1018-00009 · Client 1018 · Examination Proceedings

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PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT

ATTORNEY-CLIENT PRIVILEGED

CALL NOTES / CONFERENCE MEMORANDUM

This memorandum reflects the mental impressions, conclusions, opinions, and legal theories of counsel. This document was prepared in anticipation of litigation and is protected from disclosure by the attorney work product doctrine, the attorney-client privilege, and any other applicable privilege or protection. This memorandum should not be disclosed to any person or entity outside of Calderwood & Harkness LLP without the express written authorization of the Responsible Partner.

Matter: Penterra Pharmaceuticals Corp. — IRS Transfer Pricing Examination Defense

C&H Matter Number: 1018-00009

IRS Exam Team ID: LB&I-NE-TP-2022-00641

Taxpayer: Penterra Pharmaceuticals Corp. ("PPC"), EIN 22-3741856

Tax Years at Issue: 2017, 2018, 2019, 2020

Subject: Notes of Telephone Conference with IRS Office of Chief Counsel (Franklin Rosario, Attorney-Advisor, Transfer Pricing) — Discussion of IRS Legal Positions Regarding CSA Compliance, Legacy IP Royalty Rate, and Economic Substance of Penterra Biotech Ireland Ltd. ("PBI")

Date of Call: September 20, 2023

Prepared by: Garrett Simmons, Lead Associate, Tax Department, Calderwood & Harkness LLP

Reviewed by: Leonard Cross, Responsible Partner, Tax Department, Calderwood & Harkness LLP

Date of Memorandum: September 20, 2023

1. Call Logistics

Date and Time: September 20, 2023, 2:00 p.m. to 3:35 p.m. Eastern Time (approximately 95 minutes).

Format: Telephone conference call.

Calderwood & Harkness Participants:

• Leonard Cross, Responsible Partner, Tax Department

• Garrett Simmons, Lead Associate, Tax Department

• Leila Nazari, Working Associate, Tax Department (note-taker)

IRS Participants:

• Franklin Rosario, Attorney-Advisor, IRS Office of Chief Counsel, Transfer Pricing Practice Group (present for the entirety of the call)

• Donna Hirabayashi, Senior Counsel, IRS Office of Chief Counsel (present for portions of the call, joining at approximately 2:25 p.m. during the PCT undervaluation discussion)

• Supervisory Revenue Agent Gerald Meskill (joined at the outset for introductory remarks; departed the call at approximately 2:07 p.m.)

• Lead Revenue Agent Patricia Dunleavy (joined the call at approximately 2:45 p.m. for the factual discussion regarding PBI's economic substance)

IRS Personnel Not on Call: Dr. Alan Washburne, IRS Economist, was not present on the call. However, Rosario referenced Dr. Washburne's economic analysis and valuation conclusions on multiple occasions throughout the discussion, as noted in detail below.

Purpose of Call: The call was convened at the request of IRS Chief Counsel to discuss the IRS's legal positions on three principal issues — (i) compliance with the cost-sharing arrangement ("CSA") under Treasury Regulation § 1.482-7, including the reasonably anticipated benefits ("RAB") methodology and the platform contribution transaction ("PCT") valuation; (ii) the arm's-length royalty rate applicable to legacy intangible property; and (iii) the economic substance and DEMPE functions of Penterra Biotech Ireland Ltd. ("PBI") — in advance of the anticipated issuance of a Notice of Proposed Adjustment ("NOPA"). The call served as a follow-up to the mid-examination conference held on May 25, 2023, and was conducted after the substantial completion of the Information Document Request ("IDR") process. A total of 47 IDRs were issued by the examination team between June 2022 and September 2023.

Note Regarding IDR Status: As of the date of the call, Calderwood & Harkness had completed and submitted responses to IDR Nos. 1 through 46 on behalf of PPC. The response to IDR No. 47 (the final substantive IDR, requesting supplemental documentation including employee compensation data and travel records) was pending at the time of the call and was subsequently submitted on September 29, 2023. During his opening remarks, Rosario acknowledged receipt of the responses to IDR Nos. 1 through 46 and indicated that the examination team was in the process of reviewing the final submissions.

2. Opening Remarks

2.1 Supervisory Revenue Agent Meskill's Introduction

Supervisory Revenue Agent Gerald Meskill opened the call at approximately 2:00 p.m. Meskill stated that the examination team had substantially completed its factual development of the case and that the primary purpose of the call was to provide an opportunity for IRS Chief Counsel and taxpayer's counsel to discuss the respective legal positions of the parties before the examination team finalized its proposed adjustments. Meskill characterized the call as a "pre-NOPA legal issues conference" and indicated that the IRS anticipated issuing a formal Notice of Proposed Adjustment in the coming weeks. (The NOPA was ultimately issued on October 12, 2023.)

Meskill acknowledged PPC's cooperation throughout the examination process, noting that PPC and its counsel had been responsive to the 47 IDRs issued during the examination period. Meskill stated that the examination team believed it had obtained a comprehensive factual record and that the remaining IDR No. 47 response was expected to supplement, rather than fundamentally alter, the factual foundation for the team's analysis.

After these introductory remarks, Meskill departed the call at approximately 2:07 p.m., turning the discussion over to Attorney-Advisor Rosario.

2.2 Cross's Opening Statement

Following Meskill's departure, Cross thanked Meskill for his remarks and thanked the examination team for the professional manner in which the examination had been conducted. Cross then provided an opening statement on behalf of PPC.

Cross stated that PPC maintained that its intercompany pricing and transfer pricing positions were fully compliant with Internal Revenue Code § 482 and all applicable Treasury Regulations, including specifically Treasury Regulation §§ 1.482-4 (regarding the licensing of intangible property) and 1.482-7 (regarding cost-sharing arrangements). Cross emphasized that PPC's positions were not aggressive or novel, but rather reflected a straightforward application of established principles to the facts and circumstances of PPC's global pharmaceutical business.

Cross noted that PPC had prepared contemporaneous transfer pricing documentation for all four tax years at issue (2017 through 2020). This documentation was prepared by Crestfield & Associates LLP, under the direction of Susan Lam, Transfer Pricing Partner, and constituted qualifying contemporaneous documentation within the meaning of IRC § 6662(e)(3)(B) and Treasury Regulation § 1.6662-6(d). Cross stated that the documentation established both the selection and application of PPC's transfer pricing methods and demonstrated that PPC's intercompany pricing satisfied the arm's-length standard.

Cross further noted that PPC's transfer pricing positions were supported by independent economic analyses prepared by Whitmore Valuation Group LLC ("WVG"), under the direction of Dr. Helena Vasquez, Managing Director. Cross stated that WVG had been engaged pursuant to a Kovel arrangement with Calderwood & Harkness, and that WVG's analyses confirmed that PPC's intercompany pricing fell within the arm's-length range under each applicable method.

Cross expressed his hope that the discussion during the call might serve to narrow the issues in dispute and potentially avoid the need for formal proposed adjustments on certain positions. Cross stated that PPC was prepared to discuss each of the IRS's anticipated positions in a constructive manner and to provide any additional factual information that might assist in resolving the issues at the examination level.

3. IRS Legal Position: CSA Compliance and Cost-Sharing Ratios

3.1 Rosario's Position on Reasonably Anticipated Benefits

Rosario stated that IRS Chief Counsel had conducted a thorough review of the CSA agreement between PPC and PBI, which was effective as of July 1, 2012, as well as the annual cost-sharing calculations for tax years 2017 through 2020. Rosario indicated that Chief Counsel had identified what it believed to be material deficiencies in PPC's determination of the reasonably anticipated benefits ("RAB") attributable to each CSA participant, and that these deficiencies resulted in a misallocation of intangible development costs between PPC and PBI.

Rosario articulated Chief Counsel's primary contention as follows: PPC's projections of RAB systematically understated the value attributable to the United States-based research and development activities and the United States market, with the consequence that PBI's cost-sharing percentages were set at levels that were too low relative to the benefits PBI was reasonably anticipated to derive from the CSA intangibles. Rosario stated that the RAB projections failed to appropriately account for the concentration of innovative and high-value R&D activities at PPC's facilities in the United States, and instead allocated disproportionate anticipated benefits to PBI's non-Americas territory based on revenue projections that, in Chief Counsel's view, did not adequately reflect the underlying value creation.

Rosario identified PBI's cost-sharing percentages for the years at issue as follows:

Rosario stated that these percentages were inadequate in light of the growth in PBI's non-Americas revenue during the period and the concentration of R&D activities in the United States. Rosario indicated that the IRS's position would be to increase PBI's cost-sharing percentage by approximately 8 to 12 percentage points across each of the four tax years. Rosario provided the following specific figures representing Chief Counsel's proposed cost-sharing allocations:

Rosario further identified the total qualified R&D costs underlying the CSA for each year at issue:

Based on the proposed percentage increases and the total qualified R&D costs, Rosario stated that the CSA cost-sharing adjustment across all four tax years would be approximately $235 million in the aggregate. Rosario characterized this as the single largest component of the anticipated proposed adjustment.

3.2 Rosario's Position on PCT Undervaluation

Rosario then turned to the platform contribution transaction ("PCT") and its implications for the ongoing cost-sharing analysis. Rosario noted that the original PCT payment — reflecting PBI's buy-in to PPC's pre-existing intangible property — was $312 million, paid on July 1, 2012, contemporaneous with the effective date of the CSA. Rosario acknowledged that tax year 2012 was outside the scope of the current examination and that the IRS was not directly proposing to adjust the 2012 PCT payment itself. However, Rosario stated that the IRS viewed the PCT undervaluation as highly relevant evidence bearing on the ongoing CSA cost-sharing ratios, insofar as the below-arm's-length PCT payment was indicative of a systematic undervaluation of the contributed intangible property that persisted through the examination years.

Rosario referenced the economic analysis prepared by IRS Economist Dr. Alan Washburne. Rosario stated that Dr. Washburne had performed an income-method valuation of the pre-existing intangible property contributed by PPC to the CSA and had concluded that the arm's-length value of the PCT was approximately $852 million. This represented a delta of approximately $540 million from PPC's $312 million PCT payment. Rosario stated that Dr. Washburne's valuation employed a weighted average cost of capital ("WACC") of 7.2% as the discount rate, and utilized revenue projections that Chief Counsel believed were more realistic and better supported by contemporaneous market data than the assumptions employed by PPC and its advisors.

Cross pushed back on the PCT valuation issue directly. Cross noted that PPC's defense PCT valuation, which had been conducted by Whitmore Valuation Group under the direction of Dr. Vasquez, utilized a WACC of 9.8%. Cross stated that the 9.8% rate was appropriate for the pharmaceutical industry risk profile and particularly for the early-stage intangible property at issue, which involved compounds at various stages of clinical development and regulatory approval as of the 2012 valuation date. Cross noted that WVG's analysis yielded an arm's-length range of $278 million to $361 million for the PCT, and that PPC's actual payment of $312 million fell squarely within that range — indeed, it was near the midpoint. Cross stated that the $312 million payment therefore satisfied the arm's-length standard under any reasonable application of the income method.

Rosario responded that Chief Counsel disagreed with the risk premium adjustments that led to PPC's 9.8% discount rate. Rosario stated that Dr. Washburne's analysis reflected comparable pharmaceutical company betas more accurately and that the risk adjustments applied by WVG were excessive and not supported by the empirical data on pharmaceutical industry cost of capital. Rosario indicated that the 260 basis point differential between the two discount rates (9.8% versus 7.2%) was the principal driver of the divergence in PCT valuations.

At this point, Senior Counsel Donna Hirabayashi joined the call (at approximately 2:25 p.m.). Hirabayashi added that Chief Counsel's position did not require a direct adjustment to tax year 2012 income. Rather, Chief Counsel viewed the PCT undervaluation as informing the appropriate calibration of the ongoing cost-sharing ratios for the examination years (2017–2020). Hirabayashi stated that the ongoing cost-sharing ratios were the mechanism through which the undervaluation of the pre-existing contributed intangible property would be addressed, and that this approach was consistent with the regulatory framework under Treasury Regulation § 1.482-7.

3.3 Cross's Rebuttal on CSA Positions

Cross provided a detailed rebuttal of the IRS's CSA positions. Cross stated that PPC's RAB projections were prepared contemporaneously with each annual cost-sharing calculation and were updated annually using the best available data at the time each projection was made. Cross stated that this approach was fully consistent with the requirements of Treasury Regulation § 1.482-7(e), which requires that cost-sharing contributions be determined based on each controlled participant's share of reasonably anticipated benefits from the intangible development activity.

Cross emphasized the distinction between ex ante projections and ex post outcomes. Cross noted that PBI's non-Americas revenue had, in fact, grown in line with or below the projections used in the RAB calculation for each of the four tax years. Cross stated that any deviation between ex post actual results and the ex ante projections did not invalidate the projections under the regulations, provided that the projections were reasonable when made. Cross argued that the IRS's position improperly sought to apply hindsight to RAB projections that were reasonable at the time they were developed.

Cross cited the best method rule under Treasury Regulation § 1.482-1(d) and argued that PPC's methodology — using projected revenue splits by territory as the basis for the RAB allocation — was the most reliable method available under the circumstances. Cross stated that PPC had considered and appropriately rejected alternative approaches, including profit-based measures, and had documented the reasons for its method selection in its contemporaneous transfer pricing documentation.

Cross further noted that PPC's positions were consistent with the holdings in relevant case law, including the Tax Court's decisions in Altera Corp. v. Commissioner and Harborview Corporation, Inc. v. Commissioner. Cross also referenced the OECD Transfer Pricing Guidelines, specifically Chapter VIII on cost contribution arrangements, which Cross stated supported PPC's approach to the RAB determination and cost-sharing allocation.

Rosario acknowledged Cross's citations to the case law but sought to distinguish PPC's facts from those cases. Rosario noted that PBI's headcount was relatively small — having grown from 52 employees at the time of incorporation in 2012 to 185 employees by 2020 — relative to the non-Americas revenue PBI reported (€2.14 billion in fiscal year 2020). Rosario stated that this disparity between headcount and revenue, in his view, suggested that PBI's RAB share should be lower, not higher, and that the true value creation underlying PBI's reported revenue was occurring in the United States through PPC's R&D and strategic management activities. Cross responded that revenue-to-headcount ratios were not a recognized metric under the transfer pricing regulations for determining RAB shares, and that PBI's revenue reflected the value of the intangible property rights PBI held, not merely the activities of PBI's employees.

4. IRS Legal Position: Legacy IP Royalty Rate

4.1 Rosario's Position on the 4.5% Rate

Rosario turned to the second principal area of proposed adjustment: the royalty rate applicable to legacy intangible property. Rosario explained that the term "legacy IP," as used in the examination, referred to pre-2012 vintage pharmaceutical compounds that were developed by PPC prior to the effective date of the CSA and that were not covered by the CSA's intangible development activity. PBI licensed these legacy compounds from PPC under a separate intercompany license agreement and paid PPC a royalty of 4.5% of net sales for the right to commercialize the legacy compounds in PBI's non-Americas territory.

Rosario stated that Chief Counsel's position was that the 4.5% royalty rate was substantially below the arm's-length rate. Rosario indicated that the IRS would propose increasing the royalty rate to 11.0% of net sales, representing an increase of 650 basis points. Rosario stated that this proposed rate was based on comparable uncontrolled transaction ("CUT") data derived from third-party pharmaceutical licensing agreements that Dr. Washburne had selected and analyzed. Rosario characterized the IRS's CUT comparables as arm's-length agreements involving pharmaceutical compounds at a similar stage of the commercial lifecycle.

Rosario identified PBI's net sales of legacy compounds in the non-Americas territory for each of the four tax years:

Rosario acknowledged the declining revenue trajectory of the legacy compounds but stated that the magnitude of the revenue base was nonetheless substantial and that the 4.5% rate failed to adequately compensate PPC for the value of the underlying intangible property. Based on the proposed rate increase from 4.5% to 11.0%, Rosario stated that the royalty adjustment across all four tax years would total approximately $188 million in the aggregate.

4.2 Cross's Rebuttal on Royalty Rate

Cross stated that PPC had a strong factual and legal basis for the 4.5% royalty rate and that the IRS's proposed rate of 11.0% was not supported by properly selected and analyzed comparable uncontrolled transactions.

Cross stated that Whitmore Valuation Group's CUT analysis, conducted by Dr. Vasquez and her team, had identified 14 comparable uncontrolled pharmaceutical license agreements through a rigorous comparability screening process. Cross stated that these 14 agreements yielded an interquartile range of 3.1% to 6.8%, with a median of 4.4%. Cross emphasized that PPC's 4.5% royalty rate fell squarely within the arm's-length interquartile range and was virtually at the median. Cross stated that this result conclusively satisfied the arm's-length standard under Treasury Regulation § 1.482-4 and that no adjustment was warranted.

Cross directly challenged the IRS's proposed 11.0% rate, stating that it was derived from CUT agreements that were not sufficiently comparable to PBI's license of PPC's legacy compounds. Cross specifically questioned whether Dr. Washburne's selected CUT agreements involved comparable intangibles — that is, late-lifecycle legacy pharmaceutical compounds with declining revenue trajectories and limited remaining patent life — or whether they instead involved earlier-stage compounds with greater growth potential that would warrant higher royalty rates. Cross stated that the lifecycle stage and revenue trajectory of the licensed intangible property were critical comparability factors and that failure to account for these factors would render a CUT analysis unreliable.

Rosario responded that the IRS's CUT selection focused primarily on therapeutic-area comparability, noting that Dr. Washburne had selected CUT agreements involving oncology and immunology compounds, which were the same therapeutic areas as the PPC legacy compounds at issue. Rosario stated that therapeutic-area comparability was the most important comparability factor in the pharmaceutical context, as it captured the market dynamics, competitive landscape, and regulatory environment most relevant to pricing.

Cross disputed this characterization. Cross argued that product lifecycle stage, revenue trajectory, and remaining patent life were equally or more important comparability factors under the regulations than therapeutic area alone. Cross noted that a license of a recently approved oncology compound with twenty years of remaining patent protection and a growing revenue trajectory would command a fundamentally different royalty rate than a license of a late-lifecycle oncology compound with declining revenues and limited remaining exclusivity. Cross stated that the legacy compounds at issue were in a declining revenue phase — as demonstrated by the year-over-year decline from $814.6 million in 2017 to $624.1 million in 2020 — and that failure to account for this characteristic rendered the IRS's CUT analysis unreliable.

Hirabayashi, who remained on the call, indicated that Chief Counsel was confident in the comparability of its CUT selection but acknowledged that the royalty rate issue would be "fact-intensive" at Appeals. Cross noted this acknowledgment for the record.

5. IRS Legal Position: Economic Substance of PBI

5.1 Rosario's Position on Economic Substance and DEMPE Functions

Rosario stated that Chief Counsel's position also included a challenge to PBI's economic substance, framed in terms of the DEMPE analysis framework. Rosario asserted that the key DEMPE functions — Development, Enhancement, Maintenance, Protection, and Exploitation of intangible property — remained substantially in the United States at PPC's headquarters in Princeton Junction, New Jersey, notwithstanding PBI's formal status as a CSA participant and IP owner for the non-Americas territory.

Rosario articulated the IRS's specific contentions with respect to each DEMPE function as follows:

Development: All research and development activity was conducted by PPC personnel at PPC's U.S. facilities. PBI contributed cost-sharing payments under the CSA but did not itself perform the R&D activities. Rosario stated that PBI's financial contributions, standing alone, did not constitute the performance of the Development function.

Enhancement: Product improvements, formulation refinements, and line extensions were initiated and directed by PPC's U.S.-based R&D and commercial teams. Rosario stated that the evidence reviewed by the examination team did not demonstrate that PBI exercised meaningful control over Enhancement activities.

Maintenance: Quality control systems, pharmacovigilance reporting infrastructure, and ongoing post-market surveillance were centrally managed from PPC's U.S. operations. Rosario acknowledged that PBI had some regulatory personnel but stated that the core Maintenance systems were designed, implemented, and overseen from the United States.

Protection: Patent prosecution strategies, IP enforcement actions, and defensive litigation were directed by PPC's U.S. legal team. Rosario stated that PBI did not maintain an independent legal function capable of directing Protection activities across its 68-country territory.

Exploitation: While PBI nominally made commercial decisions for the non-Americas territory, Rosario asserted that key strategic direction — including global pricing frameworks, brand strategy, and key account management for major markets — emanated from PPC's U.S. management.

Rosario emphasized the disparity between PBI's headcount of 185 employees (as of 2020) and PBI's reported non-Americas revenue of €2.14 billion in fiscal year 2020. Rosario questioned whether PBI had sufficient personnel to exercise genuine control over the DEMPE functions attributed to it, and stated that the revenue-to-employee ratio was indicative of a structure in which the substantive value creation occurred in the United States.

At approximately 2:45 p.m., Lead Revenue Agent Patricia Dunleavy joined the call. Dunleavy supplemented Rosario's legal analysis with factual observations drawn from the IDR responses. Dunleavy noted that several PBI commercial strategy documents produced in response to IDR Nos. 18 and 35 bore evidence of PPC U.S. executive involvement, including annotations, comments, and tracked-change edits attributable to U.S.-based personnel. Dunleavy further noted that travel records produced in the IDR process showed regular visits by PPC U.S. personnel to PBI's offices in Dublin, which Dunleavy characterized as evidence of U.S.-based oversight and control rather than arm's-length collaboration.

5.2 Cross's Rebuttal on PBI Substance

Cross responded emphatically that PBI maintained robust economic substance and that the evidence produced in the 46 completed IDR responses (with the IDR No. 47 response forthcoming) fully supported PBI's role as a genuine IP owner and active CSA participant. Cross stated that the IRS's characterization of PBI as lacking economic substance was inconsistent with the documentary record and reflected a fundamental misunderstanding of PBI's operations.

Cross enumerated the following key substance indicators:

Physical Presence: PBI maintained approximately 18,000 square feet of dedicated office space at Sandyford Business Park, Dublin (D18 K7T4). This space housed PBI's full-time employees and served as the operational headquarters for PBI's non-Americas commercial activities.

Headcount and Personnel: PBI's headcount grew from 52 employees at the time of its incorporation in 2012 to 185 employees by 2020. This growth reflected PBI's expanding operational capabilities. PBI's personnel included dedicated teams in regulatory affairs, medical affairs, commercial strategy, market access, supply chain management, and finance.

Senior Management: PBI's Managing Director, Aidan Naughton, was resident in Ireland and exercised genuine decision-making authority over PBI's commercial operations. Cross stated that Mr. Naughton's authority was not merely nominal and that the documentary evidence — including board minutes, internal correspondence, and strategic planning documents — demonstrated that Mr. Naughton and his Dublin-based team made real, consequential business decisions.

Board Governance: PBI held 42 board meetings in Dublin during the four tax years at issue (2017 through 2020), consisting of regular quarterly meetings plus special sessions as needed. Cross stated that these board meetings addressed key decisions on matters including pricing across PBI's territory, market entry strategies for new country markets, regulatory submission timelines, capital expenditure approvals, and strategic planning.

Regulatory Expenditures: PBI incurred €47.2 million in cumulative regulatory expenditures during 2017 through 2020 for the preparation and submission of regulatory filings across 68 country markets in the non-Americas territory. Cross stated that this level of expenditure reflected PBI's active engagement in the regulatory process and its responsibility for obtaining and maintaining marketing authorizations in its territory.

Independent Pricing Decisions: PBI made independent pricing decisions across 68 country markets, tailored to local market conditions, reimbursement frameworks, and competitive dynamics. Cross stated that the documentary evidence supporting PBI's independent pricing authority was particularly strong and had been produced in response to IDR Nos. 35 and 18.

Market Risk: PBI bore genuine market risk for the non-Americas territories, including inventory risk and distribution risk. PBI managed its supply chain through its arrangement with Penterra Manufacturing Ireland Ltd. ("PMI"), a contract manufacturer located at Ringaskiddy, County Cork, Ireland, and through a network of third-party distribution partners across PBI's territory.

Independent Financial Infrastructure: PBI maintained independent banking relationships with Glenmore Bank Ireland plc and operated an independent treasury function. PBI's financial operations were managed by its Dublin-based finance team.

Cross further noted that Calderwood & Harkness had conducted 12 key employee interviews at PBI's Dublin offices during August and September 2022. These interviews documented the roles, decision-making authority, and functional contributions of PBI's senior personnel and were conducted in accordance with the examination team's protocols. Cross stated that the interview record fully corroborated PBI's substance and the genuine exercise of DEMPE functions in Ireland.

Cross stated that PBI's substance was consistent with the requirements of the OECD Transfer Pricing Guidelines, including both the 2017 and 2022 revisions, and specifically Chapter VI on intangibles and the DEMPE analysis framework. Cross stated that the Guidelines recognize that a CSA participant that funds intangible development and exercises control over the funded activities is entitled to a return commensurate with its contributions, and that PBI satisfied these requirements.

With respect to Dunleavy's observations regarding travel by PPC U.S. personnel to Dublin, Cross stated that such travel was evidence of collaboration between PPC and PBI, not evidence of U.S. control over PBI's operations. Cross noted that collaboration between related entities within a multinational enterprise is normal, expected, and consistent with arm's-length behavior. Cross stated that the relevant inquiry was whether PBI exercised genuine control over its DEMPE functions, not whether PBI operated in complete isolation from PPC.

5.3 Rosario's Response

Rosario responded by indicating that Chief Counsel recognized that PBI had some operational presence in Ireland. However, Rosario maintained that the "control" over key DEMPE functions — particularly the Development and Protection functions — had not shifted to Ireland in a meaningful sense. Rosario stated that PBI's financial contributions to the CSA and its employment of regulatory and commercial personnel did not equate to the exercise of control over the core value-creating functions, which remained centered in the United States.

Rosario clarified that the IRS was not asserting a complete lack of economic substance on the part of PBI, which could potentially lead to a disregard of PBI as an entity or a wholesale recharacterization of the intercompany transactions. Rather, Rosario stated that Chief Counsel's position was that the allocation of income to PBI was disproportionate to the functions PBI actually performed, the assets PBI employed, and the risks PBI bore. Rosario stated that this analysis supported and reinforced the proposed adjustments to both the CSA cost-sharing ratios and the legacy IP royalty rate, rather than constituting a standalone adjustment category.

6. Discussion of Correlative Adjustments and Double-Counting

Cross raised the issue of potential double-counting between the IRS's two principal adjustment categories — the CSA cost-sharing adjustments and the legacy IP royalty rate adjustments. Cross noted that both proposed adjustments targeted the allocation of income between PPC and PBI with respect to overlapping product lines and revenue streams. Cross stated that if the IRS increased both the cost-sharing percentages (thereby reducing PBI's income from CSA intangibles) and the royalty rate (thereby reducing PBI's income from legacy IP), the combined effect would result in an impermissible double-counting of the income reallocation from PBI to PPC. Cross characterized this as a fundamental structural flaw in the IRS's proposed adjustment framework.

Rosario acknowledged Cross's concern regarding double-counting. Rosario stated that the examination team was aware of the overlap and that a correlative offset would be applied to avoid double-counting, consistent with the principles set forth in Treasury Regulation § 1.482-1(g). Rosario indicated that the correlative offset was estimated at approximately $42 to $43 million. (The correlative offset was ultimately quantified at $42.65 million in the NOPA issued on October 12, 2023.)

Cross acknowledged Rosario's representation regarding the correlative offset but stated that PPC reserved its right to challenge the adequacy of the offset. Cross noted that PPC's preliminary analysis suggested that the true overlap between the two adjustment categories might be greater than $42 to $43 million, and that PPC would conduct a detailed analysis of the correlative offset once the specific calculations underlying the NOPA were available.

7. Discussion of Penalty Position

7.1 Rosario's Position on IRC § 6662(e) Penalty

Rosario indicated that Chief Counsel was recommending the assertion of the substantial valuation misstatement penalty under IRC § 6662(e) at the 20% rate, applicable to any net § 482 allocation. Rosario stated that if the total proposed adjustment of approximately $380 million was sustained, the resulting penalty exposure — calculated at the 21% corporate tax rate — would be approximately $16 million. Rosario provided the following calculation:

$380.4 million (net proposed § 482 adjustment) × 21% (corporate tax rate) × 20% (§ 6662(e) penalty rate) = approximately $15.98 million.

Rosario noted that the IRS had reserved on, but was not currently asserting, the 40% gross valuation misstatement penalty under IRC § 6662(h). Rosario stated that Chief Counsel's current recommendation was limited to the 20% penalty, though the reservation of the 40% penalty was noted for the record.

7.2 Cross's Response on Penalty Protection

Cross stated firmly that PPC had a complete defense to any penalty under IRC § 6662(e) and that the assertion of the penalty in this case would be unwarranted and unsupportable. Cross identified the following bases for PPC's penalty protection:

First, PPC had contemporaneous transfer pricing documentation prepared by Crestfield & Associates LLP, under the direction of Susan Lam, Transfer Pricing Partner, for all four tax years at issue (2017 through 2020). Cross stated that this documentation satisfied the requirements of IRC § 6662(e)(3)(B) and the corresponding regulations, and that it constituted qualifying contemporaneous documentation within the meaning of the penalty-protection safe harbor.

Second, the contemporaneous documentation was prepared under the penalty-protection standards and established both the selection and application of PPC's transfer pricing methods. The documentation addressed the factual background, the functional analysis, the selection of the best method, the identification and analysis of comparable transactions, the application of the selected method, and the conclusion that PPC's intercompany pricing fell within the arm's-length range.

Third, PPC's transfer pricing positions were supported by the independent economic analyses prepared by Whitmore Valuation Group LLC, a qualified and experienced economic consulting firm with recognized expertise in pharmaceutical transfer pricing.

Fourth, PPC acted with reasonable cause and in good faith in establishing its intercompany pricing, as demonstrated by the engagement of qualified outside counsel and economic advisors, the preparation of contemporaneous documentation, and the consistent application of arm's-length pricing methodologies.

Cross stated that the assertion of a substantial valuation misstatement penalty in the face of qualifying contemporaneous documentation was inconsistent with the statutory safe harbor and would be extremely difficult for the IRS to sustain at Appeals or, if necessary, in Tax Court proceedings. Cross noted that this was precisely the type of case in which the contemporaneous documentation safe harbor was designed to provide protection, and that PPC's documentation was comprehensive, well-supported, and prepared in accordance with recognized professional standards.

Rosario stated that Chief Counsel would nonetheless recommend the penalty in the NOPA and that the penalty question would be addressed during any subsequent proceedings, including at Appeals. Rosario did not directly engage with Cross's substantive arguments regarding the adequacy of PPC's contemporaneous documentation.

8. Anticipated Timeline and Next Steps

Rosario indicated that Chief Counsel expected to finalize its analysis and supporting legal memoranda in the coming weeks and to support the examination team's issuance of a Notice of Proposed Adjustment within approximately three to four weeks from the date of the call. (The NOPA was ultimately issued on October 12, 2023, approximately three weeks after the call.)

Rosario confirmed that the NOPA would cover all four tax years at issue (2017, 2018, 2019, and 2020) and would encompass all three adjustment categories discussed during the call: (i) the CSA cost-sharing ratio adjustments; (ii) the legacy IP royalty rate adjustment; and (iii) the economic substance and DEMPE analysis as supporting analysis for the quantum adjustments. Rosario stated that the economic substance analysis would be incorporated into the NOPA as part of the factual and legal basis for the proposed adjustments, rather than as a separate and independent adjustment category.

Rosario confirmed that a 30-Day Letter would follow the NOPA, providing PPC with the opportunity to file a formal Protest and request consideration of the proposed adjustments by the IRS Office of Appeals (now the IRS Independent Office of Appeals).

Cross reiterated PPC's intention to vigorously defend its positions at every stage of the administrative process and, if necessary, in judicial proceedings. Cross stated that PPC would exercise its right to file a Protest if the proposed adjustments were issued as discussed during the call. Cross noted that PPC had confidence in the strength of its factual record and legal positions and that PPC was prepared for a thorough and comprehensive Appeals process.

Cross asked whether there was any possibility of narrowing the issues in dispute before the NOPA was formally issued, suggesting that there might be opportunities for agreement on certain factual premises or methodological questions that could reduce the scope of the dispute. Rosario stated that Chief Counsel had reached its conclusions on the legal issues and that the examination team would proceed with the issuance of the NOPA as planned. Rosario did not foreclose the possibility of further discussions but indicated that any such discussions would be more productive after the NOPA was issued and the parties had a concrete proposal to address.

Rosario and Cross agreed that any further factual submissions, including PPC's response to IDR No. 47, should be directed to Lead Revenue Agent Patricia Dunleavy through the established channels. Cross confirmed that the IDR No. 47 response was on track for submission on September 29, 2023.

The call concluded at approximately 3:35 p.m. ET.

9. Privileged Observations and Strategic Notes

CALDERWOOD & HARKNESS LLP — INTERNAL ONLY ATTORNEY WORK PRODUCT — NOT FOR DISTRIBUTION

The following observations and strategic assessments reflect the mental impressions, conclusions, opinions, and legal theories of counsel following the September 20, 2023 call. These observations are intended solely for internal use by the Calderwood & Harkness engagement team and are subject to the full protections of the attorney work product doctrine and the attorney-client privilege.

Cross's Post-Call Assessment:

CSA Cost-Sharing Position. The IRS's CSA position appears to rest heavily on Dr. Washburne's economic analysis, and particularly on the PCT valuation at $852 million using a 7.2% WACC. The 260 basis point differential between Dr. Washburne's 7.2% discount rate and WVG's 9.8% discount rate is the central driver of the divergence in PCT valuations and, by extension, of the IRS's position on the ongoing cost-sharing ratios. Rebutting the discount rate differential will be critical at Appeals. We should instruct Dr. Vasquez to prepare a detailed analysis demonstrating why the 9.8% rate is more appropriate for early-stage pharmaceutical IP, including a comprehensive review of comparable company betas, pharmaceutical industry cost-of-capital studies, and risk premium benchmarking data. The selection and weighting of comparable companies in Dr. Washburne's WACC calculation should be a primary focus of our rebuttal.

Legacy IP Royalty Rate Position. The royalty rate position (11.0% versus 4.5%) appears to be the most vulnerable component of the IRS's proposed adjustments. The strength of WVG's CUT analysis — 14 comparable agreements, an interquartile range of 3.1% to 6.8%, and a median of 4.4% — provides a compelling factual basis for PPC's 4.5% rate. The IRS's CUT selection appears to rely on agreements that are not sufficiently comparable, particularly with respect to product lifecycle characteristics and revenue trajectory. The fact that PPC's rate falls at the median of a well-constructed comparable set should be very persuasive at Appeals. Hirabayashi's comment that the royalty issue would be "fact-intensive at Appeals" is a significant concession and suggests that Chief Counsel recognizes meaningful litigation hazard on this issue. This may be an area where we can achieve a favorable resolution at the Appeals level.

Economic Substance / DEMPE Analysis. The economic substance argument was presented more as supporting analysis for the quantum adjustments than as a standalone recharacterization. This is significant. Rosario appeared to concede that PBI has "some" operational substance, and the IRS is not asserting a complete disregard of PBI as an entity. This concession weakens the IRS's overall position, because it implicitly acknowledges that PBI is a genuine participant in the CSA and a genuine licensee of legacy IP, which in turn supports PBI's entitlement to income from both the CSA intangibles and the licensed legacy compounds. At Appeals, we should emphasize that the IRS's own acknowledgment of PBI's substance undermines its position on the cost-sharing ratios and royalty rate.

Penalty Position. The penalty position appears pro forma. The strength of PPC's contemporaneous documentation — prepared by a qualified firm (Crestfield), covering all four tax years, and satisfying the penalty-protection standards — should support full abatement of the penalty at Appeals. Rosario's refusal to engage with the substance of Cross's penalty protection arguments during the call is noteworthy and suggests that Chief Counsel may not have strong confidence in the penalty position.

Correlative Offset. The discussion of the $42 to $43 million correlative offset confirms that the IRS recognizes the double-counting risk inherent in its adjustment framework. This is a potential negotiating lever at Appeals. We should develop a detailed analysis demonstrating that the true overlap between the CSA and royalty adjustments is substantially greater than $42 to $43 million, which would further reduce the net proposed adjustment.

Immediate Next Steps:

• Instruct Whitmore Valuation Group (Dr. Vasquez) to begin preparing a detailed rebuttal of Dr. Washburne's economic analysis immediately upon receipt of the NOPA, with a particular focus on the WACC/Discount rate differential, the PCT valuation methodology, and the CUT selection for the royalty rate analysis.

• Assign Nazari to research the Appeals procedures under Revenue Procedure 2015-41, including the requirements for a qualifying Protest, the format and content standards, and the timeline for Appeals consideration.

• Begin preliminary work on the Protest framework and outline in anticipation of the NOPA, so that PPC is positioned to file a comprehensive and well-supported Protest promptly after receipt of the 30-Day Letter.

• Coordinate with Ciarán Thornbury at Thornbury & Keogh in Dublin regarding the potential Irish tax implications of the proposed adjustments, including the possibility of double taxation and the availability of competent authority / mutual agreement procedure ("MAP") relief under the U.S.-Ireland Income Tax Treaty (Convention Between the Government of the United States of America and the Government of Ireland for the Avoidance of Double Taxation). This coordination should be initiated promptly so that Thornbury & Keogh can advise on the Irish Revenue perspective and the procedural requirements for initiating a MAP request if necessary.

• Advise Marcus Whitfield (General Counsel, PPC) and Deborah Staines (SVP Tax, PPC) promptly of the anticipated NOPA timeline and recommend scheduling a conference call with PPC senior management — including CEO Raj Iyer and CFO Thomas Falk — to discuss strategy once the NOPA is received.

10. Action Items

11. Distribution

Internal Distribution Only — Privileged and Confidential; Attorney Work Product

Copies of this memorandum are to be distributed as follows:

• Leonard Cross, Responsible Partner, Tax Department, Calderwood & Harkness LLP

• Sylvia Hartwell, Partner, Tax Department, Calderwood & Harkness LLP

• Garrett Simmons, Lead Associate, Tax Department, Calderwood & Harkness LLP

• Leila Nazari, Working Associate, Tax Department, Calderwood & Harkness LLP

A copy of this memorandum will be transmitted to Marcus Whitfield (General Counsel, Penterra Pharmaceuticals Corp.) and Deborah Staines (SVP Tax, Penterra Pharmaceuticals Corp.) under separate cover email with appropriate privilege designations.

This memorandum is not to be shared with Crestfield & Associates LLP, Whitmore Valuation Group LLC, or Thornbury & Keogh absent specific written direction from Leonard Cross.

PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT — ATTORNEY-CLIENT PRIVILEGED Calderwood & Harkness LLP	C&H Matter No. 1018-00009	Penterra Pharmaceuticals Corp. Prepared by Garrett Simmons	Reviewed by Leonard Cross	September 20, 2023
Tax Year	PBI Cost-Sharing Percentage (PPC's Position)
2017	38.2%
2018	39.6%
2019	41.1%
2020	42.7%
Tax Year	PBI Cost-Sharing Percentage (IRS's Proposed Position)
2017	48.2% (an increase of 10.0 percentage points)
2018	50.6% (an increase of 11.0 percentage points)
2019	52.3% (an increase of 11.2 percentage points)
2020	53.7% (an increase of 11.0 percentage points)
Tax Year	Total Qualified R&D Costs
2017	$487.3 million
2018	$523.8 million
2019	$561.2 million
2020	$598.4 million
Tax Year	Legacy Compound Non-Americas Net Sales
2017	$814.6 million
2018	$762.3 million
2019	$691.8 million
2020	$624.1 million
No.	Action Item	Responsible	Deadline
1	Finalize and submit IDR No. 47 response (supplemental documentation including employee compensation data and travel records for PBI personnel)	Simmons / Nazari	September 29, 2023
2	Brief Marcus Whitfield and Deborah Staines on call outcome; forward these notes under separate cover with privilege designation	Cross	September 21, 2023
3	Alert Whitmore Valuation Group (Dr. Vasquez) to begin preliminary rebuttal framework for Dr. Washburne's economic analysis, focusing on WACC differential, PCT valuation, and CUT selection	Cross / Simmons	Week of September 25, 2023

4	Research Rev. Proc. 2015-41 Appeals procedures, including Protest requirements, format standards, and timeline considerations	Nazari	October 15, 2023
5	Begin drafting Protest framework and outline in anticipation of NOPA issuance	Simmons / Nazari	Upon receipt of NOPA
6	Coordinate with Ciarán Thornbury (Thornbury & Keogh, Dublin) regarding potential Irish tax implications and competent authority / MAP considerations under U.S.-Ireland Treaty	Nazari	October 2023
7	Update matter status report (Q3 2023) to reflect substance of call and anticipated NOPA timeline	Simmons	October 3, 2023
8	Review statute of limitations for TY 2017 and TY 2018; confirm that Form 872 consents to extend the assessment period are current and extend through at least December 31, 2024	Nazari	October 2023
9	Prepare for client conference call with Whitfield, Staines, Iyer, and Falk upon receipt of NOPA; coordinate scheduling with Sylvia Hartwell	Cross / Hartwell	Upon NOPA issuance

PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
ATTORNEY-CLIENT PRIVILEGED
CALL NOTES / CONFERENCE MEMORANDUM
This memorandum reflects the mental impressions, conclusions, opinions, and legal theories of counsel. This document was prepared in anticipation of litigation and is protected from disclosure by the attorney work product doctrine, the attorney-client privilege, and any other applicable privilege or protection. This memorandum should not be disclosed to any person or entity outside of Calderwood & Harkness LLP without the express written authorization of the Responsible Partner.
Matter: Penterra Pharmaceuticals Corp. — IRS Transfer Pricing Examination Defense
C&H Matter Number: 1018-00009
IRS Exam Team ID: LB&I-NE-TP-2022-00641
Taxpayer: Penterra Pharmaceuticals Corp. ("PPC"), EIN 22-3741856
Tax Years at Issue: 2017, 2018, 2019, 2020
Subject: Notes of Telephone Conference with IRS Office of Chief Counsel (Franklin Rosario, Attorney-Advisor, Transfer Pricing) — Discussion of IRS Legal Positions Regarding CSA Compliance, Legacy IP Royalty Rate, and Economic Substance of Penterra Biotech Ireland Ltd. ("PBI")
Date of Call: September 20, 2023
Prepared by: Garrett Simmons, Lead Associate, Tax Department, Calderwood & Harkness LLP
Reviewed by: Leonard Cross, Responsible Partner, Tax Department, Calderwood & Harkness LLP
Date of Memorandum: September 20, 2023
1. Call Logistics
Date and Time: September 20, 2023, 2:00 p.m. to 3:35 p.m. Eastern Time (approximately 95 minutes).
Format: Telephone conference call.
Calderwood & Harkness Participants:
•  Leonard Cross, Responsible Partner, Tax Department
•  Garrett Simmons, Lead Associate, Tax Department
•  Leila Nazari, Working Associate, Tax Department (note-taker)
IRS Participants:
•  Franklin Rosario, Attorney-Advisor, IRS Office of Chief Counsel, Transfer Pricing Practice Group (present for the entirety of the call)
•  Donna Hirabayashi, Senior Counsel, IRS Office of Chief Counsel (present for portions of the call, joining at approximately 2:25 p.m. during the PCT undervaluation discussion)
•  Supervisory Revenue Agent Gerald Meskill (joined at the outset for introductory remarks; departed the call at approximately 2:07 p.m.)
•  Lead Revenue Agent Patricia Dunleavy (joined the call at approximately 2:45 p.m. for the factual discussion regarding PBI's economic substance)
IRS Personnel Not on Call: Dr. Alan Washburne, IRS Economist, was not present on the call. However, Rosario referenced Dr. Washburne's economic analysis and valuation conclusions on multiple occasions throughout the discussion, as noted in detail below.
Purpose of Call: The call was convened at the request of IRS Chief Counsel to discuss the IRS's legal positions on three principal issues — (i) compliance with the cost-sharing arrangement ("CSA") under Treasury Regulation § 1.482-7, including the reasonably anticipated benefits ("RAB") methodology and the platform contribution transaction ("PCT") valuation; (ii) the arm's-length royalty rate applicable to legacy intangible property; and (iii) the economic substance and DEMPE functions of Penterra Biotech Ireland Ltd. ("PBI") — in advance of the anticipated issuance of a Notice of Proposed Adjustment ("NOPA"). The call served as a follow-up to the mid-examination conference held on May 25, 2023, and was conducted after the substantial completion of the Information Document Request ("IDR") process. A total of 47 IDRs were issued by the examination team between June 2022 and September 2023.
Note Regarding IDR Status: As of the date of the call, Calderwood & Harkness had completed and submitted responses to IDR Nos. 1 through 46 on behalf of PPC. The response to IDR No. 47 (the final substantive IDR, requesting supplemental documentation including employee compensation data and travel records) was pending at the time of the call and was subsequently submitted on September 29, 2023. During his opening remarks, Rosario acknowledged receipt of the responses to IDR Nos. 1 through 46 and indicated that the examination team was in the process of reviewing the final submissions.
2. Opening Remarks
2.1 Supervisory Revenue Agent Meskill's Introduction
Supervisory Revenue Agent Gerald Meskill opened the call at approximately 2:00 p.m. Meskill stated that the examination team had substantially completed its factual development of the case and that the primary purpose of the call was to provide an opportunity for IRS Chief Counsel and taxpayer's counsel to discuss the respective legal positions of the parties before the examination team finalized its proposed adjustments. Meskill characterized the call as a "pre-NOPA legal issues conference" and indicated that the IRS anticipated issuing a formal Notice of Proposed Adjustment in the coming weeks. (The NOPA was ultimately issued on October 12, 2023.)
Meskill acknowledged PPC's cooperation throughout the examination process, noting that PPC and its counsel had been responsive to the 47 IDRs issued during the examination period. Meskill stated that the examination team believed it had obtained a comprehensive factual record and that the remaining IDR No. 47 response was expected to supplement, rather than fundamentally alter, the factual foundation for the team's analysis.
After these introductory remarks, Meskill departed the call at approximately 2:07 p.m., turning the discussion over to Attorney-Advisor Rosario.
2.2 Cross's Opening Statement
Following Meskill's departure, Cross thanked Meskill for his remarks and thanked the examination team for the professional manner in which the examination had been conducted. Cross then provided an opening statement on behalf of PPC.
Cross stated that PPC maintained that its intercompany pricing and transfer pricing positions were fully compliant with Internal Revenue Code § 482 and all applicable Treasury Regulations, including specifically Treasury Regulation §§ 1.482-4 (regarding the licensing of intangible property) and 1.482-7 (regarding cost-sharing arrangements). Cross emphasized that PPC's positions were not aggressive or novel, but rather reflected a straightforward application of established principles to the facts and circumstances of PPC's global pharmaceutical business.
Cross noted that PPC had prepared contemporaneous transfer pricing documentation for all four tax years at issue (2017 through 2020). This documentation was prepared by Crestfield & Associates LLP, under the direction of Susan Lam, Transfer Pricing Partner, and constituted qualifying contemporaneous documentation within the meaning of IRC § 6662(e)(3)(B) and Treasury Regulation § 1.6662-6(d). Cross stated that the documentation established both the selection and application of PPC's transfer pricing methods and demonstrated that PPC's intercompany pricing satisfied the arm's-length standard.
Cross further noted that PPC's transfer pricing positions were supported by independent economic analyses prepared by Whitmore Valuation Group LLC ("WVG"), under the direction of Dr. Helena Vasquez, Managing Director. Cross stated that WVG had been engaged pursuant to a Kovel arrangement with Calderwood & Harkness, and that WVG's analyses confirmed that PPC's intercompany pricing fell within the arm's-length range under each applicable method.
Cross expressed his hope that the discussion during the call might serve to narrow the issues in dispute and potentially avoid the need for formal proposed adjustments on certain positions. Cross stated that PPC was prepared to discuss each of the IRS's anticipated positions in a constructive manner and to provide any additional factual information that might assist in resolving the issues at the examination level.
3. IRS Legal Position: CSA Compliance and Cost-Sharing Ratios
3.1 Rosario's Position on Reasonably Anticipated Benefits
Rosario stated that IRS Chief Counsel had conducted a thorough review of the CSA agreement between PPC and PBI, which was effective as of July 1, 2012, as well as the annual cost-sharing calculations for tax years 2017 through 2020. Rosario indicated that Chief Counsel had identified what it believed to be material deficiencies in PPC's determination of the reasonably anticipated benefits ("RAB") attributable to each CSA participant, and that these deficiencies resulted in a misallocation of intangible development costs between PPC and PBI.
Rosario articulated Chief Counsel's primary contention as follows: PPC's projections of RAB systematically understated the value attributable to the United States-based research and development activities and the United States market, with the consequence that PBI's cost-sharing percentages were set at levels that were too low relative to the benefits PBI was reasonably anticipated to derive from the CSA intangibles. Rosario stated that the RAB projections failed to appropriately account for the concentration of innovative and high-value R&D activities at PPC's facilities in the United States, and instead allocated disproportionate anticipated benefits to PBI's non-Americas territory based on revenue projections that, in Chief Counsel's view, did not adequately reflect the underlying value creation.
Rosario identified PBI's cost-sharing percentages for the years at issue as follows:
Rosario stated that these percentages were inadequate in light of the growth in PBI's non-Americas revenue during the period and the concentration of R&D activities in the United States. Rosario indicated that the IRS's position would be to increase PBI's cost-sharing percentage by approximately 8 to 12 percentage points across each of the four tax years. Rosario provided the following specific figures representing Chief Counsel's proposed cost-sharing allocations:
Rosario further identified the total qualified R&D costs underlying the CSA for each year at issue:
Based on the proposed percentage increases and the total qualified R&D costs, Rosario stated that the CSA cost-sharing adjustment across all four tax years would be approximately $235 million in the aggregate. Rosario characterized this as the single largest component of the anticipated proposed adjustment.
3.2 Rosario's Position on PCT Undervaluation
Rosario then turned to the platform contribution transaction ("PCT") and its implications for the ongoing cost-sharing analysis. Rosario noted that the original PCT payment — reflecting PBI's buy-in to PPC's pre-existing intangible property — was $312 million, paid on July 1, 2012, contemporaneous with the effective date of the CSA. Rosario acknowledged that tax year 2012 was outside the scope of the current examination and that the IRS was not directly proposing to adjust the 2012 PCT payment itself. However, Rosario stated that the IRS viewed the PCT undervaluation as highly relevant evidence bearing on the ongoing CSA cost-sharing ratios, insofar as the below-arm's-length PCT payment was indicative of a systematic undervaluation of the contributed intangible property that persisted through the examination years.
Rosario referenced the economic analysis prepared by IRS Economist Dr. Alan Washburne. Rosario stated that Dr. Washburne had performed an income-method valuation of the pre-existing intangible property contributed by PPC to the CSA and had concluded that the arm's-length value of the PCT was approximately $852 million. This represented a delta of approximately $540 million from PPC's $312 million PCT payment. Rosario stated that Dr. Washburne's valuation employed a weighted average cost of capital ("WACC") of 7.2% as the discount rate, and utilized revenue projections that Chief Counsel believed were more realistic and better supported by contemporaneous market data than the assumptions employed by PPC and its advisors.
Cross pushed back on the PCT valuation issue directly. Cross noted that PPC's defense PCT valuation, which had been conducted by Whitmore Valuation Group under the direction of Dr. Vasquez, utilized a WACC of 9.8%. Cross stated that the 9.8% rate was appropriate for the pharmaceutical industry risk profile and particularly for the early-stage intangible property at issue, which involved compounds at various stages of clinical development and regulatory approval as of the 2012 valuation date. Cross noted that WVG's analysis yielded an arm's-length range of $278 million to $361 million for the PCT, and that PPC's actual payment of $312 million fell squarely within that range — indeed, it was near the midpoint. Cross stated that the $312 million payment therefore satisfied the arm's-length standard under any reasonable application of the income method.
Rosario responded that Chief Counsel disagreed with the risk premium adjustments that led to PPC's 9.8% discount rate. Rosario stated that Dr. Washburne's analysis reflected comparable pharmaceutical company betas more accurately and that the risk adjustments applied by WVG were excessive and not supported by the empirical data on pharmaceutical industry cost of capital. Rosario indicated that the 260 basis point differential between the two discount rates (9.8% versus 7.2%) was the principal driver of the divergence in PCT valuations.
At this point, Senior Counsel Donna Hirabayashi joined the call (at approximately 2:25 p.m.). Hirabayashi added that Chief Counsel's position did not require a direct adjustment to tax year 2012 income. Rather, Chief Counsel viewed the PCT undervaluation as informing the appropriate calibration of the ongoing cost-sharing ratios for the examination years (2017–2020). Hirabayashi stated that the ongoing cost-sharing ratios were the mechanism through which the undervaluation of the pre-existing contributed intangible property would be addressed, and that this approach was consistent with the regulatory framework under Treasury Regulation § 1.482-7.
3.3 Cross's Rebuttal on CSA Positions
Cross provided a detailed rebuttal of the IRS's CSA positions. Cross stated that PPC's RAB projections were prepared contemporaneously with each annual cost-sharing calculation and were updated annually using the best available data at the time each projection was made. Cross stated that this approach was fully consistent with the requirements of Treasury Regulation § 1.482-7(e), which requires that cost-sharing contributions be determined based on each controlled participant's share of reasonably anticipated benefits from the intangible development activity.
Cross emphasized the distinction between ex ante projections and ex post outcomes. Cross noted that PBI's non-Americas revenue had, in fact, grown in line with or below the projections used in the RAB calculation for each of the four tax years. Cross stated that any deviation between ex post actual results and the ex ante projections did not invalidate the projections under the regulations, provided that the projections were reasonable when made. Cross argued that the IRS's position improperly sought to apply hindsight to RAB projections that were reasonable at the time they were developed.
Cross cited the best method rule under Treasury Regulation § 1.482-1(d) and argued that PPC's methodology — using projected revenue splits by territory as the basis for the RAB allocation — was the most reliable method available under the circumstances. Cross stated that PPC had considered and appropriately rejected alternative approaches, including profit-based measures, and had documented the reasons for its method selection in its contemporaneous transfer pricing documentation.
Cross further noted that PPC's positions were consistent with the holdings in relevant case law, including the Tax Court's decisions in Altera Corp. v. Commissioner and Harborview Corporation, Inc. v. Commissioner. Cross also referenced the OECD Transfer Pricing Guidelines, specifically Chapter VIII on cost contribution arrangements, which Cross stated supported PPC's approach to the RAB determination and cost-sharing allocation.
Rosario acknowledged Cross's citations to the case law but sought to distinguish PPC's facts from those cases. Rosario noted that PBI's headcount was relatively small — having grown from 52 employees at the time of incorporation in 2012 to 185 employees by 2020 — relative to the non-Americas revenue PBI reported (€2.14 billion in fiscal year 2020). Rosario stated that this disparity between headcount and revenue, in his view, suggested that PBI's RAB share should be lower, not higher, and that the true value creation underlying PBI's reported revenue was occurring in the United States through PPC's R&D and strategic management activities. Cross responded that revenue-to-headcount ratios were not a recognized metric under the transfer pricing regulations for determining RAB shares, and that PBI's revenue reflected the value of the intangible property rights PBI held, not merely the activities of PBI's employees.
4. IRS Legal Position: Legacy IP Royalty Rate
4.1 Rosario's Position on the 4.5% Rate
Rosario turned to the second principal area of proposed adjustment: the royalty rate applicable to legacy intangible property. Rosario explained that the term "legacy IP," as used in the examination, referred to pre-2012 vintage pharmaceutical compounds that were developed by PPC prior to the effective date of the CSA and that were not covered by the CSA's intangible development activity. PBI licensed these legacy compounds from PPC under a separate intercompany license agreement and paid PPC a royalty of 4.5% of net sales for the right to commercialize the legacy compounds in PBI's non-Americas territory.
Rosario stated that Chief Counsel's position was that the 4.5% royalty rate was substantially below the arm's-length rate. Rosario indicated that the IRS would propose increasing the royalty rate to 11.0% of net sales, representing an increase of 650 basis points. Rosario stated that this proposed rate was based on comparable uncontrolled transaction ("CUT") data derived from third-party pharmaceutical licensing agreements that Dr. Washburne had selected and analyzed. Rosario characterized the IRS's CUT comparables as arm's-length agreements involving pharmaceutical compounds at a similar stage of the commercial lifecycle.
Rosario identified PBI's net sales of legacy compounds in the non-Americas territory for each of the four tax years:
Rosario acknowledged the declining revenue trajectory of the legacy compounds but stated that the magnitude of the revenue base was nonetheless substantial and that the 4.5% rate failed to adequately compensate PPC for the value of the underlying intangible property. Based on the proposed rate increase from 4.5% to 11.0%, Rosario stated that the royalty adjustment across all four tax years would total approximately $188 million in the aggregate.
4.2 Cross's Rebuttal on Royalty Rate
Cross stated that PPC had a strong factual and legal basis for the 4.5% royalty rate and that the IRS's proposed rate of 11.0% was not supported by properly selected and analyzed comparable uncontrolled transactions.
Cross stated that Whitmore Valuation Group's CUT analysis, conducted by Dr. Vasquez and her team, had identified 14 comparable uncontrolled pharmaceutical license agreements through a rigorous comparability screening process. Cross stated that these 14 agreements yielded an interquartile range of 3.1% to 6.8%, with a median of 4.4%. Cross emphasized that PPC's 4.5% royalty rate fell squarely within the arm's-length interquartile range and was virtually at the median. Cross stated that this result conclusively satisfied the arm's-length standard under Treasury Regulation § 1.482-4 and that no adjustment was warranted.
Cross directly challenged the IRS's proposed 11.0% rate, stating that it was derived from CUT agreements that were not sufficiently comparable to PBI's license of PPC's legacy compounds. Cross specifically questioned whether Dr. Washburne's selected CUT agreements involved comparable intangibles — that is, late-lifecycle legacy pharmaceutical compounds with declining revenue trajectories and limited remaining patent life — or whether they instead involved earlier-stage compounds with greater growth potential that would warrant higher royalty rates. Cross stated that the lifecycle stage and revenue trajectory of the licensed intangible property were critical comparability factors and that failure to account for these factors would render a CUT analysis unreliable.
Rosario responded that the IRS's CUT selection focused primarily on therapeutic-area comparability, noting that Dr. Washburne had selected CUT agreements involving oncology and immunology compounds, which were the same therapeutic areas as the PPC legacy compounds at issue. Rosario stated that therapeutic-area comparability was the most important comparability factor in the pharmaceutical context, as it captured the market dynamics, competitive landscape, and regulatory environment most relevant to pricing.
Cross disputed this characterization. Cross argued that product lifecycle stage, revenue trajectory, and remaining patent life were equally or more important comparability factors under the regulations than therapeutic area alone. Cross noted that a license of a recently approved oncology compound with twenty years of remaining patent protection and a growing revenue trajectory would command a fundamentally different royalty rate than a license of a late-lifecycle oncology compound with declining revenues and limited remaining exclusivity. Cross stated that the legacy compounds at issue were in a declining revenue phase — as demonstrated by the year-over-year decline from $814.6 million in 2017 to $624.1 million in 2020 — and that failure to account for this characteristic rendered the IRS's CUT analysis unreliable.
Hirabayashi, who remained on the call, indicated that Chief Counsel was confident in the comparability of its CUT selection but acknowledged that the royalty rate issue would be "fact-intensive" at Appeals. Cross noted this acknowledgment for the record.
5. IRS Legal Position: Economic Substance of PBI
5.1 Rosario's Position on Economic Substance and DEMPE Functions
Rosario stated that Chief Counsel's position also included a challenge to PBI's economic substance, framed in terms of the DEMPE analysis framework. Rosario asserted that the key DEMPE functions — Development, Enhancement, Maintenance, Protection, and Exploitation of intangible property — remained substantially in the United States at PPC's headquarters in Princeton Junction, New Jersey, notwithstanding PBI's formal status as a CSA participant and IP owner for the non-Americas territory.
Rosario articulated the IRS's specific contentions with respect to each DEMPE function as follows:
Development: All research and development activity was conducted by PPC personnel at PPC's U.S. facilities. PBI contributed cost-sharing payments under the CSA but did not itself perform the R&D activities. Rosario stated that PBI's financial contributions, standing alone, did not constitute the performance of the Development function.
Enhancement: Product improvements, formulation refinements, and line extensions were initiated and directed by PPC's U.S.-based R&D and commercial teams. Rosario stated that the evidence reviewed by the examination team did not demonstrate that PBI exercised meaningful control over Enhancement activities.
Maintenance: Quality control systems, pharmacovigilance reporting infrastructure, and ongoing post-market surveillance were centrally managed from PPC's U.S. operations. Rosario acknowledged that PBI had some regulatory personnel but stated that the core Maintenance systems were designed, implemented, and overseen from the United States.
Protection: Patent prosecution strategies, IP enforcement actions, and defensive litigation were directed by PPC's U.S. legal team. Rosario stated that PBI did not maintain an independent legal function capable of directing Protection activities across its 68-country territory.
Exploitation: While PBI nominally made commercial decisions for the non-Americas territory, Rosario asserted that key strategic direction — including global pricing frameworks, brand strategy, and key account management for major markets — emanated from PPC's U.S. management.
Rosario emphasized the disparity between PBI's headcount of 185 employees (as of 2020) and PBI's reported non-Americas revenue of €2.14 billion in fiscal year 2020. Rosario questioned whether PBI had sufficient personnel to exercise genuine control over the DEMPE functions attributed to it, and stated that the revenue-to-employee ratio was indicative of a structure in which the substantive value creation occurred in the United States.
At approximately 2:45 p.m., Lead Revenue Agent Patricia Dunleavy joined the call. Dunleavy supplemented Rosario's legal analysis with factual observations drawn from the IDR responses. Dunleavy noted that several PBI commercial strategy documents produced in response to IDR Nos. 18 and 35 bore evidence of PPC U.S. executive involvement, including annotations, comments, and tracked-change edits attributable to U.S.-based personnel. Dunleavy further noted that travel records produced in the IDR process showed regular visits by PPC U.S. personnel to PBI's offices in Dublin, which Dunleavy characterized as evidence of U.S.-based oversight and control rather than arm's-length collaboration.
5.2 Cross's Rebuttal on PBI Substance
Cross responded emphatically that PBI maintained robust economic substance and that the evidence produced in the 46 completed IDR responses (with the IDR No. 47 response forthcoming) fully supported PBI's role as a genuine IP owner and active CSA participant. Cross stated that the IRS's characterization of PBI as lacking economic substance was inconsistent with the documentary record and reflected a fundamental misunderstanding of PBI's operations.
Cross enumerated the following key substance indicators:
Physical Presence: PBI maintained approximately 18,000 square feet of dedicated office space at Sandyford Business Park, Dublin (D18 K7T4). This space housed PBI's full-time employees and served as the operational headquarters for PBI's non-Americas commercial activities.
Headcount and Personnel: PBI's headcount grew from 52 employees at the time of its incorporation in 2012 to 185 employees by 2020. This growth reflected PBI's expanding operational capabilities. PBI's personnel included dedicated teams in regulatory affairs, medical affairs, commercial strategy, market access, supply chain management, and finance.
Senior Management: PBI's Managing Director, Aidan Naughton, was resident in Ireland and exercised genuine decision-making authority over PBI's commercial operations. Cross stated that Mr. Naughton's authority was not merely nominal and that the documentary evidence — including board minutes, internal correspondence, and strategic planning documents — demonstrated that Mr. Naughton and his Dublin-based team made real, consequential business decisions.
Board Governance: PBI held 42 board meetings in Dublin during the four tax years at issue (2017 through 2020), consisting of regular quarterly meetings plus special sessions as needed. Cross stated that these board meetings addressed key decisions on matters including pricing across PBI's territory, market entry strategies for new country markets, regulatory submission timelines, capital expenditure approvals, and strategic planning.
Regulatory Expenditures: PBI incurred €47.2 million in cumulative regulatory expenditures during 2017 through 2020 for the preparation and submission of regulatory filings across 68 country markets in the non-Americas territory. Cross stated that this level of expenditure reflected PBI's active engagement in the regulatory process and its responsibility for obtaining and maintaining marketing authorizations in its territory.
Independent Pricing Decisions: PBI made independent pricing decisions across 68 country markets, tailored to local market conditions, reimbursement frameworks, and competitive dynamics. Cross stated that the documentary evidence supporting PBI's independent pricing authority was particularly strong and had been produced in response to IDR Nos. 35 and 18.
Market Risk: PBI bore genuine market risk for the non-Americas territories, including inventory risk and distribution risk. PBI managed its supply chain through its arrangement with Penterra Manufacturing Ireland Ltd. ("PMI"), a contract manufacturer located at Ringaskiddy, County Cork, Ireland, and through a network of third-party distribution partners across PBI's territory.
Independent Financial Infrastructure: PBI maintained independent banking relationships with Glenmore Bank Ireland plc and operated an independent treasury function. PBI's financial operations were managed by its Dublin-based finance team.
Cross further noted that Calderwood & Harkness had conducted 12 key employee interviews at PBI's Dublin offices during August and September 2022. These interviews documented the roles, decision-making authority, and functional contributions of PBI's senior personnel and were conducted in accordance with the examination team's protocols. Cross stated that the interview record fully corroborated PBI's substance and the genuine exercise of DEMPE functions in Ireland.
Cross stated that PBI's substance was consistent with the requirements of the OECD Transfer Pricing Guidelines, including both the 2017 and 2022 revisions, and specifically Chapter VI on intangibles and the DEMPE analysis framework. Cross stated that the Guidelines recognize that a CSA participant that funds intangible development and exercises control over the funded activities is entitled to a return commensurate with its contributions, and that PBI satisfied these requirements.
With respect to Dunleavy's observations regarding travel by PPC U.S. personnel to Dublin, Cross stated that such travel was evidence of collaboration between PPC and PBI, not evidence of U.S. control over PBI's operations. Cross noted that collaboration between related entities within a multinational enterprise is normal, expected, and consistent with arm's-length behavior. Cross stated that the relevant inquiry was whether PBI exercised genuine control over its DEMPE functions, not whether PBI operated in complete isolation from PPC.
5.3 Rosario's Response
Rosario responded by indicating that Chief Counsel recognized that PBI had some operational presence in Ireland. However, Rosario maintained that the "control" over key DEMPE functions — particularly the Development and Protection functions — had not shifted to Ireland in a meaningful sense. Rosario stated that PBI's financial contributions to the CSA and its employment of regulatory and commercial personnel did not equate to the exercise of control over the core value-creating functions, which remained centered in the United States.
Rosario clarified that the IRS was not asserting a complete lack of economic substance on the part of PBI, which could potentially lead to a disregard of PBI as an entity or a wholesale recharacterization of the intercompany transactions. Rather, Rosario stated that Chief Counsel's position was that the allocation of income to PBI was disproportionate to the functions PBI actually performed, the assets PBI employed, and the risks PBI bore. Rosario stated that this analysis supported and reinforced the proposed adjustments to both the CSA cost-sharing ratios and the legacy IP royalty rate, rather than constituting a standalone adjustment category.
6. Discussion of Correlative Adjustments and Double-Counting
Cross raised the issue of potential double-counting between the IRS's two principal adjustment categories — the CSA cost-sharing adjustments and the legacy IP royalty rate adjustments. Cross noted that both proposed adjustments targeted the allocation of income between PPC and PBI with respect to overlapping product lines and revenue streams. Cross stated that if the IRS increased both the cost-sharing percentages (thereby reducing PBI's income from CSA intangibles) and the royalty rate (thereby reducing PBI's income from legacy IP), the combined effect would result in an impermissible double-counting of the income reallocation from PBI to PPC. Cross characterized this as a fundamental structural flaw in the IRS's proposed adjustment framework.
Rosario acknowledged Cross's concern regarding double-counting. Rosario stated that the examination team was aware of the overlap and that a correlative offset would be applied to avoid double-counting, consistent with the principles set forth in Treasury Regulation § 1.482-1(g). Rosario indicated that the correlative offset was estimated at approximately $42 to $43 million. (The correlative offset was ultimately quantified at $42.65 million in the NOPA issued on October 12, 2023.)
Cross acknowledged Rosario's representation regarding the correlative offset but stated that PPC reserved its right to challenge the adequacy of the offset. Cross noted that PPC's preliminary analysis suggested that the true overlap between the two adjustment categories might be greater than $42 to $43 million, and that PPC would conduct a detailed analysis of the correlative offset once the specific calculations underlying the NOPA were available.
7. Discussion of Penalty Position
7.1 Rosario's Position on IRC § 6662(e) Penalty
Rosario indicated that Chief Counsel was recommending the assertion of the substantial valuation misstatement penalty under IRC § 6662(e) at the 20% rate, applicable to any net § 482 allocation. Rosario stated that if the total proposed adjustment of approximately $380 million was sustained, the resulting penalty exposure — calculated at the 21% corporate tax rate — would be approximately $16 million. Rosario provided the following calculation:
$380.4 million (net proposed § 482 adjustment) × 21% (corporate tax rate) × 20% (§ 6662(e) penalty rate) = approximately $15.98 million.
Rosario noted that the IRS had reserved on, but was not currently asserting, the 40% gross valuation misstatement penalty under IRC § 6662(h). Rosario stated that Chief Counsel's current recommendation was limited to the 20% penalty, though the reservation of the 40% penalty was noted for the record.
7.2 Cross's Response on Penalty Protection
Cross stated firmly that PPC had a complete defense to any penalty under IRC § 6662(e) and that the assertion of the penalty in this case would be unwarranted and unsupportable. Cross identified the following bases for PPC's penalty protection:
First, PPC had contemporaneous transfer pricing documentation prepared by Crestfield & Associates LLP, under the direction of Susan Lam, Transfer Pricing Partner, for all four tax years at issue (2017 through 2020). Cross stated that this documentation satisfied the requirements of IRC § 6662(e)(3)(B) and the corresponding regulations, and that it constituted qualifying contemporaneous documentation within the meaning of the penalty-protection safe harbor.
Second, the contemporaneous documentation was prepared under the penalty-protection standards and established both the selection and application of PPC's transfer pricing methods. The documentation addressed the factual background, the functional analysis, the selection of the best method, the identification and analysis of comparable transactions, the application of the selected method, and the conclusion that PPC's intercompany pricing fell within the arm's-length range.
Third, PPC's transfer pricing positions were supported by the independent economic analyses prepared by Whitmore Valuation Group LLC, a qualified and experienced economic consulting firm with recognized expertise in pharmaceutical transfer pricing.
Fourth, PPC acted with reasonable cause and in good faith in establishing its intercompany pricing, as demonstrated by the engagement of qualified outside counsel and economic advisors, the preparation of contemporaneous documentation, and the consistent application of arm's-length pricing methodologies.
Cross stated that the assertion of a substantial valuation misstatement penalty in the face of qualifying contemporaneous documentation was inconsistent with the statutory safe harbor and would be extremely difficult for the IRS to sustain at Appeals or, if necessary, in Tax Court proceedings. Cross noted that this was precisely the type of case in which the contemporaneous documentation safe harbor was designed to provide protection, and that PPC's documentation was comprehensive, well-supported, and prepared in accordance with recognized professional standards.
Rosario stated that Chief Counsel would nonetheless recommend the penalty in the NOPA and that the penalty question would be addressed during any subsequent proceedings, including at Appeals. Rosario did not directly engage with Cross's substantive arguments regarding the adequacy of PPC's contemporaneous documentation.
8. Anticipated Timeline and Next Steps
Rosario indicated that Chief Counsel expected to finalize its analysis and supporting legal memoranda in the coming weeks and to support the examination team's issuance of a Notice of Proposed Adjustment within approximately three to four weeks from the date of the call. (The NOPA was ultimately issued on October 12, 2023, approximately three weeks after the call.)
Rosario confirmed that the NOPA would cover all four tax years at issue (2017, 2018, 2019, and 2020) and would encompass all three adjustment categories discussed during the call: (i) the CSA cost-sharing ratio adjustments; (ii) the legacy IP royalty rate adjustment; and (iii) the economic substance and DEMPE analysis as supporting analysis for the quantum adjustments. Rosario stated that the economic substance analysis would be incorporated into the NOPA as part of the factual and legal basis for the proposed adjustments, rather than as a separate and independent adjustment category.
Rosario confirmed that a 30-Day Letter would follow the NOPA, providing PPC with the opportunity to file a formal Protest and request consideration of the proposed adjustments by the IRS Office of Appeals (now the IRS Independent Office of Appeals).
Cross reiterated PPC's intention to vigorously defend its positions at every stage of the administrative process and, if necessary, in judicial proceedings. Cross stated that PPC would exercise its right to file a Protest if the proposed adjustments were issued as discussed during the call. Cross noted that PPC had confidence in the strength of its factual record and legal positions and that PPC was prepared for a thorough and comprehensive Appeals process.
Cross asked whether there was any possibility of narrowing the issues in dispute before the NOPA was formally issued, suggesting that there might be opportunities for agreement on certain factual premises or methodological questions that could reduce the scope of the dispute. Rosario stated that Chief Counsel had reached its conclusions on the legal issues and that the examination team would proceed with the issuance of the NOPA as planned. Rosario did not foreclose the possibility of further discussions but indicated that any such discussions would be more productive after the NOPA was issued and the parties had a concrete proposal to address.
Rosario and Cross agreed that any further factual submissions, including PPC's response to IDR No. 47, should be directed to Lead Revenue Agent Patricia Dunleavy through the established channels. Cross confirmed that the IDR No. 47 response was on track for submission on September 29, 2023.
The call concluded at approximately 3:35 p.m. ET.
9. Privileged Observations and Strategic Notes
CALDERWOOD & HARKNESS LLP — INTERNAL ONLY ATTORNEY WORK PRODUCT — NOT FOR DISTRIBUTION
The following observations and strategic assessments reflect the mental impressions, conclusions, opinions, and legal theories of counsel following the September 20, 2023 call. These observations are intended solely for internal use by the Calderwood & Harkness engagement team and are subject to the full protections of the attorney work product doctrine and the attorney-client privilege.
Cross's Post-Call Assessment:
CSA Cost-Sharing Position. The IRS's CSA position appears to rest heavily on Dr. Washburne's economic analysis, and particularly on the PCT valuation at $852 million using a 7.2% WACC. The 260 basis point differential between Dr. Washburne's 7.2% discount rate and WVG's 9.8% discount rate is the central driver of the divergence in PCT valuations and, by extension, of the IRS's position on the ongoing cost-sharing ratios. Rebutting the discount rate differential will be critical at Appeals. We should instruct Dr. Vasquez to prepare a detailed analysis demonstrating why the 9.8% rate is more appropriate for early-stage pharmaceutical IP, including a comprehensive review of comparable company betas, pharmaceutical industry cost-of-capital studies, and risk premium benchmarking data. The selection and weighting of comparable companies in Dr. Washburne's WACC calculation should be a primary focus of our rebuttal.
Legacy IP Royalty Rate Position. The royalty rate position (11.0% versus 4.5%) appears to be the most vulnerable component of the IRS's proposed adjustments. The strength of WVG's CUT analysis — 14 comparable agreements, an interquartile range of 3.1% to 6.8%, and a median of 4.4% — provides a compelling factual basis for PPC's 4.5% rate. The IRS's CUT selection appears to rely on agreements that are not sufficiently comparable, particularly with respect to product lifecycle characteristics and revenue trajectory. The fact that PPC's rate falls at the median of a well-constructed comparable set should be very persuasive at Appeals. Hirabayashi's comment that the royalty issue would be "fact-intensive at Appeals" is a significant concession and suggests that Chief Counsel recognizes meaningful litigation hazard on this issue. This may be an area where we can achieve a favorable resolution at the Appeals level.
Economic Substance / DEMPE Analysis. The economic substance argument was presented more as supporting analysis for the quantum adjustments than as a standalone recharacterization. This is significant. Rosario appeared to concede that PBI has "some" operational substance, and the IRS is not asserting a complete disregard of PBI as an entity. This concession weakens the IRS's overall position, because it implicitly acknowledges that PBI is a genuine participant in the CSA and a genuine licensee of legacy IP, which in turn supports PBI's entitlement to income from both the CSA intangibles and the licensed legacy compounds. At Appeals, we should emphasize that the IRS's own acknowledgment of PBI's substance undermines its position on the cost-sharing ratios and royalty rate.
Penalty Position. The penalty position appears pro forma. The strength of PPC's contemporaneous documentation — prepared by a qualified firm (Crestfield), covering all four tax years, and satisfying the penalty-protection standards — should support full abatement of the penalty at Appeals. Rosario's refusal to engage with the substance of Cross's penalty protection arguments during the call is noteworthy and suggests that Chief Counsel may not have strong confidence in the penalty position.
Correlative Offset. The discussion of the $42 to $43 million correlative offset confirms that the IRS recognizes the double-counting risk inherent in its adjustment framework. This is a potential negotiating lever at Appeals. We should develop a detailed analysis demonstrating that the true overlap between the CSA and royalty adjustments is substantially greater than $42 to $43 million, which would further reduce the net proposed adjustment.
Immediate Next Steps:
•  Instruct Whitmore Valuation Group (Dr. Vasquez) to begin preparing a detailed rebuttal of Dr. Washburne's economic analysis immediately upon receipt of the NOPA, with a particular focus on the WACC/Discount rate differential, the PCT valuation methodology, and the CUT selection for the royalty rate analysis.
•  Assign Nazari to research the Appeals procedures under Revenue Procedure 2015-41, including the requirements for a qualifying Protest, the format and content standards, and the timeline for Appeals consideration.
•  Begin preliminary work on the Protest framework and outline in anticipation of the NOPA, so that PPC is positioned to file a comprehensive and well-supported Protest promptly after receipt of the 30-Day Letter.
•  Coordinate with Ciarán Thornbury at Thornbury & Keogh in Dublin regarding the potential Irish tax implications of the proposed adjustments, including the possibility of double taxation and the availability of competent authority / mutual agreement procedure ("MAP") relief under the U.S.-Ireland Income Tax Treaty (Convention Between the Government of the United States of America and the Government of Ireland for the Avoidance of Double Taxation). This coordination should be initiated promptly so that Thornbury & Keogh can advise on the Irish Revenue perspective and the procedural requirements for initiating a MAP request if necessary.
•  Advise Marcus Whitfield (General Counsel, PPC) and Deborah Staines (SVP Tax, PPC) promptly of the anticipated NOPA timeline and recommend scheduling a conference call with PPC senior management — including CEO Raj Iyer and CFO Thomas Falk — to discuss strategy once the NOPA is received.
10. Action Items
11. Distribution
Internal Distribution Only — Privileged and Confidential; Attorney Work Product
Copies of this memorandum are to be distributed as follows:
•  Leonard Cross, Responsible Partner, Tax Department, Calderwood & Harkness LLP
•  Sylvia Hartwell, Partner, Tax Department, Calderwood & Harkness LLP
•  Garrett Simmons, Lead Associate, Tax Department, Calderwood & Harkness LLP
•  Leila Nazari, Working Associate, Tax Department, Calderwood & Harkness LLP
A copy of this memorandum will be transmitted to Marcus Whitfield (General Counsel, Penterra Pharmaceuticals Corp.) and Deborah Staines (SVP Tax, Penterra Pharmaceuticals Corp.) under separate cover email with appropriate privilege designations.
This memorandum is not to be shared with Crestfield & Associates LLP, Whitmore Valuation Group LLC, or Thornbury & Keogh absent specific written direction from Leonard Cross.
PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT — ATTORNEY-CLIENT PRIVILEGED Calderwood & Harkness LLP | C&H Matter No. 1018-00009 | Penterra Pharmaceuticals Corp. Prepared by Garrett Simmons | Reviewed by Leonard Cross | September 20, 2023
Tax Year | PBI Cost-Sharing Percentage (PPC's Position)
2017 | 38.2%
2018 | 39.6%
2019 | 41.1%
2020 | 42.7%
Tax Year | PBI Cost-Sharing Percentage (IRS's Proposed Position)
2017 | 48.2% (an increase of 10.0 percentage points)
2018 | 50.6% (an increase of 11.0 percentage points)
2019 | 52.3% (an increase of 11.2 percentage points)
2020 | 53.7% (an increase of 11.0 percentage points)
Tax Year | Total Qualified R&D Costs
2017 | $487.3 million
2018 | $523.8 million
2019 | $561.2 million
2020 | $598.4 million
Tax Year | Legacy Compound Non-Americas Net Sales
2017 | $814.6 million
2018 | $762.3 million
2019 | $691.8 million
2020 | $624.1 million
No. | Action Item | Responsible | Deadline
1 | Finalize and submit IDR No. 47 response (supplemental documentation including employee compensation data and travel records for PBI personnel) | Simmons / Nazari | September 29, 2023
2 | Brief Marcus Whitfield and Deborah Staines on call outcome; forward these notes under separate cover with privilege designation | Cross | September 21, 2023
3 | Alert Whitmore Valuation Group (Dr. Vasquez) to begin preliminary rebuttal framework for Dr. Washburne's economic analysis, focusing on WACC differential, PCT valuation, and CUT selection | Cross / Simmons | Week of September 25, 2023
4 | Research Rev. Proc. 2015-41 Appeals procedures, including Protest requirements, format standards, and timeline considerations | Nazari | October 15, 2023
5 | Begin drafting Protest framework and outline in anticipation of NOPA issuance | Simmons / Nazari | Upon receipt of NOPA
6 | Coordinate with Ciarán Thornbury (Thornbury & Keogh, Dublin) regarding potential Irish tax implications and competent authority / MAP considerations under U.S.-Ireland Treaty | Nazari | October 2023
7 | Update matter status report (Q3 2023) to reflect substance of call and anticipated NOPA timeline | Simmons | October 3, 2023
8 | Review statute of limitations for TY 2017 and TY 2018; confirm that Form 872 consents to extend the assessment period are current and extend through at least December 31, 2024 | Nazari | October 2023
9 | Prepare for client conference call with Whitfield, Staines, Iyer, and Falk upon receipt of NOPA; coordinate scheduling with Sylvia Hartwell | Cross / Hartwell | Upon NOPA issuance

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