**ATTORNEY-CLIENT PRIVILEGED AND CONFIDENTIAL — DO NOT FORWARD WITHOUT COUNSEL'S APPROVAL**
Marcus, Deborah, and Rajesh:
Thank you all for your participation in yesterday's Appeals conference. I wanted to provide a comprehensive debrief while the proceedings are fresh, and to outline our immediate next steps. This memorandum summarizes the conference held on February 28, 2024, at the IRS Appeals Office in Manhattan.
For reference: C&H Matter No. 1018-00009; Exam Team ID LB&I-NE-TP-2022-00641; PPC EIN 22-3741856; Tax Years 2017–2020.
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**I. Conference Logistics and Attendees**
The conference convened at the IRS Appeals Office in Manhattan on February 28, 2024, and ran approximately three and a half hours.
*Penterra/Calderwood & Harkness attendees:* Leonard Cross, Sylvia Hartwell, and Garrett Simmons (Calderwood & Harkness); Marcus Whitfield and Deborah Staines (PPC); Dr. Helena Vasquez (Whitmore Valuation Group).
*IRS:* Appeals Officer Noreen Castañeda, who was assigned to this case in January 2024. Notably, Castañeda conducted the conference without other IRS personnel present — no exam team members and no Chief Counsel attorneys (neither Rosario nor Hirabayashi were in attendance). This is standard at the Appeals level and consistent with the independence of the Appeals function.
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**II. Summary of Conference Proceedings — Issue by Issue**
**A. CSA Cost-Sharing Ratio Adjustments ($235.01M Proposed)**
I presented PPC's position that PBI's cost-sharing percentages — 38.2% (2017), 39.6% (2018), 41.1% (2019), and 42.7% (2020) — were based on reasonably anticipated benefits as required by Treas. Reg. § 1.482-7. I then walked through the IRS exam team's proposed increases (to 48.2%, 50.6%, 52.3%, and 53.7%, respectively), which would generate additional cost-sharing payments of $48.73M, $57.61M, $62.85M, and $65.82M across the four years. The total qualified R&D cost pools for the relevant periods were $487.3M (2017), $523.8M (2018), $561.2M (2019), and $598.4M (2020).
Dr. Vasquez presented Whitmore's CPM/TNMM analysis, which tested PBI's operating margins against 22 comparable distributors and IP-holding companies. The analysis demonstrated that PBI fell within the interquartile range in all four years. She also presented the revenue projection analysis for Veritaxol, Imvara, and Cerulon across Americas and non-Americas territories, which supports the benefit-share calculation underlying PBI's cost-sharing percentages.
*Castañeda's Reaction:* She asked detailed questions about PPC's projected revenue splits and how non-Americas revenue growth tracked against projections. Importantly, she appeared to acknowledge that the exam team's proposed 8–12 percentage point upward adjustments were aggressive. She specifically questioned whether a smaller adjustment — in the range of 2–3 percentage points — might be more defensible. This line of questioning suggests she sees significant hazards of litigation for the government on this issue and is exploring a more moderate position.
**B. Legacy IP Royalty Rate ($188.04M Proposed)**
I presented PPC's 4.5% royalty rate on legacy compound net sales in non-Americas territories. Dr. Vasquez then presented Whitmore's CUT analysis, which identified 14 comparable uncontrolled pharmaceutical license agreements with an interquartile range of 3.1%–6.8% and a median of 4.4%. This places PPC's 4.5% rate squarely within the arm's-length range under Treas. Reg. § 1.482-4.
We contrasted this with the IRS exam team's proposed 11.0% rate, which was based on the IRS's own selected CUTs, and highlighted the rebuttal memorandum prepared by Dr. Vasquez and Dr. Chakrabarti challenging the CUT selection criteria employed by the government's expert, Dr. Washburne. We also noted the declining legacy compound sales trajectory ($814.6M in 2017 declining to $624.1M in 2020), which further undermines the reasonableness of the IRS's high rate. The proposed royalty adjustments by year were $52.95M (2017), $49.55M (2018), $44.97M (2019), and $40.57M (2020).
*Castañeda's Reaction:* This appeared to be PPC's strongest issue. Castañeda expressed skepticism about the IRS's 11.0% rate, noting the wide gap between the exam team's selected comparables and the broader market data. She asked Dr. Vasquez several follow-up questions about the 14 CUT agreements, particularly regarding comparability adjustments and product lifecycle considerations. She seemed persuaded that PPC's CUT analysis was more rigorous than the exam team's. She did ask us to provide supplemental written detail on two additional comparable agreements that Dr. Vasquez referenced during the presentation — we will prepare and submit that material promptly (see Section IV below).
**C. Economic Substance / DEMPE Functions**
Marcus and I presented the extensive evidence of PBI's economic substance in Ireland: 185 employees (up from 52 at establishment in 2012); approximately 18,000 square feet of office space at Sandyford Business Park in Dublin; 42 board meetings held in Dublin during 2017–2020; €47.2M in cumulative regulatory expenditure on submissions across 68 country markets; and PBI's independent pricing decisions. We referenced PBI's managing director, Aidan Naughton, along with the 12 key employee interview summaries demonstrating substantive DEMPE (Development, Enhancement, Maintenance, Protection, Exploitation) functions performed in Ireland. We also highlighted PBI's independent banking relationship with Glenmore Bank Ireland plc and its own treasury operations, as well as PBI's revenue of €2.14B and pre-tax income of €1.06B in FY 2020 — all supported by its own financial and operational infrastructure.
*Castañeda's Reaction:* She did not press hard on economic substance. She asked a few clarifying questions about the ratio of PBI employees to total revenue — i.e., whether the headcount was truly proportionate to PBI's functions — but seemed generally satisfied that PBI was more than a shell entity. Our sense is that she does not view the economic substance challenge as a strong position for the government, which is consistent with the exam team's own treatment of it as a secondary argument.
**D. PCT Valuation (Background Issue)**
Although the PCT payment of $312M relates to the 2012 buy-in (outside the examination years), I addressed Castañeda's questions about how the IRS's view of the PCT valuation — $852M under the IRS's income method using a 7.2% WACC — influenced the proposed CSA and royalty adjustments for 2017–2020. Dr. Vasquez presented Whitmore's DCF/income-method analysis using a 9.8% WACC, which yielded an arm's-length range of $278M–$361M for the PCT. PPC's $312M payment falls comfortably within that range. Dr. Vasquez walked through the WACC/Discount rate analysis in detail, explaining why the IRS's 7.2% rate was inappropriately low for pharmaceutical IP with significant development risk.
*Castañeda's Reaction:* She acknowledged the technical complexity of the discount rate dispute but did not appear to rely heavily on the PCT issue as an independent basis for adjustment in the examination years.
**E. Correlative Offset**
We addressed the $42.65M correlative offset that the exam team allowed to avoid double-counting between the CSA and royalty adjustments. Castañeda accepted that some offset would be required in any settlement to avoid double-counting. There was no significant dispute on this point.
**F. Penalty — IRC § 6662(e)**
I presented PPC's contemporaneous transfer pricing documentation, originally prepared by Crestfield & Associates under IRC § 6662(e) penalty-protection standards, for all four years. I argued PPC's reasonable cause defense: PPC relied on qualified professionals, maintained contemporaneous documentation, and its positions were within arm's-length ranges supported by independent economic analysis. The proposed penalty was $15.98M (20% of tax on $380.4M).
*Castañeda's Reaction:* She appeared strongly inclined to abate the penalty entirely. She acknowledged the quality of PPC's contemporaneous documentation and stated that she generally views penalty protection under § 6662(e)(3)(B) as appropriate where the taxpayer has maintained comprehensive documentation and relied on qualified advisors. This is a very positive signal.
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**III. Overall Assessment and Settlement Trajectory**
Our overall assessment is that the conference went very well for PPC. Castañeda is a methodical, experienced Appeals Officer who had clearly reviewed the Protest (filed December 22, 2023) and supporting exhibits in detail before the conference. She indicated she would be in a position to make a settlement proposal within approximately two weeks.
Based on her reactions and the questions she asked, our expectation is that any settlement offer will reflect a very substantial reduction from the $380.4M net proposed adjustment — likely in the range that we previously identified in the settlement authority memorandum (target of 10–15% of the proposed adjustment, with a ceiling of 20%).
More specifically, our assessment by issue is as follows:
- **Royalty Rate:** This issue appears likely to be resolved most favorably for PPC, possibly approaching a full concession by the government. - **CSA Cost-Sharing:** We anticipate some modest adjustment, but well below the exam team's proposed levels. Castañeda's questions about a 2–3 percentage point adjustment are encouraging. - **Economic Substance / DEMPE:** This argument appears likely to be largely abandoned by Appeals. - **Penalty:** Abatement appears highly likely.
I want to be appropriately cautious — we have not yet received a formal proposal, and Appeals Officers can and do surprise practitioners. But the overall trajectory is favorable.
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**IV. Immediate Next Steps**
1. **Supplemental Submission:** We will prepare and submit a supplemental written submission to Appeals Officer Castañeda with the additional CUT comparable data she requested. Our target delivery is within one week — by approximately March 8, 2024. Garrett Simmons will coordinate with Dr. Vasquez at Whitmore Valuation Group on this supplemental data.
2. **Settlement Range Analysis:** We will prepare an updated sensitivity/settlement range analysis so that PPC management is positioned to evaluate any offer promptly upon receipt.
3. **Availability:** I would ask that Marcus, Deborah, and Rajesh be available for a conference call on short notice once the settlement proposal is received. Timing will depend on Castañeda, but we should anticipate a proposal in mid-to-late March.
4. **Form 906 Closing Agreement:** Once terms are agreed upon, we will need to initiate the Form 906 Closing Agreement process with Appeals.
5. **Statute of Limitations:** As a reminder, the statute of limitations extensions (Forms 872) for TY 2017 and TY 2018 are in place through December 31, 2024. We have adequate time, but there is no reason for delay.
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**V. Additional Observations**
A few additional notes from the conference:
Marcus, I want to acknowledge that your contribution during the conference was particularly effective. Your explanation of PBI's operational decision-making processes and your firsthand knowledge of the cost-sharing methodology were well-received by Castañeda and added genuine credibility to our presentation. Castañeda engaged with you directly on several points, which is a positive indicator — it signals that she viewed the PPC team as knowledgeable and forthcoming.
Dr. Vasquez's presentation of the economic analyses was clear and compelling. Castañeda engaged substantively with the data rather than challenging it, which in my experience is a strong indicator that she found the analysis credible.
Finally, there was no indication that the IRS exam team (Revenue Agent Dunleavy, Supervisory Agent Meskill) or Chief Counsel (Rosario, Hirabayashi) provided adverse input to Appeals. This is consistent with the standard independence of the Appeals function, but worth noting — it suggests we are not facing behind-the-scenes resistance from the exam team.
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**VI. Confidentiality**
I want to reiterate that this communication is protected by the attorney-client privilege and the work-product doctrine. It should not be shared outside the recipients and authorized PPC personnel without Calderwood & Harkness's prior written approval.
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I am happy to schedule a follow-up call early next week to discuss any questions or to walk through any of this in greater detail. Please let me know what works for your schedules.
Best regards,
**Leonard Cross** Partner, Tax Department Calderwood & Harkness LLP 1735 Market Street, Suite 3100 Philadelphia, PA 19103 Tel: (215) 864-7200 Email: lcross@calderwoodharkness.com
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