Dear Ciarán,
I hope this finds you well. I am writing in connection with C&H Matter No. 1018-00009 — the ongoing IRS Large Business & International Division examination of Penterra Pharmaceuticals Corp. ("PPC") (EIN 22-3741856), Exam Team LB&I-NE-TP-2022-00641, for tax years 2017 through 2020. As you know, Leonard Cross and I have been coordinating with your team on the Irish-side implications of this examination throughout the course of the audit.
I am pleased to report that IRS Appeals Officer Noreen Castañeda issued a formal settlement offer on March 15, 2024. PPC management has reviewed the terms and is expected to formally approve acceptance within the next few days — we anticipate written acceptance by March 22. We view this as a favorable outcome for the client.
The purpose of this email is to provide you with a detailed summary of the U.S. settlement terms and to request Thornbury & Keogh's analysis of the potential Irish tax consequences for Penterra Biopharma International DAC ("PBI") (Irish Tax Reference 3218764T; registered office at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4, Ireland) arising from the settlement. We would also appreciate your guidance on any required Irish filings, disclosures, or other procedural steps that PBI should be considering at this stage.
**I. Summary of U.S. Settlement Terms**
For context, the IRS originally proposed net adjustments of approximately $380.4 million across TY 2017–2020, comprising three components:
- **CSA cost-sharing ratio adjustments:** $235.01 million. The IRS proposed increasing PBI's cost-sharing percentage by 8 to 12 percentage points per year above PPC's reported ratios (which ranged from 38.2% in 2017 to 42.7% in 2020 under the cost-sharing arrangement effective since July 1, 2012). - **Legacy IP royalty rate adjustments:** $188.04 million. The IRS proposed increasing the royalty rate on legacy intellectual property licensed from PPC to PBI from the contractual rate of 4.5% to 11.0% of non-Americas net sales (legacy net sales for the relevant years were $814.6M (2017), $762.3M (2018), $691.8M (2019), and $624.1M (2020)). - **Correlative offset allowed by the examination team:** negative $42.65 million.
The settlement amount is **$47.6 million** in total adjustments across all four years, representing approximately 12.51% of the IRS's proposed $380.4 million. The year-by-year allocation is as follows:
| Tax Year
Key financial terms:
- **U.S. federal tax due:** Approximately $10.0 million ($47.6M × 21%, with TY 2017 subject to a blended rate given the pre-TCJA 35% rate for part of the year). - **Estimated interest:** Approximately $2.84 million. - **IRC § 6662(e) penalty:** Fully abated. Appeals accepted PPC's reasonable-cause defense and contemporaneous documentation as establishing penalty protection under § 6662(e)(3)(B).
The settlement will be memorialized in a **Form 906 Closing Agreement**, which we expect to be executed by the end of March 2024.
One point of particular significance for the Irish analysis: the settlement does not formally specify whether the $47.6 million adjustment is attributable to the CSA cost-sharing issue, the royalty rate issue, or some blend of the two. As I discuss below, this characterization question has meaningful Irish tax implications.
**II. Analysis of Potential Irish Tax Consequences**
We have identified the following areas where the U.S. settlement may have Irish tax ramifications for PBI. I have organized these by issue and have included specific questions for T&K at the end of each section, with a consolidated numbered list in Section III below.
**A. Correlative / Corresponding Adjustments and Double Taxation Risk**
The $47.6 million U.S. adjustment increases PPC's U.S.-source taxable income for 2017–2020. To the extent this adjustment is attributable to intercompany transactions between PPC and PBI — which it almost certainly is, given that both the CSA and the legacy IP license are bilateral arrangements between PPC and PBI (with Penterra Holdings Luxembourg S.à r.l. as an intermediate holding entity that is disregarded for U.S. federal tax purposes) — PBI may have a basis to claim a correlative reduction in its Irish taxable income to avoid economic double taxation.
The Convention Between the Government of the United States of America and the Government of Ireland for the Avoidance of Double Taxation (the "U.S.-Ireland Treaty") provides for mutual agreement procedures ("MAP") under Article 25, pursuant to which PPC and PBI could seek competent authority relief to eliminate the double taxation arising from the U.S. adjustment. As you may recall, Leonard circulated a memorandum in December 2023 analyzing the competent authority relief options available to PPC/PBI, and the question of whether to pursue a MAP request remains open pending the outcome of the IRS examination — which we now have.
The key question for T&K is whether PBI should seek a corresponding adjustment from Irish Revenue, and if so, through what mechanism. Would Irish Revenue accept the U.S. settlement — particularly one memorialized in a Form 906 Closing Agreement — as a sufficient basis for adjusting PBI's assessable trading profits for the relevant periods? Or would a bilateral MAP request through the Irish and U.S. competent authorities be necessary to achieve relief?
**B. Impact on PBI's Knowledge Development box (KDB) Claims**
As you are aware, PBI has claimed benefits under Ireland's Knowledge Development box regime at an effective rate of 6.25% on qualifying IP income from FY 2016 forward, as compared to the standard 12.5% trading income rate. The U.S. settlement could interact with PBI's KDB claims in several ways, depending on how the adjustment is characterized:
1. **If characterized primarily as a CSA cost-sharing adjustment** (i.e., the IRS concluded that PBI should have borne a higher share of R&D costs under the cost-sharing arrangement): The consequence in Ireland might be that PBI's deductible R&D cost-sharing payments were understated for 2017–2020. Since qualifying expenditure on R&D is a component of the modified nexus fraction in the KDB formula, an increase in PBI's R&D cost-sharing payments could affect the quantum of PBI's KDB-eligible income.
2. **If characterized primarily as a royalty rate adjustment** (i.e., PBI should have paid a higher royalty to PPC on legacy IP): PBI would have a larger deduction for outbound royalty payments, reducing Irish taxable income — but this would also reduce the pool of income eligible for KDB treatment and raises the withholding tax question discussed in Section C below.
That said, I would note that the settlement amount is relatively modest in the context of PBI's overall financial profile. PBI's FY 2020 pre-tax income was approximately €1.06 billion on revenue of €2.14 billion. A $47.6 million adjustment spread across four years — roughly $11–13 million per year — would represent a de minimis proportion of PBI's total KDB-eligible income in any given year. However, I would appreciate T&K's confirmation that this is indeed the case under the KDB computational mechanics, and that there are no cliff effects or thresholds we should be concerned about.
**C. Irish Withholding Tax on Royalty Adjustments**
To the extent the settlement is attributable to an increase in the royalty rate on legacy IP licensed from PPC to PBI, the additional royalty payments — if recognized as such by Irish Revenue — could in principle trigger Irish withholding tax obligations on the incremental amounts. Under the U.S.-Ireland Treaty, the withholding tax rate on royalties paid by an Irish resident to a U.S. resident is generally reduced to 0%, but I would ask T&K to confirm that this treaty relief remains applicable in the specific circumstances and that no Irish withholding tax liability arises on any incremental royalty amounts.
**D. Transfer Pricing Documentation — Irish Requirements**
The Irish transfer pricing rules, as significantly strengthened by Finance Act 2019 (effective for chargeable periods commencing on or after January 1, 2020), impose arm's-length requirements and contemporaneous documentation obligations that are, in many respects, more rigorous than the pre-2020 regime. PBI currently maintains transfer pricing documentation supporting its intercompany arrangements with PPC (and with Penterra Manufacturing Ireland Ltd., the contract manufacturer operating at cost plus 8%).
Given that PPC has now reached a settlement with the IRS on its transfer pricing positions for 2017–2020, I would ask T&K to advise on whether PBI's existing Irish transfer pricing documentation needs to be updated or supplemented to reflect the settlement outcome. Additionally, we would value T&K's assessment of whether the U.S. settlement could prompt an independent Irish Revenue transfer pricing inquiry into PBI's arrangements — particularly given PBI's scale (185 employees and €2.14 billion in revenue as of FY 2020) and the fact that the IRS examination and settlement will be a matter of record.
**E. Amended Irish Returns / Voluntary Disclosure**
If a correlative adjustment is warranted — whether through a unilateral request to Irish Revenue or through a bilateral MAP process — PBI may need to file amended Corporation Tax returns (CT1 forms) for the 2017–2020 fiscal years. Alternatively, if Irish Revenue will not grant a unilateral corresponding adjustment, the MAP/competent authority route may be the only available mechanism.
I would ask T&K to advise on the procedural options available to PBI, including whether a voluntary disclosure to Irish Revenue would be advisable in these circumstances (and, if so, whether a "qualifying disclosure" within the meaning of the Code of Practice for Revenue Audit and other Compliance Interventions would be appropriate or necessary).
**III. Specific Questions for T&K**
To consolidate the questions raised above, we would appreciate T&K's analysis on the following:
1. Does T&K recommend pursuing a correlative/corresponding adjustment with Irish Revenue in respect of the $47.6 million U.S. settlement? If so, should PBI proceed by way of a unilateral request to Irish Revenue, or should PPC and PBI jointly pursue a bilateral MAP request under Article 25 of the U.S.-Ireland Treaty?
2. What is the impact, if any, of the settlement on PBI's Knowledge Development box claims for FY 2016–2020? Does the quantum of the settlement, or its characterization as a CSA cost-sharing adjustment versus a royalty rate adjustment (or a blend), affect the KDB computation?
3. Please confirm that no Irish withholding tax liability arises on any incremental royalty amounts that may be recognized as a result of the settlement, given the 0% treaty rate under the U.S.-Ireland Treaty.
4. Should PBI's Irish transfer pricing documentation be updated or supplemented in light of the settlement?
5. In T&K's assessment, is there a material risk that the U.S. settlement could trigger an independent Irish Revenue transfer pricing audit of PBI?
6. What amended filing obligations, if any, arise for PBI in respect of FY 2017–2020?
7. Please provide an estimate of T&K's fees for the analysis described above and for any required filings or submissions. For budgeting purposes, I note that T&K's fees to date on this matter are approximately €312,500.
**IV. Timeline and Next Steps**
As noted, PPC is expected to formally accept the settlement offer by March 22, 2024, and we anticipate that the Form 906 Closing Agreement will be executed by the end of March. In light of this timeline, we would greatly appreciate T&K's initial written response within approximately two weeks — i.e., by April 3, 2024 — so that C&H and PPC management can evaluate PBI's Irish tax position alongside the finalization of the U.S. settlement.
We are happy to schedule a call at your convenience with Leonard, Garrett, and me to discuss the issues outlined above before you begin your written analysis. Please let us know your availability and we will coordinate.
I should also note that Leonard and I have separately been discussing the MAP/competent authority question internally, and I will revert to you on the strategic direction once PPC management has had an opportunity to weigh in on that decision. We recognize that the MAP and unilateral-adjustment paths involve different trade-offs, and we want to ensure alignment with the client before committing to a course of action.
Regarding attachments: the settlement offer analysis memo prepared by Leonard and Kathryn Hartwell, dated March 18, 2024, contains additional detail on the settlement terms and our recommended course of action. We will transmit that memo to you separately once PPC has formally accepted the offer, as the client has asked that we hold distribution until acceptance is confirmed. In the meantime, you may wish to refer back to Leonard's December 2023 memorandum on competent authority relief, which provides useful background.
**V. Confidentiality**
As indicated in the subject line, this communication is privileged and confidential, and is subject to the attorney-client privilege and the work-product doctrine. Please treat it accordingly within T&K and do not share this email or its contents with any parties outside Thornbury & Keogh without our prior written authorization.
Thank you, Ciarán, for T&K's continued support and excellent counsel throughout this matter. We very much value the partnership and look forward to working through these Irish-side questions with you.
With kind regards,
Leila Nazari Associate, Tax Department Calderwood & Harkness LLP 1735 Market Street, Suite 3100 Philadelphia, PA 19103 Tel: (215) 864-7200 Email: lnazari@calderwoodharkness.com
---
*CONFIDENTIALITY NOTICE: This email message, including any attachments, is for the sole use of the intended recipient(s) and may contain confidential and privileged information protected by the attorney-client privilege, the work-product doctrine, or other applicable law. Any unauthorized review, use, disclosure, or distribution is prohibited. If you are not the intended recipient, please contact the sender by reply email and destroy all copies of the original message.*