PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT
MATTER STATUS REPORT — Q1 2023
CALDERWOOD & HARKNESS LLP Tax Department
April 3, 2023
FROM: Leonard Cross, Responsible Partner, and Sylvia Hartwell, Billing Partner Calderwood & Harkness LLP, Tax Department
TO: Marcus Whitfield, Vice President, Global Tax, Penterra Pharmaceuticals Corp. Deborah Staines, General Counsel, Penterra Pharmaceuticals Corp. Rajesh Iyer, Chief Financial Officer, Penterra Pharmaceuticals Corp.
RE: IRS Transfer Pricing Examination Defense — Penterra Pharmaceuticals Corp. (TY 2017–2020)
Matter Number: 1018-00009
IRS Exam Team ID: LB&I-NE-TP-2022-00641
Reporting Period: January 1, 2023 – March 31, 2023
This memorandum constitutes a privileged and confidential attorney-client communication and attorney work product prepared in connection with the provision of legal advice. This document and all attachments are protected from disclosure by the attorney-client privilege, the work-product doctrine, and all other applicable privileges. No portion of this document may be disclosed to any third party without the prior written consent of Calderwood & Harkness LLP. Inadvertent disclosure does not constitute a waiver of any applicable privilege.
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1. Executive Summary
This Matter Status Report covers activity during the first quarter of 2023 (January 1 through March 31, 2023) in connection with the ongoing Internal Revenue Service Large Business & International Division ("LB&I") examination of Penterra Pharmaceuticals Corp.'s ("PPC" or the "Company") transfer pricing methodology for tax years 2017 through 2020.
The examination was formally opened on May 16, 2022, when PPC received IRS Letter 2205-A notifying the Company that its federal income tax returns for the years at issue had been selected for examination. The primary focus of the examination is the intercompany royalty rates and cost-sharing payments between PPC's U.S. operations and its wholly owned Irish subsidiary, Penterra Biopharma International DAC ("PBI"), which serves as the Company's principal operating entity for markets outside the Americas.
Calderwood & Harkness LLP ("C&H") was engaged by PPC effective June 2, 2022, to represent the Company in connection with the examination. IRS Form 2848 (Power of Attorney and Declaration of Representative) was filed with the IRS on June 8, 2022, designating Leonard Cross (Partner), Sylvia Hartwell (Partner), Garrett Simmons (Associate), and Leila Nazari (Associate) as authorized representatives of PPC before the Internal Revenue Service with respect to the tax years under examination.
During Q1 2023, the engagement experienced the following significant developments:
• Continued IDR Response Activity. The IRS issued Information Document Requests ("IDRs") Nos. 22 through approximately 28, and C&H filed responses to several material IDRs, including IDR No. 22 (banking records), IDR No. 25 (comparable license agreements supporting the CUT analysis), and successfully negotiated a narrowing of the scope of IDR No. 26, which C&H objected to as overly broad and unduly burdensome.
• Completion of Updated Functional Analysis. C&H, in coordination with Whitmore Valuation Group LLC ("Whitmore"), completed and dated the updated functional analysis for PBI on March 15, 2023. This analysis incorporates additional employee interviews and documentary evidence gathered since the original October 2022 version and significantly strengthens the economic substance record.
• Ongoing Coordination with Whitmore Valuation Group. Work continued with Whitmore (retained under Kovel arrangement, reference 1018-00009-KV) to maintain readiness for rebuttal and to support the updated functional analysis.
• IRS Economist Engagement. In late February and early March 2023, C&H learned that the IRS exam team engaged Dr. Alan Washburne of the IRS Transfer Pricing Practice to conduct an independent economic analysis of PPC's transfer pricing arrangements. This development was anticipated in C&H's defense strategy, and the team is well-positioned to respond.
As of quarter-end, approximately 28 of the 47 IDRs that will ultimately be issued over the course of the examination have been served. The examination remains squarely in the information-gathering phase, and no formal proposed adjustments have been issued by the IRS.
PPC's positions — specifically, the cost-sharing arrangement ("CSA") cost-sharing ratios of 38.2% to 42.7%, the legacy IP royalty rate of 4.5% of non-Americas net sales, and the platform contribution transaction ("PCT") payment of $312 million — remain well-supported by contemporaneous documentation prepared at the time of the transactions, the Company's transfer pricing study prepared by Crestfield & Associates LLP, and the independent economic analyses prepared by Whitmore Valuation Group.
2. Examination Background and Scope
2.1 The Taxpayer
Penterra Pharmaceuticals Corp. (EIN 22-3741856; Nasdaq ticker PPCA) is a publicly traded specialty pharmaceutical and biotechnology company headquartered at 2200 Independence Boulevard, Princeton Junction, New Jersey 08550. For fiscal year 2020, PPC reported consolidated global revenue of approximately $6.82 billion and consolidated pre-tax income of approximately $1.47 billion. The Company is engaged in the discovery, development, manufacturing, and commercialization of innovative pharmaceutical products across its core therapeutic areas, including oncology, immunology, and rare disease.
2.2 Tax Returns Under Examination
The IRS is examining PPC's U.S. federal income tax returns (Forms 1120) for tax years 2017, 2018, 2019, and 2020 (each filed timely, including extensions). The examination encompasses a four-year window that straddles the enactment of the Tax Cuts and Jobs Act of 2017 ("TCJA"), with TY 2017 subject to the pre-TCJA 35% corporate tax rate and TY 2018 through 2020 subject to the post-TCJA 21% rate. The TCJA transition, and in particular the introduction of the Global Intangible Low-Taxed Income ("GILTI") regime under IRC § 951A and the Base Erosion and Anti-Abuse Tax ("BEAT") under IRC § 59A, are relevant contextual factors, although the primary focus of the examination remains on transfer pricing under IRC § 482.
2.3 IRS Examination Team
The examination is being conducted by the LB&I Northeast Transfer Pricing Practice under the following personnel:
• Gerald Meskill — Supervisory Revenue Agent (Team Manager)
• Patricia Dunleavy — Lead Revenue Agent (primary C&H point of contact for IDRs and day-to-day examination matters)
• Dr. Alan Washburne — IRS Transfer Pricing Practice Economist (engaged during Q1 2023, as discussed in Section 3.3 below)
The examination was assigned IRS Team ID LB&I-NE-TP-2022-00641.
2.4 Primary Areas of IRS Focus
Based on the IDRs issued to date, pre-examination correspondence, and discussions with the IRS exam team, the IRS's examination is focused on four principal areas:
(1) Cost-Sharing Arrangement. The CSA between PPC and PBI, which became effective July 1, 2012, pursuant to which PBI co-funds qualified R&D costs incurred by PPC in exchange for rights to exploit resulting intangible property in territories outside the Americas. PBI's cost-sharing percentages during the years at issue, as determined by the reasonably anticipated benefit ("RAB") share methodology, ranged from 38.2% in TY 2017 to 42.7% in TY 2020. Total qualified R&D costs subject to the CSA rose from $487.3 million in 2017 to $598.4 million in 2020, reflecting the Company's continued investment in its development pipeline.
(2) Platform Contribution Transaction. The PCT payment of $312 million made by PBI to PPC on July 1, 2012, in connection with the establishment of the CSA. The PCT was intended to compensate PPC for the pre-existing intangible property (the "platform contributions") made available to the CSA by PPC. The PCT was valued using the income method under Treas. Reg. § 1.482-7(g)(4), with a discounted cash flow analysis prepared contemporaneously by PPC's then-retained economic consultants. The IRS has signaled interest in whether the $312 million payment reflected arm's-length consideration at the time of the transaction.
(3) Legacy IP Royalty Rate. The royalty rate of 4.5% of non-Americas net sales charged by PPC to PBI for the use of pre-CSA legacy intangible property. Non-Americas net sales subject to the royalty declined over the examination period from $814.6 million in 2017 to $624.1 million in 2020, consistent with the maturation and loss of exclusivity of certain pre-CSA legacy compounds. The royalty rate was established based on a comparable uncontrolled transaction ("CUT") analysis under Treas. Reg. § 1.482-4(c).
(4) Economic Substance of PBI. The IRS has issued multiple IDRs focused on PBI's operations, personnel, decision-making authority, and physical presence in Ireland, which suggests the examination team may consider whether PBI possesses sufficient economic substance to be respected as the owner of its intangible property rights and as a bona fide participant in the CSA. This line of inquiry also implicates the DEMPE (Development, Enhancement, Maintenance, Protection, and Exploitation) framework and the question of whether PBI performs sufficient functions and controls sufficient risks to be entitled to the income attributed to it under the transfer pricing arrangements.
2.5 Corporate Structure
For purposes of the transactions under examination, PPC's relevant corporate structure is as follows:
• Penterra Pharmaceuticals Corp. ("PPC") — U.S. parent corporation (C corporation, EIN 22-3741856). Conducts substantially all R&D activities in the United States; holds Americas commercial operations.
• Penterra Holdings Luxembourg S.à r.l. ("PHL") — Luxembourg private limited liability company (Registre de Commerce et des Sociétés, Luxembourg, No. B 168452). Wholly owned by PPC. Classified as a disregarded entity for U.S. federal income tax purposes under Treas. Reg. § 301.7701-3.
• Penterra Biopharma International DAC ("PBI") — Irish designated activity company (Irish Revenue tax reference No. 3218764T). Wholly owned by PHL. PBI is the counterparty to the CSA and the licensee of legacy IP under the intercompany royalty arrangement. PBI serves as PPC's principal operating entity for non-Americas markets, maintaining offices and personnel in Dublin, Ireland.
• Penterra Manufacturing Ireland Ltd. ("PMI") — Irish company (Companies Registration Office No. 512347). Wholly owned by PBI. PMI operates as a contract manufacturer for PBI, manufacturing pharmaceutical products at its facility in Cork, Ireland, under a contract manufacturing agreement. PMI is compensated at cost plus 8%, a markup determined through benchmarking to be within the arm's-length range for limited-risk contract manufacturers in the pharmaceutical sector.
The Luxembourg entity, PHL, was interposed for commercial and regulatory reasons at the time the Irish operations were established and has no material assets, employees, or operations of its own. Its disregarded entity classification for U.S. tax purposes means that, from the IRS's perspective, PBI is treated as directly owned by PPC.
3. Q1 2023 Activity Summary
3.1 Information Document Requests (IDRs)
3.1.1 IDRs Issued During Q1 2023. During the first quarter of 2023, the IRS examination team issued IDRs No. 22 through approximately No. 28. These requests continued the IRS's systematic gathering of information concerning PPC's transfer pricing arrangements, PBI's operations and substance, and supporting economic data.
As of March 31, 2023, a cumulative total of approximately 28 IDRs had been issued by the IRS examination team. Based on the pace and scope of the examination, C&H anticipates that the IRS will ultimately issue approximately 47 IDRs over the full course of the information-gathering phase, which is expected to continue through approximately September 2023.
3.1.2 Key IDR Responses Filed During Q1 2023. The following IDR responses filed during Q1 2023 are of particular significance to the defense:
IDR No. 22 — Banking Records and Glenmore Bank Ireland plc Statements. C&H filed the response to IDR No. 22 on January 20, 2023. This IDR requested detailed banking records for PBI for the years under examination. The response produced PBI's bank statements maintained with Glenmore Bank Ireland plc, PBI's primary banking relationship in Dublin. The bank statements demonstrate that PBI maintains independent treasury operations in Dublin, including separate account management, cash management functions, and direct payment and receipt of funds in connection with PBI's commercial operations. The existence of independent treasury operations is an important indicia of PBI's economic substance and operational independence from PPC's U.S. treasury function.
IDR No. 25 — Comparable License Agreements / CUT Support. C&H filed the response to IDR No. 25 on February 15, 2023. This IDR requested production of the third-party license agreements identified as comparables in PPC's CUT analysis, which serves as the basis for the 4.5% legacy IP royalty rate. The response produced redacted versions of the comparable license agreements, with redactions limited to commercially sensitive third-party information not relevant to the comparability analysis. Accompanying the production was a detailed memorandum explaining the basis for the CUT analysis, the comparability factors considered, and the adjustments made to enhance comparability. This IDR response is a critical component of the defense of the 4.5% royalty rate.
IDR No. 26 — Scope Objection. On February 15, 2023, Leonard Cross submitted a formal letter to Lead Revenue Agent Patricia Dunleavy objecting to the scope of IDR No. 26 as overly broad and unduly burdensome. IDR No. 26, as originally drafted, requested the production of all communications between PPC and PBI personnel relating to "any aspect of PBI's operations or business activities" for the four-year examination period — a request that, if complied with literally, would have required the review and production of hundreds of thousands of documents at enormous expense and with negligible marginal benefit to the examination. C&H's letter detailed the specific grounds for the objection, including the disproportionate burden relative to the informational value, the overbreadth of the request, and the availability of more targeted alternatives. Following the letter and a subsequent telephone discussion between Cross and Dunleavy on March 1, 2023, the IRS agreed to narrow IDR No. 26 to focus on specific categories of communications relating to (i) PBI's strategic decision-making, (ii) CSA governance and cost-pool determinations, and (iii) IP development and management activities. The narrowed IDR No. 26 is being responded to in Q2 2023.
3.1.3 IDR Tracking and Privilege Log. All IDR responses continue to be tracked via the master IDR tracker maintained by Garrett Simmons and Leila Nazari, which logs each IDR by number, date of issuance, subject matter, due date, response date, and status. A privilege log is maintained in connection with each IDR response for all documents withheld on the basis of the attorney-client privilege and the work-product doctrine. The privilege log is being maintained in a format consistent with IRS best practices and the requirements of IRM 25.5.4.7.6, in anticipation of any future challenge by the IRS to privilege assertions.
3.1.4 Coordination with Crestfield & Associates. C&H continued its coordination with Crestfield & Associates LLP ("Crestfield"), PPC's outside tax return preparers and transfer pricing advisors. Martin Ogilvy (Engagement Partner) and Susan Lam (Transfer Pricing Partner) at Crestfield have been providing ongoing support to C&H in connection with IDR responses, including access to return data, tax provision workpapers, and the contemporaneous transfer pricing documentation prepared by Crestfield for the years at issue. Crestfield's cooperation has been timely and professional, and the relationship between the engagement teams continues to function efficiently.
3.2 Updated Functional Analysis — PBI
3.2.1 Completion and Date. The revised and updated functional analysis for PBI was completed and dated March 15, 2023. This analysis supersedes the initial version dated October 2022 and incorporates substantially additional factual material gathered during the 2022–2023 IDR process.
3.2.2 Preparation Team. The updated functional analysis was prepared by C&H (primarily Garrett Simmons and Leila Nazari, with review and direction by Leonard Cross and Sylvia Hartwell) in close coordination with Whitmore Valuation Group LLC. Dr. Helena Vasquez, Managing Director, and Dr. Rohan Chakrabarti, Senior Director, at Whitmore provided economic analysis support and ensured that the functional analysis is consistent with and supportive of Whitmore's economic benchmarking work.
3.2.3 Additional Evidence Incorporated. The updated functional analysis incorporates the following categories of additional evidence beyond the October 2022 version:
• Additional PBI employee interviews conducted via videoconference and in-person in Dublin during Q4 2022 and Q1 2023, including interviews with PBI's Managing Director, Aidan Naughton; PBI's Head of Regulatory Affairs; PBI's VP of Commercial Strategy; and PBI's Director of Supply Chain Operations.
• Documentary evidence produced in response to IDRs issued during the second half of 2022 and early 2023, including board minutes, internal memoranda, strategic planning documents, and correspondence between PBI personnel and third-party distributors, regulatory authorities, and contract manufacturers.
• Updated headcount and organizational data provided by PBI's human resources function and verified against Irish Revenue employer records.
3.2.4 Key Substance Indicators. The updated functional analysis documents the following key indicators of PBI's economic substance, operational independence, and DEMPE-related functions:
• Headcount. PBI's headcount grew from 52 employees at the time of its establishment in 2012 to 185 employees by the end of 2020. The workforce includes personnel across regulatory affairs, medical affairs, commercial strategy, market access, supply chain management, legal and compliance, finance and accounting, human resources, and general management. The breadth and depth of PBI's workforce is consistent with a bona fide operating entity performing significant functions and exercising meaningful control over its business operations.
• Board Governance. A total of 42 board meetings were held in Dublin during the 2017–2020 examination period, consisting of regularly scheduled quarterly meetings and additional special sessions convened as needed. Board meeting minutes document independent decision-making on matters including product pricing for non-Americas markets, market entry and exit decisions, selection and oversight of distribution partners, capital expenditure approvals, and regulatory strategy. The board composition includes independent Irish-resident directors in addition to PPC-nominated directors.
• Regulatory Expenditures. PBI incurred cumulative regulatory expenditures of approximately €47.2 million on submissions across 68 country markets during the 2017–2020 period. These expenditures relate to marketing authorization applications, post-marketing commitments, pharmacovigilance obligations, and regulatory compliance activities undertaken by PBI's regulatory affairs team in Dublin, often in coordination with local regulatory consultants in individual markets.
• Physical Presence. PBI maintains approximately 18,000 square feet of office space at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4. The office serves as PBI's principal place of business and houses the majority of its Dublin-based workforce. The office includes dedicated meeting rooms, IT infrastructure, and administrative support facilities.
• Operational Management. Managing Director Aidan Naughton exercises day-to-day operational control over PBI's business activities. Naughton is based in Dublin, reports to PBI's board of directors, and has authority over commercial operations, personnel decisions, vendor relationships, and strategic initiatives within PBI's scope of responsibility.
3.2.5 Significance to the Defense. The updated functional analysis significantly strengthens PPC's ability to rebut any potential economic substance challenge or DEMPE-based argument that PBI lacks sufficient functions, assets, and risks to be respected as the beneficial owner of its intangible property rights and as a genuine participant in the CSA. The analysis demonstrates that PBI is not a passive holding company or a shell entity, but rather an active operating business that performs meaningful value-adding functions, employs significant personnel, bears genuine business risks, and exercises independent decision-making authority with respect to the exploitation of intangible property in non-Americas markets.
3.3 IRS Economist Engagement
3.3.1 Identification of Dr. Alan Washburne. During Q1 2023, the IRS examination team engaged Dr. Alan Washburne of the IRS Transfer Pricing Practice to conduct an independent economic analysis of PPC's transfer pricing arrangements. C&H learned of Dr. Washburne's involvement through communications with the examination team in late February and early March 2023. Specifically, Lead Revenue Agent Dunleavy informed C&H during a routine status call on February 28, 2023, that the examination team had requested and received approval for economist support, and Dr. Washburne was subsequently identified by name in a follow-up email on March 7, 2023.
3.3.2 Anticipated Scope of Analysis. Based on C&H's understanding of IRS examination practices and the areas of focus of the examination to date, Dr. Washburne is expected to examine the following areas:
(a) The PCT valuation methodology employed by PPC and whether the $312 million payment made by PBI on July 1, 2012, reflected arm's-length consideration for the platform contributions made available to the CSA;
(b) The CSA cost-sharing ratios and the reasonably anticipated benefit ("RAB") projections underlying PBI's share of qualified R&D costs, including the revenue and profit projections used to determine RAB shares;
(c) The legacy IP royalty rate of 4.5% and the comparable uncontrolled transaction ("CUT") data relied upon by PPC to establish the arm's-length character of the rate.
3.3.3 C&H's Preparedness. This development, while noteworthy, was anticipated in C&H's defense strategy from the outset of the engagement. The retention of the IRS's own economist is a standard step in large transfer pricing examinations and typically precedes the formulation of proposed adjustments. C&H has worked closely with Whitmore Valuation Group throughout 2022 and early 2023 to ensure that PPC's economic analyses are rigorous, well-documented, and defensible. Whitmore's completed work product includes the following:
• CUT Analysis (Legacy IP Royalty Rate). Whitmore identified 14 comparable pharmaceutical license agreements through a systematic search of public and proprietary databases. The interquartile range ("IQR") of royalty rates observed in the comparable transactions is 3.1% to 6.8%, with a median of 4.4%. PPC's royalty rate of 4.5% falls at the median of the comparable range, providing strong support for the arm's-length character of the rate.
• CPM/TNMM Analysis (PBI Profitability). Whitmore performed a comparable profits method ("CPM") and transactional net margin method ("TNMM") analysis testing PBI's operating margins against a set of 22 comparable companies. PBI's operating margins during the examination period fall within the arm's-length range established by the comparables, supporting the conclusion that PBI's overall profitability is consistent with the functions performed, assets employed, and risks assumed.
• PCT Income-Method / DCF Valuation. Whitmore prepared an independent valuation of the PCT using the income method under Treas. Reg. § 1.482-7(g)(4), employing a discounted cash flow ("DCF") analysis. The valuation concluded that the arm's-length range for the PCT payment is $278 million to $361 million, based on a weighted average cost of capital ("WACC") of 9.8%. PPC's actual PCT payment of $312 million falls within this range, supporting the arm's-length character of the transaction.
3.3.4 Recommendation. C&H recommends proactive engagement with the IRS economist in Q2 2023. Specifically, C&H recommends that PPC authorize C&H and Whitmore to request a meeting or telephone conference with Dr. Washburne and the examination team at which PPC's economic analyses would be presented and discussed. This approach is consistent with best practices in large transfer pricing examinations and is designed to ensure that the IRS economist has the benefit of PPC's analyses before reaching preliminary conclusions. Early engagement of this nature can help avoid misunderstandings, narrow areas of disagreement, and potentially reduce the scope of any proposed adjustment. This recommendation is discussed further in Section 12 (Action Items) below.
3.4 Coordination with Irish Tax Advisors
3.4.1 Thornbury & Keogh. During Q1 2023, Leila Nazari continued C&H's coordination with Ciarán Thornbury at Thornbury & Keogh ("T&K"), PBI's and PMI's Irish tax advisors. T&K is located at 22 Fitzwilliam Square, Dublin 2, D02 YH68, Ireland. Nazari communicated with Thornbury on a regular basis throughout the quarter to ensure alignment between the U.S. and Irish aspects of PPC's transfer pricing defense.
3.4.2 Additional Substance Documentation. At C&H's request, T&K provided additional PBI substance documentation, including copies of Irish Revenue filings and supporting materials related to PBI's Knowledge Development box ("KDB") claim. The KDB regime, introduced under the Finance Act 2015, provides a reduced effective tax rate of 6.25% on qualifying IP income for companies that conduct qualifying R&D activities in Ireland. PBI has claimed the KDB benefit from fiscal year 2016 forward. The standard Irish corporation tax trading rate applicable to PBI's non-KDB income is 12.5%.
The KDB documentation provided by T&K demonstrates that PBI has substantiated its KDB claims to the satisfaction of Irish Revenue, which involves detailed analysis of PBI's qualifying R&D expenditures, the nexus between those expenditures and qualifying IP income, and the modified nexus approach for determining the proportion of income eligible for the reduced rate. This documentation is relevant to the U.S. examination insofar as it provides additional third-party verification of PBI's R&D-related activities and economic substance.
3.4.3 Irish Revenue Status. T&K confirmed during Q1 2023 that no parallel inquiry or audit has been initiated by Irish Revenue with respect to PBI's transfer pricing arrangements for any of the relevant periods. This is a favorable development, as the absence of a concurrent Irish examination reduces the risk of conflicting positions and potential double taxation. C&H will continue to monitor this status through T&K.
3.5 Legal Research and Analysis
During Q1 2023, the C&H team continued to refine and update the legal research memoranda that were initially prepared during the second half of 2022 in connection with PPC's defense. These memoranda address the following subjects:
• IRC § 482 Arm's-Length Standard and Best Method Rule. Analysis of the arm's-length standard under IRC § 482 and the best method rule under Treas. Reg. § 1.482-1(d), including the relative reliability of the CUT, CPM/TNMM, and income-method approaches employed in PPC's transfer pricing analyses.
• Qualified Cost-Sharing Arrangements. Comprehensive analysis of the CSA regulations under Treas. Reg. § 1.482-7, including the requirements for a qualified cost-sharing arrangement, the determination of reasonably anticipated benefits, the allocation of intangible development costs, and the PCT rules. This memorandum addresses both the "old" regulations (applicable to the establishment of the CSA in 2012) and the "new" regulations (as amended by T.D. 9568), as well as transitional issues.
• Arm's-Length Royalty Rate. Analysis of the determination of an arm's-length royalty rate under Treas. Reg. § 1.482-4, with particular focus on the CUT method, comparability factors specific to pharmaceutical IP licensing, and the treatment of declining revenue streams for legacy compounds.
• Economic Substance Doctrine and DEMPE Functions. Analysis of the judicial economic substance doctrine as codified by IRC § 7701(o), as well as the DEMPE framework articulated in the OECD Transfer Pricing Guidelines (2017 and 2022 editions), and the extent to which these concepts are relevant to the IRS's evaluation of PBI's role in the transfer pricing structure.
• IRC § 6662(e) Penalty Protection and Contemporaneous Documentation. Analysis of the transfer pricing penalty provisions under IRC § 6662(e) and the requirements for establishing reasonable cause and good faith under IRC § 6664(c), including the contemporaneous documentation requirements of Treas. Reg. § 1.6662-6(d). This memorandum concludes that PPC's contemporaneous transfer pricing documentation, prepared by Crestfield, satisfies the regulatory requirements and should provide penalty protection in the event of an adjustment.
• TCJA Impact Analysis. Analysis of the impact of the TCJA on PPC's transfer pricing positions, including the reduction of the U.S. corporate tax rate from 35% (TY 2017, pre-TCJA) to 21% (TY 2018–2020, post-TCJA, effective January 1, 2018), and the implications of the GILTI regime (IRC § 951A) and the BEAT (IRC § 59A) for PPC's intercompany transactions with PBI.
No new significant legal developments — whether in the form of legislation, regulations, or case law — affecting PPC's transfer pricing positions occurred during Q1 2023. The legal research memoranda remain current and will continue to be updated as developments warrant.
4. Anticipated NOPA Timeline and Next Steps
4.1 Projected Timeline
Based on the current pace of the examination, the volume and complexity of outstanding IDRs, and the recent engagement of the IRS economist, C&H estimates the following timeline for the next major phase of the examination:
• Information Gathering Completion: Mid- to late-Q3 2023 (approximately August–September 2023). The IRS is expected to issue additional IDRs through approximately September 2023, bringing the total to an estimated 47 IDRs. The information-gathering phase will conclude when the examination team and the IRS economist have obtained sufficient factual and economic data to formulate proposed adjustments.
• Notice of Proposed Adjustment (NOPA): Q3 or Q4 2023 (approximately September–December 2023). Following the close of the information-gathering phase and Dr. Washburne's completion of his independent economic analysis, C&H anticipates that the IRS will issue a NOPA. The NOPA will set forth the IRS's proposed adjustments to PPC's transfer pricing for the years at issue, the legal and economic basis for those adjustments, and the amount of any proposed deficiency.
It should be noted that these projections are subject to change based on the IRS's own internal scheduling, resource allocation, and the resolution of any outstanding disputes regarding the scope of IDRs.
4.2 Key Anticipated Milestones for Q2–Q3 2023
The following milestones are anticipated during Q2 and Q3 2023:
1. Continued IDR Response Activity. C&H will continue to prepare and file responses to outstanding and newly issued IDRs, with a target of completing the IDR response phase by approximately September 2023.
2. Mid-Examination Conference Request. C&H plans to submit a written request to the IRS exam team (Supervisory Revenue Agent Meskill and Lead Revenue Agent Dunleavy) for a mid-examination conference. The purpose of this conference would be to discuss the status of the examination, narrow the remaining issues under consideration, and understand the IRS's preliminary areas of concern. C&H is targeting May 2023 for this request. A mid-examination conference can be an effective tool for focusing the examination, avoiding unnecessary IDRs, and identifying opportunities for early resolution of certain issues.
3. Meeting with IRS Economist. As discussed in Section 3.3 above, C&H recommends requesting a meeting or telephone conference with Dr. Washburne to understand his analytical approach and to present PPC's economic analyses proactively.
4. Whitmore Rebuttal Preparation. C&H will continue to coordinate with Whitmore Valuation Group in anticipation of rebuttal work that will be necessary once the IRS economist's analysis is received or a NOPA is issued. Whitmore is maintaining readiness to prepare a comprehensive rebuttal report on an expedited timeline.
5. IRS Office of Chief Counsel. C&H anticipates the possible engagement of attorneys from the IRS Office of Chief Counsel as the examination approaches the NOPA stage. Based on available information, the assigned counsel may include Franklin Rosario (Attorney-Advisor) and Donna Hirabayashi (Senior Counsel). C&H will monitor for any indication of Chief Counsel involvement and will coordinate with the assigned attorneys as appropriate.
4.3 Compliance Assurance Process
PPC was not a participant in the IRS Compliance Assurance Process ("CAP") for the tax years at issue. Accordingly, the examination is proceeding under standard LB&I examination procedures, including the standard IDR process, NOPA procedures, and the availability of the IRS Appeals function following any unagreed proposed adjustments.
5. Statute of Limitations Status
C&H is carefully tracking the assessment statute of limitations under IRC § 6501 for each of the four tax years under examination. The current status is as follows:
*Filing dates reflect extensions of time to file; actual filing dates to be confirmed against IRS records.
TY 2017. The original three-year assessment period for TY 2017 would have expired on April 15, 2021 (three years from the original due date of the return). Prior to the opening of the current examination, PPC executed IRS Form 872 (Consent to Extend the Time to Assess Tax) extending the assessment period through December 31, 2024. Accordingly, the IRS has until that date to assess any deficiency for TY 2017.
TY 2018. Similarly, PPC executed Form 872 extending the assessment period for TY 2018 through December 31, 2024.
TY 2019. The TY 2019 return remains within its original three-year statutory period, but that period is approaching expiration. Depending on the duration of the examination and the IRS's timeline for issuing a NOPA, it may be necessary for PPC to execute a Form 872 extension for TY 2019. C&H is monitoring the expiration date closely and will advise PPC in advance if an extension becomes necessary. Any Form 872 extension should be limited to the minimum period required to accommodate the examination timeline.
TY 2020. The TY 2020 return is within its original three-year statutory period, with sufficient time remaining under the current examination timeline. C&H is monitoring.
All statute of limitations dates are tracked in C&H's dedicated statute of limitations tracking spreadsheet, which is reviewed and updated monthly by Leila Nazari. No expiration risk exists during the current reporting period, and C&H will advise PPC promptly of any action required to protect the statute.
6. Budget and Fee Status
6.1 Calderwood & Harkness Fees
Pursuant to the engagement letter dated June 2, 2022, C&H estimated that total legal fees for the engagement — encompassing the examination defense phase (IDR responses, NOPA response), the Protest and Appeals phases, and potential post-Appeals resolution — would fall in the range of $4.5 million to $7.0 million. This range was based on assumptions regarding the scope, complexity, and duration of the examination, the number and complexity of issues raised, and the likelihood of proceeding through the full Appeals process.
C&H's billing rates for the 2022 calendar year were as follows:
Updated 2023 billing rates became effective January 1, 2023, per C&H's annual billing rate schedule, a copy of which was provided to PPC's legal department in December 2022.
Year-to-date C&H fees for Q1 2023 (January 1 through March 31, 2023) will be detailed in the forthcoming monthly billing summaries. Cumulative C&H fees from the inception of the engagement (June 2, 2022) through March 31, 2023, are tracking within the lower-to-mid portion of the estimated fee range, which is consistent with projected expenditure for the IDR and pre-NOPA phase of the engagement. The more fee-intensive phases of the engagement — including the NOPA response, Protest preparation, and IRS Appeals proceedings — are expected to occur in late 2023 and through early-to-mid 2024.
C&H matter number for billing and conflict purposes: 1018-00009.
6.2 Whitmore Valuation Group Fees
Whitmore Valuation Group LLC ("Whitmore"), with offices at 200 Ashbury Asset Advisors, Suite 700, Boston, Massachusetts 02109, is PPC's retained economic consultant for the examination. Whitmore is engaged under a Kovel arrangement (reference 1018-00009-KV, dated June 20, 2022) to preserve the attorney-client privilege and work-product protection over Whitmore's work product and communications.
Whitmore bills at a blended hourly rate of $650 per hour across all professional levels. A substantial portion of Whitmore's initial economic analysis work — including the CUT analysis, the CPM/TNMM analysis, and the PCT DCF valuation — was completed during 2022. Whitmore's Q1 2023 charges relate primarily to support for the updated PBI functional analysis and ongoing availability of the Whitmore team for consultation and strategic discussions.
Additional rebuttal work by Whitmore is anticipated once the IRS economist's analysis is received or a NOPA is issued. C&H will provide PPC with updated fee estimates for the rebuttal phase when the scope of the required work becomes clearer.
6.3 Thornbury & Keogh Fees
Thornbury & Keogh's fees for Irish tax coordination and support during Q1 2023 are within the expected range. Cumulative T&K fees from the inception of the engagement through March 31, 2023, are tracking toward an ultimate total of approximately €312,500 (approximately $341,200 at the average EUR/USD exchange rate for the period). T&K's fees cover ongoing coordination with C&H, preparation and provision of Irish substance documentation, monitoring of Irish Revenue activity, and availability for consultation on Irish tax issues.
6.4 Budget Outlook
Based on the current examination trajectory and the anticipated issuance of a NOPA in Q3 or Q4 2023, the overall engagement fee is expected to fall within the original estimated range of $4.5 million to $7.0 million for C&H legal fees. The Protest and Appeals phases, which are anticipated to commence in late 2023 and continue through early-to-mid 2024, will constitute a significant portion of the remaining fees. C&H will provide updated budget projections as the examination progresses and the scope of post-NOPA work becomes clearer.
C&H is committed to managing the engagement efficiently and will continue to staff matters at the most cost-effective level consistent with the complexity and significance of the issues involved. C&H welcomes any discussion with PPC's management regarding budget expectations and fee management strategies.
7. FIN 48 / ASC 740-10 Reserve
7.1 Current Reserve
PPC maintains a reserve for uncertain tax positions under Financial Accounting Standards Board Interpretation No. 48 ("FIN 48"), codified as ASC 740-10 (Accounting for Uncertainty in Income Taxes), in the amount of $62.4 million related to the Irish IP structure, including the CSA, the PCT, and the legacy IP royalty arrangements. This reserve reflects PPC's assessment of the tax benefit that, under ASC 740-10, is not more likely than not to be sustained upon examination by the IRS, taking into account the technical merits of the positions and the probability of various outcomes.
7.2 C&H's Legal Analysis
C&H prepared a detailed legal analysis in September 2022 supporting PPC's FIN 48 reserve calculation. This analysis evaluated the technical merits of PPC's transfer pricing positions, assessed the likelihood that the IRS would propose adjustments, modeled various scenarios and their associated probabilities, and concluded that the $62.4 million reserve was appropriate. The analysis was provided to Crestfield & Associates LLP for purposes of supporting PPC's external audit.
7.3 Q1 2023 Assessment
Based on the developments during Q1 2023, no change to the FIN 48 reserve is recommended at this time. The examination remains in the information-gathering stage without any formal proposed adjustments having been issued. The engagement of the IRS economist, while a significant development, was anticipated in C&H's original analysis and does not, standing alone, alter the probability assessment underlying the reserve.
C&H will reassess the reserve analysis promptly upon the issuance of any NOPA or upon the occurrence of any other material development that could affect the probability-weighted analysis. In particular, the specific amount and basis of any IRS-proposed adjustment will be a critical input into the updated reserve analysis.
7.4 Institutional Shareholder Monitoring
PPC's management should be aware that Ridgeview Capital Management LP (Douglas Everett, Managing Partner), PPC's largest institutional shareholder at approximately 8.3% of outstanding shares, actively monitors FIN 48 disclosures in PPC's SEC filings. Any material change to the FIN 48 reserve will be reflected in PPC's financial statements and will likely attract attention from institutional investors and sell-side analysts. C&H will work with PPC's disclosure counsel and financial reporting team to ensure that any reserve adjustments are appropriately disclosed and communicated.
8. Hargrove Credit Facility Considerations
PPC's revolving credit facility of $1.5 billion with Hargrove National Bank, N.A. (100 Federal Street, Boston, Massachusetts 02110; Christine Bellucci, Senior Vice President, Relationship Manager) contains covenants relating to tax indemnities and material tax events. Specifically, certain provisions of the credit agreement require PPC to provide notice to the administrative agent upon the occurrence of a "Material Tax Event," which is defined to include, among other things, the receipt of a proposed deficiency or assessment from a taxing authority in excess of a specified threshold.
As of Q1 2023, no reporting obligation under the credit facility has been triggered. No formal proposed adjustment or deficiency notice has been issued by the IRS, and the examination remains in the information-gathering phase. Accordingly, the receipt of IDRs and the conduct of the examination itself do not constitute a Material Tax Event under the credit agreement.
C&H continues to monitor the covenant implications of the examination and will advise PPC promptly if any development triggers a reporting obligation or other covenant requirement. Upon the issuance of a NOPA, C&H will review the specific terms of the credit agreement in coordination with PPC's corporate counsel to determine whether notification is required.
9. SEC Disclosure Considerations
9.1 Ongoing Disclosure Obligations
PPC's ongoing obligations under the Securities Exchange Act of 1934 and the rules and regulations of the Securities and Exchange Commission require disclosure of material contingent liabilities, including pending or threatened tax controversies, in PPC's periodic filings on Forms 10-K and 10-Q. The applicable accounting standards (ASC 450, Contingencies, and ASC 740-10, Income Taxes) govern the recognition, measurement, and disclosure of contingent tax liabilities.
9.2 Current Disclosure Posture
PPC has disclosed the existence of the IRS examination in both its annual report on Form 10-K for the fiscal year ended December 31, 2022, and in its quarterly reports on Form 10-Q. The current disclosure describes the examination in general terms, identifies the tax years at issue, notes the existence of the FIN 48 reserve, and states that PPC believes its transfer pricing positions are well-supported and intends to vigorously defend its positions. C&H has reviewed and provided input on the current disclosure language.
9.3 Q1 2023 Assessment
Based on the developments during Q1 2023, no material change in SEC disclosure is required at this time. The examination remains in the information-gathering phase, no proposed adjustments have been issued, and the FIN 48 reserve has not been adjusted. The engagement of the IRS economist, while a meaningful development in the context of the examination defense, does not rise to the level of a material development requiring supplemental disclosure.
Disclosure will require updating upon the issuance of any NOPA or upon any other material development, such as a significant change to the FIN 48 reserve. C&H will coordinate with PPC's disclosure counsel and external auditors to ensure that any required updates are prepared on a timely basis.
10. Key Products Under Examination
The following is a brief summary of key product revenue data relevant to the transfer pricing issues under examination. This data provides context for the CSA cost-sharing ratios, the legacy IP royalty base, and the overall magnitude of the intercompany transactions at issue.
10.1 Veritaxol (Oncology)
Veritaxol is PPC's oncology blockbuster product, approved for the treatment of multiple solid tumor indications. For fiscal year 2020, Veritaxol generated global net sales of approximately $3.12 billion, of which approximately $1.34 billion was attributable to non-Americas markets served by PBI. Veritaxol is the largest single product in PPC's portfolio and is a primary driver of both the CSA cost-sharing ratio calculations (through its contribution to PBI's reasonably anticipated benefits) and the overall transfer pricing economics of the Irish structure.
10.2 Imvara (Immunology)
Imvara is PPC's leading immunology product, approved for the treatment of several autoimmune and inflammatory conditions. For fiscal year 2020, Imvara generated global net sales of approximately $1.87 billion, of which approximately $0.79 billion was attributable to non-Americas markets. Imvara represents PPC's second-largest product and is a significant contributor to PBI's revenue and profitability.
10.3 Cerulon (Rare Disease)
Cerulon is a specialty product in PPC's rare disease portfolio. For fiscal year 2020, Cerulon generated global net sales of approximately $0.62 billion, of which approximately $0.28 billion was attributable to non-Americas markets. While smaller in absolute terms than Veritaxol or Imvara, Cerulon commands premium pricing and generates high operating margins, which are relevant to the CPM/TNMM benchmarking analysis.
10.4 Legacy Compound Revenue Trends
The non-Americas net sales of legacy compounds subject to the 4.5% royalty rate declined over the examination period as follows:
This declining trend is consistent with the natural lifecycle of pharmaceutical products approaching and passing patent expiry and loss of exclusivity, and is relevant to the IRS's evaluation of the legacy IP royalty rate and the arm's-length character of the 4.5% rate applied to a diminishing revenue base.
11. Engagement Team and Contact Information
The following professionals are assigned to the PPC engagement:
Calderwood & Harkness LLP
Leonard Cross — Responsible Partner, Tax Calderwood & Harkness LLP 1735 Market Street, Suite 3100 Philadelphia, Pennsylvania 19103 Admitted: New York, New Jersey, District of Columbia Experience: 28 years specializing in transfer pricing controversy, IRS examination defense, and international tax disputes. Mr. Cross has represented multinational corporations in numerous large-scale transfer pricing examinations and Appeals proceedings, including multiple matters involving pharmaceutical and life sciences companies with cost-sharing arrangements and IP-intensive structures.
Sylvia Hartwell — Billing Partner, Tax Calderwood & Harkness LLP 600 Lexington Avenue New York, New York 10022 Admitted: New York, District of Columbia Experience: 22 years of experience in international tax controversy. Ms. Hartwell leads C&H's international tax controversy practice and has extensive experience with IRS LB&I examinations, competent authority proceedings, and transfer pricing disputes.
Garrett Simmons — Lead Associate, Tax Calderwood & Harkness LLP 1735 Market Street, Suite 3100 Philadelphia, Pennsylvania 19103 Admitted: New York Experience: 7 years of experience specializing in transfer pricing economic analysis and IRS controversy. Mr. Simmons serves as the day-to-day lead on IDR responses and economic analysis coordination with Whitmore Valuation Group.
Leila Nazari — Working Associate, Tax Calderwood & Harkness LLP 1735 Market Street, Suite 3100 Philadelphia, Pennsylvania 19103 Admitted: New York, New Jersey Experience: 4 years of experience focusing on international tax structuring and controversy support. Ms. Nazari manages the IDR tracker, privilege log, statute of limitations tracking, and coordination with Irish tax advisors.
Third-Party Consultant. Dr. Helena Vasquez — Managing Director Whitmore Valuation Group LLC 200 Ashbury Asset Advisors, Suite 700 Boston, Massachusetts 02109 Retained under Kovel arrangement dated June 20, 2022 (reference 1018-00009-KV). Dr. Vasquez leads the economic analysis team at Whitmore and is responsible for the CUT analysis, CPM/TNMM analysis, and PCT DCF valuation prepared in support of PPC's transfer pricing positions.
12. Action Items and Recommended Next Steps for Q2 2023
Based on the developments during Q1 2023 and the current status of the examination, C&H recommends the following action items for Q2 2023:
1. Continue IDR Responses. Continue preparing and filing responses to outstanding and anticipated IDRs, with a target of completing the IDR response phase by approximately September 2023. Maintain rigorous tracking of all IDRs, response deadlines, and privilege assertions through the master IDR tracker and privilege log.
2. Request Mid-Examination Conference. Submit a written request to the IRS examination team (Supervisory Revenue Agent Meskill and Lead Revenue Agent Dunleavy) for a mid-examination conference to discuss the status of the examination, narrow the remaining issues under consideration, and understand the IRS's preliminary areas of concern. Target date for the request: May 2023.
3. Engage with IRS Economist. Prepare for and participate in a meeting or telephone conference with IRS economist Dr. Alan Washburne to understand his analytical approach and methodology, and to present PPC's economic analyses proactively. C&H and Whitmore Valuation Group should jointly prepare presentation materials for this engagement.
4. Whitmore Rebuttal Preparation. Continue coordination with Whitmore Valuation Group on preparation for potential rebuttal work. Ensure that Whitmore's team maintains readiness to prepare a comprehensive rebuttal report on an expedited timeline following receipt of the IRS economist's analysis or the issuance of a NOPA.
5. Irish Tax Coordination. Continue coordination with Thornbury & Keogh on Irish tax aspects of the defense, including monitoring for any Irish Revenue activity, updating PBI substance documentation as needed, and ensuring alignment between the U.S. and Irish positions.
6. Crestfield Data Requests. Follow up with Crestfield & Associates LLP on any outstanding data requests for IDR responses. Ensure that Crestfield's workpapers and contemporaneous documentation remain accessible and organized for efficient retrieval.
7. Statute of Limitations Monitoring. Continue monitoring statute of limitations dates for all four tax years. Prepare Form 872 extension requests as needed, particularly for TY 2019, where the original statutory period may be approaching expiration.
8. Quarterly Status Call. Schedule a quarterly status call with PPC management (Whitfield, Staines, and Iyer) to discuss developments, strategy, and any decisions requiring client input. C&H recommends scheduling this call for the first or second week of July 2023, following the conclusion of Q2.
9. SEC and Credit Facility Monitoring. Continue monitoring SEC disclosure requirements and Hargrove credit facility covenant implications. Advise PPC promptly of any development that triggers a reporting obligation or disclosure update.
13. Conclusion
The IRS examination of PPC's transfer pricing for TY 2017–2020 remains in the information-gathering phase as of the end of Q1 2023. No formal proposed adjustments have been issued, and the examination is proceeding in an orderly fashion through the IDR process.
PPC's transfer pricing positions — the CSA cost-sharing ratios, the legacy IP royalty rate of 4.5%, and the PCT payment of $312 million — are well-documented by contemporaneous transfer pricing studies and supported by the robust independent economic analyses prepared by Whitmore Valuation Group. The updated functional analysis for PBI, completed in March 2023, further strengthens PPC's position on the economic substance of PBI and its role as a bona fide CSA participant and IP-holding company.
The IRS's engagement of economist Dr. Alan Washburne is a significant but fully anticipated development that signals the examination is progressing toward the formulation of proposed adjustments. C&H and Whitmore are well-positioned to engage proactively with the IRS economist and to respond comprehensively to any proposed adjustment that may be issued.
The next Matter Status Report, covering Q2 2023 activity, will address the outcomes of the mid-examination conference (if held), further IDR activity and responses, any developments arising from the IRS economist's analysis, and updated projections for the NOPA timeline.
C&H remains available to discuss any aspect of the examination defense at PPC's convenience. Please do not hesitate to contact Leonard Cross (direct line and email on file) or Sylvia Hartwell (direct line and email on file) with any questions or to schedule a discussion.
Respectfully submitted,
CALDERWOOD & HARKNESS LLP
By: ________
Leonard Cross Partner, Tax Department 1735 Market Street, Suite 3100 Philadelphia, PA 19103
By: ________
Sylvia Hartwell Partner, Tax Department 600 Lexington Avenue New York, NY 10022
Date: April 3, 2023