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CALDERWOOD & HARKNESS LLP Counsellors at Law

1735 Market Street, Suite 3100 Philadelphia, PA 19103 Tel: (215) 864-7200

Fax: (215) 864-7201

600 Lexington Avenue New York, NY 10022 Tel: (212) 506-5100

Fax: (212) 506-5101

www.calderwoodharkness.com

November 20, 2023

VIA EMAIL AND FIRST CLASS MAIL — PRIVILEGED AND CONFIDENTIAL

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

Re: Penterra Pharmaceuticals Corp. (EIN: 22-3741856) — Updated Legal Analysis Regarding ASC 740-10 (FIN 48) Uncertain Tax Position Reserve — IRS Transfer Pricing Examination, Tax Years 2017–2020; Notice of Proposed Adjustment Issued October 12, 2023

C&H Matter No.: 1018-00009

Dear Mr. Ogilvy:

I. Purpose and Context of the Letter

This letter updates the prior legal analysis issued by Calderwood & Harkness LLP ("C&H") on September 20, 2022, regarding the uncertain tax position ("UTP") reserve maintained by Penterra Pharmaceuticals Corp. ("PPC" or the "Company") under ASC 740-10 (formerly Financial Accounting Standards Board Interpretation No. 48, "FIN 48") with respect to PPC's Irish intellectual property-holding structure and intercompany transfer pricing arrangements with Penterra Biopharma International DAC ("PBI"), a Designated Activity Company organized under the laws of Ireland.

This updated analysis is prompted by the Internal Revenue Service's ("IRS") issuance of a Notice of Proposed Adjustment ("NOPA") on October 12, 2023, covering all four tax years currently under examination — tax years ("TY") 2017, 2018, 2019, and 2020. The NOPA proposes net adjustments totaling $380,400,000 across all four years, encompassing both cost-sharing arrangement ("CSA") cost-allocation adjustments and royalty rate adjustments under Section 482 of the Internal Revenue Code of 1986, as amended (the "Code" or "IRC"), as well as an associated substantial valuation misstatement penalty under IRC § 6662(e).

The purpose of this letter is to provide Crestfield & Associates LLP ("Crestfield") with revised legal conclusions for use in PPC's year-end 2023 financial statement reserve analysis under ASC 740-10 for the fiscal year ending December 31, 2023. Specifically, this letter addresses (i) whether PPC's transfer pricing positions continue to satisfy the "more-likely-than-not" recognition threshold under ASC 740-10-25, (ii) the appropriate measurement of the tax benefit under ASC 740-10-30 in light of the NOPA, and (iii) our recommendation regarding the adequacy of PPC's existing FIN 48 reserve.

We note at the outset that this letter reflects privileged legal analysis and is provided at the direction of PPC — and with the consent and at the request of PPC General Counsel Deborah Staines — for purposes of Crestfield's audit and financial reporting functions. This communication is protected by the attorney-client privilege and the work-product doctrine. The furnishing of this letter to Crestfield in connection with its audit responsibilities does not constitute a waiver of any applicable privilege. This letter should not be disclosed to the IRS or to any third party without the express written consent of PPC.

II. Background — IRS Examination and IP Structure

A. Examination Overview

The IRS Large Business & International Division ("LB&I") opened an examination of PPC's federal income tax returns for TY 2017 through TY 2020 on May 16, 2022, as communicated to PPC via Letter 2205-A (Notification of Examination). The examination has been conducted under IRS Case File No. LB&I-NE-TP-2022-00641 and has been led by Supervisory Revenue Agent Gerald Meskill, with Lead Revenue Agent Patricia Dunleavy serving as the primary examiner on the transfer pricing issues.

The IRS has assigned Dr. Alan Washburne of the IRS Transfer Pricing Practice as the government's economist. Dr. Washburne has prepared the IRS's economic analyses underlying the proposed adjustments, including the government's comparable uncontrolled transaction ("CUT") analysis and discounted cash flow ("DCF") valuation of the platform contribution transaction ("PCT"). Additionally, the IRS Office of Chief Counsel has provided legal support to the examination team through Attorney-Advisor Franklin Rosario and Senior Counsel Donna Hirabayashi, both of whom participated in the substantive legal conferences held with C&H during the course of the examination.

The examination has been extensive. Between June 2022 and September 2023, the IRS issued forty-seven (47) Information Document Requests ("IDRs"), which covered the full range of PPC's transfer pricing documentation, CSA records, intercompany agreements, financial projections, R&D expenditure allocations, PBI's operational records, and related matters. PPC responded to all IDRs on a timely basis, in consultation with C&H and Crestfield. C&H also participated in three formal legal conferences with the IRS examination team and Chief Counsel representatives, held on November 15, 2022, April 18, 2023, and August 9, 2023.

It is noted that PPC was not a participant in the IRS Compliance Assurance Process ("CAP") for the tax years at issue. Accordingly, the examination followed the standard LB&I audit process, and the NOPA represents the IRS examination team's fully developed position.

B. Intercompany Transfer Pricing Structure

PBI is a Designated Activity Company organized under the laws of Ireland, incorporated on March 15, 2012, with its registered office at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4, Ireland. PBI is a wholly owned indirect subsidiary of PPC, held through the following ownership chain: PPC owns 100% of Penterra Holdings Luxembourg S.à r.l. ("PHL"), a société à responsabilité limitée organized under the laws of Luxembourg (Luxembourg RCS No. B 168452), which in turn owns 100% of PBI. PHL is treated as a disregarded entity for U.S. federal income tax purposes under Treas. Reg. § 301.7701-3, with the result that PBI is treated for U.S. tax purposes as a direct subsidiary of PPC.

The intercompany transfer pricing structure at issue in the examination consists of the following principal elements:

Cost-Sharing Arrangement. PPC and PBI entered into a qualified cost-sharing arrangement effective July 1, 2012, pursuant to Treas. Reg. § 1.482-7. Under the CSA, PBI co-funds a share of PPC's intangible development costs (primarily pharmaceutical R&D expenditures) in exchange for the rights to exploit the resulting pharmaceutical intellectual property outside the Americas (i.e., in Europe, Asia-Pacific, Middle East, and Africa, collectively referred to as the "non-Americas territories"). PPC retains the rights to exploit such IP in the Americas (defined as North America, Central America, South America, and the Caribbean). The cost-sharing percentages are determined annually based on the parties' respective reasonably anticipated benefits ("RABs") from the intangible development activities, calculated in accordance with the methodology set forth in the CSA documentation and Treas. Reg. § 1.482-7(e).

Platform Contribution Transaction. In connection with the formation of the CSA, PBI made a PCT payment of $312,000,000 to PPC on July 1, 2012, representing arm's-length compensation for a buy-in to PPC's pre-existing intellectual property — primarily clinical-stage and approved oncology compounds, including the foundational IP underlying what would later become PPC's flagship oncology product, Veritaxol. The PCT valuation was supported by a contemporaneous economic analysis prepared by the Whitmore Valuation Group ("Whitmore"), which employed a DCF/income method analysis using a weighted average cost of capital ("WACC") of 9.8%, yielding an arm's-length range of $278,000,000 to $361,000,000. The PCT payment of $312,000,000 fell within this range.

Legacy IP License. Separately from the CSA, PBI licensed certain pre-2012 vintage pharmaceutical compounds from PPC pursuant to a license agreement dated July 1, 2012. The license covers PBI's right to manufacture, market, and distribute these legacy compounds in the non-Americas territories at a royalty rate of 4.5% of net sales. The royalty rate was supported by a CUT analysis prepared by Whitmore, which identified fourteen comparable pharmaceutical license agreements, yielding an interquartile range ("IQR") of 3.1% to 6.8% and a median of 4.4%.

PBI's Operations. PBI maintains substantial operations in Dublin, Ireland. As of 2020, PBI employed 185 persons, including personnel performing regulatory, medical-affairs, commercial-strategy, and supply-chain functions. PBI holds its own regulatory registrations, maintains independent pricing authority across sixty-eight (68) country markets in the non-Americas territories, and conducted forty-two (42) formal board of directors meetings during the TY 2017–2020 period. PBI maintains independent banking relationships with Glenmore Bank Ireland plc and occupies approximately 18,000 square feet of office space in Dublin. During TY 2017–2020, PBI incurred cumulative regulatory expenditures of approximately €47.2 million.

Contract Manufacturing. Penterra Manufacturing Ireland Ltd. ("PMI"), a separate Irish subsidiary, operates as a contract manufacturer for PBI under a contract manufacturing agreement providing for cost-plus 8% compensation. PMI's manufacturing activities supply product for PBI's non-Americas territory distribution.

Key Products. The products most relevant to the transfer pricing issues at hand are: (i) Veritaxol, PPC's flagship oncology compound, which generated approximately $3.12 billion in global net sales in 2020; (ii) Imvara, an immunology compound with approximately $1.87 billion in global net sales in 2020; and (iii) Cerulon, a rare-disease therapeutic with approximately $0.62 billion in global net sales in 2020.

C. PPC's Prior FIN 48 Reserve

As of year-end 2022, PPC maintained an ASC 740-10 reserve of $62,400,000 for uncertain tax positions related to the Irish IP-holding structure and intercompany transfer pricing arrangements described above. This reserve level was reflected in PPC's Annual Report on Form 10-K for the fiscal year ended December 31, 2022, as filed with the Securities and Exchange Commission.

C&H's prior analysis, set forth in our letter dated September 20, 2022, supported the adequacy of the $62,400,000 reserve based on our assessment of both the more-likely-than-not recognition threshold and the measurement criteria under ASC 740-10. That prior analysis was rendered before the IRS issued the NOPA on October 12, 2023, and before the full scope and magnitude of the IRS's proposed adjustments were known. The issuance of the NOPA represents material new information that requires C&H to reassess the measurement step of its FIN 48 analysis, as discussed in Sections IV and V below.

III. Summary of the NOPA — Proposed Adjustments ($380.4M)

The NOPA, dated October 12, 2023, proposes aggregate net adjustments of $380,400,000 to PPC's taxable income across TY 2017–2020 under IRC § 482. The proposed adjustments fall into two principal categories — CSA cost-sharing ratio adjustments and royalty rate adjustments — together with a correlative offset to avoid double-counting. The NOPA also proposes a substantial valuation misstatement penalty under IRC § 6662(e). Each component is summarized below.

A. CSA Cost-Sharing Ratio Adjustments ($235,010,000)

The IRS proposes increasing PBI's cost-sharing percentage — i.e., the share of intangible development costs allocated to PBI — by eight to twelve percentage points for each of the four examination years. The IRS asserts that PPC's RAB projections systematically understated the value of U.S.-source anticipated benefits relative to non-Americas-source anticipated benefits, resulting in an over-allocation of costs to PPC (and a corresponding under-allocation to PBI). The IRS's position effectively claims that PBI should have borne a greater share of the R&D expenditures, with a corresponding increase in PPC's U.S. taxable income by the amount of the cost-sharing differential.

The year-by-year detail of the IRS's proposed CSA cost-sharing ratio adjustments is as follows:

The subtotal of the IRS's proposed CSA adjustments is $235,010,000.

B. Royalty Rate Adjustments ($188,040,000)

The IRS proposes increasing the royalty rate under the legacy IP license from 4.5% to 11.0% of net sales, asserting that PPC's royalty rate is below the arm's-length range. The IRS's proposed increase is based on Dr. Washburne's CUT analysis, which identified a different set of comparable license transactions than those identified by Whitmore and derived a substantially higher arm's-length royalty rate. The IRS's CUT analysis and the specific comparables relied upon are addressed in our legal analysis below.

The year-by-year detail of the IRS's proposed royalty rate adjustments is as follows:

The subtotal of the IRS's proposed royalty adjustments is approximately $188,040,000 (with minor rounding adjustments reflected in the NOPA).

C. PCT Undervaluation Background

In connection with the NOPA, the IRS also asserted that PBI's PCT payment of $312,000,000 undervalued PPC's pre-existing intellectual property by approximately $540,000,000. The IRS valued the pre-existing IP at approximately $852,000,000, using an income method with a WACC of 7.2% and revenue projections that exceeded those employed by Whitmore in its contemporaneous valuation. However, because the PCT occurred on July 1, 2012 — which falls outside the examination years of TY 2017–2020 — the IRS did not directly propose an adjustment to the PCT itself. Instead, the IRS's position on the PCT serves as a foundational predicate for its proposed adjustments to the ongoing CSA cost-sharing ratios and royalty rates for the examination years, on the theory that the initial undervaluation of the IP contributed to an ongoing misallocation of intercompany income.

D. Economic Substance Challenge

In addition to its economic-based transfer pricing arguments, the IRS asserted in part that PBI lacked sufficient economic substance to justify its role as an IP owner and CSA participant. Specifically, the IRS contended that the key Development, Enhancement, Maintenance, Protection, and Exploitation ("DEMPE") functions with respect to the licensed and co-developed IP remained predominantly in the United States, and that PBI served primarily as a cost-sharing payment conduit rather than a genuine participant in the intangible development and exploitation activities. This argument, while secondary to the IRS's primary economic adjustments, underpins the IRS's overall theory that the intercompany transfer pricing arrangements do not reflect arm's-length dealings. C&H addresses this argument in our legal analysis in Section IV below.

E. Correlative Offset and Net Adjustment

The IRS allowed a correlative offset of ($42,650,000) to eliminate double-counting between the CSA cost-sharing adjustments and the royalty rate adjustments. This offset accounts for the overlap that would otherwise arise because the increased royalty payments (at 11.0% rather than 4.5%) would reduce PBI's income and thereby reduce PBI's RAB, which in turn would reduce PBI's cost-sharing obligation. The offset avoids taxing the same intercompany flow twice.

The net proposed adjustment is calculated as follows:

F. Proposed Penalty

The IRS has proposed the substantial valuation misstatement penalty under IRC § 6662(e) at the 20% rate, applied to the underpayment of tax attributable to the net IRC § 482 allocation. The IRS calculated the proposed penalty as follows:

$380,400,000 (net proposed adjustment) × 21% (corporate tax rate) × 20% (penalty rate) = approximately $15,977,000.

We note that the IRS's penalty calculation applies the 21% corporate tax rate uniformly, without adjusting for the 35% rate applicable to TY 2017; if the blended rate were applied, the penalty amount would be modestly higher. We address this further in our reserve analysis below.

The IRS expressly reserved but did not assert the 40% gross valuation misstatement penalty under IRC § 6662(h). If the IRS were to subsequently assert the 40% penalty, the penalty exposure would increase to approximately $31,954,000.

IV. Updated Legal Analysis of PPC's Transfer Pricing Positions

A. Recognition Step — More-Likely-Than-Not Threshold (ASC 740-10-25)

Under ASC 740-10-25, a tax position may be recognized in the financial statements only if it is "more-likely-than-not" (i.e., a likelihood of more than 50%) that the position will be sustained upon examination by the taxing authority, including resolution of any related appeals or litigation, based solely on the technical merits of the position. This threshold is applied to each unit of account — here, each of PPC's three principal transfer pricing positions (the CSA cost-sharing ratios, the 4.5% royalty rate, and the PCT valuation) as well as the IRS's economic substance challenge.

It is C&H's conclusion that all of PPC's transfer pricing positions continue to meet the more-likely-than-not recognition threshold as of November 20, 2023. Specifically, it is more-likely-than-not that each of PPC's positions would be sustained on its technical merits if fully litigated before the United States Tax Court or a United States District Court. Our basis for this conclusion with respect to each position is set forth below.

CSA Cost-Sharing Ratios. PPC's cost-sharing ratios (ranging from 38.2% to 42.7% for PBI's share across TY 2017–2020) are supported by contemporaneous transfer pricing documentation prepared by Crestfield in compliance with Treas. Reg. § 1.482-7. The cost-sharing percentages reflect bona fide RAB projections derived from PPC's and PBI's respective revenue and operating income forecasts for the Americas and non-Americas territories. The projections were prepared using established internal forecasting models, reviewed and updated annually, and subjected to external verification by Whitmore. While the IRS challenges the projections as understating U.S.-source value, PPC's methodology is consistent with the regulatory framework under Treas. Reg. § 1.482-7(e), and the projections are grounded in defensible assumptions. Accordingly, we conclude that PPC's CSA cost-sharing position is more-likely-than-not to be sustained.

Royalty Rate (4.5%). PPC's 4.5% royalty rate for the legacy IP license is supported by Whitmore's CUT analysis, which identified fourteen comparable pharmaceutical license agreements. The interquartile range derived from these comparables is 3.1% to 6.8%, with a median of 4.4%. PPC's rate of 4.5% falls essentially at the median and well within the IQR. Under the arm's-length standard of IRC § 482 and the best-method analysis framework of Treas. Reg. § 1.482-1(c), a taxpayer's selected price that falls within the arm's-length range established by the best method is treated as an arm's-length result. We believe Whitmore's CUT analysis constitutes the best method, and PPC's rate is solidly within the resulting range. Accordingly, we conclude that PPC's royalty rate position is more-likely-than-not to be sustained.

PCT Valuation ($312M). Although the PCT year (2012) is outside the examination years, the PCT valuation is relevant because it underpins the IRS's arguments regarding the ongoing CSA and royalty arrangements. PPC's PCT payment of $312,000,000 is within the arm's-length range of $278,000,000 to $361,000,000 established by Whitmore's DCF/income method analysis using a WACC of 9.8%. The IRS's competing valuation of $852,000,000, which uses a WACC of 7.2% and more aggressive revenue projections, relies on assumptions that C&H and Whitmore believe are not well-supported and that overstate the present value of the pre-existing IP. We conclude that PPC's PCT position is more-likely-than-not correct.

PBI Economic Substance. The factual record developed during the examination overwhelmingly supports PBI's status as a bona fide entity with genuine economic substance. The evidence includes: (i) PBI's 185-person workforce performing regulatory, medical-affairs, commercial-strategy, and supply-chain functions; (ii) forty-two formal board of directors meetings held during TY 2017–2020, with documented agendas, minutes, and resolutions; (iii) cumulative regulatory expenditures of approximately €47.2 million; (iv) independent pricing authority across sixty-eight country markets; (v) 18,000 square feet of office space in Dublin; (vi) independent banking with Glenmore Bank Ireland plc; and (vii) PBI's growth from 52 employees at inception to 185 by 2020, reflecting genuine investment in operational capacity. This evidence establishes that PBI performs significant DEMPE functions and is not merely a conduit entity. We conclude that the IRS's economic substance argument is more-likely-than-not to fail.

Summary on Recognition. We emphasize that the issuance of the NOPA does not, by itself, alter the technical-merits analysis under ASC 740-10-25. A proposed adjustment by the IRS is one step in the administrative process and does not reflect a final determination. The recognition analysis turns on the legal and factual merits of the positions, not on the fact that the IRS has challenged them. However, the NOPA does provide new and material information relevant to the measurement step of the FIN 48 analysis, which we address below.

B. Measurement Step — Revised Assessment of Cumulative Probability (ASC 740-10-30)

Under ASC 740-10-30, tax positions that satisfy the more-likely-than-not recognition threshold must be measured at the "largest amount of tax benefit that is greater than 50 percent likely of being realized upon settlement with the taxing authority that has full knowledge of all relevant information." This measurement requires an assessment of the cumulative probability distribution of potential outcomes, taking into account all available evidence, including the positions of both the taxpayer and the taxing authority.

The NOPA and the IRS's stated positions now provide materially new information about the IRS's analytical approach, the specific adjustments it proposes, and the magnitude of the claimed adjustments. C&H has conducted a thorough assessment of the IRS's vulnerabilities and the strengths and weaknesses of PPC's positions based on the full record developed through the forty-seven IDR responses, all economic analyses (both PPC's and the IRS's), the legal conferences held during the examination, and C&H's independent legal research and analysis. Our assessment of each position is as follows.

1. CSA Cost-Sharing Position. The IRS's proposed percentage increases of eight to twelve percentage points in PBI's cost-sharing allocation rest on the IRS's assertion that PPC's RAB projections systematically understated the value of anticipated benefits attributable to the U.S. market. Dr. Washburne's analysis for the IRS employed alternative revenue projections that assigned higher growth rates to U.S.-source revenue and lower growth rates to non-Americas-source revenue than those used by PPC.

C&H has reviewed the IRS's analysis and has identified several significant vulnerabilities. First, the IRS's revenue projections do not adequately account for PBI's growing market share in the non-Americas territories, which reflects PBI's independent commercial contributions — including PBI's development of market-specific formulations, independent regulatory filings in key markets such as Japan (through PBI's partnership with Nakamura Seiyaku K.K.), and PBI's commercial-strategy initiatives in the European Union. Second, the IRS's approach applies hindsight-based adjustments to what should be a prospective RAB calculation, which is inconsistent with the framework of Treas. Reg. § 1.482-7(e)(2)(ii), which requires measurement based on reasonably anticipated benefits at the time of the cost-sharing allocation. Third, the IRS's proposed percentage increases are not evenly calibrated and appear to reflect a reverse-engineering of a target income allocation rather than an independent economic analysis of anticipated benefits.

That said, C&H acknowledges that PPC's position on the CSA cost-sharing ratios is not without hazard. The IRS's challenge to the benefit-share projections has some basis in the range of reasonable forecasting assumptions, and a trier of fact could credit certain of the IRS's alternative assumptions — particularly with respect to the relative growth rates of certain oncology products in the U.S. market versus the non-Americas territories. Projections inherently involve judgment, and the IRS's proposed percentages, while aggressive, are not so far outside the range of defensible positions as to be dismissed outright.

Estimated probability-weighted exposure on the CSA issue: moderate. C&H believes that some concession on this issue is probable if the case proceeds to IRS Appeals or litigation. However, we believe PPC's positions on cost-sharing ratios are substantially more defensible than the IRS's proposed adjustments, and the most probable settlement range would involve adjustments significantly below the IRS's $235,010,000 proposed CSA adjustment.

2. Royalty Rate Position. The IRS's proposed royalty rate of 11.0% relies on Dr. Washburne's CUT analysis, which identified a set of comparable license transactions different from those identified by Whitmore. C&H and Whitmore have reviewed the IRS's comparables and believe they are distinguishable on several critical comparability factors. In particular, several of the IRS's selected CUT transactions involve earlier-stage pharmaceutical compounds (pre-Phase III or Phase III clinical-stage) where the licensor's risk exposure is significantly greater than in PPC's situation, which involved fully approved and commercially established compounds. Other CUT transactions selected by the IRS involve broader IP bundles — including manufacturing know-how, trade names, and marketing intangibles — rather than the narrower pharmaceutical compound licenses at issue in PPC's legacy IP license.

PPC's royalty rate of 4.5% is solidly within the IQR (3.1%–6.8%) established by Whitmore's CUT analysis and is essentially at the median of 4.4%. The IRS's proposed rate of 11.0% lies far above Whitmore's IQR and, in C&H's view, does not reflect arm's-length pricing for the type of license at issue. Under the best-method analysis framework, C&H believes that Whitmore's CUT set is more reliable than the IRS's due to superior functional comparability.

Estimated probability-weighted exposure on the royalty issue: lower. C&H views this as the strongest of PPC's positions. We believe there is a high probability that PPC would prevail in full or with only nominal adjustment on the royalty rate issue if the matter were litigated or resolved at IRS Appeals.

3. Economic Substance / DEMPE Position. C&H views the IRS's economic substance argument as a secondary position that supplements the IRS's primary economic-based transfer pricing adjustments. The factual record developed during the examination, including PBI's responses to the IDRs, strongly supports PBI's genuine economic substance and its performance of meaningful DEMPE functions.

In particular, C&H notes the following evidence that significantly undermines the IRS's assertion that key DEMPE functions resided in the United States:

• PBI's headcount grew from 52 employees at the time of its incorporation in 2012 to 185 employees by 2020, reflecting sustained investment in operational capacity and human capital.

• PBI employed experienced senior executives in Dublin, including a Chief Commercial Officer (non-Americas), a Vice President of Regulatory Affairs (non-Americas), and a Head of Supply Chain, each of whom reported to PBI's board of directors and exercised independent decision-making authority.

• PBI incurred cumulative regulatory expenditures of approximately €47.2 million during TY 2017–2020, reflecting PBI's direct engagement with regulatory authorities in the European Union (European Medicines Agency), Japan (Pharmaceuticals and Medical Devices Agency), and other key markets.

• PBI's board of directors held forty-two formal meetings during the four-year examination period, with detailed agendas, board papers, and resolutions reflecting substantive governance and strategic decision-making.

• PBI exercised independent pricing authority across sixty-eight country markets, with documented pricing methodologies and market-specific pricing strategies.

• PBI maintained 18,000 square feet of office space in Dublin and independent banking relationships with Glenmore Bank Ireland plc.

In light of this robust factual record, C&H concludes that the IRS's economic substance argument faces substantial challenges and is unlikely to succeed.

Estimated probability-weighted exposure on the economic substance issue: low.

4. PCT Valuation (Background Impact). As noted above, the PCT year (2012) is outside the examination years, and the IRS did not propose a direct adjustment to the PCT in the NOPA. However, the IRS's assertion that the PCT of $312,000,000 undervalued PPC's pre-existing IP by approximately $540,000,000 (the IRS valued the IP at $852,000,000) underpins the IRS's proposed adjustments to the ongoing CSA and royalty arrangements for TY 2017–2020. To the extent the IRS's PCT valuation is shown to be incorrect — which C&H believes is the case — it weakens the foundation of the IRS's broader transfer pricing theory.

The principal point of disagreement on the PCT is the appropriate WACC. PPC and Whitmore used a WACC of 9.8%, which is well-supported by pharmaceutical-industry cost-of-capital data and is consistent with the risk profile of the pre-existing IP, which at the time of the PCT included clinical-stage compounds with significant development and regulatory risk. The IRS's WACC of 7.2% implies a substantially lower risk premium and is more consistent with the cost of capital for a diversified pharmaceutical company at the corporate level than for a specific portfolio of pharmaceutical intellectual property assets. C&H has identified published academic and industry data supporting a WACC in the range of 9.0% to 11.0% for pharmaceutical IP portfolios of this nature, and we believe that PPC's 9.8% WACC is defensible.

The IRS's revenue projections for the PCT valuation also exceeded PPC's and Whitmore's projections, reflecting higher assumed peak sales and longer revenue tails. While the IRS's revenue projections benefit from hindsight — certain of PPC's products performed well commercially after 2012 — the arm's-length standard requires that the PCT be valued based on information known or knowable at the time of the transaction, not with the benefit of hindsight. See Treas. Reg. § 1.482-7(g)(4)(vi)(F).

This analysis indirectly strengthens PPC's positions on both the CSA and royalty issues, as it demonstrates that the IRS's broader theory is predicated on a contested and, in our view, unsupported PCT valuation.

5. Penalty Position. The IRS has proposed a substantial valuation misstatement penalty of approximately $15,977,000 under IRC § 6662(e). PPC maintained contemporaneous transfer pricing documentation for all four examination years, which was originally prepared by Crestfield in compliance with the penalty-protection standards of IRC § 6662(e)(3)(B) and Treas. Reg. § 1.6662-6(d). The documentation includes detailed best-method analyses, functional analyses of PPC and PBI, comparability studies, and economic analyses supporting PPC's transfer pricing results for both the CSA and the legacy IP license.

C&H has reviewed this documentation and believes it satisfies the requirements for a reasonable-cause and good-faith defense under IRC § 6664(c) and Treas. Reg. § 1.6664-4. Specifically, PPC engaged qualified transfer pricing professionals (Crestfield and Whitmore), obtained and relied upon contemporaneous economic analyses using recognized transfer pricing methods, and maintained documentation that was current and available upon audit. Additionally, PPC's transfer pricing results fell within the arm's-length ranges identified by its economic advisors, and PPC had a reasonable basis for its positions.

C&H believes PPC has a strong reasonable-cause defense, and penalty abatement is more-likely-than-not. However, the 20% penalty of approximately $15,977,000 must be considered as part of the overall reserve analysis, as discussed in Section V below.

C. Impact of TCJA on Measurement

TY 2017 was the last year subject to the pre-Tax Cuts and Jobs Act ("TCJA") corporate income tax rate of 35%. TY 2018, TY 2019, and TY 2020 are subject to the post-TCJA corporate income tax rate of 21%. This rate differential is relevant to the quantification of both the potential tax impact of any § 482 adjustment and the appropriate level of the FIN 48 reserve.

Specifically, a dollar of income adjustment in TY 2017 generates 35 cents of incremental federal income tax, compared to 21 cents for each dollar of adjustment in TY 2018–2020. Because the IRS's proposed adjustments are distributed across all four years — with TY 2017 accounting for approximately $101,679,000 of the $380,400,000 net proposed adjustment (representing the sum of TY 2017 CSA and royalty adjustments, net of the TY 2017 allocable share of the correlative offset) — the blended effective tax rate applicable to the full proposed adjustment is somewhat higher than 21%. This rate differential is incorporated into C&H's reserve analysis.

V. Revised Reserve Recommendation

A. Prior Reserve Level

As discussed in Section II.C above, PPC maintained an ASC 740-10 reserve of $62,400,000 as of year-end 2022. This reserve was established based on C&H's September 20, 2022 analysis and was reflected in PPC's Form 10-K for the fiscal year ended December 31, 2022.

B. Updated Analysis

Based on our updated analysis in light of the NOPA and the $380,400,000 in proposed adjustments, C&H concludes that the FIN 48 reserve should be reviewed but does not require a material increase for year-end 2023 financial statement purposes. Our rationale for this conclusion is as follows:

Continued Recognition. As set forth in Section IV.A, all of PPC's transfer pricing positions continue to meet the more-likely-than-not recognition threshold under ASC 740-10-25. Accordingly, PPC is entitled to recognize the tax benefit associated with its reported transfer pricing positions, subject to the measurement step.

Measurement Analysis. Under the measurement step of ASC 740-10-30, the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement remains high relative to PPC's as-reported positions. Stated differently, C&H's probability-weighted analysis indicates that PPC is more likely than not to sustain the substantial majority of the income allocation reflected in its filed returns. While some concession — particularly on the CSA cost-sharing ratios — is a probable outcome, the magnitude of any likely concession is, in our assessment, encompassed within the existing $62,400,000 reserve.

Anticipated Resolution at Appeals. The examination is expected to be resolved through the IRS Appeals process. C&H has obtained an extension of the Protest filing deadline to December 22, 2023 (from the original November 8, 2023, thirty-day letter deadline) and intends to file a detailed formal Protest contesting all proposed adjustments for TY 2017–2020. The case is expected to be assigned to an IRS Appeals Officer in January 2024, with an Appeals conference anticipated in late February or early March 2024.

Historical Precedent. Historical data from IRS Appeals settlements in comparable transfer pricing cases — particularly cases involving pharmaceutical cost-sharing arrangements, legacy IP license royalty rates, and economic substance challenges — indicate that final settlements typically result in adjustments substantially below the full NOPA amount. While each case is fact-specific, the pattern of Appeals outcomes in analogous matters supports C&H's view that a full-value outcome is unlikely.

Hazards Analysis. C&H's preliminary hazards-of-litigation analysis — taking into account the strengths and weaknesses of PPC's positions on each issue, the quality of PPC's contemporaneous documentation, the vulnerabilities in the IRS's analysis identified in Section IV.B above, and the applicable legal standards — suggests that the probability-weighted adjustment is significantly below the full $380,400,000 proposed by the IRS.

Recommendation. Based on the foregoing analysis, C&H believes the existing $62,400,000 reserve remains reasonable and adequate for year-end 2023 financial statement purposes. We do not recommend an increase in the reserve at this time.

C&H notes that this assessment is necessarily subject to change as the IRS Appeals process develops. Material developments — including the assignment of the case to a specific Appeals Officer, the substance of the Appeals conference, any communications from IRS Appeals regarding settlement positions, or any change in the applicable legal framework — could affect our analysis. C&H has been advised that the case has been tentatively assigned to Appeals Officer Noreen Castañeda, with a conference anticipated in late February 2024. C&H will provide an updated assessment following the Appeals conference.

C. Sensitivity to Outcomes

For Crestfield's reference, C&H provides the following sensitivity analysis:

Full-Value Scenario. If the case were resolved at 100% of the proposed adjustment ($380,400,000), the total incremental federal income tax would be approximately $79,880,000, calculated using a blended rate that accounts for the 35% rate applicable to TY 2017 and the 21% rate applicable to TY 2018–2020. In addition, if the penalty were sustained in full, the penalty exposure would be approximately $15,977,000, for a combined exposure of approximately $95,857,000. C&H does not consider a full-value outcome probable.

Existing Reserve Coverage. The existing reserve of $62,400,000 encompasses a reasonable range of likely outcomes. It would cover a scenario in which approximately 78% of PPC's tax benefit is realized — i.e., a scenario in which the ultimate adjustment is in the range of approximately $297,000,000, representing a settlement at roughly 78% of the NOPA amount, at the blended tax rate. Given C&H's assessment that PPC's positions are substantially stronger than the IRS's on most issues — and that PPC's royalty rate position is particularly strong — C&H views the existing reserve as adequately covering the range of probable outcomes.

Further Updates. C&H will provide a further update to Crestfield and PPC following the IRS Appeals conference and will reassess the reserve recommendation at that time.

VI. Procedural Status and Next Steps

The procedural posture of the examination as of the date of this letter, and the anticipated next steps, are as follows:

C&H intends to file a comprehensive formal Protest on or before December 22, 2023, contesting all proposed adjustments for TY 2017–2020 on both factual and legal grounds. The Protest will address each of the IRS's proposed adjustments — the CSA cost-sharing ratio adjustments, the royalty rate adjustments, the correlative offset, and the proposed penalty — and will present PPC's affirmative case for sustaining its reported positions. The Protest will be supported by economic analyses prepared by Whitmore, legal memoranda prepared by C&H, and relevant factual documentation.

Following the filing of the Protest, the case is expected to be assigned to an IRS Appeals Officer. C&H has been informally advised that the case will likely be assigned to Appeals Officer Noreen Castañeda, who has experience with pharmaceutical transfer pricing matters. An Appeals conference is anticipated in late February or early March 2024.

C&H will update Crestfield and PPC as material developments occur throughout the Appeals process, including (but not limited to) any post-conference assessment, any settlement proposals communicated by IRS Appeals, and any developments that may affect the reserve analysis.

VII. Penalty-Protection Documentation Status

As noted in Section IV.B.5 above, PPC maintained contemporaneous transfer pricing documentation for all four examination years (TY 2017–2020). This documentation was originally prepared by Crestfield in compliance with the penalty-protection standards of IRC § 6662(e)(3)(B), which provides a specific exception to the substantial valuation misstatement penalty for taxpayers who maintain contemporaneous documentation establishing that the taxpayer's transfer pricing method was reasonable and was applied consistently with the documentation.

C&H has reviewed this documentation in full and believes it satisfies the substantive and procedural requirements of Treas. Reg. § 1.6662-6(d) for establishing reasonable cause and good faith. The documentation includes, among other things: (i) a detailed best-method analysis supporting the selection of PPC's transfer pricing methods for both the CSA and the legacy IP license; (ii) a comprehensive functional analysis of PPC and PBI, including analysis of the functions performed, assets used, and risks assumed by each entity; (iii) a detailed description of the CSA terms, cost-sharing calculations, and RAB projections; (iv) Whitmore's economic analyses, including the CUT analysis for the royalty rate and the CPM/TNMM analysis based on twenty-two comparable companies; and (v) annual updates reflecting changes in facts and circumstances.

The formal Protest to be filed on December 22, 2023 will include a section presenting PPC's reasonable-cause defense and requesting full abatement of the proposed IRC § 6662(e) penalty.

C&H's conclusion: It is more-likely-than-not that any proposed penalty would be abated upon Appeals consideration or, if necessary, upon litigation. Accordingly, C&H does not recommend establishing a separate FIN 48 reserve for the penalty component at this time.

VIII. GILTI and BEAT Considerations

C&H notes that for TY 2018–2020, PPC's positions with respect to Global Intangible Low-Taxed Income ("GILTI") under IRC § 951A and the Base Erosion and Anti-Abuse Tax ("BEAT") under IRC § 59A may be affected by any IRC § 482 adjustment that alters the allocation of income between PPC and PBI.

Specifically, a reduction in PBI's income resulting from increased cost-sharing payments to PPC or increased royalty payments to PPC would reduce PBI's tested income for GILTI purposes under IRC § 951A, potentially reducing PPC's GILTI inclusion. Conversely, a reduction in the base erosion payments from PPC to PBI could reduce PPC's base erosion percentage for BEAT purposes under IRC § 59A. These interactions create cross-cutting effects that partially mitigate the tax impact of any § 482 adjustment for TY 2018–2020.

These GILTI and BEAT interaction effects are factored into C&H's overall reserve analysis and are reflected in the measurement-step conclusions discussed in Section V above. However, the GILTI and BEAT effects do not change the fundamental reserve recommendation at this time.

C&H will provide a more detailed analysis of the GILTI and BEAT interaction effects as part of the Appeals process, including a quantitative assessment of the net tax impact of the proposed § 482 adjustments after accounting for GILTI and BEAT offsets.

IX. Competent Authority / Mutual Agreement Procedure

C&H is evaluating whether a request for competent authority relief under Article 25 (Mutual Agreement Procedure) of the Convention between the Government of the United States of America and the Government of Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains (the "U.S.-Ireland Income Tax Treaty") may be appropriate in order to avoid or mitigate double taxation in the event of a material § 482 adjustment. If the IRS ultimately sustains an adjustment that increases PPC's U.S. taxable income, a corresponding reduction in PBI's Irish taxable income may be sought through the competent authority process, subject to the agreement of the Irish Revenue Commissioners.

This possibility is noted for Crestfield's awareness and may become relevant depending on the ultimate settlement outcome. At this stage, C&H has not made a formal recommendation regarding a competent authority request, as such a request is typically made following a final resolution of the U.S. tax examination.

Coordination with PBI's Irish tax advisors, Thornbury & Keogh (Lead Partner: Ciarán Thornbury), is ongoing. Thornbury & Keogh has been apprised of the NOPA and the general nature of the IRS's proposed adjustments and is monitoring the situation from the Irish tax perspective.

X. Impact on Hargrove Credit Facility Covenants

C&H notes, for completeness in the context of PPC's overall financial reporting considerations, that the NOPA and any resulting tax liability may implicate certain covenants in PPC's existing credit facility. Specifically, C&H has separately analyzed the tax-indemnity provisions and material-tax-event covenants contained in PPC's $1.5 billion revolving credit facility with Hargrove National Bank, N.A., as Administrative Agent (contact: Christine Bellucci, Senior Vice President, Loan Administration).

This analysis is addressed in a separate privileged memorandum from C&H to PPC dated November 15, 2023, and is noted here solely for Crestfield's awareness. The credit facility analysis does not affect C&H's FIN 48 reserve recommendation but may be relevant to PPC's broader financial reporting and disclosure considerations.

XI. SEC Disclosure Considerations

C&H notes that PPC should evaluate its disclosure obligations under the Securities Exchange Act of 1934 with respect to the NOPA in its upcoming Annual Report on Form 10-K for the fiscal year ending December 31, 2023. In particular, PPC should consider whether the NOPA constitutes a contingent liability that must be disclosed in the notes to the financial statements under ASC 450-20, and whether the level of disclosure should be revised in light of the IRS's proposed adjustments.

C&H understands that PPC's largest institutional shareholder, Ridgeview Capital Management LP (holding approximately 8.3% of PPC's outstanding common stock; Managing Partner: Douglas Everett), closely monitors FIN 48 disclosures and has historically engaged with PPC management regarding the Company's uncertain tax position reserves. The potential for shareholder scrutiny underscores the importance of ensuring that PPC's FIN 48 disclosures are complete, accurate, and appropriately calibrated.

C&H has provided a separate analysis to PPC General Counsel Deborah Staines regarding SEC contingent-liability disclosure requirements, including the application of ASC 450-20 and the SEC's interpretive guidance on loss-contingency disclosures. That analysis is not reproduced here but is available to Crestfield upon request, subject to PPC's consent.

Crestfield should coordinate with PPC and C&H regarding the appropriate level of disclosure in the financial statements and accompanying notes for the fiscal year ending December 31, 2023, to ensure consistency between the FIN 48 reserve, the notes to the financial statements, and any discussion of tax contingencies in PPC's Management's Discussion and Analysis of Financial Condition and Results of Operations.

XII. Limitations and Caveats

This letter constitutes a legal opinion provided in connection with PPC's financial reporting obligations under ASC 740-10 and does not guarantee any particular outcome of the IRS examination, IRS Appeals process, or any potential litigation. The resolution of transfer pricing disputes involves inherent uncertainty, and the ultimate outcome may differ materially from the conclusions expressed herein.

The analysis set forth in this letter is based on the facts known to C&H as of November 20, 2023, and applicable law — including the Internal Revenue Code, Treasury Regulations, IRS administrative guidance, and relevant case law — as of that date. Any subsequent changes in facts, law, or administrative practice may affect our conclusions.

C&H's analysis will be updated as material developments occur in the IRS examination and Appeals process, including but not limited to: (i) the filing of the formal Protest and the IRS's response thereto; (ii) the assignment of the case to IRS Appeals and the scheduling of the Appeals conference; (iii) any substantive communications from IRS Appeals regarding settlement positions; (iv) any changes in applicable law or regulations; and (v) any other developments that C&H determines to be material.

This letter is protected by attorney-client privilege and the work-product doctrine. It is not to be disclosed to the IRS or to any third party without the express written consent of PPC. The furnishing of this letter to Crestfield in its capacity as PPC's independent auditor does not constitute a waiver of any applicable privilege.

C&H's analysis assumes the continued applicability of the current statutory corporate income tax rates — 21% for TY 2018–2020 and 35% for TY 2017 — and the continued applicability of the existing Treasury Regulations under IRC §§ 482, 951A, 59A, 6662, and 6664 in their current form. Any legislative or regulatory changes affecting these provisions could alter our analysis.

XIII. Conclusion

Based on the foregoing analysis, C&H's updated conclusions are as follows:

1. Recognition. PPC's transfer pricing positions — including the CSA cost-sharing ratios, the 4.5% royalty rate for the legacy IP license, the PCT valuation, and PBI's economic substance — continue to meet the more-likely-than-not recognition threshold under ASC 740-10-25 as of November 20, 2023.

2. Measurement. The measurement analysis under ASC 740-10-30, incorporating the new information provided by the NOPA, supports maintaining the current FIN 48 reserve level. The largest amount of tax benefit that is greater than 50% likely of being realized upon settlement remains high relative to PPC's as-reported positions.

3. Reserve Adequacy. PPC's existing FIN 48 reserve of $62,400,000 remains reasonable and adequate for year-end 2023 financial reporting purposes in light of the NOPA and the IRS's proposed adjustments of $380,400,000.

4. Penalty. C&H concludes that it is more-likely-than-not that the proposed IRC § 6662(e) penalty would be abated, and no separate reserve for the penalty component is recommended.

5. Further Updates. C&H will provide further updates following the filing of the formal Protest (expected on or before December 22, 2023) and the IRS Appeals proceedings (conference anticipated in late February or early March 2024).

We are available to discuss this analysis with you and your engagement team at your convenience. Please do not hesitate to contact the undersigned with any questions.

Very truly yours,

CALDERWOOD & HARKNESS LLP

By: ________

Leonard Cross Partner, Tax Department Direct: (215) 864-7244

Email: lcross@calderwoodharkness.com

Licensed in New York, New Jersey, and the District of Columbia

By: ________

Garrett Simmons Associate, Tax Department Direct: (215) 864-7318

Email: gsimmons@calderwoodharkness.com

cc: (via email)

Susan Lam, CPA, Transfer Pricing Partner, Crestfield & Associates LLP

Marcus Whitfield, Vice President, Global Tax, Penterra Pharmaceuticals Corp., 2200 Independence Boulevard, Princeton Junction, NJ 08550

Deborah Staines, General Counsel, Penterra Pharmaceuticals Corp., 2200 Independence Boulevard, Princeton Junction, NJ 08550

Sylvia Hartwell, Billing Partner, Calderwood & Harkness LLP (internal distribution)

Enclosures:

Enclosure 1: Summary Table of NOPA Proposed Adjustments by Year and Issue ($380.4M Breakdown)

Enclosure 2: Summary of Whitmore Valuation Group Economic Analyses (CUT IQR 3.1%–6.8%, Median 4.4%; CPM/TNMM 22 Comparables; PCT DCF $278M–$361M Range)

Note: Full economic reports prepared by the Whitmore Valuation Group and the draft Protest are available upon request, subject to applicable privilege protocols and PPC's consent.

Tax Year	Total R&D Costs	PPC Position (% to PBI)	IRS Proposed (% to PBI)	Increase (pp)	Additional Income to PPC
2017	$487,300,000	38.2%	48.2%	+10.0	$48,730,000
2018	$523,800,000	39.6%	50.6%	+11.0	$57,610,000
2019	$561,200,000	41.1%	52.3%	+11.2	$62,850,000
2020	$598,400,000	42.7%	53.7%	+11.0	$65,820,000
Total	$235,010,000
Tax Year	Legacy Non-Americas Net Sales	PPC Rate	IRS Rate	Differential	Additional Income to PPC
2017	$814,600,000	4.5%	11.0%	6.5%	$52,949,000
2018	$762,300,000	4.5%	11.0%	6.5%	$49,549,500
2019	$691,800,000	4.5%	11.0%	6.5%	$44,967,000
2020	$624,100,000	4.5%	11.0%	6.5%	$40,566,500
Total	$188,032,000
Component	Amount
CSA Cost-Sharing Adjustments	$235,010,000
Royalty Rate Adjustments	$188,040,000
Correlative Offset	($42,650,000)
Net Proposed Adjustment	$380,400,000
Event	Date
NOPA Issued	October 12, 2023
30-Day Letter Issued	November 8, 2023
Original Protest Filing Deadline	December 8, 2023
Extension of Protest Filing Deadline Obtained	Extended to December 22, 2023
Formal Protest to Be Filed	On or before December 22, 2023
Case Assignment to IRS Appeals (anticipated)	January 2024
Appeals Conference (anticipated)	Late February or early March 2024

CALDERWOOD & HARKNESS LLP Counsellors at Law
1735 Market Street, Suite 3100 Philadelphia, PA 19103 Tel: (215) 864-7200
Fax: (215) 864-7201
600 Lexington Avenue New York, NY 10022 Tel: (212) 506-5100
Fax: (212) 506-5101
www.calderwoodharkness.com
November 20, 2023
VIA EMAIL AND FIRST CLASS MAIL — PRIVILEGED AND CONFIDENTIAL
Martin Ogilvy, CPA Engagement Partner Crestfield & Associates LLP 1200 Avenue of the Americas New York, NY 10036
Re: Penterra Pharmaceuticals Corp. (EIN: 22-3741856) — Updated Legal Analysis Regarding ASC 740-10 (FIN 48) Uncertain Tax Position Reserve — IRS Transfer Pricing Examination, Tax Years 2017–2020; Notice of Proposed Adjustment Issued October 12, 2023
C&H Matter No.: 1018-00009
Dear Mr. Ogilvy:
I. Purpose and Context of the Letter
This letter updates the prior legal analysis issued by Calderwood & Harkness LLP ("C&H") on September 20, 2022, regarding the uncertain tax position ("UTP") reserve maintained by Penterra Pharmaceuticals Corp. ("PPC" or the "Company") under ASC 740-10 (formerly Financial Accounting Standards Board Interpretation No. 48, "FIN 48") with respect to PPC's Irish intellectual property-holding structure and intercompany transfer pricing arrangements with Penterra Biopharma International DAC ("PBI"), a Designated Activity Company organized under the laws of Ireland.
This updated analysis is prompted by the Internal Revenue Service's ("IRS") issuance of a Notice of Proposed Adjustment ("NOPA") on October 12, 2023, covering all four tax years currently under examination — tax years ("TY") 2017, 2018, 2019, and 2020. The NOPA proposes net adjustments totaling $380,400,000 across all four years, encompassing both cost-sharing arrangement ("CSA") cost-allocation adjustments and royalty rate adjustments under Section 482 of the Internal Revenue Code of 1986, as amended (the "Code" or "IRC"), as well as an associated substantial valuation misstatement penalty under IRC § 6662(e).
The purpose of this letter is to provide Crestfield & Associates LLP ("Crestfield") with revised legal conclusions for use in PPC's year-end 2023 financial statement reserve analysis under ASC 740-10 for the fiscal year ending December 31, 2023. Specifically, this letter addresses (i) whether PPC's transfer pricing positions continue to satisfy the "more-likely-than-not" recognition threshold under ASC 740-10-25, (ii) the appropriate measurement of the tax benefit under ASC 740-10-30 in light of the NOPA, and (iii) our recommendation regarding the adequacy of PPC's existing FIN 48 reserve.
We note at the outset that this letter reflects privileged legal analysis and is provided at the direction of PPC — and with the consent and at the request of PPC General Counsel Deborah Staines — for purposes of Crestfield's audit and financial reporting functions. This communication is protected by the attorney-client privilege and the work-product doctrine. The furnishing of this letter to Crestfield in connection with its audit responsibilities does not constitute a waiver of any applicable privilege. This letter should not be disclosed to the IRS or to any third party without the express written consent of PPC.
II. Background — IRS Examination and IP Structure
A. Examination Overview
The IRS Large Business & International Division ("LB&I") opened an examination of PPC's federal income tax returns for TY 2017 through TY 2020 on May 16, 2022, as communicated to PPC via Letter 2205-A (Notification of Examination). The examination has been conducted under IRS Case File No. LB&I-NE-TP-2022-00641 and has been led by Supervisory Revenue Agent Gerald Meskill, with Lead Revenue Agent Patricia Dunleavy serving as the primary examiner on the transfer pricing issues.
The IRS has assigned Dr. Alan Washburne of the IRS Transfer Pricing Practice as the government's economist. Dr. Washburne has prepared the IRS's economic analyses underlying the proposed adjustments, including the government's comparable uncontrolled transaction ("CUT") analysis and discounted cash flow ("DCF") valuation of the platform contribution transaction ("PCT"). Additionally, the IRS Office of Chief Counsel has provided legal support to the examination team through Attorney-Advisor Franklin Rosario and Senior Counsel Donna Hirabayashi, both of whom participated in the substantive legal conferences held with C&H during the course of the examination.
The examination has been extensive. Between June 2022 and September 2023, the IRS issued forty-seven (47) Information Document Requests ("IDRs"), which covered the full range of PPC's transfer pricing documentation, CSA records, intercompany agreements, financial projections, R&D expenditure allocations, PBI's operational records, and related matters. PPC responded to all IDRs on a timely basis, in consultation with C&H and Crestfield. C&H also participated in three formal legal conferences with the IRS examination team and Chief Counsel representatives, held on November 15, 2022, April 18, 2023, and August 9, 2023.
It is noted that PPC was not a participant in the IRS Compliance Assurance Process ("CAP") for the tax years at issue. Accordingly, the examination followed the standard LB&I audit process, and the NOPA represents the IRS examination team's fully developed position.
B. Intercompany Transfer Pricing Structure
PBI is a Designated Activity Company organized under the laws of Ireland, incorporated on March 15, 2012, with its registered office at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4, Ireland. PBI is a wholly owned indirect subsidiary of PPC, held through the following ownership chain: PPC owns 100% of Penterra Holdings Luxembourg S.à r.l. ("PHL"), a société à responsabilité limitée organized under the laws of Luxembourg (Luxembourg RCS No. B 168452), which in turn owns 100% of PBI. PHL is treated as a disregarded entity for U.S. federal income tax purposes under Treas. Reg. § 301.7701-3, with the result that PBI is treated for U.S. tax purposes as a direct subsidiary of PPC.
The intercompany transfer pricing structure at issue in the examination consists of the following principal elements:
Cost-Sharing Arrangement. PPC and PBI entered into a qualified cost-sharing arrangement effective July 1, 2012, pursuant to Treas. Reg. § 1.482-7. Under the CSA, PBI co-funds a share of PPC's intangible development costs (primarily pharmaceutical R&D expenditures) in exchange for the rights to exploit the resulting pharmaceutical intellectual property outside the Americas (i.e., in Europe, Asia-Pacific, Middle East, and Africa, collectively referred to as the "non-Americas territories"). PPC retains the rights to exploit such IP in the Americas (defined as North America, Central America, South America, and the Caribbean). The cost-sharing percentages are determined annually based on the parties' respective reasonably anticipated benefits ("RABs") from the intangible development activities, calculated in accordance with the methodology set forth in the CSA documentation and Treas. Reg. § 1.482-7(e).
Platform Contribution Transaction. In connection with the formation of the CSA, PBI made a PCT payment of $312,000,000 to PPC on July 1, 2012, representing arm's-length compensation for a buy-in to PPC's pre-existing intellectual property — primarily clinical-stage and approved oncology compounds, including the foundational IP underlying what would later become PPC's flagship oncology product, Veritaxol. The PCT valuation was supported by a contemporaneous economic analysis prepared by the Whitmore Valuation Group ("Whitmore"), which employed a DCF/income method analysis using a weighted average cost of capital ("WACC") of 9.8%, yielding an arm's-length range of $278,000,000 to $361,000,000. The PCT payment of $312,000,000 fell within this range.
Legacy IP License. Separately from the CSA, PBI licensed certain pre-2012 vintage pharmaceutical compounds from PPC pursuant to a license agreement dated July 1, 2012. The license covers PBI's right to manufacture, market, and distribute these legacy compounds in the non-Americas territories at a royalty rate of 4.5% of net sales. The royalty rate was supported by a CUT analysis prepared by Whitmore, which identified fourteen comparable pharmaceutical license agreements, yielding an interquartile range ("IQR") of 3.1% to 6.8% and a median of 4.4%.
PBI's Operations. PBI maintains substantial operations in Dublin, Ireland. As of 2020, PBI employed 185 persons, including personnel performing regulatory, medical-affairs, commercial-strategy, and supply-chain functions. PBI holds its own regulatory registrations, maintains independent pricing authority across sixty-eight (68) country markets in the non-Americas territories, and conducted forty-two (42) formal board of directors meetings during the TY 2017–2020 period. PBI maintains independent banking relationships with Glenmore Bank Ireland plc and occupies approximately 18,000 square feet of office space in Dublin. During TY 2017–2020, PBI incurred cumulative regulatory expenditures of approximately €47.2 million.
Contract Manufacturing. Penterra Manufacturing Ireland Ltd. ("PMI"), a separate Irish subsidiary, operates as a contract manufacturer for PBI under a contract manufacturing agreement providing for cost-plus 8% compensation. PMI's manufacturing activities supply product for PBI's non-Americas territory distribution.
Key Products. The products most relevant to the transfer pricing issues at hand are: (i) Veritaxol, PPC's flagship oncology compound, which generated approximately $3.12 billion in global net sales in 2020; (ii) Imvara, an immunology compound with approximately $1.87 billion in global net sales in 2020; and (iii) Cerulon, a rare-disease therapeutic with approximately $0.62 billion in global net sales in 2020.
C. PPC's Prior FIN 48 Reserve
As of year-end 2022, PPC maintained an ASC 740-10 reserve of $62,400,000 for uncertain tax positions related to the Irish IP-holding structure and intercompany transfer pricing arrangements described above. This reserve level was reflected in PPC's Annual Report on Form 10-K for the fiscal year ended December 31, 2022, as filed with the Securities and Exchange Commission.
C&H's prior analysis, set forth in our letter dated September 20, 2022, supported the adequacy of the $62,400,000 reserve based on our assessment of both the more-likely-than-not recognition threshold and the measurement criteria under ASC 740-10. That prior analysis was rendered before the IRS issued the NOPA on October 12, 2023, and before the full scope and magnitude of the IRS's proposed adjustments were known. The issuance of the NOPA represents material new information that requires C&H to reassess the measurement step of its FIN 48 analysis, as discussed in Sections IV and V below.
III. Summary of the NOPA — Proposed Adjustments ($380.4M)
The NOPA, dated October 12, 2023, proposes aggregate net adjustments of $380,400,000 to PPC's taxable income across TY 2017–2020 under IRC § 482. The proposed adjustments fall into two principal categories — CSA cost-sharing ratio adjustments and royalty rate adjustments — together with a correlative offset to avoid double-counting. The NOPA also proposes a substantial valuation misstatement penalty under IRC § 6662(e). Each component is summarized below.
A. CSA Cost-Sharing Ratio Adjustments ($235,010,000)
The IRS proposes increasing PBI's cost-sharing percentage — i.e., the share of intangible development costs allocated to PBI — by eight to twelve percentage points for each of the four examination years. The IRS asserts that PPC's RAB projections systematically understated the value of U.S.-source anticipated benefits relative to non-Americas-source anticipated benefits, resulting in an over-allocation of costs to PPC (and a corresponding under-allocation to PBI). The IRS's position effectively claims that PBI should have borne a greater share of the R&D expenditures, with a corresponding increase in PPC's U.S. taxable income by the amount of the cost-sharing differential.
The year-by-year detail of the IRS's proposed CSA cost-sharing ratio adjustments is as follows:
The subtotal of the IRS's proposed CSA adjustments is $235,010,000.
B. Royalty Rate Adjustments ($188,040,000)
The IRS proposes increasing the royalty rate under the legacy IP license from 4.5% to 11.0% of net sales, asserting that PPC's royalty rate is below the arm's-length range. The IRS's proposed increase is based on Dr. Washburne's CUT analysis, which identified a different set of comparable license transactions than those identified by Whitmore and derived a substantially higher arm's-length royalty rate. The IRS's CUT analysis and the specific comparables relied upon are addressed in our legal analysis below.
The year-by-year detail of the IRS's proposed royalty rate adjustments is as follows:
The subtotal of the IRS's proposed royalty adjustments is approximately $188,040,000 (with minor rounding adjustments reflected in the NOPA).
C. PCT Undervaluation Background
In connection with the NOPA, the IRS also asserted that PBI's PCT payment of $312,000,000 undervalued PPC's pre-existing intellectual property by approximately $540,000,000. The IRS valued the pre-existing IP at approximately $852,000,000, using an income method with a WACC of 7.2% and revenue projections that exceeded those employed by Whitmore in its contemporaneous valuation. However, because the PCT occurred on July 1, 2012 — which falls outside the examination years of TY 2017–2020 — the IRS did not directly propose an adjustment to the PCT itself. Instead, the IRS's position on the PCT serves as a foundational predicate for its proposed adjustments to the ongoing CSA cost-sharing ratios and royalty rates for the examination years, on the theory that the initial undervaluation of the IP contributed to an ongoing misallocation of intercompany income.
D. Economic Substance Challenge
In addition to its economic-based transfer pricing arguments, the IRS asserted in part that PBI lacked sufficient economic substance to justify its role as an IP owner and CSA participant. Specifically, the IRS contended that the key Development, Enhancement, Maintenance, Protection, and Exploitation ("DEMPE") functions with respect to the licensed and co-developed IP remained predominantly in the United States, and that PBI served primarily as a cost-sharing payment conduit rather than a genuine participant in the intangible development and exploitation activities. This argument, while secondary to the IRS's primary economic adjustments, underpins the IRS's overall theory that the intercompany transfer pricing arrangements do not reflect arm's-length dealings. C&H addresses this argument in our legal analysis in Section IV below.
E. Correlative Offset and Net Adjustment
The IRS allowed a correlative offset of ($42,650,000) to eliminate double-counting between the CSA cost-sharing adjustments and the royalty rate adjustments. This offset accounts for the overlap that would otherwise arise because the increased royalty payments (at 11.0% rather than 4.5%) would reduce PBI's income and thereby reduce PBI's RAB, which in turn would reduce PBI's cost-sharing obligation. The offset avoids taxing the same intercompany flow twice.
The net proposed adjustment is calculated as follows:
F. Proposed Penalty
The IRS has proposed the substantial valuation misstatement penalty under IRC § 6662(e) at the 20% rate, applied to the underpayment of tax attributable to the net IRC § 482 allocation. The IRS calculated the proposed penalty as follows:
$380,400,000 (net proposed adjustment) × 21% (corporate tax rate) × 20% (penalty rate) = approximately $15,977,000.
We note that the IRS's penalty calculation applies the 21% corporate tax rate uniformly, without adjusting for the 35% rate applicable to TY 2017; if the blended rate were applied, the penalty amount would be modestly higher. We address this further in our reserve analysis below.
The IRS expressly reserved but did not assert the 40% gross valuation misstatement penalty under IRC § 6662(h). If the IRS were to subsequently assert the 40% penalty, the penalty exposure would increase to approximately $31,954,000.
IV. Updated Legal Analysis of PPC's Transfer Pricing Positions
A. Recognition Step — More-Likely-Than-Not Threshold (ASC 740-10-25)
Under ASC 740-10-25, a tax position may be recognized in the financial statements only if it is "more-likely-than-not" (i.e., a likelihood of more than 50%) that the position will be sustained upon examination by the taxing authority, including resolution of any related appeals or litigation, based solely on the technical merits of the position. This threshold is applied to each unit of account — here, each of PPC's three principal transfer pricing positions (the CSA cost-sharing ratios, the 4.5% royalty rate, and the PCT valuation) as well as the IRS's economic substance challenge.
It is C&H's conclusion that all of PPC's transfer pricing positions continue to meet the more-likely-than-not recognition threshold as of November 20, 2023. Specifically, it is more-likely-than-not that each of PPC's positions would be sustained on its technical merits if fully litigated before the United States Tax Court or a United States District Court. Our basis for this conclusion with respect to each position is set forth below.
CSA Cost-Sharing Ratios. PPC's cost-sharing ratios (ranging from 38.2% to 42.7% for PBI's share across TY 2017–2020) are supported by contemporaneous transfer pricing documentation prepared by Crestfield in compliance with Treas. Reg. § 1.482-7. The cost-sharing percentages reflect bona fide RAB projections derived from PPC's and PBI's respective revenue and operating income forecasts for the Americas and non-Americas territories. The projections were prepared using established internal forecasting models, reviewed and updated annually, and subjected to external verification by Whitmore. While the IRS challenges the projections as understating U.S.-source value, PPC's methodology is consistent with the regulatory framework under Treas. Reg. § 1.482-7(e), and the projections are grounded in defensible assumptions. Accordingly, we conclude that PPC's CSA cost-sharing position is more-likely-than-not to be sustained.
Royalty Rate (4.5%). PPC's 4.5% royalty rate for the legacy IP license is supported by Whitmore's CUT analysis, which identified fourteen comparable pharmaceutical license agreements. The interquartile range derived from these comparables is 3.1% to 6.8%, with a median of 4.4%. PPC's rate of 4.5% falls essentially at the median and well within the IQR. Under the arm's-length standard of IRC § 482 and the best-method analysis framework of Treas. Reg. § 1.482-1(c), a taxpayer's selected price that falls within the arm's-length range established by the best method is treated as an arm's-length result. We believe Whitmore's CUT analysis constitutes the best method, and PPC's rate is solidly within the resulting range. Accordingly, we conclude that PPC's royalty rate position is more-likely-than-not to be sustained.
PCT Valuation ($312M). Although the PCT year (2012) is outside the examination years, the PCT valuation is relevant because it underpins the IRS's arguments regarding the ongoing CSA and royalty arrangements. PPC's PCT payment of $312,000,000 is within the arm's-length range of $278,000,000 to $361,000,000 established by Whitmore's DCF/income method analysis using a WACC of 9.8%. The IRS's competing valuation of $852,000,000, which uses a WACC of 7.2% and more aggressive revenue projections, relies on assumptions that C&H and Whitmore believe are not well-supported and that overstate the present value of the pre-existing IP. We conclude that PPC's PCT position is more-likely-than-not correct.
PBI Economic Substance. The factual record developed during the examination overwhelmingly supports PBI's status as a bona fide entity with genuine economic substance. The evidence includes: (i) PBI's 185-person workforce performing regulatory, medical-affairs, commercial-strategy, and supply-chain functions; (ii) forty-two formal board of directors meetings held during TY 2017–2020, with documented agendas, minutes, and resolutions; (iii) cumulative regulatory expenditures of approximately €47.2 million; (iv) independent pricing authority across sixty-eight country markets; (v) 18,000 square feet of office space in Dublin; (vi) independent banking with Glenmore Bank Ireland plc; and (vii) PBI's growth from 52 employees at inception to 185 by 2020, reflecting genuine investment in operational capacity. This evidence establishes that PBI performs significant DEMPE functions and is not merely a conduit entity. We conclude that the IRS's economic substance argument is more-likely-than-not to fail.
Summary on Recognition. We emphasize that the issuance of the NOPA does not, by itself, alter the technical-merits analysis under ASC 740-10-25. A proposed adjustment by the IRS is one step in the administrative process and does not reflect a final determination. The recognition analysis turns on the legal and factual merits of the positions, not on the fact that the IRS has challenged them. However, the NOPA does provide new and material information relevant to the measurement step of the FIN 48 analysis, which we address below.
B. Measurement Step — Revised Assessment of Cumulative Probability (ASC 740-10-30)
Under ASC 740-10-30, tax positions that satisfy the more-likely-than-not recognition threshold must be measured at the "largest amount of tax benefit that is greater than 50 percent likely of being realized upon settlement with the taxing authority that has full knowledge of all relevant information." This measurement requires an assessment of the cumulative probability distribution of potential outcomes, taking into account all available evidence, including the positions of both the taxpayer and the taxing authority.
The NOPA and the IRS's stated positions now provide materially new information about the IRS's analytical approach, the specific adjustments it proposes, and the magnitude of the claimed adjustments. C&H has conducted a thorough assessment of the IRS's vulnerabilities and the strengths and weaknesses of PPC's positions based on the full record developed through the forty-seven IDR responses, all economic analyses (both PPC's and the IRS's), the legal conferences held during the examination, and C&H's independent legal research and analysis. Our assessment of each position is as follows.
1. CSA Cost-Sharing Position. The IRS's proposed percentage increases of eight to twelve percentage points in PBI's cost-sharing allocation rest on the IRS's assertion that PPC's RAB projections systematically understated the value of anticipated benefits attributable to the U.S. market. Dr. Washburne's analysis for the IRS employed alternative revenue projections that assigned higher growth rates to U.S.-source revenue and lower growth rates to non-Americas-source revenue than those used by PPC.
C&H has reviewed the IRS's analysis and has identified several significant vulnerabilities. First, the IRS's revenue projections do not adequately account for PBI's growing market share in the non-Americas territories, which reflects PBI's independent commercial contributions — including PBI's development of market-specific formulations, independent regulatory filings in key markets such as Japan (through PBI's partnership with Nakamura Seiyaku K.K.), and PBI's commercial-strategy initiatives in the European Union. Second, the IRS's approach applies hindsight-based adjustments to what should be a prospective RAB calculation, which is inconsistent with the framework of Treas. Reg. § 1.482-7(e)(2)(ii), which requires measurement based on reasonably anticipated benefits at the time of the cost-sharing allocation. Third, the IRS's proposed percentage increases are not evenly calibrated and appear to reflect a reverse-engineering of a target income allocation rather than an independent economic analysis of anticipated benefits.
That said, C&H acknowledges that PPC's position on the CSA cost-sharing ratios is not without hazard. The IRS's challenge to the benefit-share projections has some basis in the range of reasonable forecasting assumptions, and a trier of fact could credit certain of the IRS's alternative assumptions — particularly with respect to the relative growth rates of certain oncology products in the U.S. market versus the non-Americas territories. Projections inherently involve judgment, and the IRS's proposed percentages, while aggressive, are not so far outside the range of defensible positions as to be dismissed outright.
Estimated probability-weighted exposure on the CSA issue: moderate. C&H believes that some concession on this issue is probable if the case proceeds to IRS Appeals or litigation. However, we believe PPC's positions on cost-sharing ratios are substantially more defensible than the IRS's proposed adjustments, and the most probable settlement range would involve adjustments significantly below the IRS's $235,010,000 proposed CSA adjustment.
2. Royalty Rate Position. The IRS's proposed royalty rate of 11.0% relies on Dr. Washburne's CUT analysis, which identified a set of comparable license transactions different from those identified by Whitmore. C&H and Whitmore have reviewed the IRS's comparables and believe they are distinguishable on several critical comparability factors. In particular, several of the IRS's selected CUT transactions involve earlier-stage pharmaceutical compounds (pre-Phase III or Phase III clinical-stage) where the licensor's risk exposure is significantly greater than in PPC's situation, which involved fully approved and commercially established compounds. Other CUT transactions selected by the IRS involve broader IP bundles — including manufacturing know-how, trade names, and marketing intangibles — rather than the narrower pharmaceutical compound licenses at issue in PPC's legacy IP license.
PPC's royalty rate of 4.5% is solidly within the IQR (3.1%–6.8%) established by Whitmore's CUT analysis and is essentially at the median of 4.4%. The IRS's proposed rate of 11.0% lies far above Whitmore's IQR and, in C&H's view, does not reflect arm's-length pricing for the type of license at issue. Under the best-method analysis framework, C&H believes that Whitmore's CUT set is more reliable than the IRS's due to superior functional comparability.
Estimated probability-weighted exposure on the royalty issue: lower. C&H views this as the strongest of PPC's positions. We believe there is a high probability that PPC would prevail in full or with only nominal adjustment on the royalty rate issue if the matter were litigated or resolved at IRS Appeals.
3. Economic Substance / DEMPE Position. C&H views the IRS's economic substance argument as a secondary position that supplements the IRS's primary economic-based transfer pricing adjustments. The factual record developed during the examination, including PBI's responses to the IDRs, strongly supports PBI's genuine economic substance and its performance of meaningful DEMPE functions.
In particular, C&H notes the following evidence that significantly undermines the IRS's assertion that key DEMPE functions resided in the United States:
• PBI's headcount grew from 52 employees at the time of its incorporation in 2012 to 185 employees by 2020, reflecting sustained investment in operational capacity and human capital.
• PBI employed experienced senior executives in Dublin, including a Chief Commercial Officer (non-Americas), a Vice President of Regulatory Affairs (non-Americas), and a Head of Supply Chain, each of whom reported to PBI's board of directors and exercised independent decision-making authority.
• PBI incurred cumulative regulatory expenditures of approximately €47.2 million during TY 2017–2020, reflecting PBI's direct engagement with regulatory authorities in the European Union (European Medicines Agency), Japan (Pharmaceuticals and Medical Devices Agency), and other key markets.
• PBI's board of directors held forty-two formal meetings during the four-year examination period, with detailed agendas, board papers, and resolutions reflecting substantive governance and strategic decision-making.
• PBI exercised independent pricing authority across sixty-eight country markets, with documented pricing methodologies and market-specific pricing strategies.
• PBI maintained 18,000 square feet of office space in Dublin and independent banking relationships with Glenmore Bank Ireland plc.
In light of this robust factual record, C&H concludes that the IRS's economic substance argument faces substantial challenges and is unlikely to succeed.
Estimated probability-weighted exposure on the economic substance issue: low.
4. PCT Valuation (Background Impact). As noted above, the PCT year (2012) is outside the examination years, and the IRS did not propose a direct adjustment to the PCT in the NOPA. However, the IRS's assertion that the PCT of $312,000,000 undervalued PPC's pre-existing IP by approximately $540,000,000 (the IRS valued the IP at $852,000,000) underpins the IRS's proposed adjustments to the ongoing CSA and royalty arrangements for TY 2017–2020. To the extent the IRS's PCT valuation is shown to be incorrect — which C&H believes is the case — it weakens the foundation of the IRS's broader transfer pricing theory.
The principal point of disagreement on the PCT is the appropriate WACC. PPC and Whitmore used a WACC of 9.8%, which is well-supported by pharmaceutical-industry cost-of-capital data and is consistent with the risk profile of the pre-existing IP, which at the time of the PCT included clinical-stage compounds with significant development and regulatory risk. The IRS's WACC of 7.2% implies a substantially lower risk premium and is more consistent with the cost of capital for a diversified pharmaceutical company at the corporate level than for a specific portfolio of pharmaceutical intellectual property assets. C&H has identified published academic and industry data supporting a WACC in the range of 9.0% to 11.0% for pharmaceutical IP portfolios of this nature, and we believe that PPC's 9.8% WACC is defensible.
The IRS's revenue projections for the PCT valuation also exceeded PPC's and Whitmore's projections, reflecting higher assumed peak sales and longer revenue tails. While the IRS's revenue projections benefit from hindsight — certain of PPC's products performed well commercially after 2012 — the arm's-length standard requires that the PCT be valued based on information known or knowable at the time of the transaction, not with the benefit of hindsight. See Treas. Reg. § 1.482-7(g)(4)(vi)(F).
This analysis indirectly strengthens PPC's positions on both the CSA and royalty issues, as it demonstrates that the IRS's broader theory is predicated on a contested and, in our view, unsupported PCT valuation.
5. Penalty Position. The IRS has proposed a substantial valuation misstatement penalty of approximately $15,977,000 under IRC § 6662(e). PPC maintained contemporaneous transfer pricing documentation for all four examination years, which was originally prepared by Crestfield in compliance with the penalty-protection standards of IRC § 6662(e)(3)(B) and Treas. Reg. § 1.6662-6(d). The documentation includes detailed best-method analyses, functional analyses of PPC and PBI, comparability studies, and economic analyses supporting PPC's transfer pricing results for both the CSA and the legacy IP license.
C&H has reviewed this documentation and believes it satisfies the requirements for a reasonable-cause and good-faith defense under IRC § 6664(c) and Treas. Reg. § 1.6664-4. Specifically, PPC engaged qualified transfer pricing professionals (Crestfield and Whitmore), obtained and relied upon contemporaneous economic analyses using recognized transfer pricing methods, and maintained documentation that was current and available upon audit. Additionally, PPC's transfer pricing results fell within the arm's-length ranges identified by its economic advisors, and PPC had a reasonable basis for its positions.
C&H believes PPC has a strong reasonable-cause defense, and penalty abatement is more-likely-than-not. However, the 20% penalty of approximately $15,977,000 must be considered as part of the overall reserve analysis, as discussed in Section V below.
C. Impact of TCJA on Measurement
TY 2017 was the last year subject to the pre-Tax Cuts and Jobs Act ("TCJA") corporate income tax rate of 35%. TY 2018, TY 2019, and TY 2020 are subject to the post-TCJA corporate income tax rate of 21%. This rate differential is relevant to the quantification of both the potential tax impact of any § 482 adjustment and the appropriate level of the FIN 48 reserve.
Specifically, a dollar of income adjustment in TY 2017 generates 35 cents of incremental federal income tax, compared to 21 cents for each dollar of adjustment in TY 2018–2020. Because the IRS's proposed adjustments are distributed across all four years — with TY 2017 accounting for approximately $101,679,000 of the $380,400,000 net proposed adjustment (representing the sum of TY 2017 CSA and royalty adjustments, net of the TY 2017 allocable share of the correlative offset) — the blended effective tax rate applicable to the full proposed adjustment is somewhat higher than 21%. This rate differential is incorporated into C&H's reserve analysis.
V. Revised Reserve Recommendation
A. Prior Reserve Level
As discussed in Section II.C above, PPC maintained an ASC 740-10 reserve of $62,400,000 as of year-end 2022. This reserve was established based on C&H's September 20, 2022 analysis and was reflected in PPC's Form 10-K for the fiscal year ended December 31, 2022.
B. Updated Analysis
Based on our updated analysis in light of the NOPA and the $380,400,000 in proposed adjustments, C&H concludes that the FIN 48 reserve should be reviewed but does not require a material increase for year-end 2023 financial statement purposes. Our rationale for this conclusion is as follows:
Continued Recognition. As set forth in Section IV.A, all of PPC's transfer pricing positions continue to meet the more-likely-than-not recognition threshold under ASC 740-10-25. Accordingly, PPC is entitled to recognize the tax benefit associated with its reported transfer pricing positions, subject to the measurement step.
Measurement Analysis. Under the measurement step of ASC 740-10-30, the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement remains high relative to PPC's as-reported positions. Stated differently, C&H's probability-weighted analysis indicates that PPC is more likely than not to sustain the substantial majority of the income allocation reflected in its filed returns. While some concession — particularly on the CSA cost-sharing ratios — is a probable outcome, the magnitude of any likely concession is, in our assessment, encompassed within the existing $62,400,000 reserve.
Anticipated Resolution at Appeals. The examination is expected to be resolved through the IRS Appeals process. C&H has obtained an extension of the Protest filing deadline to December 22, 2023 (from the original November 8, 2023, thirty-day letter deadline) and intends to file a detailed formal Protest contesting all proposed adjustments for TY 2017–2020. The case is expected to be assigned to an IRS Appeals Officer in January 2024, with an Appeals conference anticipated in late February or early March 2024.
Historical Precedent. Historical data from IRS Appeals settlements in comparable transfer pricing cases — particularly cases involving pharmaceutical cost-sharing arrangements, legacy IP license royalty rates, and economic substance challenges — indicate that final settlements typically result in adjustments substantially below the full NOPA amount. While each case is fact-specific, the pattern of Appeals outcomes in analogous matters supports C&H's view that a full-value outcome is unlikely.
Hazards Analysis. C&H's preliminary hazards-of-litigation analysis — taking into account the strengths and weaknesses of PPC's positions on each issue, the quality of PPC's contemporaneous documentation, the vulnerabilities in the IRS's analysis identified in Section IV.B above, and the applicable legal standards — suggests that the probability-weighted adjustment is significantly below the full $380,400,000 proposed by the IRS.
Recommendation. Based on the foregoing analysis, C&H believes the existing $62,400,000 reserve remains reasonable and adequate for year-end 2023 financial statement purposes. We do not recommend an increase in the reserve at this time.
C&H notes that this assessment is necessarily subject to change as the IRS Appeals process develops. Material developments — including the assignment of the case to a specific Appeals Officer, the substance of the Appeals conference, any communications from IRS Appeals regarding settlement positions, or any change in the applicable legal framework — could affect our analysis. C&H has been advised that the case has been tentatively assigned to Appeals Officer Noreen Castañeda, with a conference anticipated in late February 2024. C&H will provide an updated assessment following the Appeals conference.
C. Sensitivity to Outcomes
For Crestfield's reference, C&H provides the following sensitivity analysis:
Full-Value Scenario. If the case were resolved at 100% of the proposed adjustment ($380,400,000), the total incremental federal income tax would be approximately $79,880,000, calculated using a blended rate that accounts for the 35% rate applicable to TY 2017 and the 21% rate applicable to TY 2018–2020. In addition, if the penalty were sustained in full, the penalty exposure would be approximately $15,977,000, for a combined exposure of approximately $95,857,000. C&H does not consider a full-value outcome probable.
Existing Reserve Coverage. The existing reserve of $62,400,000 encompasses a reasonable range of likely outcomes. It would cover a scenario in which approximately 78% of PPC's tax benefit is realized — i.e., a scenario in which the ultimate adjustment is in the range of approximately $297,000,000, representing a settlement at roughly 78% of the NOPA amount, at the blended tax rate. Given C&H's assessment that PPC's positions are substantially stronger than the IRS's on most issues — and that PPC's royalty rate position is particularly strong — C&H views the existing reserve as adequately covering the range of probable outcomes.
Further Updates. C&H will provide a further update to Crestfield and PPC following the IRS Appeals conference and will reassess the reserve recommendation at that time.
VI. Procedural Status and Next Steps
The procedural posture of the examination as of the date of this letter, and the anticipated next steps, are as follows:
C&H intends to file a comprehensive formal Protest on or before December 22, 2023, contesting all proposed adjustments for TY 2017–2020 on both factual and legal grounds. The Protest will address each of the IRS's proposed adjustments — the CSA cost-sharing ratio adjustments, the royalty rate adjustments, the correlative offset, and the proposed penalty — and will present PPC's affirmative case for sustaining its reported positions. The Protest will be supported by economic analyses prepared by Whitmore, legal memoranda prepared by C&H, and relevant factual documentation.
Following the filing of the Protest, the case is expected to be assigned to an IRS Appeals Officer. C&H has been informally advised that the case will likely be assigned to Appeals Officer Noreen Castañeda, who has experience with pharmaceutical transfer pricing matters. An Appeals conference is anticipated in late February or early March 2024.
C&H will update Crestfield and PPC as material developments occur throughout the Appeals process, including (but not limited to) any post-conference assessment, any settlement proposals communicated by IRS Appeals, and any developments that may affect the reserve analysis.
VII. Penalty-Protection Documentation Status
As noted in Section IV.B.5 above, PPC maintained contemporaneous transfer pricing documentation for all four examination years (TY 2017–2020). This documentation was originally prepared by Crestfield in compliance with the penalty-protection standards of IRC § 6662(e)(3)(B), which provides a specific exception to the substantial valuation misstatement penalty for taxpayers who maintain contemporaneous documentation establishing that the taxpayer's transfer pricing method was reasonable and was applied consistently with the documentation.
C&H has reviewed this documentation in full and believes it satisfies the substantive and procedural requirements of Treas. Reg. § 1.6662-6(d) for establishing reasonable cause and good faith. The documentation includes, among other things: (i) a detailed best-method analysis supporting the selection of PPC's transfer pricing methods for both the CSA and the legacy IP license; (ii) a comprehensive functional analysis of PPC and PBI, including analysis of the functions performed, assets used, and risks assumed by each entity; (iii) a detailed description of the CSA terms, cost-sharing calculations, and RAB projections; (iv) Whitmore's economic analyses, including the CUT analysis for the royalty rate and the CPM/TNMM analysis based on twenty-two comparable companies; and (v) annual updates reflecting changes in facts and circumstances.
The formal Protest to be filed on December 22, 2023 will include a section presenting PPC's reasonable-cause defense and requesting full abatement of the proposed IRC § 6662(e) penalty.
C&H's conclusion: It is more-likely-than-not that any proposed penalty would be abated upon Appeals consideration or, if necessary, upon litigation. Accordingly, C&H does not recommend establishing a separate FIN 48 reserve for the penalty component at this time.
VIII. GILTI and BEAT Considerations
C&H notes that for TY 2018–2020, PPC's positions with respect to Global Intangible Low-Taxed Income ("GILTI") under IRC § 951A and the Base Erosion and Anti-Abuse Tax ("BEAT") under IRC § 59A may be affected by any IRC § 482 adjustment that alters the allocation of income between PPC and PBI.
Specifically, a reduction in PBI's income resulting from increased cost-sharing payments to PPC or increased royalty payments to PPC would reduce PBI's tested income for GILTI purposes under IRC § 951A, potentially reducing PPC's GILTI inclusion. Conversely, a reduction in the base erosion payments from PPC to PBI could reduce PPC's base erosion percentage for BEAT purposes under IRC § 59A. These interactions create cross-cutting effects that partially mitigate the tax impact of any § 482 adjustment for TY 2018–2020.
These GILTI and BEAT interaction effects are factored into C&H's overall reserve analysis and are reflected in the measurement-step conclusions discussed in Section V above. However, the GILTI and BEAT effects do not change the fundamental reserve recommendation at this time.
C&H will provide a more detailed analysis of the GILTI and BEAT interaction effects as part of the Appeals process, including a quantitative assessment of the net tax impact of the proposed § 482 adjustments after accounting for GILTI and BEAT offsets.
IX. Competent Authority / Mutual Agreement Procedure
C&H is evaluating whether a request for competent authority relief under Article 25 (Mutual Agreement Procedure) of the Convention between the Government of the United States of America and the Government of Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains (the "U.S.-Ireland Income Tax Treaty") may be appropriate in order to avoid or mitigate double taxation in the event of a material § 482 adjustment. If the IRS ultimately sustains an adjustment that increases PPC's U.S. taxable income, a corresponding reduction in PBI's Irish taxable income may be sought through the competent authority process, subject to the agreement of the Irish Revenue Commissioners.
This possibility is noted for Crestfield's awareness and may become relevant depending on the ultimate settlement outcome. At this stage, C&H has not made a formal recommendation regarding a competent authority request, as such a request is typically made following a final resolution of the U.S. tax examination.
Coordination with PBI's Irish tax advisors, Thornbury & Keogh (Lead Partner: Ciarán Thornbury), is ongoing. Thornbury & Keogh has been apprised of the NOPA and the general nature of the IRS's proposed adjustments and is monitoring the situation from the Irish tax perspective.
X. Impact on Hargrove Credit Facility Covenants
C&H notes, for completeness in the context of PPC's overall financial reporting considerations, that the NOPA and any resulting tax liability may implicate certain covenants in PPC's existing credit facility. Specifically, C&H has separately analyzed the tax-indemnity provisions and material-tax-event covenants contained in PPC's $1.5 billion revolving credit facility with Hargrove National Bank, N.A., as Administrative Agent (contact: Christine Bellucci, Senior Vice President, Loan Administration).
This analysis is addressed in a separate privileged memorandum from C&H to PPC dated November 15, 2023, and is noted here solely for Crestfield's awareness. The credit facility analysis does not affect C&H's FIN 48 reserve recommendation but may be relevant to PPC's broader financial reporting and disclosure considerations.
XI. SEC Disclosure Considerations
C&H notes that PPC should evaluate its disclosure obligations under the Securities Exchange Act of 1934 with respect to the NOPA in its upcoming Annual Report on Form 10-K for the fiscal year ending December 31, 2023. In particular, PPC should consider whether the NOPA constitutes a contingent liability that must be disclosed in the notes to the financial statements under ASC 450-20, and whether the level of disclosure should be revised in light of the IRS's proposed adjustments.
C&H understands that PPC's largest institutional shareholder, Ridgeview Capital Management LP (holding approximately 8.3% of PPC's outstanding common stock; Managing Partner: Douglas Everett), closely monitors FIN 48 disclosures and has historically engaged with PPC management regarding the Company's uncertain tax position reserves. The potential for shareholder scrutiny underscores the importance of ensuring that PPC's FIN 48 disclosures are complete, accurate, and appropriately calibrated.
C&H has provided a separate analysis to PPC General Counsel Deborah Staines regarding SEC contingent-liability disclosure requirements, including the application of ASC 450-20 and the SEC's interpretive guidance on loss-contingency disclosures. That analysis is not reproduced here but is available to Crestfield upon request, subject to PPC's consent.
Crestfield should coordinate with PPC and C&H regarding the appropriate level of disclosure in the financial statements and accompanying notes for the fiscal year ending December 31, 2023, to ensure consistency between the FIN 48 reserve, the notes to the financial statements, and any discussion of tax contingencies in PPC's Management's Discussion and Analysis of Financial Condition and Results of Operations.
XII. Limitations and Caveats
This letter constitutes a legal opinion provided in connection with PPC's financial reporting obligations under ASC 740-10 and does not guarantee any particular outcome of the IRS examination, IRS Appeals process, or any potential litigation. The resolution of transfer pricing disputes involves inherent uncertainty, and the ultimate outcome may differ materially from the conclusions expressed herein.
The analysis set forth in this letter is based on the facts known to C&H as of November 20, 2023, and applicable law — including the Internal Revenue Code, Treasury Regulations, IRS administrative guidance, and relevant case law — as of that date. Any subsequent changes in facts, law, or administrative practice may affect our conclusions.
C&H's analysis will be updated as material developments occur in the IRS examination and Appeals process, including but not limited to: (i) the filing of the formal Protest and the IRS's response thereto; (ii) the assignment of the case to IRS Appeals and the scheduling of the Appeals conference; (iii) any substantive communications from IRS Appeals regarding settlement positions; (iv) any changes in applicable law or regulations; and (v) any other developments that C&H determines to be material.
This letter is protected by attorney-client privilege and the work-product doctrine. It is not to be disclosed to the IRS or to any third party without the express written consent of PPC. The furnishing of this letter to Crestfield in its capacity as PPC's independent auditor does not constitute a waiver of any applicable privilege.
C&H's analysis assumes the continued applicability of the current statutory corporate income tax rates — 21% for TY 2018–2020 and 35% for TY 2017 — and the continued applicability of the existing Treasury Regulations under IRC §§ 482, 951A, 59A, 6662, and 6664 in their current form. Any legislative or regulatory changes affecting these provisions could alter our analysis.
XIII. Conclusion
Based on the foregoing analysis, C&H's updated conclusions are as follows:
1. Recognition. PPC's transfer pricing positions — including the CSA cost-sharing ratios, the 4.5% royalty rate for the legacy IP license, the PCT valuation, and PBI's economic substance — continue to meet the more-likely-than-not recognition threshold under ASC 740-10-25 as of November 20, 2023.
2. Measurement. The measurement analysis under ASC 740-10-30, incorporating the new information provided by the NOPA, supports maintaining the current FIN 48 reserve level. The largest amount of tax benefit that is greater than 50% likely of being realized upon settlement remains high relative to PPC's as-reported positions.
3. Reserve Adequacy. PPC's existing FIN 48 reserve of $62,400,000 remains reasonable and adequate for year-end 2023 financial reporting purposes in light of the NOPA and the IRS's proposed adjustments of $380,400,000.
4. Penalty. C&H concludes that it is more-likely-than-not that the proposed IRC § 6662(e) penalty would be abated, and no separate reserve for the penalty component is recommended.
5. Further Updates. C&H will provide further updates following the filing of the formal Protest (expected on or before December 22, 2023) and the IRS Appeals proceedings (conference anticipated in late February or early March 2024).
We are available to discuss this analysis with you and your engagement team at your convenience. Please do not hesitate to contact the undersigned with any questions.
Very truly yours,
CALDERWOOD & HARKNESS LLP
By: ________
Leonard Cross Partner, Tax Department Direct: (215) 864-7244
Email: lcross@calderwoodharkness.com
Licensed in New York, New Jersey, and the District of Columbia
By: ________
Garrett Simmons Associate, Tax Department Direct: (215) 864-7318
Email: gsimmons@calderwoodharkness.com
cc: (via email)
Susan Lam, CPA, Transfer Pricing Partner, Crestfield & Associates LLP
Marcus Whitfield, Vice President, Global Tax, Penterra Pharmaceuticals Corp., 2200 Independence Boulevard, Princeton Junction, NJ 08550
Deborah Staines, General Counsel, Penterra Pharmaceuticals Corp., 2200 Independence Boulevard, Princeton Junction, NJ 08550
Sylvia Hartwell, Billing Partner, Calderwood & Harkness LLP (internal distribution)
Enclosures:
Enclosure 1: Summary Table of NOPA Proposed Adjustments by Year and Issue ($380.4M Breakdown)
Enclosure 2: Summary of Whitmore Valuation Group Economic Analyses (CUT IQR 3.1%–6.8%, Median 4.4%; CPM/TNMM 22 Comparables; PCT DCF $278M–$361M Range)
Note: Full economic reports prepared by the Whitmore Valuation Group and the draft Protest are available upon request, subject to applicable privilege protocols and PPC's consent.
Tax Year | Total R&D Costs | PPC Position (% to PBI) | IRS Proposed (% to PBI) | Increase (pp) | Additional Income to PPC
2017 | $487,300,000 | 38.2% | 48.2% | +10.0 | $48,730,000
2018 | $523,800,000 | 39.6% | 50.6% | +11.0 | $57,610,000
2019 | $561,200,000 | 41.1% | 52.3% | +11.2 | $62,850,000
2020 | $598,400,000 | 42.7% | 53.7% | +11.0 | $65,820,000
Total | $235,010,000
Tax Year | Legacy Non-Americas Net Sales | PPC Rate | IRS Rate | Differential | Additional Income to PPC
2017 | $814,600,000 | 4.5% | 11.0% | 6.5% | $52,949,000
2018 | $762,300,000 | 4.5% | 11.0% | 6.5% | $49,549,500
2019 | $691,800,000 | 4.5% | 11.0% | 6.5% | $44,967,000
2020 | $624,100,000 | 4.5% | 11.0% | 6.5% | $40,566,500
Total | $188,032,000
Component | Amount
CSA Cost-Sharing Adjustments | $235,010,000
Royalty Rate Adjustments | $188,040,000
Correlative Offset | ($42,650,000)
Net Proposed Adjustment | $380,400,000
Event | Date
NOPA Issued | October 12, 2023
30-Day Letter Issued | November 8, 2023
Original Protest Filing Deadline | December 8, 2023
Extension of Protest Filing Deadline Obtained | Extended to December 22, 2023
Formal Protest to Be Filed | On or before December 22, 2023
Case Assignment to IRS Appeals (anticipated) | January 2024
Appeals Conference (anticipated) | Late February or early March 2024

CALDERWOOD & HARKNESS LLP Counsellors at Law

CALDERWOOD & HARKNESS LLP

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