8%, respectively, with implied proceeds of approximately $131,350,000 and $90,650,000. Their tax consequences will depend on their individual adjusted tax bases in their Caliston shares (which may be nominal if shares were acquired upon founding or through the exercise of stock options at low exercise prices). Additionally, a portion of their proceeds may be attributable to the accelerated vesting of unvested equity awards, which may be characterized as ordinary income rather than capital gain and may implicate Section 280G, as discussed in Section V below.
Penterra Stock Received. Each Caliston stockholder who receives shares of Penterra common stock as part of the merger consideration will take a fair market value basis in such Penterra shares, equal to the fair market value of the Penterra shares on the date of the merger closing. Because the transaction is taxable, there is no carryover or substituted basis. The holding period for the Penterra shares received will begin on the date of the merger closing; Caliston stockholders will not be permitted to tack their holding period in Caliston shares to the Penterra shares received.
D. Tax Consequences to Penterra
Because the merger is treated as a taxable acquisition, Penterra will acquire Caliston's assets with a "stepped-up" cost basis equal to the purchase price paid for the Caliston equity, adjusted for Caliston's liabilities assumed in the merger. The purchase price will be allocated among Caliston's assets in accordance with the residual method prescribed by Section 1060 of the Code and the asset class allocation methodology set forth in Treasury Regulation Section 1.338-6.
Under this methodology, the purchase price is allocated first to Class I assets (cash and cash equivalents), then to Class II assets (actively traded personal property, certificates of deposit, and foreign currency), then to Class III assets (accounts receivable, mortgages, and credit card receivables), then to Class IV assets (inventory), then to Class V assets (all other assets not in Class I through IV or Classes VI and VII), then to Class VI assets (Section 197 intangibles other than goodwill and going concern value), and finally to Class VII assets (goodwill and going concern value).
Given that Caliston is a clinical-stage biopharmaceutical company, a significant portion of the $925,000,000 purchase price (plus assumed liabilities, if any) is expected to be allocable to Class VI intangible assets — specifically, in-process research and development ("IPR&D") associated with CLT-4019, CLT-5227, and CLT-6034 — and to Class VII goodwill. Under Section 197 of the Code, amortizable Section 197 intangibles (including goodwill, going concern value, and certain other intangible assets acquired in connection with the acquisition of a trade or business) are amortized on a straight-line basis over a fifteen (15)-year period. The amortization deductions arising from the stepped-up basis in these intangible assets will provide a meaningful tax benefit to Penterra over the amortization period, partially offsetting the premium paid in the transaction.
It is important to note that in a tax-free reorganization under Section 368, the acquiring corporation would take a carryover basis in the target's assets, equal to the target's historic tax basis. Because the transaction is taxable, Penterra benefits from the step-up in basis but forgoes the potential benefit of any net operating losses ("NOLs") or other tax attributes of Caliston that might have been preserved in a tax-free reorganization (subject to the limitations of Section 382 of the Code). However, as a clinical-stage company with limited or no taxable income, Caliston's NOLs and other tax attributes may have had limited value in any event.
IV. Contingent Value Rights — Tax Treatment
A. Overview of CVR Structure
As described in Section II.B above, the merger consideration includes CVRs providing for an aggregate contingent payment of up to One Hundred Twenty-Five Million Dollars ($125,000,000) to former Caliston stockholders, payable upon FDA approval of CLT-4019 on or before December 31, 2026. The CVRs will be issued pursuant to a Contingent Value Rights Agreement (the "CVR Agreement") to be entered into at the closing of the merger among Penterra, Columnar Trust Services, Inc. (as trustee), and a representative of the former Caliston stockholders.
The CVRs are expected to be non-transferable — that is, they may not be sold, assigned, pledged, or otherwise transferred by the holders thereof, except by operation of law (e.g., upon the death of a holder or by a partnership or trust to its partners or beneficiaries). The CVRs will not be registered under the Securities Act of 1933, as amended, and will not be listed or traded on any securities exchange or over-the-counter market. The non-transferable nature of the CVRs is relevant to the tax analysis, as discussed below.
The CVR payment, if earned, would be distributed pro rata to former Caliston stockholders in proportion to their ownership of Caliston shares immediately prior to the closing. For example, Dr. Hale, as a 28.5% stockholder, would be entitled to receive 28.5% of the CVR payment, or approximately $35,625,000 (28.5% × $125,000,000) upon achievement of the milestone.
B. Open Transaction vs. Closed Transaction Reporting
The tax treatment of the CVRs raises the question of whether the transaction should be reported under the "open transaction" doctrine or the "closed transaction" doctrine. The distinction between these two approaches is significant:
Closed Transaction Method. Under the installment sale rules of Section 453 of the Code and the contingent payment sale regulations of Treasury Regulation Section 15a-453-1, a transaction is generally treated as "closed" if the maximum amount of consideration is determinable at the time of the sale. Here, the maximum CVR payment is fixed at $125,000,000 — only the occurrence of the contingency (FDA approval of CLT-4019 by December 31, 2026) is uncertain, not the amount payable if the contingency occurs. Because the maximum consideration is determinable, the transaction is generally treated as a closed transaction under the regulatory framework.
Under closed transaction treatment, the CVRs are valued at their fair market value as of the closing date, and that fair market value is included in the "amount realized" by each Caliston stockholder at the time of the merger closing. This means that a portion of the Caliston stockholder's gain is recognized at closing based on the imputed fair market value of the CVR, even though the CVR payment has not yet been received and may never be received.
The fair market value of the CVRs at closing will depend on a probability-weighted assessment of the likelihood that CLT-4019 will receive FDA approval on or before December 31, 2026. This assessment should take into account, among other factors, the current stage of clinical development of CLT-4019, the historical probability of success for drug candidates in the relevant therapeutic area and development stage, the remaining development timeline, and regulatory risk factors. We understand that Thorngate Partners, Penterra's financial advisor on this transaction, has conducted a risk-adjusted analysis of the CLT-4019 program, and Caliston's auditor, Brentmoor Advisors LLP, may have relevant valuation data. These analyses will be critical inputs into the determination of fair market value of the CVRs for tax reporting purposes.
Consequences of Closed Transaction Treatment. If the CVRs are valued at an amount less than the $125,000,000 maximum at closing (reflecting the uncertainty of the contingency), and the full $125,000,000 is subsequently paid upon FDA approval of CLT-4019, the excess of the actual payment over the fair market value initially included in the amount realized will constitute additional capital gain recognized by the Caliston stockholders in the taxable year in which the CVR payment is received. Conversely, if the CVR lapses worthless (i.e., FDA approval is not obtained by December 31, 2026, and no payment is made), each Caliston stockholder may be entitled to recognize a capital loss equal to the fair market value of the CVR that was included in the amount realized at closing. The character of any such loss (long-term versus short-term) will depend on the stockholder's holding period for the CVR, measured from the closing date.
Open Transaction Method. Under the open transaction doctrine, the CVRs would not be valued at closing, and the Caliston stockholder would recover its adjusted basis first and recognize gain only when and to the extent the aggregate consideration received (including any CVR payment) exceeds the stockholder's basis. However, the open transaction doctrine is disfavored by the IRS and is available only in "rare and extraordinary" circumstances where the fair market value of the contingent right is not reasonably ascertainable. See Burnet v. Logan, 283 U.S. 404 (1931); Treas. Reg. §15a-453-1(d)(2)(iii). Given that the maximum CVR amount is fixed at $125,000,000 and the probability of the milestone can be estimated with reasonable accuracy based on available clinical data, we do not believe the open transaction doctrine would be sustained for the CVRs in this transaction. Accordingly, closed transaction treatment is the appropriate reporting method.
C. Installment Sale Considerations
Section 453 of the Code generally provides for installment sale treatment of gains from the sale of property where at least one payment is received after the close of the taxable year in which the sale occurs. However, several considerations are relevant here:
Exclusion for Publicly Traded Stock. Section 453(f)(3) provides that installment sale treatment is not available for sales of stock traded on an established securities market. This exclusion does not apply to the sale of Caliston stock, as Caliston is privately held and its shares are not traded on any exchange or market. Accordingly, this exclusion does not preclude installment sale reporting for the CVR component of the transaction.
Fixed Maximum Amount. Because the maximum CVR payment is fixed at $125,000,000, Treasury Regulation Section 15a-453-1(c) governs the installment reporting methodology. Under this regulation, the taxpayer's basis is recovered ratably over the maximum period during which payments may be received, using a fraction in which the numerator is the taxpayer's basis and the denominator is the maximum aggregate consideration (including the CVR maximum). This ensures that basis is allocated across the upfront consideration and the potential CVR payment proportionally.
Practical Application. In practice, each Caliston stockholder would allocate its adjusted tax basis in its Caliston shares across the total potential consideration (upfront cash + fair market value of Penterra stock + $125,000,000 maximum CVR), and would recognize gain at closing to the extent the amount realized (including the fair market value of the CVR) exceeds the allocated basis. If the CVR is later paid, additional gain would be recognized to the extent the actual payment exceeds the fair market value attributed to the CVR at closing.
Recommendation. We recommend that C&H and the Company engage experienced tax advisors to determine the appropriate fair market value of the CVRs at closing and to advise on the specific reporting method to be adopted. The selected reporting method and the tax treatment of the CVRs should be disclosed in the proxy statement to be furnished to Caliston stockholders in connection with the merger, along with a recommendation that each stockholder consult its own tax advisor with respect to its individual circumstances.
D. Imputed Interest / OID Considerations
If the CVR payment is characterized as a deferred payment of purchase price, the original issue discount ("OID") rules of Sections 1272 through 1275 of the Code and the imputed interest rules of Sections 483 and 1274 of the Code could potentially apply to treat a portion of the deferred payment as imputed interest income rather than additional purchase price.
Under Section 483, if a deferred payment exceeds the present value of such payment (Discounted at the applicable federal rate), the excess is recharacterized as imputed interest, which is ordinary income to the recipient and deductible by the payor. Similarly, under Section 1274, deferred payment obligations that do not provide for adequate stated interest may give rise to OID.
However, in the context of the proposed CVRs, the practical impact of these provisions is likely minimal for the following reasons:
(i) The CVR payment is contingent upon an uncertain regulatory milestone (FDA approval of CLT-4019 by December 31, 2026). Because the payment is not a fixed obligation — and may never be made at all — the imputed interest and OID rules are generally inapplicable to contingent payments that are truly uncertain in both amount and timing.
(ii) The CVR Agreement should be structured so that the CVR payment, if earned, is payable within thirty (30) days of achievement of the FDA approval milestone, rather than on a fixed future date. This structure emphasizes the contingent nature of the obligation and further supports the position that the payment is additional purchase price, not deferred consideration subject to imputed interest.
We recommend that the CVR Agreement be drafted to include provisions that minimize the risk of OID characterization, including specifying prompt payment following milestone achievement and avoiding language that could be construed as creating a fixed obligation to pay on a date certain.
V. Section 280G — Parachute Payment Analysis for Caliston Employees
A. Overview of Section 280G
Sections 280G and 4999 of the Code impose significant tax penalties on certain compensation payments that are contingent on a change in ownership or control of a corporation. Specifically:
• Section 280G disallows the corporate income tax deduction for "excess parachute payments." An "excess parachute payment" is the portion of any "parachute payment" that exceeds the recipient's "base amount." A "parachute payment" is any payment in the nature of compensation to (or for the benefit of) a "disqualified individual" that is contingent on a change in the ownership or effective control of the corporation (or in the ownership of a substantial portion of the assets of the corporation), where the aggregate present value of all such payments equals or exceeds three times the recipient's base amount. The "base amount" is the individual's average annualized compensation includible in gross income for the five most recent taxable years ending before the date of the change of control (generally, the five-year average of W-2 compensation).
• Section 4999 imposes a nondeductible twenty percent (20%) excise tax on the recipient of any excess parachute payment. This excise tax is in addition to regular federal income tax and is not creditable against the recipient's regular tax liability.
The term "disqualified individual" includes any individual who, with respect to the corporation undergoing the change of control, is (a) an officer, (b) a shareholder holding more than one percent (1%) of the outstanding stock of the corporation (by fair market value), or (c) a "highly compensated individual" (defined as an individual who is, or would be, among the highest-paid one percent (1%) of the employees of the corporation, or, if less, the highest-paid 250 employees).
B. Application to Caliston Employees
Caliston currently has ninety-four (94) employees. Based on information available to C&H, the following individuals are likely to be classified as "disqualified individuals" for purposes of Section 280G:
(i) Dr. Nadia Sorensen, Chief Executive Officer and holder of a 14.2% equity stake in Caliston. As an officer and a greater-than-1% stockholder, Dr. Sorensen is a disqualified individual.
(ii) Dr. Raj Malhotra, Chief Scientific Officer and holder of a 9.8% equity stake in Caliston. As an officer and a greater-than-1% stockholder, Dr. Malhotra is a disqualified individual.
(iii) Dr. Evan Whitmore, Head of Clinical Development and a member of the Caliston board of directors. As an officer and director, Dr. Whitmore is a disqualified individual.
(iv) Other officers and highly compensated employees of Caliston who may be classified as disqualified individuals based on their compensation levels and/or equity holdings.
The types of payments that are contingent on, or proximate to, the change of control and must be included in the parachute payment calculation include:
• Accelerated vesting of unvested equity awards (stock options, restricted stock, restricted stock units) triggered by the merger closing;
• Transaction bonuses payable upon or in connection with the closing of the merger;
• Severance benefits payable upon termination of employment following the change of control;
• The value of any non-competition consideration (for example, the non-competition agreement to be entered into by Dr. Sorensen in connection with the merger); and
• Any other payments in the nature of compensation that are contingent on the change of control.
All such payments must be aggregated for each disqualified individual and compared to the three-times-base-amount threshold. If the aggregate present value of a disqualified individual's parachute payments equals or exceeds three times the individual's base amount, the entire amount in excess of the base amount (not merely the excess over three times the base amount) is treated as an excess parachute payment, subject to the Section 4999 excise tax and the Section 280G deduction disallowance.
With respect to Dr. Sorensen, it is important to distinguish between payments that constitute merger consideration for her vested Caliston equity interest and payments that constitute compensation in the nature of parachute payments. Dr. Sorensen's 14.2% equity stake in Caliston implies merger proceeds of approximately $131,350,000 (14.2% × $925,000,000). To the extent these proceeds represent the fair market value of Dr. Sorensen's vested equity, they should not be treated as parachute payments, because they are consideration for the sale of a capital asset rather than compensation contingent on the change of control. However, any proceeds attributable to the accelerated vesting of unvested equity awards (which acceleration is triggered by the merger closing) would be treated as compensation and included in the parachute payment calculation.
A detailed analysis of each disqualified individual's base amount, parachute payments, and potential excise tax exposure should be conducted as promptly as practicable. This analysis will require access to the employment agreements, offer letters, equity award agreements, change-of-control severance plans, and historical W-2 compensation data for each affected individual.
C. Caliston as a Private Company — Stockholder Vote Exception
Section 280G(b)(5)(B) of the Code provides an important exception for privately held corporations. Under this provision, the parachute payment rules of Section 280G do not apply if both of the following conditions are met:
(i) The payment is approved by a vote of the persons who owned, immediately before the change of control, more than seventy-five percent (75%) of the outstanding stock of the corporation entitled to vote (determined by value), after adequate disclosure to all such stockholders of all material facts concerning the payments; and
(ii) The disqualified individual whose payments are being voted upon does not participate in the vote with respect to his or her own payments (i.e., the individual's shares are excluded from both the numerator and denominator of the vote calculation).
Because Caliston is a privately held corporation, this exception is potentially available to eliminate Section 280G exposure for the transaction. However, the practical feasibility of obtaining the required stockholder approval must be carefully evaluated.
Practical Analysis. Based on the Caliston capitalization table, the stockholders who are not disqualified individuals (or whose shares are not required to be excluded from a particular vote) include Dr. Marcus Hale (28.5%), Ridgeline Ventures, LP (22.3%), Meridian Life Sciences Fund III, LP (18.7%), and potentially other stockholders in the founders/management pool who are not themselves disqualified individuals. Caliston stockholders holding approximately 69.5% of the outstanding equity are expected to execute the written consent to approve the merger itself. However, the Section 280G stockholder vote requires approval by holders of more than 75% of the outstanding shares entitled to vote (by value), with the disqualified individual's own shares excluded from the vote.
For example, in a vote on Dr. Sorensen's parachute payments, her 14.2% stake would be excluded, and the vote would be conducted among holders of the remaining 85.8% of the outstanding equity. To satisfy the 75% threshold within this adjusted pool, affirmative votes representing more than approximately 64.35% of total outstanding equity (75% × 85.8%) would be required. This threshold is potentially achievable if the institutional investors (Ridgeline Ventures and Meridian III, together holding 41.0%) and Dr. Hale (28.5%) support the vote, as their combined holdings (69.5%) would exceed the required threshold.
Similar calculations would need to be performed for each disqualified individual whose payments are subject to the vote, excluding that individual's shares from the denominator in each case.
Recommendation. We recommend that the Section 280G stockholder vote be pursued for each disqualified individual whose parachute payment exposure is material. If the vote fails with respect to any disqualified individual, that individual would bear the 20% excise tax under Section 4999, and Penterra would lose the deduction under Section 280G for the excess parachute payment. Accordingly, the consequences of a failed vote should be considered in negotiating the treatment of parachute payments in the merger agreement.
We further recommend that the merger agreement include a covenant requiring Caliston to use commercially reasonable efforts to obtain a Section 280G stockholder vote prior to closing. The vote should be structured in accordance with the requirements of Section 280G(b)(5)(B) and the applicable Treasury Regulations, including full and adequate disclosure to all Caliston stockholders of all material facts concerning the parachute payments.
D. Deductibility Impact on Penterra
If excess parachute payments are made to Caliston disqualified individuals in connection with the merger and the Section 280G stockholder vote exception is not obtained, the tax consequences to Penterra are as follows:
• Penterra, as the surviving corporation, will be disallowed a deduction under Section 280G for the "excess parachute payment" portion of each such payment. The lost deduction, at Penterra's marginal federal corporate income tax rate of twenty-one percent (21%), could be material depending on the aggregate amount of excess parachute payments. For example, if the aggregate excess parachute payments across all disqualified individuals total $50,000,000, the lost deduction would result in an incremental federal tax cost to Penterra of approximately $10,500,000 (21% × $50,000,000).
• In addition, to the extent Caliston employment agreements or equity plans contain "gross-up" provisions — that is, provisions obligating the employer to reimburse the employee for the Section 4999 excise tax — the cost of the gross-up payments themselves would be subject to the same Section 280G deduction disallowance and would further increase the aggregate cost of the parachute payments to Penterra. Gross-up provisions effectively "cascade," as the gross-up payment is itself an excess parachute payment, requiring an additional gross-up, and so on. We recommend that all Caliston employment agreements, change-of-control provisions, and equity plans be reviewed for the existence of gross-up provisions, and that consideration be given to negotiating "best net" or "cutback" provisions as alternatives.
Under a "best net" or "cutback" approach, the disqualified individual's parachute payments would be reduced (if necessary) to the largest amount that would not trigger the Section 280G excise tax, but only if the after-tax benefit to the individual from the reduced payment exceeds the after-tax benefit from receiving the full payment and bearing the excise tax. This approach eliminates the gross-up exposure entirely and reduces the overall cost to Penterra.
VI. State Income Tax Considerations
A. Caliston Stockholder State Tax
In addition to federal income tax, Caliston stockholders will be subject to state income tax on the gain recognized in the merger, to the extent such gain is subject to tax in the stockholder's state of residence (for individuals) or the state or states in which the stockholder has nexus (for entities).
Massachusetts. Individual Caliston stockholders who are residents of Massachusetts will be subject to Massachusetts income tax on their capital gains from the merger. Massachusetts currently imposes a flat income tax rate of five percent (5%) on most categories of income, including capital gains. Effective January 1, 2023, the "Fair Share Amendment" (Article 44 of the Amendments to the Massachusetts Constitution) imposes an additional four percent (4%) surtax on taxable income in excess of One Million Dollars ($1,000,000), bringing the total Massachusetts income tax rate on gains above the threshold to nine percent (9%). Given the magnitude of the gains expected to be realized by the principal Caliston stockholders, substantially all of their merger gain would be subject to the 9% combined Massachusetts rate.
Dr. Marcus Hale — New Jersey. Dr. Hale is a resident of New Jersey. New Jersey does not provide preferential tax rates for capital gains; instead, capital gains are taxed as ordinary income under the New Jersey Gross Income Tax. The top marginal rate under the New Jersey Gross Income Tax is currently ten and three-quarters percent (10.75%) on income in excess of $1,000,000. Given Dr. Hale's implied gain of approximately $221,625,000, substantially all of his gain will be subject to the top New Jersey rate.
The combined federal and New Jersey tax burden on Dr. Hale's gain from the merger is estimated as follows:
This estimate is approximate and does not take into account potential credits for state taxes paid (the deduction for state and local taxes is limited to $10,000 per year for individual taxpayers under Section 164(b)(6) of the Code, as amended by the Tax Cuts and Jobs Act of 2017), the alternative minimum tax, or other individual-specific adjustments. Dr. Hale should be advised to consult with his personal tax advisors regarding his specific situation.
Partnership / LP Investors. The gain recognized by Ridgeline Ventures, LP and Meridian Life Sciences Fund III, LP will flow through to their respective partners and members. The state income tax consequences for each partner will depend on the partner's state of residency or domicile. To the extent the partnership has nexus in a state (for example, through the partnership's own activities or through the location of the assets giving rise to the gain), the state may impose a filing obligation on the partnership and/or its partners even if the partners are not residents of that state. Ridgeline Ventures and Meridian III should consult their own tax advisors regarding the state tax consequences to their partners.
B. Penterra State Tax and Nexus
Current Filing Profile. Penterra is headquartered in New Jersey and currently files state income tax returns in multiple states in which it has nexus through employees, offices, or business activities.
New Nexus in Massachusetts. The acquisition of Caliston will likely create new nexus for Penterra in the Commonwealth of Massachusetts, given Caliston's principal office and substantially all of its employees (94) are located in Cambridge, Massachusetts. Post-closing, Penterra will be required to assess whether it has a Massachusetts corporate excise tax filing obligation, taking into account the combined reporting rules applicable in Massachusetts. Massachusetts imposes a corporate excise tax on corporations with nexus in the state, consisting of an income component (currently 8% of net income apportioned to Massachusetts) and a non-income component (based on property or net worth).
Asset Step-Up Amortization Deductions. The availability of amortization deductions on the stepped-up basis in Caliston's intangible assets (discussed in Section III.D) will vary by state. Certain states decouple from the federal Section 197 amortization provisions or impose limitations on the recognition of amortization deductions arising from asset step-ups in acquisitions. For example, some states require the use of the target's historical tax basis for purposes of computing state taxable income, effectively denying the benefit of the step-up at the state level. Penterra's state tax advisors should conduct a state-by-state analysis of the availability of the amortization deductions.
Post-Closing Integration. We recommend that Penterra's tax department conduct a comprehensive state tax nexus analysis following the closing of the merger, taking into account the addition of Caliston's employees, facilities, and business activities to Penterra's operations. This analysis should address filing obligations, apportionment of income, and the potential availability or limitation of amortization deductions in each relevant state.
C. Delaware Considerations
Both Penterra and Caliston are incorporated in the State of Delaware. Delaware does not impose a corporate income tax on corporations that are merely incorporated in Delaware but do not conduct business within the state. To the extent Penterra and Caliston maintain their Delaware incorporation solely for legal and governance purposes and do not conduct business activities in Delaware (other than maintaining a registered agent), the Delaware holding company exemption should shield the entities from Delaware income tax.
However, Delaware does impose an annual franchise tax on domestic corporations incorporated in the state. The franchise tax is calculated based on either the authorized shares method or the assumed par value capital method, whichever results in a lower tax. Following the merger, the surviving entity (Penterra) will continue to be subject to Delaware franchise tax obligations, and the obligation should be reflected in post-closing budgeting and compliance planning.
VII. Structuring Observations and Recommendations
Based on the analysis set forth above, we offer the following observations and recommendations for the Special Committee's consideration:
A. Taxable Structure — Cost-Benefit Summary
The taxable treatment of the proposed merger has both advantages and disadvantages relative to a potential tax-free reorganization structure:
Advantages of Taxable Treatment:
• Purchase price step-up and amortization. Penterra will acquire Caliston's assets with a stepped-up cost basis equal to the purchase price, generating significant Section 197 amortization deductions over fifteen (15) years. This benefit is not available in a tax-free reorganization, where the acquiror takes a carryover basis in the target's assets.
• Structural simplicity. A taxable acquisition does not require satisfaction of the COI or COBE requirements, eliminating the risk that the IRS could challenge the tax-free treatment of the transaction and impose tax retroactively on Caliston stockholders.
• Flexibility in consideration mix. Penterra retains full flexibility to determine the cash/stock ratio without regard to the 40% stock threshold required for COI. This permits Penterra to minimize dilution to its existing stockholders.
Disadvantages of Taxable Treatment:
• Immediate tax recognition for Caliston stockholders. Each Caliston stockholder will recognize gain on the merger at closing, rather than deferring gain on the stock component (as would be the case in a tax-free reorganization where stock received qualifies for nonrecognition under Section 354 of the Code).
• No deferral benefit for stock consideration. In a tax-free reorganization, the 25% stock component ($231,250,000) would have been received on a tax-deferred basis, with gain recognized only upon a subsequent disposition of the Penterra stock. In the proposed taxable structure, Caliston stockholders will pay tax on the full fair market value of the Penterra stock received at closing.
Conclusion on Structure. Given the negotiated 75% cash / 25% stock consideration mix, taxable treatment is effectively locked in. Restructuring the transaction to achieve tax-free treatment would require increasing the stock component to approximately $370,000,000 to $420,000,000 (depending on CVR treatment), which would significantly increase dilution to Penterra shareholders, alter the negotiated economic terms, and likely require renegotiation of the transaction. We do not recommend pursuing a restructuring for this purpose.
B. CVR Valuation
We recommend that Penterra engage a qualified independent valuation firm to establish the fair market value of the CVRs at closing for tax reporting purposes. Alternatively, Thorngate Partners (Penterra's financial advisor) or Brentmoor Advisors LLP (Caliston's auditor) may be in a position to provide a probability-weighted valuation of the CVRs based on their analysis of the CLT-4019 development program and the probability of FDA approval by December 31, 2026.
The valuation should be completed prior to or concurrent with the closing of the merger, as the fair market value of the CVRs will directly affect the amount realized by each Caliston stockholder and the gain or loss recognized at closing. The proxy statement to be furnished to Caliston stockholders should describe the tax treatment of the CVRs, including the closed transaction reporting methodology, and should advise each stockholder to consult its own tax advisor regarding the individual impact.
C. Section 280G Mitigation
We recommend the following steps to mitigate Section 280G exposure in connection with the transaction:
1. Merger Agreement Covenant. Include a covenant in the merger agreement requiring Caliston to use commercially reasonable efforts to obtain a stockholder vote satisfying Section 280G(b)(5)(B) of the Code prior to the closing of the merger. The covenant should specify that Caliston will prepare and distribute the required disclosure materials to its stockholders and solicit the required votes for each disqualified individual.
2. Quantification of Exposure. Promptly review all Caliston employment agreements, offer letters, change-of-control severance plans, equity award agreements (including stock option agreements and restricted stock unit agreements), and any other arrangements that could give rise to parachute payments. Quantify the potential parachute payment exposure for each disqualified individual, including Dr. Sorensen, Dr. Malhotra, Dr. Whitmore, and any other affected employees.
3. Gross-Up Provisions. Identify any gross-up provisions in existing Caliston employment agreements or plans that would obligate Caliston or Penterra to reimburse affected employees for the Section 4999 excise tax. Consider negotiating the elimination of gross-up provisions and replacing them with "best net" or "cutback" provisions, which would reduce the aggregate cost to Penterra while potentially leaving the affected employee in a comparable or better after-tax position.
D. Withholding and Reporting Obligations
Penterra (or the exchange agent appointed in connection with the merger) will have the following withholding and reporting obligations with respect to the merger consideration:
Form 1099-B Reporting. Cash consideration paid to Caliston stockholders in exchange for their Caliston shares is subject to information reporting on IRS Form 1099-B. Penterra or the exchange agent must furnish Form 1099-B to each Caliston stockholder (other than corporate or exempt recipients) and file copies with the IRS. Backup withholding at the rate of twenty-four percent (24%) may apply if a stockholder fails to provide a valid taxpayer identification number (TIN) or is subject to backup withholding for other reasons.
Penterra Stock. Shares of Penterra common stock issued as merger consideration are not subject to withholding, but the fair market value of the shares must be reported as part of the merger consideration on Form 1099-B.
FIRPTA Considerations. If any Caliston stockholders are non-U.S. persons (i.e., nonresident alien individuals, foreign corporations, foreign partnerships, or other foreign entities), withholding under Section 1445 of the Code (the Foreign Investment in Real Property Tax Act, or "FIRPTA") may apply. Under FIRPTA, a transferee of a "United States real property interest" ("USRPI") is generally required to withhold fifteen percent (15%) of the amount realized by the transferor. A USRPI includes stock in a "United States real property holding corporation" ("USRPHC"), which is any domestic corporation in which the fair market value of United States real property interests equals or exceeds fifty percent (50%) of the aggregate fair market value of the corporation's worldwide real property interests plus other assets used or held for use in a trade or business. Given that Caliston is a clinical-stage biopharmaceutical company whose assets consist primarily of intellectual property, clinical data, and cash, it is unlikely that Caliston would qualify as a USRPHC. Nevertheless, a FIRPTA analysis should be conducted as part of the pre-closing due diligence, and appropriate certifications should be obtained from Caliston or its stockholders.
VIII. Summary of Key Tax Conclusions
For the convenience of the Special Committee, the principal tax conclusions of this memorandum are summarized below:
1. Fully Taxable Transaction. The proposed merger is a fully taxable transaction for Caliston stockholders. The 75% cash / 25% stock consideration mix falls well below the 40% continuity of interest threshold required for tax-free reorganization treatment under Section 368 of the Code. Each Caliston stockholder will recognize gain or loss upon the exchange of Caliston shares for the merger consideration.
2. CVR Treatment. The CVRs should be treated under the closed transaction method, based on the fixed maximum of $125,000,000. The fair market value of the CVRs at closing should be formally determined by a qualified independent valuation firm and included in the amount realized by each Caliston stockholder.
3. Section 280G Exposure. Section 280G parachute payment exposure exists for Caliston disqualified individuals, including Dr. Sorensen, Dr. Malhotra, and Dr. Whitmore, among others. The private company stockholder vote exception under Section 280G(b)(5)(B) should be pursued as a mitigation strategy, and a covenant to that effect should be included in the merger agreement.
4. State Income Tax Implications. State income tax consequences are material for high-gain individual stockholders. Dr. Hale faces a combined federal and New Jersey effective tax rate of approximately 34.55% on his implied gain of $221,625,000. Massachusetts residents face a combined state rate of up to 9% on gains above $1,000,000 due to the recently enacted surtax. Partnership investors should consult their own advisors regarding flow-through state tax implications.
5. Penterra Benefits from Step-Up. Penterra will benefit from a stepped-up cost basis in Caliston's assets, including significant Section 197 intangible assets (IPR&D and goodwill), amortizable on a straight-line basis over fifteen (15) years. The amortization deductions will partially offset the premium paid in the transaction over the amortization period.
6. Proxy Statement Disclosure. These conclusions should be reflected in the tax disclosure section of the proxy statement to be prepared in connection with the merger. The proxy statement should advise Caliston stockholders that the transaction is taxable, describe the treatment of the CVRs, and recommend that each stockholde

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