1018-00009 · Client 1018 · Correspondence/Third Party

letter-to-crestfield-fin48-support-20220920.docx DOCUMENT M&A / Corporate

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PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT COMMUNICATION

CALDERWOOD & HARKNESS LLP Attorneys at Law

1735 Market Street, Suite 3100 Philadelphia, PA 19103 Tel: (215) 448-6200	Fax: (215) 448-6201
600 Lexington Avenue New York, NY 10022 Tel: (212) 536-7400	Fax: (212) 536-7401

www.calderwoodharkness.com

September 20, 2022

Martin Ogilvy, CPA Engagement Partner Crestfield & Associates LLP 1200 Avenue of the Americas New York, NY 10036

Re: Penterra Pharmaceuticals Corp. (EIN: 22-3741856) — ASC 740-10 (FIN 48) Analysis — Uncertain Tax Positions Related to Transfer Pricing, Tax Years 2017–2020 Matter No. 1018-00009

Dear Mr. Ogilvy:

I. Purpose and Scope of Letter

Calderwood & Harkness LLP ("C&H" or the "Firm") serves as outside tax counsel to Penterra Pharmaceuticals Corp. ("PPC" or the "Company") in connection with the defense of an ongoing examination by the Internal Revenue Service, Large Business & International Division (Exam Team ID: LB&I-NE-TP-2022-00641) of PPC's federal income tax returns (Forms 1120) for tax years ended December 31, 2017, December 31, 2018, December 31, 2019, and December 31, 2020 (collectively, the "Exam Years"). The examination was initiated on May 16, 2022, when PPC received IRS Letter 2205-A notifying the Company that its returns for the Exam Years had been selected for examination.

The purpose of this letter is to provide C&H's legal analysis and conclusions regarding PPC's uncertain tax positions related to its Irish intellectual-property-holding structure, for use by Crestfield & Associates LLP ("Crestfield") in its assessment of PPC's reserves under Financial Accounting Standards Board ("FASB") Accounting Standards Codification Topic 740-10, Income Taxes ("ASC 740-10"), formerly known as FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"), in Crestfield's capacity as PPC's independent auditor. This letter addresses the recognition and measurement of uncertain tax positions arising from PPC's intercompany transfer pricing arrangements, including the cost-sharing arrangement, the legacy intellectual property royalty, and the platform contribution transaction, each as described in further detail below.

We note at the outset that Susan Lam, Crestfield's Transfer Pricing Partner, originally prepared PPC's contemporaneous transfer pricing documentation for the Exam Years pursuant to the requirements of Treasury Regulation § 1.6662-6 and the penalty-protection standards of Internal Revenue Code ("IRC") § 6662(e). This letter is not intended to duplicate or supersede that economic documentation, but rather to provide the legal overlay—specifically, C&H's independent analysis of the legal merits of PPC's tax positions and the attendant litigation risk—for financial statement reserve purposes under the two-step recognition and measurement framework prescribed by ASC 740-10.

This letter is provided at the direction of PPC's Vice President of Global Tax, Marcus Whitfield, and General Counsel, Deborah Staines, each of whom has authorized the limited disclosure of this privileged attorney-client communication to Crestfield solely for the purpose of supporting PPC's financial statement audit.

Privilege Notice. This letter constitutes a privileged attorney-client communication between C&H and PPC. The sharing of this letter with Crestfield, at PPC's direction and for the limited purpose described above, is not intended to waive, and does not waive, the attorney-client privilege, the work-product doctrine, or any other applicable privilege or protection. Crestfield's receipt and use of this letter are subject to the limitations set forth in Section X below.

II. Background — PPC's International IP Structure

A. Corporate Structure Overview

PPC is a corporation organized under the laws of the State of Delaware, publicly traded on the Nasdaq Global Select Market under the ticker symbol "PPCA," and headquartered at 2200 Independence Boulevard, Princeton Junction, New Jersey 08550. PPC is a specialty pharmaceutical and biotechnology company focused on the research, development, manufacture, and commercialization of innovative therapeutics in the fields of oncology, immunology, and rare-disease treatments.

For the fiscal year ended December 31, 2020, PPC reported annual net revenue of approximately $6.82 billion and pre-tax income of approximately $1.47 billion. As of the same date, PPC employed approximately 14,500 individuals globally, including employees in the United States, Ireland, the United Kingdom, Germany, Japan, and various other jurisdictions. PPC's Chief Executive Officer is Catherine Falk, and its Chief Financial Officer is Rajesh Iyer.

B. Entity Chain

The relevant entity chain for purposes of the transfer pricing positions discussed herein is as follows:

1. Penterra Pharmaceuticals Corp. ("PPC") — A Delaware corporation; the ultimate parent entity and U.S. taxpayer.

2. Penterra Holdings Luxembourg S.à r.l. ("PHL") — A société à responsabilité limitée organized under the laws of the Grand Duchy of Luxembourg, with its registered office at 14, rue Aldringen, L-1118 Luxembourg, Luxembourg (Registre de Commerce et des Sociétés No. B 168452). PHL is wholly owned (100%) by PPC and has elected, or is otherwise treated, as a disregarded entity for U.S. federal income tax purposes pursuant to Treasury Regulation § 301.7701-3. Accordingly, for U.S. federal income tax purposes, PHL's assets, liabilities, and operations are treated as those of PPC.

3. Penterra Biopharma International DAC ("PBI") — A Designated Activity Company organized under the laws of Ireland, with its registered office at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4, Ireland (Irish Tax Reference: 3218764T). PBI is wholly owned (100%) by PHL and, through PHL, is an indirect wholly owned subsidiary of PPC. PBI serves as the intellectual property holding company and principal for the commercialization of PPC's pharmaceutical products outside the Americas territory (as defined below). PBI is treated as a controlled foreign corporation ("CFC") for U.S. federal income tax purposes under IRC §§ 957 and 958.

4. Penterra Manufacturing Ireland Ltd. ("PMI") — An Irish private limited company (Companies Registration Office No. 512347), located at Unit 7, Ringaskiddy Industrial Estate, Co. Cork T12 PX29, Ireland. PMI is wholly owned by PBI and operates as a contract manufacturer under a cost-plus arrangement with PBI, pursuant to which PMI receives a markup of 8% on its fully loaded costs. As of December 31, 2020, PMI employed approximately 620 individuals at its Cork manufacturing facility.

C. Cost-Sharing Arrangement

PBI was incorporated on March 15, 2012, as part of PPC's restructuring of its international operations. Effective July 1, 2012, PPC and PBI entered into a qualified cost-sharing arrangement (the "CSA") governed by Treasury Regulation § 1.482-7. Under the CSA, PBI acquired the right to develop and exploit PPC's existing and future pharmaceutical intellectual property portfolio outside the Americas territory, defined for purposes of the CSA as North America (the United States, Canada, and Mexico), Central America, South America, and the Caribbean (collectively, the "Americas").

In connection with the execution of the CSA, PBI made a platform contribution transaction ("PCT") payment to PPC in the amount of $312 million on July 1, 2012, representing arm's-length consideration for PBI's buy-in to PPC's pre-existing intellectual property, which at the time consisted primarily of clinical-stage and approved oncology compounds, associated regulatory dossiers, and related know-how. The basis for this PCT payment and its valuation are discussed further in Section V.D below.

Under the ongoing terms of the CSA, PBI makes cost-sharing payments to PPC that are proportional to the parties' reasonably anticipated benefits ("RAB") from the shared intangible development activities, as required by Treasury Regulation § 1.482-7(e). The cost-sharing ratios applied during the Exam Years, and the corresponding dollar amounts of PBI's share of total qualified research and development costs, were as follows:

The gradual increase in PBI's cost-sharing ratio from 38.2% in 2017 to 42.7% in 2020 reflects the growth of PBI's non-Americas revenue as a proportion of PPC's consolidated global revenue over this period, consistent with the RAB methodology adopted in the CSA and applied prospectively.

D. Legacy IP Royalty Arrangement

Separately from the CSA, PBI licenses from PPC certain legacy pharmaceutical compounds—those with a pre-2012 vintage that were not covered by the CSA's prospective cost-sharing mechanism—under an intercompany license agreement (the "Legacy IP License"). Under the Legacy IP License, PBI pays PPC a royalty of 4.5% of net sales of the licensed legacy products in the non-Americas territory. The Legacy IP License covers a discrete group of mature products that were fully developed and approved prior to the execution of the CSA.

The following table sets forth the relevant net sales of legacy compounds in the non-Americas territory and the corresponding royalty payments during the Exam Years:

The declining trajectory of legacy compound net sales reflects the natural product lifecycle of these mature therapies, including generic competition and market erosion in certain non-Americas jurisdictions.

E. PBI's Functions, Assets, and Risks

PBI is not a "shell" or "brass plate" entity. Throughout the Exam Years, PBI maintained a substantial operational presence in Ireland and performed significant functions, bore meaningful risks, and employed substantial assets in connection with the development and commercialization of PPC's pharmaceutical products outside the Americas.

Personnel and Management. PBI's Managing Director during the Exam Years was Aidan Naughton, an experienced pharmaceutical industry executive based in Dublin. PBI employs personnel across multiple functional areas, including regulatory affairs, medical affairs, commercial strategy, supply-chain management, market access, pharmacovigilance, and finance. PBI's headcount grew from 52 employees at the time of its incorporation in 2012 to 185 employees as of December 31, 2020, reflecting the expansion of PBI's commercial operations and the increasing scope of its responsibilities.

Office Space. PBI maintains approximately 18,000 square feet of dedicated office space at Claremont House, Sandyford Business Park, Dublin, Ireland. This space houses PBI's management, regulatory, commercial, and administrative functions.

Corporate Governance. PBI's board of directors held a total of 42 formal board meetings in Dublin during the period from January 1, 2017, through December 31, 2020. These meetings included regularly scheduled quarterly sessions as well as special sessions convened to address significant commercial and strategic decisions, including product launches, pricing determinations, partnership negotiations, and regulatory submissions.

Regulatory Expenditures. During the Exam Years, PBI incurred cumulative regulatory expenditures of approximately €47.2 million in connection with non-Americas regulatory submissions, including European Medicines Agency ("EMA") marketing authorization applications, national-level submissions in over 40 countries, post-approval commitments, and pharmacovigilance activities.

Commercial Decision-Making. PBI exercises independent pricing decisions across 68 country markets in its non-Americas territory. PBI is responsible for market-entry decisions, the selection and management of distribution partners, the negotiation of government reimbursement and tender pricing, and the development and execution of commercial launch strategies. PBI bears the economic risk associated with the commercial success or failure of PPC's products in the non-Americas territory.

Banking. PBI maintains its principal operating accounts with Glenmore Bank Ireland plc, a licensed Irish credit institution, and conducts its treasury and cash management functions through those accounts.

F. Key Products

The following table summarizes PPC's key products and the division of net sales between Americas and non-Americas territories for fiscal year 2020:

Veritaxol, PPC's flagship oncology product, is a blockbuster therapy that accounts for the largest share of both global and non-Americas revenue. Imvara and Cerulon represent significant growth products in the immunology and rare-disease categories, respectively. Each of these products involves IP that is the subject of the CSA.

G. Irish Tax Position

PBI is subject to Irish corporate income tax at the standard rate of 12.5% on its trading income. Beginning with fiscal year 2016, PBI has also claimed the benefit of Ireland's Knowledge Development box ("KDB") regime, which provides a reduced effective tax rate of 6.25% on qualifying intellectual property income derived from qualifying assets that result from qualifying R&D activities carried on in Ireland. PBI's Irish tax affairs are managed by Thornbury & Keogh, Chartered Tax Advisors, of Dublin, Ireland, under the supervision of lead tax partner Ciarán Thornbury.

The differential between PBI's Irish effective tax rate (12.5%, or 6.25% for KDB-qualifying income) and the U.S. corporate income tax rate (35% for tax year 2017; 21% for tax years 2018–2020) is the fundamental driver of the transfer pricing issues under examination and the source of the uncertain tax positions analyzed in this letter.

III. Status of IRS Examination

The IRS Large Business & International Division opened its examination of PPC's federal income tax returns for the Exam Years on May 16, 2022, through the issuance of IRS Letter 2205-A. The examination is being conducted out of the IRS's Northeast Area office and is focused principally on PPC's international transfer pricing arrangements, with particular attention to the CSA, the Legacy IP License, and the PCT.

The key members of the IRS examination team and their supporting personnel are as follows:

• Supervisory Revenue Agent (Team Manager): Gerald Meskill

• Lead Revenue Agent: Patricia Dunleavy

• IRS Economist (Transfer Pricing Practice): Dr. Alan Washburne

• IRS Office of Chief Counsel, Attorney-Advisor: Franklin Rosario

• IRS Office of Chief Counsel, Senior Counsel: Donna Hirabayashi

As of the date of this letter, the IRS has issued approximately 23 Information Document Requests ("IDRs") covering a wide range of topics, including PPC's organizational structure, the CSA and Legacy IP License agreements, PBI's financial statements, PBI's board minutes and corporate governance materials, the contemporaneous transfer pricing documentation prepared by Crestfield, PPC's and PBI's R&D expenditure allocation methodology, Veritaxol clinical trial data, product-level profitability information, and comparable company and comparable transaction data. C&H is actively responding to these IDRs in coordination with PPC's internal tax department and is managing the document production process. We anticipate that additional IDRs will be issued as the examination progresses.

No Notice of Proposed Adjustment ("NOPA") has been issued as of the date of this letter. Accordingly, the IRS's formal positions on the transfer pricing issues have not yet been articulated. Our analysis of the likely areas of IRS challenge is based on the pattern of IDR activity to date, the focus areas identified during the opening conference, and our experience with similar IRS examinations of pharmaceutical and biotechnology companies.

PPC was not a participant in the IRS's Compliance Assurance Process ("CAP") for the Exam Years. Accordingly, the examination is being conducted as a standard post-filing audit.

Kovel Arrangement. C&H has retained Whitmore Valuation Group LLC ("Whitmore") to provide independent economic analyses, benchmarking studies, and expert reports supporting PPC's transfer pricing positions. Whitmore is led by Dr. Helena Vasquez, a recognized expert in pharmaceutical transfer pricing economics. Whitmore's engagement is conducted under a Kovel arrangement, formalized in a Kovel letter dated June 20, 2022, and referenced as Matter No. 1018-00009-KV. Under this arrangement, Whitmore's work product and communications with C&H are protected by the attorney-client privilege and the work-product doctrine, as Whitmore functions as a non-testifying consulting expert retained by counsel to assist in the provision of legal services to PPC. See United States v. Kovel, 296 F.2d 918 (2d Cir. 1961).

IV. Identification of Uncertain Tax Positions

A. Overview of Positions at Issue

Based on our review of the examination activity to date and our assessment of the legal and economic merits of PPC's transfer pricing positions, we have identified three principal uncertain tax positions related to PPC's Irish IP-holding structure for purposes of the intercompany transfer pricing rules under IRC § 482:

Position 1: Cost-Sharing Arrangement — Reasonably Anticipated Benefit Shares and Cost-Sharing Ratios. Whether the CSA cost-sharing ratios applied by PPC and PBI during the Exam Years (38.2% to 42.7% for PBI) accurately reflect the parties' reasonably anticipated benefits from the shared intangible development activities, as required by Treasury Regulation § 1.482-7(e).

Position 2: Legacy IP Royalty Rate. Whether the 4.5% royalty rate applied to PBI's net sales of legacy compounds in the non-Americas territory under the Legacy IP License constitutes arm's-length consideration for the licensed intellectual property, as required by Treasury Regulation § 1.482-4.

Position 3: Platform Contribution Transaction (PCT) Valuation. Whether the $312 million PCT payment made by PBI to PPC on July 1, 2012, in connection with the execution of the CSA, adequately compensated PPC for the pre-existing intellectual property contributed to the CSA, as required by Treasury Regulation § 1.482-7(g).

Additionally, a closely related threshold position involves the economic substance of PBI as an entity capable of owning intellectual property, performing the functions and bearing the risks associated with that ownership, and serving as a qualified participant in the CSA. While we treat economic substance as a foundational issue that underlies all three of the enumerated positions, we also address it independently in Section V.E below.

B. Anticipated Areas of IRS Challenge

Based on the pattern and substance of the IDRs issued to date, as well as the involvement of IRS Economist Dr. Washburne and Office of Chief Counsel attorneys Rosario and Hirabayashi, we anticipate that the IRS will focus its challenge on the following specific aspects of PPC's transfer pricing positions:

1. CSA Cost-Sharing Percentages. Whether the cost-sharing percentages of 38.2% to 42.7% allocated to PBI understate the U.S.-source share of reasonably anticipated benefits from shared intangible development activities. The IRS may contend that PPC's RAB methodology underweights the value of PPC's U.S.-based R&D capabilities, personnel, and infrastructure, and that a higher cost-sharing percentage should be allocated to the non-Americas participant.

2. Legacy IP Royalty Rate. Whether the 4.5% royalty rate on non-Americas net sales of legacy compounds is below arm's length. Based on our experience and the nature of the IDRs issued to date, we anticipate that the IRS may propose a significantly higher royalty rate, potentially based on the IRS's own selection of comparable uncontrolled transactions ("CUTs") that may include agreements with higher royalty rates but potentially weaker comparability to PPC's specific facts and circumstances.

3. PCT Valuation. Whether the $312 million PCT payment adequately compensated PPC for the pre-existing intellectual property contributed to the CSA. The IRS may argue for a significantly higher PCT value based on alternative discount rate assumptions and revenue growth projections in a discounted cash flow analysis.

4. Economic Substance and DEMPE Functions. Whether PBI possesses sufficient economic substance and performs adequate functions related to the Development, Enhancement, Maintenance, Protection, and Exploitation ("DEMPE") of the intellectual property to justify its role as IP owner and CSA participant. This line of challenge, if pursued, would be directed at undermining PBI's entitlement to the residual profits attributable to IP ownership.

V. ASC 740-10 Legal Analysis — Recognition Step (More-Likely-Than-Not)

A. Applicable Standard

Under ASC 740-10-25-6, a tax position should be recognized in the financial statements only if it is "more likely than not" (defined as a likelihood of more than 50 percent) that the position will be sustained upon examination by the relevant taxing authority, including resolution of any related appeals or litigation processes, based solely on the technical merits of the position. The evaluation of a tax position's technical merits should be based on legislation, regulations, case law, revenue rulings, revenue procedures, and other administrative guidance and interpretive authority in effect as of the reporting date.

ASC 740-10-25-7 provides that the more-likely-than-not recognition threshold should be applied assuming that the taxing authority will examine the position and have full knowledge of all relevant information. In the present case, this assumption is not hypothetical; the IRS has in fact commenced an examination of PPC's returns for the Exam Years and has full access to relevant information through the IDR process.

We apply this recognition standard to each of PPC's uncertain tax positions below.

B. Position 1: CSA Cost-Sharing Ratios

PPC's Position. PPC maintains that the cost-sharing ratios applied during the Exam Years—38.2% (2017), 39.6% (2018), 41.1% (2019), and 42.7% (2020) for PBI—accurately reflect the parties' reasonably anticipated benefits from the shared intangible development activities conducted under the CSA, as required by Treasury Regulation § 1.482-7(e)(2), and are consistent with the arm's-length standard set forth in IRC § 482 and Treasury Regulation § 1.482-1(b).

Supporting Analysis. PPC's RAB allocation methodology is based on a prospective revenue-split approach that projects the relative shares of future revenue expected to be generated by PPC (Americas) and PBI (non-Americas) from products developed under the CSA. The increasing share allocated to PBI during the Exam Years reflects the growing penetration of PPC's products in non-Americas markets, particularly in the European Union, Japan, and emerging markets, and is supported by contemporaneous market data, historical sales trends, and management's reasonable revenue forecasts.

In addition to the contemporaneous RAB analysis, Whitmore Valuation Group has performed a confirmatory analysis under the comparable profits method ("CPM") / transactional net margin method ("TNMM") framework. Whitmore identified a set of 22 comparable distributors and IP-holding companies operating in the pharmaceutical and biotechnology sector and tested PBI's operating margins against the interquartile range derived from these comparables. In all four Exam Years, PBI's operating margins fall within the interquartile range of the comparable set, confirming that PBI's profitability is consistent with arm's-length returns.

Legal Authority. PPC's position is supported by the following legal authorities:

• Treasury Regulation § 1.482-7(e)(2), which prescribes the methodology for determining RAB shares in a qualified cost-sharing arrangement;

• The best method rule under Treasury Regulation § 1.482-1(c), which requires selection of the most reliable measure of an arm's-length result;

• Treasury Regulation § 1.482-1(d), which sets forth the comparability standards applicable to all § 482 analyses;

• Relevant Tax Court precedent in cost-sharing cases, including the analytical framework applied in cases involving the reliability of RAB projections and the selection of appropriate allocation keys.

Contemporaneous Documentation. PPC maintained contemporaneous transfer pricing documentation for all four Exam Years, prepared by Crestfield & Associates under the penalty-protection standards of IRC § 6662(e) and Treasury Regulation § 1.6662-6. This documentation sets forth the CSA methodology, the RAB analysis, the cost-sharing ratios, and the supporting economic data in substantial detail.

Conclusion. Based on the foregoing analysis, C&H believes that PPC's cost-sharing ratios for the Exam Years are well-supported by the applicable regulatory framework, the contemporaneous economic analysis, and the confirmatory benchmarking performed by Whitmore. We conclude that this position meets the more-likely-than-not threshold for recognition under ASC 740-10-25.

C. Position 2: Legacy IP Royalty Rate (4.5%)

PPC's Position. PPC maintains that the 4.5% royalty rate applied to PBI's net sales of legacy compounds in the non-Americas territory under the Legacy IP License reflects arm's-length consideration for the licensed intellectual property, determined under the comparable uncontrolled transaction ("CUT") method prescribed by Treasury Regulation § 1.482-4(c).

Supporting Analysis. Whitmore Valuation Group conducted a comprehensive comparable uncontrolled transaction analysis and identified 14 comparable uncontrolled pharmaceutical license agreements involving the licensing of mature, commercialized pharmaceutical compounds to related or unrelated distributors or commercialization partners. The interquartile range of royalty rates observed in these 14 agreements is 3.1% to 6.8% of net sales, with a median of 4.4%. PPC's 4.5% royalty rate falls squarely within this arm's-length range and is virtually identical to the median of the comparable set.

Whitmore's selection of comparable agreements was based on a rigorous application of the comparability factors set forth in Treasury Regulation § 1.482-4(c)(2), including the nature and stage of the licensed intangible, the terms and conditions of the license (including territory, exclusivity, and field of use), the functions performed and risks borne by the licensee, and the economic conditions of the relevant markets. Adjustments were made where necessary to enhance comparability.

We are aware that the IRS may challenge the comparability of PPC's selected CUTs and may propose a significantly higher royalty rate—potentially up to 11.0%—based on the IRS's own selection of comparable transactions. However, based on our review of the types of agreements that the IRS has sought in its IDRs and our experience in comparable cases, we believe that any IRS-proposed CUT set at or near the 11.0% level would rely on agreements that are materially less comparable to PPC's Legacy IP License than the CUTs identified by Whitmore. In particular, we anticipate that IRS-proposed CUTs may involve earlier-stage compounds with greater upside potential, different territorial scope, or different risk allocation profiles, all of which would tend to inflate the observed royalty rates and reduce their comparability to PPC's arrangement.

Legal Authority. PPC's position is supported by the following:

• Treasury Regulation § 1.482-4(c), which sets forth the CUT method for determining arm's-length royalty rates for controlled transfers of intangible property;

• Treasury Regulation § 1.482-1(c) and (d), the best method rule and comparability standards;

• The analytical framework applied by the Tax Court in Harborview Corporation, Inc. v. Commissioner, T.C. Memo. 2016-112, aff'd in part, rev'd in part, 900 F.3d 610 (8th Cir. 2018), and on remand, T.C. Memo. 2022-84, in which the court evaluated the reliability of competing CUT analyses in a pharmaceutical/medical device transfer pricing context and emphasized the importance of functional and risk comparability in CUT selection;

• Additional Tax Court and appellate authority addressing the CUT methodology and the proper application of comparability adjustments.

Conclusion. Based on the strength of Whitmore's comparable transaction analysis, the positioning of PPC's 4.5% rate near the median of a well-supported interquartile range, and the applicable legal authorities, C&H believes that this position meets the more-likely-than-not threshold for recognition under ASC 740-10-25.

D. Position 3: PCT Valuation ($312M)

PPC's Position. PPC maintains that the $312 million PCT payment made by PBI to PPC on July 1, 2012, represents arm's-length consideration for the pre-existing intellectual property contributed by PPC to the CSA, as required by Treasury Regulation § 1.482-7(g).

Supporting Analysis. Whitmore Valuation Group performed a discounted cash flow ("DCF") / income-method analysis to determine the arm's-length value of the pre-existing IP contributed by PPC to the CSA as of July 1, 2012. The DCF analysis projected the future cash flows attributable to the contributed IP in the non-Americas territory over the remaining useful life of the relevant compounds, and discounted those cash flows to present value using a weighted average cost of capital ("WACC") of 9.8%.

The 9.8% WACC was derived from a capital asset pricing model ("CAPM") analysis using pharmaceutical-industry-specific inputs, including: (i) a risk-free rate based on the 20-year U.S. Treasury yield as of July 2012; (ii) an equity risk premium based on the Westmark Consulting Group (now Sundial Advisors) long-horizon equity risk premium; (iii) a beta coefficient derived from a set of publicly traded pharmaceutical companies comparable to PPC in terms of therapeutic focus, revenue scale, and product lifecycle profile; and (iv) a size premium consistent with PPC's market capitalization. The resulting WACC of 9.8% reflects the risk profile of the specific IP assets contributed—primarily clinical-stage and recently approved oncology compounds—and the inherent uncertainties in projecting non-Americas revenue streams for those assets over a multi-decade horizon.

Based on this analysis, Whitmore concluded that the arm's-length range for the PCT payment is $278 million to $361 million. The $312 million payment actually made falls within this range and is consistent with the arm's-length standard.

Anticipated IRS Challenge. We anticipate that the IRS may challenge the PCT valuation on the basis of two principal contentions: (i) that the appropriate discount rate is lower than 9.8%, potentially as low as 7.2%, reflecting the IRS's view that the contributed IP was less risky than PPC and Whitmore have assessed; and (ii) that the revenue growth assumptions used in the DCF analysis are too conservative, underestimating the future commercial success of the contributed compounds (including Veritaxol, which has since become a blockbuster product). A lower discount rate combined with higher revenue projections would yield a significantly higher PCT value under the income method—potentially up to $852 million, representing a delta of approximately $540 million over the $312 million payment actually made.

The dispute over the appropriate discount rate is a common area of contention in transfer pricing PCT valuations. C&H believes that the 9.8% WACC used by Whitmore is well-supported by the pharmaceutical-industry-specific risk premiums and beta comparables, and that the IRS's potential 7.2% rate would fail to account for the substantial development and commercialization risk that existed as of the July 2012 valuation date. The revenue projections used in PPC's analysis were based on contemporaneous forecasts prepared by PPC's commercial teams as of mid-2012 and were not informed by hindsight; the use of later-developed actual results to second-guess contemporaneous projections is disfavored under the applicable regulations and case law.

We note that 2012—the year of the PCT payment—is outside the Exam Years (2017–2020). However, the IRS may seek to use a PCT undervaluation theory to recharacterize the ongoing CSA cost-sharing ratios and royalty rates during the Exam Years as failing to reflect the full value of contributed IP. Under this theory, an inadequate PCT would imply that PBI obtained IP rights at below-market value, and the IRS could argue that the ongoing CSA and royalty arrangements should be adjusted to account for this undercompensation. This risk of collateral impact on the Exam Year positions is factored into our measurement analysis in Section VI below.

Legal Authority. PPC's position is supported by the following:

• Treasury Regulation § 1.482-7(g), which governs PCT payments in qualified cost-sharing arrangements and prescribes methodologies for determining arm's-length compensation for platform contributions;

• The income method for valuation of intangibles under Treasury Regulation § 1.482-7(g)(4);

• IRC § 367(d), which represents a potential alternative legal theory that the IRS could invoke for the outbound transfer of intangible property to a CFC, though PPC believes the CSA regulations are the more appropriate framework;

• Case law addressing the income-method valuation of pharmaceutical and technology intangibles in the transfer pricing context, including decisions addressing the selection of appropriate discount rates and the use of contemporaneous versus hindsight-informed revenue projections.

Conclusion. Based on the foregoing analysis, C&H believes that PPC's PCT valuation meets the more-likely-than-not threshold for recognition under ASC 740-10-25. We note, however, that the discount rate issue presents some litigation hazard, as courts have reached varying conclusions on the appropriate WACC in comparable pharmaceutical DCF analyses. This residual uncertainty is reflected in our measurement analysis in Section VI.

E. PBI Economic Substance

PPC's Position. PPC maintains that PBI has sufficient economic substance to be recognized as the owner of non-Americas intellectual property rights and as a qualified participant in the CSA, and that PBI performs meaningful DEMPE functions with respect to the intellectual property it holds.

Supporting Evidence. C&H has compiled and reviewed the following evidence in support of PBI's economic substance:

• Personnel: PBI employed 185 individuals as of December 31, 2020, up from 52 at inception in 2012. These employees span regulatory affairs, medical affairs, commercial strategy, supply-chain management, market access, pharmacovigilance, finance, and administrative functions.

• Corporate Governance: PBI's board of directors held 42 formal board meetings in Dublin during the period 2017–2020, including quarterly sessions and special sessions. Board meetings involved substantive deliberations on commercial strategy, product launches, pricing decisions, regulatory submissions, and other matters of strategic importance to PBI's operations.

• Regulatory Expenditures: PBI incurred cumulative regulatory expenditures of approximately €47.2 million during the Exam Years in connection with EMA and national-level regulatory submissions, post-approval commitments, and pharmacovigilance activities.

• Commercial Decision-Making: PBI exercises independent pricing decisions across 68 country markets in the non-Americas territory. PBI selects and manages distribution partners, negotiates government reimbursement and tender pricing, and develops and executes product launch strategies.

• Physical Presence: PBI maintains approximately 18,000 square feet of dedicated office space at Sandyford Business Park, Dublin.

• Banking: PBI maintains its principal operating accounts with Glenmore Bank Ireland plc, an Irish-licensed credit institution, and conducts its treasury and cash management functions locally.

• Management: Managing Director Aidan Naughton exercises genuine commercial authority over PBI's operations and reports to PPC's global leadership on PBI's performance.

DEMPE Analysis. C&H has prepared a detailed DEMPE analysis demonstrating that PBI performs substantial functions across each of the five DEMPE categories:

• Development: PBI co-funds research and development activities through its cost-sharing payments under the CSA, bearing its proportionate share of R&D costs and risks.

• Enhancement: PBI performs activities that enhance the value of the IP in non-Americas markets, including the conduct of region-specific clinical studies, the generation of real-world evidence, and the development of market-specific formulations and packaging.

• Maintenance: PBI is responsible for maintaining the value of the IP through ongoing pharmacovigilance, product quality monitoring, and lifecycle management in its territory.

• Protection: PBI files and prosecutes regulatory submissions, manages product registrations across 68 country markets, and coordinates with PPC on global patent strategy as it relates to non-Americas jurisdictions.

• Exploitation: PBI is responsible for the commercial exploitation of the IP in the non-Americas territory, including pricing, marketing, distribution, and sales activities.

Legal Authority. PBI's economic substance is supported by:

• The economic substance doctrine as codified in IRC § 7701(o) and as applied in the transfer pricing context;

• OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2017 and 2022 revisions), Chapter VI (Special Considerations for Intangibles) and Chapter VIII (Cost Contribution Arrangements), which provide persuasive (though not binding) authority on the importance of functions, assets, and risks—and specifically DEMPE functions—in allocating intangible-related returns among controlled entities;

• Case law addressing the substance of foreign entities in the transfer pricing context, including decisions examining whether a foreign subsidiary possesses sufficient personnel, decision-making authority, and operational capability to be respected as the economic owner of intangible property.

Conclusion. Based on the substantial body of evidence demonstrating PBI's operational presence, personnel, corporate governance, regulatory activity, commercial decision-making, and DEMPE functions, C&H believes that PBI's economic substance meets the more-likely-than-not threshold for recognition under ASC 740-10-25. We regard the economic substance evidence as robust.

VI. ASC 740-10 Legal Analysis — Measurement Step

A. Applicable Standard

For tax positions that are recognized (i.e., that meet the more-likely-than-not threshold), ASC 740-10-30-7 requires measurement at the "largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement." This measurement standard requires a cumulative probability assessment of the potential outcomes of the tax position, considering all available evidence, including the facts and circumstances of the position, relevant technical authorities, and the entity's experience with similar positions and the relevant taxing authority.

The measurement step is inherently forward-looking and requires the exercise of significant judgment. Unlike the recognition step (which is a binary yes/no determination), the measurement step requires quantification of the benefit amount that the entity is more than 50% likely to realize, taking into account the full range of possible settlement outcomes and their relative probabilities.

B. Exposure Quantification

C&H has assessed the range of potential IRS adjustments based on the examination activity to date, IRS precedent in pharmaceutical transfer pricing cases, and the relative strength and weakness of PPC's positions across the three uncertain tax positions identified above. The following summarizes the range of potential exposure on each position:

Position 1: CSA Cost-Sharing Ratios. If the IRS were to assert that PBI's cost-sharing percentages during the Exam Years should be increased by 8 to 12 percentage points (e.g., from 38.2%–42.7% to approximately 46.2%–54.7%), the resulting additional allocation of intangible development costs to PPC (i.e., a reduction in PBI's cost-sharing obligation with a corresponding increase in deemed U.S.-source income) would yield additional taxable income to PPC of approximately $48 million to $66 million per year across the Exam Years, or a total four-year incremental income adjustment in the range of approximately $192 million to $264 million.

Position 2: Legacy IP Royalty Rate. If the IRS were to propose a royalty rate as high as 11.0% (compared to PPC's 4.5%), the resulting additional royalty income that would be imputed to PPC for the Exam Years would be approximately $40 million to $53 million per year, reflecting the differential applied to legacy compound net sales declining from $814.6 million in 2017 to $624.1 million in 2020. The total four-year incremental income adjustment would be in the range of approximately $160 million to $180 million.

Position 3: PCT-Related Recharacterization. While the PCT itself was a 2012 transaction and is not directly subject to adjustment in the Exam Years, the IRS could use a PCT undervaluation theory to support larger adjustments to the CSA cost-sharing ratios and royalty rates during the Exam Years. To the extent the IRS argues that the $312 million PCT understated the value of contributed IP by as much as $540 million (based on the IRS's potential $852 million valuation), this differential could provide the foundation for enhanced adjustments across Positions 1 and 2. However, to the extent that adjustments to the CSA cost-sharing ratios and the royalty rate are asserted independently, there would be significant overlap and potential for double-counting between the PCT recharacterization and the direct CSA/royalty adjustments. Any IRS adjustments would need to account for correlative offsets to avoid such double-counting.

Aggregate Exposure. Taking into account the potential adjustments across all three positions, and before application of correlative adjustments and offsets, the total potential four-year proposed adjustment could range from approximately $350 million to $425 million of additional taxable income allocated to PPC. After application of correlative adjustments (to eliminate overlap between the CSA and royalty adjustments and to reflect the offsetting effect of any increased U.S. tax liability against foreign tax credits), the net exposure would be reduced, though the precise amount of such reduction would depend on the specific positions taken by the IRS in any future NOPA.

Tax Rate Impact. The tax impact of any adjustments would be affected by the reduction in the U.S. corporate income tax rate from 35% to 21% pursuant to the Tax Cuts and Jobs Act of 2017 (the "TCJA"), effective January 1, 2018. Accordingly, any adjustment to PPC's taxable income for tax year 2017 would be taxed at 35%, while adjustments for tax years 2018, 2019, and 2020 would be taxed at 21%. This rate differential increases the per-dollar tax exposure for the 2017 tax year relative to subsequent years.

C. Recommended Reserve Amount

Based on C&H's legal analysis and our cumulative probability assessment of the potential outcomes of PPC's uncertain tax positions, we offer the following conclusions regarding the appropriate reserve level under ASC 740-10:

Overall Assessment. PPC's positions on all three uncertain tax issues—the CSA cost-sharing ratios, the legacy IP royalty rate, and the PCT valuation—are well-supported by applicable legal authorities, contemporaneous transfer pricing documentation, and independent economic analyses prepared by Whitmore Valuation Group. As set forth in Section V above, C&H believes that each position individually meets the more-likely-than-not threshold for recognition under ASC 740-10-25.

However, there is inherent uncertainty in transfer pricing controversy that must be reflected in the measurement of the recognized benefit. Transfer pricing disputes necessarily involve subjective judgments regarding comparability analysis, the selection of comparable transactions and comparable companies, the determination of appropriate discount rates, and the allocation of intangible-related benefits among controlled entities. Courts have acknowledged this inherent imprecision, and settlement outcomes in transfer pricing cases—whether at IRS Appeals or in litigation—frequently result in resolution at a fraction of the proposed adjustment, particularly in cases where the taxpayer has strong contemporaneous documentation and credible economic support.

Taking into account the strength of PPC's technical positions, the quality of the contemporaneous documentation prepared by Crestfield, the independence and rigor of Whitmore's economic analyses, the realistic range of settlement outcomes based on C&H's experience with similar IRS examinations of pharmaceutical companies, and the applicable tax rates, C&H supports PPC's current ASC 740-10 reserve for uncertain tax positions related to the Irish IP structure in the amount of $62.4 million. This reserve amount reflects the cumulative probability-weighted measurement of the largest benefit amount that is greater than 50 percent likely of being realized upon ultimate settlement of the tax positions, as required by ASC 740-10-30-7.

The $62.4 million reserve amount implies that PPC expects, on a probability-weighted basis, to retain the substantial majority of the tax benefits associated with its Irish IP structure, while recognizing a prudent reserve for the possibility that some portion of the benefit may be conceded in settlement or on adverse resolution of specific technical issues (most notably the discount rate issue in the PCT valuation and the potential for the IRS to identify more comparable CUTs at higher royalty rates in the legacy IP analysis).

Reassessment. The reserve should be reassessed as the examination progresses, and C&H will provide updated analysis on a periodic basis and promptly upon the occurrence of material developments. In particular, the reserve should be reassessed upon: (i) the issuance of any NOPA by the IRS; (ii) the engagement of settlement discussions with IRS Appeals; or (iii) any material change in the applicable legal authority.

VII. Penalty Protection Analysis

IRC § 6662(e) imposes a 20% accuracy-related penalty on any underpayment of tax attributable to a substantial valuation misstatement in connection with a § 482 transfer pricing adjustment. Under IRC § 6662(h), the penalty rate increases to 40% in the case of a gross valuation misstatement (i.e., an adjustment that is 400% or more of the correct transfer price, or 25% or less of the correct transfer price). These penalty provisions are of particular significance in transfer pricing cases, where the magnitude of proposed adjustments can be substantial.

However, IRC § 6662(e)(3)(B) provides a reasonable-cause exception to the substantial valuation misstatement penalty. Under this exception, no penalty shall be imposed if the taxpayer demonstrates that: (i) the transfer pricing methodology used was reasonable; (ii) the taxpayer's use of such methodology was reasonable; and (iii) the taxpayer maintained contemporaneous documentation establishing its reasonable belief that the transfer pricing methodology and its application were consistent with IRC § 482 and the applicable regulations. The specific requirements for such contemporaneous documentation are set forth in Treasury Regulation § 1.6662-6.

PPC maintained contemporaneous transfer pricing documentation for all four Exam Years. This documentation was prepared by Crestfield & Associates (specifically, by Susan Lam and her transfer pricing team) and meets the requirements of Treasury Regulation § 1.6662-6 in all material respects, including: the specification of the controlled transactions; the selection and application of the best method; the identification and analysis of comparable transactions and comparable companies; the documentation of the comparability factors considered; and the economic analysis supporting the arm's-length nature of PPC's intercompany pricing.

Based on our review of the contemporaneous documentation and the underlying economic analyses, C&H believes that PPC has a strong reasonable-cause defense to any § 6662(e) penalty assertion. PPC's transfer pricing methodologies were reasonable, PPC's application of those methodologies was reasonable, and PPC maintained the required contemporaneous documentation. The availability of this penalty-protection defense further supports the reserve level set forth in Section VI.C, as it indicates that any ultimate adjustment to PPC's transfer pricing positions would not be subject to the 20% (or 40%) penalty enhancement.

VIII. TCJA Considerations

The Tax Cuts and Jobs Act (Pub. L. 115-97), enacted on December 22, 2017, and effective for tax years beginning after December 31, 2017, introduced several provisions that are relevant to the measurement of PPC's uncertain tax positions for the Exam Years.

Corporate Tax Rate Reduction. The TCJA reduced the U.S. federal corporate income tax rate from 35% to 21%, effective January 1, 2018. For PPC's Exam Years, this means that any transfer pricing adjustment for tax year 2017 would be subject to the higher 35% rate, while adjustments for tax years 2018, 2019, and 2020 would be subject to the reduced 21% rate. This differential materially affects the per-dollar tax cost of any adjustment: a $100 million income adjustment in 2017 would generate $35 million of additional tax liability, whereas the same adjustment in 2018–2020 would generate $21 million. The disproportionate impact of the 2017 tax year on total potential exposure has been factored into the reserve quantification discussed in Section VI.

GILTI. The TCJA introduced the Global Intangible Low-Taxed Income ("GILTI") provisions under IRC § 951A, effective for tax years beginning after December 31, 2017. Under GILTI, U.S. shareholders of CFCs are required to include in gross income the CFC's tested income to the extent it exceeds a deemed return on the CFC's qualified business asset investment ("QBAI"). To the extent that any § 482 adjustment increases PBI's income (or reduces PBI's cost-sharing deductions), it may have secondary effects on PPC's GILTI inclusion, the GILTI high-tax exclusion analysis, and the availability of foreign tax credits under IRC § 960. These secondary GILTI effects have been considered in the reserve quantification, though they are complex and depend on the specific nature and magnitude of any adjustment.

BEAT. The TCJA also introduced the Base Erosion and Anti-Abuse Tax ("BEAT") under IRC § 59A, which imposes a minimum tax on certain large corporations that make deductible payments to related foreign persons. To the extent that PPC claims deductions for intercompany payments to PBI (such as cost-sharing payments or other intercompany charges), these payments may be treated as base erosion payments subject to the BEAT calculation. Any § 482 adjustment that recharacterizes the magnitude or nature of intercompany payments could affect PPC's BEAT liability. These potential interactions have been considered in the overall reserve analysis.

IX. Limitations and Caveats

The analysis and conclusions set forth in this letter are subject to the following limitations and caveats:

1. Current Knowledge. This analysis is based on the facts known to C&H as of the date of this letter, September 20, 2022, and on the current status of the IRS examination as described in Section III above. No NOPA has been issued as of this date, and the IRS's formal positions on the transfer pricing issues have not yet been articulated in writing.

2. No Guarantees. The conclusions expressed in this letter represent C&H's best professional judgment as to the technical merits and likely outcomes of PPC's tax positions based on current law and facts. They do not constitute a guarantee or assurance that the positions will be sustained in their entirety, or that the reserve amount recommended herein will prove to be adequate or excessive in light of future developments.

3. Need for Reassessment. The analysis set forth herein may require revision as the examination progresses. Specific developments that could necessitate reassessment include, but are not limited to: (a) the issuance of a NOPA by the IRS on any of the positions discussed herein; (b) the development of new factual information, whether through the IDR process, IRS summons activity, or otherwise; (c) changes in relevant legal authority, including the issuance of new regulations, revenue rulings, or court decisions bearing on the issues discussed herein; or (d) a significant change in PPC's business operations or intercompany arrangements.

4. Periodic Updates. C&H will provide updated analysis on a periodic basis, at least quarterly, and will provide prompt supplemental analysis upon the occurrence of any material development in the examination.

5. Limited Purpose. This letter is provided solely for the purpose of supporting Crestfield & Associates LLP's assessment of PPC's ASC 740-10 reserves in connection with PPC's financial statement audit. This letter should not be relied upon for any other purpose, including but not limited to investment decisions, credit determinations, regulatory filings (other than PPC's financial statements to the extent the ASC 740-10 analysis is incorporated therein), or advice to third parties.

6. Scope of Legal Analysis. The opinions and conclusions expressed herein are limited to matters of U.S. federal income tax law, including the Internal Revenue Code, Treasury Regulations, and applicable administrative and judicial authorities. This letter does not address: (a) the tax laws of Ireland or any other foreign jurisdiction; (b) state or local tax law; (c) non-tax legal issues, including securities law, corporate law, or accounting standards (other than to the extent we have applied the legal framework of ASC 740-10 to PPC's tax positions); or (d) any tax positions of PPC other than those specifically identified and analyzed herein.

X. Privilege and Confidentiality

This letter constitutes a privileged and confidential attorney-client communication between Calderwood & Harkness LLP, as outside tax counsel, and Penterra Pharmaceuticals Corp., as client. The analysis, conclusions, and work product reflected in this letter are protected by the attorney-client privilege and the work-product doctrine.

This letter is being shared with Crestfield & Associates LLP at the express direction of PPC, through its authorized representatives Marcus Whitfield and Deborah Staines, solely for the limited purpose of supporting Crestfield's assessment of PPC's ASC 740-10 reserves in connection with PPC's financial statement audit. The disclosure of this letter to Crestfield for this limited purpose does not waive, and is not intended to waive, the attorney-client privilege, the work-product doctrine, or any other applicable privilege, immunity, or protection. See, e.g., United States v. Kraft Voss CPAs LLP, 610 F.3d 129 (D.C. Cir. 2010) (disclosure of privileged materials to independent auditor for financial statement audit purposes may be protected under common-interest doctrine or limited-waiver theory, depending on the circumstances and jurisdiction).

Crestfield should treat this letter as confidential and should not disclose its contents, in whole or in part, to any third party without the prior written consent of PPC. In the event that Crestfield receives a subpoena, court order, or other compulsory process seeking the production of this letter, Crestfield should promptly notify C&H and PPC before making any production, to allow PPC an opportunity to assert applicable privileges and protections.

Additionally, we note that the Kovel arrangement between C&H and Whitmore Valuation Group LLC (reference 1018-00009-KV, dated June 20, 2022) provides privilege protection over Whitmore's economic analyses, work papers, and communications with C&H that are referenced in this letter. Any request for production of Whitmore's materials should be directed to C&H, and Whitmore's materials should not be produced without PPC's prior written consent.

XI. Conclusion and Availability

We trust that this analysis will be of assistance to Crestfield in its assessment of PPC's ASC 740-10 reserves for the current audit cycle. As noted above, we will provide updated analysis on a periodic basis and promptly upon the occurrence of material developments in the IRS examination. We are available to discuss this analysis with Crestfield and PPC at your convenience, whether by telephone, video conference, or in person.

For questions regarding this letter or to schedule a discussion, please contact:

Leonard Cross, Partner, Tax Department Telephone: (215) 448-6247

Email: lcross@calderwoodharkness.com

Garrett Simmons, Associate, Tax Department Telephone: (215) 448-6319

Email: gsimmons@calderwoodharkness.com

We would be pleased to supplement or update this analysis as additional information becomes available or as the examination progresses.

Very truly yours,

CALDERWOOD & HARKNESS LLP

By: ________

Leonard Cross Partner, Tax Department 1735 Market Street, Suite 3100 Philadelphia, PA 19103

cc:

Marcus Whitfield, Vice President, Global Tax, Penterra Pharmaceuticals Corp. Deborah Staines, General Counsel, Penterra Pharmaceuticals Corp. Sylvia Hartwell, Partner, Calderwood & Harkness LLP Garrett Simmons, Associate, Calderwood & Harkness LLP Susan Lam, Transfer Pricing Partner, Crestfield & Associates LLP

Tax Year	PBI CSA Share (%)	PBI Cost Share Payment	Total R&D Costs
2017	38.2%	$186.15M	$487.3M
2018	39.6%	$207.42M	$523.8M
2019	41.1%	$230.65M	$561.2M
2020	42.7%	$255.52M	$598.4M
Tax Year	Legacy Compound Net Sales (Non-Americas)	Royalty Payment (4.5%)
2017	$814.6M	$36.66M
2018	$762.3M	$34.30M
2019	$691.8M	$31.13M
2020	$624.1M	$28.08M
Product	Therapeutic Area	Global Net Sales (2020)	Non-Americas Net Sales (2020)
Veritaxol	Oncology	$3.12B	$1.34B
Imvara	Immunology	$1.87B	$0.79B
Cerulon	Rare Disease	$0.62B	$0.28B

PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT COMMUNICATION
CALDERWOOD & HARKNESS LLP Attorneys at Law
1735 Market Street, Suite 3100 Philadelphia, PA 19103 Tel: (215) 448-6200 | Fax: (215) 448-6201
600 Lexington Avenue New York, NY 10022 Tel: (212) 536-7400 | Fax: (212) 536-7401
www.calderwoodharkness.com
September 20, 2022
Martin Ogilvy, CPA Engagement Partner Crestfield & Associates LLP 1200 Avenue of the Americas New York, NY 10036
Re: Penterra Pharmaceuticals Corp. (EIN: 22-3741856) — ASC 740-10 (FIN 48) Analysis — Uncertain Tax Positions Related to Transfer Pricing, Tax Years 2017–2020 Matter No. 1018-00009
Dear Mr. Ogilvy:
I. Purpose and Scope of Letter
Calderwood & Harkness LLP ("C&H" or the "Firm") serves as outside tax counsel to Penterra Pharmaceuticals Corp. ("PPC" or the "Company") in connection with the defense of an ongoing examination by the Internal Revenue Service, Large Business & International Division (Exam Team ID: LB&I-NE-TP-2022-00641) of PPC's federal income tax returns (Forms 1120) for tax years ended December 31, 2017, December 31, 2018, December 31, 2019, and December 31, 2020 (collectively, the "Exam Years"). The examination was initiated on May 16, 2022, when PPC received IRS Letter 2205-A notifying the Company that its returns for the Exam Years had been selected for examination.
The purpose of this letter is to provide C&H's legal analysis and conclusions regarding PPC's uncertain tax positions related to its Irish intellectual-property-holding structure, for use by Crestfield & Associates LLP ("Crestfield") in its assessment of PPC's reserves under Financial Accounting Standards Board ("FASB") Accounting Standards Codification Topic 740-10, Income Taxes ("ASC 740-10"), formerly known as FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"), in Crestfield's capacity as PPC's independent auditor. This letter addresses the recognition and measurement of uncertain tax positions arising from PPC's intercompany transfer pricing arrangements, including the cost-sharing arrangement, the legacy intellectual property royalty, and the platform contribution transaction, each as described in further detail below.
We note at the outset that Susan Lam, Crestfield's Transfer Pricing Partner, originally prepared PPC's contemporaneous transfer pricing documentation for the Exam Years pursuant to the requirements of Treasury Regulation § 1.6662-6 and the penalty-protection standards of Internal Revenue Code ("IRC") § 6662(e). This letter is not intended to duplicate or supersede that economic documentation, but rather to provide the legal overlay—specifically, C&H's independent analysis of the legal merits of PPC's tax positions and the attendant litigation risk—for financial statement reserve purposes under the two-step recognition and measurement framework prescribed by ASC 740-10.
This letter is provided at the direction of PPC's Vice President of Global Tax, Marcus Whitfield, and General Counsel, Deborah Staines, each of whom has authorized the limited disclosure of this privileged attorney-client communication to Crestfield solely for the purpose of supporting PPC's financial statement audit.
Privilege Notice. This letter constitutes a privileged attorney-client communication between C&H and PPC. The sharing of this letter with Crestfield, at PPC's direction and for the limited purpose described above, is not intended to waive, and does not waive, the attorney-client privilege, the work-product doctrine, or any other applicable privilege or protection. Crestfield's receipt and use of this letter are subject to the limitations set forth in Section X below.
II. Background — PPC's International IP Structure
A. Corporate Structure Overview
PPC is a corporation organized under the laws of the State of Delaware, publicly traded on the Nasdaq Global Select Market under the ticker symbol "PPCA," and headquartered at 2200 Independence Boulevard, Princeton Junction, New Jersey 08550. PPC is a specialty pharmaceutical and biotechnology company focused on the research, development, manufacture, and commercialization of innovative therapeutics in the fields of oncology, immunology, and rare-disease treatments.
For the fiscal year ended December 31, 2020, PPC reported annual net revenue of approximately $6.82 billion and pre-tax income of approximately $1.47 billion. As of the same date, PPC employed approximately 14,500 individuals globally, including employees in the United States, Ireland, the United Kingdom, Germany, Japan, and various other jurisdictions. PPC's Chief Executive Officer is Catherine Falk, and its Chief Financial Officer is Rajesh Iyer.
B. Entity Chain
The relevant entity chain for purposes of the transfer pricing positions discussed herein is as follows:
1. Penterra Pharmaceuticals Corp. ("PPC") — A Delaware corporation; the ultimate parent entity and U.S. taxpayer.
2. Penterra Holdings Luxembourg S.à r.l. ("PHL") — A société à responsabilité limitée organized under the laws of the Grand Duchy of Luxembourg, with its registered office at 14, rue Aldringen, L-1118 Luxembourg, Luxembourg (Registre de Commerce et des Sociétés No. B 168452). PHL is wholly owned (100%) by PPC and has elected, or is otherwise treated, as a disregarded entity for U.S. federal income tax purposes pursuant to Treasury Regulation § 301.7701-3. Accordingly, for U.S. federal income tax purposes, PHL's assets, liabilities, and operations are treated as those of PPC.
3. Penterra Biopharma International DAC ("PBI") — A Designated Activity Company organized under the laws of Ireland, with its registered office at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4, Ireland (Irish Tax Reference: 3218764T). PBI is wholly owned (100%) by PHL and, through PHL, is an indirect wholly owned subsidiary of PPC. PBI serves as the intellectual property holding company and principal for the commercialization of PPC's pharmaceutical products outside the Americas territory (as defined below). PBI is treated as a controlled foreign corporation ("CFC") for U.S. federal income tax purposes under IRC §§ 957 and 958.
4. Penterra Manufacturing Ireland Ltd. ("PMI") — An Irish private limited company (Companies Registration Office No. 512347), located at Unit 7, Ringaskiddy Industrial Estate, Co. Cork T12 PX29, Ireland. PMI is wholly owned by PBI and operates as a contract manufacturer under a cost-plus arrangement with PBI, pursuant to which PMI receives a markup of 8% on its fully loaded costs. As of December 31, 2020, PMI employed approximately 620 individuals at its Cork manufacturing facility.
C. Cost-Sharing Arrangement
PBI was incorporated on March 15, 2012, as part of PPC's restructuring of its international operations. Effective July 1, 2012, PPC and PBI entered into a qualified cost-sharing arrangement (the "CSA") governed by Treasury Regulation § 1.482-7. Under the CSA, PBI acquired the right to develop and exploit PPC's existing and future pharmaceutical intellectual property portfolio outside the Americas territory, defined for purposes of the CSA as North America (the United States, Canada, and Mexico), Central America, South America, and the Caribbean (collectively, the "Americas").
In connection with the execution of the CSA, PBI made a platform contribution transaction ("PCT") payment to PPC in the amount of $312 million on July 1, 2012, representing arm's-length consideration for PBI's buy-in to PPC's pre-existing intellectual property, which at the time consisted primarily of clinical-stage and approved oncology compounds, associated regulatory dossiers, and related know-how. The basis for this PCT payment and its valuation are discussed further in Section V.D below.
Under the ongoing terms of the CSA, PBI makes cost-sharing payments to PPC that are proportional to the parties' reasonably anticipated benefits ("RAB") from the shared intangible development activities, as required by Treasury Regulation § 1.482-7(e). The cost-sharing ratios applied during the Exam Years, and the corresponding dollar amounts of PBI's share of total qualified research and development costs, were as follows:
The gradual increase in PBI's cost-sharing ratio from 38.2% in 2017 to 42.7% in 2020 reflects the growth of PBI's non-Americas revenue as a proportion of PPC's consolidated global revenue over this period, consistent with the RAB methodology adopted in the CSA and applied prospectively.
D. Legacy IP Royalty Arrangement
Separately from the CSA, PBI licenses from PPC certain legacy pharmaceutical compounds—those with a pre-2012 vintage that were not covered by the CSA's prospective cost-sharing mechanism—under an intercompany license agreement (the "Legacy IP License"). Under the Legacy IP License, PBI pays PPC a royalty of 4.5% of net sales of the licensed legacy products in the non-Americas territory. The Legacy IP License covers a discrete group of mature products that were fully developed and approved prior to the execution of the CSA.
The following table sets forth the relevant net sales of legacy compounds in the non-Americas territory and the corresponding royalty payments during the Exam Years:
The declining trajectory of legacy compound net sales reflects the natural product lifecycle of these mature therapies, including generic competition and market erosion in certain non-Americas jurisdictions.
E. PBI's Functions, Assets, and Risks
PBI is not a "shell" or "brass plate" entity. Throughout the Exam Years, PBI maintained a substantial operational presence in Ireland and performed significant functions, bore meaningful risks, and employed substantial assets in connection with the development and commercialization of PPC's pharmaceutical products outside the Americas.
Personnel and Management. PBI's Managing Director during the Exam Years was Aidan Naughton, an experienced pharmaceutical industry executive based in Dublin. PBI employs personnel across multiple functional areas, including regulatory affairs, medical affairs, commercial strategy, supply-chain management, market access, pharmacovigilance, and finance. PBI's headcount grew from 52 employees at the time of its incorporation in 2012 to 185 employees as of December 31, 2020, reflecting the expansion of PBI's commercial operations and the increasing scope of its responsibilities.
Office Space. PBI maintains approximately 18,000 square feet of dedicated office space at Claremont House, Sandyford Business Park, Dublin, Ireland. This space houses PBI's management, regulatory, commercial, and administrative functions.
Corporate Governance. PBI's board of directors held a total of 42 formal board meetings in Dublin during the period from January 1, 2017, through December 31, 2020. These meetings included regularly scheduled quarterly sessions as well as special sessions convened to address significant commercial and strategic decisions, including product launches, pricing determinations, partnership negotiations, and regulatory submissions.
Regulatory Expenditures. During the Exam Years, PBI incurred cumulative regulatory expenditures of approximately €47.2 million in connection with non-Americas regulatory submissions, including European Medicines Agency ("EMA") marketing authorization applications, national-level submissions in over 40 countries, post-approval commitments, and pharmacovigilance activities.
Commercial Decision-Making. PBI exercises independent pricing decisions across 68 country markets in its non-Americas territory. PBI is responsible for market-entry decisions, the selection and management of distribution partners, the negotiation of government reimbursement and tender pricing, and the development and execution of commercial launch strategies. PBI bears the economic risk associated with the commercial success or failure of PPC's products in the non-Americas territory.
Banking. PBI maintains its principal operating accounts with Glenmore Bank Ireland plc, a licensed Irish credit institution, and conducts its treasury and cash management functions through those accounts.
F. Key Products
The following table summarizes PPC's key products and the division of net sales between Americas and non-Americas territories for fiscal year 2020:
Veritaxol, PPC's flagship oncology product, is a blockbuster therapy that accounts for the largest share of both global and non-Americas revenue. Imvara and Cerulon represent significant growth products in the immunology and rare-disease categories, respectively. Each of these products involves IP that is the subject of the CSA.
G. Irish Tax Position
PBI is subject to Irish corporate income tax at the standard rate of 12.5% on its trading income. Beginning with fiscal year 2016, PBI has also claimed the benefit of Ireland's Knowledge Development box ("KDB") regime, which provides a reduced effective tax rate of 6.25% on qualifying intellectual property income derived from qualifying assets that result from qualifying R&D activities carried on in Ireland. PBI's Irish tax affairs are managed by Thornbury & Keogh, Chartered Tax Advisors, of Dublin, Ireland, under the supervision of lead tax partner Ciarán Thornbury.
The differential between PBI's Irish effective tax rate (12.5%, or 6.25% for KDB-qualifying income) and the U.S. corporate income tax rate (35% for tax year 2017; 21% for tax years 2018–2020) is the fundamental driver of the transfer pricing issues under examination and the source of the uncertain tax positions analyzed in this letter.
III. Status of IRS Examination
The IRS Large Business & International Division opened its examination of PPC's federal income tax returns for the Exam Years on May 16, 2022, through the issuance of IRS Letter 2205-A. The examination is being conducted out of the IRS's Northeast Area office and is focused principally on PPC's international transfer pricing arrangements, with particular attention to the CSA, the Legacy IP License, and the PCT.
The key members of the IRS examination team and their supporting personnel are as follows:
• Supervisory Revenue Agent (Team Manager): Gerald Meskill
• Lead Revenue Agent: Patricia Dunleavy
• IRS Economist (Transfer Pricing Practice): Dr. Alan Washburne
• IRS Office of Chief Counsel, Attorney-Advisor: Franklin Rosario
• IRS Office of Chief Counsel, Senior Counsel: Donna Hirabayashi
As of the date of this letter, the IRS has issued approximately 23 Information Document Requests ("IDRs") covering a wide range of topics, including PPC's organizational structure, the CSA and Legacy IP License agreements, PBI's financial statements, PBI's board minutes and corporate governance materials, the contemporaneous transfer pricing documentation prepared by Crestfield, PPC's and PBI's R&D expenditure allocation methodology, Veritaxol clinical trial data, product-level profitability information, and comparable company and comparable transaction data. C&H is actively responding to these IDRs in coordination with PPC's internal tax department and is managing the document production process. We anticipate that additional IDRs will be issued as the examination progresses.
No Notice of Proposed Adjustment ("NOPA") has been issued as of the date of this letter. Accordingly, the IRS's formal positions on the transfer pricing issues have not yet been articulated. Our analysis of the likely areas of IRS challenge is based on the pattern of IDR activity to date, the focus areas identified during the opening conference, and our experience with similar IRS examinations of pharmaceutical and biotechnology companies.
PPC was not a participant in the IRS's Compliance Assurance Process ("CAP") for the Exam Years. Accordingly, the examination is being conducted as a standard post-filing audit.
Kovel Arrangement. C&H has retained Whitmore Valuation Group LLC ("Whitmore") to provide independent economic analyses, benchmarking studies, and expert reports supporting PPC's transfer pricing positions. Whitmore is led by Dr. Helena Vasquez, a recognized expert in pharmaceutical transfer pricing economics. Whitmore's engagement is conducted under a Kovel arrangement, formalized in a Kovel letter dated June 20, 2022, and referenced as Matter No. 1018-00009-KV. Under this arrangement, Whitmore's work product and communications with C&H are protected by the attorney-client privilege and the work-product doctrine, as Whitmore functions as a non-testifying consulting expert retained by counsel to assist in the provision of legal services to PPC. See United States v. Kovel, 296 F.2d 918 (2d Cir. 1961).
IV. Identification of Uncertain Tax Positions
A. Overview of Positions at Issue
Based on our review of the examination activity to date and our assessment of the legal and economic merits of PPC's transfer pricing positions, we have identified three principal uncertain tax positions related to PPC's Irish IP-holding structure for purposes of the intercompany transfer pricing rules under IRC § 482:
Position 1: Cost-Sharing Arrangement — Reasonably Anticipated Benefit Shares and Cost-Sharing Ratios. Whether the CSA cost-sharing ratios applied by PPC and PBI during the Exam Years (38.2% to 42.7% for PBI) accurately reflect the parties' reasonably anticipated benefits from the shared intangible development activities, as required by Treasury Regulation § 1.482-7(e).
Position 2: Legacy IP Royalty Rate. Whether the 4.5% royalty rate applied to PBI's net sales of legacy compounds in the non-Americas territory under the Legacy IP License constitutes arm's-length consideration for the licensed intellectual property, as required by Treasury Regulation § 1.482-4.
Position 3: Platform Contribution Transaction (PCT) Valuation. Whether the $312 million PCT payment made by PBI to PPC on July 1, 2012, in connection with the execution of the CSA, adequately compensated PPC for the pre-existing intellectual property contributed to the CSA, as required by Treasury Regulation § 1.482-7(g).
Additionally, a closely related threshold position involves the economic substance of PBI as an entity capable of owning intellectual property, performing the functions and bearing the risks associated with that ownership, and serving as a qualified participant in the CSA. While we treat economic substance as a foundational issue that underlies all three of the enumerated positions, we also address it independently in Section V.E below.
B. Anticipated Areas of IRS Challenge
Based on the pattern and substance of the IDRs issued to date, as well as the involvement of IRS Economist Dr. Washburne and Office of Chief Counsel attorneys Rosario and Hirabayashi, we anticipate that the IRS will focus its challenge on the following specific aspects of PPC's transfer pricing positions:
1. CSA Cost-Sharing Percentages. Whether the cost-sharing percentages of 38.2% to 42.7% allocated to PBI understate the U.S.-source share of reasonably anticipated benefits from shared intangible development activities. The IRS may contend that PPC's RAB methodology underweights the value of PPC's U.S.-based R&D capabilities, personnel, and infrastructure, and that a higher cost-sharing percentage should be allocated to the non-Americas participant.
2. Legacy IP Royalty Rate. Whether the 4.5% royalty rate on non-Americas net sales of legacy compounds is below arm's length. Based on our experience and the nature of the IDRs issued to date, we anticipate that the IRS may propose a significantly higher royalty rate, potentially based on the IRS's own selection of comparable uncontrolled transactions ("CUTs") that may include agreements with higher royalty rates but potentially weaker comparability to PPC's specific facts and circumstances.
3. PCT Valuation. Whether the $312 million PCT payment adequately compensated PPC for the pre-existing intellectual property contributed to the CSA. The IRS may argue for a significantly higher PCT value based on alternative discount rate assumptions and revenue growth projections in a discounted cash flow analysis.
4. Economic Substance and DEMPE Functions. Whether PBI possesses sufficient economic substance and performs adequate functions related to the Development, Enhancement, Maintenance, Protection, and Exploitation ("DEMPE") of the intellectual property to justify its role as IP owner and CSA participant. This line of challenge, if pursued, would be directed at undermining PBI's entitlement to the residual profits attributable to IP ownership.
V. ASC 740-10 Legal Analysis — Recognition Step (More-Likely-Than-Not)
A. Applicable Standard
Under ASC 740-10-25-6, a tax position should be recognized in the financial statements only if it is "more likely than not" (defined as a likelihood of more than 50 percent) that the position will be sustained upon examination by the relevant taxing authority, including resolution of any related appeals or litigation processes, based solely on the technical merits of the position. The evaluation of a tax position's technical merits should be based on legislation, regulations, case law, revenue rulings, revenue procedures, and other administrative guidance and interpretive authority in effect as of the reporting date.
ASC 740-10-25-7 provides that the more-likely-than-not recognition threshold should be applied assuming that the taxing authority will examine the position and have full knowledge of all relevant information. In the present case, this assumption is not hypothetical; the IRS has in fact commenced an examination of PPC's returns for the Exam Years and has full access to relevant information through the IDR process.
We apply this recognition standard to each of PPC's uncertain tax positions below.
B. Position 1: CSA Cost-Sharing Ratios
PPC's Position. PPC maintains that the cost-sharing ratios applied during the Exam Years—38.2% (2017), 39.6% (2018), 41.1% (2019), and 42.7% (2020) for PBI—accurately reflect the parties' reasonably anticipated benefits from the shared intangible development activities conducted under the CSA, as required by Treasury Regulation § 1.482-7(e)(2), and are consistent with the arm's-length standard set forth in IRC § 482 and Treasury Regulation § 1.482-1(b).
Supporting Analysis. PPC's RAB allocation methodology is based on a prospective revenue-split approach that projects the relative shares of future revenue expected to be generated by PPC (Americas) and PBI (non-Americas) from products developed under the CSA. The increasing share allocated to PBI during the Exam Years reflects the growing penetration of PPC's products in non-Americas markets, particularly in the European Union, Japan, and emerging markets, and is supported by contemporaneous market data, historical sales trends, and management's reasonable revenue forecasts.
In addition to the contemporaneous RAB analysis, Whitmore Valuation Group has performed a confirmatory analysis under the comparable profits method ("CPM") / transactional net margin method ("TNMM") framework. Whitmore identified a set of 22 comparable distributors and IP-holding companies operating in the pharmaceutical and biotechnology sector and tested PBI's operating margins against the interquartile range derived from these comparables. In all four Exam Years, PBI's operating margins fall within the interquartile range of the comparable set, confirming that PBI's profitability is consistent with arm's-length returns.
Legal Authority. PPC's position is supported by the following legal authorities:
• Treasury Regulation § 1.482-7(e)(2), which prescribes the methodology for determining RAB shares in a qualified cost-sharing arrangement;
• The best method rule under Treasury Regulation § 1.482-1(c), which requires selection of the most reliable measure of an arm's-length result;
• Treasury Regulation § 1.482-1(d), which sets forth the comparability standards applicable to all § 482 analyses;
• Relevant Tax Court precedent in cost-sharing cases, including the analytical framework applied in cases involving the reliability of RAB projections and the selection of appropriate allocation keys.
Contemporaneous Documentation. PPC maintained contemporaneous transfer pricing documentation for all four Exam Years, prepared by Crestfield & Associates under the penalty-protection standards of IRC § 6662(e) and Treasury Regulation § 1.6662-6. This documentation sets forth the CSA methodology, the RAB analysis, the cost-sharing ratios, and the supporting economic data in substantial detail.
Conclusion. Based on the foregoing analysis, C&H believes that PPC's cost-sharing ratios for the Exam Years are well-supported by the applicable regulatory framework, the contemporaneous economic analysis, and the confirmatory benchmarking performed by Whitmore. We conclude that this position meets the more-likely-than-not threshold for recognition under ASC 740-10-25.
C. Position 2: Legacy IP Royalty Rate (4.5%)
PPC's Position. PPC maintains that the 4.5% royalty rate applied to PBI's net sales of legacy compounds in the non-Americas territory under the Legacy IP License reflects arm's-length consideration for the licensed intellectual property, determined under the comparable uncontrolled transaction ("CUT") method prescribed by Treasury Regulation § 1.482-4(c).
Supporting Analysis. Whitmore Valuation Group conducted a comprehensive comparable uncontrolled transaction analysis and identified 14 comparable uncontrolled pharmaceutical license agreements involving the licensing of mature, commercialized pharmaceutical compounds to related or unrelated distributors or commercialization partners. The interquartile range of royalty rates observed in these 14 agreements is 3.1% to 6.8% of net sales, with a median of 4.4%. PPC's 4.5% royalty rate falls squarely within this arm's-length range and is virtually identical to the median of the comparable set.
Whitmore's selection of comparable agreements was based on a rigorous application of the comparability factors set forth in Treasury Regulation § 1.482-4(c)(2), including the nature and stage of the licensed intangible, the terms and conditions of the license (including territory, exclusivity, and field of use), the functions performed and risks borne by the licensee, and the economic conditions of the relevant markets. Adjustments were made where necessary to enhance comparability.
We are aware that the IRS may challenge the comparability of PPC's selected CUTs and may propose a significantly higher royalty rate—potentially up to 11.0%—based on the IRS's own selection of comparable transactions. However, based on our review of the types of agreements that the IRS has sought in its IDRs and our experience in comparable cases, we believe that any IRS-proposed CUT set at or near the 11.0% level would rely on agreements that are materially less comparable to PPC's Legacy IP License than the CUTs identified by Whitmore. In particular, we anticipate that IRS-proposed CUTs may involve earlier-stage compounds with greater upside potential, different territorial scope, or different risk allocation profiles, all of which would tend to inflate the observed royalty rates and reduce their comparability to PPC's arrangement.
Legal Authority. PPC's position is supported by the following:
• Treasury Regulation § 1.482-4(c), which sets forth the CUT method for determining arm's-length royalty rates for controlled transfers of intangible property;
• Treasury Regulation § 1.482-1(c) and (d), the best method rule and comparability standards;
• The analytical framework applied by the Tax Court in Harborview Corporation, Inc. v. Commissioner, T.C. Memo. 2016-112, aff'd in part, rev'd in part, 900 F.3d 610 (8th Cir. 2018), and on remand, T.C. Memo. 2022-84, in which the court evaluated the reliability of competing CUT analyses in a pharmaceutical/medical device transfer pricing context and emphasized the importance of functional and risk comparability in CUT selection;
• Additional Tax Court and appellate authority addressing the CUT methodology and the proper application of comparability adjustments.
Conclusion. Based on the strength of Whitmore's comparable transaction analysis, the positioning of PPC's 4.5% rate near the median of a well-supported interquartile range, and the applicable legal authorities, C&H believes that this position meets the more-likely-than-not threshold for recognition under ASC 740-10-25.
D. Position 3: PCT Valuation ($312M)
PPC's Position. PPC maintains that the $312 million PCT payment made by PBI to PPC on July 1, 2012, represents arm's-length consideration for the pre-existing intellectual property contributed by PPC to the CSA, as required by Treasury Regulation § 1.482-7(g).
Supporting Analysis. Whitmore Valuation Group performed a discounted cash flow ("DCF") / income-method analysis to determine the arm's-length value of the pre-existing IP contributed by PPC to the CSA as of July 1, 2012. The DCF analysis projected the future cash flows attributable to the contributed IP in the non-Americas territory over the remaining useful life of the relevant compounds, and discounted those cash flows to present value using a weighted average cost of capital ("WACC") of 9.8%.
The 9.8% WACC was derived from a capital asset pricing model ("CAPM") analysis using pharmaceutical-industry-specific inputs, including: (i) a risk-free rate based on the 20-year U.S. Treasury yield as of July 2012; (ii) an equity risk premium based on the Westmark Consulting Group (now Sundial Advisors) long-horizon equity risk premium; (iii) a beta coefficient derived from a set of publicly traded pharmaceutical companies comparable to PPC in terms of therapeutic focus, revenue scale, and product lifecycle profile; and (iv) a size premium consistent with PPC's market capitalization. The resulting WACC of 9.8% reflects the risk profile of the specific IP assets contributed—primarily clinical-stage and recently approved oncology compounds—and the inherent uncertainties in projecting non-Americas revenue streams for those assets over a multi-decade horizon.
Based on this analysis, Whitmore concluded that the arm's-length range for the PCT payment is $278 million to $361 million. The $312 million payment actually made falls within this range and is consistent with the arm's-length standard.
Anticipated IRS Challenge. We anticipate that the IRS may challenge the PCT valuation on the basis of two principal contentions: (i) that the appropriate discount rate is lower than 9.8%, potentially as low as 7.2%, reflecting the IRS's view that the contributed IP was less risky than PPC and Whitmore have assessed; and (ii) that the revenue growth assumptions used in the DCF analysis are too conservative, underestimating the future commercial success of the contributed compounds (including Veritaxol, which has since become a blockbuster product). A lower discount rate combined with higher revenue projections would yield a significantly higher PCT value under the income method—potentially up to $852 million, representing a delta of approximately $540 million over the $312 million payment actually made.
The dispute over the appropriate discount rate is a common area of contention in transfer pricing PCT valuations. C&H believes that the 9.8% WACC used by Whitmore is well-supported by the pharmaceutical-industry-specific risk premiums and beta comparables, and that the IRS's potential 7.2% rate would fail to account for the substantial development and commercialization risk that existed as of the July 2012 valuation date. The revenue projections used in PPC's analysis were based on contemporaneous forecasts prepared by PPC's commercial teams as of mid-2012 and were not informed by hindsight; the use of later-developed actual results to second-guess contemporaneous projections is disfavored under the applicable regulations and case law.
We note that 2012—the year of the PCT payment—is outside the Exam Years (2017–2020). However, the IRS may seek to use a PCT undervaluation theory to recharacterize the ongoing CSA cost-sharing ratios and royalty rates during the Exam Years as failing to reflect the full value of contributed IP. Under this theory, an inadequate PCT would imply that PBI obtained IP rights at below-market value, and the IRS could argue that the ongoing CSA and royalty arrangements should be adjusted to account for this undercompensation. This risk of collateral impact on the Exam Year positions is factored into our measurement analysis in Section VI below.
Legal Authority. PPC's position is supported by the following:
• Treasury Regulation § 1.482-7(g), which governs PCT payments in qualified cost-sharing arrangements and prescribes methodologies for determining arm's-length compensation for platform contributions;
• The income method for valuation of intangibles under Treasury Regulation § 1.482-7(g)(4);
• IRC § 367(d), which represents a potential alternative legal theory that the IRS could invoke for the outbound transfer of intangible property to a CFC, though PPC believes the CSA regulations are the more appropriate framework;
• Case law addressing the income-method valuation of pharmaceutical and technology intangibles in the transfer pricing context, including decisions addressing the selection of appropriate discount rates and the use of contemporaneous versus hindsight-informed revenue projections.
Conclusion. Based on the foregoing analysis, C&H believes that PPC's PCT valuation meets the more-likely-than-not threshold for recognition under ASC 740-10-25. We note, however, that the discount rate issue presents some litigation hazard, as courts have reached varying conclusions on the appropriate WACC in comparable pharmaceutical DCF analyses. This residual uncertainty is reflected in our measurement analysis in Section VI.
E. PBI Economic Substance
PPC's Position. PPC maintains that PBI has sufficient economic substance to be recognized as the owner of non-Americas intellectual property rights and as a qualified participant in the CSA, and that PBI performs meaningful DEMPE functions with respect to the intellectual property it holds.
Supporting Evidence. C&H has compiled and reviewed the following evidence in support of PBI's economic substance:
• Personnel: PBI employed 185 individuals as of December 31, 2020, up from 52 at inception in 2012. These employees span regulatory affairs, medical affairs, commercial strategy, supply-chain management, market access, pharmacovigilance, finance, and administrative functions.
• Corporate Governance: PBI's board of directors held 42 formal board meetings in Dublin during the period 2017–2020, including quarterly sessions and special sessions. Board meetings involved substantive deliberations on commercial strategy, product launches, pricing decisions, regulatory submissions, and other matters of strategic importance to PBI's operations.
• Regulatory Expenditures: PBI incurred cumulative regulatory expenditures of approximately €47.2 million during the Exam Years in connection with EMA and national-level regulatory submissions, post-approval commitments, and pharmacovigilance activities.
• Commercial Decision-Making: PBI exercises independent pricing decisions across 68 country markets in the non-Americas territory. PBI selects and manages distribution partners, negotiates government reimbursement and tender pricing, and develops and executes product launch strategies.
• Physical Presence: PBI maintains approximately 18,000 square feet of dedicated office space at Sandyford Business Park, Dublin.
• Banking: PBI maintains its principal operating accounts with Glenmore Bank Ireland plc, an Irish-licensed credit institution, and conducts its treasury and cash management functions locally.
• Management: Managing Director Aidan Naughton exercises genuine commercial authority over PBI's operations and reports to PPC's global leadership on PBI's performance.
DEMPE Analysis. C&H has prepared a detailed DEMPE analysis demonstrating that PBI performs substantial functions across each of the five DEMPE categories:
• Development: PBI co-funds research and development activities through its cost-sharing payments under the CSA, bearing its proportionate share of R&D costs and risks.
• Enhancement: PBI performs activities that enhance the value of the IP in non-Americas markets, including the conduct of region-specific clinical studies, the generation of real-world evidence, and the development of market-specific formulations and packaging.
• Maintenance: PBI is responsible for maintaining the value of the IP through ongoing pharmacovigilance, product quality monitoring, and lifecycle management in its territory.
• Protection: PBI files and prosecutes regulatory submissions, manages product registrations across 68 country markets, and coordinates with PPC on global patent strategy as it relates to non-Americas jurisdictions.
• Exploitation: PBI is responsible for the commercial exploitation of the IP in the non-Americas territory, including pricing, marketing, distribution, and sales activities.
Legal Authority. PBI's economic substance is supported by:
• The economic substance doctrine as codified in IRC § 7701(o) and as applied in the transfer pricing context;
• OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2017 and 2022 revisions), Chapter VI (Special Considerations for Intangibles) and Chapter VIII (Cost Contribution Arrangements), which provide persuasive (though not binding) authority on the importance of functions, assets, and risks—and specifically DEMPE functions—in allocating intangible-related returns among controlled entities;
• Case law addressing the substance of foreign entities in the transfer pricing context, including decisions examining whether a foreign subsidiary possesses sufficient personnel, decision-making authority, and operational capability to be respected as the economic owner of intangible property.
Conclusion. Based on the substantial body of evidence demonstrating PBI's operational presence, personnel, corporate governance, regulatory activity, commercial decision-making, and DEMPE functions, C&H believes that PBI's economic substance meets the more-likely-than-not threshold for recognition under ASC 740-10-25. We regard the economic substance evidence as robust.
VI. ASC 740-10 Legal Analysis — Measurement Step
A. Applicable Standard
For tax positions that are recognized (i.e., that meet the more-likely-than-not threshold), ASC 740-10-30-7 requires measurement at the "largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement." This measurement standard requires a cumulative probability assessment of the potential outcomes of the tax position, considering all available evidence, including the facts and circumstances of the position, relevant technical authorities, and the entity's experience with similar positions and the relevant taxing authority.
The measurement step is inherently forward-looking and requires the exercise of significant judgment. Unlike the recognition step (which is a binary yes/no determination), the measurement step requires quantification of the benefit amount that the entity is more than 50% likely to realize, taking into account the full range of possible settlement outcomes and their relative probabilities.
B. Exposure Quantification
C&H has assessed the range of potential IRS adjustments based on the examination activity to date, IRS precedent in pharmaceutical transfer pricing cases, and the relative strength and weakness of PPC's positions across the three uncertain tax positions identified above. The following summarizes the range of potential exposure on each position:
Position 1: CSA Cost-Sharing Ratios. If the IRS were to assert that PBI's cost-sharing percentages during the Exam Years should be increased by 8 to 12 percentage points (e.g., from 38.2%–42.7% to approximately 46.2%–54.7%), the resulting additional allocation of intangible development costs to PPC (i.e., a reduction in PBI's cost-sharing obligation with a corresponding increase in deemed U.S.-source income) would yield additional taxable income to PPC of approximately $48 million to $66 million per year across the Exam Years, or a total four-year incremental income adjustment in the range of approximately $192 million to $264 million.
Position 2: Legacy IP Royalty Rate. If the IRS were to propose a royalty rate as high as 11.0% (compared to PPC's 4.5%), the resulting additional royalty income that would be imputed to PPC for the Exam Years would be approximately $40 million to $53 million per year, reflecting the differential applied to legacy compound net sales declining from $814.6 million in 2017 to $624.1 million in 2020. The total four-year incremental income adjustment would be in the range of approximately $160 million to $180 million.
Position 3: PCT-Related Recharacterization. While the PCT itself was a 2012 transaction and is not directly subject to adjustment in the Exam Years, the IRS could use a PCT undervaluation theory to support larger adjustments to the CSA cost-sharing ratios and royalty rates during the Exam Years. To the extent the IRS argues that the $312 million PCT understated the value of contributed IP by as much as $540 million (based on the IRS's potential $852 million valuation), this differential could provide the foundation for enhanced adjustments across Positions 1 and 2. However, to the extent that adjustments to the CSA cost-sharing ratios and the royalty rate are asserted independently, there would be significant overlap and potential for double-counting between the PCT recharacterization and the direct CSA/royalty adjustments. Any IRS adjustments would need to account for correlative offsets to avoid such double-counting.
Aggregate Exposure. Taking into account the potential adjustments across all three positions, and before application of correlative adjustments and offsets, the total potential four-year proposed adjustment could range from approximately $350 million to $425 million of additional taxable income allocated to PPC. After application of correlative adjustments (to eliminate overlap between the CSA and royalty adjustments and to reflect the offsetting effect of any increased U.S. tax liability against foreign tax credits), the net exposure would be reduced, though the precise amount of such reduction would depend on the specific positions taken by the IRS in any future NOPA.
Tax Rate Impact. The tax impact of any adjustments would be affected by the reduction in the U.S. corporate income tax rate from 35% to 21% pursuant to the Tax Cuts and Jobs Act of 2017 (the "TCJA"), effective January 1, 2018. Accordingly, any adjustment to PPC's taxable income for tax year 2017 would be taxed at 35%, while adjustments for tax years 2018, 2019, and 2020 would be taxed at 21%. This rate differential increases the per-dollar tax exposure for the 2017 tax year relative to subsequent years.
C. Recommended Reserve Amount
Based on C&H's legal analysis and our cumulative probability assessment of the potential outcomes of PPC's uncertain tax positions, we offer the following conclusions regarding the appropriate reserve level under ASC 740-10:
Overall Assessment. PPC's positions on all three uncertain tax issues—the CSA cost-sharing ratios, the legacy IP royalty rate, and the PCT valuation—are well-supported by applicable legal authorities, contemporaneous transfer pricing documentation, and independent economic analyses prepared by Whitmore Valuation Group. As set forth in Section V above, C&H believes that each position individually meets the more-likely-than-not threshold for recognition under ASC 740-10-25.
However, there is inherent uncertainty in transfer pricing controversy that must be reflected in the measurement of the recognized benefit. Transfer pricing disputes necessarily involve subjective judgments regarding comparability analysis, the selection of comparable transactions and comparable companies, the determination of appropriate discount rates, and the allocation of intangible-related benefits among controlled entities. Courts have acknowledged this inherent imprecision, and settlement outcomes in transfer pricing cases—whether at IRS Appeals or in litigation—frequently result in resolution at a fraction of the proposed adjustment, particularly in cases where the taxpayer has strong contemporaneous documentation and credible economic support.
Taking into account the strength of PPC's technical positions, the quality of the contemporaneous documentation prepared by Crestfield, the independence and rigor of Whitmore's economic analyses, the realistic range of settlement outcomes based on C&H's experience with similar IRS examinations of pharmaceutical companies, and the applicable tax rates, C&H supports PPC's current ASC 740-10 reserve for uncertain tax positions related to the Irish IP structure in the amount of $62.4 million. This reserve amount reflects the cumulative probability-weighted measurement of the largest benefit amount that is greater than 50 percent likely of being realized upon ultimate settlement of the tax positions, as required by ASC 740-10-30-7.
The $62.4 million reserve amount implies that PPC expects, on a probability-weighted basis, to retain the substantial majority of the tax benefits associated with its Irish IP structure, while recognizing a prudent reserve for the possibility that some portion of the benefit may be conceded in settlement or on adverse resolution of specific technical issues (most notably the discount rate issue in the PCT valuation and the potential for the IRS to identify more comparable CUTs at higher royalty rates in the legacy IP analysis).
Reassessment. The reserve should be reassessed as the examination progresses, and C&H will provide updated analysis on a periodic basis and promptly upon the occurrence of material developments. In particular, the reserve should be reassessed upon: (i) the issuance of any NOPA by the IRS; (ii) the engagement of settlement discussions with IRS Appeals; or (iii) any material change in the applicable legal authority.
VII. Penalty Protection Analysis
IRC § 6662(e) imposes a 20% accuracy-related penalty on any underpayment of tax attributable to a substantial valuation misstatement in connection with a § 482 transfer pricing adjustment. Under IRC § 6662(h), the penalty rate increases to 40% in the case of a gross valuation misstatement (i.e., an adjustment that is 400% or more of the correct transfer price, or 25% or less of the correct transfer price). These penalty provisions are of particular significance in transfer pricing cases, where the magnitude of proposed adjustments can be substantial.
However, IRC § 6662(e)(3)(B) provides a reasonable-cause exception to the substantial valuation misstatement penalty. Under this exception, no penalty shall be imposed if the taxpayer demonstrates that: (i) the transfer pricing methodology used was reasonable; (ii) the taxpayer's use of such methodology was reasonable; and (iii) the taxpayer maintained contemporaneous documentation establishing its reasonable belief that the transfer pricing methodology and its application were consistent with IRC § 482 and the applicable regulations. The specific requirements for such contemporaneous documentation are set forth in Treasury Regulation § 1.6662-6.
PPC maintained contemporaneous transfer pricing documentation for all four Exam Years. This documentation was prepared by Crestfield & Associates (specifically, by Susan Lam and her transfer pricing team) and meets the requirements of Treasury Regulation § 1.6662-6 in all material respects, including: the specification of the controlled transactions; the selection and application of the best method; the identification and analysis of comparable transactions and comparable companies; the documentation of the comparability factors considered; and the economic analysis supporting the arm's-length nature of PPC's intercompany pricing.
Based on our review of the contemporaneous documentation and the underlying economic analyses, C&H believes that PPC has a strong reasonable-cause defense to any § 6662(e) penalty assertion. PPC's transfer pricing methodologies were reasonable, PPC's application of those methodologies was reasonable, and PPC maintained the required contemporaneous documentation. The availability of this penalty-protection defense further supports the reserve level set forth in Section VI.C, as it indicates that any ultimate adjustment to PPC's transfer pricing positions would not be subject to the 20% (or 40%) penalty enhancement.
VIII. TCJA Considerations
The Tax Cuts and Jobs Act (Pub. L. 115-97), enacted on December 22, 2017, and effective for tax years beginning after December 31, 2017, introduced several provisions that are relevant to the measurement of PPC's uncertain tax positions for the Exam Years.
Corporate Tax Rate Reduction. The TCJA reduced the U.S. federal corporate income tax rate from 35% to 21%, effective January 1, 2018. For PPC's Exam Years, this means that any transfer pricing adjustment for tax year 2017 would be subject to the higher 35% rate, while adjustments for tax years 2018, 2019, and 2020 would be subject to the reduced 21% rate. This differential materially affects the per-dollar tax cost of any adjustment: a $100 million income adjustment in 2017 would generate $35 million of additional tax liability, whereas the same adjustment in 2018–2020 would generate $21 million. The disproportionate impact of the 2017 tax year on total potential exposure has been factored into the reserve quantification discussed in Section VI.
GILTI. The TCJA introduced the Global Intangible Low-Taxed Income ("GILTI") provisions under IRC § 951A, effective for tax years beginning after December 31, 2017. Under GILTI, U.S. shareholders of CFCs are required to include in gross income the CFC's tested income to the extent it exceeds a deemed return on the CFC's qualified business asset investment ("QBAI"). To the extent that any § 482 adjustment increases PBI's income (or reduces PBI's cost-sharing deductions), it may have secondary effects on PPC's GILTI inclusion, the GILTI high-tax exclusion analysis, and the availability of foreign tax credits under IRC § 960. These secondary GILTI effects have been considered in the reserve quantification, though they are complex and depend on the specific nature and magnitude of any adjustment.
BEAT. The TCJA also introduced the Base Erosion and Anti-Abuse Tax ("BEAT") under IRC § 59A, which imposes a minimum tax on certain large corporations that make deductible payments to related foreign persons. To the extent that PPC claims deductions for intercompany payments to PBI (such as cost-sharing payments or other intercompany charges), these payments may be treated as base erosion payments subject to the BEAT calculation. Any § 482 adjustment that recharacterizes the magnitude or nature of intercompany payments could affect PPC's BEAT liability. These potential interactions have been considered in the overall reserve analysis.
IX. Limitations and Caveats
The analysis and conclusions set forth in this letter are subject to the following limitations and caveats:
1. Current Knowledge. This analysis is based on the facts known to C&H as of the date of this letter, September 20, 2022, and on the current status of the IRS examination as described in Section III above. No NOPA has been issued as of this date, and the IRS's formal positions on the transfer pricing issues have not yet been articulated in writing.
2. No Guarantees. The conclusions expressed in this letter represent C&H's best professional judgment as to the technical merits and likely outcomes of PPC's tax positions based on current law and facts. They do not constitute a guarantee or assurance that the positions will be sustained in their entirety, or that the reserve amount recommended herein will prove to be adequate or excessive in light of future developments.
3. Need for Reassessment. The analysis set forth herein may require revision as the examination progresses. Specific developments that could necessitate reassessment include, but are not limited to: (a) the issuance of a NOPA by the IRS on any of the positions discussed herein; (b) the development of new factual information, whether through the IDR process, IRS summons activity, or otherwise; (c) changes in relevant legal authority, including the issuance of new regulations, revenue rulings, or court decisions bearing on the issues discussed herein; or (d) a significant change in PPC's business operations or intercompany arrangements.
4. Periodic Updates. C&H will provide updated analysis on a periodic basis, at least quarterly, and will provide prompt supplemental analysis upon the occurrence of any material development in the examination.
5. Limited Purpose. This letter is provided solely for the purpose of supporting Crestfield & Associates LLP's assessment of PPC's ASC 740-10 reserves in connection with PPC's financial statement audit. This letter should not be relied upon for any other purpose, including but not limited to investment decisions, credit determinations, regulatory filings (other than PPC's financial statements to the extent the ASC 740-10 analysis is incorporated therein), or advice to third parties.
6. Scope of Legal Analysis. The opinions and conclusions expressed herein are limited to matters of U.S. federal income tax law, including the Internal Revenue Code, Treasury Regulations, and applicable administrative and judicial authorities. This letter does not address: (a) the tax laws of Ireland or any other foreign jurisdiction; (b) state or local tax law; (c) non-tax legal issues, including securities law, corporate law, or accounting standards (other than to the extent we have applied the legal framework of ASC 740-10 to PPC's tax positions); or (d) any tax positions of PPC other than those specifically identified and analyzed herein.
X. Privilege and Confidentiality
This letter constitutes a privileged and confidential attorney-client communication between Calderwood & Harkness LLP, as outside tax counsel, and Penterra Pharmaceuticals Corp., as client. The analysis, conclusions, and work product reflected in this letter are protected by the attorney-client privilege and the work-product doctrine.
This letter is being shared with Crestfield & Associates LLP at the express direction of PPC, through its authorized representatives Marcus Whitfield and Deborah Staines, solely for the limited purpose of supporting Crestfield's assessment of PPC's ASC 740-10 reserves in connection with PPC's financial statement audit. The disclosure of this letter to Crestfield for this limited purpose does not waive, and is not intended to waive, the attorney-client privilege, the work-product doctrine, or any other applicable privilege, immunity, or protection. See, e.g., United States v. Kraft Voss CPAs LLP, 610 F.3d 129 (D.C. Cir. 2010) (disclosure of privileged materials to independent auditor for financial statement audit purposes may be protected under common-interest doctrine or limited-waiver theory, depending on the circumstances and jurisdiction).
Crestfield should treat this letter as confidential and should not disclose its contents, in whole or in part, to any third party without the prior written consent of PPC. In the event that Crestfield receives a subpoena, court order, or other compulsory process seeking the production of this letter, Crestfield should promptly notify C&H and PPC before making any production, to allow PPC an opportunity to assert applicable privileges and protections.
Additionally, we note that the Kovel arrangement between C&H and Whitmore Valuation Group LLC (reference 1018-00009-KV, dated June 20, 2022) provides privilege protection over Whitmore's economic analyses, work papers, and communications with C&H that are referenced in this letter. Any request for production of Whitmore's materials should be directed to C&H, and Whitmore's materials should not be produced without PPC's prior written consent.
XI. Conclusion and Availability
We trust that this analysis will be of assistance to Crestfield in its assessment of PPC's ASC 740-10 reserves for the current audit cycle. As noted above, we will provide updated analysis on a periodic basis and promptly upon the occurrence of material developments in the IRS examination. We are available to discuss this analysis with Crestfield and PPC at your convenience, whether by telephone, video conference, or in person.
For questions regarding this letter or to schedule a discussion, please contact:
Leonard Cross, Partner, Tax Department Telephone: (215) 448-6247
Email: lcross@calderwoodharkness.com
Garrett Simmons, Associate, Tax Department Telephone: (215) 448-6319
Email: gsimmons@calderwoodharkness.com
We would be pleased to supplement or update this analysis as additional information becomes available or as the examination progresses.
Very truly yours,
CALDERWOOD & HARKNESS LLP
By: ________
Leonard Cross Partner, Tax Department 1735 Market Street, Suite 3100 Philadelphia, PA 19103
cc:
Marcus Whitfield, Vice President, Global Tax, Penterra Pharmaceuticals Corp. Deborah Staines, General Counsel, Penterra Pharmaceuticals Corp. Sylvia Hartwell, Partner, Calderwood & Harkness LLP Garrett Simmons, Associate, Calderwood & Harkness LLP Susan Lam, Transfer Pricing Partner, Crestfield & Associates LLP
Tax Year | PBI CSA Share (%) | PBI Cost Share Payment | Total R&D Costs
2017 | 38.2% | $186.15M | $487.3M
2018 | 39.6% | $207.42M | $523.8M
2019 | 41.1% | $230.65M | $561.2M
2020 | 42.7% | $255.52M | $598.4M
Tax Year | Legacy Compound Net Sales (Non-Americas) | Royalty Payment (4.5%)
2017 | $814.6M | $36.66M
2018 | $762.3M | $34.30M
2019 | $691.8M | $31.13M
2020 | $624.1M | $28.08M
Product | Therapeutic Area | Global Net Sales (2020) | Non-Americas Net Sales (2020)
Veritaxol | Oncology | $3.12B | $1.34B
Imvara | Immunology | $1.87B | $0.79B
Cerulon | Rare Disease | $0.62B | $0.28B

PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT COMMUNICATION

CALDERWOOD & HARKNESS LLP

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