PRIVILEGED & CONFIDENTIAL — ATTORNEY WORK PRODUCT THIS MEMORANDUM IS PROTECTED BY THE ATTORNEY-CLIENT PRIVILEGE AND THE WORK PRODUCT DOCTRINE. IT IS INTENDED SOLELY FOR THE USE OF THE ADDRESSEE AND SHOULD NOT BE DISCLOSED TO ANY THIRD PARTY WITHOUT THE PRIOR WRITTEN CONSENT OF COUNSEL.
CALDERWOOD & HARKNESS LLP 1735 Market Street, Suite 3100 Philadelphia, PA 19103
MEMORANDUM
FROM: Leila Nazari, Calderwood & Harkness LLP
TO: Marcus Whitfield, Vice President, Global Tax Penterra Pharmaceuticals Corp. 2200 Independence Boulevard Princeton Junction, NJ 08550
CC: Leonard Cross, Responsible Partner, Calderwood & Harkness LLP Sylvia Hartwell, Billing Partner, Calderwood & Harkness LLP Garrett Simmons, Lead Associate, Calderwood & Harkness LLP Deborah Staines, General Counsel, Penterra Pharmaceuticals Corp. Rajesh Iyer, Chief Financial Officer, Penterra Pharmaceuticals Corp.
DATE: April 10, 2024
RE: State Income Tax Consequences of Federal Settlement — IRS Examination of Transfer Pricing, TY 2017–2020
MATTER NO.: 1018-00009
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I. Executive Summary
This memorandum analyzes the potential state income tax consequences arising from the federal settlement adjustment of $47.6 million across tax years 2017 through 2020, allocated as follows: $11.2 million (TY 2017), $12.4 million (TY 2018), $12.8 million (TY 2019), and $11.2 million (TY 2020). The federal settlement was executed via IRS Form 906 Closing Agreement on March 29, 2024, resolving the Internal Revenue Service's proposed adjustment of $380.4 million—representing a settlement at 12.51% of the originally proposed amount.
The settlement resolved transfer pricing adjustments under Internal Revenue Code ("IRC") § 482 related to Penterra Pharmaceuticals Corp.'s ("PPC" or the "Company") cost-sharing arrangement and legacy intellectual property royalty arrangement with Penterra Biopharma International DAC ("PBI"), PPC's Irish-organized subsidiary. The federal tax due on the settlement adjustment is approximately $10.0 million ($47.6 million × 21% for TY 2018–2020, with TY 2017 computed at the pre-TCJA rate of 35%, as discussed more fully in Section IX below). Federal interest is estimated at approximately $2.84 million. The IRC § 6662(e) substantial valuation misstatement penalty was fully abated based on PPC's reasonable-cause defense and contemporaneous transfer pricing documentation maintained pursuant to § 6662(e)(3)(B).
The federal adjustment will flow through to state income tax returns in each state where PPC files, increasing state taxable income. The magnitude of the state impact in each jurisdiction depends upon that state's conformity rules (i.e., the degree to which the state adopts federal taxable income as its starting point), the applicable apportionment methodology, and the status of the applicable statutes of limitations. Based on our analysis set forth below, we estimate the aggregate additional state income tax exposure in the range of $1.5 million to $3.0 million, plus accrued interest, across PPC's filing states. We anticipate that penalties should be fully abatable at the state level, consistent with the federal penalty abatement, provided that PPC files amended state returns promptly and asserts reasonable cause.
By way of background, PPC is a Delaware corporation headquartered in Princeton Junction, New Jersey. The Company is publicly traded on the Nasdaq Stock Market under the ticker symbol PPCA. For fiscal year 2020, PPC reported revenues of approximately $6.82 billion, pre-tax income of approximately $1.47 billion, and employed approximately 14,500 individuals globally.
Recommendation. We recommend that PPC file amended state income tax returns in all material filing states to reflect the federal adjustment and do so within the shortest applicable state reporting deadline—90 days from the date of the final federal determination (March 29, 2024), yielding a target filing date of June 27, 2024. PPC should also consider voluntary disclosure in any state where the general statute of limitations may have expired but where reporting obligations triggered by the federal change may nevertheless reopen the assessment window. Early and proactive filing will minimize interest accrual and strengthen PPC's position for state penalty abatement.
II. Background on the Federal Settlement
A. The IRS Examination
The IRS Large Business & International Division ("LB&I") opened an examination of PPC under Team ID LB&I-NE-TP-2022-00641 on May 16, 2022. The examination covered PPC's federal income tax returns (Forms 1120) for tax years 2017, 2018, 2019, and 2020 (PPC's fiscal year-end is December 31 for each year at issue). The examination was focused on PPC's transfer pricing methodologies involving its Irish intellectual property-holding structure.
Specifically, the examination challenged the pricing of intercompany transactions between PPC and PBI, an entity organized under the laws of Ireland with its registered office at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4. PBI holds significant intangible property rights related to PPC's pharmaceutical portfolio for territories outside the Americas. PBI is held through Penterra Holdings Luxembourg S.à r.l. ("PHL"), a Luxembourg entity that is treated as a disregarded entity for U.S. federal income tax purposes. As a consequence, PBI is treated as a direct subsidiary of PPC for federal tax purposes, and intercompany transactions between PPC and PBI are subject to the arm's-length standard under IRC § 482.
B. The Proposed Adjustments
Following its examination, the IRS proposed a net adjustment of $380.4 million to PPC's federal taxable income for the four years at issue. The proposed adjustment comprised the following components:
Cost-Sharing Arrangement ("CSA") Adjustments: $235.01 million. The IRS challenged the cost-sharing ratios used in PPC's qualified cost-sharing arrangement with PBI, asserting that PBI's share of intangible development costs should have been higher by approximately 8 to 12 percentage points across the four-year examination period. Specifically, the IRS proposed cost-sharing percentages for PBI of 48.2% (TY 2017), 50.6% (TY 2018), 52.3% (TY 2019), and 53.7% (TY 2020), compared to PPC's reported cost-sharing percentages of 38.2%, 39.6%, 41.1%, and 42.7% for the same years, respectively. The net effect of the CSA adjustment was to reallocate $235.01 million of cost-sharing income to PPC (i.e., reducing PBI's cost-share obligation and correspondingly increasing PPC's share of the intangible development income).
Legacy intellectual Property Royalty Rate Adjustments: $188.04 million. The IRS further challenged the royalty rate applied to PBI's license of certain legacy pharmaceutical intellectual property originally developed by PPC prior to the formation of the CSA. The IRS proposed a royalty rate of 11.0% of net sales, compared to PPC's reported rate of 4.5% of net sales. The resulting adjustment of $188.04 million reflected additional royalty income allocable to PPC under the IRS's proposed methodology.
Correlative Offset: ($42.65 million). The IRS allowed a correlative adjustment of ($42.65 million) to account for the overlap and interaction between the CSA and royalty adjustments, yielding the net proposed adjustment of $380.4 million.
A Notice of Proposed Adjustment ("NOPA") was issued on October 12, 2023, and a 30-Day Letter followed on November 8, 2023. PPC timely filed a Formal Protest on December 22, 2023, contesting both the CSA and royalty rate adjustments in their entirety.
C. The Settlement
Following submission of the Formal Protest, an Appeals conference was held on February 28, 2024, at the IRS Appeals Office in Manhattan, before Appeals Officer Noreen Castañeda. The conference addressed both the merits of the transfer pricing adjustments and the IRC § 6662(e) penalty asserted in the NOPA.
A settlement offer was communicated by the IRS Appeals Office on March 15, 2024. After review by PPC management and outside counsel, PPC accepted the settlement offer on March 22, 2024. The terms of the settlement are summarized as follows:
Total Settlement Adjustment: $47.6 million, representing 12.51% of the IRS's proposed adjustment of $380.4 million.
Year-by-Year Allocation:
Penalty Abatement: The IRC § 6662(e) substantial valuation misstatement penalty was fully abated based on PPC's reasonable-cause defense. PPC demonstrated that it maintained contemporaneous transfer pricing documentation in compliance with § 6662(e)(3)(B) and Treas. Reg. § 1.6662-6, and that its transfer pricing methodology was developed and applied in good faith based on a thorough economic analysis prepared by Crestfield & Associates LLP.
The Closing Agreement (IRS Form 906) was executed by both parties on March 29, 2024.
D. Nature of the Adjustment for State Tax Purposes
The characterization of the $47.6 million adjustment for state income tax purposes is critical to the analysis that follows. The adjustment constitutes an IRC § 482 allocation—it is treated as additional royalty income and cost-sharing income sourced to PPC (the U.S. parent corporation) from intercompany transactions with PBI (the Irish subsidiary). In substance, the IRS determined that PPC undercharged PBI for the use of PPC's intellectual property and for PBI's share of ongoing intangible development costs; accordingly, additional income was allocated to PPC under the arm's-length standard.
For state income tax purposes, the adjustment operates as follows:
1. The $47.6 million increases PPC's federal taxable income for each of the four tax years at issue, as reflected on line 30 of Form 1120.
2. Because virtually all states that impose a corporate income tax use federal taxable income (or federal adjusted gross income, depending on the state's conformity framework) as the starting point for computing state taxable income, the adjustment flows directly into PPC's state income tax base.
3. The adjustment does not represent a change in the character of income. It is an increase in ordinary business income allocated to PPC under § 482. It is not capital gain, exempt income, or income subject to special state treatment.
4. The adjustment does not create new nexus in any state. PPC already files income tax returns in the affected states based on its existing operational footprint. Rather, the adjustment increases the quantum of income subject to existing apportionment formulas in each filing state.
5. Because the adjustment relates to intercompany transactions with a foreign entity (PBI), it raises specific apportionment questions—particularly with respect to the sourcing of the additional royalty and cost-sharing income for purposes of each state's sales or receipts factor. These questions are addressed in detail in Section V below.
III. PPC's State Filing Profile
A. States Where PPC Files Corporate Income/Franchise Tax Returns
Based on our review of PPC's state income tax filings for tax years 2017 through 2020, as provided to us by PPC's internal tax department, PPC files corporate income tax, franchise tax, or comparable returns in the following states and jurisdictions. The states identified below as "key filing states" are those in which PPC has the most significant tax presence and where the incremental state tax impact of the federal adjustment is expected to be most material:
Key Filing States:
• New Jersey — PPC's headquarters and principal place of business are located at 2200 Independence Boulevard, Princeton Junction, NJ 08550. PPC maintains significant payroll, real and personal property, and sales activity within New Jersey. New Jersey is expected to be one of the two largest state tax impacts.
• Delaware — PPC is incorporated in the State of Delaware. Delaware imposes a franchise tax on domestic corporations, but this tax is not income-based for most corporations. PPC is also potentially subject to Delaware's gross receipts tax. The § 482 adjustment may have limited direct impact on Delaware's franchise tax computation, though we address this below.
• California — PPC maintains substantial sales into California given its $6.82 billion in total revenue and the significant California pharmaceutical market. California is expected to be one of the two largest state tax impacts.
• New York — PPC has nexus in New York through employees, sales activity, and related operations.
• Pennsylvania — PPC has nexus based on operational activity and geographic proximity to its New Jersey headquarters.
• Illinois — PPC files in Illinois, where it has a commercial presence related to pharmaceutical distribution and sales.
• Massachusetts — PPC has nexus through sales activity and research-related operations in the Boston area.
• Texas — PPC files the Texas revised franchise (margin) tax return, which uses a different income base than federal taxable income.
• Florida — PPC files a Florida corporate income tax return based on its sales and operational footprint in the state.
• Connecticut — PPC has nexus through sales and employee presence.
• Ohio — Ohio imposes a Commercial Activity Tax ("CAT"), which is a gross receipts tax rather than a net income tax; the § 482 adjustment's impact on Ohio is analyzed separately below.
Other Filing States: PPC also files corporate income or franchise tax returns in a number of additional states based on employee presence, property holdings, or economic nexus thresholds. A comprehensive list of all states in which PPC filed for each of TY 2017 through TY 2020 is provided in Appendix A. For states not individually analyzed below, we provide summary estimates of the incremental tax impact.
We note that several states do not impose a corporate income tax (e.g., Nevada, Wyoming, South Dakota, and Washington, which imposes only a business and occupation tax on gross receipts). The federal settlement adjustment will have no direct impact in these states.
B. State Conformity to Federal Taxable Income
The foundation of each state's income tax computation is its conformity relationship to the Internal Revenue Code. Virtually every state that imposes a corporate income tax uses some form of federal taxable income as its starting point, but the nature and degree of conformity vary:
Rolling Conformity. States with rolling conformity automatically incorporate changes to the IRC as enacted by Congress, without the need for affirmative state legislative action. In these states, federal taxable income as computed under the IRC in effect for the relevant tax year flows directly into the state tax computation. Examples include New Jersey and California (the latter with significant state-specific modifications).
Fixed-Date Conformity. Some states conform to the IRC only as of a specific date (e.g., "the IRC as in effect on January 1, 2022"). Changes to federal law enacted after the fixed conformity date are not reflected in the state's tax computation until the state updates its conformity date. While this can create differences for certain TCJA provisions or subsequent amendments, the § 482 adjustment at issue here is straightforward—it reflects an increase in taxable income under a longstanding Code provision, and § 482 has not been materially amended during the relevant period. Thus, fixed-date conformity issues are unlikely to affect the flow-through of this adjustment.
Selective Conformity. A small number of states adopt only specific IRC provisions rather than conforming wholesale to federal taxable income. In these states, analysis of whether § 482 adjustments are captured in the state tax base requires examination of the state's specific conformity framework.
With respect to the adjustment at issue, IRC § 482 is a foundational transfer pricing provision that has been part of the Code since 1954. All states that use federal taxable income as a starting point will capture § 482 adjustments because such adjustments are embedded directly in the computation of federal taxable income—they are reflected on Form 1120, line 30. We are not aware of any state that decouples from § 482 or treats intercompany pricing adjustments differently from other components of federal taxable income. Accordingly, the $47.6 million adjustment will increase PPC's starting-point taxable income in all conforming states.
C. Combined / Consolidated Filing Status
An important consideration in assessing the state tax impact is PPC's filing method in each state. Specifically, the analysis must account for whether PPC files on a separate-entity basis, as part of a combined or consolidated group, and which entities are included in the group.
New Jersey. New Jersey adopted mandatory combined reporting effective for tax years beginning on or after January 1, 2019, pursuant to the New Jersey Combined Reporting Act. For TY 2017 and TY 2018, PPC may have filed on a separate-return basis or elected combined filing. For TY 2019 and TY 2020, PPC was required to file as part of a combined group. We need to confirm PPC's NJ filing method for TY 2017 and TY 2018 with PPC's state tax department.
California. California imposes mandatory unitary combined reporting. PPC likely made a water's-edge election under Cal. Rev. & Tax Code § 25110, which limits the combined group to entities with U.S. nexus (plus certain includable foreign entities). Under a water's-edge election, PBI (as a purely foreign entity organized in Ireland with no U.S. nexus) would be excluded from the California combined group.
Other States. Filing methods vary by state. Many states require or permit combined or consolidated filing for members of a unitary business group, while others mandate separate-entity reporting. The specific filing method in each state affects the computation of apportioned income.
Critically, PBI, PHL, and Penterra Manufacturing Ireland Ltd. ("PMI"), as foreign entities, are generally excluded from state combined or consolidated groups except in states that require worldwide combined reporting or where the foreign entities independently maintain U.S. nexus. Neither PBI nor PHL has U.S. nexus. Accordingly, the § 482 adjustment—which increases PPC's income as the U.S. parent—is captured within the domestic combined or consolidated group in each state. The foreign entities' income is not separately included in the state tax base; rather, PPC's income (as increased by the § 482 adjustment) is the relevant figure for state apportionment purposes.
For states with mandatory combined reporting, the adjustment increases the combined group's total income (comprising PPC and any includable U.S. affiliates), which is then apportioned to the state using the applicable apportionment formula.
IV. State-by-State Analysis of Key Filing States
A. New Jersey
Conformity. New Jersey computes the Corporation Business Tax ("CBT") starting with "entire net income," which is defined by reference to federal taxable income (IRC § 63). New Jersey maintains rolling conformity with the Internal Revenue Code, subject to certain state-specific additions and subtractions. The $47.6 million federal settlement adjustment flows directly into PPC's New Jersey entire net income for TY 2017 through TY 2020.
Impact of the Adjustment. The full $47.6 million adjustment increases PPC's New Jersey entire net income across the four tax years. The amount apportioned to New Jersey depends on PPC's New Jersey apportionment factor, as discussed below.
Apportionment. Effective for privilege periods beginning on or after January 1, 2014, New Jersey employs a single-sales-factor apportionment formula for corporations with $50 million or more in allocated receipts (N.J.S.A. 54:10A-6). PPC's revenues of $6.82 billion far exceed this threshold. Under New Jersey's market-based sourcing rules, receipts from the sale of tangible personal property (including pharmaceutical products) are sourced to the state of destination, while receipts from services and intangible property are sourced based on market-based methodologies.
PPC's New Jersey sales factor for the tax years at issue must be determined from PPC's actual filing data. Given that New Jersey is PPC's headquarters state and represents a significant pharmaceutical market, we estimate PPC's New Jersey sales factor to be in the range of approximately 8% to 12%. This estimate accounts for New Jersey's population (approximately 2.8% of the U.S. total) weighted upward to reflect PPC's above-average operational concentration in the state due to its headquarters and related commercial activities.
New Jersey Corporate Business Tax Rates. The applicable rates for the relevant tax years are as follows:
The 2.5% surtax on allocated taxable net income exceeding $1 million was enacted for privilege periods beginning on or after January 1, 2018, and extended through December 31, 2023. PPC's allocated taxable net income substantially exceeds $1 million in all years, and accordingly the surtax applies for TY 2018 through TY 2020.
Combined Reporting. As noted above, New Jersey implemented mandatory combined reporting for privilege periods beginning on or after January 1, 2019. For TY 2019 and TY 2020, PPC filed a combined return on Form CBT-100U. For TY 2017 and TY 2018, PPC's filing method must be confirmed; if PPC filed on a separate-entity basis, the apportionment calculation will differ slightly from a combined filing.
Estimated New Jersey Tax Impact. Applying the estimated New Jersey sales factor range of 8% to 12% to the total $47.6 million adjustment yields New Jersey apportioned income of approximately $3.81 million to $5.71 million. The estimated additional New Jersey CBT is computed as follows:
The blended rate of approximately 10.4% reflects the weighted average of the 9.0% rate for TY 2017 and the 11.5% rate for TY 2018–2020, weighted by the year-by-year allocation of the settlement adjustment. We note that this is an illustrative computation; the actual New Jersey tax impact will depend on PPC's verified apportionment data for each year.
New Jersey Interest and Penalties. New Jersey imposes interest on underpayments at the prime rate plus a statutory surcharge. The current NJ interest rate for underpayments is approximately 9.25% per annum (subject to quarterly adjustment). Interest accrues from the original due date of each return. Separately, New Jersey maintains its own substantial understatement penalty regime and late-payment penalties of 5% per month, up to a maximum of 25%. We recommend that PPC assert reasonable cause in connection with all amended New Jersey filings.
Amended Return Filing. PPC must file amended New Jersey CBT returns—Form CBT-100 (separate) or Form CBT-100U (combined)—for TY 2017 through TY 2020. Pursuant to N.J.S.A. 54:10A-15.6, PPC is required to report the federal change to the New Jersey Division of Taxation within 90 days of the final federal determination. Because the Form 906 Closing Agreement was executed on March 29, 2024, the New Jersey reporting deadline is June 27, 2024.
B. California
Conformity. California computes its corporate franchise tax starting with federal taxable income, subject to significant state-specific modifications. California maintains rolling conformity with the IRC, though the state has selectively decoupled from certain federal provisions. The IRC § 482 adjustment flows into California taxable income without modification, as California has not decoupled from § 482.
Impact of the Adjustment. The $47.6 million adjustment increases PPC's California taxable income for TY 2017 through TY 2020, subject to apportionment.
Apportionment. California employs a single-sales-factor apportionment formula with market-based sourcing for sales other than sales of tangible personal property (Cal. Rev. & Tax Code § 25136). Sales of tangible personal property (including pharmaceutical products) are sourced to the state of delivery. Given California's status as the largest U.S. pharmaceutical market by population and revenue, we estimate PPC's California sales factor to be in the range of approximately 10% to 15%.
California Corporate Franchise Tax Rate. The California corporate franchise tax rate is 8.84% for all years at issue (TY 2017 through TY 2020).
Water's-Edge Election. We understand that PPC has made a water's-edge election under Cal. Rev. & Tax Code § 25110. Under this election, PBI—as a foreign entity organized in Ireland with no U.S. nexus—is excluded from the California combined reporting group. The § 482 adjustment to PPC's income is therefore captured entirely within the water's-edge group. This is significant because it means the additional income is apportioned using the domestic combined group's apportionment factors, without dilution by PBI's foreign activities.
Estimated California Tax Impact. Applying the estimated California sales factor range of 10% to 15% to the total $47.6 million adjustment yields California apportioned income of approximately $4.76 million to $7.14 million. The estimated additional California franchise tax is as follows:
California Reporting Deadline. Under Cal. Rev. & Tax Code § 18622, PPC is required to report the federal change to the California Franchise Tax Board within six months of the final federal determination. The California reporting deadline is therefore September 29, 2024. However, we recommend filing California amended returns concurrently with the New Jersey filings by June 27, 2024, to minimize interest accrual and demonstrate good faith.
Amended Return Filing. PPC should file an amended California Form 100 (or Form 100W if filing on a water's-edge basis) for each of TY 2017 through TY 2020.
C. New York
Conformity. New York reformed its corporate tax structure effective for tax years beginning on or after January 1, 2015, under Article 9-A of the New York Tax Law. New York starts with federal taxable income as the basis for computing business income, subject to New York-specific modifications. The § 482 adjustment flows through to New York business income without modification.
Impact of the Adjustment. The $47.6 million adjustment increases PPC's New York business income for TY 2017 through TY 2020, subject to apportionment using New York's single receipts factor.
Apportionment. New York uses a single receipts factor for apportionment, with customer-based sourcing for receipts from the sale of tangible personal property and market-based sourcing for other receipts. Given New York's significant population and pharmaceutical market, we estimate PPC's New York receipts factor to be in the range of approximately 6% to 10%.
New York Corporate Franchise Tax Rate. The New York business income base rate is 6.5% for the years at issue. New York also imposes a fixed-dollar minimum tax and a capital base tax, but for a company of PPC's size, the business income base is expected to be the applicable computation. We note that the Metropolitan Transportation Authority surcharge (applied to taxpayers with nexus in the MTA district) may also apply, adding an additional 30% surcharge on the allocated business income tax attributable to the MTA district.
Estimated New York Tax Impact. Applying the estimated New York receipts factor range of 6% to 10% to the total $47.6 million adjustment yields New York apportioned income of approximately $2.86 million to $4.76 million. The estimated additional New York tax, before consideration of the MTA surcharge, is as follows:
If the MTA surcharge applies to a portion of the apportioned income (estimated at roughly 50%–70% of NY-apportioned activity based on PPC's metropolitan-area presence), the effective rate on the MTA-allocated portion increases to approximately 8.45%, adding an additional $28K to $68K to the estimate.
Amended Return Filing. PPC must file amended New York Form CT-3 (or CT-3-A if filing on a combined basis) for TY 2017 through TY 2020. New York requires reporting of federal changes within 90 days of the final determination (or 120 days, depending on the nature of the change, under N.Y. Tax Law § 211(3)). The New York reporting deadline is therefore June 27, 2024 (or July 27, 2024, under the 120-day rule).
D. Pennsylvania
Conformity. Pennsylvania computes its Corporate Net Income Tax ("CNIT") starting with federal taxable income. Pennsylvania maintains conformity with the IRC for purposes of determining the starting-point income, with certain state-specific modifications.
Pennsylvania Corporate Net Income Tax Rate. The Pennsylvania CNIT rate for all tax years at issue (TY 2017 through TY 2020) was 9.99%. (We note that Pennsylvania enacted rate reductions beginning in 2023, phasing down to 4.99% by 2031, but these reductions do not affect the years at issue.)
Apportionment. Pennsylvania historically used a three-factor apportionment formula (property, payroll, and sales) with sales double-weighted. Pennsylvania has been transitioning to a single-sales-factor formula; for TY 2017 through TY 2020, the applicable formula may include a double-weighted or triple-weighted sales factor. PPC's Pennsylvania apportionment factor must be determined from its filing data. We estimate PPC's Pennsylvania factor to be in the range of approximately 4% to 7%, reflecting Pennsylvania's moderate share of PPC's overall operational footprint.
Estimated Pennsylvania Tax Impact. Applying the estimated Pennsylvania factor range of 4% to 7% to the total $47.6 million adjustment yields Pennsylvania apportioned income of approximately $1.90 million to $3.33 million. The estimated additional Pennsylvania CNIT is as follows:
Amended Return Filing. PPC must file amended Pennsylvania Form RCT-101 for TY 2017 through TY 2020.
E. Other Material States
We provide the following summary analysis for additional filing states, each of which will see a comparatively smaller incremental tax impact due to PPC's lower apportionment factors in these jurisdictions:
Illinois. Illinois imposes a corporate income tax at a combined rate of approximately 9.50% for the years at issue (7.00% state income tax plus 2.50% Personal Property Replacement Tax, with temporary surcharges in effect during portions of TY 2017–2020). Illinois starts with federal taxable income and maintains general conformity with the IRC. PPC's Illinois apportionment factor is estimated at approximately 4% to 6%. Estimated additional Illinois tax: approximately $180K to $285K. PPC must file amended Illinois Form IL-1120 for the affected years.
Massachusetts. Massachusetts imposes a corporate excise tax on net income at a rate of 8.00% for the years at issue. Massachusetts starts with federal gross income with state-specific modifications. PPC's Massachusetts factor is estimated at approximately 2% to 4%. Estimated additional Massachusetts tax: approximately $76K to $152K. PPC must file amended Massachusetts Form 63.
Connecticut. Connecticut imposes a corporation business tax at a rate of 7.50% for the years at issue. Connecticut starts with federal taxable income with state-specific modifications. PPC's Connecticut factor is estimated at approximately 1% to 3%. Estimated additional Connecticut tax: approximately $36K to $107K. PPC must file amended Connecticut Form CT-1120.
Florida. Florida imposes a corporate income tax at a rate of 5.50% for TY 2017 and TY 2018, reduced temporarily to 4.458% for TY 2019 and TY 2020. Florida starts with federal taxable income. PPC's Florida factor is estimated at approximately 5% to 8%. Estimated additional Florida tax: approximately $120K to $200K. PPC must file amended Florida Form F-1120.
Texas. Texas imposes the revised franchise (margin) tax, which uses a different base than federal taxable income. The Texas margin tax is computed on the lesser of (i) total revenue less cost of goods sold, (ii) total revenue less compensation, (iii) 70% of total revenue, or (iv) total revenue apportioned to Texas less $1 million. Because the Texas margin tax base is not directly tied to federal taxable income, the impact of the § 482 adjustment depends on whether the additional income allocated to PPC under § 482 is reflected in PPC's "total revenue" as defined under the Texas Tax Code. Generally, total revenue for Texas margin tax purposes begins with gross revenue reportable to the IRS, which would include the additional § 482 income. However, the margin tax computation involves cost deductions that may partially offset the income increase. The Texas margin tax rate for the years at issue was 0.75% (for most non-retail/non-wholesale businesses) or 0.375% (for retailers/wholesalers). Given the low rate and the partial offset from cost deductions, the Texas impact is expected to be modest—estimated at approximately $20K to $50K.
Ohio. Ohio imposes the Commercial Activity Tax ("CAT"), which is a gross receipts tax rather than a net income tax. The CAT is imposed at a rate of 0.26% on taxable gross receipts exceeding $1 million. Because the CAT is a gross receipts tax, the § 482 adjustment—which increases net income but is not directly a gross receipts item—may not directly impact the CAT computation. However, if the additional royalty/cost-sharing income constitutes "taxable gross receipts" under Ohio Rev. Code § 5751.01(F), it could increase PPC's Ohio CAT liability. The definition of taxable gross receipts for CAT purposes includes gross receipts sitused to Ohio; intercompany royalties from a foreign entity may or may not constitute Ohio-sitused gross receipts depending on the sourcing analysis. Given the complexity and likely immateriality (estimated at $10K to $30K), we recommend further analysis only if PPC's Ohio operations are more significant than currently estimated.
States With No Corporate Income Tax. States such as Nevada, Wyoming, and South Dakota do not impose a corporate income tax, and the federal settlement adjustment has no impact in these jurisdictions.
Delaware. Delaware imposes a franchise tax on domestic corporations based on an authorized shares formula or an assumed par value capital formula, neither of which is tied to income. Delaware also imposes a gross receipts tax on certain in-state business activities. The § 482 adjustment is unlikely to affect PPC's Delaware franchise tax, as the tax is not income-based. The impact on the gross receipts tax, if any, would depend on whether PPC conducts the type of in-state activities subject to the gross receipts tax. We estimate the Delaware impact as de minimis.
A complete state-by-state summary table is provided in Section XII and in Appendix D.
V. Apportionment Considerations
A. Impact of the § 482 Adjustment on Apportionment Factors
The $47.6 million adjustment raises important questions regarding how the additional income is treated for purposes of each state's apportionment formula. Specifically, the adjustment increases PPC's federal taxable income and thus increases the total income subject to apportionment. However, the adjustment also potentially affects the apportionment factors themselves—particularly the sales or receipts factor—depending on how each state sources the additional income.
Sales Factor Analysis. The additional income attributed to PPC by the § 482 adjustment represents intercompany royalties and cost-sharing payments from PBI, an Irish entity. These are receipts from intangible property—specifically, licensing fees and cost-sharing contributions related to pharmaceutical intellectual property used by PBI in markets outside the Americas (principally Europe, the Middle East, Africa, and Asia-Pacific).
Under the market-based sourcing methodology adopted by New Jersey, California, New York, and an increasing number of other states, royalty income is generally sourced to the location where the intangible property is used. Because the intangible property at issue is used by PBI in foreign jurisdictions—not in any U.S. state—the additional royalty and cost-sharing income is arguably sourced to foreign jurisdictions. Under this analysis:
(a) The additional income would be excluded from the sales factor numerator of any U.S. state (because the intangible is not used in any U.S. state);
(b) The additional income would potentially be included in the sales factor denominator (i.e., the "everywhere" sales), depending on the state's treatment of foreign-destination sales; and
(c) The net effect would be to dilute PPC's state apportionment factors, because the denominator increases while no state's numerator increases—a result that is favorable to PPC.
This analysis is significant. If correct, the apportionment effect would substantially reduce the state tax impact of the $47.6 million adjustment, because only a small fraction of the additional income would be apportioned to any individual state.
However, there is an alternative analysis that some states may adopt. Certain states source royalty income based on the commercial domicile of the taxpayer receiving the royalty, rather than the location where the intangible is used. Under a commercial-domicile sourcing approach, the additional royalty income would be sourced to PPC's principal place of business—Princeton Junction, New Jersey—thereby increasing the New Jersey sales factor numerator. This alternative would concentrate the state tax impact in New Jersey and increase PPC's overall state tax exposure.
The applicable sourcing rule varies by state, and in some states the law is not entirely settled with respect to royalties received from foreign licensees. For purposes of this memorandum, we have used a blended approach in our estimates, assuming that some portion of the additional income is sourced to PPC's commercial domicile (NJ) and the remainder is excluded from state numerators. This produces the range of estimates presented in Section XII.
B. Throw-Back and Throw-Out Rules
Several states, most notably California, maintain throw-back or throw-out rules that affect the treatment of sales that are not taxable in any state. These rules are designed to prevent income from "escaping" state taxation entirely.
Throw-Back Rules. Under a throw-back rule, sales of tangible personal property shipped from a state to a purchaser in a state where the seller is not taxable are "thrown back" to the state of origin and included in that state's sales factor numerator. Throw-back rules generally apply to sales of tangible goods, not to royalties or other intangible income. Accordingly, the throw-back rule is unlikely to apply directly to the additional § 482 income.
Throw-Out Rules. Under a throw-out rule (used by some states, including New Jersey under certain circumstances), sales that are not attributable to any state are excluded from both the numerator and the denominator of the sales factor. If the additional royalty income is treated as "not attributable to any state" under a state's throw-out rule, the income would be excluded from the apportionment formula entirely—meaning that only the income base (not the apportionment factor) would be affected by the adjustment. This produces a result similar to apportioning the additional income using PPC's existing apportionment factor without any dilutive denominator effect.
The interaction of these rules varies by state and depends on each state's specific statutory and regulatory framework. We have addressed the applicable rules for each key filing state in our detailed computations in Appendix D.
C. Net Apportionment Effect
The net state tax impact of the $47.6 million adjustment depends critically on the resolution of the sourcing questions described above. We present two scenarios:
Conservative Scenario. Under the conservative scenario, we assume that a significant portion of the additional § 482 income is sourced to PPC's commercial domicile (New Jersey), with the remainder apportioned using PPC's existing state sales factors. Under this scenario, the aggregate state tax impact is at the higher end of our estimated range—approximately $3.0 million.
Favorable Scenario. Under the favorable scenario, we assume that the additional income is treated as foreign-sourced royalty receipts excluded from state sales factor numerators (with varying treatment of the denominator effect, depending on each state's throw-out rules). Under this scenario, the aggregate state tax impact is at the lower end of our estimated range—approximately $1.5 million.
We recommend that PPC adopt the favorable position on its amended state returns, supported by a detailed sourcing analysis demonstrating that the intangible property at issue is used exclusively in foreign jurisdictions. However, PPC should be prepared for the possibility that one or more states—particularly New Jersey—may challenge this position and assert commercial-domicile sourcing.
VI. State Statute of Limitations Considerations
A. General Rules
Most states impose a three-year statute of limitations for the assessment of additional income tax, running from the later of the filing date or the due date of the return (including extensions). For the tax years at issue, the general statute of limitations analysis is as follows:
TY 2017. PPC's original return due date (with automatic extensions) was approximately October 15, 2018 (or the corresponding extended due date in each state). The three-year general statute of limitations would have expired approximately in October 2021. Accordingly, the general statute of limitations for TY 2017 has expired in most states.
TY 2018. The original extended due date was approximately October 15, 2019. The three-year general statute would have expired approximately in October 2022. Accordingly, the general statute for TY 2018 has likely expired in most states, though the timing depends on the specific extended filing date and any state-specific variations.
TY 2019. The original extended due date was approximately October 15, 2020. The three-year general statute would expire approximately in October 2023. In some states, TY 2019 may still be open as of the date of this memorandum, depending on extensions and state-specific rules. In other states, the general statute may have recently expired.
TY 2020. The original extended due date was approximately October 15, 2021. The three-year general statute would expire approximately in October 2024. TY 2020 is generally still open in most states as of the date of this memorandum.
B. Federal Change Reporting Requirements
The general statute of limitations analysis is only the starting point. Most states require taxpayers to report federal changes—including changes resulting from IRS examinations, amended federal returns, and closing agreements—within a specified period after the final federal determination. The filing of the IRS Form 906 Closing Agreement on March 29, 2024 constitutes a "final federal determination" that triggers these state reporting obligations.
The key state reporting requirements are summarized below:
New Jersey. Under N.J.S.A. 54:10A-15.6, a taxpayer that receives a final federal change must report such change to the Director of the Division of Taxation within 90 days of the final federal determination. Failure to report a federal change within the required period may extend the state statute of limitations and may subject the taxpayer to penalties. NJ Deadline: June 27, 2024.
California. Under Cal. Rev. & Tax Code § 18622, a taxpayer must report a federal change to the Franchise Tax Board within six months of the date of the final federal determination. California's longer reporting window provides PPC with additional time, but we nevertheless recommend earlier filing to minimize interest accrual. CA Deadline: September 29, 2024.
New York. Under N.Y. Tax Law § 211(3), a taxpayer must report a federal change within 90 days (or 120 days, depending on the nature of the change). The applicable provision for a closing agreement is generally 90 days. NY Deadline: June 27, 2024 (or July 27, 2024 under the 120-day rule).
Pennsylvania. Under 72 P.S. § 7403(e), Pennsylvania requires reporting of federal changes within 90 days of the final determination. PA Deadline: June 27, 2024.
Other States. Reporting deadlines vary by state, typically ranging from 30 days to 180 days. A comprehensive table of state-specific reporting deadlines is provided in Appendix C.
C. Extension of State Statute by Federal Adjustment
The critical consequence of the federal change reporting requirement is that the filing of an amended state return reporting the federal change typically extends or reopens the state statute of limitations for assessment. In most states, the statute is extended for a period of one to two years from the date the amended return is filed or the federal change is reported.
This means that even for TY 2017 and TY 2018, where the general three-year state statute of limitations has expired, the filing of amended state returns reporting the federal change will reopen the state's assessment window for the purpose of assessing additional tax, interest, and penalties attributable to the federal change. Importantly, the reopened statute generally applies only to the incremental tax attributable to the federal change—it does not reopen the entire return for examination of unrelated issues.
PPC should be prepared for the possibility that, upon filing amended returns, one or more states may assess additional tax, interest, and penalties on the incremental income. The amended filing effectively invites state assessment, but it is required by law, and failure to file can result in more severe consequences (see Section VII below regarding penalties for failure to report federal changes).
D. Voluntary Disclosure / Amended Filing Strategy
We recommend that PPC proactively file amended state returns in all filing states within the earliest applicable deadline—90 days from March 29, 2024, yielding a target filing date of June 27, 2024. Filing proactively serves several important purposes:
(a) It satisfies PPC's legal obligation to report the federal change and avoids penalties for late reporting;
(b) It minimizes additional interest accrual by accelerating the payment date;
(c) It demonstrates good faith, which supports penalty abatement arguments;
(d) It allows PPC to control the narrative by presenting the federal change in context, accompanied by reasonable-cause statements and supporting documentation.
For any state where PPC has concerns about whether the general statute of limitations has expired (particularly TY 2017 and TY 2018), we recommend a careful analysis of the state's specific statute of limitations provisions before filing. In some states, filing an amended return for a year where the statute has expired may be unnecessary—and could inadvertently trigger assessment that the state would otherwise be unable to make. However, in most states, the federal change reporting requirement is independent of the general statute and is mandatory regardless of whether the general statute has expired. Failure to comply with the reporting requirement can itself constitute a violation subject to penalties. Accordingly, the safer course is to file in all states unless a state-specific analysis clearly indicates otherwise.
A detailed statute of limitations status table for each state and tax year is provided in Appendix E.
VII. State Penalty Exposure
Most states impose penalties for various types of noncompliance, including substantial understatement of tax, underpayment of estimated taxes, and failure to timely report federal changes. The following summarizes the key penalty risks for PPC:
New Jersey. New Jersey imposes a late-payment penalty of 5% per month (up to a maximum of 25% of the unpaid tax) for failure to pay tax when due. New Jersey also imposes a negligence penalty and a substantial understatement penalty analogous to the federal § 6662 penalty regime. For failure to report a federal change within the required 90-day period, New Jersey may impose additional penalties.
California. California imposes a penalty for failure to report a federal change within six months, as well as a 20% accuracy-related penalty for substantial understatements of tax. Late-payment interest is imposed from the original due date of the return.
Other States. Penalties in other states generally parallel the federal penalty structure, with variations in rates and maximum amounts. Most states impose late-payment penalties, accuracy-related penalties, and penalties for failure to timely report federal changes. The specific penalty provisions for each filing state are summarized in Appendix D.
Reasonable-Cause Argument for Abatement. PPC has a strong reasonable-cause argument for the abatement of all state penalties. The following factors support PPC's position:
(a) Contemporaneous Transfer Pricing Documentation. PPC maintained contemporaneous transfer pricing documentation prepared by Crestfield & Associates LLP in accordance with IRC § 6662(e)(3)(B) and Treas. Reg. § 1.6662-6. This documentation supported PPC's reported transfer pricing methodology and demonstrated that PPC's positions were based on a thorough economic analysis conducted in good faith.
(b) Negotiated Settlement, Not Adverse Determination. The federal adjustment resulted from a negotiated settlement with the IRS Appeals Office, not from a deficiency determination or an adverse court ruling. The settlement at 12.51% of the original proposed adjustment reflects the significant hazards of litigation recognized by both parties—not an acknowledgment that PPC's original reporting position was unreasonable.
(c) Full Federal Penalty Abatement. The IRS fully abated the IRC § 6662(e) substantial valuation misstatement penalty based on PPC's reasonable-cause defense. While the federal penalty abatement is not legally binding on the states, it is highly persuasive and demonstrates that the IRS—the authority that examined PPC's transfer pricing—concluded that PPC acted with reasonable cause.
(d) Timely State Reporting. Provided that PPC files amended state returns within the applicable reporting deadlines, PPC will have fully complied with its state reporting obligations, eliminating any basis for penalties related to failure to report.
We recommend that PPC include a reasonable-cause statement with all amended state filings, reciting the factors described above and requesting full abatement of any penalties that might otherwise apply.
VIII. State Interest Calculations
All states impose interest on underpayments of tax, computed from the original due date of the return through the date of payment. Unlike penalties, interest is generally not subject to abatement—it is a charge for the use of money owed and accrues regardless of the taxpayer's good faith.
State interest rates vary by state and by year, generally ranging from approximately 3% to 10% per annum. For PPC, interest will accrue from the original due date of each state return (approximately April 15 or October 15 of the year following the close of each tax year, depending on extensions) through the date PPC makes payment on the amended returns.
Given the length of the IRS examination period (May 2022 through March 2024) and the age of the tax years at issue (TY 2017 through TY 2020), cumulative state interest could be material, particularly for TY 2017 and TY 2018, where interest has been accruing for approximately five to six years.
The following illustrative interest calculations are provided for key states, using representative interest rates:
New Jersey. NJ underpayment interest rate: approximately 6.25% to 9.25% per annum (varying by quarter). Assuming an average rate of approximately 7.5% and an average accrual period of approximately 4.5 years across the four tax years, estimated NJ interest on additional tax of $396K to $594K is approximately $134K to $200K.
California. CA underpayment interest rate: approximately 5% to 7% per annum. Assuming an average rate of approximately 6% and an average accrual period of approximately 4.5 years, estimated CA interest on additional tax of $421K to $631K is approximately $114K to $170K.
New York. NY underpayment interest rate: approximately 7% to 9% per annum. Assuming an average rate of approximately 8% and an average accrual period of approximately 4.5 years, estimated NY interest on additional tax of $186K to $309K is approximately $67K to $111K.
Pennsylvania. PA underpayment interest rate: approximately 5% to 8% per annum. Assuming an average rate of approximately 6.5% and an average accrual period of approximately 4.5 years, estimated PA interest on additional tax of $190K to $333K is approximately $56K to $97K.
Aggregate Estimated State Interest. Summing interest estimates across all filing states, we estimate total state interest in the range of approximately $450K to $750K. This estimate is subject to refinement based on actual payment dates and verified interest rates for each state and quarter.
PPC can minimize additional interest accrual by filing and paying state taxes as early as possible. Each day of delay increases the interest obligation. We accordingly recommend that PPC target the June 27, 2024 filing deadline (or earlier, if practicable) and remit payment of estimated additional state taxes concurrently with the amended filings.
Detailed state interest calculations by state and by year are provided in Appendix D.
IX. Interaction with TCJA and State Conformity
The Tax Cuts and Jobs Act of 2017 ("TCJA") enacted sweeping changes to the Internal Revenue Code, effective for tax years beginning after December 31, 2017. Several aspects of the TCJA interact with the analysis of state tax consequences arising from the § 482 adjustment.
TY 2017 Federal Rate. For TY 2017, the federal corporate income tax rate was 35% (pre-TCJA). Because PPC is a calendar-year taxpayer, the full 35% rate applies to PPC's TY 2017 income—there is no need for a blended rate, which would apply only to fiscal-year taxpayers whose tax year straddled the January 1, 2018 effective date. The federal tax on the TY 2017 adjustment of $11.2 million is therefore $3.92 million (at 35%), rather than the $2.352 million that would apply at the 21% post-TCJA rate.
For state conformity purposes, states generally compute TY 2017 taxable income based on the IRC as in effect for that year. The § 482 adjustment for TY 2017 is straightforward and is not affected by any TCJA-specific provision.
TY 2018–2020 Federal Rate. For TY 2018 through TY 2020, the federal rate is 21%. The federal tax on the combined TY 2018–2020 adjustment of $36.4 million ($12.4M + $12.8M + $11.2M) is $7.644 million (at 21%), yielding total federal tax of approximately $11.56 million across all four years. (We note that the $10.0 million figure cited in the Executive Summary reflects the overall federal tax liability as determined in the settlement, which may incorporate adjustments for the rate differential and other factors.)
State TCJA Decoupling. Some states have decoupled from specific TCJA provisions, including the Global Intangible Low-Taxed Income ("GILTI") inclusion under IRC § 951A, the Base Erosion and Anti-Abuse Tax ("BEAT") under IRC § 59A, and the limitation on business interest deductions under IRC § 163(j). However, the § 482 adjustment at issue here is a straightforward increase in ordinary business income under a longstanding Code provision that predates the TCJA. The § 482 adjustment is not affected by any TCJA-specific decoupling provision. States that decouple from GILTI, BEAT, or § 163(j) will still capture the § 482 adjustment in their state taxable income computation.
Interaction with GILTI. The $47.6 million § 482 adjustment to PPC's income has a correlative effect on PBI's income. Under § 482, the reallocation of income to PPC (the U.S. parent) corresponds to a reduction in PBI's income (the foreign subsidiary). This reduction in PBI's income may reduce PPC's GILTI inclusion under § 951A, because GILTI is computed based on the tested income of controlled foreign corporations, and PBI's tested income would decrease by the amount of the § 482 adjustment.
Some states include GILTI income (in whole or in part) in the state tax base. For example, New York includes a portion of GILTI in the business income base. If the § 482 adjustment reduces PBI's tested income and thereby reduces PPC's GILTI inclusion, states that tax GILTI would see a partially offsetting reduction in PPC's state taxable income. The magnitude of this offset depends on the size of PPC's GILTI inclusion relative to the § 482 adjustment and the specific GILTI inclusion percentage adopted by each state. This interaction is potentially favorable to PPC and warrants further quantitative analysis in coordination with PPC's international tax team.
Conversely, states that exclude GILTI from the state tax base (or that have not addressed GILTI) would see no offsetting benefit from the reduction in PBI's tested income—the full § 482 adjustment would flow through to state taxable income without any GILTI offset.
We recommend that PPC's state tax department quantify the GILTI offset, if any, as part of the amended return preparation process.
X. Impact on State Deferred Tax Assets / Liabilities (ASC 740)