Helena,
Happy New Year to you and the Whitmore team. I hope the holidays treated you well. I'm writing to get us moving on what I expect will be the centerpiece of our Appeals presentation in the Penterra matter.
**Background and Current Posture**
As you know, the IRS issued the NOPA on October 12, 2023, proposing net adjustments of $380.4 million across tax years 2017–2020. The proposed adjustments break down as $235.01M in CSA cost-sharing adjustments, $188.04M in royalty rate adjustments, less a $42.65M correlative offset. We filed the formal Protest on behalf of Penterra Pharmaceuticals Corp. (EIN 22-3741856) on December 22, 2023. The case has now been assigned to Appeals Officer Noreen Castañeda, and I anticipate requesting an Appeals conference for late February — likely the last week of the month.
The economic analysis prepared by Dr. Alan Washburne of the IRS Transfer Pricing Practice is the analytical backbone of the proposed adjustments. We need to take it apart methodically.
**The Request**
I'm asking Whitmore Valuation Group to prepare a comprehensive rebuttal memorandum addressing Dr. Washburne's economic analysis. The memorandum should be authored by you and Rohan, prepared under the Kovel engagement (reference 1018-00009-KV, per our Kovel letter dated June 20, 2022), and marked as privileged attorney work product prepared at the direction of counsel. Please address the memorandum to Calderwood & Harkness LLP, attention Leonard Cross, and caption it as prepared at the request of counsel in connection with C&H Matter 1018-00009.
Your prior reports — the CUT analysis (November 2022), CPM/TNMM analysis (November 2022), PCT valuation/DCF report (December 2022), and WACC/Discount rate analysis (December 2022) — should serve as the foundation. Where updated or supplemental benchmarking data is available, please incorporate it.
I've identified the following areas where Dr. Washburne's analysis is most vulnerable. I'd like the rebuttal to address each substantively:
**A. PCT Valuation / Discount Rate (WACC)**
Dr. Washburne used an income method with a WACC of 7.2% to value the platform contribution transaction at $852M — nearly three times the $312M actually paid by PBI on July 1, 2012. As you'll recall, your own DCF analysis used a WACC of 9.8%, yielding a range of $278M–$361M, which places the $312M PCT payment comfortably within the arm's-length range.
The rebuttal should demonstrate why 9.8% is the appropriate discount rate. I'd like you to walk through the risk premiums, beta comparables, and pharmaceutical-industry cost of capital in detail, and explain why Dr. Washburne's 7.2% materially understates the risk profile. I recognize the PCT itself occurred in 2012, outside the exam years, but the IRS is using the alleged PCT undervaluation as the lever to recharacterize the ongoing CSA cost-sharing ratios and royalty rates across TY 2017–2020. We need to pull that lever out of their hands.
**B. CSA Cost-Sharing Ratios**
The IRS proposes increasing PBI's cost-sharing percentage by 8–12 percentage points in each year:
- 2017: 38.2% → 48.2% (total R&D pool: $487.3M; proposed additional payment: $48.73M) - 2018: 39.6% → 50.6% (total R&D pool: $523.8M; proposed additional: $57.61M) - 2019: 41.1% → 52.3% (total R&D pool: $561.2M; proposed additional: $62.85M) - 2020: 42.7% → 53.7% (total R&D pool: $598.4M; proposed additional: $65.82M)
Dr. Washburne asserts that PPC's projections of reasonably anticipated benefits systematically understated U.S.-source value. The rebuttal should challenge his revenue projections head-on and demonstrate that PPC's cost-sharing ratios properly reflected reasonably anticipated benefits under Treas. Reg. § 1.482-7. Please reference and update your existing cost-sharing ratio analysis and revenue projection work, including the Americas vs. non-Americas splits for Veritaxol, Imvara, and Cerulon.
**C. Royalty Rate — CUT Selection**
This is where I think Dr. Washburne is most exposed. The IRS proposes increasing the legacy IP royalty rate from 4.5% to 11.0% of net sales, generating proposed royalty adjustments totaling $188.04M across the four years (based on non-Americas legacy compound net sales of $814.6M, $762.3M, $691.8M, and $624.1M, respectively).
Your CUT analysis identified 14 comparable uncontrolled pharmaceutical license agreements with an interquartile range of 3.1%–6.8% and a median of 4.4%. PPC's 4.5% rate falls squarely within that arm's-length range. I'd like the rebuttal to specifically challenge Dr. Washburne's CUT selection criteria — I suspect he cherry-picked agreements involving different therapeutic areas, different stages of product lifecycle, or agreements with materially different risk allocation profiles. Show why your 14 comparables are more reliable and why his set fails the comparability standards.
**D. Revenue Growth Rate Assumptions**
Dr. Washburne appears to have used overly aggressive revenue growth projections in his income-method analysis, which inflates the value of IP allocated to non-Americas territories. The rebuttal should present actual versus projected revenue data and demonstrate that PPC's contemporaneous projections were reasonable. The declining trajectory of legacy compound sales is particularly important here — the actual performance data should speak powerfully.
**E. PBI Economic Substance / DEMPE Functions**
I understand this is primarily a legal argument, and we'll handle it as such in the brief. But Dr. Washburne's analysis partially rests on the assertion that key DEMPE functions — Development, Enhancement, Maintenance, Protection, and Exploitation — remained in the United States. To the extent the rebuttal can incorporate the factual record demonstrating PBI's substantive operations, it would strengthen both the economic and legal arguments. The key data points:
- Growth from 52 employees at establishment in 2012 to 185 employees during the exam period - 42 board meetings held in Dublin across 2017–2020 - €47.2M in cumulative regulatory expenditures - Independent pricing decisions across 68 country markets - Approximately 18,000 sq ft of office space at Sandyford Business Park - Independent banking relationship with Glenmore Bank Ireland plc
I'd also like you to highlight the CPM/TNMM results — your analysis tested PBI's operating margins against 22 comparable companies and showed PBI within the interquartile range in all four years. That's strong corroborative evidence that PBI operated at arm's length, and Appeals should see it front and center.
**Timeline and Logistics**
I'd like a draft rebuttal memorandum by approximately January 26 — that gives us roughly three weeks, and gives the legal team adequate time to review, comment, and finalize before the Appeals conference. I anticipate the conference will be scheduled for late February, likely February 28, at the IRS Appeals Office in Manhattan.
Garrett Simmons will be the day-to-day point of contact for data requests and coordination. If you need additional financial data, updated workpapers, or anything from the Crestfield & Associates documentation, please flag it for Garrett and he'll get it to you promptly. Garrett already has copies of both the NOPA (including Dr. Washburne's economic analysis) and the Protest, if you need to reference either.
**Privilege Reminder**
As always, please ensure that all work product is marked as privileged and confidential — prepared at the direction of counsel under the Kovel arrangement. Communications regarding this engagement should be treated accordingly.
**Next Steps**
Helena, I want to thank you and your team for the excellent work throughout the examination phase. The quality of the prior reports put us in a strong position, and I'm confident the rebuttal will be equally rigorous. This memorandum will be a critical component of our Appeals presentation, and I believe a well-executed rebuttal gives us a real opportunity to achieve a favorable resolution — or at minimum significantly narrow the adjustments.
I'd like to schedule a call early next week to discuss scope and approach before you begin drafting. Garrett, would you coordinate a time that works for Helena, Rohan, and our team? Ideally Monday or Tuesday.
Looking forward to it.
Best regards,
Leonard Cross Partner, Tax Department Calderwood & Harkness LLP 1735 Market Street, Suite 3100 Philadelphia, PA 19103 Tel: (215) 554-7200 lcross@calderwoodharkness.com
--- CONFIDENTIALITY NOTICE: This email and any attachments are privileged and confidential, intended solely for the use of the individual or entity to whom it is addressed. If you are not the intended recipient, please notify the sender immediately and delete this message. Any unauthorized review, use, disclosure, or distribution is prohibited.