PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
Appeals Conference Talking Points — Leonard Cross
February 28, 2024
Conference Attendees — PPC Side:
IRS Side:
This memorandum is prepared solely for the internal use of Leonard Cross and the Calderwood & Harkness LLP engagement team in connection with the IRS Appeals conference scheduled for February 28, 2024. This document constitutes attorney work product and is protected from disclosure under the work-product doctrine. It contains attorney mental impressions, conclusions, opinions, and legal theories, as well as confidential settlement parameters authorized by the client. Under no circumstances should this document, or any portion thereof, be provided or disclosed to the IRS, the Appeals Officer, or any third party. If the Appeals Officer requests a copy of any presentation materials, refer her to the Formal Protest and accompanying exhibits, which have been separately filed.
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I. Opening Statement Talking Points
I.A. Introduction and Framing
Mr. Cross should open the conference by thanking Appeals Officer Castañeda for scheduling the conference and for her attention to the matter. The introduction should be warm, professional, and efficient. The following script provides a framework, though Mr. Cross should deliver the remarks conversationally.
Suggested Language:
"Good morning, Ms. Castañeda. Thank you for scheduling this conference and for the time you have devoted to reviewing the Protest and the administrative record. We appreciate the opportunity to present Penterra Pharmaceuticals' position on the proposed adjustments, and we look forward to a productive discussion."
Mr. Cross should then introduce each attendee by name, affiliation, and role:
• Leonard Cross — Lead counsel, Calderwood & Harkness LLP, representing Penterra Pharmaceuticals Corp. in this matter.
• Sylvia Hartwell — Calderwood & Harkness LLP, senior member of the engagement team.
• Garrett Simmons — Calderwood & Harkness LLP, will be available for document reference support.
• Marcus Whitfield — Vice President, Global Tax, Penterra Pharmaceuticals Corp. Mr. Whitfield oversees PPC's global tax function and has direct knowledge of the company's intercompany arrangements and operations.
• Deborah Staines — General Counsel, Penterra Pharmaceuticals Corp. Ms. Staines is available to address any legal or governance questions relating to PPC and its subsidiaries.
• Dr. Helena Vasquez — Managing Director, Whitmore Valuation Group LLC. Dr. Vasquez is PPC's economic expert and led the transfer pricing economic analysis supporting PPC's positions. She is available to address any technical economic questions the Appeals Officer may have.
Mr. Cross should then provide a brief background on the taxpayer:
Penterra Pharmaceuticals Corp. ("PPC") is a publicly traded specialty pharmaceutical and biotechnology company headquartered at 2200 Independence Boulevard, Princeton Junction, New Jersey 08550. PPC's common stock is listed on the Nasdaq Global Select Market under the ticker symbol PPCA. For fiscal year 2020, PPC reported total revenue of approximately $6.82 billion. The company employs approximately 14,500 people globally and focuses on the development, manufacture, and commercialization of therapeutics in three primary areas: oncology, immunology, and rare-disease therapeutics.
The examination at issue involves tax years 2017, 2018, 2019, and 2020. The examination was conducted by LB&I Northeast Transfer Pricing Examination Team, Exam Team ID LB&I-NE-TP-2022-00641, and was opened on May 16, 2022.
Following the conclusion of the examination, PPC received a Notice of Proposed Adjustment ("NOPA") dated October 12, 2023, proposing a net adjustment of $380.4 million across the four tax years. PPC timely filed its Formal Protest on December 22, 2023, contesting the proposed adjustments in their entirety.
PPC respectfully submits that the proposed adjustments are without merit on both legal and economic grounds. The transfer pricing methodologies employed by PPC fully satisfy the arm's-length standard under Internal Revenue Code Section 482 and the Treasury Regulations promulgated thereunder. PPC's intercompany arrangements reflect genuine economic substance, contemporaneous documentation, and pricing consistent with arm's-length results as measured by multiple reliable methods.
I.B. Summary of PPC's Position
After the introductory framing, Mr. Cross should provide a concise overview of PPC's affirmative position. This summary is designed to orient the Appeals Officer before the detailed discussion of each issue.
Suggested Language:
PPC's position rests on four principal pillars:
First, PPC's intercompany arrangements — specifically, the qualified cost-sharing arrangement ("CSA") with Penterra Biopharma International DAC ("PBI"), and the legacy IP royalty license — reflect arm's-length pricing. Both arrangements are supported by contemporaneous transfer pricing documentation and robust economic analyses prepared by qualified professionals. The cost-sharing ratios were determined using the reasonably anticipated benefits methodology required by Treasury Regulation Section 1.482-7 and corroborated by a CPM/TNMM analysis. The royalty rate was established using the comparable uncontrolled transaction ("CUT") method under Treasury Regulation Section 1.482-4, and the 4.5% rate falls squarely within — and essentially at the median of — the interquartile range of 14 comparable uncontrolled license agreements.
Second, PBI is a substantive Irish entity that performs real Development, Enhancement, Maintenance, Protection, and Exploitation ("DEMPE") functions with respect to the pharmaceutical IP it co-owns under the CSA and the legacy IP it licenses. PBI has genuine economic substance, with 185 employees, independent governance, and a track record of autonomous commercial decision-making across 68 country markets outside the Americas.
Third, PPC's contemporaneous transfer pricing documentation for all four tax years satisfies the requirements of Treasury Regulation Section 1.6662-6(d) and establishes penalty protection under IRC Section 6662(e)(3)(B). PPC acted in good faith and with reasonable cause in adopting its transfer pricing positions.
Fourth, the examination team's proposed adjustments overstate PPC's U.S.-source income by a factor of approximately eight times relative to what the arm's-length standard supports. The proposed adjustments are based on flawed methodological choices — including an inappropriately low discount rate for PCT valuation, an outlier royalty rate that falls well above the interquartile range of properly selected comparables, and cost-sharing ratio adjustments that disregard PBI's actual and projected revenue performance.
I.C. Summary of the IRS Proposed Adjustment
Mr. Cross should briefly summarize the proposed adjustments so that all parties are working from the same baseline. This also demonstrates command of the record and invites the Appeals Officer to follow along.
Suggested Language:
"For the record, let me briefly summarize the proposed adjustments as set forth in the NOPA dated October 12, 2023."
The proposed adjustments are structured as follows:
In addition, the IRS has proposed a substantial valuation misstatement penalty under IRC Section 6662(e) in the amount of $15,980,000, computed as 20% of the tax underpayment attributable to the proposed $380.4 million adjustment at the 21% corporate tax rate.
PPC contests each of these proposed adjustments and the proposed penalty in their entirety. We will now address each issue in turn.
II. Issue 1: Cost-Sharing Arrangement — Reasonably Anticipated Benefits and Cost-Sharing Ratios
II.A. Background and Key Facts
This is the largest of the proposed adjustments at $235.01 million, and the area of greatest quantitative contention between PPC and the examination team. Mr. Cross should lay the factual foundation carefully.
Key Facts to Establish:
The CSA was executed effective July 1, 2012, between PPC, as the U.S.-based participant, and PBI, as the non-U.S. participant. The CSA is a qualified cost-sharing arrangement within the meaning of Treasury Regulation Section 1.482-7.
PBI was incorporated on March 15, 2012, as a Designated Activity Company under Irish law. It is registered at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4, Ireland. PBI is a wholly owned subsidiary of Penterra Holdings Luxembourg S.à r.l. ("PHL"), a Luxembourg société à responsabilité limitée located at 14 rue Aldringen, L-1118 Luxembourg. PHL is treated as a disregarded entity for U.S. federal income tax purposes. PHL is, in turn, wholly owned by PPC, such that PBI is an indirect, wholly owned subsidiary of PPC.
Under the terms of the CSA, PBI acquired the right to develop and exploit PPC's pharmaceutical intellectual property portfolio outside the Americas — defined as North America, Central America, South America, and the Caribbean. In exchange for these rights, PBI made a platform contribution transaction ("PCT") payment of $312 million as a lump sum on July 1, 2012, compensating PPC for the value of pre-existing intangible property contributed to the CSA. In addition, PBI makes ongoing cost-sharing payments proportional to its reasonably anticipated benefits ("RAB") from the covered intangibles.
PBI's cost-sharing percentages for the tax years at issue, and the resulting cost-sharing payments, are as follows:
These percentages were determined based on projected revenue splits between PPC's Americas territory and PBI's non-Americas territory, as required under the RAB methodology. The projections were built product by product, reflecting the specific revenue trajectories of PPC's key therapeutic products — Veritaxol (oncology), Imvara (immunology), and Cerulon (rare disease) — across each geographic territory.
II.B. IRS Position (to Rebut)
The examination team's NOPA proposes increasing PBI's cost-sharing percentage by 8 to 12 percentage points across the four examination years, as follows:
The examination team's primary theory is that PPC's revenue projections for purposes of determining reasonably anticipated benefits understated the value attributable to U.S.-source activities. In essence, the IRS contends that a greater share of total anticipated value should be allocated to U.S.-originated functions, thereby increasing PBI's share of costs to compensate for the purported underallocation.
Additionally, the IRS economist, Dr. Alan Washburne, asserts that the $312 million PCT payment made in 2012 undervalued the pre-existing IP by approximately $540 million. Using the income method with a weighted average cost of capital ("WACC") of 7.2% and different revenue projections, the IRS valued the pre-existing IP portfolio at $852 million. Although 2012 falls outside the examination period, the IRS relies on this purported undervaluation as a basis to recharacterize the ongoing CSA ratios for 2017 through 2020, arguing that the ratios are infected by the same projections and methodological assumptions that allegedly produced an undervalued PCT.
II.C. PPC's Affirmative Talking Points
Mr. Cross should present the following affirmative points in support of PPC's cost-sharing ratios. These talking points establish that the ratios were properly determined under the applicable regulations and are corroborated by reliable economic analysis.
Point 1: Methodology Complies with the Regulations.
PPC's cost-sharing ratios were determined using the methodology prescribed by Treasury Regulation Section 1.482-7, which requires cost-sharing payments to be proportional to each participant's share of reasonably anticipated benefits from the covered intangibles. PPC measured RAB using projected revenue splits between the Americas territory and the non-Americas territory. This is a standard and well-accepted approach under the regulations, and it was applied consistently across all four tax years.
Point 2: Revenue Projections Were Contemporaneous and Product-Specific.
The revenue projections underlying the RAB calculations were not generic estimates or top-down allocations. They were prepared contemporaneously using detailed, product-by-product forecasts for PPC's three principal therapeutic products: Veritaxol (oncology), Imvara (immunology), and Cerulon (rare disease). These forecasts reflected actual market data, regulatory timelines in each territory, competitive dynamics, patent expiration schedules, and geographic market-penetration assumptions. The projections were prepared by PPC's commercial finance team in coordination with PBI's commercial strategy group and reviewed by PPC's transfer pricing advisors at Crestfield & Associates LLP.
Point 3: Actual Revenue Data Validates the Projections.
The actual non-Americas share of total revenue was consistently in the 38% to 43% range across all three key products, precisely tracking the cost-sharing percentages used by PPC:
These actual results demonstrate that PPC's projections were reasonable and that the cost-sharing ratios accurately reflected the economic reality of the business. The non-Americas revenue share tracked within a narrow band that is fully consistent with PBI's cost-sharing percentages of 38.2% to 42.7% over the period.
Point 4: CPM/TNMM Analysis Confirms Arm's-Length Results.
In addition to the RAB methodology, Whitmore Valuation Group LLC conducted a comparable profits method ("CPM") / transactional net margin method ("TNMM") analysis to test whether PBI's operating results were consistent with arm's-length outcomes. Dr. Vasquez and her team identified 22 comparable distributor and IP-holding companies and benchmarked PBI's operating margins against this set. In all four examination years, PBI's operating margins fell within the interquartile range of the comparables, confirming that PBI earned arm's-length returns. This analysis provides independent corroboration of the CSA ratios under the best method rule of Treasury Regulation Section 1.482-1(d).
Point 5: Gradual Increase in PBI's Cost-Sharing Percentage Is Economically Rational.
The gradual increase in PBI's cost-sharing percentage — from 38.2% in 2017 to 42.7% in 2020 — reflects the organic growth in non-Americas revenue as PBI expanded its commercial operations into additional country markets. By 2020, PBI was operating in 68 markets across EMEA and APAC. This growth trajectory is precisely what one would expect from a substantive pharmaceutical operation investing in market entry and commercial infrastructure. The increasing cost-sharing percentage tracks the increasing proportion of anticipated benefits accruing to PBI's territory, as the regulations require.
II.D. Rebuttal of PCT Undervaluation Claim
The IRS's secondary argument — that the $312 million PCT payment undervalued the pre-existing IP portfolio — requires direct rebuttal, even though it relates to a transaction that occurred in 2012, outside the examination years.
Point 1: The IRS's WACC Is Inappropriately Low.
The IRS's $852 million PCT valuation relies on Dr. Alan Washburne's income method / Discounted cash flow ("DCF") analysis using a weighted average cost of capital of 7.2%. This discount rate is inappropriately low for a pharmaceutical IP portfolio at PBI's stage of development. A 7.2% WACC would be appropriate for the overall cost of capital of a large, diversified, mature pharmaceutical company with a portfolio of approved, commercialized products and predictable cash flows. It is not appropriate for valuing a specific IP portfolio that, as of July 2012, included clinical-stage compounds subject to significant regulatory approval risk, market-entry risk in multiple international territories, and pipeline attrition risk inherent in pharmaceutical development.
Point 2: Dr. Vasquez's Independent Analysis Supports PPC's PCT Payment.
Dr. Helena Vasquez and Dr. Rohan Chakrabarti of Whitmore Valuation Group LLC conducted an independent income method / DCF analysis of the pre-existing IP portfolio using a WACC of 9.8%. This discount rate was derived using standard cost-of-capital methodology with pharmaceutical-industry betas, adjusted for company-specific risk factors including the clinical-stage profile of certain compounds and the geographic market-entry risks associated with PBI's non-Americas territory. The 9.8% WACC reflects appropriate risk premiums for pharmaceutical IP, including regulatory risk, market-entry risk, and pipeline attrition. The Whitmore analysis yields an arm's-length range of $278 million to $361 million for the PCT. The $312 million lump-sum payment made by PBI falls squarely within this arm's-length range, at approximately the midpoint.
Point 3: The IRS's Revenue Projections Were Aggressive.
Dr. Washburne's revenue projections assumed substantially higher non-Americas growth rates than were supported by contemporaneous market data available as of mid-2012. His projections embedded aggressive assumptions regarding the speed and breadth of PBI's market penetration in EMEA and APAC territories, including markets where regulatory approvals had not yet been obtained and where PBI had not yet established commercial infrastructure. These assumptions inflated the projected cash flows and, in turn, inflated the PCT valuation.
Point 4: Even Correcting the IRS's Own Model Produces a Lower Valuation.
Even accepting the IRS's own DCF methodology and revenue projections but correcting the discount rate from 7.2% to 9.8%, the resulting PCT valuation falls well below $852 million, substantially narrowing the gap and demonstrating that the discount rate is the primary driver of the difference. The sensitivity analysis is documented in Dr. Vasquez's rebuttal memorandum, which was submitted as part of the Formal Protest.
Point 5: 2012 Is Outside the Examination Period — The PCT Cannot Be Used as a Backdoor Adjustment.
The 2012 PCT transaction falls outside the examination period of TY 2017 through TY 2020. The IRS cannot use a backdoor recharacterization of the PCT value to inflate ongoing cost-sharing ratios when those ratios independently satisfy the arm's-length standard based on their own RAB analysis and CPM/TNMM corroboration. The regulations require the CSA ratios to be tested on a year-by-year basis using reasonably anticipated benefits, not reverse-engineered from a disputed valuation of a pre-period transaction.
II.E. Anticipated Questions and Responses
The following questions may arise during the conference regarding the CSA cost-sharing ratio issue. Mr. Cross should be prepared to respond substantively but concisely.
Q: Why did PBI's cost-sharing percentage increase over the period?
A: The cost-sharing percentages increased from 38.2% to 42.7% because non-Americas revenue grew as a proportion of global revenue during this period. This growth was driven by PBI's successful market-entry efforts in additional countries, particularly for Veritaxol in EMEA and APAC territories. The cost-sharing ratios tracked actual and projected revenue splits on a year-by-year basis, as required by Treasury Regulation Section 1.482-7. This is not an indication of manipulation; it is the natural result of applying the prescribed methodology to an expanding international business.
Q: How did PPC determine the WACC for the PCT valuation?
A: Dr. Vasquez at Whitmore Valuation Group applied standard cost-of-capital methodology using pharmaceutical-industry betas from publicly available datasets, adjusted for company-specific risk factors. The 9.8% WACC reflects the risk profile of an IP portfolio that, as of the July 2012 valuation date, included both approved compounds and clinical-stage compounds with meaningful attrition risk. The methodology and supporting data are fully documented in Whitmore's discount rate and WACC analysis, which is included as an exhibit to the Formal Protest. Dr. Vasquez is available to walk through the analysis in detail if the Appeals Officer has technical questions.
Q: What is PPC's position on the best method for testing the CSA?
A: PPC applied the reasonably anticipated benefits method under Treasury Regulation Section 1.482-7(e), which is the prescribed method for determining cost-sharing ratios under a QCSA. PPC corroborated the RAB results using a CPM/TNMM analysis of PBI's operating margins benchmarked against 22 comparable companies. Both methods confirm arm's-length results. Under the best method rule of Treasury Regulation Section 1.482-1(d), the RAB method is the most direct and reliable method for testing the cost-sharing ratios, and the CPM/TNMM analysis provides valuable corroboration.
Q: Did the Tax Cuts and Jobs Act rate change from 35% to 21% affect the cost-sharing ratio calculation?
A: No. The cost-sharing ratios are based on reasonably anticipated benefits, which are measured by projected revenues — an economic measure that is independent of statutory tax rates. The TCJA's reduction of the corporate tax rate from 35% to 21%, effective January 1, 2018, affected the tax cost of any proposed adjustment (i.e., the tax liability flowing from an adjustment) but did not alter the underlying economic methodology used to determine the cost-sharing percentages. PPC did not change its CSA methodology or cost-sharing ratios in response to the TCJA.
III. Issue 2: Legacy IP Royalty Rate (4.5% vs. IRS's 11.0%)
III.A. Background and Key Facts
In addition to the CSA governing the jointly developed IP portfolio, PBI licenses certain legacy compounds from PPC. These are compounds that pre-date the formation of the CSA in 2012 and are not covered by the cost-sharing arrangement. PBI pays PPC a royalty of 4.5% of net sales of these legacy compounds in the non-Americas territory.
The legacy compound portfolio consists of mature pharmaceutical products that had been commercialized by PPC prior to the formation of PBI and the CSA. These products are in the later stages of their commercial lifecycles, with declining revenue trajectories reflecting patent expirations, loss of data exclusivity, and increasing generic competition.
PBI's net sales of legacy compounds in the non-Americas territory, and the resulting royalty payments to PPC, are as follows:
The declining sales trajectory over the four-year period is significant. It reflects the natural lifecycle maturation of the legacy products — patent expirations, entry of generic competitors, and therapeutic substitution as newer products (including those developed under the CSA) displaced legacy treatments. This declining trajectory is a hallmark of mature pharmaceutical IP and is a factor that must be considered in selecting comparable royalty rates.
III.B. IRS Position (to Rebut)
The examination team proposes increasing the royalty rate from 4.5% to 11.0%, asserting that PPC's legacy IP commands a higher royalty based on the IRS economist's analysis of third-party pharmaceutical licensing agreements using the comparable uncontrolled transaction ("CUT") method.
The proposed additional royalty adjustments are as follows:
The 11.0% royalty rate proposed by the IRS is more than double PPC's 4.5% rate and represents a dramatic departure from the arm's-length range established by properly selected comparable transactions.
III.C. PPC's Affirmative Talking Points
Point 1: PPC Applied the CUT Method — the Best Method for Royalty Rate Testing.
PPC applied the comparable uncontrolled transaction method under Treasury Regulation Section 1.482-4, which is the most direct and reliable method for testing intercompany royalty rates when comparable third-party license agreements are available. The CUT method directly compares the royalty rate charged in the controlled transaction (PPC-to-PBI, 4.5%) with royalty rates observed in comparable uncontrolled transactions between unrelated parties. When reliable CUTs are available — as they are here — the CUT method is the best method under the hierarchy established by the regulations.
Point 2: The 4.5% Rate Falls Within the Interquartile Range and at the Median.
Whitmore Valuation Group LLC, through Dr. Vasquez and Dr. Chakrabarti, identified 14 comparable uncontrolled pharmaceutical license agreements through a rigorous screening process. These agreements were selected based on detailed comparability criteria, including therapeutic area, product maturity, geographic scope, exclusivity terms, risk allocation, and royalty base definitions. The statistical results of the comparable set are as follows:
PPC's 4.5% royalty rate falls within the interquartile range and is virtually identical to the median of the comparable set at 4.4%. This is precisely the result the arm's-length standard is designed to produce. A controlled transaction that falls within the interquartile range of comparables satisfies the arm's-length standard, and no adjustment is warranted under Treasury Regulation Section 1.482-1(d).
Point 3: The IRS's 11.0% Rate Is an Outlier.
The IRS's proposed 11.0% royalty rate is more than 4 percentage points above the top of the interquartile range (6.8%). An 11.0% rate is an outlier result that does not reflect arm's-length pricing as determined by the weight of the comparable evidence. If anything, the IRS's proposed rate would place PBI's royalty obligation well above what any unrelated licensee would agree to pay for mature pharmaceutical IP with declining sales and increasing generic competition.
Point 4: The IRS's Comparable Selection Is Flawed.
Dr. Washburne's analysis selected a different set of CUT agreements that fail proper comparability analysis under Treasury Regulation Section 1.482-4(c). Specifically, Dr. Washburne's comparables include agreements that:
• Involve different therapeutic areas with materially different market dynamics and competitive landscapes than PPC's legacy oncology and immunology products;
• Cover early-stage or pre-approval compounds with significantly different risk profiles (higher risk justifies higher royalty rates, but is not comparable to PPC's mature, approved legacy compounds);
• Provide for exclusive worldwide rights rather than geographically limited non-Americas rights, reflecting a broader scope of exclusivity that commands a premium not applicable to PBI's license; and
• Allocate risk differently, including agreements where the licensee bears development risk that PBI does not bear for the legacy products (which are already fully developed and approved).
These comparability defects render Dr. Washburne's CUT set unreliable. The resulting 11.0% rate reflects selection bias in the IRS's comparable search, not an arm's-length result. Dr. Vasquez and Dr. Chakrabarti's rebuttal memorandum, prepared in January 2024 and submitted with the Formal Protest, provides a detailed, agreement-by-agreement critique of the IRS economist's CUT selection criteria.
Point 5: The Declining Sales Trajectory Supports a Lower Rate.
The legacy compound portfolio generated $814.6 million in non-Americas net sales in 2017, declining to $624.1 million by 2020 — a 23.4% decline over four years. This trajectory reflects the natural lifecycle of mature pharmaceutical products facing patent expirations and increasing generic competition. As the economic value of the licensed IP diminishes over time, the appropriate arm's-length royalty rate declines correspondingly, or at minimum remains stable. A royalty rate of 4.5% on a declining revenue base is entirely consistent with arm's-length pricing. If anything, the declining trajectory further supports a rate at or below the median, not an increase to 11.0%.
III.D. Anticipated Questions and Responses
Q: Why did PPC use a 4.5% rate rather than the median 4.4%?
A: The 4.5% royalty rate was established at the time the legacy license was negotiated, prior to 2012, based on contemporaneous benchmarking against available comparable agreements. It is within the interquartile range and essentially at the median. The 0.1 percentage point difference between 4.5% and the 4.4% median is immaterial — it translates to approximately $624,000 per year at the 2020 revenue level. This difference does not give rise to an adjustment under the arm's-length standard. The regulations do not require the taxpayer to hit the exact median; they require the result to fall within the range of arm's-length outcomes, which it clearly does.
Q: How did the IRS arrive at 11.0%?
A: Dr. Washburne's analysis selected a different set of CUT agreements that are not properly comparable to PBI's legacy license. His CUTs include licenses involving pipeline compounds in the pre-approval stage, exclusive worldwide rights, and materially different risk profiles. These agreements command higher royalty rates because they reflect higher risk, broader exclusivity, and different value contributions — none of which are present in PBI's legacy license of mature, approved products in a limited geographic territory. The 11.0% rate reflects selection bias in the IRS economist's comparables, not an arm's-length result. Dr. Vasquez can walk through the specific deficiencies in Dr. Washburne's comparable set if the Appeals Officer has questions.
Q: Did PPC consider any method other than the CUT method?
A: The CUT method is the most reliable method under the best method rule when reliable comparable transactions are available, which they are here. Whitmore Valuation Group identified 14 comparable license agreements that meet the comparability requirements of Treasury Regulation Section 1.482-4(c). Given the availability of reliable CUTs, the CUT method is the best method. Whitmore also corroborated the CUT result using the CPM/TNMM as a secondary method, which confirmed that PBI's operating results were consistent with arm's-length returns after accounting for the 4.5% royalty payment.
Q: What about the declining sales trajectory — shouldn't that affect the rate?
A: If anything, the declining trajectory supports a lower rate, not a higher one. Legacy products face generic competition and patent expirations that progressively erode the value of the licensed IP. An arm's-length licensee would not agree to pay a higher royalty rate for IP of diminishing commercial value. The 4.5% rate, applied to a declining revenue base, produces a declining stream of royalty payments — from $36.66 million in 2017 to $28.08 million in 2020 — which is precisely the economic result one would expect in an arm's-length arrangement involving mature pharmaceutical IP.
IV. Issue 3: Economic Substance of PBI
IV.A. Background and Key Facts
The IRS's NOPA asserted, in part, that PBI lacked sufficient economic substance to justify its role as IP owner and CSA participant. The examination team argued that key DEMPE functions — Development, Enhancement, Maintenance, Protection, and Exploitation — remained concentrated in the United States, and that PBI was essentially a holding company or conduit entity without the functional capacity to earn the returns it reported.
This assertion is not merely wrong — it is contradicted by overwhelming evidence in the administrative record. PPC's evidence of PBI's economic substance is extensive, documented, and was provided to the examination team in response to multiple Information Document Requests throughout the course of the examination.
IV.B. PPC's Affirmative Talking Points — PBI Substance Evidence
Mr. Cross should present the following evidence systematically, covering personnel, governance, physical presence, regulatory activity, commercial decision-making, risk bearing, financial infrastructure, manufacturing oversight, and financial scale.
Personnel:
PBI grew from 52 employees at the time of incorporation in 2012 to 185 employees by the end of 2020. PBI's workforce includes professionals across regulatory affairs, medical affairs, commercial strategy, supply chain management, market access, pharmacovigilance, quality assurance, and finance. This is not a token headcount — it represents a full-service pharmaceutical operation capable of managing drug commercialization across 68 country markets.
Managing Director:
Aidan Naughton serves as Managing Director of PBI and has held that position since 2013. Mr. Naughton is resident in Ireland and has day-to-day authority over PBI's non-Americas commercial operations. He is a pharmaceutical industry veteran with over 25 years of experience in international pharmaceutical commercialization. Mr. Naughton makes key decisions regarding market entry, pricing strategy, distribution partner selection, and resource allocation across PBI's territories.
Board Governance:
PBI held 42 board meetings during the 2017 through 2020 period, all conducted in Dublin, Ireland. These meetings occurred on at least a quarterly basis, with additional special sessions as needed. Board minutes — which were produced in response to IDR No. 5 — document substantive decision-making on matters including product pricing in specific country markets, market entry timing and strategy, regulatory submission priorities, distribution partner selection and termination, capital expenditure approvals, and intercompany arrangement terms. The board minutes reflect genuine governance, not pro forma rubber-stamping.
Office Presence:
PBI maintains approximately 18,000 square feet of office space at Claremont House, Sandyford Business Park, Dublin D18 K7T4, Ireland. This facility houses PBI's management team, regulatory and medical affairs staff, commercial operations personnel, and support functions. The office is a functioning pharmaceutical headquarters, not a registered-office mailbox.
Regulatory Expenditures:
PBI incurred cumulative regulatory expenditures of €47.2 million during the 2017 through 2020 period. These expenditures covered drug registration and approval submissions across PBI's non-Americas markets, including submissions to the European Medicines Agency ("EMA"), national competent authorities in EMEA, and regulatory bodies across APAC. Regulatory submissions are among the most critical DEMPE functions in the pharmaceutical industry, and PBI's substantial and sustained investment in regulatory activities is compelling evidence of its substantive role.
Independent Commercial Decisions:
PBI independently made pricing decisions across 68 country markets in EMEA and APAC. Pricing in the pharmaceutical industry is highly localized, reflecting national reimbursement systems, reference pricing frameworks, formulary negotiations, and competitive dynamics. PBI's internal pricing approval memos, which were produced during the examination, demonstrate that PBI's commercial team analyzed local market conditions and made independent pricing recommendations that were approved by PBI management, not directed from PPC's headquarters in Princeton Junction.
Risk Bearing:
PBI bore market risk for all non-Americas territories. PBI made key decisions regarding the timing and sequencing of market entry in new countries, pricing levels within each market, the selection and management of distribution partners, and the allocation of commercial resources across its portfolio of products and territories. These are the kinds of strategic risk decisions that distinguish a substantive business operation from a passive holding entity.
Banking and Treasury:
PBI maintained independent treasury operations with Glenmore Bank Ireland plc, its principal Irish bank. PBI managed its own cash flows, inter-company settlement processes, foreign exchange exposure, and funding of operating expenditures through its Irish banking relationships.
Contract Manufacturing Management:
PBI managed its contract manufacturer, Penterra Manufacturing Ireland Ltd. ("PMI"), located at Unit 7, Ringaskiddy Industrial Estate, Co. Cork T12 PX29, Ireland. PMI operates under a cost-plus 8% arrangement with PBI and employs approximately 620 people manufacturing oncology and immunology biologics. PBI's supply chain team was responsible for production scheduling, quality oversight, inventory management, and distribution logistics for the non-Americas territory. The management of a 620-person manufacturing operation is a significant commercial function that demonstrates PBI's operational depth.
Personnel Interviews:
Calderwood & Harkness LLP and Whitmore Valuation Group LLC conducted interviews of 12 key PBI employees in Dublin during August and September 2022. All 12 interviewees confirmed that they exercised substantive decision-making authority and performed genuine functional roles within PBI's operations. The interviews covered regulatory affairs, medical affairs, commercial strategy, supply chain management, and finance, and the interview summaries were provided to the examination team.
Financial Scale:
PBI generated €2.14 billion in revenue and €1.06 billion in pre-tax income in fiscal year 2020. An entity with over €2 billion in annual revenue, 185 employees, 68 country markets, a managed manufacturing facility with 620 employees, and €47.2 million in regulatory expenditures is not a "shell" or a "conduit." It is a substantial, functioning pharmaceutical business.
IV.C. DEMPE Analysis Framework
To organize the economic substance evidence within the analytical framework that the Appeals Officer will apply, Mr. Cross should walk through each DEMPE function and demonstrate PBI's substantive contributions. The following analysis corresponds to the DEMPE Functions Matrix that has been prepared as an exhibit.
Development:
PBI co-funded R&D costs under the CSA, bearing 38.2% to 42.7% of total qualified R&D costs during the examination years. PBI's cost-sharing payments during 2017–2020 totaled approximately $879.7 million. This is not passive co-funding — PBI's regulatory affairs personnel managed non-Americas clinical trial coordination, regulatory submissions, and approval processes. PBI's development contribution is both financial (through cost-sharing) and functional (through regulatory management).
Enhancement:
PBI's medical affairs team conducted post-marketing studies, label extension work, and pharmacovigilance activities for non-Americas territories. These enhancement activities improved and expanded the value of the covered intangibles in PBI's territory, including the development of additional indications and the generation of real-world evidence data to support reimbursement submissions.
Maintenance:
PBI managed product lifecycle activities, including pharmacovigilance (adverse event reporting and risk management), quality oversight (coordination with PMI and external contract manufacturers), and ongoing regulatory compliance (post-approval commitments, variations, and periodic safety update reports) for the non-Americas territory.
Protection:
PBI managed intellectual property protection and enforcement in its territories. This included non-Americas patent filings, patent prosecution, trademark registrations, and enforcement actions against infringers. PBI's legal team coordinated with local counsel in multiple jurisdictions to maintain and defend the IP portfolio.
Exploitation:
PBI served as the principal for non-Americas commercialization. PBI managed distribution arrangements with third-party distributors and direct sales organizations, set pricing across 68 country markets, negotiated market access and reimbursement terms with national health authorities and payers, and directed marketing and commercial strategy for its territory. PBI's exploitation function is the revenue-generating core of its business and is performed entirely by PBI's own personnel under PBI's own governance.
The DEMPE Functions Matrix, prepared as an exhibit, details the allocation of each function between PPC (United States) and PBI (Ireland) for each of PPC's three key products — Veritaxol, Imvara, and Cerulon. Mr. Cross should reference this exhibit by tab number during the conference.
IV.D. Legal Authority
The legal standard for economic substance in the transfer pricing context is well established and supports PBI's position.
Under Treasury Regulation Section 1.482-7, a controlled participant in a qualified cost-sharing arrangement must exercise control over the development and exploitation of the covered intangibles. PBI clearly satisfies this requirement through its co-funding of R&D, its management of non-Americas regulatory processes, and its autonomous commercialization of the covered products across 68 country markets.
The OECD Transfer Pricing Guidelines, as revised in 2017 and 2022, devote extensive attention to the DEMPE framework in Chapter VI (Special Considerations for Intangibles) and Chapter VIII (Cost Contribution Arrangements). The OECD guidance provides that an entity claiming entitlement to IP-related returns must perform the DEMPE functions that generate those returns, or must control and bear the risk associated with those functions. PBI satisfies this requirement across all five DEMPE dimensions, as documented above.
The economic substance doctrine, as applied in the transfer pricing context, requires that the entity have meaningful operations — not merely a legal domicile or a set of signed agreements. PBI clearly exceeds any reasonable threshold for economic substance, with 185 employees, €47.2 million in regulatory expenditures, 42 board meetings over four years, independent pricing authority across 68 country markets, and management of a 620-person manufacturing operation. The examination team's characterization of PBI as lacking substance is not supported by the record.
IV.E. Anticipated Questions and Responses
Q: How much of PPC's total R&D activity was performed in the U.S. versus Ireland?
A: The majority of laboratory research and early-stage clinical development was performed in the United States at PPC's research facilities. However, PBI managed non-Americas regulatory submissions, late-stage clinical trial coordination for non-Americas jurisdictions, and commercial development activities in its territory. The CSA structure is specifically designed to address this division of labor: PPC performs the bulk of the R&D, and PBI compensates PPC for PBI's share of those costs through the cost-sharing payments. PBI's entitlement to returns from the covered intangibles derives not only from its financial co-funding of R&D, but also from its performance of the non-Americas DEMPE functions that generate the value in PBI's territory. This is precisely the structure contemplated by the CSA regulations.
Q: Did PBI have independent authority to set prices, or did PPC dictate pricing?
A: PBI independently set prices across 68 country markets, as documented in PBI's internal pricing approval memos, commercial strategy presentations, and board minutes. PPC's U.S.-based pricing team had no authority over non-Americas pricing. While PBI and PPC coordinated on global product strategy — as any parent and subsidiary would — the pricing decisions for the non-Americas territory were made by PBI's commercial team and approved by PBI's management and board. The documentation on this point is extensive and was produced during the examination.
Q: How many of PBI's 185 employees were senior decision-makers versus administrative staff?
A: PBI's headcount included senior commercial leaders, regulatory affairs directors, medical affairs managers, supply chain leaders, and other professionals with substantive decision-making roles. The 12 personnel interviews conducted by Calderwood & Harkness and Whitmore in Dublin confirmed substantive decision-making authority across multiple functional areas. Detailed organizational charts were produced in response to IDR No. 8 and are part of the administrative record. While PBI also employed administrative and support staff, this is true of any operating business. The relevant inquiry is whether PBI had personnel with the expertise and authority to perform DEMPE functions — and the answer is unequivocally yes.
Q: Was Aidan Naughton truly independent, or did he take direction from Princeton Junction?
A: Mr. Naughton reported to PBI's board of directors, which met quarterly in Dublin. While Mr. Naughton coordinated with PPC's global leadership team on matters of overall corporate strategy — which is normal and expected within any multinational enterprise — he exercised autonomous authority over non-Americas operations, pricing, commercial strategy, and resource allocation. PBI's board minutes document numerous instances where Mr. Naughton presented strategic recommendations, responded to board questions, and received board approval for significant commercial decisions. His role was that of an operating executive running a substantial business, not a puppet executing instructions from the U.S. parent.
V. Issue 4: PCT Valuation (Indirect — Supporting CSA Arguments)
V.A. Core Talking Points
Although the PCT payment was made on July 1, 2012, and falls outside the examination years of 2017 through 2020, the IRS has invoked the PCT valuation as a supporting basis for its proposed adjustments to the ongoing CSA cost-sharing ratios. Accordingly, PPC must address the PCT valuation to prevent it from being used as a lever to increase the proposed CSA adjustments.
Point 1: The PCT Payment Was Within the Arm's-Length Range.
The $312 million PCT payment made on July 1, 2012, represented the buy-in to pre-existing intellectual property, primarily consisting of clinical-stage and approved oncology compounds. Calderwood & Harkness and Whitmore Valuation Group's DCF analysis, using a WACC of 9.8%, yields an arm's-length range of $278 million to $361 million. The $312 million payment falls within this range, at approximately the midpoint. This result is fully consistent with the arm's-length standard.
Point 2: The IRS's $852 Million Valuation Relies on an Inappropriately Low WACC.
The IRS's $852 million PCT valuation relies on Dr. Washburne's income method using a WACC of 7.2%. As discussed in Section II.D above, this discount rate is inappropriate for a pharmaceutical IP portfolio with significant regulatory and market risk. The 7.2% rate reflects the overall cost of capital of a mature, diversified pharmaceutical company — not the risk profile of the specific IP portfolio being valued, which as of 2012 included clinical-stage compounds with meaningful attrition risk.
Point 3: Critical Deficiencies in the IRS's Approach.
The IRS's PCT valuation suffers from several specific deficiencies:
• discount Rate: The 7.2% WACC reflects a mature pharmaceutical company's overall cost of capital, not the risk profile of the specific IP portfolio. The portfolio included clinical-stage compounds subject to significant regulatory approval risk, pipeline attrition risk, and geographic market-entry risk in territories where PBI had not yet established commercial operations.
• Revenue Projections: The IRS's revenue projections assumed aggressive non-Americas growth rates that were not supported by contemporaneous market data available as of the July 2012 valuation date. The IRS's projections exceeded actual realized revenue in several key markets and time periods.
• Generic Competition and Patent Expirations: The IRS's analysis did not adequately account for the impact of generic competition timelines and patent expiration dates on the projected cash flows from the IP portfolio. These factors reduce the present value of future cash flows and should have been reflected in both the revenue projections and the terminal value assumptions.
Point 4: Correcting the discount Rate Narrows the Gap Dramatically.
Even accepting the IRS's own methodology and revenue projections but correcting the discount rate from 7.2% to 9.8%, the resulting PCT valuation falls well below $852 million. This demonstrates that the discount rate is the primary driver of the valuation difference, and that the selection of an appropriate, risk-adjusted discount rate is the critical analytical question.
Point 5: The PCT Is Irrelevant to the Ongoing CSA Ratios.
Regardless of the PCT valuation, the ongoing cost-sharing ratios for 2017 through 2020 are independently tested and validated based on reasonably anticipated benefits. The IRS's attempt to use a disputed PCT valuation from 2012 — a year outside the examination period — to inflate ongoing CSA ratios is analytically unsound. The cost-sharing ratios and the PCT are distinct analyses under the regulations. Even if one were to disagree about the PCT value, the ongoing annual cost-sharing payments are separately validated by the CPM/TNMM analysis showing PBI's operating margins within the interquartile range of 22 comparables. The two analyses stand independently.
V.B. Anticipated Questions and Responses
Q: Why should we accept a 9.8% WACC over 7.2%?
A: The 9.8% WACC is derived from a rigorous cost-of-capital analysis using pharmaceutical-industry betas with adjustments for PBI's specific risk profile, including regulatory approval risk for clinical-stage compounds, geographic market-entry risk in territories where PBI had not yet established operations, and pipeline attrition risk inherent in pharmaceutical development. Dr. Vasquez's analysis is consistent with published academic and industry studies on pharmaceutical cost of capital, which consistently demonstrate that the cost of capital for pharmaceutical IP portfolios — particularly those with clinical-stage components — exceeds the overall WACC of diversified pharmaceutical companies. The IRS's 7.2% WACC would be appropriate for a diversified, mature pharmaceutical company's overall operations but is not appropriate for a specific IP portfolio with concentrated, higher-risk cash flows.
Q: If the PCT were undervalued, wouldn't that infect the ongoing CSA ratios?
A: No. The cost-sharing ratios are independently tested each year based on reasonably anticipated benefits, which are measured by projected revenue splits. The RAB analysis does not depend on the PCT valuation — they are distinct components of the CSA regulations. Even if one disagreed about the PCT value, the ongoing annual cost-sharing payments are separately validated by the CPM/TNMM analysis, which shows PBI's operating margins falling within the interquartile range of 22 comparable companies in each of the four examination years. The PCT and the ongoing ratios are two different questions, and the regulations treat them as such. The IRS cannot conflate them.
VI. Issue 5: Correlative Offset