PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT PREPARED IN ANTICIPATION OF LITIGATION
This memorandum is protected by the attorney-client privilege and the attorney work product doctrine. It was prepared by counsel in anticipation of litigation and at the direction of Calderwood & Harkness LLP in connection with the representation of Penterra Pharmaceuticals Corp. This memorandum is not to be disclosed to any person or entity outside the attorney-client relationship without the express prior written consent of Calderwood & Harkness LLP.
MEMORANDUM
TO: Dr. Helena Vasquez, Managing Director, Whitmore Valuation Group LLC
FROM: Garrett Simmons, Lead Associate, Calderwood & Harkness LLP
CC: Leonard Cross, Responsible Partner; Sylvia Hartwell, Billing Partner; Leila Nazari, Working Associate
DATE: February 22, 2024
RE: Preparation for IRS Appeals Conference — Penterra Pharmaceuticals Corp. (EIN 22-3741856), Tax Years 2017–2020; C&H Matter No. 1018-00009; IRS Exam Team ID LB&I-NE-TP-2022-00641
SUBJECT: Witness Preparation — Presentation of Whitmore Valuation Group Economic Analyses at Appeals Conference Scheduled for February 28, 2024
I. Purpose and Overview
The purpose of this memorandum is to prepare you, Dr. Vasquez, for your role presenting Whitmore Valuation Group LLC's ("Whitmore") economic analyses at the IRS Appeals conference scheduled for February 28, 2024, at the IRS Appeals Office in Manhattan. As you are aware, Whitmore was retained under a Kovel arrangement (Kovel letter executed June 20, 2022, reference 1018-00009-KV) to perform independent economic analyses under the direction of Calderwood & Harkness LLP ("C&H") in connection with C&H's representation of Penterra Pharmaceuticals Corp. ("PPC" or the "taxpayer") in this transfer pricing matter. Under this arrangement, Whitmore's work product is protected by the attorney-client privilege and the attorney work product doctrine, and all analyses were prepared at the direction of counsel for the purpose of providing legal advice to PPC.
The Appeals conference will be conducted before Appeals Officer Noreen Castañeda. The following individuals are expected to attend on behalf of PPC:
• Leonard Cross, Responsible Partner, Calderwood & Harkness LLP — lead presenter on legal arguments
• Sylvia Hartwell, Billing Partner, Calderwood & Harkness LLP
• Garrett Simmons, Lead Associate, Calderwood & Harkness LLP
• Marcus Whitfield, Vice President, Global Tax, Penterra Pharmaceuticals Corp. — client representative
• Deborah Staines, General Counsel, Penterra Pharmaceuticals Corp.
• Dr. Helena Vasquez, Managing Director, Whitmore Valuation Group LLC — economic analysis presenter
The overall matter involves an IRS Large Business and International ("LB&I") Division examination challenging the transfer pricing methodology used in PPC's Irish intellectual property-holding structure. PPC's Irish subsidiary, Penterra BioSciences Ireland Limited ("PBI"), is the tested party. The IRS issued a Notice of Proposed Adjustment ("NOPA") on October 12, 2023, proposing aggregate adjustments of $380.4 million across tax years 2017 through 2020. PPC, through C&H, filed a formal Protest on December 22, 2023, and the case has been assigned to IRS Appeals.
Your specific role at the conference is to present and defend Whitmore's Comparable Uncontrolled Transaction ("CUT") analysis, Comparable Profits Method / Transactional Net Margin Method ("CPM/TNMM") analysis, and Platform Contribution Transaction ("PCT") valuation using the discounted cash flow ("DCF") approach. You will also be expected to respond to economic questions posed by Appeals Officer Castañeda and, potentially, by IRS economist Dr. Alan Washburne if he participates by telephone.
This memorandum covers the following: conference logistics and format; a summary of the IRS proposed adjustments; a summary of Whitmore's economic analyses; key messages for the conference; anticipated questions and suggested responses; topics to avoid or redirect; presentation style and demeanor guidance; the pre-conference preparation schedule; key financial figures for quick reference; and contact information for day-of coordination. Please review this memorandum carefully in conjunction with all Whitmore reports and the rebuttal memorandum.
II. Conference Logistics and Format
A. Date, Time, and Location
The Appeals conference is scheduled for February 28, 2024. The conference will be held at the IRS Appeals Office in Manhattan. The precise address and conference room number will be confirmed by C&H no later than February 26, 2024.
You should plan to arrive at the IRS Appeals Office no later than 9:00 AM. The conference is scheduled to begin at 9:30 AM. Security screening at the IRS facility may take 15–20 minutes, and you should allow additional time for that process. Please bring valid government-issued photo identification (a U.S. passport or driver's license is acceptable). The conference is expected to last the full day, with an anticipated four to six hours of substantive discussion, exclusive of any breaks and lunch.
B. Conference Participants
On the PPC side, the following individuals will attend:
1. Leonard Cross — lead counsel and lead presenter on legal arguments
2. Sylvia Hartwell — billing partner
3. Garrett Simmons — lead associate and point of contact for logistics
4. Marcus Whitfield — VP, Global Tax, PPC (client representative)
5. Deborah Staines — General Counsel, PPC
6. Dr. Helena Vasquez — Whitmore Valuation Group (economic analysis presenter)
On the IRS side, the primary participant will be Appeals Officer Noreen Castañeda. Based on prior communications with the Appeals Office, it is possible that Appeals Officer Castañeda will be accompanied by IRS economist Dr. Alan Washburne and/or Attorney-Advisor Franklin Rosario, although Appeals conferences typically do not include members of the original examination team. Dr. Washburne and Mr. Rosario may, however, be available by telephone if Appeals Officer Castañeda wishes to consult with them during the conference. We do not anticipate the presence of IRS Revenue Agent Katherine Ngo or any other member of the LB&I examination team in person.
C. Presentation Sequence
The conference will follow a structured presentation format, with the PPC team presenting its case first, followed by questions from Appeals Officer Castañeda. The planned sequence is as follows:
1. Leonard Cross will open with a legal overview and case framing, addressing PPC's overall transfer pricing structure, the regulatory framework under IRC § 482 and the applicable Treasury Regulations, and the legal deficiencies in the IRS's proposed adjustments. This opening segment is expected to last approximately 30–45 minutes.
2. Dr. Helena Vasquez will then present Whitmore's economic analyses, covering (a) the CUT analysis of the legacy IP royalty rate, (b) the CPM/TNMM analysis of PBI's operating margins, (c) the PCT valuation using the income method/DCF approach, (d) the WACC/Discount rate analysis, and (e) the key conclusions of Whitmore's rebuttal of Dr. Washburne's analysis. This segment is expected to last approximately 45 to 60 minutes.
3. Leonard Cross will then address legal arguments concerning PBI's economic substance, its DEMPE (Development, Enhancement, Maintenance, Protection, and Exploitation) contributions, and penalty protection under IRC § 6662(e).
4. Questions and answers are expected to follow each segment. Appeals Officer Castañeda will likely ask follow-up questions during and after each presentation segment. You should be prepared for interjections during your presentation as well as for a more extended Q&A session at the conclusion of the economic analysis presentation.
A Northgate Services Inc. presentation has been prepared for the conference (file name: appeals-conference-presentation.pptx). Your slides cover your economic methodology, benchmarking results, and the PCT valuation. The slide deck will be finalized and transmitted to you by February 25, 2024. Hard copies of the slide deck will be available at the conference for all participants.
D. Materials
You should bring hard copies of the following materials to the conference, each of which should be tabbed and readily accessible:
• CUT Analysis Report (November 2022)
• CPM/TNMM Analysis Report (November 2022)
• PCT Valuation/DCF Report (December 2022)
• WACC/Discount Rate Analysis (December 2022)
• Rebuttal Memorandum of Dr. Washburne's Analysis (January 2024)
• Benchmarking Study Workbook (containing full comparable transaction and comparable company data)
All of these materials are included in the Appeals Conference Document Binder that has been assembled by C&H. Tab references for each document within the binder will be provided to you by Garrett Simmons no later than February 26, 2024. Please ensure that you have reviewed all materials thoroughly before the practice session on February 26.
In addition, please bring your own working copies of any underlying workpapers, Excel models, or source data that you may need to reference in responding to detailed questions from Appeals Officer Castañeda. If you have additional backup slides or supplemental analyses that are not included in the main presentation deck, please coordinate with Simmons to ensure they are available at the conference.
III. Summary of IRS Proposed Adjustments Under Challenge
This section summarizes the IRS proposed adjustments set forth in the NOPA dated October 12, 2023, which PPC is challenging through the Appeals process. It is important that you are thoroughly familiar with these adjustments, as your economic analyses are directed at demonstrating that PPC's transfer pricing positions produce arm's-length results and that the IRS adjustments are not warranted.
A. CSA Cost-Sharing Ratio Adjustments ($235.01 Million)
The IRS proposed increasing PBI's cost-sharing percentages under the qualified cost-sharing arrangement ("CSA") between PPC and PBI by approximately 8 to 12 percentage points in each of the four examination years. The IRS's position is that PPC's projections of reasonably anticipated benefits ("RAB") understated the value attributable to U.S.-source contributions, resulting in PBI bearing an insufficient share of the joint R&D costs. The specific adjustments by year are as follows:
The IRS asserts that PPC's RAB projections did not adequately reflect the anticipated benefits from U.S.-originated intellectual property and clinical development activities. In the IRS's view, the U.S. parent's contribution to the overall value of the CSA intangibles was systematically understated, resulting in PBI's cost-sharing percentage being set too low. Your CUT analysis, CPM/TNMM analysis, and PCT valuation collectively address and refute this assertion.
B. Royalty Rate Adjustments ($188.04 Million)
The IRS proposed increasing the royalty rate applicable to PBI's license of legacy (pre-CSA) intellectual property from PPC from PPC's rate of 4.5% of net sales to 11.0% of net sales. This adjustment applies to PBI's sales of products covered by legacy IP that pre-dated the CSA. The annual adjustments, calculated at the 6.5 percentage-point differential, are as follows:
The IRS relied on its own CUT data derived from third-party pharmaceutical licensing agreements in support of the 11.0% rate. As discussed in Section IV.A below and in the Whitmore Rebuttal Memorandum, the IRS's CUT selection methodology was materially flawed, and the 11.0% rate is not supported by reliable comparable data.
C. Correlative Offset and Net Adjustment
The IRS examination team allowed a correlative offset of ($42.65 million) to avoid double-counting between the CSA cost-sharing adjustments and the royalty rate adjustments. This offset reflects the IRS's acknowledgment that, to the extent the cost-sharing ratio is adjusted upward, some portion of the royalty rate adjustment would result in duplicative taxation.
The net proposed adjustment across all four examination years is:
The IRS has also proposed an IRC § 6662(e) penalty for substantial valuation misstatement in the amount of $15.98 million, calculated as $380.4 million × 21% (corporate tax rate) × 20% (penalty rate). Cross will address penalty protection and reasonable cause defenses at the conference; however, your analysis is relevant to demonstrating that PPC had reasonable cause for its positions, as the transfer pricing was supported by contemporaneous economic studies prepared by Crestfield & Associates and independently validated by Whitmore.
D. PCT Undervaluation (Background)
While the 2012 tax year in which the PCT occurred is outside the examination years (2017–2020), the IRS has used the alleged PCT undervaluation as a theoretical underpinning for its adjustments to the ongoing CSA cost-sharing ratios and royalty rates. Specifically, the IRS valued the PCT at $852 million, compared to PPC's actual PCT payment of $312 million, yielding a delta of $540 million. The IRS's theory is that PBI's underpayment for the pre-existing IP at the time of the CSA formation demonstrates that PBI consistently understated the value of U.S.-originated IP, and that this undervaluation carried forward into the RAB projections and royalty rate determinations for the examination years.
You should be prepared to explain clearly and concisely why the $312 million PCT payment falls within the arm's-length range of $278 million to $361 million as determined by Whitmore's income method/DCF analysis, and why the IRS's $852 million figure is unreliable due to the use of an inappropriately low discount rate, overly optimistic revenue projections incorporating impermissible hindsight bias, and the failure to properly account for development risk as it existed at the time of the PCT in July 2012.
IV. Summary of Whitmore Valuation Group Economic Analyses
This section provides a detailed summary of each of Whitmore's economic analyses that you will be presenting at the Appeals conference. You should be prepared to discuss each analysis in depth and to respond to questions about methodology, data sources, results, and the bases for your conclusions.
A. CUT Analysis — Legacy IP Royalty Rate
Objective. The objective of the CUT analysis is to demonstrate that PPC's 4.5% royalty rate on legacy IP licenses to PBI is within the arm's-length range under the Comparable Uncontrolled Transaction method.
Methodology. The analysis was conducted under the CUT method as prescribed by Treasury Regulation § 1.482-4(c). Under this method, the royalty rate charged in a controlled transaction is compared to the royalty rate charged in comparable uncontrolled transactions between unrelated parties. Whitmore conducted an extensive search of publicly available pharmaceutical licensing agreements to identify comparable transactions involving the licensing of pharmaceutical IP with similar characteristics to the PPC-PBI legacy IP license.
Comparable Transaction Selection. Whitmore identified 14 comparable uncontrolled pharmaceutical license agreements through a rigorous screening process. The comparability factors analyzed include:
• Therapeutic area — agreements involving pharmaceutical compounds in the same or similar therapeutic areas (oncology, immunology, and related specialties) as PPC's legacy portfolio
• Stage of development — agreements involving compounds at comparable stages of clinical or commercial development
• Geographic scope — agreements covering non-U.S. territories, consistent with PBI's license scope
• Exclusivity — agreements providing exclusive rights, consistent with PBI's exclusive license for non-Americas territories
• Remaining patent life — agreements involving IP with comparable remaining patent protection periods
• Revenue base — agreements of comparable commercial scale and revenue potential
Results. The results of the CUT analysis are as follows:
PPC's 4.5% royalty rate falls squarely within the interquartile range and is essentially at the median of the comparable data. This result strongly supports the conclusion that PPC's royalty rate is an arm's-length rate.
Contrast with IRS Position. The IRS's proposed 11.0% royalty rate is well above the 75th percentile of Whitmore's comparable sample. The IRS's CUT selection methodology, as detailed in the Whitmore Rebuttal Memorandum (January 2024), was flawed in several material respects, including the inclusion of agreements with materially different characteristics (different therapeutic areas, different exclusivity terms, bundled service arrangements, and different risk allocations). These comparability deficiencies render the IRS's proposed rate unreliable.
B. CPM / TNMM Analysis — PBI Operating Margins
Objective. The objective of the CPM/TNMM analysis is to test whether PBI's operating margins are consistent with arm's-length results for entities performing comparable functions and bearing comparable risks.
Methodology. The analysis was conducted using the Comparable Profits Method ("CPM") under U.S. Treasury Regulation § 1.482-5, which corresponds to the Transactional Net Margin Method ("TNMM") under the OECD Transfer Pricing Guidelines. Under this methodology, PBI's operating margins are compared to the operating margins of comparable independent companies that perform similar functions, employ similar assets, and bear similar risks.
Comparable Company Selection. Whitmore identified 22 comparable companies, consisting of independent distributors and IP-holding companies operating in the pharmaceutical and life sciences industries. The selection process involved functional screening (to identify companies serving as IP-holding entities and principals bearing market risk), geographic and industry screens, and financial data requirements (to ensure the availability of reliable financial statements for the test period).
Results. PBI's operating margins fell within the interquartile range of the comparable companies in all four examination years (2017 through 2020). This result confirms that PBI's overall profitability is consistent with its functional profile as an IP owner and principal for non-Americas territories. PBI is not a mere conduit or shell entity; it performs genuine functions, employs real assets, and bears meaningful risks in 68 country markets.
C. PCT Valuation — Income Method / DCF Approach
Objective. The objective of the PCT valuation is to demonstrate that the $312 million PCT payment made by PBI to PPC on July 1, 2012, in connection with PBI's buy-in to the CSA, was within the arm's-length range.
Methodology. The PCT was valued using the income method / Discounted cash flow approach under Treasury Regulation § 1.482-7(g)(4). Under this method, the value of the pre-existing intangibles contributed to the CSA is determined by projecting the future cash flows attributable to those intangibles and discounting them to present value at an appropriate discount rate.
Key Assumptions. The key assumptions underlying Whitmore's DCF analysis include:
• Weighted Average Cost of Capital (WACC): 9.8% (PPC/Whitmore position), compared to the IRS's proposed WACC of 7.2%. The 9.8% rate reflects the cost of capital appropriate for pharmaceutical intellectual property, particularly clinical-stage and recently approved compounds, and includes a company-specific risk premium for development-stage pharmaceutical IP. The detailed derivation of the 9.8% WACC is set forth in Whitmore's December 2022 WACC/Discount Rate Analysis.
• Revenue Projections: Revenue projections were based on product-level forecasts for PPC's key compounds, including Veritaxol, Imvara, Cerulon, and other pipeline compounds. These projections were prepared as of the PCT date (July 1, 2012) and reflect the information available and the uncertainties present at that time.
• Terminal Value, Growth Rates, and Useful Life: Assumptions regarding terminal value, long-term growth rates, and the useful economic life of the intangibles were based on industry benchmarks and the specific characteristics of PPC's IP portfolio.
Results. Whitmore's analysis determined that the arm's-length range for the PCT payment is $278 million to $361 million. PPC's actual PCT payment of $312 million falls within this range, supporting the conclusion that the PCT was conducted at arm's length.
The IRS's valuation of $852 million results from three principal analytical errors: (1) the use of an inappropriately low discount rate of 7.2%, which fails to reflect the risk profile of pharmaceutical IP at the PCT date; (2) the use of overly optimistic revenue projections that incorporate actual (realized) revenue data — i.e., hindsight — rather than the projections that were reasonably available at the time of the PCT; and (3) the failure to properly account for development risk for clinical-stage compounds, including Veritaxol, which had not yet received regulatory approval in non-Americas markets at the time of the PCT.
D. WACC / Discount Rate Analysis
Whitmore's December 2022 technical memorandum provides detailed support for the 9.8% WACC used in the PCT valuation. The discount rate was derived using a standard build-up methodology, with the following components:
• Risk-free rate: Based on the yield on U.S. Treasury securities with a maturity matching the expected useful life of the intangibles.
• Equity risk premium: Based on historical equity risk premium data and forward-looking estimates for the pharmaceutical and biotechnology industries.
• Beta: Beta comparables were drawn from specialty pharmaceutical and biotechnology companies with risk profiles comparable to PPC's IP portfolio. This is a critical distinction from the IRS's approach, which drew beta comparables from mature, diversified pharmaceutical companies with lower systematic risk.
• Company-specific risk premium: An additional premium reflecting the specific development-stage risk associated with PPC's clinical-stage compounds at the time of the PCT. The IRS's analysis fails to include any such premium.
• Size premium adjustment: A premium reflecting the empirical relationship between firm size and expected returns, based on the characteristics of the PBI entity and the specific IP portfolio.
Critique of the IRS's 7.2% WACC. The IRS's 7.2% discount rate is inadequate for several reasons:
1. It understates the equity risk premium applicable to pharmaceutical IP with significant clinical-stage development risk.
2. It derives beta from mature, diversified pharmaceutical companies (e.g., large-cap multinationals with diversified product portfolios) rather than specialty pharmaceutical and biotechnology companies that are more comparable to the risk profile of PPC's IP portfolio at the time of the PCT.
3. It fails to include any company-specific risk premium for clinical-stage compounds, notwithstanding the significant development, regulatory, and commercialization risks associated with those compounds as of July 2012.
4. The cumulative effect of these errors is to substantially overstate the present value of the projected cash flows, yielding the inflated $852 million valuation.
You should be prepared to walk through the WACC build-up in detail and to explain each component in accessible terms for Appeals Officer Castañeda.
E. Rebuttal of IRS Economist Dr. Washburne's Analysis
Whitmore (prepared by Dr. Vasquez and Dr. Rohan Chakrabarti) issued a comprehensive rebuttal memorandum dated January 2024 addressing the economic analysis prepared by IRS economist Dr. Alan Washburne. The key criticisms of Dr. Washburne's analysis are as follows:
1. CUT Selection. Dr. Washburne's comparable license agreements include agreements with materially different terms from the PPC-PBI legacy IP license. Specifically, several of Dr. Washburne's selected CUTs involve different therapeutic areas, include non-exclusive licenses (whereas PBI's license is exclusive), cover different geographic scopes, and bundle ancillary services (such as manufacturing, distribution, and co-promotion arrangements) with the IP license. These comparability deficiencies render the CUTs unreliable as benchmarks for the PPC-PBI royalty rate.
2. discount Rate. Dr. Washburne used a 7.2% WACC without adequate justification for the low rate. As discussed above, this rate fails to account for pharmaceutical development risk and relies on beta comparables from mature, diversified pharmaceutical companies rather than more closely comparable specialty pharma and biotech firms.
3. Revenue Projections. Dr. Washburne's analysis incorporated actual (realized) revenues as proxies for projected revenues at the time of the CSA, introducing impermissible hindsight bias. Transfer pricing analysis must be based on the information and projections that were reasonably available at the time of the controlled transaction. The use of actual performance data from 2013 through 2020 to value a 2012 PCT and to determine ongoing cost-sharing ratios is inconsistent with Treasury Regulation § 1.482-7(g)(4) and well-established case law.
4. Cost-Sharing Ratio. Dr. Washburne's reasonably anticipated benefit calculation did not properly weight the risks borne by PBI in non-Americas markets. PBI bore genuine market risk, regulatory risk, and pricing risk in 68 country markets — risks that should be reflected in a lower cost-sharing percentage for PBI (not a higher one as proposed by the IRS). Dr. Washburne's analysis treats PBI as if it were a passive participant in the CSA, which is inconsistent with PBI's actual functional profile.
You should be prepared to walk through each of these criticisms point by point at the conference. The rebuttal memorandum is included in the Appeals Conference Document Binder and should be readily accessible during your presentation and the Q&A session.
V. Key Messages for Dr. Vasquez
The following key messages should inform your presentation and responses to questions throughout the conference. These messages are designed to frame the economic analysis in a manner that is persuasive and consistent with PPC's overall position, while maintaining the objectivity and credibility expected of an independent economist.
A. Overarching Theme
PPC's transfer pricing methodology was rigorous, contemporaneously documented, and produced arm's-length results under the best method rule set forth in Treasury Regulation § 1.482-1(d). PPC's original transfer pricing studies were prepared by Crestfield & Associates (under the direction of Susan Lam, Principal) at or near the time of the relevant transactions and in the ordinary course of business. Whitmore's independent analyses, conducted under Kovel engagement at the direction of C&H, confirm that PPC's positions fall squarely within the arm's-length range on every measure tested — the legacy IP royalty rate, PBI's operating margins, and the PCT payment.
B. On the CUT Analysis (Royalty Rate)
• The 4.5% royalty rate is supported by 14 carefully selected comparable agreements and falls essentially at the median of the comparable data (4.4%).
• The IRS's proposed 11.0% rate is an outlier with no support in the reliable comparable data; it substantially exceeds the 75th percentile of the interquartile range.
• The robustness of Whitmore's comparability screening process should be emphasized: agreements were screened for therapeutic area, IP stage of development, geographic scope, exclusivity provisions, remaining patent life, and revenue base.
• If Appeals Officer Castañeda asks about specific comparables, you should refer to the benchmarking study workbook and be prepared to discuss the top five or six most closely comparable agreements in detail, including the specific comparability factors that make each agreement a reliable benchmark.
C. On the CPM/TNMM Analysis
• PBI's operating margins are consistent with its role as an IP owner and principal entity — not a mere conduit, shell, or limited-risk distributor.
• The 22 comparable companies were selected using rigorous functional and financial screening criteria, and PBI's margins fall within the interquartile range of the comparables in all four examination years.
• PBI bears genuine market risk, makes independent commercial decisions across 68 country markets, employs 185 people (grown from 52 at inception of the CSA), and incurred €47.2 million in regulatory submission costs during the 2017–2020 period.
D. On the PCT Valuation
• The $312 million PCT payment was determined using the income method/DCF approach, which is the best method for valuing pharmaceutical IP under Treasury Regulation § 1.482-7(g)(4) given the unique nature of the IP portfolio and the availability of reliable financial projections.
• The 9.8% WACC properly reflects the pharmaceutical-industry cost of capital for clinical-stage and recently approved compounds as of the July 2012 PCT date.
• The IRS's 7.2% discount rate understates the risk associated with the IP portfolio and inappropriately inflates the PCT valuation to $852 million.
• At the time of the PCT in July 2012, the key products — particularly Veritaxol — were in clinical stages of development, and the non-Americas revenue potential was highly uncertain. Veritaxol had not yet received regulatory approval in most non-Americas markets, and commercial success was far from assured.
• By 2020, Veritaxol achieved $1.34 billion in non-Americas net sales, but this blockbuster outcome was not reasonably foreseeable in 2012. Hindsight bias must be excluded from the PCT valuation, consistent with the regulations and established case law.
E. On PBI's Economic Substance (Supporting Points)
While you are presenting economic analysis rather than legal arguments (which are the province of Mr. Cross), you should be prepared to reference PBI's functions and risk profile as they inform and support the economic analysis. The following points may be relevant in the context of explaining PBI's functional profile and why the CPM/TNMM analysis supports PBI's margins:
• PBI makes genuine DEMPE contributions, including the maintenance and exploitation of IP in non-Americas territories, managing pricing, regulatory submissions, and commercial strategy across 68 markets.
• PBI exercises independent pricing authority across those 68 markets and engages in local regulatory and market access activities.
• PBI's board of directors held 42 board meetings in Dublin during the 2017–2020 period, reflecting active governance and oversight.
• PBI incurred €47.2 million in regulatory submission costs during the examination years, representing a substantial real investment in the maintenance and exploitation of the licensed IP.
• PBI operates from approximately 18,000 square feet of office space at Sandyford Business Park, Dublin.
• PBI's revenue for fiscal year 2020 was €2.14 billion, with pre-tax income of €1.06 billion.
• PBI maintains independent banking relationships with Glenmore Bank Ireland plc and manages its own treasury operations.
These facts are relevant to explaining why PBI is not a conduit entity and why its operating margins, while reflecting the returns to IP ownership, are consistent with arm's-length results for an entity performing its functions and bearing its risks.
VI. Anticipated Questions from Appeals Officer Castañeda
This section sets forth the questions we anticipate Appeals Officer Castañeda may ask during the conference, along with suggested responses. These suggested responses are intended to serve as frameworks for your answers; you should adapt them as appropriate based on the specific context of each question and the flow of the conference discussion. Please review these carefully and practice articulating the key points concisely and clearly.
A. Questions on CUT Methodology
Question 1: "How did you select your 14 comparable license agreements? What databases did you use?"
Suggested Response: Describe the systematic search methodology employed by Whitmore, including the databases searched (e.g., Vireo Health IT, Sundial Health IT, SEC filings, and publicly available licensing agreement databases), the initial screening criteria applied to the raw universe of agreements, and the refinements made to arrive at the final set of 14 comparables. Emphasize the specific screening criteria: therapeutic area (oncology, immunology, and related specialties), geographic scope (non-U.S. or global licenses with identifiable non-U.S. components), exclusivity (exclusive licenses comparable to PBI's exclusive license for non-Americas territories), stage of development (compounds at comparable clinical or early-commercial stages), deal size and revenue base, and remaining patent life. Note that all 14 selected agreements involve pharmaceutical IP in the same or closely related therapeutic areas as PPC's legacy portfolio. Explain that the screening criteria were designed to maximize comparability and that agreements with material comparability deficiencies were excluded.
Question 2: "Why is the IRS's 11.0% rate not supported by your data?"
Suggested Response: Explain that the 11.0% rate proposed by the IRS substantially exceeds the 75th percentile of the interquartile range established by Whitmore's 14 comparable agreements (IQR of 3.1% to 6.8%). Walk through the IRS's CUT selection and explain that the IRS's selected comparables include agreements with materially different characteristics: agreements involving different types of IP (e.g., medical device IP, diagnostic IP), agreements that bundle IP licenses with service agreements (such as co-promotion or manufacturing arrangements), agreements with different risk allocations (e.g., agreements where the licensee bears minimal commercial risk), and agreements covering different geographic scopes. These comparability deficiencies cause the IRS's sample to reflect royalty rates that are not reliable benchmarks for the PPC-PBI legacy IP license. Note that when the IRS's CUTs are adjusted for these differences, or when the non-comparable agreements are excluded, the resulting rates are consistent with Whitmore's IQR.
Question 3: "Can you explain why you excluded certain agreements that the IRS included?"
Suggested Response: Walk through the specific comparability deficiencies in the IRS's selected CUTs, referring to the detailed analysis in the Whitmore Rebuttal Memorandum. For each excluded agreement, explain the specific comparability factor(s) that rendered it unsuitable as a benchmark: differences in therapeutic area, differences in exclusivity terms, the bundling of non-IP services, or materially different geographic scope. Emphasize that the best method rule under Treasury Regulation § 1.482-1(d) and the comparability factors under Treasury Regulation § 1.482-4(c) require that comparable transactions be selected based on rigorous comparability analysis, and that agreements with material comparability deficiencies should not be included in the benchmark set. Conclude by noting that Whitmore's exclusion of these agreements is consistent with best practices in transfer pricing analysis and with the regulatory framework.
Question 4: "What adjustments, if any, did you make to the comparable royalty rates?"
Suggested Response: Describe any comparability adjustments that were made to the comparable royalty rates to account for residual differences between the comparable transactions and the PPC-PBI license. For example, if adjustments were made for differences in geographic scope (e.g., adjustments to reflect the value of exclusivity in non-Americas territories versus global licenses), differences in payment terms (e.g., upfront payments versus ongoing royalties), or other factors, explain the basis for each adjustment and the quantitative impact. Where unadjusted rates are used, explain why the residual differences are minor and do not materially affect comparability. Note that the use of an interquartile range inherently accounts for some degree of variation among comparables, and that PPC's 4.5% rate falls near the median of the unadjusted and adjusted ranges.
B. Questions on PCT Valuation / Discount Rate
Question 5: "Why did you use a 9.8% WACC instead of the IRS's 7.2%?"
Suggested Response: Explain the component build-up of the 9.8% WACC, walking through each element: the risk-free rate, the equity risk premium (based on historical data and forward-looking estimates for pharmaceutical and biotechnology companies), the beta (derived from specialty pharmaceutical and biotechnology companies with risk profiles comparable to PPC's IP portfolio, rather than from large-cap diversified pharmaceutical companies), the company-specific risk premium (reflecting the specific development, regulatory, and commercialization risks associated with PPC's clinical-stage compounds as of July 2012), and the size premium. Emphasize that pharmaceutical IP — especially clinical-stage compounds with uncertain regulatory and commercial outcomes — carries substantial development risk that requires a higher discount rate to properly reflect the risk-adjusted value of the projected cash flows. Cite industry cost-of-capital studies that support the 9.8% rate for comparable pharmaceutical IP portfolios. Note that the IRS's 7.2% rate is more appropriate for mature, low-risk pharmaceutical portfolios with diversified, established products — not for a portfolio that included significant clinical-stage development risk at the time of the PCT.
Question 6: "Your PCT range is $278M–$361M. How sensitive is this to the discount rate?"
Suggested Response: Acknowledge that the PCT valuation is sensitive to the discount rate, as is inherent in any DCF analysis. Present the sensitivity analysis from Whitmore's report, showing how the PCT value changes as the WACC varies. Explain that even with a moderate reduction in the WACC — for example, to 8.5% — the $312 million PCT payment remains within the arm's-length range. It is only at the IRS's 7.2% rate that the value approaches the IRS's $852 million figure, and that rate is not justified for the reasons discussed (understated equity risk premium, inappropriate beta selection, absence of company-specific risk premium). The sensitivity analysis demonstrates that the PCT valuation is robust across a reasonable range of discount rate assumptions and that the IRS's result is driven primarily by its selection of an unsupportably low discount rate.
Question 7: "Didn't the actual performance of the IP exceed your original projections?"
Suggested Response: Emphasize that transfer pricing must be evaluated based on the information available at the time of the transaction — in this case, July 1, 2012 — and not with the benefit of hindsight. At the time of the PCT, Veritaxol was in clinical-stage development in non-Americas markets, and its eventual blockbuster success (achieving $1.34 billion in non-Americas net sales by 2020) was far from certain. There were significant regulatory, competitive, and market access risks in 2012 that could have resulted in substantially lower — or no — non-Americas revenues. The use of actual performance data to value a transaction that occurred years before those revenues were realized introduces impermissible hindsight bias. Cite Treasury Regulation § 1.482-7(g)(4), which requires that the PCT be valued based on "reasonably anticipated" benefits at the time of the transaction, and cite applicable case law prohibiting the use of hindsight in transfer pricing analysis. Note that the projections used by PPC in 2012 were prepared in the ordinary course of business, were consistent with contemporaneous industry analyst forecasts, and reflected the genuine uncertainties that existed at the time.
C. Questions on CSA Cost-Sharing Ratios
Question 8: "How did you determine the reasonably anticipated benefit shares?"
Suggested Response: Explain the revenue-based projection methodology used under Treasury Regulation § 1.482-7(e) to determine each participant's share of reasonably anticipated benefits. Walk through the calculation for each year, showing how the 38.2% to 42.7% PBI cost-sharing percentages were derived based on projected non-Americas revenues relative to projected total (Americas and non-Americas) revenues. Explain that revenue-based RAB projections are the most commonly used and widely accepted approach for determining cost-sharing percentages, and that PPC's projections were prepared contemporaneously and updated annually in the ordinary course of business.
Question 9: "Why should the IRS accept your projections over its own?"
Suggested Response: PPC's projections were contemporaneous — prepared at or near the time of the relevant cost-sharing determinations and in the ordinary course of business. They were based on the information available to PPC's commercial and finance teams at the time, were consistent with contemporaneous industry analyst forecasts, and reflected the genuine uncertainties and risks in non-Americas markets. The IRS's projections, by contrast, incorporate hindsight by relying on actual revenue data and ex post commercial outcomes that were not known or reasonably foreseeable at the time the cost-sharing percentages were determined. Furthermore, the IRS's projections systematically overweight the U.S. market's contribution to the total value of the CSA intangibles, without adequately accounting for the risks and investments borne by PBI in non-Americas markets. The regulations require the use of prospective projections, not retrospective actual data, as the basis for RAB determinations.
Question 10: "How do you respond to the IRS's assertion that the cost-sharing ratios fail to reflect the full value of U.S.-contributed IP?"
Suggested Response: Explain that the PCT payment of $312 million already compensated PPC for the pre-existing IP that PPC contributed to the CSA at its formation. The ongoing cost-sharing payments reflect PBI's proportionate share of new R&D investment undertaken after the CSA's formation, not a second payment for pre-existing IP. The IRS's position effectively seeks to double-count the value of U.S.-contributed IP — once through an adjustment to the PCT payment and again through adjustments to the ongoing cost-sharing ratios. The correlative offset of $42.65 million partially addresses this double-counting, but the IRS's remaining position still involves substantial overlap. The economic analysis demonstrates that PBI's cost-sharing percentages are consistent with its projected share of reasonably anticipated benefits and do not understate the U.S. parent's contribution.
D. Questions on CPM/TNMM
Question 11: "How did you select the 22 comparable companies?"
Suggested Response: Describe the functional screening process used to identify comparable companies, focusing on companies that serve as IP-holding entities and principals bearing genuine market risk in the pharmaceutical and life sciences industries. Explain the geographic and industry screens applied (e.g., companies operating in pharmaceutical and life sciences sectors, with operations in multiple geographic markets), the financial data requirements (e.g., availability of audited financial statements for the test period, publicly traded or with publicly available financial data), and any exclusions applied (e.g., companies undergoing significant restructuring, companies with material non-pharmaceutical operations, or companies with fewer than three years of financial data). Emphasize that the selected comparables perform functions and bear risks that are comparable to PBI's functional profile as an IP owner and principal.
Question 12: "PBI's operating margins seem high for a company with only 185 employees. How do you justify this?"
Suggested Response: PBI's operating margins reflect its role as an IP owner and principal entity — not a cost-plus service provider or limited-risk distributor. The returns to IP ownership are fundamentally different from the returns to labor or distribution services. An IP-holding entity that owns valuable pharmaceutical intangibles and bears market risk is expected to earn higher margins than a limited-risk distributor or a service provider, because it bears the entrepreneurial risk associated with the commercial exploitation of that IP. The relevant comparables for benchmarking PBI's margins are other IP-holding and principal entities, not limited-risk distributors or contract service providers. When PBI is compared to the appropriate set of 22 comparable IP-holding and principal companies, its margins fall within the interquartile range in all four examination years. Additionally, PBI's headcount of 185 people is not trivial; the company has grown substantially from 52 employees at inception and employs specialists in regulatory affairs, commercial operations, finance, and management across 68 country markets.
E. General / Cross-Cutting Questions
Question 13: "Has Dr. Washburne's analysis identified any errors in your work?"
Suggested Response: No material errors have been identified in Whitmore's analysis. Dr. Washburne's critiques relate to methodological choices — specifically, CUT selection criteria and discount rate assumptions — where Whitmore's approach is better supported by the available data and the applicable regulations. Whitmore has reviewed Dr. Washburne's critiques in detail and has responded to each of them in the January 2024 Rebuttal Memorandum. Whitmore stands by its methodology, data, and conclusions. Where Dr. Washburne has identified computational or data points that warranted verification, Whitmore confirmed the accuracy of its work.
Question 14: "What is the best method for determining the arm's-length royalty rate? For the PCT?"
Suggested Response: For the legacy IP royalty rate, the CUT method is the best method under Treasury Regulation § 1.482-1(d), because reliable comparable uncontrolled transactions are available. The existence of 14 comparable pharmaceutical licensing agreements with sufficient comparability makes the CUT method the most direct and reliable means of determining the arm's-length royalty rate. For the PCT valuation, the income method/DCF approach is the best method under Treasury Regulation § 1.482-7(g)(4), given the unique nature of PPC's pharmaceutical IP portfolio and the availability of reliable, contemporaneous financial projections. Alternative methods — such as the market approach — are less reliable for PCT valuation because there are no directly comparable PCT transactions involving pharmaceutical IP portfolios with similar characteristics. The income method/DCF is the most widely used and accepted approach for valuing pharmaceutical IP in PCT contexts, and it produces the most reliable result when applied with appropriate assumptions.
VII. Topics to Avoid or Redirect
The following topics should be avoided during your presentation and responses to questions. If any of these topics arise, you should redirect the question as described below.
A. Legal Conclusions
You should not offer legal opinions on the application of IRC § 482, the economic substance doctrine, the step transaction doctrine, or penalty provisions, including reasonable cause or good faith defenses under IRC § 6662(e). These are legal questions that will be addressed by Leonard Cross. If you are asked a question that calls for a legal opinion or legal conclusion, you should redirect by stating: "That's a legal question that is better addressed by counsel." Cross will be alert to such questions and will step in to address them if appropriate.
B. Settlement Posture
Under no circumstances should you discuss PPC's settlement posture, settlement authority, or willingness to concede any portion of the proposed adjustment. The Appeals conference is an opportunity to present PPC's substantive position; settlement discussions, if they occur, will be conducted separately by counsel and the client. If Appeals Officer Castañeda or any IRS representative asks about settlement or compromise, you should respond: "I'm here to present the economic analysis; settlement discussions are matters for counsel and the taxpayer."
C. Privileged Communications
You must not disclose the substance of any communications with C&H attorneys, PPC management, or other members of the legal team regarding case strategy, litigation planning, or the assessment of strengths and weaknesses of PPC's position. The Kovel arrangement under which you were retained protects your work under the attorney-client privilege and the attorney work product doctrine. Inadvertent disclosure of the substance of strategy discussions could waive the privilege, which would be severely detrimental to PPC's position. All work product prepared by Whitmore in this matter was prepared at the direction of counsel for the purpose of providing legal advice to PPC, and should be described as such if the basis for your engagement is questioned.
D. Other Tax Years or Future Positions
You should not volunteer information about PPC's transfer pricing for tax years outside the scope of the examination — that is, years prior to 2017 or subsequent to 2020. You should not discuss any potential future changes to PPC's transfer pricing methodology, any pending or contemplated restructuring of PPC's international operations, or any other forward-looking information about PPC's tax planning. If you are asked directly about the 2012 PCT year, note that 2012 is not under examination and that the PCT analysis is relevant to the conference only as context for the 2017–2020 cost-sharing and royalty rate issues. Do not expand the discussion beyond this limited context.
E. PPC's FIN 48 Reserve
You must not discuss the $62.4 million FIN 48 (ASC 740-10) uncertain tax position reserve maintained by PPC in connection with the transfer pricing positions under examination, or any changes to that reserve. This is a financial reporting matter governed by U.S. GAAP and is not relevant to the Appeals proceeding. Disclosure of the reserve amount or PPC's internal assessment of the likelihood of sustaining its positions could be prejudicial to PPC's interests. If asked about financial reserves or uncertain tax positions, redirect by stating that financial reporting matters are outside the scope of your economic analysis.
VIII. Presentation Style and Demeanor Guidance
A. Tone
Your tone throughout the conference should be professional, measured, and objective. You are presenting as an independent economist retained to perform rigorous economic analyses, not as an advocate for PPC. While your analyses support PPC's positions, your credibility depends on being perceived as a careful, data-driven analyst whose conclusions are the product of sound methodology rather than predetermined advocacy.
Be confident but not combative. Acknowledge reasonable questions and answer them directly. Do not be evasive or dismissive. If Appeals Officer Castañeda raises a valid methodological point or identifies an area where the analysis involves judgment, acknowledge the judgment call and explain why Whitmore's choice is the more defensible one based on the data and the applicable regulatory framework.
Demonstrate thorough mastery of the data and methodology without being condescending or dismissive of the IRS's positions. Appeals Officer Castañeda is experienced in transfer pricing matters and will appreciate a presentation that is substantive and responsive, not one that treats the IRS's analysis as unworthy of serious engagement. Address the IRS's positions directly and explain specifically why Whitmore's approach is superior, rather than simply asserting that the IRS is wrong.
B. Use of Visuals
You should refer to the Northgate Services Inc. slides (appeals-conference-presentation.pptx) during your presentation. The slide deck is designed to support your oral presentation with clear visual depictions of the key analyses and results. The key slides for your segment include:
• Comparable transaction summary chart — listing the 14 CUT agreements and their key comparability characteristics
• IQR box plot for royalty rates — visually depicting the interquartile range and showing PPC's 4.5% rate relative to the IQR and the IRS's 11.0% rate