1018-00009 · Client 1018 · Examination Proceedings

irs-economist-meeting-notes.docx DOCUMENT M&A / Corporate

100 / 176 ← → ✕

PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT

This memorandum constitutes attorney work product prepared in anticipation of litigation and is protected from disclosure by the attorney work product doctrine, the attorney-client privilege, and all other applicable privileges. This document should not be disclosed to any person outside the scope of the applicable privilege without the express prior authorization of Leonard Cross, Responsible Partner. Any inadvertent disclosure does not constitute a waiver of any privilege.

CALDERWOOD & HARKNESS LLP Meeting Notes — Conference Call with IRS Economist Dr. Alan Washburne

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. (EIN: 22-3741856)

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

Date of Meeting/Call: August 15, 2023

Time: 2:00 p.m. – 3:45 p.m. (Eastern)

Format: Teleconference (IRS-initiated)

Notes Prepared By: Garrett Simmons, Lead Associate, Calderwood & Harkness LLP

Reviewed By: Leonard Cross, Responsible Partner, Calderwood & Harkness LLP

Date of Notes: August 15, 2023 (finalized August 16, 2023)

1. Attendees

1.1 IRS Attendees

The following individuals participated on the call on behalf of the Internal Revenue Service:

• Dr. Alan Washburne, Economist, IRS Transfer Pricing Practice — principal presenter of the IRS's preliminary economic analysis and methodology throughout the call.

• Patricia Dunleavy, Lead Revenue Agent, IRS Large Business & International Division (LB&I) — served as the examination team's primary administrative coordinator for the call; introduced procedural topics and addressed questions regarding the Information Document Request (IDR) process and timeline for proposed adjustments.

• Gerald Meskill, Supervisory Revenue Agent / Team Manager, IRS LB&I — joined briefly at the outset of the call for introductory remarks; departed the call after approximately ten minutes and did not participate in the substantive economic discussion.

• Franklin Rosario, Attorney-Advisor, IRS Office of Chief Counsel — participated in a listening and advisory role for the duration of the call. Mr. Rosario did not substantively participate beyond brief remarks regarding the legal framework applicable to the economic substance analysis (see Section 4 below).

1.2 Taxpayer / Counsel Attendees

The following individuals participated on the call on behalf of the taxpayer, Penterra Pharmaceuticals Corp. ("PPC"), and its outside advisors:

• Leonard Cross, Responsible Partner, Calderwood & Harkness LLP — lead counsel for the taxpayer; directed substantive questioning and stated PPC's positions throughout the call.

• Garrett Simmons, Lead Associate, Calderwood & Harkness LLP — notetaker for the call; participated in limited procedural discussions.

• Marcus Whitfield, Vice President of Global Tax, Penterra Pharmaceuticals Corp. — participated as PPC's in-house tax representative; did not make substantive statements on the call but was present to hear the IRS's disclosed methodology and preliminary numbers.

• Dr. Helena Vasquez, Managing Director, Whitmore Valuation Group LLC — participated under Kovel arrangement (C&H Matter Ref. 1018-00009-KV) as PPC's independent economic expert. Dr. Vasquez raised substantive economic questions regarding discount rate methodology, comparability screening, and the use of hindsight-informed revenue projections.

2. Purpose and Background of the Call

The call was requested by Revenue Agent Dunleavy by email to Garrett Simmons on August 8, 2023. Dunleavy's email stated that the purpose of the call was to provide PPC's representatives with an opportunity to discuss Dr. Washburne's preliminary economic analysis and methodology as part of the ongoing transfer pricing examination of PPC's intercompany transactions with Penterra Biopharma International DAC ("PBI"), a wholly owned Irish subsidiary of PPC, for the tax years 2017 through 2020. The call was characterized by the IRS as a courtesy pre-adjustment conference intended to provide the taxpayer with transparency regarding the economic direction of the examination before any formal proposed adjustment was issued.

As background, this transfer pricing examination was initiated in June 2022. Between that date and the date of this call, a total of forty-seven (47) Information Document Requests (IDRs) have been issued by the examination team to PPC, with final IDRs still outstanding through September 2023. The examination covers all intercompany transactions between PPC and PBI during the examination period, with principal focus on (a) the cost-sharing arrangement (CSA) between PPC and PBI, effective July 1, 2012, including the platform contribution transaction (PCT) payment, and (b) a legacy intellectual property royalty arrangement pursuant to which PBI pays PPC a royalty of 4.5% on non-Americas net sales of compounds developed prior to 2012.

Supervisory Revenue Agent Meskill opened the call at approximately 2:00 p.m. by noting the IRS's intent to give PPC "a fair opportunity" to understand the economic direction of the examination before any formal proposed adjustment was issued. He stated that the purpose of the call was to present Dr. Washburne's preliminary findings and to provide PPC's representatives with an opportunity to ask questions and present their own views. He emphasized that the IRS wanted to conduct the examination in a cooperative and transparent manner, consistent with the LB&I examination process. After these introductory remarks, Meskill departed the call at approximately 2:10 p.m.

Cross acknowledged the purpose of the call and thanked the IRS team for the opportunity to discuss the economic analysis in advance of any formal proposed adjustment. Cross stated, however, that PPC reserved all rights and objections with respect to any issue discussed on the call, including but not limited to the right to challenge the legal and factual bases for any proposed adjustment. Cross further stated that any statements by PPC's representatives on the call — including statements by PPC's in-house personnel and PPC's retained economic experts — were not to be construed as concessions or admissions on any issue, and that PPC's participation in the call was without prejudice to any position PPC might take in future proceedings, including any Protest, Appeals, or litigation.

3. Dr. Washburne's Presentation of Methodology

3.1 Overview of Approach

Dr. Washburne began his presentation at approximately 2:12 p.m. by providing an overview of the scope and framework of his economic analysis. He stated that he had been retained by the LB&I examination team to evaluate the arm's-length character of two sets of intercompany transactions between PPC and PBI:

(a) The cost-sharing arrangement (CSA) between PPC and PBI, effective July 1, 2012, including the platform contribution transaction (PCT) payment of $312 million made by PBI to PPC upon execution of the CSA, and the ongoing cost-sharing percentages applied to allocate qualified research and development expenditures between PPC and PBI for each of the tax years at issue; and

(b) The legacy intellectual property royalty arrangement under which PBI pays PPC a royalty of 4.5% of non-Americas net sales in respect of pre-2012 compounds — i.e., compounds for which development was completed and regulatory approval was obtained prior to the effective date of the CSA on July 1, 2012.

Dr. Washburne stated that his analysis was conducted under the arm's-length standard prescribed by Section 482 of the Internal Revenue Code and that he evaluated PPC's transfer pricing methodologies against the standards set forth in Treasury Regulations §§ 1.482-4 (regarding transfers of intangible property) and 1.482-7 (regarding cost-sharing arrangements). He described his approach as applying the analytical framework contemplated by those regulations to determine whether PPC's reported intercompany pricing reflected results that were consistent with the results that would have been obtained between uncontrolled parties dealing at arm's length.

Dr. Washburne emphasized that the best method rule under Treasury Regulations § 1.482-1(d) served as the guiding principle for his selection of specific transfer pricing methods. He stated that in each instance, he selected the method that, under the facts and circumstances, provided "the most reliable measure of an arm's length result," taking into account the degree of comparability between controlled and uncontrolled transactions and the quality of the data and assumptions used.

3.2 PCT Valuation — Income Method

Dr. Washburne disclosed that the principal component of his analysis of the CSA involved a revaluation of the pre-existing intellectual property contributed by PPC to the CSA as part of the platform contribution transaction (PCT). He stated that he valued the PCT using an income method — specifically, a discounted cash flow (DCF) approach — pursuant to Treasury Regulations § 1.482-7(g)(4). He noted that PPC's own PCT valuation, prepared at the time of the CSA's execution in 2012, also employed an income method, and that his analysis was therefore based on the same methodological framework as PPC's but with different inputs and assumptions.

Revenue Projections. Dr. Washburne stated that a key area of divergence between his analysis and PPC's 2012 PCT valuation concerned the revenue projections used in the DCF model. He disclosed that he used revenue projections that he described as "adjusted for actual outcomes" — meaning that he applied hindsight-informed revenue data from 2012 through 2020 to recalibrate the revenue projections originally used in PPC's 2012 PCT valuation. He stated that actual non-Americas product revenue growth for PPC's two most significant compounds — Veritaxol and Imvara — substantially exceeded PPC's 2012 projections, which Dr. Washburne characterized as "conservative" and as having systematically underestimated the revenue potential of the contributed IP.

Dr. Washburne specifically cited the following actual revenue figures as evidence that PPC's original revenue assumptions understated the reasonably anticipated benefits of the contributed IP:

• Veritaxol: Non-Americas net sales reached $1.34 billion in 2020, substantially exceeding PPC's 2012 projection for that year.

• Imvara: Non-Americas net sales reached $790 million in 2020, also substantially exceeding the original 2012 projection.

• Cerulon: Non-Americas net sales of $280 million in 2020 were approximately in line with the original 2012 projections. Dr. Washburne acknowledged that Cerulon's performance was consistent with PPC's forecasting.

Dr. Washburne stated that, in his view, the significant outperformance of Veritaxol and Imvara relative to the 2012 projections indicated that PPC's original forecasts were not reflective of reasonably anticipated benefits at the time of the CSA, and that a more reliable valuation of the PCT could be obtained by incorporating the actual revenue trajectory observed during the 2012–2020 period.

discount Rate. Dr. Washburne disclosed that he applied a weighted-average cost of capital (WACC) of 7.2% as the discount rate in his DCF analysis. He described this discount rate as reflecting a pharmaceutical-industry WACC derived from publicly traded specialty pharmaceutical companies, adjusted downward because, in his view, the IP portfolio at issue — which consisted primarily of late-stage clinical and approved compounds with established commercial track records — carried lower development risk than the average pharmaceutical IP portfolio. He stated that the specific components of his 7.2% WACC were as follows:

• A risk-free rate of approximately 2.1%, based on mid-2012 U.S. Treasury yields;

• An equity risk premium of 5.5%;

• A beta of 0.85, based on his comparable company set of publicly traded specialty pharmaceutical and biotechnology companies; and

• A debt premium reflecting PPC's investment-grade credit profile.

Dr. Washburne did not disclose the specific companies included in his comparable company set for the beta calculation during the call (see Section 3.6 below for the detailed discount rate discussion).

Resulting PCT Valuation. Dr. Washburne stated that his preliminary PCT valuation was approximately $852 million, compared to PPC's actual PCT payment of $312 million at the time of the CSA in 2012. He described the resulting delta of approximately $540 million as "significant" and stated that this differential formed the foundation for his analysis of the cost-sharing adjustments for the examination years.

Dr. Washburne acknowledged that the year 2012 — the year in which the PCT was executed — was outside the examination years at issue (TY 2017–2020). However, he stated that the IRS's position was that the undervaluation of the PCT was directly relevant to the examination years because the initial undervaluation of the contributed IP affected the allocation of intangible value between the parties, which in turn informed the reasonably anticipated benefits (RAB) calculation used to determine PBI's cost-sharing percentages in each of the examination years. In other words, the undervaluation of the PCT at inception had a cascading effect on the cost-sharing ratios throughout the life of the CSA, including during the examination period.

C&H/Whitmore Observations Noted During Call. Cross asked Dr. Washburne whether his PCT valuation accounted for the regulatory and commercial risk borne by PBI in non-Americas markets, including country-specific pricing risk across sixty-eight (68) separate country markets in which PBI commercialized PPC's pharmaceutical products. Cross noted that non-Americas markets include jurisdictions with significant pricing regulation (e.g., reference pricing systems in the European Union, government price controls in Japan and South Korea, and variable reimbursement frameworks across emerging markets), each of which introduces distinct commercial risk that should be reflected in the valuation.

Dr. Washburne responded that his analysis "considered aggregate market risk" but did not model country-by-country risk factors. He stated that it would be impractical to model risk on a country-by-country basis for sixty-eight markets and that aggregate projections were a reasonable and reliable approach.

Dr. Vasquez noted — but did not elaborate on the call, consistent with the team's practice of reserving detailed rebuttal for written submissions — that the use of hindsight-informed revenue projections was inconsistent with the standard under Treasury Regulations § 1.482-7, which calls for valuation based on "reasonably anticipated" benefits at the time of the transaction (i.e., as of the date of the PCT in 2012), not based on actual revenue results observed in subsequent years. Dr. Vasquez indicated that a detailed rebuttal of this methodology would be provided in PPC's written response.

3.3 CSA Cost-Sharing Ratio Analysis

Dr. Washburne next addressed his analysis of the reasonably anticipated benefits (RAB) split used to determine PBI's cost-sharing percentages for each of the four examination years. He stated that the cost-sharing percentages determine the allocation of qualified research and development expenditures between PPC and PBI under the CSA, and that, in his view, PPC's reported cost-sharing percentages for PBI were too low, resulting in PBI underpaying its share of the qualified R&D costs.

PPC's Reported Cost-Sharing Percentages for PBI. The cost-sharing percentages reported by PPC for PBI's share of total qualified R&D expenditures in each examination year were as follows:

Dr. Washburne's Proposed Cost-Sharing Percentages for PBI. Dr. Washburne disclosed the following proposed cost-sharing percentages, reflecting his adjusted RAB analysis:

Basis for the Proposed Adjustments. Dr. Washburne stated that PPC's reported RAB projections understated the proportion of benefits attributable to non-Americas territories for three principal reasons:

(a) PCT Undervaluation Effect. The original PCT undervalued PBI's intangible property rights, meaning PBI received more valuable rights than were accounted for in PPC's 2012 valuation. Because the RAB calculation is designed to reflect the anticipated benefits each party derives from the CSA, and because PBI's IP rights were worth more than the PCT payment reflected, PBI's share of reasonably anticipated benefits — and thus its cost-sharing obligation — should have been correspondingly higher.

(b) Systematic Forecasting Bias. Actual non-Americas revenue growth exceeded PPC's RAB projections in each examination year, suggesting, in Dr. Washburne's view, a systematic bias in PPC's forecasting methodology that consistently understated PBI's anticipated benefits.

(c) DEMPE Function Reattribution. Certain development, enhancement, maintenance, protection, and exploitation (DEMPE) functions that PPC attributed to PBI should, in Dr. Washburne's analysis, more properly be attributed to U.S.-based personnel at PPC. This reattribution would reduce PBI's independent contribution to value creation and necessitate a higher cost-share paid by PBI to compensate PPC for the functions and risk borne by PPC's U.S. operations.

Resulting Proposed CSA Adjustments. Based on the foregoing, Dr. Washburne disclosed the following proposed additional cost-sharing payments that would be owed by PBI to PPC:

DEMPE Function Discussion. Cross asked Dr. Washburne to identify the specific DEMPE functions that he believed were improperly attributed to PBI. Dr. Washburne responded that, in his analysis, key development activities — specifically, formulation development, clinical trial oversight, and regulatory strategy "at the global level" — remained "predominantly under the control of" PPC's U.S. operations in Princeton, New Jersey, and that PBI's headcount of 185 employees in 2020 was "limited" relative to the scale of IP exploitation undertaken through the non-Americas territory.

Cross responded by noting PPC's position that PBI exercised independent decision-making across sixty-eight (68) country markets in the non-Americas territory and provided the following specific data points in support of PBI's substantive DEMPE functions:

• PBI held forty-two (42) board meetings in Dublin, Ireland during the 2017–2020 examination period, at which key strategic, commercial, and operational decisions were made by PBI's board of directors.

• PBI incurred a cumulative total of €47.2 million in regulatory expenditures in the non-Americas territory during the 2017–2020 period, reflecting PBI's independent management of regulatory submissions, approvals, post-marketing surveillance, and pharmacovigilance activities across multiple jurisdictions.

• PBI made autonomous pricing and market-entry decisions for all products commercialized in the non-Americas territory, including independent assessment of market conditions, competitive dynamics, and reimbursement environments in each country market.

Dr. Washburne acknowledged these data points but stated that his analysis focused on "where the value-driving decisions were made, not the volume of local activities." He indicated that, in his view, the key decisions that drove the value of the IP — including decisions regarding the overall development strategy, clinical development programs, and global regulatory positioning — were made by PPC's U.S.-based operations, and that PBI's activities, while genuine, were more appropriately characterized as downstream commercialization activities rather than value-driving DEMPE functions.

3.4 Legacy IP Royalty Rate Analysis — CUT Method

Dr. Washburne next addressed his analysis of the 4.5% royalty rate applicable to PBI's non-Americas net sales of pre-2012 compounds under the legacy IP royalty arrangement. He stated that he analyzed the arm's-length character of the 4.5% royalty rate using the comparable uncontrolled transaction (CUT) method, pursuant to Treasury Regulations § 1.482-4.

Comparable Third-Party Agreements. Dr. Washburne stated that he had identified a set of comparable third-party pharmaceutical license agreements to serve as the basis for his CUT analysis. He provided the following details regarding his comparable set:

• He did not disclose the exact number of comparable agreements in his set on the call but indicated that it was "a meaningful sample" — sufficient, in his view, to provide a reliable indication of arm's-length royalty rates.

• He stated that the comparable agreements involved the licensing of "established pharmaceutical compounds" — i.e., compounds that had already received regulatory approval and were generating revenue at the time of the license — for exploitation in defined geographic territories.

• He stated that the therapeutic areas and stage of commercialization of the licensed compounds in his comparables were consistent with the characteristics of PPC's pre-2012 compounds.

• He stated that his comparable license agreements showed royalty rates ranging from approximately 8% to 14% of net sales, with a central tendency "in the range of 10% to 12%."

• Based on this analysis, he proposed applying an arm's-length royalty rate of 11.0% of net sales, which he described as "the midpoint of the most reliable comparables" within his set.

Resulting Proposed Royalty Adjustments. Based on the proposed increase in the royalty rate from 4.5% to 11.0% (a differential of 6.5 percentage points), Dr. Washburne disclosed the following proposed additional royalty payments that would be owed by PBI to PPC:

C&H/Whitmore Observations Noted During Call. Dr. Vasquez raised several questions regarding the reliability of Dr. Washburne's CUT analysis. She asked Dr. Washburne whether his comparable agreements were screened for functional comparability — specifically, whether the licensees in his comparable agreements bore the same level of commercial risk, performed the same DEMPE functions, and had the same scope of geographic territory as PBI. Dr. Vasquez noted that comparability under Treasury Regulations § 1.482-4(c) requires consideration of the functions performed, risks assumed, and contractual terms of both the controlled and uncontrolled transactions, and that mere similarity in the nature of the IP or therapeutic area is insufficient to establish comparability.

Dr. Washburne responded that his comparable agreements were "selected based on the nature of the IP, therapeutic area, and stage of commercialization" of the licensed compounds. He acknowledged, however, that he had not performed adjustments for differences in licensee functions or risk allocation between the comparable agreements and the PPC-PBI legacy royalty arrangement. He did not explain why such adjustments were unnecessary or how the absence of such adjustments affected the reliability of his analysis.

Cross noted that Whitmore Valuation Group's independent CUT analysis — prepared as part of PPC's contemporaneous transfer pricing documentation — had identified fourteen (14) comparable pharmaceutical license agreements with an interquartile range (IQR) of 3.1% to 6.8% and a median royalty rate of 4.4%. Cross stated that PPC's 4.5% royalty rate fell squarely within Whitmore's interquartile range and was virtually identical to the median of Whitmore's comparable set. Cross emphasized the significant divergence between the two comparable sets — Whitmore's IQR of 3.1%–6.8% versus Dr. Washburne's range of 8%–14% — and stated that this divergence underscored the need for careful scrutiny of the comparability criteria and screening methodology used by each party.

Dr. Washburne stated that he was "aware of the taxpayer's benchmarking" but believed his comparable set was "more directly comparable" to the PPC-PBI legacy royalty arrangement. He did not elaborate on why his comparable set was more directly comparable or identify specific criteria that differentiated his comparables from those identified by Whitmore.

Cross asked Dr. Washburne whether he would be willing to share his list of comparable agreements — or at least identifying details sufficient for Whitmore Valuation Group to evaluate the comparability of his selected transactions. Dr. Washburne deferred this request to Revenue Agent Dunleavy. Dunleavy stated that the IRS would "consider the request" and that the information might be provided "through the normal IDR process" if a formal adjustment was ultimately proposed. She did not commit to providing the information on any specific timeline.

3.5 Correlative Offset and Interaction of Adjustments

Dr. Washburne acknowledged, in response to a question from Cross, that there was potential for double-counting between the CSA cost-sharing adjustments (which effectively increase PBI's costs and thus reduce PBI's taxable income under the CSA) and the legacy royalty rate adjustment (which independently increases the amount PBI pays to PPC in the form of royalties). Both adjustments, taken together, would increase the income reported by PPC and decrease the income reported by PBI, and to the extent both adjustments capture overlapping economic value, a correlative offset would be necessary to avoid overstating the aggregate adjustment.

Dr. Washburne stated that the IRS's economic analysis would allow a correlative offset to avoid double-counting between the two sets of adjustments. However, he did not quantify the amount of the correlative offset on the call. He stated that the precise amount of the offset would depend on the final calculation of each adjustment and would be reflected in any formal proposed adjustment.

Cross noted that PPC expected any proposed adjustment to clearly identify and quantify such offsets, and that the failure to do so would result in an overstated adjustment that would not reflect arm's-length pricing. Cross emphasized that transparency regarding the interaction of adjustments was essential for PPC to meaningfully evaluate and respond to any proposed adjustment.

Note: The Notice of Proposed Adjustment (NOPA) subsequently issued on October 12, 2023 included a correlative offset of $42.65 million, reducing the aggregate proposed adjustment from $423.05 million (gross) to approximately $380.40 million (net).

3.6 discount Rate Discussion — Detailed Exchange

A substantial portion of the call — approximately twenty (20) minutes, from approximately 3:00 p.m. to 3:20 p.m. — was devoted to a detailed discussion of the divergence between Dr. Washburne's discount rate of 7.2% (WACC) and the 9.8% WACC reflected in PPC/Whitmore's analysis. This issue was identified during the call as the single most impactful economic variable in the PCT valuation, and the discussion was the most substantive and technically detailed exchange of the call.

Dr. Washburne's Comparable Company Set. Dr. Vasquez asked Dr. Washburne to identify the specific companies included in his comparable company set for the beta calculation. Dr. Washburne stated that he used "a group of specialty pharmaceutical and biotech companies with market capitalizations above $2 billion" as the basis for his comparable company set. He declined to provide the specific company names on the call, again deferring to the IDR process for any further disclosure of the underlying data and assumptions. He stated that the IRS's practice was to provide such detail in connection with a formal proposed adjustment, and that the call was intended as an informal overview rather than a full disclosure of his analysis.

Dr. Vasquez's Critique of the 7.2% WACC. Dr. Vasquez stated that the 7.2% WACC was inappropriately low for a PCT valuation involving pharmaceutical intellectual property. She articulated the following specific grounds for this position:

(a) Commercial Risk of Pharmaceutical IP. Pharmaceutical intellectual property carries significant commercial risk that is not adequately captured by a corporate-level WACC. These risks include patent cliffs (i.e., the loss of patent protection and accompanying entry of generic competition), competitive entry by branded therapeutics in the same indication, and regulatory changes across multiple jurisdictions that can materially affect pricing, reimbursement, and market access. These risks are specific to the intangible assets and are, in many cases, substantially greater than the risks borne by the enterprise as a whole.

(b) Asset-Specific vs. Corporate-Level discount Rate. The appropriate discount rate for a PCT valuation should reflect the specific risk profile of the intangible assets being valued, not the corporate-level WACC of the licensor. The cash flows associated with a portfolio of pharmaceutical compounds are subject to different and, in many respects, higher risks than the overall cash flows of a diversified pharmaceutical company. Dr. Vasquez noted that it is a well-established principle in valuation theory that the discount rate should match the risk profile of the cash flows being discounted.

(c) OECD Transfer Pricing Guidelines. The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (Chapter VI, particularly paragraphs 6.155 through 6.178) contemplate risk-adjusted discount rates that reflect the economic circumstances of the transaction, including the specific risk characteristics of the intangible assets at issue.

Whitmore's 9.8% WACC. Dr. Vasquez stated that Whitmore Valuation Group's 9.8% WACC reflected the following components:

• A higher equity risk premium of 6.2% (compared to Dr. Washburne's 5.5%);

• A beta of 1.10 (compared to Dr. Washburne's 0.85), reflecting pharmaceutical-specific risk and the higher volatility of pharmaceutical companies relative to the broader market;

• An intangible-asset-specific risk premium of approximately 1.5% above the corporate-level WACC, to reflect the higher risk profile of the IP-specific cash flow stream versus the company's overall cash flows.

Dr. Vasquez emphasized that the intangible-asset-specific premium of approximately 1.5% was critical to achieving a discount rate that accurately reflected the risk of the specific cash flows being valued in the PCT context. She stated that the corporate WACC reflects the blended risk of all of the company's assets and activities — including low-risk assets such as working capital and tangible assets — and that using the corporate WACC without adjustment to value a high-risk intangible asset stream would systematically understate the discount rate and overstate the present value of the intangible assets.

Dr. Washburne's Response. Dr. Washburne stated his view that the intangible-asset-specific risk premium was "not supported by the regulations" and that the corporate WACC was the appropriate starting point for a DCF valuation of the PCT. He acknowledged the theoretical basis for asset-specific discount rates but stated that, in his experience, the corporate WACC provided a sufficiently reliable measure for the type of IP at issue. He further stated that the IP at issue — consisting of approved compounds with established revenue streams — warranted a lower discount rate than pre-clinical or early clinical-stage assets, and that the 7.2% WACC reflected this lower risk profile. He did not specifically address the OECD guidance cited by Dr. Vasquez.

Cross stated that PPC would provide a detailed written analysis of the discount rate issue in due course, including a comprehensive rebuttal of Dr. Washburne's 7.2% WACC and supporting analysis for Whitmore's 9.8% WACC.

4. Economic Substance Discussion

Following the conclusion of Dr. Washburne's presentation of his quantitative methodology, Revenue Agent Dunleavy raised the IRS's position regarding PBI's economic substance. She asked Dr. Washburne to summarize the economic indicators he considered in connection with PBI's operational profile.

Dr. Washburne stated that while his analysis was "primarily quantitative" — focused on the transfer pricing methods and economic calculations described above — he had also reviewed certain qualitative indicators of PBI's economic substance as part of his overall assessment of the CSA and royalty arrangements. Specifically, he reviewed PBI's headcount data, which showed fifty-two (52) employees in 2012 growing to one hundred eighty-five (185) employees in 2020. He noted that PBI's ratio of employees to revenue — approximately €2.14 billion in non-Americas revenue with 185 employees, yielding a ratio of approximately €11.6 million per employee — suggested a "thin operational footprint" relative to the scale of IP-related income earned by PBI. He stated that this ratio was, in his view, indicative of a structure in which significant value-driving activities were performed outside of PBI (i.e., by PPC's U.S. operations) while PBI served primarily as a holding entity for IP rights and a conduit for intercompany payments.

Dr. Washburne acknowledged the existence of the forty-two (42) board meetings held in Dublin during the examination period and PBI's approximately 18,000 square feet of office space at Sandyford Business Park, Dublin. However, he characterized these as "indicative of governance" rather than "value-driving activity." He stated that governance activities — such as board oversight, compliance, and administrative functions — were distinct from the substantive DEMPE functions that, in his analysis, drove the value of PPC's pharmaceutical IP.

Cross responded that economic substance is demonstrated by the totality of PBI's functions, assets, and risks — not merely by headcount ratios or revenue-per-employee metrics. He stated that PBI maintained a robust and independent operational presence in Ireland and across the non-Americas territory and provided the following specific data points:

• PBI incurred €47.2 million in cumulative regulatory expenditures during the 2017–2020 examination period, reflecting its independent management of regulatory submissions, approvals, post-marketing surveillance, and pharmacovigilance activities across multiple jurisdictions.

• PBI exercised independent control over pricing decisions across sixty-eight (68) non-Americas country markets, including autonomous assessment of market conditions, competitive dynamics, government pricing regulations, and reimbursement environments.

• PBI managed contract manufacturing through Penterra Manufacturing Ireland Ltd. ("PMI"), a related entity with 620 employees at its manufacturing facility in Ringaskiddy, County Cork, Ireland, operating under a cost-plus 8% arrangement. PBI's management of PMI's manufacturing operations constituted a significant operational function, involving oversight of production scheduling, quality assurance, supply chain management, and distribution logistics.

• PBI maintained independent banking operations with Glenmore Bank Ireland plc, including its own cash management, treasury, and intercompany settlement functions.

Cross stated that the IRS's economic substance analysis, to the extent it relied primarily on headcount ratios and revenue-per-employee metrics, failed to account for the full range of PBI's substantive economic activities and did not reflect the arm's-length standard, which requires a holistic functional analysis.

Franklin Rosario briefly intervened at this point to note that the IRS's economic substance arguments would be "developed more fully in any formal proposed adjustment" and that the examination team intended to present a comprehensive analysis of PBI's DEMPE functions in the context of any Notice of Proposed Adjustment. He referenced the DEMPE framework as the applicable analytical framework under both the Treasury Regulations and the OECD Transfer Pricing Guidelines. Mr. Rosario did not elaborate further and did not make any additional substantive remarks during the remainder of the call.

5. Discussion of Penalty Considerations

Revenue Agent Dunleavy noted, toward the end of the call, that the examination team was also evaluating the potential applicability of the substantial valuation misstatement penalty under IRC § 6662(e). She stated that the penalty, if applicable, would impose an additional twenty percent (20%) penalty on the portion of the tax underpayment attributable to a Section 482 allocation. She did not indicate whether the examination team had reached a preliminary conclusion on the penalty issue but stated that it remained under active consideration.

Cross responded by stating that PPC had contemporaneous transfer pricing documentation for all four tax years at issue (2017, 2018, 2019, and 2020). He stated that the documentation was prepared by Crestfield & Associates LLP, under the supervision of Susan Lam, Transfer Pricing Partner, and that PPC's reported transfer pricing positions were supported by independent economic analysis conducted by qualified professionals in accordance with the applicable regulations.

Cross stated PPC's view that it had clear penalty protection under IRC § 6662(e)(3)(B) on the basis of both reasonable cause and contemporaneous documentation. He noted that PPC's transfer pricing documentation satisfied the requirements of Treas. Reg. § 1.6662-6 and that PPC's positions were based on reasonable applications of recognized transfer pricing methods, supported by robust economic analyses, and prepared with due diligence by qualified professionals.

Dunleavy acknowledged receipt of PPC's transfer pricing documentation, which had been produced in response to IDR No. 4, dated August 1, 2022. She stated that the penalty question would be addressed "if and when" a formal adjustment was proposed and that the examination team would consider all relevant factors at that time. She did not provide any further detail regarding the IRS's preliminary assessment of the penalty issue.

6. Procedural Discussion and Next Steps

At approximately 3:35 p.m., the discussion turned to procedural matters and next steps. Dunleavy stated that the IRS anticipated completing its economic analysis and issuing any proposed adjustment "by late September or October 2023." She noted that the timeline was subject to the completion of Dr. Washburne's final report and the examination team's internal review process.

Note: The Notice of Proposed Adjustment (NOPA) was subsequently issued on October 12, 2023.

Cross asked whether the IRS would provide a draft of Dr. Washburne's economist report before any formal proposed adjustment was issued. He stated that providing the report in advance would allow PPC to engage constructively with the IRS's economic analysis and potentially narrow the issues in dispute before a formal adjustment was proposed. Dunleavy stated that providing a draft of the economist report was "not standard procedure" but that the IRS would "consider sharing additional detail" with PPC during the IDR process. She did not commit to providing the report.

Cross reiterated PPC's request for the IRS economist's comparable company list (used for the beta calculation in the discount rate analysis) and comparable transaction list (used for the CUT analysis of the royalty rate). Cross stated that disclosure of these lists was essential for Whitmore Valuation Group to evaluate the comparability of Dr. Washburne's selected data points and to prepare a meaningful response. Dunleavy agreed to "take it under advisement" and stated that the examination team would respond to the request in due course.

The parties agreed that there were no further IDR responses currently outstanding from PPC. Dunleavy indicated, however, that additional IDRs — beyond the forty-seven already issued through the date of the call — might be forthcoming. She noted that Dr. Washburne's analysis might require supplemental compensation and travel data for PBI's employees, and that additional IDRs might be issued to obtain this information.

Note: A total of forty-seven (47) IDRs were ultimately issued through September 2023.

The call concluded at approximately 3:45 p.m. Eastern.

7. C&H Internal Observations and Action Items

The following observations and action items are for internal use by the Calderwood & Harkness team and Whitmore Valuation Group (under Kovel privilege) only. These observations reflect preliminary attorney work product assessments and should not be shared with the client or any third party without prior authorization from Leonard Cross.

7.1 Key Observations

1. Discount Rate as the Pivotal Economic Issue. Dr. Washburne's 7.2% WACC is the single most impactful assumption driving the PCT overvaluation. The differential between Dr. Washburne's 7.2% WACC and PPC/Whitmore's 9.8% WACC accounts for the vast majority of the $540 million gap between the IRS's proposed PCT value of $852 million and PPC's actual $312 million PCT payment. Preliminary sensitivity analysis conducted by Dr. Vasquez's team indicates that, at PPC/Whitmore's 9.8% WACC, the PCT value range is approximately $278 million to $361 million — well within the range of PPC's actual $312 million payment. The discount rate dispute will therefore be the pivotal economic issue in any Protest, Appeals, or litigation proceeding. It is critical that the team develop a comprehensive, well-supported rebuttal of Dr. Washburne's 7.2% WACC, including detailed support for Whitmore's 9.8% WACC and the intangible-asset-specific risk premium.

2. CUT Selection Methodology — Material Flaw. Dr. Washburne's CUT selection for the royalty rate analysis appears materially flawed. He acknowledged on the call that he had not performed functional comparability adjustments for differences in licensee functions, risk allocation, or geographic scope between his comparable agreements and the PPC-PBI legacy royalty arrangement. This omission is a significant vulnerability in his analysis, as the Treasury Regulations and OECD Guidelines require careful comparability analysis, including appropriate adjustments for differences between controlled and uncontrolled transactions. Moreover, his comparable range (8%–14%) diverges significantly from Whitmore's fourteen-agreement comparable set (IQR: 3.1%–6.8%, median 4.4%), which was prepared with rigorous functional comparability screening. It is imperative that the team obtain and scrutinize Dr. Washburne's comparable agreement list when and if it is disclosed, and that the rebuttal report address the divergence in detail.

3. Hindsight Bias in Revenue Projections. The IRS's use of hindsight-informed revenue projections for the PCT valuation is a significant vulnerability in the IRS's position. Treasury Regulations § 1.482-7 requires that the PCT be valued based on the "reasonably anticipated" benefits at the time of the transaction (July 2012), not on the basis of actual revenue results observed during the subsequent eight years. Dr. Washburne's use of actual 2012–2020 revenue data to recalibrate the original 2012 projections effectively converts an ex ante valuation into an ex post reconciliation, which is inconsistent with the regulatory framework. This issue should be a prominent feature of the rebuttal analysis and, if necessary, the Protest filing.

4. Economic Substance Challenge — Secondary. The economic substance challenge appears to be secondary to the quantitative transfer pricing adjustments. Dr. Washburne acknowledged on the call that his analysis was "primarily quantitative," and the substance arguments raised by Dunleavy and Rosario appeared to serve as a supporting narrative rather than an independent basis for adjustment. PPC's functional analysis already addresses the substantive DEMPE functions performed by PBI, and the team should ensure that the DEMPE functions matrix is updated to address the specific data points raised by Dr. Washburne on the call (e.g., the employee-to-revenue ratio, the characterization of board meetings as "governance" rather than "value-driving activity").

5. Correlative Offset. The correlative offset discussion confirms that the IRS is aware of the double-counting risk inherent in simultaneously adjusting the CSA cost-sharing ratios and the legacy royalty rate. PPC should ensure that any NOPA includes an explicit, adequately quantified correlative offset, and should be prepared to challenge the sufficiency of any offset proposed by the IRS. The eventual $42.65 million offset included in the NOPA should be independently verified by Whitmore.

7.2 Action Items

The following action items were identified following the call:

1. [Cross] Debrief with Marcus Whitfield (VP of Global Tax, PPC) and Deborah Staines (General Counsel, PPC). Provide a summary of Dr. Washburne's disclosed methodology and preliminary numbers. Target: August 17, 2023.

2. [Simmons / Dr. Vasquez] Prepare internal memorandum rebutting Dr. Washburne's WACC of 7.2%, to be developed into a formal rebuttal report for use in Protest and Appeals proceedings. The memorandum should fully document the support for Whitmore's 9.8% WACC, including the risk-free rate, equity risk premium of 6.2%, beta of 1.10, and the intangible-asset-specific risk premium of approximately 1.5%. The memorandum should also address Dr. Washburne's assertion that the intangible-asset-specific premium is "not supported by the regulations."

3. [Dr. Vasquez / Dr. Chakrabarti] Begin drafting the comprehensive rebuttal of Dr. Washburne's economic analysis, addressing the following principal topics:

(a) Hindsight bias in revenue projections and the applicable legal standard under Treas. Reg. § 1.482-7 (reasonably anticipated benefits at the time of the PCT);

(b) WACC/Discount rate assumptions, including the case for the intangible-asset-specific risk premium;

(d) DEMPE function attribution and the proper allocation of value-driving functions between PPC and PBI.

4. [Simmons] Follow up with Revenue Agent Dunleavy in writing (letter or email) to reiterate PPC's request for Dr. Washburne's comparable company list (used for the beta calculation) and comparable transaction list (used for the CUT analysis). The written request should reference the discussion on the call and the IRS's agreement to "take it under advisement."

5. [Nazari] Update the DEMPE functions matrix with additional data points raised on the call, including Dr. Washburne's characterization of PBI's employee-to-revenue ratio as indicating a "thin operational footprint" and his characterization of PBI's board meetings as "indicative of governance" rather than "value-driving activity." The updated matrix should ensure that the functional analysis fully addresses these points with specific, documented evidence of PBI's substantive DEMPE functions.

6. [Cross] Coordinate with Ciarán Thornbury at Thornbury & Keogh Solicitors (Dublin) regarding any Irish tax implications of Dr. Washburne's methodology, particularly the Knowledge Development box (6.25% effective rate) and how the IRS's proposed recharacterization of PBI's functions and income might interact with PBI's Irish tax position. Consider whether a competent authority proceeding under the U.S.-Ireland income tax treaty may become relevant.

7. [Simmons] Update the status update memorandum for the Q3 2023 quarterly report to PPC management, incorporating the substance of this call and the IRS's preliminary proposed adjustment amounts. The memorandum should be suitable for review by PPC's Audit Committee and should be marked as privileged.

8. [Cross] Assess whether the IRS's preliminary aggregate adjustment numbers — approximately $235 million (CSA) plus approximately $188 million (royalty) minus a correlative offset, yielding an estimated net adjustment of approximately $380 million — align with previous exposure estimates included in PPC's FIN 48 / ASC 740 analysis. Update the sensitivity analysis to reflect the IRS's disclosed methodology and preliminary numbers.

8. Distribution

These meeting notes have been distributed as follows:

Calderwood & Harkness LLP:

• Leonard Cross, Responsible Partner

• Sylvia Hartwell, Partner

• Garrett Simmons, Lead Associate

• Leila Nazari, Associate

Whitmore Valuation Group LLC (under Kovel privilege, C&H Matter Ref. 1018-00009-KV):

• Dr. Helena Vasquez, Managing Director

• Dr. Rohan Chakrabarti, Director

Copy to file: C&H Matter 1018-00009

Not distributed to client. These notes have not been distributed to client personnel pending Mr. Cross's review and preparation of a separate client-facing summary memorandum. Any distribution to the client will be made at Mr. Cross's direction.

Prepared by:

________________________________________

Garrett Simmons Lead Associate Calderwood & Harkness LLP

Date: August 15, 2023 (finalized August 16, 2023)

Reviewed by:

________________________________________

Leonard Cross Responsible Partner Calderwood & Harkness LLP

Date: August 16, 2023

PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT This memorandum is protected by the attorney-client privilege and the attorney work product doctrine. It has been prepared in anticipation of litigation and reflects the mental impressions, conclusions, and legal theories of counsel. Any inadvertent disclosure does not constitute a waiver of any applicable privilege.

Tax Year	PBI Share (%)	Total Qualified R&D	PBI Cost-Share Amount
2017	38.2%	$487.3M	$186.15M
2018	39.6%	$523.8M	$207.42M
2019	41.1%	$561.2M	$230.65M
2020	42.7%	$598.4M	$255.52M
Tax Year	PBI Share — PPC Reported	PBI Share — IRS Proposed	Increase (ppt)
2017	38.2%	48.2%	+10.0
2018	39.6%	50.6%	+11.0
2019	41.1%	52.3%	+11.2
2020	42.7%	53.7%	+11.0
Tax Year	Additional Cost-Share to PPC
2017	$48.73M
2018	$57.61M
2019	$62.85M
2020	$65.82M
Total	$235.01M
Tax Year	Non-Americas Net Sales (Pre-2012 Compounds)	Rate Differential	Additional Royalty
2017	$814.6M	6.5%	$52.95M
2018	$762.3M	6.5%	$49.55M
2019	$691.8M	6.5%	$44.97M
2020	$624.1M	6.5%	$40.57M
Total	$188.04M

PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT
This memorandum constitutes attorney work product prepared in anticipation of litigation and is protected from disclosure by the attorney work product doctrine, the attorney-client privilege, and all other applicable privileges. This document should not be disclosed to any person outside the scope of the applicable privilege without the express prior authorization of Leonard Cross, Responsible Partner. Any inadvertent disclosure does not constitute a waiver of any privilege.
CALDERWOOD & HARKNESS LLP Meeting Notes — Conference Call with IRS Economist Dr. Alan Washburne
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. (EIN: 22-3741856)
Tax Years at Issue: 2017, 2018, 2019, 2020
Date of Meeting/Call: August 15, 2023
Time: 2:00 p.m. – 3:45 p.m. (Eastern)
Format: Teleconference (IRS-initiated)
Notes Prepared By: Garrett Simmons, Lead Associate, Calderwood & Harkness LLP
Reviewed By: Leonard Cross, Responsible Partner, Calderwood & Harkness LLP
Date of Notes: August 15, 2023 (finalized August 16, 2023)
1. Attendees
1.1 IRS Attendees
The following individuals participated on the call on behalf of the Internal Revenue Service:
•  Dr. Alan Washburne, Economist, IRS Transfer Pricing Practice — principal presenter of the IRS's preliminary economic analysis and methodology throughout the call.
•  Patricia Dunleavy, Lead Revenue Agent, IRS Large Business & International Division (LB&I) — served as the examination team's primary administrative coordinator for the call; introduced procedural topics and addressed questions regarding the Information Document Request (IDR) process and timeline for proposed adjustments.
•  Gerald Meskill, Supervisory Revenue Agent / Team Manager, IRS LB&I — joined briefly at the outset of the call for introductory remarks; departed the call after approximately ten minutes and did not participate in the substantive economic discussion.
•  Franklin Rosario, Attorney-Advisor, IRS Office of Chief Counsel — participated in a listening and advisory role for the duration of the call. Mr. Rosario did not substantively participate beyond brief remarks regarding the legal framework applicable to the economic substance analysis (see Section 4 below).
1.2 Taxpayer / Counsel Attendees
The following individuals participated on the call on behalf of the taxpayer, Penterra Pharmaceuticals Corp. ("PPC"), and its outside advisors:
•  Leonard Cross, Responsible Partner, Calderwood & Harkness LLP — lead counsel for the taxpayer; directed substantive questioning and stated PPC's positions throughout the call.
•  Garrett Simmons, Lead Associate, Calderwood & Harkness LLP — notetaker for the call; participated in limited procedural discussions.
•  Marcus Whitfield, Vice President of Global Tax, Penterra Pharmaceuticals Corp. — participated as PPC's in-house tax representative; did not make substantive statements on the call but was present to hear the IRS's disclosed methodology and preliminary numbers.
•  Dr. Helena Vasquez, Managing Director, Whitmore Valuation Group LLC — participated under Kovel arrangement (C&H Matter Ref. 1018-00009-KV) as PPC's independent economic expert. Dr. Vasquez raised substantive economic questions regarding discount rate methodology, comparability screening, and the use of hindsight-informed revenue projections.
2. Purpose and Background of the Call
The call was requested by Revenue Agent Dunleavy by email to Garrett Simmons on August 8, 2023. Dunleavy's email stated that the purpose of the call was to provide PPC's representatives with an opportunity to discuss Dr. Washburne's preliminary economic analysis and methodology as part of the ongoing transfer pricing examination of PPC's intercompany transactions with Penterra Biopharma International DAC ("PBI"), a wholly owned Irish subsidiary of PPC, for the tax years 2017 through 2020. The call was characterized by the IRS as a courtesy pre-adjustment conference intended to provide the taxpayer with transparency regarding the economic direction of the examination before any formal proposed adjustment was issued.
As background, this transfer pricing examination was initiated in June 2022. Between that date and the date of this call, a total of forty-seven (47) Information Document Requests (IDRs) have been issued by the examination team to PPC, with final IDRs still outstanding through September 2023. The examination covers all intercompany transactions between PPC and PBI during the examination period, with principal focus on (a) the cost-sharing arrangement (CSA) between PPC and PBI, effective July 1, 2012, including the platform contribution transaction (PCT) payment, and (b) a legacy intellectual property royalty arrangement pursuant to which PBI pays PPC a royalty of 4.5% on non-Americas net sales of compounds developed prior to 2012.
Supervisory Revenue Agent Meskill opened the call at approximately 2:00 p.m. by noting the IRS's intent to give PPC "a fair opportunity" to understand the economic direction of the examination before any formal proposed adjustment was issued. He stated that the purpose of the call was to present Dr. Washburne's preliminary findings and to provide PPC's representatives with an opportunity to ask questions and present their own views. He emphasized that the IRS wanted to conduct the examination in a cooperative and transparent manner, consistent with the LB&I examination process. After these introductory remarks, Meskill departed the call at approximately 2:10 p.m.
Cross acknowledged the purpose of the call and thanked the IRS team for the opportunity to discuss the economic analysis in advance of any formal proposed adjustment. Cross stated, however, that PPC reserved all rights and objections with respect to any issue discussed on the call, including but not limited to the right to challenge the legal and factual bases for any proposed adjustment. Cross further stated that any statements by PPC's representatives on the call — including statements by PPC's in-house personnel and PPC's retained economic experts — were not to be construed as concessions or admissions on any issue, and that PPC's participation in the call was without prejudice to any position PPC might take in future proceedings, including any Protest, Appeals, or litigation.
3. Dr. Washburne's Presentation of Methodology
3.1 Overview of Approach
Dr. Washburne began his presentation at approximately 2:12 p.m. by providing an overview of the scope and framework of his economic analysis. He stated that he had been retained by the LB&I examination team to evaluate the arm's-length character of two sets of intercompany transactions between PPC and PBI:
(a) The cost-sharing arrangement (CSA) between PPC and PBI, effective July 1, 2012, including the platform contribution transaction (PCT) payment of $312 million made by PBI to PPC upon execution of the CSA, and the ongoing cost-sharing percentages applied to allocate qualified research and development expenditures between PPC and PBI for each of the tax years at issue; and
(b) The legacy intellectual property royalty arrangement under which PBI pays PPC a royalty of 4.5% of non-Americas net sales in respect of pre-2012 compounds — i.e., compounds for which development was completed and regulatory approval was obtained prior to the effective date of the CSA on July 1, 2012.
Dr. Washburne stated that his analysis was conducted under the arm's-length standard prescribed by Section 482 of the Internal Revenue Code and that he evaluated PPC's transfer pricing methodologies against the standards set forth in Treasury Regulations §§ 1.482-4 (regarding transfers of intangible property) and 1.482-7 (regarding cost-sharing arrangements). He described his approach as applying the analytical framework contemplated by those regulations to determine whether PPC's reported intercompany pricing reflected results that were consistent with the results that would have been obtained between uncontrolled parties dealing at arm's length.
Dr. Washburne emphasized that the best method rule under Treasury Regulations § 1.482-1(d) served as the guiding principle for his selection of specific transfer pricing methods. He stated that in each instance, he selected the method that, under the facts and circumstances, provided "the most reliable measure of an arm's length result," taking into account the degree of comparability between controlled and uncontrolled transactions and the quality of the data and assumptions used.
3.2 PCT Valuation — Income Method
Dr. Washburne disclosed that the principal component of his analysis of the CSA involved a revaluation of the pre-existing intellectual property contributed by PPC to the CSA as part of the platform contribution transaction (PCT). He stated that he valued the PCT using an income method — specifically, a discounted cash flow (DCF) approach — pursuant to Treasury Regulations § 1.482-7(g)(4). He noted that PPC's own PCT valuation, prepared at the time of the CSA's execution in 2012, also employed an income method, and that his analysis was therefore based on the same methodological framework as PPC's but with different inputs and assumptions.
Revenue Projections. Dr. Washburne stated that a key area of divergence between his analysis and PPC's 2012 PCT valuation concerned the revenue projections used in the DCF model. He disclosed that he used revenue projections that he described as "adjusted for actual outcomes" — meaning that he applied hindsight-informed revenue data from 2012 through 2020 to recalibrate the revenue projections originally used in PPC's 2012 PCT valuation. He stated that actual non-Americas product revenue growth for PPC's two most significant compounds — Veritaxol and Imvara — substantially exceeded PPC's 2012 projections, which Dr. Washburne characterized as "conservative" and as having systematically underestimated the revenue potential of the contributed IP.
Dr. Washburne specifically cited the following actual revenue figures as evidence that PPC's original revenue assumptions understated the reasonably anticipated benefits of the contributed IP:
•  Veritaxol: Non-Americas net sales reached $1.34 billion in 2020, substantially exceeding PPC's 2012 projection for that year.
•  Imvara: Non-Americas net sales reached $790 million in 2020, also substantially exceeding the original 2012 projection.
•  Cerulon: Non-Americas net sales of $280 million in 2020 were approximately in line with the original 2012 projections. Dr. Washburne acknowledged that Cerulon's performance was consistent with PPC's forecasting.
Dr. Washburne stated that, in his view, the significant outperformance of Veritaxol and Imvara relative to the 2012 projections indicated that PPC's original forecasts were not reflective of reasonably anticipated benefits at the time of the CSA, and that a more reliable valuation of the PCT could be obtained by incorporating the actual revenue trajectory observed during the 2012–2020 period.
discount Rate. Dr. Washburne disclosed that he applied a weighted-average cost of capital (WACC) of 7.2% as the discount rate in his DCF analysis. He described this discount rate as reflecting a pharmaceutical-industry WACC derived from publicly traded specialty pharmaceutical companies, adjusted downward because, in his view, the IP portfolio at issue — which consisted primarily of late-stage clinical and approved compounds with established commercial track records — carried lower development risk than the average pharmaceutical IP portfolio. He stated that the specific components of his 7.2% WACC were as follows:
•  A risk-free rate of approximately 2.1%, based on mid-2012 U.S. Treasury yields;
•  An equity risk premium of 5.5%;
•  A beta of 0.85, based on his comparable company set of publicly traded specialty pharmaceutical and biotechnology companies; and
•  A debt premium reflecting PPC's investment-grade credit profile.
Dr. Washburne did not disclose the specific companies included in his comparable company set for the beta calculation during the call (see Section 3.6 below for the detailed discount rate discussion).
Resulting PCT Valuation. Dr. Washburne stated that his preliminary PCT valuation was approximately $852 million, compared to PPC's actual PCT payment of $312 million at the time of the CSA in 2012. He described the resulting delta of approximately $540 million as "significant" and stated that this differential formed the foundation for his analysis of the cost-sharing adjustments for the examination years.
Dr. Washburne acknowledged that the year 2012 — the year in which the PCT was executed — was outside the examination years at issue (TY 2017–2020). However, he stated that the IRS's position was that the undervaluation of the PCT was directly relevant to the examination years because the initial undervaluation of the contributed IP affected the allocation of intangible value between the parties, which in turn informed the reasonably anticipated benefits (RAB) calculation used to determine PBI's cost-sharing percentages in each of the examination years. In other words, the undervaluation of the PCT at inception had a cascading effect on the cost-sharing ratios throughout the life of the CSA, including during the examination period.
C&H/Whitmore Observations Noted During Call. Cross asked Dr. Washburne whether his PCT valuation accounted for the regulatory and commercial risk borne by PBI in non-Americas markets, including country-specific pricing risk across sixty-eight (68) separate country markets in which PBI commercialized PPC's pharmaceutical products. Cross noted that non-Americas markets include jurisdictions with significant pricing regulation (e.g., reference pricing systems in the European Union, government price controls in Japan and South Korea, and variable reimbursement frameworks across emerging markets), each of which introduces distinct commercial risk that should be reflected in the valuation.
Dr. Washburne responded that his analysis "considered aggregate market risk" but did not model country-by-country risk factors. He stated that it would be impractical to model risk on a country-by-country basis for sixty-eight markets and that aggregate projections were a reasonable and reliable approach.
Dr. Vasquez noted — but did not elaborate on the call, consistent with the team's practice of reserving detailed rebuttal for written submissions — that the use of hindsight-informed revenue projections was inconsistent with the standard under Treasury Regulations § 1.482-7, which calls for valuation based on "reasonably anticipated" benefits at the time of the transaction (i.e., as of the date of the PCT in 2012), not based on actual revenue results observed in subsequent years. Dr. Vasquez indicated that a detailed rebuttal of this methodology would be provided in PPC's written response.
3.3 CSA Cost-Sharing Ratio Analysis
Dr. Washburne next addressed his analysis of the reasonably anticipated benefits (RAB) split used to determine PBI's cost-sharing percentages for each of the four examination years. He stated that the cost-sharing percentages determine the allocation of qualified research and development expenditures between PPC and PBI under the CSA, and that, in his view, PPC's reported cost-sharing percentages for PBI were too low, resulting in PBI underpaying its share of the qualified R&D costs.
PPC's Reported Cost-Sharing Percentages for PBI. The cost-sharing percentages reported by PPC for PBI's share of total qualified R&D expenditures in each examination year were as follows:
Dr. Washburne's Proposed Cost-Sharing Percentages for PBI. Dr. Washburne disclosed the following proposed cost-sharing percentages, reflecting his adjusted RAB analysis:
Basis for the Proposed Adjustments. Dr. Washburne stated that PPC's reported RAB projections understated the proportion of benefits attributable to non-Americas territories for three principal reasons:
(a) PCT Undervaluation Effect. The original PCT undervalued PBI's intangible property rights, meaning PBI received more valuable rights than were accounted for in PPC's 2012 valuation. Because the RAB calculation is designed to reflect the anticipated benefits each party derives from the CSA, and because PBI's IP rights were worth more than the PCT payment reflected, PBI's share of reasonably anticipated benefits — and thus its cost-sharing obligation — should have been correspondingly higher.
(b) Systematic Forecasting Bias. Actual non-Americas revenue growth exceeded PPC's RAB projections in each examination year, suggesting, in Dr. Washburne's view, a systematic bias in PPC's forecasting methodology that consistently understated PBI's anticipated benefits.
(c) DEMPE Function Reattribution. Certain development, enhancement, maintenance, protection, and exploitation (DEMPE) functions that PPC attributed to PBI should, in Dr. Washburne's analysis, more properly be attributed to U.S.-based personnel at PPC. This reattribution would reduce PBI's independent contribution to value creation and necessitate a higher cost-share paid by PBI to compensate PPC for the functions and risk borne by PPC's U.S. operations.
Resulting Proposed CSA Adjustments. Based on the foregoing, Dr. Washburne disclosed the following proposed additional cost-sharing payments that would be owed by PBI to PPC:
DEMPE Function Discussion. Cross asked Dr. Washburne to identify the specific DEMPE functions that he believed were improperly attributed to PBI. Dr. Washburne responded that, in his analysis, key development activities — specifically, formulation development, clinical trial oversight, and regulatory strategy "at the global level" — remained "predominantly under the control of" PPC's U.S. operations in Princeton, New Jersey, and that PBI's headcount of 185 employees in 2020 was "limited" relative to the scale of IP exploitation undertaken through the non-Americas territory.
Cross responded by noting PPC's position that PBI exercised independent decision-making across sixty-eight (68) country markets in the non-Americas territory and provided the following specific data points in support of PBI's substantive DEMPE functions:
•  PBI held forty-two (42) board meetings in Dublin, Ireland during the 2017–2020 examination period, at which key strategic, commercial, and operational decisions were made by PBI's board of directors.
•  PBI incurred a cumulative total of €47.2 million in regulatory expenditures in the non-Americas territory during the 2017–2020 period, reflecting PBI's independent management of regulatory submissions, approvals, post-marketing surveillance, and pharmacovigilance activities across multiple jurisdictions.
•  PBI made autonomous pricing and market-entry decisions for all products commercialized in the non-Americas territory, including independent assessment of market conditions, competitive dynamics, and reimbursement environments in each country market.
Dr. Washburne acknowledged these data points but stated that his analysis focused on "where the value-driving decisions were made, not the volume of local activities." He indicated that, in his view, the key decisions that drove the value of the IP — including decisions regarding the overall development strategy, clinical development programs, and global regulatory positioning — were made by PPC's U.S.-based operations, and that PBI's activities, while genuine, were more appropriately characterized as downstream commercialization activities rather than value-driving DEMPE functions.
3.4 Legacy IP Royalty Rate Analysis — CUT Method
Dr. Washburne next addressed his analysis of the 4.5% royalty rate applicable to PBI's non-Americas net sales of pre-2012 compounds under the legacy IP royalty arrangement. He stated that he analyzed the arm's-length character of the 4.5% royalty rate using the comparable uncontrolled transaction (CUT) method, pursuant to Treasury Regulations § 1.482-4.
Comparable Third-Party Agreements. Dr. Washburne stated that he had identified a set of comparable third-party pharmaceutical license agreements to serve as the basis for his CUT analysis. He provided the following details regarding his comparable set:
•  He did not disclose the exact number of comparable agreements in his set on the call but indicated that it was "a meaningful sample" — sufficient, in his view, to provide a reliable indication of arm's-length royalty rates.
•  He stated that the comparable agreements involved the licensing of "established pharmaceutical compounds" — i.e., compounds that had already received regulatory approval and were generating revenue at the time of the license — for exploitation in defined geographic territories.
•  He stated that the therapeutic areas and stage of commercialization of the licensed compounds in his comparables were consistent with the characteristics of PPC's pre-2012 compounds.
•  He stated that his comparable license agreements showed royalty rates ranging from approximately 8% to 14% of net sales, with a central tendency "in the range of 10% to 12%."
•  Based on this analysis, he proposed applying an arm's-length royalty rate of 11.0% of net sales, which he described as "the midpoint of the most reliable comparables" within his set.
Resulting Proposed Royalty Adjustments. Based on the proposed increase in the royalty rate from 4.5% to 11.0% (a differential of 6.5 percentage points), Dr. Washburne disclosed the following proposed additional royalty payments that would be owed by PBI to PPC:
C&H/Whitmore Observations Noted During Call. Dr. Vasquez raised several questions regarding the reliability of Dr. Washburne's CUT analysis. She asked Dr. Washburne whether his comparable agreements were screened for functional comparability — specifically, whether the licensees in his comparable agreements bore the same level of commercial risk, performed the same DEMPE functions, and had the same scope of geographic territory as PBI. Dr. Vasquez noted that comparability under Treasury Regulations § 1.482-4(c) requires consideration of the functions performed, risks assumed, and contractual terms of both the controlled and uncontrolled transactions, and that mere similarity in the nature of the IP or therapeutic area is insufficient to establish comparability.
Dr. Washburne responded that his comparable agreements were "selected based on the nature of the IP, therapeutic area, and stage of commercialization" of the licensed compounds. He acknowledged, however, that he had not performed adjustments for differences in licensee functions or risk allocation between the comparable agreements and the PPC-PBI legacy royalty arrangement. He did not explain why such adjustments were unnecessary or how the absence of such adjustments affected the reliability of his analysis.
Cross noted that Whitmore Valuation Group's independent CUT analysis — prepared as part of PPC's contemporaneous transfer pricing documentation — had identified fourteen (14) comparable pharmaceutical license agreements with an interquartile range (IQR) of 3.1% to 6.8% and a median royalty rate of 4.4%. Cross stated that PPC's 4.5% royalty rate fell squarely within Whitmore's interquartile range and was virtually identical to the median of Whitmore's comparable set. Cross emphasized the significant divergence between the two comparable sets — Whitmore's IQR of 3.1%–6.8% versus Dr. Washburne's range of 8%–14% — and stated that this divergence underscored the need for careful scrutiny of the comparability criteria and screening methodology used by each party.
Dr. Washburne stated that he was "aware of the taxpayer's benchmarking" but believed his comparable set was "more directly comparable" to the PPC-PBI legacy royalty arrangement. He did not elaborate on why his comparable set was more directly comparable or identify specific criteria that differentiated his comparables from those identified by Whitmore.
Cross asked Dr. Washburne whether he would be willing to share his list of comparable agreements — or at least identifying details sufficient for Whitmore Valuation Group to evaluate the comparability of his selected transactions. Dr. Washburne deferred this request to Revenue Agent Dunleavy. Dunleavy stated that the IRS would "consider the request" and that the information might be provided "through the normal IDR process" if a formal adjustment was ultimately proposed. She did not commit to providing the information on any specific timeline.
3.5 Correlative Offset and Interaction of Adjustments
Dr. Washburne acknowledged, in response to a question from Cross, that there was potential for double-counting between the CSA cost-sharing adjustments (which effectively increase PBI's costs and thus reduce PBI's taxable income under the CSA) and the legacy royalty rate adjustment (which independently increases the amount PBI pays to PPC in the form of royalties). Both adjustments, taken together, would increase the income reported by PPC and decrease the income reported by PBI, and to the extent both adjustments capture overlapping economic value, a correlative offset would be necessary to avoid overstating the aggregate adjustment.
Dr. Washburne stated that the IRS's economic analysis would allow a correlative offset to avoid double-counting between the two sets of adjustments. However, he did not quantify the amount of the correlative offset on the call. He stated that the precise amount of the offset would depend on the final calculation of each adjustment and would be reflected in any formal proposed adjustment.
Cross noted that PPC expected any proposed adjustment to clearly identify and quantify such offsets, and that the failure to do so would result in an overstated adjustment that would not reflect arm's-length pricing. Cross emphasized that transparency regarding the interaction of adjustments was essential for PPC to meaningfully evaluate and respond to any proposed adjustment.
Note: The Notice of Proposed Adjustment (NOPA) subsequently issued on October 12, 2023 included a correlative offset of $42.65 million, reducing the aggregate proposed adjustment from $423.05 million (gross) to approximately $380.40 million (net).
3.6 discount Rate Discussion — Detailed Exchange
A substantial portion of the call — approximately twenty (20) minutes, from approximately 3:00 p.m. to 3:20 p.m. — was devoted to a detailed discussion of the divergence between Dr. Washburne's discount rate of 7.2% (WACC) and the 9.8% WACC reflected in PPC/Whitmore's analysis. This issue was identified during the call as the single most impactful economic variable in the PCT valuation, and the discussion was the most substantive and technically detailed exchange of the call.
Dr. Washburne's Comparable Company Set. Dr. Vasquez asked Dr. Washburne to identify the specific companies included in his comparable company set for the beta calculation. Dr. Washburne stated that he used "a group of specialty pharmaceutical and biotech companies with market capitalizations above $2 billion" as the basis for his comparable company set. He declined to provide the specific company names on the call, again deferring to the IDR process for any further disclosure of the underlying data and assumptions. He stated that the IRS's practice was to provide such detail in connection with a formal proposed adjustment, and that the call was intended as an informal overview rather than a full disclosure of his analysis.
Dr. Vasquez's Critique of the 7.2% WACC. Dr. Vasquez stated that the 7.2% WACC was inappropriately low for a PCT valuation involving pharmaceutical intellectual property. She articulated the following specific grounds for this position:
(a) Commercial Risk of Pharmaceutical IP. Pharmaceutical intellectual property carries significant commercial risk that is not adequately captured by a corporate-level WACC. These risks include patent cliffs (i.e., the loss of patent protection and accompanying entry of generic competition), competitive entry by branded therapeutics in the same indication, and regulatory changes across multiple jurisdictions that can materially affect pricing, reimbursement, and market access. These risks are specific to the intangible assets and are, in many cases, substantially greater than the risks borne by the enterprise as a whole.
(b) Asset-Specific vs. Corporate-Level discount Rate. The appropriate discount rate for a PCT valuation should reflect the specific risk profile of the intangible assets being valued, not the corporate-level WACC of the licensor. The cash flows associated with a portfolio of pharmaceutical compounds are subject to different and, in many respects, higher risks than the overall cash flows of a diversified pharmaceutical company. Dr. Vasquez noted that it is a well-established principle in valuation theory that the discount rate should match the risk profile of the cash flows being discounted.
(c) OECD Transfer Pricing Guidelines. The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (Chapter VI, particularly paragraphs 6.155 through 6.178) contemplate risk-adjusted discount rates that reflect the economic circumstances of the transaction, including the specific risk characteristics of the intangible assets at issue.
Whitmore's 9.8% WACC. Dr. Vasquez stated that Whitmore Valuation Group's 9.8% WACC reflected the following components:
•  A higher equity risk premium of 6.2% (compared to Dr. Washburne's 5.5%);
•  A beta of 1.10 (compared to Dr. Washburne's 0.85), reflecting pharmaceutical-specific risk and the higher volatility of pharmaceutical companies relative to the broader market;
•  An intangible-asset-specific risk premium of approximately 1.5% above the corporate-level WACC, to reflect the higher risk profile of the IP-specific cash flow stream versus the company's overall cash flows.
Dr. Vasquez emphasized that the intangible-asset-specific premium of approximately 1.5% was critical to achieving a discount rate that accurately reflected the risk of the specific cash flows being valued in the PCT context. She stated that the corporate WACC reflects the blended risk of all of the company's assets and activities — including low-risk assets such as working capital and tangible assets — and that using the corporate WACC without adjustment to value a high-risk intangible asset stream would systematically understate the discount rate and overstate the present value of the intangible assets.
Dr. Washburne's Response. Dr. Washburne stated his view that the intangible-asset-specific risk premium was "not supported by the regulations" and that the corporate WACC was the appropriate starting point for a DCF valuation of the PCT. He acknowledged the theoretical basis for asset-specific discount rates but stated that, in his experience, the corporate WACC provided a sufficiently reliable measure for the type of IP at issue. He further stated that the IP at issue — consisting of approved compounds with established revenue streams — warranted a lower discount rate than pre-clinical or early clinical-stage assets, and that the 7.2% WACC reflected this lower risk profile. He did not specifically address the OECD guidance cited by Dr. Vasquez.
Cross stated that PPC would provide a detailed written analysis of the discount rate issue in due course, including a comprehensive rebuttal of Dr. Washburne's 7.2% WACC and supporting analysis for Whitmore's 9.8% WACC.
4. Economic Substance Discussion
Following the conclusion of Dr. Washburne's presentation of his quantitative methodology, Revenue Agent Dunleavy raised the IRS's position regarding PBI's economic substance. She asked Dr. Washburne to summarize the economic indicators he considered in connection with PBI's operational profile.
Dr. Washburne stated that while his analysis was "primarily quantitative" — focused on the transfer pricing methods and economic calculations described above — he had also reviewed certain qualitative indicators of PBI's economic substance as part of his overall assessment of the CSA and royalty arrangements. Specifically, he reviewed PBI's headcount data, which showed fifty-two (52) employees in 2012 growing to one hundred eighty-five (185) employees in 2020. He noted that PBI's ratio of employees to revenue — approximately €2.14 billion in non-Americas revenue with 185 employees, yielding a ratio of approximately €11.6 million per employee — suggested a "thin operational footprint" relative to the scale of IP-related income earned by PBI. He stated that this ratio was, in his view, indicative of a structure in which significant value-driving activities were performed outside of PBI (i.e., by PPC's U.S. operations) while PBI served primarily as a holding entity for IP rights and a conduit for intercompany payments.
Dr. Washburne acknowledged the existence of the forty-two (42) board meetings held in Dublin during the examination period and PBI's approximately 18,000 square feet of office space at Sandyford Business Park, Dublin. However, he characterized these as "indicative of governance" rather than "value-driving activity." He stated that governance activities — such as board oversight, compliance, and administrative functions — were distinct from the substantive DEMPE functions that, in his analysis, drove the value of PPC's pharmaceutical IP.
Cross responded that economic substance is demonstrated by the totality of PBI's functions, assets, and risks — not merely by headcount ratios or revenue-per-employee metrics. He stated that PBI maintained a robust and independent operational presence in Ireland and across the non-Americas territory and provided the following specific data points:
•  PBI incurred €47.2 million in cumulative regulatory expenditures during the 2017–2020 examination period, reflecting its independent management of regulatory submissions, approvals, post-marketing surveillance, and pharmacovigilance activities across multiple jurisdictions.
•  PBI exercised independent control over pricing decisions across sixty-eight (68) non-Americas country markets, including autonomous assessment of market conditions, competitive dynamics, government pricing regulations, and reimbursement environments.
•  PBI managed contract manufacturing through Penterra Manufacturing Ireland Ltd. ("PMI"), a related entity with 620 employees at its manufacturing facility in Ringaskiddy, County Cork, Ireland, operating under a cost-plus 8% arrangement. PBI's management of PMI's manufacturing operations constituted a significant operational function, involving oversight of production scheduling, quality assurance, supply chain management, and distribution logistics.
•  PBI maintained independent banking operations with Glenmore Bank Ireland plc, including its own cash management, treasury, and intercompany settlement functions.
Cross stated that the IRS's economic substance analysis, to the extent it relied primarily on headcount ratios and revenue-per-employee metrics, failed to account for the full range of PBI's substantive economic activities and did not reflect the arm's-length standard, which requires a holistic functional analysis.
Franklin Rosario briefly intervened at this point to note that the IRS's economic substance arguments would be "developed more fully in any formal proposed adjustment" and that the examination team intended to present a comprehensive analysis of PBI's DEMPE functions in the context of any Notice of Proposed Adjustment. He referenced the DEMPE framework as the applicable analytical framework under both the Treasury Regulations and the OECD Transfer Pricing Guidelines. Mr. Rosario did not elaborate further and did not make any additional substantive remarks during the remainder of the call.
5. Discussion of Penalty Considerations
Revenue Agent Dunleavy noted, toward the end of the call, that the examination team was also evaluating the potential applicability of the substantial valuation misstatement penalty under IRC § 6662(e). She stated that the penalty, if applicable, would impose an additional twenty percent (20%) penalty on the portion of the tax underpayment attributable to a Section 482 allocation. She did not indicate whether the examination team had reached a preliminary conclusion on the penalty issue but stated that it remained under active consideration.
Cross responded by stating that PPC had contemporaneous transfer pricing documentation for all four tax years at issue (2017, 2018, 2019, and 2020). He stated that the documentation was prepared by Crestfield & Associates LLP, under the supervision of Susan Lam, Transfer Pricing Partner, and that PPC's reported transfer pricing positions were supported by independent economic analysis conducted by qualified professionals in accordance with the applicable regulations.
Cross stated PPC's view that it had clear penalty protection under IRC § 6662(e)(3)(B) on the basis of both reasonable cause and contemporaneous documentation. He noted that PPC's transfer pricing documentation satisfied the requirements of Treas. Reg. § 1.6662-6 and that PPC's positions were based on reasonable applications of recognized transfer pricing methods, supported by robust economic analyses, and prepared with due diligence by qualified professionals.
Dunleavy acknowledged receipt of PPC's transfer pricing documentation, which had been produced in response to IDR No. 4, dated August 1, 2022. She stated that the penalty question would be addressed "if and when" a formal adjustment was proposed and that the examination team would consider all relevant factors at that time. She did not provide any further detail regarding the IRS's preliminary assessment of the penalty issue.
6. Procedural Discussion and Next Steps
At approximately 3:35 p.m., the discussion turned to procedural matters and next steps. Dunleavy stated that the IRS anticipated completing its economic analysis and issuing any proposed adjustment "by late September or October 2023." She noted that the timeline was subject to the completion of Dr. Washburne's final report and the examination team's internal review process.
Note: The Notice of Proposed Adjustment (NOPA) was subsequently issued on October 12, 2023.
Cross asked whether the IRS would provide a draft of Dr. Washburne's economist report before any formal proposed adjustment was issued. He stated that providing the report in advance would allow PPC to engage constructively with the IRS's economic analysis and potentially narrow the issues in dispute before a formal adjustment was proposed. Dunleavy stated that providing a draft of the economist report was "not standard procedure" but that the IRS would "consider sharing additional detail" with PPC during the IDR process. She did not commit to providing the report.
Cross reiterated PPC's request for the IRS economist's comparable company list (used for the beta calculation in the discount rate analysis) and comparable transaction list (used for the CUT analysis of the royalty rate). Cross stated that disclosure of these lists was essential for Whitmore Valuation Group to evaluate the comparability of Dr. Washburne's selected data points and to prepare a meaningful response. Dunleavy agreed to "take it under advisement" and stated that the examination team would respond to the request in due course.
The parties agreed that there were no further IDR responses currently outstanding from PPC. Dunleavy indicated, however, that additional IDRs — beyond the forty-seven already issued through the date of the call — might be forthcoming. She noted that Dr. Washburne's analysis might require supplemental compensation and travel data for PBI's employees, and that additional IDRs might be issued to obtain this information.
Note: A total of forty-seven (47) IDRs were ultimately issued through September 2023.
The call concluded at approximately 3:45 p.m. Eastern.
7. C&H Internal Observations and Action Items
The following observations and action items are for internal use by the Calderwood & Harkness team and Whitmore Valuation Group (under Kovel privilege) only. These observations reflect preliminary attorney work product assessments and should not be shared with the client or any third party without prior authorization from Leonard Cross.
7.1 Key Observations
1. Discount Rate as the Pivotal Economic Issue. Dr. Washburne's 7.2% WACC is the single most impactful assumption driving the PCT overvaluation. The differential between Dr. Washburne's 7.2% WACC and PPC/Whitmore's 9.8% WACC accounts for the vast majority of the $540 million gap between the IRS's proposed PCT value of $852 million and PPC's actual $312 million PCT payment. Preliminary sensitivity analysis conducted by Dr. Vasquez's team indicates that, at PPC/Whitmore's 9.8% WACC, the PCT value range is approximately $278 million to $361 million — well within the range of PPC's actual $312 million payment. The discount rate dispute will therefore be the pivotal economic issue in any Protest, Appeals, or litigation proceeding. It is critical that the team develop a comprehensive, well-supported rebuttal of Dr. Washburne's 7.2% WACC, including detailed support for Whitmore's 9.8% WACC and the intangible-asset-specific risk premium.
2. CUT Selection Methodology — Material Flaw. Dr. Washburne's CUT selection for the royalty rate analysis appears materially flawed. He acknowledged on the call that he had not performed functional comparability adjustments for differences in licensee functions, risk allocation, or geographic scope between his comparable agreements and the PPC-PBI legacy royalty arrangement. This omission is a significant vulnerability in his analysis, as the Treasury Regulations and OECD Guidelines require careful comparability analysis, including appropriate adjustments for differences between controlled and uncontrolled transactions. Moreover, his comparable range (8%–14%) diverges significantly from Whitmore's fourteen-agreement comparable set (IQR: 3.1%–6.8%, median 4.4%), which was prepared with rigorous functional comparability screening. It is imperative that the team obtain and scrutinize Dr. Washburne's comparable agreement list when and if it is disclosed, and that the rebuttal report address the divergence in detail.
3. Hindsight Bias in Revenue Projections. The IRS's use of hindsight-informed revenue projections for the PCT valuation is a significant vulnerability in the IRS's position. Treasury Regulations § 1.482-7 requires that the PCT be valued based on the "reasonably anticipated" benefits at the time of the transaction (July 2012), not on the basis of actual revenue results observed during the subsequent eight years. Dr. Washburne's use of actual 2012–2020 revenue data to recalibrate the original 2012 projections effectively converts an ex ante valuation into an ex post reconciliation, which is inconsistent with the regulatory framework. This issue should be a prominent feature of the rebuttal analysis and, if necessary, the Protest filing.
4. Economic Substance Challenge — Secondary. The economic substance challenge appears to be secondary to the quantitative transfer pricing adjustments. Dr. Washburne acknowledged on the call that his analysis was "primarily quantitative," and the substance arguments raised by Dunleavy and Rosario appeared to serve as a supporting narrative rather than an independent basis for adjustment. PPC's functional analysis already addresses the substantive DEMPE functions performed by PBI, and the team should ensure that the DEMPE functions matrix is updated to address the specific data points raised by Dr. Washburne on the call (e.g., the employee-to-revenue ratio, the characterization of board meetings as "governance" rather than "value-driving activity").
5. Correlative Offset. The correlative offset discussion confirms that the IRS is aware of the double-counting risk inherent in simultaneously adjusting the CSA cost-sharing ratios and the legacy royalty rate. PPC should ensure that any NOPA includes an explicit, adequately quantified correlative offset, and should be prepared to challenge the sufficiency of any offset proposed by the IRS. The eventual $42.65 million offset included in the NOPA should be independently verified by Whitmore.
7.2 Action Items
The following action items were identified following the call:
1.  [Cross] Debrief with Marcus Whitfield (VP of Global Tax, PPC) and Deborah Staines (General Counsel, PPC). Provide a summary of Dr. Washburne's disclosed methodology and preliminary numbers. Target: August 17, 2023.
2.  [Simmons / Dr. Vasquez] Prepare internal memorandum rebutting Dr. Washburne's WACC of 7.2%, to be developed into a formal rebuttal report for use in Protest and Appeals proceedings. The memorandum should fully document the support for Whitmore's 9.8% WACC, including the risk-free rate, equity risk premium of 6.2%, beta of 1.10, and the intangible-asset-specific risk premium of approximately 1.5%. The memorandum should also address Dr. Washburne's assertion that the intangible-asset-specific premium is "not supported by the regulations."
3.  [Dr. Vasquez / Dr. Chakrabarti] Begin drafting the comprehensive rebuttal of Dr. Washburne's economic analysis, addressing the following principal topics:
(a) Hindsight bias in revenue projections and the applicable legal standard under Treas. Reg. § 1.482-7 (reasonably anticipated benefits at the time of the PCT);
(b) WACC/Discount rate assumptions, including the case for the intangible-asset-specific risk premium;
(c) CUT selection methodology and the absence of functional comparability adjustments; and
(d) DEMPE function attribution and the proper allocation of value-driving functions between PPC and PBI.
4.  [Simmons] Follow up with Revenue Agent Dunleavy in writing (letter or email) to reiterate PPC's request for Dr. Washburne's comparable company list (used for the beta calculation) and comparable transaction list (used for the CUT analysis). The written request should reference the discussion on the call and the IRS's agreement to "take it under advisement."
5.  [Nazari] Update the DEMPE functions matrix with additional data points raised on the call, including Dr. Washburne's characterization of PBI's employee-to-revenue ratio as indicating a "thin operational footprint" and his characterization of PBI's board meetings as "indicative of governance" rather than "value-driving activity." The updated matrix should ensure that the functional analysis fully addresses these points with specific, documented evidence of PBI's substantive DEMPE functions.
6.  [Cross] Coordinate with Ciarán Thornbury at Thornbury & Keogh Solicitors (Dublin) regarding any Irish tax implications of Dr. Washburne's methodology, particularly the Knowledge Development box (6.25% effective rate) and how the IRS's proposed recharacterization of PBI's functions and income might interact with PBI's Irish tax position. Consider whether a competent authority proceeding under the U.S.-Ireland income tax treaty may become relevant.
7.  [Simmons] Update the status update memorandum for the Q3 2023 quarterly report to PPC management, incorporating the substance of this call and the IRS's preliminary proposed adjustment amounts. The memorandum should be suitable for review by PPC's Audit Committee and should be marked as privileged.
8.  [Cross] Assess whether the IRS's preliminary aggregate adjustment numbers — approximately $235 million (CSA) plus approximately $188 million (royalty) minus a correlative offset, yielding an estimated net adjustment of approximately $380 million — align with previous exposure estimates included in PPC's FIN 48 / ASC 740 analysis. Update the sensitivity analysis to reflect the IRS's disclosed methodology and preliminary numbers.
8. Distribution
These meeting notes have been distributed as follows:
Calderwood & Harkness LLP:
•  Leonard Cross, Responsible Partner
•  Sylvia Hartwell, Partner
•  Garrett Simmons, Lead Associate
•  Leila Nazari, Associate
Whitmore Valuation Group LLC (under Kovel privilege, C&H Matter Ref. 1018-00009-KV):
•  Dr. Helena Vasquez, Managing Director
•  Dr. Rohan Chakrabarti, Director
Copy to file: C&H Matter 1018-00009
Not distributed to client. These notes have not been distributed to client personnel pending Mr. Cross's review and preparation of a separate client-facing summary memorandum. Any distribution to the client will be made at Mr. Cross's direction.
Prepared by:
________________________________________
Garrett Simmons Lead Associate Calderwood & Harkness LLP
Date: August 15, 2023 (finalized August 16, 2023)
Reviewed by:
________________________________________
Leonard Cross Responsible Partner Calderwood & Harkness LLP
Date: August 16, 2023
PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT This memorandum is protected by the attorney-client privilege and the attorney work product doctrine. It has been prepared in anticipation of litigation and reflects the mental impressions, conclusions, and legal theories of counsel. Any inadvertent disclosure does not constitute a waiver of any applicable privilege.
Tax Year | PBI Share (%) | Total Qualified R&D | PBI Cost-Share Amount
2017 | 38.2% | $487.3M | $186.15M
2018 | 39.6% | $523.8M | $207.42M
2019 | 41.1% | $561.2M | $230.65M
2020 | 42.7% | $598.4M | $255.52M
Tax Year | PBI Share — PPC Reported | PBI Share — IRS Proposed | Increase (ppt)
2017 | 38.2% | 48.2% | +10.0
2018 | 39.6% | 50.6% | +11.0
2019 | 41.1% | 52.3% | +11.2
2020 | 42.7% | 53.7% | +11.0
Tax Year | Additional Cost-Share to PPC
2017 | $48.73M
2018 | $57.61M
2019 | $62.85M
2020 | $65.82M
Total | $235.01M
Tax Year | Non-Americas Net Sales (Pre-2012 Compounds) | Rate Differential | Additional Royalty
2017 | $814.6M | 6.5% | $52.95M
2018 | $762.3M | 6.5% | $49.55M
2019 | $691.8M | 6.5% | $44.97M
2020 | $624.1M | 6.5% | $40.57M
Total | $188.04M

PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT

Record

Parties

Dates

Amounts