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PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT

MEMORANDUM

July 25, 2022

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

TO: Leonard Cross, Responsible Partner; Sylvia Hartwell, Billing Partner

CC: Leila Nazari, Working Associate

RE: Analysis of Cost-Sharing Arrangement Agreement Between Penterra Pharmaceuticals Corp. and Penterra Biopharma International DAC — Key Terms and Compliance with Treas. Reg. § 1.482-7

MATTER NO.: 1018-00009

CLIENT: Penterra Pharmaceuticals Corp. (EIN: 22-3741856)

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I. Executive Summary

This memorandum analyzes the qualified cost-sharing arrangement ("CSA") agreement executed effective July 1, 2012, between Penterra Pharmaceuticals Corp. ("PPC") and Penterra Biopharma International DAC ("PBI") for compliance with the regulatory requirements governing qualified cost-sharing arrangements under Treasury Regulation § 1.482-7. The analysis is undertaken in the context of an ongoing examination by the IRS Large Business & International Division (Exam Team ID: LB&I-NE-TP-2022-00641), which was opened on May 16, 2022, and covers Tax Years 2017 through 2020. The CSA has emerged as a central focus of the examination.

The IRS has indicated through preliminary communications, including informal discussions at the opening conference and through Information Document Requests ("IDRs") served to date, that it may challenge the platform contribution transaction ("PCT") valuations as well as the ongoing cost-sharing ratios, asserting that both understate PPC's U.S.-source income under Internal Revenue Code § 482. Specifically, the IRS appears to be positioning to argue that the PCT payment of $312 million, which PBI paid to PPC in 2012 for the buy-in to pre-existing intellectual property, significantly undervalued the pre-existing IP portfolio. The IRS has further signaled that it intends to propose increasing PBI's cost-sharing percentages by approximately 8 to 12 percentage points across each of the examination years, which would result in additional cost-sharing payments flowing to PPC totaling approximately $235.01 million over the four-year period.

Based on my analysis of the CSA agreement, the applicable Treasury Regulations, the contemporaneous transfer pricing documentation prepared by Crestfield & Associates LLP, and the preliminary independent analysis performed by Whitmore Valuation Group LLC under a Kovel arrangement, it is my conclusion that the CSA agreement substantially complies with the requirements of Treas. Reg. § 1.482-7 in all material respects. The agreement identifies two qualifying controlled participants, defines the scope of intangible development activity with adequate specificity, employs a recognized methodology for determining reasonably anticipated benefits, provides for proportionate cost allocation with an annual true-up mechanism, documents the PCT payment, and satisfies the applicable administrative requirements regarding written agreements, documentation, and reporting.

That said, certain areas warrant strengthened documentation and clarification for defense purposes. In particular, the significant disparity between PPC's PCT valuation ($312 million) and the IRS's preliminary valuation ($852 million) presents a meaningful area of exposure that will require robust economic analysis and detailed factual support. Additionally, PBI's relatively small initial headcount at the CSA's inception in 2012 (52 employees) may invite scrutiny regarding PBI's qualification as a bona fide controlled participant, although PBI's subsequent growth to 185 employees by 2020 and its substantive functional contributions support its eligibility.

It should be noted that PPC was not enrolled in the IRS Compliance Assurance Process ("CAP") for any of the tax years at issue. Contemporaneous transfer pricing documentation for TY 2017 through TY 2020 was prepared by Crestfield & Associates LLP under the direction of Susan Lam, Transfer Pricing Partner, in accordance with the requirements of IRC § 6662(e) and the associated penalty-protection standards. The adequacy of this documentation for penalty-protection purposes is addressed in a separate memorandum.

II. Background

A. Corporate Structure

The relevant entities in the Penterra group for purposes of this analysis are as follows:

Penterra Pharmaceuticals Corp. ("PPC"). PPC is a Delaware corporation, publicly traded on the Nasdaq Stock Market under ticker symbol PPCA, with its principal executive offices located at 2200 Independence Boulevard, Princeton Junction, New Jersey 08550. PPC operates as a specialty pharmaceuticals and biotechnology company, with therapeutic focus areas spanning oncology, immunology, and rare-disease therapeutics. For its fiscal year ending December 31, 2020, PPC reported consolidated global revenue of approximately $6.82 billion and consolidated pre-tax income of approximately $1.47 billion. As of December 31, 2020, PPC employed approximately 14,500 individuals worldwide, with the majority of its research and development personnel based in the United States at its Princeton Junction campus and at satellite research facilities in Cambridge, Massachusetts, and San Diego, California. PPC is the parent entity of the Penterra corporate group and serves as one of the two controlled participants in the CSA.

Penterra Biopharma International DAC ("PBI"). PBI is 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's Irish Tax Reference Number is 3218764T. PBI functions as an intellectual property holding company and serves as the principal entity for commercialization of Penterra products in all markets outside the Americas. For its fiscal year ending December 31, 2020, PBI reported revenue of approximately €2.14 billion and pre-tax income of approximately €1.06 billion. PBI employed 185 individuals as of December 31, 2020, a significant increase from the 52 employees at the time of its establishment in 2012. PBI's Managing Director is Aidan Naughton, who is based in Dublin and oversees PBI's commercial, regulatory, and strategic operations. PBI occupies approximately 18,000 square feet of office space at the Sandyford Business Park facility in Dublin. PBI is the second controlled participant in the CSA and holds the rights to exploit CSA intangibles in all territories outside the Americas.

Penterra Holdings Luxembourg S.à r.l. ("PHL"). PHL is a société à responsabilité limitée organized under the laws of the Grand Duchy of Luxembourg, with RCS Number B 168452 and its registered office at 14 rue Aldringen, L-1118 Luxembourg. PHL is an intermediate holding entity that is the 100% direct owner of PBI. PHL is itself 100% owned by PPC. Critically, PHL has elected to be treated as a disregarded entity for U.S. federal income tax purposes, and accordingly, PBI is treated as owned directly by PPC for purposes of the IRC § 482 analysis. PHL does not participate in the CSA as a separate controlled participant.

Penterra Manufacturing Ireland Ltd. ("PMI"). PMI is a private limited company incorporated under Irish law (Irish CRO Number 512347), with its principal manufacturing facility located at Unit 7, Ringaskiddy Industrial Estate, Co. Cork T12 PX29, Ireland. PMI operates as a contract manufacturer of PPC's oncology and immunology biologics for non-Americas markets. PMI performs its manufacturing services under a cost-plus intercompany arrangement with PBI, under which PMI is compensated at cost plus an 8% markup. As of December 31, 2020, PMI employed approximately 620 individuals at its Ringaskiddy facility, primarily production, quality assurance, and supply chain personnel. PMI is a wholly-owned subsidiary of PBI.

Ownership Chain. The relevant ownership chain is as follows: PPC (Delaware, U.S.) → PHL (Luxembourg, disregarded entity) → PBI (Ireland, DAC) → PMI (Ireland, contract manufacturer). For U.S. federal tax purposes, PHL's disregarded status means the effective chain is PPC → PBI → PMI.

B. History of the CSA

PBI was incorporated on March 15, 2012, as part of PPC's strategic initiative to establish an international platform for the commercialization and development of its pharmaceutical IP portfolio outside the Americas. Following PBI's incorporation and initial capitalization, the CSA agreement was negotiated and executed with an effective date of July 1, 2012.

Under the terms of the CSA, PBI acquired the right to participate in the ongoing development and exploitation of PPC's pharmaceutical IP portfolio in all territories outside the Americas, which the agreement defines as North America, Central America, South America, and the Caribbean (collectively, the "Americas"). The non-Americas territory encompasses all of Europe, the Middle East, Africa ("EMEA"), and the Asia-Pacific region ("APAC").

As consideration for PBI's buy-in to PPC's pre-existing intellectual property — which at the time consisted primarily of clinical-stage and approved oncology compounds, including the compound that would become Veritaxol, as well as the early-stage immunology pipeline — PBI made a lump-sum platform contribution transaction ("PCT") payment of $312 million to PPC on July 1, 2012. This PCT payment was intended to compensate PPC at arm's length for PBI's acquisition of rights in PPC's pre-existing IP portfolio for exploitation in the non-Americas territory. The PCT valuation was prepared by Crestfield & Associates LLP using a discounted cash flow ("DCF") methodology.

Following the execution of the CSA and the payment of the PCT, PBI assumed ongoing cost-sharing obligations proportional to its share of reasonably anticipated benefits ("RAB") from the intangible development activity ("IDA") conducted under the CSA. The parties agreed to a revenue-based RAB methodology, under which each participant's share of qualifying IDA costs is determined annually based on projected revenue splits between the Americas territory (PPC) and the non-Americas territory (PBI).

Separately from the CSA, PBI licensed certain legacy compounds from PPC. These legacy compounds — which are of pre-2012 vintage and were not included in the scope of the CSA — are licensed to PBI under a separate intercompany license agreement at a royalty rate of 4.5% of net sales. The terms and arm's-length character of this separate legacy IP license arrangement are analyzed in a separate memorandum and are not the primary subject of this analysis, except to the extent that interaction with the CSA raises compliance or consistency issues.

C. Key Products Covered

The CSA covers PPC's pharmaceutical IP portfolio across its three core therapeutic areas: oncology, immunology, and rare-disease therapeutics. The most significant products covered by the CSA during the examination years are as follows:

Veritaxol (Oncology). Veritaxol is PPC's blockbuster oncology product and represents the single largest revenue contributor across the Penterra portfolio. For fiscal year 2020, Veritaxol generated global net sales of approximately $3.12 billion, of which approximately $1.34 billion (approximately 43% of global net sales) was attributable to the non-Americas territory within PBI's scope. Veritaxol received its initial FDA approval in 2013 and has subsequently received approvals in multiple non-Americas markets, including the European Union, Japan, China, and Australia, among others.

Imvara (Immunology). Imvara is PPC's leading immunology product. For fiscal year 2020, Imvara generated global net sales of approximately $1.87 billion, of which approximately $0.79 billion (approximately 42% of global net sales) was attributable to the non-Americas territory. Imvara was approved by the FDA in 2015 and by the European Medicines Agency ("EMA") in 2016.

Cerulon (Rare Disease). Cerulon is PPC's principal rare-disease therapeutic. For fiscal year 2020, Cerulon generated global net sales of approximately $0.62 billion, of which approximately $0.28 billion (approximately 45% of global net sales) was attributable to the non-Americas territory. Cerulon received orphan drug designation in both the United States and the European Union.

The non-Americas share of global revenues for each of these key products during the examination years has been in the range of approximately 42% to 45%, reflecting the growing but still somewhat U.S.-centric revenue profile of the overall portfolio.

D. IRS Examination Focus

The IRS Large Business & International Division opened its examination of PPC on May 16, 2022, covering Tax Years 2017, 2018, 2019, and 2020. The examination team is led by Supervisory Revenue Agent Gerald Meskill, who serves as Team Manager, and Lead Revenue Agent Patricia Dunleavy, who is the principal examining agent. The IRS has also assigned an IRS Economist, Dr. Alan Washburne, who has been involved in the economic analysis of both the PCT valuation and the cost-sharing ratios. Attorney-Advisor Franklin Rosario from the IRS Office of Chief Counsel is advising the examination team, under the supervision of Senior Counsel Donna Hirabayashi. The examination was assigned Exam Team ID: LB&I-NE-TP-2022-00641.

The IRS's primary positions, as communicated through IDRs, informal discussions, and preliminary workpapers shared during the examination, are as follows:

First, the IRS contends that the PCT payment of $312 million significantly undervalued the pre-existing IP contributed by PPC to the CSA. The IRS's own income-method valuation of the pre-existing IP, prepared or supervised by Dr. Washburne, yields a value of approximately $852 million. The principal technical driver of this disparity is the discount rate: the IRS employs a weighted average cost of capital ("WACC") of 7.2%, while PPC's valuation (as independently validated by Whitmore Valuation Group) employs a WACC of 9.8%. This discount rate difference, combined with what appear to be more aggressive revenue projections on the IRS's side (assuming faster and more complete market penetration in non-Americas territories), accounts for the $540 million delta between the two valuations.

Second, the IRS seeks to recharacterize the ongoing CSA cost-sharing ratios for TY 2017 through TY 2020 as failing to reflect the full value of the intellectual property contributed by PPC. The IRS proposes increasing PBI's cost-sharing percentage by approximately 8 to 12 percentage points across each examination year, which would result in proposed additional cost-sharing payments to PPC of approximately $48.73 million (TY 2017), $57.61 million (TY 2018), $62.85 million (TY 2019), and $65.82 million (TY 2020), for a subtotal of approximately $235.01 million.

Third, the IRS further asserts that PBI lacked sufficient economic substance to justify its role as IP owner and CSA participant, arguing that the key DEMPE functions (Development, Enhancement, Maintenance, Protection, and Exploitation of intangibles) remained principally in the United States throughout the examination period.

It is worth noting that the PCT payment year (2012) is outside the statute of limitations for the examination years (2017–2020). Accordingly, the IRS is not proposing a direct adjustment to the 2012 PCT payment but is instead seeking to build the asserted PCT undervaluation into its proposed adjustments to the ongoing cost-sharing ratios for the examination years.

III. Regulatory Framework — Treas. Reg. § 1.482-7

A. Overview of Qualified Cost-Sharing Arrangement Requirements

The regulatory framework governing cost-sharing arrangements between controlled parties is set forth in Treasury Regulation § 1.482-7, which was substantially revised in 2011 (the "2011 Temporary Regulations") and finalized in 2012 (T.D. 9568, 76 Fed. Reg. 80082 (Dec. 22, 2011)). The regulations define the requirements for a "qualified cost-sharing arrangement" and establish the standards by which the IRS evaluates whether the terms of a CSA — including the cost-sharing ratios and any platform contribution transactions — satisfy the arm's-length standard under IRC § 482.

Under Treas. Reg. § 1.482-7(b), a qualified cost-sharing arrangement is an arrangement between two or more controlled participants to share the costs and risks of developing intangibles in proportion to their reasonably anticipated benefits from exploitation of those intangibles. The regulations establish a detailed framework of requirements that must be satisfied for an arrangement to qualify as a CSA and to avoid adjustment by the IRS under IRC § 482.

The core requirements for a qualified cost-sharing arrangement, as set forth in the regulations, include the following: (i) two or more controlled participants, each of which must be a controlled taxpayer that reasonably anticipates deriving benefits from the exploitation of cost-shared intangibles; (ii) an agreement to share the costs and risks of intangible development activity in proportion to reasonably anticipated benefits; and (iii) compliance with specified administrative requirements, including the maintenance of a written agreement, adequate documentation, and appropriate reporting.

The CSA regulations operate within the broader framework of the arm's-length standard under IRC § 482 and Treas. Reg. § 1.482-1(d). The arm's-length standard requires that the results of transactions between controlled parties be consistent with the results that would have been realized if uncontrolled parties had engaged in the same transaction under the same circumstances. The "best method rule" under Treas. Reg. § 1.482-1(c) requires the selection of the pricing method that provides the most reliable measure of an arm's-length result, considering the quality of data and assumptions employed.

The CSA regulations also interact with Treas. Reg. § 1.482-4, which sets forth the methods for determining arm's-length consideration for transfers of intangible property, and Treas. Reg. § 1.482-7(g), which specifically addresses the methods for determining arm's-length compensation for platform contribution transactions. The income method, the acquisition price method, the market capitalization method, and the residual profit split method are among the specified methods for valuing PCTs under Treas. Reg. § 1.482-7(g)(4)-(7).

B. Key Regulatory Provisions Analyzed

The following provisions of Treas. Reg. § 1.482-7 are the principal regulatory provisions analyzed in this memorandum:

Treas. Reg. § 1.482-7(b)(1): Controlled Participants. This provision defines the eligibility requirements for controlled participants in a CSA. Each participant must be a controlled taxpayer within the meaning of Treas. Reg. § 1.482-1(i)(5), must reasonably anticipate benefits from exploitation of the cost-shared intangibles in its assigned territory, and must substantially comply with the provisions of the CSA.

Treas. Reg. § 1.482-7(b)(2) and (d): Intangible Development Activity ("IDA"). These provisions define the scope of intangible development activity covered by the CSA and establish requirements for identifying and describing the research, development, and other activities that constitute the IDA. The regulations require that the CSA specify the nature of the IDA, the cost-sharing intangibles reasonably anticipated to result from that activity, and the categories of costs to be shared.

Treas. Reg. § 1.482-7(b)(3): Cost Contributions. This provision establishes the requirement that each controlled participant's share of IDA costs must be proportional to its share of reasonably anticipated benefits from the cost-shared intangibles.

Treas. Reg. § 1.482-7(e): Reasonably Anticipated Benefits ("RAB"). This provision sets forth the requirements for measuring and projecting the reasonably anticipated benefits that each controlled participant expects to derive from exploitation of the cost-shared intangibles. The regulations permit the use of various benefit measures, including revenue-based and profit-based projections.

Treas. Reg. § 1.482-7(f): Cost Allocations. This provision addresses the mechanics of allocating IDA costs among controlled participants and the treatment of various cost categories, including stock-based compensation costs.

Treas. Reg. § 1.482-7(g): Platform Contribution Transactions ("PCT"). This provision establishes the requirements and methods for determining arm's-length compensation when a controlled participant contributes pre-existing intangibles (platform contributions) to the CSA. The regulations specify several methods for valuing PCTs, including the income method (DCF), the acquisition price method, the market capitalization method, and the residual profit split method.

Treas. Reg. § 1.482-7(k): Administrative Requirements. This provision sets forth the administrative requirements for CSAs, including the requirement for a written agreement, contemporaneous documentation, and appropriate tax return reporting.

IV. Analysis of Key CSA Terms and Regulatory Compliance

A. Controlled Participant Eligibility — Treas. Reg. § 1.482-7(b)(1)

Treasury Regulation § 1.482-7(b)(1) requires that each controlled participant in a CSA satisfy three conditions: (i) the participant must be a "controlled taxpayer" within the meaning of Treas. Reg. § 1.482-1(i)(5), meaning it must be one of two or more organizations, trades, or businesses owned or controlled directly or indirectly by the same interests; (ii) the participant must "reasonably anticipate" deriving benefits from exploitation of the cost-shared intangibles in its assigned territory; and (iii) the participant must "substantially comply" with the material provisions of the CSA throughout the relevant period.

PPC's Eligibility. PPC is a U.S. corporation organized under the laws of the State of Delaware. As the parent entity of the Penterra corporate group and the 100% indirect owner of PBI (through PHL), PPC and PBI are clearly controlled taxpayers within the meaning of Treas. Reg. § 1.482-1(i)(5). PPC retains the exclusive rights to exploit cost-shared intangibles in the Americas territory under the CSA. PPC conducts substantial U.S.-based research and development operations and commercial activities that generate the Americas-territory revenue from the CSA intangibles. PPC has consistently derived significant revenue from the exploitation of CSA intangibles in the Americas throughout the examination years. PPC has substantially complied with the provisions of the CSA, including its cost-sharing obligations, the annual true-up mechanism, and the reporting and documentation requirements. Accordingly, PPC satisfies all three elements of the controlled participant eligibility requirements without meaningful controversy.

PBI's Eligibility. PBI is a Designated Activity Company organized under Irish law and is a controlled taxpayer within the meaning of Treas. Reg. § 1.482-1(i)(5) by virtue of PPC's 100% indirect ownership through PHL. PBI reasonably anticipates — and has in fact derived — substantial benefits from the exploitation of CSA intangibles in the non-Americas territory (EMEA and APAC). As noted above, non-Americas revenue for the key CSA products ranged from approximately 42% to 45% of global net sales in 2020, reflecting a growing and substantial revenue base in PBI's assigned territory. PBI bore market risk for the non-Americas territory and made key commercial decisions, including pricing, market entry strategy, and distribution partner selection across 68 country markets.

PBI had 52 employees at the time of its establishment in 2012, growing steadily to 185 employees by 2020. PBI's workforce includes regulatory affairs, medical affairs, commercial strategy, and supply chain personnel, and its Managing Director, Aidan Naughton, is based in Dublin and exercises day-to-day management authority over PBI's operations. PBI has substantially complied with the provisions of the CSA, including its cost-sharing payments, the annual true-up process, and the maintenance of adequate records and financial reporting.

PHL Treatment. PHL is treated as a disregarded entity for U.S. federal income tax purposes. As a result, PHL does not participate in the CSA as a separate controlled participant. PBI is treated as owned directly by PPC for purposes of the IRC § 482 analysis. This treatment is consistent with the regulations, which look through disregarded entities for purposes of determining controlled participant status.

Assessment. Both PPC and PBI satisfy the controlled participant eligibility requirements under Treas. Reg. § 1.482-7(b)(1). PPC's qualification is straightforward. PBI's qualification is supported by its status as a controlled taxpayer, its reasonable anticipation of (and actual derivation of) benefits from exploitation of CSA intangibles in the non-Americas territory, and its substantial compliance with the CSA terms. The IRS's economic substance challenge to PBI's status as a legitimate controlled participant is addressed in greater detail in the separate economic substance analysis memorandum being prepared by Nazari (anticipated completion: August 18, 2022). That analysis will address, among other issues, the OECD Transfer Pricing Guidelines' emphasis on "people functions" and the substance requirements under Irish tax law as they relate to PBI's operational profile.

Vulnerability Noted. PBI's relatively small initial headcount of 52 employees at the time of the CSA's execution in 2012 may invite scrutiny from the IRS. The IRS may argue that PBI was established primarily as a tax-motivated IP holding structure with insufficient operational substance to qualify as a bona fide controlled participant at the CSA's inception. However, several factors mitigate this vulnerability: (a) PBI's headcount grew steadily and substantially, from 52 in 2012 to 185 by 2020, reflecting a genuine build-out of operational capabilities; (b) even at inception, PBI's 52 employees included senior commercial, regulatory, and medical affairs professionals with direct responsibility for PBI's non-Americas operations; (c) the regulations do not impose a minimum headcount requirement, and numerous precedents exist for CSA participants with comparable or smaller workforces at inception; and (d) PBI's substantive functional contributions — including independent pricing decisions, regulatory strategy, and market access activities — support its qualification as a genuine participant regardless of absolute headcount.

B. Scope of Intangible Development Activity ("IDA") — Treas. Reg. § 1.482-7(b)(2) and (d)

Treasury Regulation § 1.482-7(b)(2) and (d) require that the CSA specify the intangible development activity and the cost-sharing intangibles that are reasonably anticipated to result from that activity. The regulations define "intangible development activity" broadly to encompass any activity that is reasonably anticipated to contribute to developing cost-shared intangibles, including research and development, design, testing, manufacturing process development, and related activities.

The CSA agreement between PPC and PBI defines the IDA as encompassing all research, development, regulatory, and clinical activities undertaken by or on behalf of PPC and PBI relating to PPC's pharmaceutical IP portfolio in the areas of oncology, immunology, and rare-disease therapeutics, for exploitation in the non-Americas territory. Specifically, the IDA encompasses the following categories of activity:

• Drug discovery and preclinical research activities

• Clinical development activities, including Phase I, Phase II, Phase III, and Phase IV clinical trials

• Regulatory submissions and related regulatory affairs activities (including filings with the EMA, individual country regulatory authorities, and other non-Americas regulatory bodies)

• Lifecycle management activities, including label expansion studies, new formulation development, and line extensions

• Formulation and process improvements related to the cost-shared intangibles

The CSA agreement provides a detailed listing of qualifying R&D cost categories that constitute the IDA cost pool. These cost categories include: personnel costs (salaries, wages, benefits, and related employment costs for R&D personnel); laboratory and facility costs (including depreciation, rent, utilities, and maintenance for R&D facilities); clinical trial costs (including investigator fees, site costs, patient recruitment costs, and clinical monitoring costs); regulatory filing fees; outsourced contract research organization ("CRO") costs; and licensing-in fees for enabling technologies used in the IDA.

The total qualified R&D costs comprising the IDA cost pool for each of the examination years were as follows:

The steady increase in total qualified R&D costs over the examination period reflects PPC's expanding clinical pipeline, particularly the progression of several oncology and immunology compounds through later-stage clinical development and the initiation of lifecycle management programs for Veritaxol and Imvara.

Assessment. The CSA agreement's definition of the IDA is sufficiently specific to satisfy the requirements of Treas. Reg. § 1.482-7(b)(2) and (d). The agreement identifies the relevant therapeutic areas, the categories of qualifying activities, and the specific cost categories that comprise the IDA cost pool. The cost pool composition is well-documented in the CSA agreement and in Crestfield & Associates' contemporaneous transfer pricing documentation for each examination year.

It is recommended that the Crestfield documentation (Susan Lam, lead) be cross-checked against the CSA agreement terms to confirm complete consistency between the IDA definition in the agreement and the cost pool composition reflected in the annual transfer pricing reports. Any discrepancies, even if minor, should be identified and addressed before responding to further IRS IDRs on this topic.

It is also worth noting that the CSA agreement expressly excludes legacy compounds of pre-2012 vintage from the scope of the IDA. These legacy compounds are subject to the separate license/royalty arrangement between PPC and PBI at a royalty rate of 4.5% of net sales. This exclusion is consistent with the structure of the overall arrangement and ensures that the CSA cost pool does not include costs attributable to the development or maintenance of intangibles that are compensated through the separate royalty mechanism rather than through cost sharing.

C. Reasonably Anticipated Benefits ("RAB") Methodology — Treas. Reg. § 1.482-7(e)

Treasury Regulation § 1.482-7(e) requires that each controlled participant's share of IDA costs be proportional to its share of reasonably anticipated benefits ("RAB") from the cost-shared intangibles. The regulations provide that RAB must be estimated on a basis that is "consistent with the economic substance of the arrangement," taking into account the controlled participants' respective territories, their expected exploitation of the cost-shared intangibles, and all other relevant factors. The regulations permit the use of various benefit measures, including revenue-based projections, units-based projections, and other reasonable measures, provided the chosen measure reliably reflects each participant's share of anticipated benefits.

RAB Methodology in the CSA Agreement. The CSA agreement employs a revenue-based RAB methodology, under which each controlled participant's share of IDA costs is determined based on projected revenue splits between the Americas territory (PPC) and the non-Americas territory (PBI). The revenue projections are prepared annually using a forward-looking three-year rolling average model that incorporates the following inputs:

• Historical sales data for each product and territory

• Market growth rates by therapeutic area and geography

• Pipeline probability-adjusted revenue estimates for clinical-stage compounds

• Territory-specific factors, including regulatory approval timelines, pricing and reimbursement dynamics, market access conditions, and competitive landscape assessments

The revenue projections are prepared collaboratively by PPC's corporate finance and commercial operations teams, with input from PBI's commercial strategy and market analytics personnel, and are documented annually as part of the CSA true-up process.

PBI's Cost-Sharing Percentages. Based on the RAB methodology described above, PBI's cost-sharing percentages for the four examination years, as reflected in PPC's transfer pricing documentation, are set forth below:

The gradual increase in PBI's cost-sharing percentage over the examination period is consistent with the actual revenue trajectory, which reflects the growth of non-Americas markets as a share of total global sales for the key CSA products. As noted in Section II.C above, the non-Americas share of global net sales for Veritaxol, Imvara, and Cerulon ranged from approximately 42% to 45% in 2020, up from lower percentages in earlier years. The convergence between PBI's projected RAB percentage and its actual revenue share provides meaningful support for the reliability and reasonableness of the RAB methodology.

IRS's Proposed Cost-Sharing Percentages. The IRS has proposed significantly higher cost-sharing percentages for PBI across all four examination years:

Under the IRS's proposed percentages, the additional cost-sharing payments that would flow from PBI to PPC for each examination year are as follows:

The IRS's basis for these proposed adjustments appears to rest on the assertion that PPC's revenue projections systematically understated the value of U.S.-source contributions — particularly the value of PPC's U.S.-based R&D capabilities and intellectual property — to non-Americas revenue. In other words, the IRS appears to be arguing that the benefits PBI derives from the CSA intangibles are greater than PBI's revenue-based RAB percentage suggests, because a significant portion of the value embedded in non-Americas revenue is attributable to PPC's U.S.-based R&D infrastructure, talent, and know-how.

Assessment. The RAB methodology as documented in the CSA agreement follows a reasonable approach that is consistent with the regulatory framework. Revenue-based benefit projections are one of the methods expressly contemplated by Treas. Reg. § 1.482-7(e)(2) as a basis for measuring reasonably anticipated benefits. The key defense points with respect to the RAB methodology are as follows:

First, the revenue projections underlying PBI's cost-sharing percentages are grounded in contemporaneous data — including historical sales figures, market-specific growth rates, and pipeline probability assessments — and reflect the actual revenue trajectory observed over the examination period. The fact that PBI's projected RAB percentages closely track PBI's actual share of global revenues for the key CSA products provides strong support for the reliability of the projections.

Second, the forward-looking three-year rolling average model employed in the CSA agreement is a recognized and reasonable approach to projecting RAB, as it smooths out annual fluctuations while remaining responsive to evolving market conditions.

Third, the gradual increase in PBI's cost-sharing percentage over the examination period — from 38.2% in 2017 to 42.7% in 2020 — is consistent with the documented growth of non-Americas markets and does not suggest any systematic understatement of PBI's anticipated benefits.

Potential Vulnerability. The IRS may argue that a revenue-based RAB methodology understates the benefits that PBI derives from PPC's pre-existing R&D infrastructure and capabilities, on the theory that a significant portion of the "value" embedded in PBI's non-Americas revenue is attributable to the intellectual property and know-how generated through PPC's U.S.-based R&D activities. To defend against this argument, it will be necessary to establish that PBI's own contributions — including its regulatory expenditures ($47.2 million cumulatively during 2017–2020), market access activities, distribution infrastructure, and local clinical and commercial activities — independently and substantively drive non-Americas revenue. The economic analysis being prepared by Whitmore Valuation Group (Dr. Helena Vasquez, lead; Dr. Rohan Chakrabarti, supporting) will be critical in this regard.

Whitmore Valuation Group LLC has been retained under a Kovel arrangement (Kovel letter dated June 20, 2022, reference 1018-00009-KV; blended engagement rate of $650 per hour) to perform an independent analysis of the RAB methodology and to validate the reasonably anticipated benefits projections. This work is currently underway, and we anticipate receiving Whitmore's preliminary analysis in the fourth quarter of 2022.

D. Cost Contributions and Allocation — Treas. Reg. § 1.482-7(f)

Treasury Regulation § 1.482-7(f) requires that the costs to be shared under a CSA include all costs of the intangible development activity, including costs incurred by or on behalf of any controlled participant. The costs must be allocated among the controlled participants in proportion to their respective RAB shares, as determined under the methodology described in Section IV.C above.

The CSA agreement between PPC and PBI provides for a comprehensive cost allocation mechanism. The agreement identifies the cost categories that constitute the IDA cost pool, consistent with the categories enumerated in Treas. Reg. § 1.482-7(d)(1). These include direct R&D costs (such as personnel costs for scientists, researchers, and clinical personnel directly involved in the IDA), indirect R&D costs (such as facility costs, equipment depreciation, and allocated overhead), and stock-based compensation costs for employees whose activities are reasonably associated with the IDA.

The CSA agreement includes an annual true-up mechanism that operates as follows: at each year-end, actual qualified R&D costs incurred during the year by each controlled participant are tallied and compared to the cost-sharing payments made during the year based on budgeted costs. Any difference between the actual cost-share amount (determined by applying the RAB-based cost-sharing percentage to the actual total IDA cost pool) and the payments made during the year is settled through a true-up payment within 60 days of the end of the fiscal year. This annual true-up mechanism is a recognized best practice in CSA administration and ensures that actual cost-sharing allocations align with the RAB-determined percentages on an annual basis.

Stock-Based Compensation Treatment. The treatment of stock-based compensation costs in the CSA cost pool is a potentially significant issue in light of the Tax Court's decision in Altera Corp. v. Commissioner, 145 T.C. 91 (2015), and the subsequent Ninth Circuit decision in Altera Corp. v. Commissioner, 941 F.3d 1200 (9th Cir. 2019). The Altera litigation addressed whether Treasury Regulation § 1.482-7(d)(2), which requires the inclusion of stock-based compensation in CSA cost pools, is valid under the Administrative Procedure Act. The detailed analysis of the Altera holding and its implications for PPC's CSA is the subject of a separate memorandum being prepared by Simmons and Nazari (anticipated completion: September 15, 2022), which will also address the Tax Court's decision in Harborview Corporation, Inc. v. Commissioner insofar as it bears on transfer pricing methodology.

Assessment. The cost allocation methodology employed in the CSA agreement is consistent with the requirements of Treas. Reg. § 1.482-7(f). The agreement identifies all relevant cost categories, provides for allocation in proportion to RAB shares, and includes an annual true-up mechanism that ensures actual cost allocations align with the RAB percentages. The inclusion of direct R&D costs, indirect R&D costs, and stock-based compensation costs in the cost pool is consistent with the regulatory requirements.

Recommendation. We recommend verifying with Crestfield & Associates (Susan Lam, Transfer Pricing Partner) that stock-based compensation was treated consistently with the Altera holding across all four examination years and that the approach to identifying and allocating stock-based compensation costs to the IDA cost pool is documented in the contemporaneous transfer pricing reports. Consistent treatment of stock-based compensation is essential to avoiding any additional IRS challenge on this issue, particularly given the ongoing uncertainty surrounding the Altera holding in circuits outside the Ninth Circuit.

E. Platform Contribution Transaction ("PCT") — Treas. Reg. § 1.482-7(g)

Treasury Regulation § 1.482-7(g) provides that when a controlled participant makes available to a CSA the results of its prior research and development activities — i.e., pre-existing intangibles, referred to as "platform contributions" — the other participants must compensate the contributing party at arm's length through a platform contribution transaction ("PCT") payment. The PCT payment must reflect the arm's-length value of the platform contributions as of the date they are made available to the CSA. The regulations specify several methods for valuing PCTs, including the income method, the acquisition price method, the market capitalization method, and the residual profit split method.

PCT in the PPC-PBI CSA. Under the terms of the CSA agreement, PBI paid PPC a lump-sum PCT payment of $312 million on July 1, 2012, as compensation for PBI's buy-in to PPC's pre-existing pharmaceutical IP portfolio. The platform contributions consisted primarily of clinical-stage and approved oncology compounds — most significantly, the compound that would become Veritaxol — as well as the early-stage immunology pipeline, including the compound that would become Imvara. The PCT payment was structured as a single lump-sum payment rather than a series of periodic payments.

PCT Valuation Methodology. The original PCT valuation was prepared by Crestfield & Associates LLP using the income method, specifically a discounted cash flow ("DCF") analysis. Under the DCF approach, the value of the platform contributions was determined by projecting the future cash flows that PBI reasonably anticipated deriving from the exploitation of the pre-existing IP in the non-Americas territory, discounted to present value using an appropriate risk-adjusted discount rate (WACC).

PPC's Defense Position. PPC contends that the PCT payment of $312 million is within the arm's-length range for the platform contributions. This position is supported by the independent DCF analysis performed by Whitmore Valuation Group LLC, which employed a WACC of 9.8% and yielded an arm's-length range of $278 million to $361 million. The PCT payment of $312 million falls near the midpoint of this independently derived range, providing substantial support for the arm's-length character of the payment.

IRS Position. The IRS has valued the platform contributions at $852 million, using the income method with a significantly lower discount rate (WACC of 7.2%) and different — and, in PPC's view, more aggressive — revenue projections. The IRS's revenue projections appear to assume faster and more complete market penetration in non-Americas territories than was reasonably anticipated as of July 2012. The $540 million delta between PPC's valuation ($312 million) and the IRS's valuation ($852 million) is driven primarily by two factors: the discount rate differential (9.8% vs. 7.2%) and the more optimistic revenue assumptions embedded in the IRS's projections.

Key Technical Dispute: Discount Rate. The discount rate is the single most significant driver of the PCT valuation disparity. PPC's WACC of 9.8% reflects the risk profile of a specialty pharmaceutical company with significant clinical-stage pipeline exposure and substantial non-Americas market risk (including regulatory uncertainty in emerging markets, pricing and reimbursement variability, and currency risk). The IRS's WACC of 7.2% implies a lower risk profile, which PPC contends fails to adequately account for the substantial risks associated with commercializing pharmaceutical products in diverse non-Americas markets as of the July 2012 valuation date. Whitmore Valuation Group's analysis of the WACC dispute, including a detailed build-up of the risk-adjusted discount rate based on comparable pharmaceutical company data, is set forth in the separate WACC analysis memorandum (anticipated December 2022 delivery).

Statute of Limitations Note. The PCT payment year (2012) falls outside the examination years (2017–2020). The IRS is therefore not proposing a direct adjustment to the 2012 PCT payment. Instead, the IRS's strategy appears to be to recharacterize the ongoing CSA cost-sharing ratios for 2017–2020 as failing to reflect the full value of the contributed IP, effectively incorporating the asserted PCT undervaluation into the ongoing annual adjustments to PBI's cost-sharing percentages. This approach presents both legal and factual issues that will need to be addressed in any Protest filing, including whether the regulations permit the IRS to effectively "re-open" a prior-year PCT valuation through adjustments to the ongoing cost-sharing ratios in later years.

Assessment. The PCT payment of $312 million appears defensible based on Whitmore's independent analysis, which confirms that the payment falls within the arm's-length range derived using a DCF methodology with a risk-adjusted discount rate that reflects the market conditions and risk profile as of the July 2012 valuation date. The CSA agreement's PCT provisions are consistent with the requirements of Treas. Reg. § 1.482-7(g), including the use of a specified valuation method (the income method) and the payment of the PCT at the time the platform contributions were made available.

The detailed PCT valuation analysis is the subject of the separate Whitmore Valuation Group report (PCT Valuation Analysis — Income Method / DCF Approach, anticipated December 2022 delivery) and the companion WACC analysis memorandum (discount Rate / WACC Analysis — PBI Platform Contribution Transaction, also anticipated December 2022). These analyses will provide the primary economic support for PPC's defense position on the PCT valuation.

F. Territory Allocation and Exclusivity

The CSA agreement clearly and unambiguously delineates the territories assigned to each controlled participant. PPC retains the exclusive rights to exploit cost-shared intangibles in the Americas, which the agreement defines to include North America, Central America, South America, and the Caribbean. PBI obtains the exclusive rights to exploit cost-shared intangibles in all territories outside the Americas, encompassing EMEA and APAC.

The territorial allocation is absolute and non-overlapping. There is no provision in the CSA agreement for shared or concurrent exploitation rights in any territory. All revenues derived from the sale of CSA products and all costs of commercialization are attributed based on the territory in which the sale occurs or the exploitation right is exercised. This clear delineation ensures that there is no ambiguity regarding the attribution of benefits to each controlled participant and that the RAB methodology can be applied without overlap or double-counting.

Assessment. The territorial delineation in the CSA agreement is clear, specific, and consistent with the requirements of Treas. Reg. § 1.482-7. No compliance issues have been identified with respect to territory allocation, and the territorial provisions do not appear to be a focus of the IRS examination.

G. Arm's-Length Standard and Best Method Rule — Treas. Reg. § 1.482-1(d)

The arm's-length standard under IRC § 482 and Treas. Reg. § 1.482-1(d) requires that the results of transactions between controlled parties be consistent with the results that would have been realized if uncontrolled parties had engaged in the same transaction under the same circumstances. The best method rule under Treas. Reg. § 1.482-1(c) requires the selection of the method that provides the most reliable measure of an arm's-length result, taking into account the quality and completeness of the data and assumptions underlying the analysis.

In the context of the PPC-PBI CSA, the arm's-length standard and best method rule apply to three principal categories of intercompany transactions:

First, with respect to the CSA cost-sharing ratios, the RAB methodology (revenue-based benefit projections) is one of the recognized approaches for determining each participant's proportionate share of IDA costs. The use of revenue-based RAB projections is consistent with the methods contemplated by Treas. Reg. § 1.482-7(e)(2).

Second, with respect to the PCT payment, the income method (DCF) is one of the specified methods under Treas. Reg. § 1.482-7(g)(4) for valuing platform contributions. The income method is generally considered the most reliable method for valuing the types of intangible assets that were the subject of the PPC-PBI PCT, and both PPC and the IRS have applied the income method, albeit with different assumptions regarding the discount rate and revenue projections.

Third, with respect to the separate legacy IP royalty rate of 4.5% of net sales, this rate is evaluated under the comparable uncontrolled transaction ("CUT") method under Treas. Reg. § 1.482-4. The CUT analysis is the subject of a separate memorandum and is not addressed in detail herein.

Whitmore Valuation Group's analysis applies multiple methods to evaluate the arm's-length character of the PPC-PBI intercompany arrangements: (a) the CUT method for the legacy IP royalty rate; (b) the comparable profits method ("CPM") / transactional net margin method ("TNMM") for PBI's operating margins, tested against a set of 22 comparable pharmaceutical companies; and (c) the income method / DCF for the PCT valuation. This multi-method approach strengthens PPC's defense position under the best method rule, as it demonstrates that the arm's-length character of the intercompany arrangements is corroborated across multiple independent methods and data sets.

Assessment. PPC's methodological approach is consistent with the best method rule. The use of the revenue-based RAB methodology for cost sharing, the income method for the PCT valuation, and the CUT method for the legacy royalty rate each represents a recognized and reliable method for the respective transaction type. Whitmore's multi-method analysis provides additional confidence in the robustness of PPC's transfer pricing positions.

V. Administrative Requirements — Treas. Reg. § 1.482-7(k)

A. Written Agreement

Treasury Regulation § 1.482-7(k)(1) requires that a qualified cost-sharing arrangement be set forth in a written agreement that is in effect before the first date on which any IDA cost is incurred. The written agreement must describe the scope of the IDA, the controlled participants, the territories, the cost-sharing methodology, and the terms for PCT payments.

The CSA agreement between PPC and PBI was executed with an effective date of July 1, 2012, prior to the commencement of any cost-sharing payments or IDA cost allocations under the arrangement. The agreement was signed by authorized representatives of both PPC and PBI: specifically, by PPC's then-Chief Financial Officer (Margaret Kensington) and PBI's Managing Director (Aidan Naughton). The agreement is a comprehensive, 47-page document that addresses all of the required elements: controlled participant identification, IDA definition, territory allocation, RAB methodology, cost allocation procedures, PCT payment terms, true-up mechanism, dispute resolution provisions, amendment procedures, and termination provisions.

Assessment. The written agreement requirement of Treas. Reg. § 1.482-7(k)(1) is satisfied. The CSA agreement was executed in a timely manner, prior to the commencement of cost sharing, and addresses all of the elements required by the regulations.

B. Documentation Requirements

Treasury Regulation § 1.482-7(k)(2) requires that controlled participants maintain documentation sufficient to establish: (i) the scope and nature of the IDA; (ii) the RAB methodology and the basis for the reasonably anticipated benefit projections; (iii) the cost allocations for each taxable year; and (iv) the PCT valuation, including the method employed, the assumptions made, and the data relied upon.

Crestfield & Associates LLP prepared contemporaneous transfer pricing documentation for PPC for Tax Years 2017 through 2020. This documentation was prepared under the direction of Susan Lam, Transfer Pricing Partner, in accordance with the requirements of IRC § 6662(e) and the associated penalty-protection standards set forth in Treas. Reg. § 1.6662-6. The documentation includes the following elements:

• A functional analysis describing the functions performed, assets employed, and risks assumed by each controlled participant

• An economic analysis, including the selection and application of the best method for each category of intercompany transaction

• A description of the IDA and the cost-shared intangibles

• The RAB projections for each taxable year, including the inputs, assumptions, and methodology employed

• The cost pool composition and the allocation of costs to each controlled participant

• A narrative description of the PCT valuation, including the DCF methodology, the discount rate, and the revenue projections employed

The contemporaneous documentation was prepared on an annual basis and was maintained in Crestfield's files, with copies provided to PPC's Tax Department for internal record-keeping. The documentation was updated annually to reflect changes in the RAB projections, the cost pool composition, and the business operations of PPC and PBI.

Assessment. The contemporaneous documentation prepared by Crestfield & Associates appears to satisfy the regulatory requirements of Treas. Reg. § 1.482-7(k)(2). However, we recommend that a thorough review of Crestfield's underlying workpapers be conducted to confirm that all required elements are present, internally consistent, and supported by adequate data. This review is particularly important in light of the IRS examination, as any gaps or inconsistencies in the contemporaneous documentation could be exploited by the IRS to challenge the reliability of PPC's transfer pricing positions.

The adequacy of the contemporaneous documentation for purposes of penalty protection under IRC § 6662(e)(3)(B) is analyzed in a separate memorandum (Simmons, anticipated completion September 2, 2022).

C. Accounting and Record-Keeping

The CSA agreement requires each controlled participant to maintain books and records sufficient to verify the cost-sharing allocations, the RAB calculations, and the true-up adjustments for each taxable year. Both PPC and PBI maintain comprehensive financial records that support the CSA calculations.

PBI maintains its primary financial records and bank accounts with Glenmore Bank Ireland plc, its principal Irish banking institution. PBI files annual Irish tax returns (Corporation Tax Return — Form CT1) with the Irish Revenue Commissioners under Irish Tax Reference Number 3218764T. PBI's Irish tax compliance is handled by Thornbury & Keogh, Chartered Accountants and Tax Advisers, under the direction of Ciarán Thornbury, Lead Partner, with offices at 22 Fitzwilliam Square, Dublin 2, Ireland.

On the U.S. side, PPC files annual U.S. federal income tax returns on Form 1120, including the reporting of intercompany transactions with PBI and other Penterra group entities. PPC also files Forms 5471 (Information Return of U.S. Persons with Respect to Certain Foreign Corporations) for PBI and for PHL (Luxembourg). The annual true-up documentation — reflecting the reconciliation of actual IDA costs and cost-sharing payments — is maintained by PPC's Tax Department and is included as part of the transfer pricing documentation files.

Assessment. The accounting and record-keeping practices of both PPC and PBI appear adequate to support the CSA calculations and to satisfy the record-keeping requirements of the regulations. No deficiencies in record-keeping have been identified at this time.

D. Reporting Requirements

PPC files Forms 5471 for PBI (and PHL, RCS Number B 168452) for each of the examination years (TY 2017–2020). These information returns report PPC's ownership interest in PBI and PHL, as well as the financial statements and intercompany transaction information for each foreign subsidiary. In addition, PPC reports intercompany transactions with PBI on Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business) as applicable.

Assessment. We recommend confirming that all Forms 5471 and 5472 for the examination years are complete, accurate, and consistent with the terms of the CSA agreement and the contemporaneous transfer pricing documentation. This verification should be coordinated with Crestfield & Associates (Martin Ogilvy, Engagement Partner) to ensure return-level consistency across all relevant filings. Any inconsistencies between the information reported on the tax returns and the terms of the CSA or the transfer pricing documentation could create unnecessary issues during the examination and should be identified and remedied at the earliest opportunity.

VI. Economic Substance of PBI as CSA Participant

Although the detailed economic substance analysis is the subject of a separate memorandum being prepared by Nazari (anticipated completion: August 18, 2022), the CSA compliance analysis must address PBI's qualification as a bona fide controlled participant, as the IRS has specifically challenged PBI's economic substance as part of its examination of the CSA. This section provides a summary of the key evidence supporting PBI's status as a substantive operational entity with genuine functional contributions to the CSA.

Evidence of PBI's Substantive Operations. The following factual predicates support PBI's qualification as a bona fide controlled participant with sufficient economic substance:

1. Headcount and Growth. PBI employed 185 individuals as of December 31, 2020, representing a more than threefold increase from its initial headcount of 52 employees at the time of its establishment in 2012. This growth trajectory reflects a genuine and sustained build-out of PBI's operational capabilities over the life of the CSA.

2. Management and Governance. PBI's Managing Director, Aidan Naughton, is based in Dublin and exercises day-to-day management authority over PBI's operations. PBI's board of directors held 42 board meetings in Dublin during the 2017–2020 examination period, comprising quarterly meetings plus special sessions convened as needed to address significant strategic, regulatory, and commercial matters.

3. Physical Presence. PBI occupies approximately 18,000 square feet of office space at Claremont House, Sandyford Business Park, Dublin, which houses PBI's regulatory affairs, medical affairs, commercial strategy, supply chain, and administrative personnel.

4. Regulatory Expenditures. PBI incurred cumulative regulatory expenditures and submission costs of approximately €47.2 million during the 2017–2020 examination period, reflecting PBI's direct and substantive involvement in obtaining and maintaining marketing authorizations across non-Americas markets, including the European Union, Japan, China, Australia, and numerous other countries.

5. Commercial Decision-Making. PBI made independent pricing decisions across 68 country markets within its non-Americas territory. These pricing decisions involved the evaluation of local market conditions, reimbursement frameworks, competitive dynamics, and regulatory requireme

PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT
MEMORANDUM
July 25, 2022
FROM: Garrett Simmons, Lead Associate, Tax Department, Calderwood & Harkness LLP
TO: Leonard Cross, Responsible Partner; Sylvia Hartwell, Billing Partner
CC: Leila Nazari, Working Associate
RE: Analysis of Cost-Sharing Arrangement Agreement Between Penterra Pharmaceuticals Corp. and Penterra Biopharma International DAC — Key Terms and Compliance with Treas. Reg. § 1.482-7
MATTER NO.: 1018-00009
CLIENT: Penterra Pharmaceuticals Corp. (EIN: 22-3741856)
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I. Executive Summary
This memorandum analyzes the qualified cost-sharing arrangement ("CSA") agreement executed effective July 1, 2012, between Penterra Pharmaceuticals Corp. ("PPC") and Penterra Biopharma International DAC ("PBI") for compliance with the regulatory requirements governing qualified cost-sharing arrangements under Treasury Regulation § 1.482-7. The analysis is undertaken in the context of an ongoing examination by the IRS Large Business & International Division (Exam Team ID: LB&I-NE-TP-2022-00641), which was opened on May 16, 2022, and covers Tax Years 2017 through 2020. The CSA has emerged as a central focus of the examination.
The IRS has indicated through preliminary communications, including informal discussions at the opening conference and through Information Document Requests ("IDRs") served to date, that it may challenge the platform contribution transaction ("PCT") valuations as well as the ongoing cost-sharing ratios, asserting that both understate PPC's U.S.-source income under Internal Revenue Code § 482. Specifically, the IRS appears to be positioning to argue that the PCT payment of $312 million, which PBI paid to PPC in 2012 for the buy-in to pre-existing intellectual property, significantly undervalued the pre-existing IP portfolio. The IRS has further signaled that it intends to propose increasing PBI's cost-sharing percentages by approximately 8 to 12 percentage points across each of the examination years, which would result in additional cost-sharing payments flowing to PPC totaling approximately $235.01 million over the four-year period.
Based on my analysis of the CSA agreement, the applicable Treasury Regulations, the contemporaneous transfer pricing documentation prepared by Crestfield & Associates LLP, and the preliminary independent analysis performed by Whitmore Valuation Group LLC under a Kovel arrangement, it is my conclusion that the CSA agreement substantially complies with the requirements of Treas. Reg. § 1.482-7 in all material respects. The agreement identifies two qualifying controlled participants, defines the scope of intangible development activity with adequate specificity, employs a recognized methodology for determining reasonably anticipated benefits, provides for proportionate cost allocation with an annual true-up mechanism, documents the PCT payment, and satisfies the applicable administrative requirements regarding written agreements, documentation, and reporting.
That said, certain areas warrant strengthened documentation and clarification for defense purposes. In particular, the significant disparity between PPC's PCT valuation ($312 million) and the IRS's preliminary valuation ($852 million) presents a meaningful area of exposure that will require robust economic analysis and detailed factual support. Additionally, PBI's relatively small initial headcount at the CSA's inception in 2012 (52 employees) may invite scrutiny regarding PBI's qualification as a bona fide controlled participant, although PBI's subsequent growth to 185 employees by 2020 and its substantive functional contributions support its eligibility.
It should be noted that PPC was not enrolled in the IRS Compliance Assurance Process ("CAP") for any of the tax years at issue. Contemporaneous transfer pricing documentation for TY 2017 through TY 2020 was prepared by Crestfield & Associates LLP under the direction of Susan Lam, Transfer Pricing Partner, in accordance with the requirements of IRC § 6662(e) and the associated penalty-protection standards. The adequacy of this documentation for penalty-protection purposes is addressed in a separate memorandum.
II. Background
A. Corporate Structure
The relevant entities in the Penterra group for purposes of this analysis are as follows:
Penterra Pharmaceuticals Corp. ("PPC"). PPC is a Delaware corporation, publicly traded on the Nasdaq Stock Market under ticker symbol PPCA, with its principal executive offices located at 2200 Independence Boulevard, Princeton Junction, New Jersey 08550. PPC operates as a specialty pharmaceuticals and biotechnology company, with therapeutic focus areas spanning oncology, immunology, and rare-disease therapeutics. For its fiscal year ending December 31, 2020, PPC reported consolidated global revenue of approximately $6.82 billion and consolidated pre-tax income of approximately $1.47 billion. As of December 31, 2020, PPC employed approximately 14,500 individuals worldwide, with the majority of its research and development personnel based in the United States at its Princeton Junction campus and at satellite research facilities in Cambridge, Massachusetts, and San Diego, California. PPC is the parent entity of the Penterra corporate group and serves as one of the two controlled participants in the CSA.
Penterra Biopharma International DAC ("PBI"). PBI is 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's Irish Tax Reference Number is 3218764T. PBI functions as an intellectual property holding company and serves as the principal entity for commercialization of Penterra products in all markets outside the Americas. For its fiscal year ending December 31, 2020, PBI reported revenue of approximately €2.14 billion and pre-tax income of approximately €1.06 billion. PBI employed 185 individuals as of December 31, 2020, a significant increase from the 52 employees at the time of its establishment in 2012. PBI's Managing Director is Aidan Naughton, who is based in Dublin and oversees PBI's commercial, regulatory, and strategic operations. PBI occupies approximately 18,000 square feet of office space at the Sandyford Business Park facility in Dublin. PBI is the second controlled participant in the CSA and holds the rights to exploit CSA intangibles in all territories outside the Americas.
Penterra Holdings Luxembourg S.à r.l. ("PHL"). PHL is a société à responsabilité limitée organized under the laws of the Grand Duchy of Luxembourg, with RCS Number B 168452 and its registered office at 14 rue Aldringen, L-1118 Luxembourg. PHL is an intermediate holding entity that is the 100% direct owner of PBI. PHL is itself 100% owned by PPC. Critically, PHL has elected to be treated as a disregarded entity for U.S. federal income tax purposes, and accordingly, PBI is treated as owned directly by PPC for purposes of the IRC § 482 analysis. PHL does not participate in the CSA as a separate controlled participant.
Penterra Manufacturing Ireland Ltd. ("PMI"). PMI is a private limited company incorporated under Irish law (Irish CRO Number 512347), with its principal manufacturing facility located at Unit 7, Ringaskiddy Industrial Estate, Co. Cork T12 PX29, Ireland. PMI operates as a contract manufacturer of PPC's oncology and immunology biologics for non-Americas markets. PMI performs its manufacturing services under a cost-plus intercompany arrangement with PBI, under which PMI is compensated at cost plus an 8% markup. As of December 31, 2020, PMI employed approximately 620 individuals at its Ringaskiddy facility, primarily production, quality assurance, and supply chain personnel. PMI is a wholly-owned subsidiary of PBI.
Ownership Chain. The relevant ownership chain is as follows: PPC (Delaware, U.S.) → PHL (Luxembourg, disregarded entity) → PBI (Ireland, DAC) → PMI (Ireland, contract manufacturer). For U.S. federal tax purposes, PHL's disregarded status means the effective chain is PPC → PBI → PMI.
B. History of the CSA
PBI was incorporated on March 15, 2012, as part of PPC's strategic initiative to establish an international platform for the commercialization and development of its pharmaceutical IP portfolio outside the Americas. Following PBI's incorporation and initial capitalization, the CSA agreement was negotiated and executed with an effective date of July 1, 2012.
Under the terms of the CSA, PBI acquired the right to participate in the ongoing development and exploitation of PPC's pharmaceutical IP portfolio in all territories outside the Americas, which the agreement defines as North America, Central America, South America, and the Caribbean (collectively, the "Americas"). The non-Americas territory encompasses all of Europe, the Middle East, Africa ("EMEA"), and the Asia-Pacific region ("APAC").
As consideration for PBI's buy-in to PPC's pre-existing intellectual property — which at the time consisted primarily of clinical-stage and approved oncology compounds, including the compound that would become Veritaxol, as well as the early-stage immunology pipeline — PBI made a lump-sum platform contribution transaction ("PCT") payment of $312 million to PPC on July 1, 2012. This PCT payment was intended to compensate PPC at arm's length for PBI's acquisition of rights in PPC's pre-existing IP portfolio for exploitation in the non-Americas territory. The PCT valuation was prepared by Crestfield & Associates LLP using a discounted cash flow ("DCF") methodology.
Following the execution of the CSA and the payment of the PCT, PBI assumed ongoing cost-sharing obligations proportional to its share of reasonably anticipated benefits ("RAB") from the intangible development activity ("IDA") conducted under the CSA. The parties agreed to a revenue-based RAB methodology, under which each participant's share of qualifying IDA costs is determined annually based on projected revenue splits between the Americas territory (PPC) and the non-Americas territory (PBI).
Separately from the CSA, PBI licensed certain legacy compounds from PPC. These legacy compounds — which are of pre-2012 vintage and were not included in the scope of the CSA — are licensed to PBI under a separate intercompany license agreement at a royalty rate of 4.5% of net sales. The terms and arm's-length character of this separate legacy IP license arrangement are analyzed in a separate memorandum and are not the primary subject of this analysis, except to the extent that interaction with the CSA raises compliance or consistency issues.
C. Key Products Covered
The CSA covers PPC's pharmaceutical IP portfolio across its three core therapeutic areas: oncology, immunology, and rare-disease therapeutics. The most significant products covered by the CSA during the examination years are as follows:
Veritaxol (Oncology). Veritaxol is PPC's blockbuster oncology product and represents the single largest revenue contributor across the Penterra portfolio. For fiscal year 2020, Veritaxol generated global net sales of approximately $3.12 billion, of which approximately $1.34 billion (approximately 43% of global net sales) was attributable to the non-Americas territory within PBI's scope. Veritaxol received its initial FDA approval in 2013 and has subsequently received approvals in multiple non-Americas markets, including the European Union, Japan, China, and Australia, among others.
Imvara (Immunology). Imvara is PPC's leading immunology product. For fiscal year 2020, Imvara generated global net sales of approximately $1.87 billion, of which approximately $0.79 billion (approximately 42% of global net sales) was attributable to the non-Americas territory. Imvara was approved by the FDA in 2015 and by the European Medicines Agency ("EMA") in 2016.
Cerulon (Rare Disease). Cerulon is PPC's principal rare-disease therapeutic. For fiscal year 2020, Cerulon generated global net sales of approximately $0.62 billion, of which approximately $0.28 billion (approximately 45% of global net sales) was attributable to the non-Americas territory. Cerulon received orphan drug designation in both the United States and the European Union.
The non-Americas share of global revenues for each of these key products during the examination years has been in the range of approximately 42% to 45%, reflecting the growing but still somewhat U.S.-centric revenue profile of the overall portfolio.
D. IRS Examination Focus
The IRS Large Business & International Division opened its examination of PPC on May 16, 2022, covering Tax Years 2017, 2018, 2019, and 2020. The examination team is led by Supervisory Revenue Agent Gerald Meskill, who serves as Team Manager, and Lead Revenue Agent Patricia Dunleavy, who is the principal examining agent. The IRS has also assigned an IRS Economist, Dr. Alan Washburne, who has been involved in the economic analysis of both the PCT valuation and the cost-sharing ratios. Attorney-Advisor Franklin Rosario from the IRS Office of Chief Counsel is advising the examination team, under the supervision of Senior Counsel Donna Hirabayashi. The examination was assigned Exam Team ID: LB&I-NE-TP-2022-00641.
The IRS's primary positions, as communicated through IDRs, informal discussions, and preliminary workpapers shared during the examination, are as follows:
First, the IRS contends that the PCT payment of $312 million significantly undervalued the pre-existing IP contributed by PPC to the CSA. The IRS's own income-method valuation of the pre-existing IP, prepared or supervised by Dr. Washburne, yields a value of approximately $852 million. The principal technical driver of this disparity is the discount rate: the IRS employs a weighted average cost of capital ("WACC") of 7.2%, while PPC's valuation (as independently validated by Whitmore Valuation Group) employs a WACC of 9.8%. This discount rate difference, combined with what appear to be more aggressive revenue projections on the IRS's side (assuming faster and more complete market penetration in non-Americas territories), accounts for the $540 million delta between the two valuations.
Second, the IRS seeks to recharacterize the ongoing CSA cost-sharing ratios for TY 2017 through TY 2020 as failing to reflect the full value of the intellectual property contributed by PPC. The IRS proposes increasing PBI's cost-sharing percentage by approximately 8 to 12 percentage points across each examination year, which would result in proposed additional cost-sharing payments to PPC of approximately $48.73 million (TY 2017), $57.61 million (TY 2018), $62.85 million (TY 2019), and $65.82 million (TY 2020), for a subtotal of approximately $235.01 million.
Third, the IRS further asserts that PBI lacked sufficient economic substance to justify its role as IP owner and CSA participant, arguing that the key DEMPE functions (Development, Enhancement, Maintenance, Protection, and Exploitation of intangibles) remained principally in the United States throughout the examination period.
It is worth noting that the PCT payment year (2012) is outside the statute of limitations for the examination years (2017–2020). Accordingly, the IRS is not proposing a direct adjustment to the 2012 PCT payment but is instead seeking to build the asserted PCT undervaluation into its proposed adjustments to the ongoing cost-sharing ratios for the examination years.
III. Regulatory Framework — Treas. Reg. § 1.482-7
A. Overview of Qualified Cost-Sharing Arrangement Requirements
The regulatory framework governing cost-sharing arrangements between controlled parties is set forth in Treasury Regulation § 1.482-7, which was substantially revised in 2011 (the "2011 Temporary Regulations") and finalized in 2012 (T.D. 9568, 76 Fed. Reg. 80082 (Dec. 22, 2011)). The regulations define the requirements for a "qualified cost-sharing arrangement" and establish the standards by which the IRS evaluates whether the terms of a CSA — including the cost-sharing ratios and any platform contribution transactions — satisfy the arm's-length standard under IRC § 482.
Under Treas. Reg. § 1.482-7(b), a qualified cost-sharing arrangement is an arrangement between two or more controlled participants to share the costs and risks of developing intangibles in proportion to their reasonably anticipated benefits from exploitation of those intangibles. The regulations establish a detailed framework of requirements that must be satisfied for an arrangement to qualify as a CSA and to avoid adjustment by the IRS under IRC § 482.
The core requirements for a qualified cost-sharing arrangement, as set forth in the regulations, include the following: (i) two or more controlled participants, each of which must be a controlled taxpayer that reasonably anticipates deriving benefits from the exploitation of cost-shared intangibles; (ii) an agreement to share the costs and risks of intangible development activity in proportion to reasonably anticipated benefits; and (iii) compliance with specified administrative requirements, including the maintenance of a written agreement, adequate documentation, and appropriate reporting.
The CSA regulations operate within the broader framework of the arm's-length standard under IRC § 482 and Treas. Reg. § 1.482-1(d). The arm's-length standard requires that the results of transactions between controlled parties be consistent with the results that would have been realized if uncontrolled parties had engaged in the same transaction under the same circumstances. The "best method rule" under Treas. Reg. § 1.482-1(c) requires the selection of the pricing method that provides the most reliable measure of an arm's-length result, considering the quality of data and assumptions employed.
The CSA regulations also interact with Treas. Reg. § 1.482-4, which sets forth the methods for determining arm's-length consideration for transfers of intangible property, and Treas. Reg. § 1.482-7(g), which specifically addresses the methods for determining arm's-length compensation for platform contribution transactions. The income method, the acquisition price method, the market capitalization method, and the residual profit split method are among the specified methods for valuing PCTs under Treas. Reg. § 1.482-7(g)(4)-(7).
B. Key Regulatory Provisions Analyzed
The following provisions of Treas. Reg. § 1.482-7 are the principal regulatory provisions analyzed in this memorandum:
Treas. Reg. § 1.482-7(b)(1): Controlled Participants. This provision defines the eligibility requirements for controlled participants in a CSA. Each participant must be a controlled taxpayer within the meaning of Treas. Reg. § 1.482-1(i)(5), must reasonably anticipate benefits from exploitation of the cost-shared intangibles in its assigned territory, and must substantially comply with the provisions of the CSA.
Treas. Reg. § 1.482-7(b)(2) and (d): Intangible Development Activity ("IDA"). These provisions define the scope of intangible development activity covered by the CSA and establish requirements for identifying and describing the research, development, and other activities that constitute the IDA. The regulations require that the CSA specify the nature of the IDA, the cost-sharing intangibles reasonably anticipated to result from that activity, and the categories of costs to be shared.
Treas. Reg. § 1.482-7(b)(3): Cost Contributions. This provision establishes the requirement that each controlled participant's share of IDA costs must be proportional to its share of reasonably anticipated benefits from the cost-shared intangibles.
Treas. Reg. § 1.482-7(e): Reasonably Anticipated Benefits ("RAB"). This provision sets forth the requirements for measuring and projecting the reasonably anticipated benefits that each controlled participant expects to derive from exploitation of the cost-shared intangibles. The regulations permit the use of various benefit measures, including revenue-based and profit-based projections.
Treas. Reg. § 1.482-7(f): Cost Allocations. This provision addresses the mechanics of allocating IDA costs among controlled participants and the treatment of various cost categories, including stock-based compensation costs.
Treas. Reg. § 1.482-7(g): Platform Contribution Transactions ("PCT"). This provision establishes the requirements and methods for determining arm's-length compensation when a controlled participant contributes pre-existing intangibles (platform contributions) to the CSA. The regulations specify several methods for valuing PCTs, including the income method (DCF), the acquisition price method, the market capitalization method, and the residual profit split method.
Treas. Reg. § 1.482-7(k): Administrative Requirements. This provision sets forth the administrative requirements for CSAs, including the requirement for a written agreement, contemporaneous documentation, and appropriate tax return reporting.
IV. Analysis of Key CSA Terms and Regulatory Compliance
A. Controlled Participant Eligibility — Treas. Reg. § 1.482-7(b)(1)
Treasury Regulation § 1.482-7(b)(1) requires that each controlled participant in a CSA satisfy three conditions: (i) the participant must be a "controlled taxpayer" within the meaning of Treas. Reg. § 1.482-1(i)(5), meaning it must be one of two or more organizations, trades, or businesses owned or controlled directly or indirectly by the same interests; (ii) the participant must "reasonably anticipate" deriving benefits from exploitation of the cost-shared intangibles in its assigned territory; and (iii) the participant must "substantially comply" with the material provisions of the CSA throughout the relevant period.
PPC's Eligibility. PPC is a U.S. corporation organized under the laws of the State of Delaware. As the parent entity of the Penterra corporate group and the 100% indirect owner of PBI (through PHL), PPC and PBI are clearly controlled taxpayers within the meaning of Treas. Reg. § 1.482-1(i)(5). PPC retains the exclusive rights to exploit cost-shared intangibles in the Americas territory under the CSA. PPC conducts substantial U.S.-based research and development operations and commercial activities that generate the Americas-territory revenue from the CSA intangibles. PPC has consistently derived significant revenue from the exploitation of CSA intangibles in the Americas throughout the examination years. PPC has substantially complied with the provisions of the CSA, including its cost-sharing obligations, the annual true-up mechanism, and the reporting and documentation requirements. Accordingly, PPC satisfies all three elements of the controlled participant eligibility requirements without meaningful controversy.
PBI's Eligibility. PBI is a Designated Activity Company organized under Irish law and is a controlled taxpayer within the meaning of Treas. Reg. § 1.482-1(i)(5) by virtue of PPC's 100% indirect ownership through PHL. PBI reasonably anticipates — and has in fact derived — substantial benefits from the exploitation of CSA intangibles in the non-Americas territory (EMEA and APAC). As noted above, non-Americas revenue for the key CSA products ranged from approximately 42% to 45% of global net sales in 2020, reflecting a growing and substantial revenue base in PBI's assigned territory. PBI bore market risk for the non-Americas territory and made key commercial decisions, including pricing, market entry strategy, and distribution partner selection across 68 country markets.
PBI had 52 employees at the time of its establishment in 2012, growing steadily to 185 employees by 2020. PBI's workforce includes regulatory affairs, medical affairs, commercial strategy, and supply chain personnel, and its Managing Director, Aidan Naughton, is based in Dublin and exercises day-to-day management authority over PBI's operations. PBI has substantially complied with the provisions of the CSA, including its cost-sharing payments, the annual true-up process, and the maintenance of adequate records and financial reporting.
PHL Treatment. PHL is treated as a disregarded entity for U.S. federal income tax purposes. As a result, PHL does not participate in the CSA as a separate controlled participant. PBI is treated as owned directly by PPC for purposes of the IRC § 482 analysis. This treatment is consistent with the regulations, which look through disregarded entities for purposes of determining controlled participant status.
Assessment. Both PPC and PBI satisfy the controlled participant eligibility requirements under Treas. Reg. § 1.482-7(b)(1). PPC's qualification is straightforward. PBI's qualification is supported by its status as a controlled taxpayer, its reasonable anticipation of (and actual derivation of) benefits from exploitation of CSA intangibles in the non-Americas territory, and its substantial compliance with the CSA terms. The IRS's economic substance challenge to PBI's status as a legitimate controlled participant is addressed in greater detail in the separate economic substance analysis memorandum being prepared by Nazari (anticipated completion: August 18, 2022). That analysis will address, among other issues, the OECD Transfer Pricing Guidelines' emphasis on "people functions" and the substance requirements under Irish tax law as they relate to PBI's operational profile.
Vulnerability Noted. PBI's relatively small initial headcount of 52 employees at the time of the CSA's execution in 2012 may invite scrutiny from the IRS. The IRS may argue that PBI was established primarily as a tax-motivated IP holding structure with insufficient operational substance to qualify as a bona fide controlled participant at the CSA's inception. However, several factors mitigate this vulnerability: (a) PBI's headcount grew steadily and substantially, from 52 in 2012 to 185 by 2020, reflecting a genuine build-out of operational capabilities; (b) even at inception, PBI's 52 employees included senior commercial, regulatory, and medical affairs professionals with direct responsibility for PBI's non-Americas operations; (c) the regulations do not impose a minimum headcount requirement, and numerous precedents exist for CSA participants with comparable or smaller workforces at inception; and (d) PBI's substantive functional contributions — including independent pricing decisions, regulatory strategy, and market access activities — support its qualification as a genuine participant regardless of absolute headcount.
B. Scope of Intangible Development Activity ("IDA") — Treas. Reg. § 1.482-7(b)(2) and (d)
Treasury Regulation § 1.482-7(b)(2) and (d) require that the CSA specify the intangible development activity and the cost-sharing intangibles that are reasonably anticipated to result from that activity. The regulations define "intangible development activity" broadly to encompass any activity that is reasonably anticipated to contribute to developing cost-shared intangibles, including research and development, design, testing, manufacturing process development, and related activities.
The CSA agreement between PPC and PBI defines the IDA as encompassing all research, development, regulatory, and clinical activities undertaken by or on behalf of PPC and PBI relating to PPC's pharmaceutical IP portfolio in the areas of oncology, immunology, and rare-disease therapeutics, for exploitation in the non-Americas territory. Specifically, the IDA encompasses the following categories of activity:
• Drug discovery and preclinical research activities
• Clinical development activities, including Phase I, Phase II, Phase III, and Phase IV clinical trials
• Regulatory submissions and related regulatory affairs activities (including filings with the EMA, individual country regulatory authorities, and other non-Americas regulatory bodies)
• Lifecycle management activities, including label expansion studies, new formulation development, and line extensions
• Formulation and process improvements related to the cost-shared intangibles
The CSA agreement provides a detailed listing of qualifying R&D cost categories that constitute the IDA cost pool. These cost categories include: personnel costs (salaries, wages, benefits, and related employment costs for R&D personnel); laboratory and facility costs (including depreciation, rent, utilities, and maintenance for R&D facilities); clinical trial costs (including investigator fees, site costs, patient recruitment costs, and clinical monitoring costs); regulatory filing fees; outsourced contract research organization ("CRO") costs; and licensing-in fees for enabling technologies used in the IDA.
The total qualified R&D costs comprising the IDA cost pool for each of the examination years were as follows:
The steady increase in total qualified R&D costs over the examination period reflects PPC's expanding clinical pipeline, particularly the progression of several oncology and immunology compounds through later-stage clinical development and the initiation of lifecycle management programs for Veritaxol and Imvara.
Assessment. The CSA agreement's definition of the IDA is sufficiently specific to satisfy the requirements of Treas. Reg. § 1.482-7(b)(2) and (d). The agreement identifies the relevant therapeutic areas, the categories of qualifying activities, and the specific cost categories that comprise the IDA cost pool. The cost pool composition is well-documented in the CSA agreement and in Crestfield & Associates' contemporaneous transfer pricing documentation for each examination year.
It is recommended that the Crestfield documentation (Susan Lam, lead) be cross-checked against the CSA agreement terms to confirm complete consistency between the IDA definition in the agreement and the cost pool composition reflected in the annual transfer pricing reports. Any discrepancies, even if minor, should be identified and addressed before responding to further IRS IDRs on this topic.
It is also worth noting that the CSA agreement expressly excludes legacy compounds of pre-2012 vintage from the scope of the IDA. These legacy compounds are subject to the separate license/royalty arrangement between PPC and PBI at a royalty rate of 4.5% of net sales. This exclusion is consistent with the structure of the overall arrangement and ensures that the CSA cost pool does not include costs attributable to the development or maintenance of intangibles that are compensated through the separate royalty mechanism rather than through cost sharing.
C. Reasonably Anticipated Benefits ("RAB") Methodology — Treas. Reg. § 1.482-7(e)
Treasury Regulation § 1.482-7(e) requires that each controlled participant's share of IDA costs be proportional to its share of reasonably anticipated benefits ("RAB") from the cost-shared intangibles. The regulations provide that RAB must be estimated on a basis that is "consistent with the economic substance of the arrangement," taking into account the controlled participants' respective territories, their expected exploitation of the cost-shared intangibles, and all other relevant factors. The regulations permit the use of various benefit measures, including revenue-based projections, units-based projections, and other reasonable measures, provided the chosen measure reliably reflects each participant's share of anticipated benefits.
RAB Methodology in the CSA Agreement. The CSA agreement employs a revenue-based RAB methodology, under which each controlled participant's share of IDA costs is determined based on projected revenue splits between the Americas territory (PPC) and the non-Americas territory (PBI). The revenue projections are prepared annually using a forward-looking three-year rolling average model that incorporates the following inputs:
• Historical sales data for each product and territory
• Market growth rates by therapeutic area and geography
• Pipeline probability-adjusted revenue estimates for clinical-stage compounds
• Territory-specific factors, including regulatory approval timelines, pricing and reimbursement dynamics, market access conditions, and competitive landscape assessments
The revenue projections are prepared collaboratively by PPC's corporate finance and commercial operations teams, with input from PBI's commercial strategy and market analytics personnel, and are documented annually as part of the CSA true-up process.
PBI's Cost-Sharing Percentages. Based on the RAB methodology described above, PBI's cost-sharing percentages for the four examination years, as reflected in PPC's transfer pricing documentation, are set forth below:
The gradual increase in PBI's cost-sharing percentage over the examination period is consistent with the actual revenue trajectory, which reflects the growth of non-Americas markets as a share of total global sales for the key CSA products. As noted in Section II.C above, the non-Americas share of global net sales for Veritaxol, Imvara, and Cerulon ranged from approximately 42% to 45% in 2020, up from lower percentages in earlier years. The convergence between PBI's projected RAB percentage and its actual revenue share provides meaningful support for the reliability and reasonableness of the RAB methodology.
IRS's Proposed Cost-Sharing Percentages. The IRS has proposed significantly higher cost-sharing percentages for PBI across all four examination years:
Under the IRS's proposed percentages, the additional cost-sharing payments that would flow from PBI to PPC for each examination year are as follows:
The IRS's basis for these proposed adjustments appears to rest on the assertion that PPC's revenue projections systematically understated the value of U.S.-source contributions — particularly the value of PPC's U.S.-based R&D capabilities and intellectual property — to non-Americas revenue. In other words, the IRS appears to be arguing that the benefits PBI derives from the CSA intangibles are greater than PBI's revenue-based RAB percentage suggests, because a significant portion of the value embedded in non-Americas revenue is attributable to PPC's U.S.-based R&D infrastructure, talent, and know-how.
Assessment. The RAB methodology as documented in the CSA agreement follows a reasonable approach that is consistent with the regulatory framework. Revenue-based benefit projections are one of the methods expressly contemplated by Treas. Reg. § 1.482-7(e)(2) as a basis for measuring reasonably anticipated benefits. The key defense points with respect to the RAB methodology are as follows:
First, the revenue projections underlying PBI's cost-sharing percentages are grounded in contemporaneous data — including historical sales figures, market-specific growth rates, and pipeline probability assessments — and reflect the actual revenue trajectory observed over the examination period. The fact that PBI's projected RAB percentages closely track PBI's actual share of global revenues for the key CSA products provides strong support for the reliability of the projections.
Second, the forward-looking three-year rolling average model employed in the CSA agreement is a recognized and reasonable approach to projecting RAB, as it smooths out annual fluctuations while remaining responsive to evolving market conditions.
Third, the gradual increase in PBI's cost-sharing percentage over the examination period — from 38.2% in 2017 to 42.7% in 2020 — is consistent with the documented growth of non-Americas markets and does not suggest any systematic understatement of PBI's anticipated benefits.
Potential Vulnerability. The IRS may argue that a revenue-based RAB methodology understates the benefits that PBI derives from PPC's pre-existing R&D infrastructure and capabilities, on the theory that a significant portion of the "value" embedded in PBI's non-Americas revenue is attributable to the intellectual property and know-how generated through PPC's U.S.-based R&D activities. To defend against this argument, it will be necessary to establish that PBI's own contributions — including its regulatory expenditures ($47.2 million cumulatively during 2017–2020), market access activities, distribution infrastructure, and local clinical and commercial activities — independently and substantively drive non-Americas revenue. The economic analysis being prepared by Whitmore Valuation Group (Dr. Helena Vasquez, lead; Dr. Rohan Chakrabarti, supporting) will be critical in this regard.
Whitmore Valuation Group LLC has been retained under a Kovel arrangement (Kovel letter dated June 20, 2022, reference 1018-00009-KV; blended engagement rate of $650 per hour) to perform an independent analysis of the RAB methodology and to validate the reasonably anticipated benefits projections. This work is currently underway, and we anticipate receiving Whitmore's preliminary analysis in the fourth quarter of 2022.
D. Cost Contributions and Allocation — Treas. Reg. § 1.482-7(f)
Treasury Regulation § 1.482-7(f) requires that the costs to be shared under a CSA include all costs of the intangible development activity, including costs incurred by or on behalf of any controlled participant. The costs must be allocated among the controlled participants in proportion to their respective RAB shares, as determined under the methodology described in Section IV.C above.
The CSA agreement between PPC and PBI provides for a comprehensive cost allocation mechanism. The agreement identifies the cost categories that constitute the IDA cost pool, consistent with the categories enumerated in Treas. Reg. § 1.482-7(d)(1). These include direct R&D costs (such as personnel costs for scientists, researchers, and clinical personnel directly involved in the IDA), indirect R&D costs (such as facility costs, equipment depreciation, and allocated overhead), and stock-based compensation costs for employees whose activities are reasonably associated with the IDA.
The CSA agreement includes an annual true-up mechanism that operates as follows: at each year-end, actual qualified R&D costs incurred during the year by each controlled participant are tallied and compared to the cost-sharing payments made during the year based on budgeted costs. Any difference between the actual cost-share amount (determined by applying the RAB-based cost-sharing percentage to the actual total IDA cost pool) and the payments made during the year is settled through a true-up payment within 60 days of the end of the fiscal year. This annual true-up mechanism is a recognized best practice in CSA administration and ensures that actual cost-sharing allocations align with the RAB-determined percentages on an annual basis.
Stock-Based Compensation Treatment. The treatment of stock-based compensation costs in the CSA cost pool is a potentially significant issue in light of the Tax Court's decision in Altera Corp. v. Commissioner, 145 T.C. 91 (2015), and the subsequent Ninth Circuit decision in Altera Corp. v. Commissioner, 941 F.3d 1200 (9th Cir. 2019). The Altera litigation addressed whether Treasury Regulation § 1.482-7(d)(2), which requires the inclusion of stock-based compensation in CSA cost pools, is valid under the Administrative Procedure Act. The detailed analysis of the Altera holding and its implications for PPC's CSA is the subject of a separate memorandum being prepared by Simmons and Nazari (anticipated completion: September 15, 2022), which will also address the Tax Court's decision in Harborview Corporation, Inc. v. Commissioner insofar as it bears on transfer pricing methodology.
Assessment. The cost allocation methodology employed in the CSA agreement is consistent with the requirements of Treas. Reg. § 1.482-7(f). The agreement identifies all relevant cost categories, provides for allocation in proportion to RAB shares, and includes an annual true-up mechanism that ensures actual cost allocations align with the RAB percentages. The inclusion of direct R&D costs, indirect R&D costs, and stock-based compensation costs in the cost pool is consistent with the regulatory requirements.
Recommendation. We recommend verifying with Crestfield & Associates (Susan Lam, Transfer Pricing Partner) that stock-based compensation was treated consistently with the Altera holding across all four examination years and that the approach to identifying and allocating stock-based compensation costs to the IDA cost pool is documented in the contemporaneous transfer pricing reports. Consistent treatment of stock-based compensation is essential to avoiding any additional IRS challenge on this issue, particularly given the ongoing uncertainty surrounding the Altera holding in circuits outside the Ninth Circuit.
E. Platform Contribution Transaction ("PCT") — Treas. Reg. § 1.482-7(g)
Treasury Regulation § 1.482-7(g) provides that when a controlled participant makes available to a CSA the results of its prior research and development activities — i.e., pre-existing intangibles, referred to as "platform contributions" — the other participants must compensate the contributing party at arm's length through a platform contribution transaction ("PCT") payment. The PCT payment must reflect the arm's-length value of the platform contributions as of the date they are made available to the CSA. The regulations specify several methods for valuing PCTs, including the income method, the acquisition price method, the market capitalization method, and the residual profit split method.
PCT in the PPC-PBI CSA. Under the terms of the CSA agreement, PBI paid PPC a lump-sum PCT payment of $312 million on July 1, 2012, as compensation for PBI's buy-in to PPC's pre-existing pharmaceutical IP portfolio. The platform contributions consisted primarily of clinical-stage and approved oncology compounds — most significantly, the compound that would become Veritaxol — as well as the early-stage immunology pipeline, including the compound that would become Imvara. The PCT payment was structured as a single lump-sum payment rather than a series of periodic payments.
PCT Valuation Methodology. The original PCT valuation was prepared by Crestfield & Associates LLP using the income method, specifically a discounted cash flow ("DCF") analysis. Under the DCF approach, the value of the platform contributions was determined by projecting the future cash flows that PBI reasonably anticipated deriving from the exploitation of the pre-existing IP in the non-Americas territory, discounted to present value using an appropriate risk-adjusted discount rate (WACC).
PPC's Defense Position. PPC contends that the PCT payment of $312 million is within the arm's-length range for the platform contributions. This position is supported by the independent DCF analysis performed by Whitmore Valuation Group LLC, which employed a WACC of 9.8% and yielded an arm's-length range of $278 million to $361 million. The PCT payment of $312 million falls near the midpoint of this independently derived range, providing substantial support for the arm's-length character of the payment.
IRS Position. The IRS has valued the platform contributions at $852 million, using the income method with a significantly lower discount rate (WACC of 7.2%) and different — and, in PPC's view, more aggressive — revenue projections. The IRS's revenue projections appear to assume faster and more complete market penetration in non-Americas territories than was reasonably anticipated as of July 2012. The $540 million delta between PPC's valuation ($312 million) and the IRS's valuation ($852 million) is driven primarily by two factors: the discount rate differential (9.8% vs. 7.2%) and the more optimistic revenue assumptions embedded in the IRS's projections.
Key Technical Dispute: Discount Rate. The discount rate is the single most significant driver of the PCT valuation disparity. PPC's WACC of 9.8% reflects the risk profile of a specialty pharmaceutical company with significant clinical-stage pipeline exposure and substantial non-Americas market risk (including regulatory uncertainty in emerging markets, pricing and reimbursement variability, and currency risk). The IRS's WACC of 7.2% implies a lower risk profile, which PPC contends fails to adequately account for the substantial risks associated with commercializing pharmaceutical products in diverse non-Americas markets as of the July 2012 valuation date. Whitmore Valuation Group's analysis of the WACC dispute, including a detailed build-up of the risk-adjusted discount rate based on comparable pharmaceutical company data, is set forth in the separate WACC analysis memorandum (anticipated December 2022 delivery).
Statute of Limitations Note. The PCT payment year (2012) falls outside the examination years (2017–2020). The IRS is therefore not proposing a direct adjustment to the 2012 PCT payment. Instead, the IRS's strategy appears to be to recharacterize the ongoing CSA cost-sharing ratios for 2017–2020 as failing to reflect the full value of the contributed IP, effectively incorporating the asserted PCT undervaluation into the ongoing annual adjustments to PBI's cost-sharing percentages. This approach presents both legal and factual issues that will need to be addressed in any Protest filing, including whether the regulations permit the IRS to effectively "re-open" a prior-year PCT valuation through adjustments to the ongoing cost-sharing ratios in later years.
Assessment. The PCT payment of $312 million appears defensible based on Whitmore's independent analysis, which confirms that the payment falls within the arm's-length range derived using a DCF methodology with a risk-adjusted discount rate that reflects the market conditions and risk profile as of the July 2012 valuation date. The CSA agreement's PCT provisions are consistent with the requirements of Treas. Reg. § 1.482-7(g), including the use of a specified valuation method (the income method) and the payment of the PCT at the time the platform contributions were made available.
The detailed PCT valuation analysis is the subject of the separate Whitmore Valuation Group report (PCT Valuation Analysis — Income Method / DCF Approach, anticipated December 2022 delivery) and the companion WACC analysis memorandum (discount Rate / WACC Analysis — PBI Platform Contribution Transaction, also anticipated December 2022). These analyses will provide the primary economic support for PPC's defense position on the PCT valuation.
F. Territory Allocation and Exclusivity
The CSA agreement clearly and unambiguously delineates the territories assigned to each controlled participant. PPC retains the exclusive rights to exploit cost-shared intangibles in the Americas, which the agreement defines to include North America, Central America, South America, and the Caribbean. PBI obtains the exclusive rights to exploit cost-shared intangibles in all territories outside the Americas, encompassing EMEA and APAC.
The territorial allocation is absolute and non-overlapping. There is no provision in the CSA agreement for shared or concurrent exploitation rights in any territory. All revenues derived from the sale of CSA products and all costs of commercialization are attributed based on the territory in which the sale occurs or the exploitation right is exercised. This clear delineation ensures that there is no ambiguity regarding the attribution of benefits to each controlled participant and that the RAB methodology can be applied without overlap or double-counting.
Assessment. The territorial delineation in the CSA agreement is clear, specific, and consistent with the requirements of Treas. Reg. § 1.482-7. No compliance issues have been identified with respect to territory allocation, and the territorial provisions do not appear to be a focus of the IRS examination.
G. Arm's-Length Standard and Best Method Rule — Treas. Reg. § 1.482-1(d)
The arm's-length standard under IRC § 482 and Treas. Reg. § 1.482-1(d) requires that the results of transactions between controlled parties be consistent with the results that would have been realized if uncontrolled parties had engaged in the same transaction under the same circumstances. The best method rule under Treas. Reg. § 1.482-1(c) requires the selection of the method that provides the most reliable measure of an arm's-length result, taking into account the quality and completeness of the data and assumptions underlying the analysis.
In the context of the PPC-PBI CSA, the arm's-length standard and best method rule apply to three principal categories of intercompany transactions:
First, with respect to the CSA cost-sharing ratios, the RAB methodology (revenue-based benefit projections) is one of the recognized approaches for determining each participant's proportionate share of IDA costs. The use of revenue-based RAB projections is consistent with the methods contemplated by Treas. Reg. § 1.482-7(e)(2).
Second, with respect to the PCT payment, the income method (DCF) is one of the specified methods under Treas. Reg. § 1.482-7(g)(4) for valuing platform contributions. The income method is generally considered the most reliable method for valuing the types of intangible assets that were the subject of the PPC-PBI PCT, and both PPC and the IRS have applied the income method, albeit with different assumptions regarding the discount rate and revenue projections.
Third, with respect to the separate legacy IP royalty rate of 4.5% of net sales, this rate is evaluated under the comparable uncontrolled transaction ("CUT") method under Treas. Reg. § 1.482-4. The CUT analysis is the subject of a separate memorandum and is not addressed in detail herein.
Whitmore Valuation Group's analysis applies multiple methods to evaluate the arm's-length character of the PPC-PBI intercompany arrangements: (a) the CUT method for the legacy IP royalty rate; (b) the comparable profits method ("CPM") / transactional net margin method ("TNMM") for PBI's operating margins, tested against a set of 22 comparable pharmaceutical companies; and (c) the income method / DCF for the PCT valuation. This multi-method approach strengthens PPC's defense position under the best method rule, as it demonstrates that the arm's-length character of the intercompany arrangements is corroborated across multiple independent methods and data sets.
Assessment. PPC's methodological approach is consistent with the best method rule. The use of the revenue-based RAB methodology for cost sharing, the income method for the PCT valuation, and the CUT method for the legacy royalty rate each represents a recognized and reliable method for the respective transaction type. Whitmore's multi-method analysis provides additional confidence in the robustness of PPC's transfer pricing positions.
V. Administrative Requirements — Treas. Reg. § 1.482-7(k)
A. Written Agreement
Treasury Regulation § 1.482-7(k)(1) requires that a qualified cost-sharing arrangement be set forth in a written agreement that is in effect before the first date on which any IDA cost is incurred. The written agreement must describe the scope of the IDA, the controlled participants, the territories, the cost-sharing methodology, and the terms for PCT payments.
The CSA agreement between PPC and PBI was executed with an effective date of July 1, 2012, prior to the commencement of any cost-sharing payments or IDA cost allocations under the arrangement. The agreement was signed by authorized representatives of both PPC and PBI: specifically, by PPC's then-Chief Financial Officer (Margaret Kensington) and PBI's Managing Director (Aidan Naughton). The agreement is a comprehensive, 47-page document that addresses all of the required elements: controlled participant identification, IDA definition, territory allocation, RAB methodology, cost allocation procedures, PCT payment terms, true-up mechanism, dispute resolution provisions, amendment procedures, and termination provisions.
Assessment. The written agreement requirement of Treas. Reg. § 1.482-7(k)(1) is satisfied. The CSA agreement was executed in a timely manner, prior to the commencement of cost sharing, and addresses all of the elements required by the regulations.
B. Documentation Requirements
Treasury Regulation § 1.482-7(k)(2) requires that controlled participants maintain documentation sufficient to establish: (i) the scope and nature of the IDA; (ii) the RAB methodology and the basis for the reasonably anticipated benefit projections; (iii) the cost allocations for each taxable year; and (iv) the PCT valuation, including the method employed, the assumptions made, and the data relied upon.
Crestfield & Associates LLP prepared contemporaneous transfer pricing documentation for PPC for Tax Years 2017 through 2020. This documentation was prepared under the direction of Susan Lam, Transfer Pricing Partner, in accordance with the requirements of IRC § 6662(e) and the associated penalty-protection standards set forth in Treas. Reg. § 1.6662-6. The documentation includes the following elements:
• A functional analysis describing the functions performed, assets employed, and risks assumed by each controlled participant
• An economic analysis, including the selection and application of the best method for each category of intercompany transaction
• A description of the IDA and the cost-shared intangibles
• The RAB projections for each taxable year, including the inputs, assumptions, and methodology employed
• The cost pool composition and the allocation of costs to each controlled participant
• A narrative description of the PCT valuation, including the DCF methodology, the discount rate, and the revenue projections employed
The contemporaneous documentation was prepared on an annual basis and was maintained in Crestfield's files, with copies provided to PPC's Tax Department for internal record-keeping. The documentation was updated annually to reflect changes in the RAB projections, the cost pool composition, and the business operations of PPC and PBI.
Assessment. The contemporaneous documentation prepared by Crestfield & Associates appears to satisfy the regulatory requirements of Treas. Reg. § 1.482-7(k)(2). However, we recommend that a thorough review of Crestfield's underlying workpapers be conducted to confirm that all required elements are present, internally consistent, and supported by adequate data. This review is particularly important in light of the IRS examination, as any gaps or inconsistencies in the contemporaneous documentation could be exploited by the IRS to challenge the reliability of PPC's transfer pricing positions.
The adequacy of the contemporaneous documentation for purposes of penalty protection under IRC § 6662(e)(3)(B) is analyzed in a separate memorandum (Simmons, anticipated completion September 2, 2022).
C. Accounting and Record-Keeping
The CSA agreement requires each controlled participant to maintain books and records sufficient to verify the cost-sharing allocations, the RAB calculations, and the true-up adjustments for each taxable year. Both PPC and PBI maintain comprehensive financial records that support the CSA calculations.
PBI maintains its primary financial records and bank accounts with Glenmore Bank Ireland plc, its principal Irish banking institution. PBI files annual Irish tax returns (Corporation Tax Return — Form CT1) with the Irish Revenue Commissioners under Irish Tax Reference Number 3218764T. PBI's Irish tax compliance is handled by Thornbury & Keogh, Chartered Accountants and Tax Advisers, under the direction of Ciarán Thornbury, Lead Partner, with offices at 22 Fitzwilliam Square, Dublin 2, Ireland.
On the U.S. side, PPC files annual U.S. federal income tax returns on Form 1120, including the reporting of intercompany transactions with PBI and other Penterra group entities. PPC also files Forms 5471 (Information Return of U.S. Persons with Respect to Certain Foreign Corporations) for PBI and for PHL (Luxembourg). The annual true-up documentation — reflecting the reconciliation of actual IDA costs and cost-sharing payments — is maintained by PPC's Tax Department and is included as part of the transfer pricing documentation files.
Assessment. The accounting and record-keeping practices of both PPC and PBI appear adequate to support the CSA calculations and to satisfy the record-keeping requirements of the regulations. No deficiencies in record-keeping have been identified at this time.
D. Reporting Requirements
PPC files Forms 5471 for PBI (and PHL, RCS Number B 168452) for each of the examination years (TY 2017–2020). These information returns report PPC's ownership interest in PBI and PHL, as well as the financial statements and intercompany transaction information for each foreign subsidiary. In addition, PPC reports intercompany transactions with PBI on Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business) as applicable.
Assessment. We recommend confirming that all Forms 5471 and 5472 for the examination years are complete, accurate, and consistent with the terms of the CSA agreement and the contemporaneous transfer pricing documentation. This verification should be coordinated with Crestfield & Associates (Martin Ogilvy, Engagement Partner) to ensure return-level consistency across all relevant filings. Any inconsistencies between the information reported on the tax returns and the terms of the CSA or the transfer pricing documentation could create unnecessary issues during the examination and should be identified and remedied at the earliest opportunity.
VI. Economic Substance of PBI as CSA Participant
Although the detailed economic substance analysis is the subject of a separate memorandum being prepared by Nazari (anticipated completion: August 18, 2022), the CSA compliance analysis must address PBI's qualification as a bona fide controlled participant, as the IRS has specifically challenged PBI's economic substance as part of its examination of the CSA. This section provides a summary of the key evidence supporting PBI's status as a substantive operational entity with genuine functional contributions to the CSA.
Evidence of PBI's Substantive Operations. The following factual predicates support PBI's qualification as a bona fide controlled participant with sufficient economic substance:
1. Headcount and Growth. PBI employed 185 individuals as of December 31, 2020, representing a more than threefold increase from its initial headcount of 52 employees at the time of its establishment in 2012. This growth trajectory reflects a genuine and sustained build-out of PBI's operational capabilities over the life of the CSA.
2. Management and Governance. PBI's Managing Director, Aidan Naughton, is based in Dublin and exercises day-to-day management authority over PBI's operations. PBI's board of directors held 42 board meetings in Dublin during the 2017–2020 examination period, comprising quarterly meetings plus special sessions convened as needed to address significant strategic, regulatory, and commercial matters.
3. Physical Presence. PBI occupies approximately 18,000 square feet of office space at Claremont House, Sandyford Business Park, Dublin, which houses PBI's regulatory affairs, medical affairs, commercial strategy, supply chain, and administrative personnel.
4. Regulatory Expenditures. PBI incurred cumulative regulatory expenditures and submission costs of approximately €47.2 million during the 2017–2020 examination period, reflecting PBI's direct and substantive involvement in obtaining and maintaining marketing authorizations across non-Americas markets, including the European Union, Japan, China, Australia, and numerous other countries.
5. Commercial Decision-Making. PBI made independent pricing decisions across 68 country markets within its non-Americas territory. These pricing decisions involved the evaluation of local market conditions, reimbursement frameworks, competitive dynamics, and regulatory requireme

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