1018-00009 · Client 1018 · IDR Responses

idr-06-response.docx DOCUMENT M&A / Corporate

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CONFIDENTIAL — TAX EXAMINATION MATERIAL

CALDERWOOD & HARKNESS LLP Attorneys at Law

1735 Market Street, Suite 3100 Philadelphia, PA 19103 Telephone: (215) 864-7200 Facsimile: (215) 864-7201 www.calderwoodharkness.com

August 18, 2022

VIA HAND DELIVERY AND ELECTRONIC MAIL

Revenue Agent Patricia Dunleavy Internal Revenue Service Large Business & International Division 600 Arch Street, Room 6214 Philadelphia, PA 19106

Re: Penterra Pharmaceuticals Corp. EIN: 22-3741856 Examination: LB&I-NE-TP-2022-00641 Tax Years Under Examination: 2017, 2018, 2019, 2020 Response to Information Document Request No. 6 IDR Subject: R&D Cost Pool Composition and Cost-Sharing Allocation Methodology

Dear Revenue Agent Dunleavy:

This firm represents Penterra Pharmaceuticals Corp. ("PPC" or the "Taxpayer") in connection with the above-referenced examination. An IRS Form 2848 (Power of Attorney and Declaration of Representative) was filed on June 8, 2022, authorizing Leonard Cross, Sylvia Hartwell, Garrett Simmons, and Leila Nazari, each a partner or associate of Calderwood & Harkness LLP ("C&H"), to represent PPC before the Internal Revenue Service in this matter. On behalf of PPC, and in connection with C&H Matter No. 1018-00009, we are writing to respond to Information Document Request No. 6 ("IDR No. 6"), dated July 14, 2022.

IDR No. 6 requested detailed information regarding (i) the composition of PPC's qualified research and development cost pool for tax years 2017 through 2020 and (ii) the methodology employed by PPC to allocate cost-sharing percentages under the cost-sharing arrangement (the "CSA") between PPC and Penterra Biopharma International DAC ("PBI"), effective as of July 1, 2012. This letter sets forth PPC's detailed narrative response to each element of the IDR, identifies the supporting documentation produced herewith, and reserves PPC's rights with respect to privileged materials and all other matters.

This response is organized as follows: Section I provides an overview of the CSA and its participants; Section II details the composition of the qualified R&D cost pool for each of tax years 2017 through 2020; Section III describes the cost-sharing allocation methodology based on reasonably anticipated benefits; Section IV identifies the supporting documentation produced; Section V addresses privilege reservations; and Section VI sets forth PPC's general reservation of rights.

I. OVERVIEW OF THE COST-SHARING ARRANGEMENT

1.1 CSA Background and Structure

PPC and PBI are parties to a Cost-Sharing Arrangement (the "CSA"), which was executed and became effective on July 1, 2012. The CSA governs the sharing of costs related to intangible development activities ("IDAs") between the two controlled participants, and allocates the rights to exploit resulting intangible property on a territorial basis.

PBI was incorporated on March 15, 2012, as a Designated Activity Company organized under the laws of Ireland, with its registered office located at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4, Ireland. PBI is wholly owned by Penterra Holdings Luxembourg S.à r.l. ("PHL"), a société à responsabilité limitée organized under the laws of Luxembourg and registered with the Luxembourg Registre de Commerce et des Sociétés under No. B 168452. PHL, in turn, is wholly owned by PPC. For U.S. federal income tax purposes, PHL has elected to be treated, and is properly classified, as a disregarded entity. Accordingly, PPC is treated as the direct owner of PBI for U.S. federal income tax purposes.

Under the terms of the CSA, PBI acquired the right to develop and exploit PPC's pharmaceutical intellectual property portfolio outside of the Americas. As used in the CSA and throughout this response, the "Americas" territory encompasses North America (including the United States, Canada, and Mexico), Central America, South America, and the Caribbean. PBI's territory (the "PBI Territory" or "Rest of World") encompasses all markets outside the Americas, including Europe, the Middle East, Africa ("EMEA"), the Asia-Pacific region ("APAC"), and all other non-Americas markets.

In consideration of PBI's acquisition of rights to the pre-existing intangible property made available under the CSA, PBI made a platform contribution transaction ("PCT") payment to PPC in the amount of $312,000,000, which was paid in full on July 1, 2012, the effective date of the CSA. The PCT payment was determined based on a discounted cash-flow valuation of the pre-existing intangibles attributable to the PBI Territory, as documented in PPC's contemporaneous transfer pricing report prepared at the time of the CSA's formation.

In addition to the PCT payment, PBI makes ongoing annual cost-sharing payments to PPC that are proportional to PBI's share of the reasonably anticipated benefits ("RAB") from the IDAs conducted under the CSA, as described in detail in Section III below.

The CSA was structured as a qualified cost-sharing arrangement within the meaning of Treasury Regulation § 1.482-7. PPC and PBI have at all relevant times maintained the CSA in compliance with the administrative, documentation, and reporting requirements set forth in that regulation, including the annual filing of the statements required by Treasury Regulation § 1.482-7(k) with each participant's timely filed income tax return.

1.2 Controlled Participants

The controlled participants in the CSA are as follows:

Penterra Pharmaceuticals Corp. ("PPC"). PPC is a Delaware corporation and the ultimate U.S. parent entity of the Penterra group of companies. PPC's global corporate headquarters are located in Princeton Junction, New Jersey, and PPC conducts substantially all of its research and development activities at its Princeton Junction campus and related U.S. facilities, including research laboratories in Cambridge, Massachusetts; San Diego, California; and Gaithersburg, Maryland. As of December 31, 2020, PPC employed approximately 14,500 individuals on a global basis. PPC is the primary conductor of IDAs under the CSA and bears the costs of those activities, subject to reimbursement from PBI pursuant to the cost-sharing allocation methodology described herein.

Penterra Biopharma International DAC ("PBI"). PBI functions as the intellectual property holding company and commercial principal for the PBI Territory. Since its establishment in 2012, PBI has grown significantly. At the time of its formation, PBI employed 52 individuals in Ireland. By December 31, 2020, PBI's headcount had grown to 185 employees, reflecting PBI's expanded role in managing regulatory affairs, medical affairs, commercial strategy, and supply-chain coordination for the PBI Territory across 68 country markets. PBI's Managing Director throughout the relevant tax years was Aidan Naughton, who reported to PPC's Chief Operating Officer.

It should be noted that Penterra Manufacturing Ireland Ltd. ("PMI"), a separate Irish subsidiary of the Penterra group, operates a pharmaceutical manufacturing facility at Unit 7, Ringaskiddy Industrial Estate, Co. Cork, Ireland. PMI provides contract manufacturing services to PBI under a separate intercompany cost-plus arrangement pursuant to which PMI is compensated at cost plus a markup of 8%. PMI is not a controlled participant in the CSA, and manufacturing costs incurred by PMI are not included in the R&D cost pool described in Section II.

1.3 Scope of Intangible Development Activity

The CSA covers intangible development activities related to PPC's core therapeutic portfolios in oncology, immunology, and rare disease. These portfolios comprise PPC's most commercially significant pharmaceutical compounds and represent the primary focus of PPC's research and development programs during the tax years under examination.

The key products subject to the CSA include:

• Veritaxol — PPC's flagship oncology product, indicated for the treatment of non-small cell lung cancer (NSCLC), metastatic breast cancer, and gastric cancer, with multiple line-extension studies and next-generation formulations under development during the relevant period;

• Imvara — PPC's lead immunology product, indicated for rheumatoid arthritis, psoriatic arthritis, and ulcerative colitis, with additional indication studies ongoing during the tax years at issue; and

• Cerulon — PPC's rare-disease product candidate, which received initial regulatory approval in the United States and European Union during the examination period and was in various stages of development and commercial launch in additional markets.

In addition to these commercially launched or late-stage products, the R&D cost pool encompasses development costs attributable to PPC's broader pipeline of early- and mid-stage compounds within these therapeutic areas, to the extent such compounds are within the scope of the IDAs covered by the CSA.

Legacy compounds that predate the CSA—i.e., compounds that were fully developed and commercially launched prior to the CSA's effective date of July 1, 2012—are not covered by the CSA. Those compounds are instead the subject of a separate intercompany royalty arrangement between PPC and PBI, pursuant to which PBI pays PPC a royalty of 4.5% of net sales for the right to commercialize such legacy products in the PBI Territory. The legacy compound licensing arrangement was addressed in PPC's response to IDR No. 3, dated July 6, 2022, and is not further discussed in this response.

II. COMPOSITION OF THE QUALIFIED R&D COST POOL (TY 2017–2020)

2.1 Aggregate Annual Qualified R&D Costs

For each of the tax years under examination, the aggregate qualified R&D costs included in the cost pool subject to sharing under the CSA are set forth below:

These figures represent the total cost pool subject to sharing under the CSA, as defined in Section 4.2 of the CSA agreement and consistent with the definition of intangible development costs under Treasury Regulation § 1.482-7(d). The amounts set forth above include all costs, charges, and expenses that are properly characterized as costs of intangible development activities within the meaning of the regulation and the terms of the CSA, as further described in Section 2.2 below.

The qualified R&D cost pool does not include any costs that are properly attributable to activities outside the scope of the CSA's intangible development activities, nor does it include costs that relate exclusively to legacy compounds covered under the separate royalty arrangement. The methodology for identifying, categorizing, and aggregating costs within the qualified R&D cost pool has been applied consistently across all four tax years under examination.

2.2 Categories of Costs Included in the R&D Cost Pool

The qualified R&D cost pool is composed of the following categories of costs, each of which represents a component of the intangible development costs incurred by PPC in connection with the IDAs conducted under the CSA:

Direct R&D Personnel Costs. This category encompasses all compensation and benefit costs for personnel directly engaged in intangible development activities. Included within this category are base salaries, wages, performance bonuses, and employee benefits (including health insurance, retirement contributions, and payroll taxes) for scientists, researchers, clinical development personnel, and regulatory scientists who are directly engaged in IDAs. Personnel costs are the single largest component of the R&D cost pool and reflect the labor-intensive nature of pharmaceutical research and clinical development. PPC maintains detailed departmental and project-level time tracking systems that permit the identification of personnel whose activities are properly characterized as IDAs under the CSA. During the examination period, the number of R&D personnel included in this category ranged from approximately 3,200 full-time equivalents in 2017 to approximately 3,800 full-time equivalents in 2020, consistent with the expansion of PPC's pipeline programs.

Contract Research Organization ("CRO") Fees. PPC engages third-party contract research organizations to conduct preclinical studies, clinical trials (Phase I through Phase III), and bioequivalence studies in support of the development of CSA-covered products and pipeline compounds. CRO fees constitute a significant and growing component of the R&D cost pool, reflecting the increasing scale and geographic reach of PPC's clinical trial programs during the examination period. Major CRO engagements during the relevant tax years included clinical trial programs for Veritaxol line extensions, Imvara indication-expansion studies, and Cerulon pivotal trials. CRO costs are included in the cost pool to the extent they are attributable to IDAs within the scope of the CSA.

Clinical Trial Costs. In addition to CRO fees, the cost pool includes other costs directly associated with the conduct of clinical trials, including patient recruitment costs, clinical trial site management fees, investigator fees paid to clinical trial principal investigators, costs of clinical supplies (including the manufacture of clinical trial materials), data management services, and biostatistical analysis. These costs are tracked on a study-by-study basis through PPC's clinical operations management system, which permits identification of the specific CSA-covered product or pipeline compound to which each cost relates.

Laboratory and Equipment Costs. This category includes the costs of laboratory consumables and reagents used in R&D activities, as well as the depreciation of R&D-dedicated equipment and facilities. PPC operates dedicated research laboratories at its Princeton Junction, Cambridge, San Diego, and Gaithersburg locations, and the costs associated with the operation and maintenance of these facilities are included in the cost pool to the extent attributable to IDAs. Depreciation of R&D equipment is computed on a straight-line basis over the useful life of the relevant asset, consistent with PPC's general depreciation policies and applicable tax depreciation rules.

Regulatory Submission Costs. This category encompasses costs incurred in connection with the preparation and filing of regulatory submissions with the U.S. Food and Drug Administration ("FDA") and equivalent non-U.S. regulatory authorities, to the extent such costs are attributable to intangible development activities under the CSA. Regulatory submission costs include the costs of preparing new drug applications ("NDAs"), supplemental NDAs, marketing authorization applications ("MAAs"), and other regulatory filings, as well as the costs of responding to regulatory queries, attending regulatory meetings, and maintaining regulatory compliance during the development phase of CSA-covered products. Post-approval regulatory maintenance costs that do not constitute IDAs are excluded from the cost pool, as described in Section 2.3 below.

Stock-Based Compensation. PPC includes in the R&D cost pool the stock option and restricted stock unit ("RSU") expense attributable to R&D personnel who are directly engaged in IDAs. Stock-based compensation expense is determined in accordance with ASC 718 (formerly SFAS 123R) for financial reporting purposes and is allocated to the R&D cost pool based on the departmental and functional classification of the employee recipients. PPC's inclusion of stock-based compensation in the cost pool is consistent with PPC's position that such costs represent a component of the total compensation provided to R&D personnel and should be treated as intangible development costs under Treasury Regulation § 1.482-7(d). PPC acknowledges that the treatment of stock-based compensation in cost-sharing arrangements has been the subject of regulatory guidance and litigation, and PPC's position is informed by its analysis of the applicable regulatory framework and relevant case law, including Altera Corp. v. Commissioner, 145 T.C. 91 (2015), rev'd, 926 F.3d 1061 (9th Cir. 2019), cert. denied, 141 S. Ct. 131 (2020).

Overhead and G&A Allocation. The cost pool includes an allocable portion of general and administrative expenses—including rent, utilities, information technology costs, and management overhead—that are attributable to R&D functions. PPC allocates G&A costs to the R&D cost pool using a headcount-based allocation methodology, under which the proportion of total G&A costs allocated to R&D is determined by the ratio of R&D headcount to total company headcount. PPC considers the headcount-based methodology to be the most reliable and administrable method for allocating shared overhead costs to the R&D function, and this methodology has been applied consistently across all four tax years under examination. A detailed description of the overhead allocation methodology and the supporting workpapers are provided in Attachment 6-D.

Depreciation and Amortization. In addition to the depreciation of R&D equipment and facilities included in the laboratory and equipment cost category, the cost pool includes amortization of previously acquired intangible assets that are used in connection with IDAs under the CSA. This category includes, for example, the amortization of technology licenses and acquired intellectual property rights that form part of the platform upon which ongoing IDA is conducted.

2.3 Costs Excluded from the R&D Cost Pool

The following categories of costs are not included in the qualified R&D cost pool:

• Sales and marketing expenses. All costs related to the promotion, advertising, distribution, and commercialization of products are excluded from the R&D cost pool. These costs are borne by the controlled participant in whose territory the relevant commercial activities occur and are not subject to sharing under the CSA.

• Manufacturing costs. Costs associated with the manufacture of commercial products are excluded from the R&D cost pool. As noted above, contract manufacturing services for the PBI Territory are provided by PMI under a separate cost-plus arrangement with PBI and are not within the scope of the CSA.

• Post-approval pharmacovigilance costs. Costs incurred in connection with post-approval safety monitoring and pharmacovigilance activities are excluded from the R&D cost pool to the extent such costs do not constitute intangible development activities. PPC draws a distinction between development-phase safety monitoring (which is included in the cost pool as a component of clinical trial costs) and post-approval pharmacovigilance (which is excluded).

• General corporate overhead not allocable to R&D. The portion of G&A costs that is not allocable to R&D functions under the headcount-based methodology is excluded from the cost pool. This includes, for example, corporate-level executive compensation, investor relations costs, and legal and compliance costs not attributable to R&D activities.

• Costs related exclusively to legacy compounds. Costs that relate solely to pre-2012 legacy compounds, which are covered under the separate intercompany royalty arrangement at 4.5% of net sales, are excluded from the R&D cost pool. To the extent that PPC's R&D personnel or facilities are used in connection with both CSA-covered and legacy compounds, PPC allocates costs between the two categories on a project-specific basis using its internal project cost accounting systems.

2.4 Year-by-Year Cost Pool Detail

A detailed breakdown of the qualified R&D cost pool by category for each of tax years 2017, 2018, 2019, and 2020 is set forth in Attachment 6-A, which accompanies this response. Attachment 6-A is provided in Microsoft Excel format and contains, for each tax year, a line-item breakdown by each of the cost categories described in Section 2.2 above. The detailed spreadsheet includes sub-categories within each major cost category, cross-references to PPC's general ledger accounts, and total columns that tie to the aggregate figures reported in Section 2.1.

The growth in the total qualified R&D cost pool from $487.3 million in tax year 2017 to $598.4 million in tax year 2020 reflects the expansion of PPC's research and development pipeline during the examination period. The principal drivers of cost pool growth include: (i) the initiation of multiple Veritaxol line-extension studies and next-generation compound programs within the oncology therapeutic area; (ii) the expansion of Imvara clinical development to additional immunology indications, including a Phase III pivotal trial for a new formulation; (iii) the advancement of Cerulon through pivotal clinical trials and toward regulatory approval in the United States and European Union; and (iv) the general increase in R&D headcount and the expansion of PPC's clinical trial operations during the period.

PPC's contemporaneous transfer pricing documentation for each of the tax years 2017 through 2020 was prepared by Crestfield & Associates LLP, with Susan Lam, CPA, serving as Transfer Pricing Partner on the engagement. The documentation was prepared in accordance with the requirements of IRC § 6662(e) and the associated penalty-protection standards of Treasury Regulation § 1.6662-6. Complete copies of the contemporaneous transfer pricing documentation reports for each of the four tax years were previously produced in response to IDR No. 4, dated July 12, 2022.

III. COST-SHARING ALLOCATION METHODOLOGY — REASONABLY ANTICIPATED BENEFITS

3.1 Governing Standard

Under Treasury Regulation § 1.482-7(e), each controlled participant's share of intangible development costs must be proportional to its share of the reasonably anticipated benefits ("RAB") attributable to the intangible development activities conducted under the CSA. The regulation requires that the RAB shares be determined using the measure of anticipated benefits that is most reliably measured, taking into account the nature of the intangible development activities and the controlled participants' expected exploitation of the resulting intangibles.

PPC has determined that the most reliable measure of anticipated benefits from the CSA-covered intangibles is the projected revenue method, as contemplated by Treasury Regulation § 1.482-7(e)(2)(ii). Under this method, each controlled participant's share of RAB is determined by reference to the projected revenue that each participant anticipates earning from the exploitation of CSA-covered intangible property in its respective territory. PPC considers the projected revenue method to be the most reliable RAB measure in the circumstances because: (i) revenue projections are routinely prepared by PPC's corporate finance and commercial teams for business planning purposes and are therefore based on reliable, contemporaneously generated data; (ii) revenue is a direct measure of the value of the intangible property to each participant, as the CSA-covered intangibles are the primary driver of each participant's revenue from CSA-covered products; and (iii) alternative measures of anticipated benefits, such as operating profit or units sold, would require additional assumptions and allocations that would reduce reliability relative to the projected revenue approach.

3.2 RAB Methodology — Projected Revenue Split

Under the projected revenue methodology, the respective shares of reasonably anticipated benefits attributable to PPC and PBI are determined by reference to the projected net revenue from CSA-covered products (Veritaxol, Imvara, Cerulon, and pipeline products in development) in each participant's territory:

• PPC Territory (Americas): Projected net revenue from CSA-covered products in North America, Central America, South America, and the Caribbean.

• PBI Territory (Rest of World): Projected net revenue from CSA-covered products in EMEA, APAC, and all other non-Americas markets.

Revenue projections are prepared on an annual basis by PPC's corporate finance and commercial teams, which have deep expertise in pharmaceutical market dynamics and maintain sophisticated forecasting models for each product and geographic market. The projections are reviewed and approved by Marcus Whitfield, PPC's Vice President of Global Tax, who coordinates with PPC's transfer pricing advisors at Crestfield & Associates LLP to ensure that the revenue projections are applied consistently and documented contemporaneously in connection with the annual CSA cost-sharing calculations.

The revenue projections incorporate the following inputs and assumptions:

• Historical revenue trends for each CSA-covered product in each territory;

• Pipeline maturity assessments and anticipated launch timelines for products in development;

• Market-specific growth assumptions, including assessments of total addressable market size, market penetration rates, and pricing dynamics;

• Competitive dynamics, including anticipated competitive launches, biosimilar or generic competition, and market share trends;

• Patent expiration schedules and their anticipated impact on product revenue;

• Regulatory approval probability adjustments, reflecting the likelihood of obtaining regulatory approval in specific markets and for specific indications; and

• Foreign exchange rate assumptions, based on forward exchange rates prevailing at the time of the projection.

The projections are prepared on a multi-year forward-looking basis, typically covering a projection period of ten years, and are discounted to present value using a risk-adjusted discount rate appropriate for the pharmaceutical industry. The resulting present-value revenue shares for PPC and PBI are then used to determine each participant's proportionate share of the annual R&D cost pool.

3.3 Cost-Sharing Percentages by Year (PPC Position)

Based on the projected revenue methodology described above, the cost-sharing percentages and corresponding dollar amounts attributable to PBI for each of the tax years under examination are as follows:

PPC's share of the R&D cost pool for each year is the remainder, calculated as 100% minus PBI's share. Accordingly, PPC's cost-sharing percentages for the four tax years are 61.8%, 60.4%, 58.9%, and 57.3%, respectively.

The increasing PBI cost-sharing percentage over the examination period—from 38.2% in tax year 2017 to 42.7% in tax year 2020—reflects the growing proportion of non-Americas revenue projected and realized during the period. Several factors contributed to this trend:

• PBI expanded its commercial operations significantly during the period, growing from operations in approximately 48 country markets in 2017 to 68 country markets by year-end 2020, including launches in key EMEA and APAC markets;

• PBI obtained new regulatory approvals for CSA-covered products in multiple jurisdictions, including marketing authorization for Imvara in Japan (approved by PMDA in 2019) and for Cerulon in the European Union (EMA marketing authorization received in 2020);

• Revenue growth in PBI's territory outpaced growth in PPC's Americas territory, particularly in the APAC region, where several key markets experienced above-average growth rates for oncology and immunology therapeutics; and

• The maturation of PPC's U.S. product portfolio and the approaching U.S. patent expirations for certain formulations of Veritaxol resulted in modestly slower projected U.S. revenue growth relative to the PBI Territory.

3.4 Key Revenue Data Supporting RAB Calculations

To illustrate the revenue data underlying the RAB calculations, set forth below is a summary of actual product-level revenue data for fiscal year 2020, the most recent year under examination:

PPC's total consolidated revenue for fiscal year 2020 was approximately $6,820,000,000 (inclusive of revenue from legacy compounds and other products not subject to the CSA). PBI's fiscal year 2020 revenue was approximately €2,140,000,000, reflecting PBI's role as the commercial principal for CSA-covered and legacy products in the PBI Territory.

It is important to note that the RAB calculations are based on projected (forward-looking) revenue rather than actual (historical) revenue. The actual revenue data presented above is provided for illustrative purposes and to demonstrate the general alignment between projected and actual revenue splits. As discussed in Section 3.6 below, any variances between projected and actual revenue are addressed through the CSA's annual true-up mechanism.

Detailed product-level revenue data by territory and by product for each of the tax years 2017 through 2020 will be produced in response to IDR No. 11, which is currently pending. PPC anticipates providing that response by the agreed-upon due date of September 15, 2022.

3.5 Consistency with Contemporaneous Documentation

The cost-sharing percentages and the RAB methodology set forth above are fully consistent with PPC's contemporaneous transfer pricing documentation prepared for each of tax years 2017 through 2020. As noted above, PPC's contemporaneous documentation was prepared by Crestfield & Associates LLP, with Martin Ogilvy, CPA, serving as Engagement Partner and Susan Lam, CPA, serving as Transfer Pricing Partner for each of the four years under examination.

The contemporaneous documentation was prepared and maintained in compliance with the principal-document and background-document requirements of IRC § 6662(e)(3)(B) and the associated penalty-protection standards of Treasury Regulation § 1.6662-6. Among other things, the documentation sets forth: (i) a detailed description of the CSA, including the identities and roles of the controlled participants; (ii) the methodology used to determine each participant's share of RAB; (iii) the revenue projections and supporting assumptions used in the RAB calculations; (iv) the composition and amount of the qualified R&D cost pool; and (v) the resulting cost-sharing percentages and cost-sharing payments for each year.

RAB calculations are updated annually prior to the filing of PPC's consolidated federal income tax return (Form 1120) for each tax year, using the most current revenue projections and cost pool data available at the time of the calculation. The contemporaneous documentation for each year is finalized and maintained in PPC's records prior to the applicable return filing date (including extensions), consistent with the timing requirements of the penalty-protection regulations.

3.6 Annual True-Up Mechanism

Section 6.4 of the CSA contains a true-up mechanism designed to reconcile any variance between the projected revenue splits used to calculate each year's cost-sharing percentages and the actual revenue splits realized in each participant's territory during the year. The true-up operates as follows:

(a) At the end of each calendar year, PPC's corporate finance team calculates the actual revenue split between the PPC Territory and the PBI Territory for CSA-covered products.

(b) The actual revenue split is compared to the projected revenue split used to determine the cost-sharing percentages for that year.

(c) If the variance between the projected and actual splits exceeds a de minimis threshold of 2.0 percentage points, a true-up adjustment is made in the subsequent year's cost-sharing calculation to correct for the over- or under-sharing that occurred in the prior year.

(d) If the variance is within the de minimis threshold, no true-up adjustment is required, and the cost-sharing percentages as originally calculated are deemed to be arm's-length.

During the tax years under examination, the variances between projected and actual revenue splits were consistently within a narrow range. In each of the four years, the variance was between approximately 0.4 and 1.7 percentage points, falling within or near the de minimis threshold. Where applicable, minor true-up adjustments were incorporated into the subsequent year's cost-sharing calculation. The cost-sharing percentages and payment amounts set forth in Section 3.3 above reflect the application of the true-up mechanism and represent the final, adjusted cost-sharing amounts for each tax year.

Detailed true-up calculation workpapers for each of the four tax years are provided in Attachment 6-E, which accompanies this response.

IV. SUPPORTING DOCUMENTATION PRODUCED

The following documents and materials are produced herewith in response to IDR No. 6:

Attachment 6-A: Detailed R&D Cost Pool Breakdown (TY 2017–2020). This attachment consists of a Microsoft Excel workbook containing a detailed breakdown of the qualified R&D cost pool by cost category (direct R&D personnel costs, CRO fees, clinical trial costs, laboratory and equipment costs, regulatory submission costs, stock-based compensation, overhead and G&A allocation, and depreciation and amortization) for each of tax years 2017, 2018, 2019, and 2020. Total amounts for each year tie to the aggregate cost pool figures reported in Section 2.1 of this response: $487,300,000 (2017), $523,800,000 (2018), $561,200,000 (2019), and $598,400,000 (2020).

Attachment 6-B: Reasonably Anticipated Benefit Calculations and Revenue Projections (TY 2017–2020). This attachment consists of a Microsoft Excel workbook containing the RAB calculation workpapers for each tax year, including the projected revenue splits between the PPC Territory (Americas) and the PBI Territory (Rest of World) for CSA-covered products and pipeline compounds. The workpapers document the resulting PBI cost-sharing percentages of 38.2% (2017), 39.6% (2018), 41.1% (2019), and 42.7% (2020), together with the key inputs and assumptions underlying the revenue projections.

Attachment 6-C: CSA Cost-Sharing Payment Records (TY 2017–2020). This attachment consists of PDF copies of the intercompany invoices issued by PPC to PBI and the corresponding payment confirmation records documenting PBI's cost-sharing payments for each tax year: $186,148,600 (2017), $207,424,800 (2018), $230,653,200 (2019), and $255,516,800 (2020). The payment records include bank transfer confirmations and intercompany account reconciliations.

Attachment 6-D: Overhead Allocation Methodology Documentation. This attachment consists of a PDF document setting forth a detailed description of the headcount-based methodology used by PPC to allocate general and administrative costs to the R&D cost pool, together with the supporting workpapers for each of the four tax years under examination. The documentation includes the headcount data used in the allocation, the total G&A cost base, and the resulting allocable amounts.

Attachment 6-E: True-Up Calculation Workpapers (TY 2017–2020). This attachment consists of a Microsoft Excel workbook containing the annual true-up calculation workpapers for each of the four tax years, documenting the comparison of projected versus actual revenue splits and any resulting true-up adjustments applied in subsequent periods.

V. PRIVILEGE RESERVATION

PPC and its counsel respectfully reserve all rights to assert the attorney-client privilege, the attorney work-product doctrine, and the tax practitioner privilege under IRC § 7525 with respect to any documents, communications, analyses, or other materials that have not been produced in connection with this response or any other response in this examination. PPC is maintaining a privilege log in connection with this examination, which identifies documents withheld on the basis of applicable privilege.

Without limitation, PPC notes that certain internal analyses and communications between PPC and its counsel, Calderwood & Harkness LLP, are being withheld as protected by the attorney-client privilege and/or the attorney work-product doctrine. In addition, certain communications and work product generated by Whitmore Valuation Group LLC, which was engaged by Calderwood & Harkness LLP under a Kovel arrangement (Reference 1018-00009-KV, dated June 20, 2022) to provide valuation and economic consulting services in connection with this examination, are likewise being withheld as protected under the attorney-client privilege, the work-product doctrine, and/or the tax practitioner privilege.

The production of documents in connection with this response, or any other response in this examination, does not constitute a waiver—express, implied, or otherwise—of any applicable privilege or protection with respect to any documents produced or withheld. PPC expressly reserves the right to assert all applicable privileges and protections at any stage of this examination or any subsequent proceedings.

VI. RESERVATION OF RIGHTS

PPC reserves all rights to supplement, amend, or clarify this response at any time, including but not limited to the right to provide additional documentation, revise the analyses set forth herein, or present additional arguments in support of PPC's transfer pricing positions. This response is based on information currently available to PPC and its advisors, and PPC does not waive any right to present additional information, arguments, or analyses at any future stage of this examination or any subsequent administrative or judicial proceedings.

Nothing in this response shall be construed as a concession by PPC that any adjustment to the cost-sharing percentages, the composition of the R&D cost pool, or any other aspect of the CSA or PPC's transfer pricing is warranted. PPC's transfer pricing positions with respect to the CSA, including the R&D cost pool composition and the RAB-based cost-sharing allocation methodology, are fully supported by contemporaneous documentation, economic analyses, and applicable law, including IRC § 482 and Treasury Regulations §§ 1.482-7 and 1.482-1(d). PPC further reserves all rights under IRC § 6662(e) and Treasury Regulation § 1.6662-6 with respect to any penalty determinations that may arise in connection with this examination.

We trust that the foregoing response and the accompanying attachments are responsive to IDR No. 6. Should you wish to discuss the materials produced herewith, or should you require any further clarification regarding the information provided, please do not hesitate to contact the undersigned or Garrett Simmons at Calderwood & Harkness LLP's Philadelphia office at 1735 Market Street, Suite 3100, Philadelphia, PA 19103, telephone (215) 864-7200. We are available to schedule a meeting or conference call at your convenience to review the response and supporting documentation.

This response is submitted on behalf of Penterra Pharmaceuticals Corp. (EIN 22-3741856) for examination LB&I-NE-TP-2022-00641.

Respectfully submitted,

CALDERWOOD & HARKNESS LLP

By: ________

Leonard Cross Partner, Tax Department Calderwood & Harkness LLP 1735 Market Street, Suite 3100 Philadelphia, PA 19103 Telephone: (215) 864-7200

Email: lcross@calderwoodharkness.com

cc: (via electronic mail)

Marcus Whitfield, Vice President, Global Tax, Penterra Pharmaceuticals Corp. Deborah Staines, General Counsel, Penterra Pharmaceuticals Corp. Sylvia Hartwell, Calderwood & Harkness LLP Garrett Simmons, Calderwood & Harkness LLP Leila Nazari, Calderwood & Harkness LLP Supervisory Revenue Agent Gerald Meskill, Team Manager, LB&I Division

Enclosures:

Attachment 6-A: Detailed R&D Cost Pool Breakdown (TY 2017–2020) [Microsoft Excel]

Attachment 6-B: Reasonably Anticipated Benefit Calculations and Revenue Projections (TY 2017–2020) [Microsoft Excel]

Attachment 6-C: CSA Cost-Sharing Payment Records (TY 2017–2020) [PDF — copies of intercompany invoices and payment confirmations]

Attachment 6-D: Overhead Allocation Methodology Documentation [PDF]

Attachment 6-E: True-Up Calculation Workpapers (TY 2017–2020) [Microsoft Excel]

Tax Year	Total Qualified R&D Cost Pool
2017	$487,300,000
2018	$523,800,000
2019	$561,200,000
2020	$598,400,000
Tax Year	PBI Cost-Sharing Percentage	Total R&D Cost Pool	PBI Cost-Sharing Amount
2017	38.2%	$487,300,000	$186,148,600
2018	39.6%	$523,800,000	$207,424,800
2019	41.1%	$561,200,000	$230,653,200
2020	42.7%	$598,400,000	$255,516,800
Product	Global Net Sales	Non-Americas Net Sales	Non-Americas Share
Veritaxol	$3,120,000,000	$1,340,000,000	~43%
Imvara	$1,870,000,000	$790,000,000	~42%
Cerulon	$620,000,000	$280,000,000	~45%

CONFIDENTIAL — TAX EXAMINATION MATERIAL
CALDERWOOD & HARKNESS LLP Attorneys at Law
1735 Market Street, Suite 3100 Philadelphia, PA 19103 Telephone: (215) 864-7200 Facsimile: (215) 864-7201 www.calderwoodharkness.com
August 18, 2022
VIA HAND DELIVERY AND ELECTRONIC MAIL
Revenue Agent Patricia Dunleavy Internal Revenue Service Large Business & International Division 600 Arch Street, Room 6214 Philadelphia, PA 19106
Re: Penterra Pharmaceuticals Corp. EIN: 22-3741856 Examination: LB&I-NE-TP-2022-00641 Tax Years Under Examination: 2017, 2018, 2019, 2020 Response to Information Document Request No. 6 IDR Subject: R&D Cost Pool Composition and Cost-Sharing Allocation Methodology
Dear Revenue Agent Dunleavy:
This firm represents Penterra Pharmaceuticals Corp. ("PPC" or the "Taxpayer") in connection with the above-referenced examination. An IRS Form 2848 (Power of Attorney and Declaration of Representative) was filed on June 8, 2022, authorizing Leonard Cross, Sylvia Hartwell, Garrett Simmons, and Leila Nazari, each a partner or associate of Calderwood & Harkness LLP ("C&H"), to represent PPC before the Internal Revenue Service in this matter. On behalf of PPC, and in connection with C&H Matter No. 1018-00009, we are writing to respond to Information Document Request No. 6 ("IDR No. 6"), dated July 14, 2022.
IDR No. 6 requested detailed information regarding (i) the composition of PPC's qualified research and development cost pool for tax years 2017 through 2020 and (ii) the methodology employed by PPC to allocate cost-sharing percentages under the cost-sharing arrangement (the "CSA") between PPC and Penterra Biopharma International DAC ("PBI"), effective as of July 1, 2012. This letter sets forth PPC's detailed narrative response to each element of the IDR, identifies the supporting documentation produced herewith, and reserves PPC's rights with respect to privileged materials and all other matters.
This response is organized as follows: Section I provides an overview of the CSA and its participants; Section II details the composition of the qualified R&D cost pool for each of tax years 2017 through 2020; Section III describes the cost-sharing allocation methodology based on reasonably anticipated benefits; Section IV identifies the supporting documentation produced; Section V addresses privilege reservations; and Section VI sets forth PPC's general reservation of rights.
I. OVERVIEW OF THE COST-SHARING ARRANGEMENT
1.1 CSA Background and Structure
PPC and PBI are parties to a Cost-Sharing Arrangement (the "CSA"), which was executed and became effective on July 1, 2012. The CSA governs the sharing of costs related to intangible development activities ("IDAs") between the two controlled participants, and allocates the rights to exploit resulting intangible property on a territorial basis.
PBI was incorporated on March 15, 2012, as a Designated Activity Company organized under the laws of Ireland, with its registered office located at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4, Ireland. PBI is wholly owned by Penterra Holdings Luxembourg S.à r.l. ("PHL"), a société à responsabilité limitée organized under the laws of Luxembourg and registered with the Luxembourg Registre de Commerce et des Sociétés under No. B 168452. PHL, in turn, is wholly owned by PPC. For U.S. federal income tax purposes, PHL has elected to be treated, and is properly classified, as a disregarded entity. Accordingly, PPC is treated as the direct owner of PBI for U.S. federal income tax purposes.
Under the terms of the CSA, PBI acquired the right to develop and exploit PPC's pharmaceutical intellectual property portfolio outside of the Americas. As used in the CSA and throughout this response, the "Americas" territory encompasses North America (including the United States, Canada, and Mexico), Central America, South America, and the Caribbean. PBI's territory (the "PBI Territory" or "Rest of World") encompasses all markets outside the Americas, including Europe, the Middle East, Africa ("EMEA"), the Asia-Pacific region ("APAC"), and all other non-Americas markets.
In consideration of PBI's acquisition of rights to the pre-existing intangible property made available under the CSA, PBI made a platform contribution transaction ("PCT") payment to PPC in the amount of $312,000,000, which was paid in full on July 1, 2012, the effective date of the CSA. The PCT payment was determined based on a discounted cash-flow valuation of the pre-existing intangibles attributable to the PBI Territory, as documented in PPC's contemporaneous transfer pricing report prepared at the time of the CSA's formation.
In addition to the PCT payment, PBI makes ongoing annual cost-sharing payments to PPC that are proportional to PBI's share of the reasonably anticipated benefits ("RAB") from the IDAs conducted under the CSA, as described in detail in Section III below.
The CSA was structured as a qualified cost-sharing arrangement within the meaning of Treasury Regulation § 1.482-7. PPC and PBI have at all relevant times maintained the CSA in compliance with the administrative, documentation, and reporting requirements set forth in that regulation, including the annual filing of the statements required by Treasury Regulation § 1.482-7(k) with each participant's timely filed income tax return.
1.2 Controlled Participants
The controlled participants in the CSA are as follows:
Penterra Pharmaceuticals Corp. ("PPC"). PPC is a Delaware corporation and the ultimate U.S. parent entity of the Penterra group of companies. PPC's global corporate headquarters are located in Princeton Junction, New Jersey, and PPC conducts substantially all of its research and development activities at its Princeton Junction campus and related U.S. facilities, including research laboratories in Cambridge, Massachusetts; San Diego, California; and Gaithersburg, Maryland. As of December 31, 2020, PPC employed approximately 14,500 individuals on a global basis. PPC is the primary conductor of IDAs under the CSA and bears the costs of those activities, subject to reimbursement from PBI pursuant to the cost-sharing allocation methodology described herein.
Penterra Biopharma International DAC ("PBI"). PBI functions as the intellectual property holding company and commercial principal for the PBI Territory. Since its establishment in 2012, PBI has grown significantly. At the time of its formation, PBI employed 52 individuals in Ireland. By December 31, 2020, PBI's headcount had grown to 185 employees, reflecting PBI's expanded role in managing regulatory affairs, medical affairs, commercial strategy, and supply-chain coordination for the PBI Territory across 68 country markets. PBI's Managing Director throughout the relevant tax years was Aidan Naughton, who reported to PPC's Chief Operating Officer.
It should be noted that Penterra Manufacturing Ireland Ltd. ("PMI"), a separate Irish subsidiary of the Penterra group, operates a pharmaceutical manufacturing facility at Unit 7, Ringaskiddy Industrial Estate, Co. Cork, Ireland. PMI provides contract manufacturing services to PBI under a separate intercompany cost-plus arrangement pursuant to which PMI is compensated at cost plus a markup of 8%. PMI is not a controlled participant in the CSA, and manufacturing costs incurred by PMI are not included in the R&D cost pool described in Section II.
1.3 Scope of Intangible Development Activity
The CSA covers intangible development activities related to PPC's core therapeutic portfolios in oncology, immunology, and rare disease. These portfolios comprise PPC's most commercially significant pharmaceutical compounds and represent the primary focus of PPC's research and development programs during the tax years under examination.
The key products subject to the CSA include:
• Veritaxol — PPC's flagship oncology product, indicated for the treatment of non-small cell lung cancer (NSCLC), metastatic breast cancer, and gastric cancer, with multiple line-extension studies and next-generation formulations under development during the relevant period;
• Imvara — PPC's lead immunology product, indicated for rheumatoid arthritis, psoriatic arthritis, and ulcerative colitis, with additional indication studies ongoing during the tax years at issue; and
• Cerulon — PPC's rare-disease product candidate, which received initial regulatory approval in the United States and European Union during the examination period and was in various stages of development and commercial launch in additional markets.
In addition to these commercially launched or late-stage products, the R&D cost pool encompasses development costs attributable to PPC's broader pipeline of early- and mid-stage compounds within these therapeutic areas, to the extent such compounds are within the scope of the IDAs covered by the CSA.
Legacy compounds that predate the CSA—i.e., compounds that were fully developed and commercially launched prior to the CSA's effective date of July 1, 2012—are not covered by the CSA. Those compounds are instead the subject of a separate intercompany royalty arrangement between PPC and PBI, pursuant to which PBI pays PPC a royalty of 4.5% of net sales for the right to commercialize such legacy products in the PBI Territory. The legacy compound licensing arrangement was addressed in PPC's response to IDR No. 3, dated July 6, 2022, and is not further discussed in this response.
II. COMPOSITION OF THE QUALIFIED R&D COST POOL (TY 2017–2020)
2.1 Aggregate Annual Qualified R&D Costs
For each of the tax years under examination, the aggregate qualified R&D costs included in the cost pool subject to sharing under the CSA are set forth below:
These figures represent the total cost pool subject to sharing under the CSA, as defined in Section 4.2 of the CSA agreement and consistent with the definition of intangible development costs under Treasury Regulation § 1.482-7(d). The amounts set forth above include all costs, charges, and expenses that are properly characterized as costs of intangible development activities within the meaning of the regulation and the terms of the CSA, as further described in Section 2.2 below.
The qualified R&D cost pool does not include any costs that are properly attributable to activities outside the scope of the CSA's intangible development activities, nor does it include costs that relate exclusively to legacy compounds covered under the separate royalty arrangement. The methodology for identifying, categorizing, and aggregating costs within the qualified R&D cost pool has been applied consistently across all four tax years under examination.
2.2 Categories of Costs Included in the R&D Cost Pool
The qualified R&D cost pool is composed of the following categories of costs, each of which represents a component of the intangible development costs incurred by PPC in connection with the IDAs conducted under the CSA:
Direct R&D Personnel Costs. This category encompasses all compensation and benefit costs for personnel directly engaged in intangible development activities. Included within this category are base salaries, wages, performance bonuses, and employee benefits (including health insurance, retirement contributions, and payroll taxes) for scientists, researchers, clinical development personnel, and regulatory scientists who are directly engaged in IDAs. Personnel costs are the single largest component of the R&D cost pool and reflect the labor-intensive nature of pharmaceutical research and clinical development. PPC maintains detailed departmental and project-level time tracking systems that permit the identification of personnel whose activities are properly characterized as IDAs under the CSA. During the examination period, the number of R&D personnel included in this category ranged from approximately 3,200 full-time equivalents in 2017 to approximately 3,800 full-time equivalents in 2020, consistent with the expansion of PPC's pipeline programs.
Contract Research Organization ("CRO") Fees. PPC engages third-party contract research organizations to conduct preclinical studies, clinical trials (Phase I through Phase III), and bioequivalence studies in support of the development of CSA-covered products and pipeline compounds. CRO fees constitute a significant and growing component of the R&D cost pool, reflecting the increasing scale and geographic reach of PPC's clinical trial programs during the examination period. Major CRO engagements during the relevant tax years included clinical trial programs for Veritaxol line extensions, Imvara indication-expansion studies, and Cerulon pivotal trials. CRO costs are included in the cost pool to the extent they are attributable to IDAs within the scope of the CSA.
Clinical Trial Costs. In addition to CRO fees, the cost pool includes other costs directly associated with the conduct of clinical trials, including patient recruitment costs, clinical trial site management fees, investigator fees paid to clinical trial principal investigators, costs of clinical supplies (including the manufacture of clinical trial materials), data management services, and biostatistical analysis. These costs are tracked on a study-by-study basis through PPC's clinical operations management system, which permits identification of the specific CSA-covered product or pipeline compound to which each cost relates.
Laboratory and Equipment Costs. This category includes the costs of laboratory consumables and reagents used in R&D activities, as well as the depreciation of R&D-dedicated equipment and facilities. PPC operates dedicated research laboratories at its Princeton Junction, Cambridge, San Diego, and Gaithersburg locations, and the costs associated with the operation and maintenance of these facilities are included in the cost pool to the extent attributable to IDAs. Depreciation of R&D equipment is computed on a straight-line basis over the useful life of the relevant asset, consistent with PPC's general depreciation policies and applicable tax depreciation rules.
Regulatory Submission Costs. This category encompasses costs incurred in connection with the preparation and filing of regulatory submissions with the U.S. Food and Drug Administration ("FDA") and equivalent non-U.S. regulatory authorities, to the extent such costs are attributable to intangible development activities under the CSA. Regulatory submission costs include the costs of preparing new drug applications ("NDAs"), supplemental NDAs, marketing authorization applications ("MAAs"), and other regulatory filings, as well as the costs of responding to regulatory queries, attending regulatory meetings, and maintaining regulatory compliance during the development phase of CSA-covered products. Post-approval regulatory maintenance costs that do not constitute IDAs are excluded from the cost pool, as described in Section 2.3 below.
Stock-Based Compensation. PPC includes in the R&D cost pool the stock option and restricted stock unit ("RSU") expense attributable to R&D personnel who are directly engaged in IDAs. Stock-based compensation expense is determined in accordance with ASC 718 (formerly SFAS 123R) for financial reporting purposes and is allocated to the R&D cost pool based on the departmental and functional classification of the employee recipients. PPC's inclusion of stock-based compensation in the cost pool is consistent with PPC's position that such costs represent a component of the total compensation provided to R&D personnel and should be treated as intangible development costs under Treasury Regulation § 1.482-7(d). PPC acknowledges that the treatment of stock-based compensation in cost-sharing arrangements has been the subject of regulatory guidance and litigation, and PPC's position is informed by its analysis of the applicable regulatory framework and relevant case law, including Altera Corp. v. Commissioner, 145 T.C. 91 (2015), rev'd, 926 F.3d 1061 (9th Cir. 2019), cert. denied, 141 S. Ct. 131 (2020).
Overhead and G&A Allocation. The cost pool includes an allocable portion of general and administrative expenses—including rent, utilities, information technology costs, and management overhead—that are attributable to R&D functions. PPC allocates G&A costs to the R&D cost pool using a headcount-based allocation methodology, under which the proportion of total G&A costs allocated to R&D is determined by the ratio of R&D headcount to total company headcount. PPC considers the headcount-based methodology to be the most reliable and administrable method for allocating shared overhead costs to the R&D function, and this methodology has been applied consistently across all four tax years under examination. A detailed description of the overhead allocation methodology and the supporting workpapers are provided in Attachment 6-D.
Depreciation and Amortization. In addition to the depreciation of R&D equipment and facilities included in the laboratory and equipment cost category, the cost pool includes amortization of previously acquired intangible assets that are used in connection with IDAs under the CSA. This category includes, for example, the amortization of technology licenses and acquired intellectual property rights that form part of the platform upon which ongoing IDA is conducted.
2.3 Costs Excluded from the R&D Cost Pool
The following categories of costs are not included in the qualified R&D cost pool:
• Sales and marketing expenses. All costs related to the promotion, advertising, distribution, and commercialization of products are excluded from the R&D cost pool. These costs are borne by the controlled participant in whose territory the relevant commercial activities occur and are not subject to sharing under the CSA.
• Manufacturing costs. Costs associated with the manufacture of commercial products are excluded from the R&D cost pool. As noted above, contract manufacturing services for the PBI Territory are provided by PMI under a separate cost-plus arrangement with PBI and are not within the scope of the CSA.
• Post-approval pharmacovigilance costs. Costs incurred in connection with post-approval safety monitoring and pharmacovigilance activities are excluded from the R&D cost pool to the extent such costs do not constitute intangible development activities. PPC draws a distinction between development-phase safety monitoring (which is included in the cost pool as a component of clinical trial costs) and post-approval pharmacovigilance (which is excluded).
• General corporate overhead not allocable to R&D. The portion of G&A costs that is not allocable to R&D functions under the headcount-based methodology is excluded from the cost pool. This includes, for example, corporate-level executive compensation, investor relations costs, and legal and compliance costs not attributable to R&D activities.
• Costs related exclusively to legacy compounds. Costs that relate solely to pre-2012 legacy compounds, which are covered under the separate intercompany royalty arrangement at 4.5% of net sales, are excluded from the R&D cost pool. To the extent that PPC's R&D personnel or facilities are used in connection with both CSA-covered and legacy compounds, PPC allocates costs between the two categories on a project-specific basis using its internal project cost accounting systems.
2.4 Year-by-Year Cost Pool Detail
A detailed breakdown of the qualified R&D cost pool by category for each of tax years 2017, 2018, 2019, and 2020 is set forth in Attachment 6-A, which accompanies this response. Attachment 6-A is provided in Microsoft Excel format and contains, for each tax year, a line-item breakdown by each of the cost categories described in Section 2.2 above. The detailed spreadsheet includes sub-categories within each major cost category, cross-references to PPC's general ledger accounts, and total columns that tie to the aggregate figures reported in Section 2.1.
The growth in the total qualified R&D cost pool from $487.3 million in tax year 2017 to $598.4 million in tax year 2020 reflects the expansion of PPC's research and development pipeline during the examination period. The principal drivers of cost pool growth include: (i) the initiation of multiple Veritaxol line-extension studies and next-generation compound programs within the oncology therapeutic area; (ii) the expansion of Imvara clinical development to additional immunology indications, including a Phase III pivotal trial for a new formulation; (iii) the advancement of Cerulon through pivotal clinical trials and toward regulatory approval in the United States and European Union; and (iv) the general increase in R&D headcount and the expansion of PPC's clinical trial operations during the period.
PPC's contemporaneous transfer pricing documentation for each of the tax years 2017 through 2020 was prepared by Crestfield & Associates LLP, with Susan Lam, CPA, serving as Transfer Pricing Partner on the engagement. The documentation was prepared in accordance with the requirements of IRC § 6662(e) and the associated penalty-protection standards of Treasury Regulation § 1.6662-6. Complete copies of the contemporaneous transfer pricing documentation reports for each of the four tax years were previously produced in response to IDR No. 4, dated July 12, 2022.
III. COST-SHARING ALLOCATION METHODOLOGY — REASONABLY ANTICIPATED BENEFITS
3.1 Governing Standard
Under Treasury Regulation § 1.482-7(e), each controlled participant's share of intangible development costs must be proportional to its share of the reasonably anticipated benefits ("RAB") attributable to the intangible development activities conducted under the CSA. The regulation requires that the RAB shares be determined using the measure of anticipated benefits that is most reliably measured, taking into account the nature of the intangible development activities and the controlled participants' expected exploitation of the resulting intangibles.
PPC has determined that the most reliable measure of anticipated benefits from the CSA-covered intangibles is the projected revenue method, as contemplated by Treasury Regulation § 1.482-7(e)(2)(ii). Under this method, each controlled participant's share of RAB is determined by reference to the projected revenue that each participant anticipates earning from the exploitation of CSA-covered intangible property in its respective territory. PPC considers the projected revenue method to be the most reliable RAB measure in the circumstances because: (i) revenue projections are routinely prepared by PPC's corporate finance and commercial teams for business planning purposes and are therefore based on reliable, contemporaneously generated data; (ii) revenue is a direct measure of the value of the intangible property to each participant, as the CSA-covered intangibles are the primary driver of each participant's revenue from CSA-covered products; and (iii) alternative measures of anticipated benefits, such as operating profit or units sold, would require additional assumptions and allocations that would reduce reliability relative to the projected revenue approach.
3.2 RAB Methodology — Projected Revenue Split
Under the projected revenue methodology, the respective shares of reasonably anticipated benefits attributable to PPC and PBI are determined by reference to the projected net revenue from CSA-covered products (Veritaxol, Imvara, Cerulon, and pipeline products in development) in each participant's territory:
• PPC Territory (Americas): Projected net revenue from CSA-covered products in North America, Central America, South America, and the Caribbean.
• PBI Territory (Rest of World): Projected net revenue from CSA-covered products in EMEA, APAC, and all other non-Americas markets.
Revenue projections are prepared on an annual basis by PPC's corporate finance and commercial teams, which have deep expertise in pharmaceutical market dynamics and maintain sophisticated forecasting models for each product and geographic market. The projections are reviewed and approved by Marcus Whitfield, PPC's Vice President of Global Tax, who coordinates with PPC's transfer pricing advisors at Crestfield & Associates LLP to ensure that the revenue projections are applied consistently and documented contemporaneously in connection with the annual CSA cost-sharing calculations.
The revenue projections incorporate the following inputs and assumptions:
• Historical revenue trends for each CSA-covered product in each territory;
• Pipeline maturity assessments and anticipated launch timelines for products in development;
• Market-specific growth assumptions, including assessments of total addressable market size, market penetration rates, and pricing dynamics;
• Competitive dynamics, including anticipated competitive launches, biosimilar or generic competition, and market share trends;
• Patent expiration schedules and their anticipated impact on product revenue;
• Regulatory approval probability adjustments, reflecting the likelihood of obtaining regulatory approval in specific markets and for specific indications; and
• Foreign exchange rate assumptions, based on forward exchange rates prevailing at the time of the projection.
The projections are prepared on a multi-year forward-looking basis, typically covering a projection period of ten years, and are discounted to present value using a risk-adjusted discount rate appropriate for the pharmaceutical industry. The resulting present-value revenue shares for PPC and PBI are then used to determine each participant's proportionate share of the annual R&D cost pool.
3.3 Cost-Sharing Percentages by Year (PPC Position)
Based on the projected revenue methodology described above, the cost-sharing percentages and corresponding dollar amounts attributable to PBI for each of the tax years under examination are as follows:
PPC's share of the R&D cost pool for each year is the remainder, calculated as 100% minus PBI's share. Accordingly, PPC's cost-sharing percentages for the four tax years are 61.8%, 60.4%, 58.9%, and 57.3%, respectively.
The increasing PBI cost-sharing percentage over the examination period—from 38.2% in tax year 2017 to 42.7% in tax year 2020—reflects the growing proportion of non-Americas revenue projected and realized during the period. Several factors contributed to this trend:
• PBI expanded its commercial operations significantly during the period, growing from operations in approximately 48 country markets in 2017 to 68 country markets by year-end 2020, including launches in key EMEA and APAC markets;
• PBI obtained new regulatory approvals for CSA-covered products in multiple jurisdictions, including marketing authorization for Imvara in Japan (approved by PMDA in 2019) and for Cerulon in the European Union (EMA marketing authorization received in 2020);
• Revenue growth in PBI's territory outpaced growth in PPC's Americas territory, particularly in the APAC region, where several key markets experienced above-average growth rates for oncology and immunology therapeutics; and
• The maturation of PPC's U.S. product portfolio and the approaching U.S. patent expirations for certain formulations of Veritaxol resulted in modestly slower projected U.S. revenue growth relative to the PBI Territory.
3.4 Key Revenue Data Supporting RAB Calculations
To illustrate the revenue data underlying the RAB calculations, set forth below is a summary of actual product-level revenue data for fiscal year 2020, the most recent year under examination:
PPC's total consolidated revenue for fiscal year 2020 was approximately $6,820,000,000 (inclusive of revenue from legacy compounds and other products not subject to the CSA). PBI's fiscal year 2020 revenue was approximately €2,140,000,000, reflecting PBI's role as the commercial principal for CSA-covered and legacy products in the PBI Territory.
It is important to note that the RAB calculations are based on projected (forward-looking) revenue rather than actual (historical) revenue. The actual revenue data presented above is provided for illustrative purposes and to demonstrate the general alignment between projected and actual revenue splits. As discussed in Section 3.6 below, any variances between projected and actual revenue are addressed through the CSA's annual true-up mechanism.
Detailed product-level revenue data by territory and by product for each of the tax years 2017 through 2020 will be produced in response to IDR No. 11, which is currently pending. PPC anticipates providing that response by the agreed-upon due date of September 15, 2022.
3.5 Consistency with Contemporaneous Documentation
The cost-sharing percentages and the RAB methodology set forth above are fully consistent with PPC's contemporaneous transfer pricing documentation prepared for each of tax years 2017 through 2020. As noted above, PPC's contemporaneous documentation was prepared by Crestfield & Associates LLP, with Martin Ogilvy, CPA, serving as Engagement Partner and Susan Lam, CPA, serving as Transfer Pricing Partner for each of the four years under examination.
The contemporaneous documentation was prepared and maintained in compliance with the principal-document and background-document requirements of IRC § 6662(e)(3)(B) and the associated penalty-protection standards of Treasury Regulation § 1.6662-6. Among other things, the documentation sets forth: (i) a detailed description of the CSA, including the identities and roles of the controlled participants; (ii) the methodology used to determine each participant's share of RAB; (iii) the revenue projections and supporting assumptions used in the RAB calculations; (iv) the composition and amount of the qualified R&D cost pool; and (v) the resulting cost-sharing percentages and cost-sharing payments for each year.
RAB calculations are updated annually prior to the filing of PPC's consolidated federal income tax return (Form 1120) for each tax year, using the most current revenue projections and cost pool data available at the time of the calculation. The contemporaneous documentation for each year is finalized and maintained in PPC's records prior to the applicable return filing date (including extensions), consistent with the timing requirements of the penalty-protection regulations.
3.6 Annual True-Up Mechanism
Section 6.4 of the CSA contains a true-up mechanism designed to reconcile any variance between the projected revenue splits used to calculate each year's cost-sharing percentages and the actual revenue splits realized in each participant's territory during the year. The true-up operates as follows:
(a) At the end of each calendar year, PPC's corporate finance team calculates the actual revenue split between the PPC Territory and the PBI Territory for CSA-covered products.
(b) The actual revenue split is compared to the projected revenue split used to determine the cost-sharing percentages for that year.
(c) If the variance between the projected and actual splits exceeds a de minimis threshold of 2.0 percentage points, a true-up adjustment is made in the subsequent year's cost-sharing calculation to correct for the over- or under-sharing that occurred in the prior year.
(d) If the variance is within the de minimis threshold, no true-up adjustment is required, and the cost-sharing percentages as originally calculated are deemed to be arm's-length.
During the tax years under examination, the variances between projected and actual revenue splits were consistently within a narrow range. In each of the four years, the variance was between approximately 0.4 and 1.7 percentage points, falling within or near the de minimis threshold. Where applicable, minor true-up adjustments were incorporated into the subsequent year's cost-sharing calculation. The cost-sharing percentages and payment amounts set forth in Section 3.3 above reflect the application of the true-up mechanism and represent the final, adjusted cost-sharing amounts for each tax year.
Detailed true-up calculation workpapers for each of the four tax years are provided in Attachment 6-E, which accompanies this response.
IV. SUPPORTING DOCUMENTATION PRODUCED
The following documents and materials are produced herewith in response to IDR No. 6:
Attachment 6-A: Detailed R&D Cost Pool Breakdown (TY 2017–2020). This attachment consists of a Microsoft Excel workbook containing a detailed breakdown of the qualified R&D cost pool by cost category (direct R&D personnel costs, CRO fees, clinical trial costs, laboratory and equipment costs, regulatory submission costs, stock-based compensation, overhead and G&A allocation, and depreciation and amortization) for each of tax years 2017, 2018, 2019, and 2020. Total amounts for each year tie to the aggregate cost pool figures reported in Section 2.1 of this response: $487,300,000 (2017), $523,800,000 (2018), $561,200,000 (2019), and $598,400,000 (2020).
Attachment 6-B: Reasonably Anticipated Benefit Calculations and Revenue Projections (TY 2017–2020). This attachment consists of a Microsoft Excel workbook containing the RAB calculation workpapers for each tax year, including the projected revenue splits between the PPC Territory (Americas) and the PBI Territory (Rest of World) for CSA-covered products and pipeline compounds. The workpapers document the resulting PBI cost-sharing percentages of 38.2% (2017), 39.6% (2018), 41.1% (2019), and 42.7% (2020), together with the key inputs and assumptions underlying the revenue projections.
Attachment 6-C: CSA Cost-Sharing Payment Records (TY 2017–2020). This attachment consists of PDF copies of the intercompany invoices issued by PPC to PBI and the corresponding payment confirmation records documenting PBI's cost-sharing payments for each tax year: $186,148,600 (2017), $207,424,800 (2018), $230,653,200 (2019), and $255,516,800 (2020). The payment records include bank transfer confirmations and intercompany account reconciliations.
Attachment 6-D: Overhead Allocation Methodology Documentation. This attachment consists of a PDF document setting forth a detailed description of the headcount-based methodology used by PPC to allocate general and administrative costs to the R&D cost pool, together with the supporting workpapers for each of the four tax years under examination. The documentation includes the headcount data used in the allocation, the total G&A cost base, and the resulting allocable amounts.
Attachment 6-E: True-Up Calculation Workpapers (TY 2017–2020). This attachment consists of a Microsoft Excel workbook containing the annual true-up calculation workpapers for each of the four tax years, documenting the comparison of projected versus actual revenue splits and any resulting true-up adjustments applied in subsequent periods.
V. PRIVILEGE RESERVATION
PPC and its counsel respectfully reserve all rights to assert the attorney-client privilege, the attorney work-product doctrine, and the tax practitioner privilege under IRC § 7525 with respect to any documents, communications, analyses, or other materials that have not been produced in connection with this response or any other response in this examination. PPC is maintaining a privilege log in connection with this examination, which identifies documents withheld on the basis of applicable privilege.
Without limitation, PPC notes that certain internal analyses and communications between PPC and its counsel, Calderwood & Harkness LLP, are being withheld as protected by the attorney-client privilege and/or the attorney work-product doctrine. In addition, certain communications and work product generated by Whitmore Valuation Group LLC, which was engaged by Calderwood & Harkness LLP under a Kovel arrangement (Reference 1018-00009-KV, dated June 20, 2022) to provide valuation and economic consulting services in connection with this examination, are likewise being withheld as protected under the attorney-client privilege, the work-product doctrine, and/or the tax practitioner privilege.
The production of documents in connection with this response, or any other response in this examination, does not constitute a waiver—express, implied, or otherwise—of any applicable privilege or protection with respect to any documents produced or withheld. PPC expressly reserves the right to assert all applicable privileges and protections at any stage of this examination or any subsequent proceedings.
VI. RESERVATION OF RIGHTS
PPC reserves all rights to supplement, amend, or clarify this response at any time, including but not limited to the right to provide additional documentation, revise the analyses set forth herein, or present additional arguments in support of PPC's transfer pricing positions. This response is based on information currently available to PPC and its advisors, and PPC does not waive any right to present additional information, arguments, or analyses at any future stage of this examination or any subsequent administrative or judicial proceedings.
Nothing in this response shall be construed as a concession by PPC that any adjustment to the cost-sharing percentages, the composition of the R&D cost pool, or any other aspect of the CSA or PPC's transfer pricing is warranted. PPC's transfer pricing positions with respect to the CSA, including the R&D cost pool composition and the RAB-based cost-sharing allocation methodology, are fully supported by contemporaneous documentation, economic analyses, and applicable law, including IRC § 482 and Treasury Regulations §§ 1.482-7 and 1.482-1(d). PPC further reserves all rights under IRC § 6662(e) and Treasury Regulation § 1.6662-6 with respect to any penalty determinations that may arise in connection with this examination.
We trust that the foregoing response and the accompanying attachments are responsive to IDR No. 6. Should you wish to discuss the materials produced herewith, or should you require any further clarification regarding the information provided, please do not hesitate to contact the undersigned or Garrett Simmons at Calderwood & Harkness LLP's Philadelphia office at 1735 Market Street, Suite 3100, Philadelphia, PA 19103, telephone (215) 864-7200. We are available to schedule a meeting or conference call at your convenience to review the response and supporting documentation.
This response is submitted on behalf of Penterra Pharmaceuticals Corp. (EIN 22-3741856) for examination LB&I-NE-TP-2022-00641.
Respectfully submitted,
CALDERWOOD & HARKNESS LLP
By: ________
Leonard Cross Partner, Tax Department Calderwood & Harkness LLP 1735 Market Street, Suite 3100 Philadelphia, PA 19103 Telephone: (215) 864-7200
Email: lcross@calderwoodharkness.com
cc: (via electronic mail)
Marcus Whitfield, Vice President, Global Tax, Penterra Pharmaceuticals Corp. Deborah Staines, General Counsel, Penterra Pharmaceuticals Corp. Sylvia Hartwell, Calderwood & Harkness LLP Garrett Simmons, Calderwood & Harkness LLP Leila Nazari, Calderwood & Harkness LLP Supervisory Revenue Agent Gerald Meskill, Team Manager, LB&I Division
Enclosures:
Attachment 6-A: Detailed R&D Cost Pool Breakdown (TY 2017–2020) [Microsoft Excel]
Attachment 6-B: Reasonably Anticipated Benefit Calculations and Revenue Projections (TY 2017–2020) [Microsoft Excel]
Attachment 6-C: CSA Cost-Sharing Payment Records (TY 2017–2020) [PDF — copies of intercompany invoices and payment confirmations]
Attachment 6-D: Overhead Allocation Methodology Documentation [PDF]
Attachment 6-E: True-Up Calculation Workpapers (TY 2017–2020) [Microsoft Excel]
Tax Year | Total Qualified R&D Cost Pool
2017 | $487,300,000
2018 | $523,800,000
2019 | $561,200,000
2020 | $598,400,000
Tax Year | PBI Cost-Sharing Percentage | Total R&D Cost Pool | PBI Cost-Sharing Amount
2017 | 38.2% | $487,300,000 | $186,148,600
2018 | 39.6% | $523,800,000 | $207,424,800
2019 | 41.1% | $561,200,000 | $230,653,200
2020 | 42.7% | $598,400,000 | $255,516,800
Product | Global Net Sales | Non-Americas Net Sales | Non-Americas Share
Veritaxol | $3,120,000,000 | $1,340,000,000 | ~43%
Imvara | $1,870,000,000 | $790,000,000 | ~42%
Cerulon | $620,000,000 | $280,000,000 | ~45%

CONFIDENTIAL — TAX EXAMINATION MATERIAL

VIA HAND DELIVERY AND ELECTRONIC MAIL

I. OVERVIEW OF THE COST-SHARING ARRANGEMENT

IV. SUPPORTING DOCUMENTATION PRODUCED

V. PRIVILEGE RESERVATION

VI. RESERVATION OF RIGHTS

CALDERWOOD & HARKNESS LLP

Record

Parties

Dates

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