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MEMORANDUM

PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT This memorandum was prepared by Calderwood & Harkness LLP at the direction of and for the benefit of Penterra Pharmaceuticals Corp. in connection with anticipated litigation and pending IRS examination proceedings. This memorandum reflects the mental impressions, conclusions, opinions, and legal theories of counsel and is protected from disclosure by the attorney-client privilege, the work-product doctrine, and all other applicable privileges.

FROM: Leila Nazari, Calderwood & Harkness LLP

TO: Leonard Cross, Sylvia Hartwell, Garrett Simmons

DATE: August 22, 2022

RE: Analysis of Intercompany Contract Manufacturing Agreement Between Penterra Biopharma International DAC and Penterra Manufacturing Ireland Ltd. — Arm's-Length Compliance Under the Cost-Plus Method

MATTER NO.: 1018-00009

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

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I. Executive Summary

This memorandum analyzes the contract manufacturing agreement (the "CMA" or the "Agreement") between Penterra Biopharma International DAC ("PBI") and Penterra Manufacturing Ireland Ltd. ("PMI") for compliance with the arm's-length standard under the cost-plus method prescribed by Treasury Regulation § 1.482-3(d). This analysis is undertaken in connection with the ongoing examination by the Internal Revenue Service Large Business & International Division (Exam Team LB&I-NE-TP-2022-00641) of the federal income tax returns of Penterra Pharmaceuticals Corp. ("PPC") for taxable years 2017 through 2020.

PMI is a wholly owned subsidiary of PBI, itself a designated activity company organized under Irish law. PMI operates as a contract manufacturer of PPC's oncology and immunology biologics for non-Americas markets under a cost-plus arrangement with a markup of cost plus eight percent (cost + 8%). PMI performs routine manufacturing functions at its facility in Ringaskiddy, Co. Cork, Ireland, does not own any intangible property, bears only limited manufacturing execution risks, and operates exclusively under the direction of and to the specifications of PBI.

Conclusion. Based on our review of the Agreement's terms, PMI's functions performed, assets employed, and risks assumed, as well as available benchmarking data and industry comparables, the cost + 8% markup is defensible as falling within the arm's-length range under Internal Revenue Code ("IRC") § 482 and the applicable Treasury Regulations. The cost-plus method is the best method for evaluating PMI's manufacturing compensation, and the 8% markup is consistent with markups observed among comparable uncontrolled contract pharmaceutical manufacturers.

Relevance to the Broader Examination. While the IRS's primary challenges in the current examination target the cost-sharing arrangement ("CSA") cost-sharing ratios and legacy intellectual property royalty rates — totaling $380.4 million in proposed adjustments across the four taxable years under examination — the PMI contract manufacturing arrangement forms an integral part of the intercompany pricing ecosystem within the PPC group. The CMA supports PBI's characterization as a full-fledged IP-holding company and commercial principal with genuine economic substance in Ireland. A well-documented and defensible contract manufacturing arrangement with PMI reinforces the coherence of PPC's overall transfer pricing framework and provides affirmative evidence of PBI's substantive management and control over the non-Americas supply chain.

This memorandum addresses the legal framework, functional analysis, cost base composition, preliminary benchmarking considerations, the arrangement's relevance to the broader IRS examination defense, potential vulnerabilities, and our recommendations for next steps.

II. Background

A. Parties to the Agreement

The CMA is entered into between two Irish entities within the PPC group: PBI, as the buyer and commercial principal, and PMI, as the contract manufacturer. The relevant characteristics of each entity are summarized below.

Penterra Biopharma International DAC ("PBI"). PBI is a designated activity company organized under the laws of Ireland, with its registered office at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4, Ireland. PBI serves as the intellectual property holding company and commercial principal for the non-Americas commercialization of PPC's pharmaceutical products. PBI holds rights to PPC's intangible property for non-Americas territories under a cost-sharing arrangement entered into with PPC effective July 1, 2012.

For the fiscal year ended December 31, 2020, PBI reported revenue of approximately €2.14 billion and pre-tax income of approximately €1.06 billion. As of December 31, 2020, PBI employed 185 individuals, a substantial increase from the 52 employees at the time of its establishment in 2012. PBI's Managing Director is Aidan Naughton, who is resident in Ireland and reports to PPC's global executive leadership. PBI is subject to the standard Irish corporation tax rate of 12.5% on trading income, and claims the benefit of Ireland's Knowledge Development box regime (effective from fiscal year 2016 onward) at a rate of 6.25% on qualifying income attributable to qualifying intellectual property assets. PBI's Irish tax advisor is Thornbury & Keogh, Dublin, with Ciarán Thornbury serving as lead partner. PBI's principal Irish banking relationship is maintained with Glenmore Bank Ireland plc.

Penterra Manufacturing Ireland Ltd. ("PMI"). PMI is an Irish private limited company, registered with the Companies Registration Office under CRO Number 512347. Its registered office is located at Unit 7, Ringaskiddy Industrial Estate, Co. Cork T12 PX29, Ireland. PMI's sole function is the contract manufacture of PPC's oncology and immunology biologics for non-Americas markets, under the direction and to the specifications of PBI.

As of the most recent period under examination, PMI employs approximately 620 individuals at its Ringaskiddy facility. These employees are principally comprised of plant operators, quality control and quality assurance personnel, logistics and packaging staff, and plant-level management. PMI operates under the CMA with PBI and is compensated on a cost-plus basis, receiving a markup of 8% on its allowable cost base for manufacturing services rendered.

B. Corporate Ownership Structure

The corporate ownership structure relevant to the CMA is as follows:

• Penterra Pharmaceuticals Corp. ("PPC") is a Delaware corporation headquartered at 2200 Independence Boulevard, Princeton Junction, New Jersey 08550. PPC's common stock is listed on the Nasdaq Stock Market under the ticker symbol PPCA. PPC is the ultimate parent of the multinational group and the U.S. taxpayer whose returns are under examination.

• PPC is the 100% shareholder of Penterra Holdings Luxembourg S.à r.l. ("PHL"), a société à responsabilité limitée organized under Luxembourg law with its registered office at 14, rue Aldringen, L-1118 Luxembourg. PHL is treated as a disregarded entity for U.S. federal income tax purposes pursuant to Treasury Regulation § 301.7701-3.

• PHL is the 100% shareholder of Penterra Biopharma International DAC ("PBI"). Because PHL is disregarded for U.S. tax purposes, PBI is treated as directly owned by PPC for purposes of IRC § 482 and the controlled transaction analysis.

• Penterra Manufacturing Ireland Ltd. ("PMI") is a subsidiary of PBI. PMI is wholly owned, directly or indirectly, by PBI.

Both PBI and PMI are Irish-resident entities. Transactions between PBI and PMI are intercompany transactions between commonly controlled entities within the meaning of IRC § 482, as they are ultimately under common control of PPC. The U.S. federal income tax consequences of the CMA flow through PHL (as a disregarded entity) and are reflected on PPC's consolidated U.S. federal income tax return.

C. The Contract Manufacturing Agreement

The CMA was entered into effective concurrent with the establishment of PBI's commercial operations following the effective date of the cost-sharing arrangement on July 1, 2012. The principal terms and provisions of the Agreement are summarized below. A more detailed summary is attached hereto as Appendix A.

Scope of Manufacturing. Under the CMA, PMI manufactures biological pharmaceutical products exclusively for PBI's non-Americas distribution network. The products manufactured by PMI include PPC's flagship oncology biologics — most significantly, Veritaxol — as well as immunology products, including Imvara, and the rare disease therapeutic Cerulon. PMI manufactures these products to PBI's specifications and in accordance with current Good Manufacturing Practice ("cGMP") standards and regulatory requirements applicable in the territories served by PBI.

The key products manufactured by PMI and their approximate non-Americas net sales for fiscal year 2020 are as follows:

Compensation Structure. PMI is compensated under the cost-plus method. Specifically, PMI receives reimbursement for its allowable cost base plus a markup of 8%. The cost base is composed of direct manufacturing costs (including raw materials, active pharmaceutical ingredients, direct labor, and facility overhead directly attributable to production), indirect manufacturing costs (including facility costs such as rent, utilities, and maintenance, quality department overhead, and plant-level administrative costs), and certain allocated corporate service costs that are attributable to PMI's manufacturing function. The cost base composition and the application of the 8% markup are discussed in greater detail in Section V below.

Title and Risk. Title to manufactured goods passes from PMI to PBI upon completion of the manufacturing process, at which point the goods are held for PBI's account pending shipment instructions. PBI bears all inventory risk on finished goods from the point of title transfer, all market risk related to the sale and distribution of products in non-Americas territories, and all product liability risk arising from the commercial exploitation of the products. PMI's risk profile under the Agreement is limited to routine manufacturing execution risk, as discussed further in Section IV.C below.

intellectual Property. PMI does not own any intellectual property. All manufacturing know-how, process technology, formulations, and product-related IP is owned by PPC and/or licensed through the CSA/PBI IP structure. PMI manufactures to specifications provided by PBI and PPC and does not independently develop, enhance, maintain, protect, or exploit any intangible property. PMI's use of PPC's manufacturing processes and technology is authorized under the CMA and related intragroup arrangements, without separate royalty or license payment from PMI — the compensation for PMI's use of such processes is implicit in the cost-plus pricing structure.

Term and Termination. The Agreement has an indefinite term, subject to annual renewal and a 12-month advance written notice period for termination by either party. This arrangement provides operational continuity while preserving contractual flexibility consistent with arm's-length commercial arrangements.

III. Applicable Legal and Regulatory Framework

A. IRC § 482 — General Authority

Section 482 of the Internal Revenue Code grants the Secretary of the Treasury (and by delegation, the Commissioner of Internal Revenue) broad authority to distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among two or more organizations, trades, or businesses owned or controlled directly or indirectly by the same interests, if the Secretary determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades, or businesses.

The foundational principle underlying IRC § 482 is the arm's-length standard. Under Treasury Regulation § 1.482-1(b)(1), a controlled transaction meets the arm's-length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances. In determining whether a controlled transaction produces an arm's-length result, the standard of comparison is the results of transactions between unrelated parties dealing at arm's length. The regulations identify several specified methods for evaluating whether the results of controlled transactions satisfy this standard, including the comparable uncontrolled price method, the resale price method, the cost-plus method, the comparable profits method, and the profit split method. See Treas. Reg. §§ 1.482-3, 1.482-5, 1.482-6.

Importantly, Treasury Regulation § 1.482-1(d) articulates the "best method rule," which requires that the arm's-length result of a controlled transaction be determined under the method that, under the facts and circumstances, provides the most reliable measure of an arm's-length result. There is no strict priority or hierarchy among the specified methods; rather, the reliability of each method depends on the degree of comparability between the controlled transaction and uncontrolled comparables, and the quality of the data and assumptions used in the analysis. The best method rule is discussed further in Section III.C below.

B. Treas. Reg. § 1.482-3(d) — Cost-Plus Method

Treasury Regulation § 1.482-3(d) prescribes the cost-plus method as one of the specified methods for determining whether the amount charged in a controlled transaction involving the transfer of tangible property is consistent with the arm's-length standard. The cost-plus method evaluates the arm's-length character of a controlled transaction by reference to the gross profit markup earned on costs by the seller (or service provider) in the controlled transaction. The method compares the gross profit markup on costs earned by the controlled manufacturer to the markups earned by comparable uncontrolled manufacturers performing similar functions, employing similar assets, and bearing similar risks.

Under the cost-plus method, the gross profit markup is calculated as follows:

Gross Profit Markup = Gross Profit / Cost of Goods Sold

The arm's-length price is determined by adding an appropriate gross profit markup to the controlled manufacturer's costs of producing the goods. The gross profit markup is considered arm's length if it falls within the interquartile range of markups earned by comparable uncontrolled manufacturers identified through a comparability analysis.

The cost-plus method is most appropriately applied in circumstances where the controlled manufacturer performs manufacturing, production, or assembly functions using property or materials furnished by the buyer (or procured to the buyer's specifications), and where the manufacturer does not contribute significant intangible property to the controlled transaction. See Treas. Reg. § 1.482-3(d)(1). In such circumstances, the cost-plus method provides a direct measure of the manufacturing return that an unrelated party would earn for performing comparable functions.

The regulations identify several comparability factors that must be considered in selecting and evaluating comparable uncontrolled transactions for purposes of the cost-plus method. These factors include, but are not limited to:

(i) Functions performed by the controlled and uncontrolled manufacturers, including the nature and complexity of the manufacturing process;

(ii) Risks assumed by the parties, including product liability risk, inventory risk, capacity utilization risk, and manufacturing execution risk;

(iii) Assets employed, including tangible assets (plant, equipment) and intangible assets, as well as working capital requirements;

(iv) Contractual terms of the arrangement, including pricing, title transfer, risk allocation, and termination provisions;

(v) Economic conditions, including market conditions, geographic factors, and industry-specific considerations; and

(vi) The nature of the products manufactured and the level of manufacturing specialization required.

Under Treasury Regulation § 1.482-3(d)(2), the appropriate cost base for the cost-plus method includes the costs of producing the product — generally, cost of goods sold — and must be consistently determined between the controlled and uncontrolled transactions being compared. The regulations further require that the cost base be defined in a manner that captures all costs incurred in performing the manufacturing function being tested.

Where the controlled transaction falls within the interquartile range of comparable uncontrolled markups, the IRS generally will not make an allocation under IRC § 482. See Treas. Reg. § 1.482-1(e)(2)(iii)(B).

C. Treas. Reg. § 1.482-1(d) — Best Method Rule

As noted above, the best method rule under Treasury Regulation § 1.482-1(d) requires that the transfer pricing method selected for evaluating a controlled transaction be the method that provides the most reliable measure of the arm's-length result. The reliability of a method depends on two principal factors: (1) the degree of comparability between the controlled transaction and uncontrolled comparables, considering functional comparability, risk comparability, and contractual and economic conditions; and (2) the quality of the data and assumptions used in the analysis.

For PMI's contract manufacturing arrangement, the cost-plus method is the best method for the following reasons:

First, PMI is a routine contract manufacturer that performs manufacturing to PBI's specifications without contributing intangible property to the controlled transaction. The cost-plus method is specifically designed to test the arm's-length character of controlled transactions in which the tested party performs manufacturing or production functions without contributing significant intangibles, and in which the tested party's value contribution is principally in the form of manufacturing services applied to costs of production. See Treas. Reg. § 1.482-3(d)(1).

Second, the cost-plus method directly tests the manufacturing return (i.e., the gross profit markup on costs) earned by PMI, which is the most relevant profit level indicator for a limited-risk contract manufacturer. Alternative methods — such as the comparable profits method or the profit split method — would introduce additional complexity and potential sources of error without improving the reliability of the analysis.

Third, the cost-plus method is consistent with the economic substance of the CMA. PMI is compensated on a cost-plus basis under the Agreement, and the cost-plus method directly evaluates whether the contractual markup (8%) produces an arm's-length result. This alignment between the contractual pricing mechanism and the testing method enhances reliability.

Fourth, reliable data on comparable uncontrolled manufacturers' cost-plus markups in the pharmaceutical manufacturing sector is available through commercial databases and industry studies, providing a sound basis for comparability analysis.

For these reasons, the cost-plus method is the best method for evaluating the arm's-length character of PMI's manufacturing compensation under the CMA.

D. OECD Transfer Pricing Guidelines — Chapter II (Methods), Chapter I (Arm's-Length Principle)

Although the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations are not binding authority for purposes of U.S. federal income tax law, they are widely recognized as persuasive authority and are frequently referenced by the IRS, the U.S. Tax Court, and other tribunals in transfer pricing disputes. The OECD Guidelines articulate the arm's-length principle in terms substantially similar to those of the U.S. Treasury Regulations and provide detailed guidance on the application of transfer pricing methods, including the cost-plus method.

Chapter I of the OECD Guidelines sets forth the arm's-length principle as the international standard for determining transfer prices between associated enterprises. The arm's-length principle requires that conditions between associated enterprises in their commercial and financial relations be consistent with those that would be made between independent enterprises.

Chapter II of the OECD Guidelines discusses the application of transfer pricing methods, including the cost-plus method. The OECD Guidelines recognize the cost-plus method as appropriate for testing the arm's-length character of controlled manufacturing transactions, particularly in the context of contract or toll manufacturing arrangements where the manufacturer performs routine functions, does not contribute valuable intangibles, and does not bear significant entrepreneurial risks.

Of particular relevance to the present analysis is the OECD's DEMPE framework — that is, the framework for analyzing the functions of Development, Enhancement, Maintenance, Protection, and Exploitation of intangible property. Under the DEMPE framework, the returns attributable to intangible property should be allocated to the entity (or entities) that perform the DEMPE functions, control the risks associated with those functions, and bear the costs of those functions. In the PBI/PMI context, PMI performs a limited DEMPE function — specifically, manufacturing (which may relate to the "Maintenance" and "Enhancement" of product quality and supply, but only in a routine, non-entrepreneurial capacity). PBI, by contrast, controls the Development, Enhancement, Maintenance, Protection, and Exploitation of the group's intangible property for non-Americas markets. This functional allocation is consistent with PMI's characterization as a limited-risk contract manufacturer entitled to a routine return, with residual profits accruing to PBI as the IP owner and commercial principal.

The consistency between the U.S. regulatory framework and the OECD Guidelines supports the defensibility of the cost-plus method and the 8% markup under both U.S. and international transfer pricing principles.

IV. Functional Analysis of PMI

A thorough functional analysis of PMI — encompassing the functions it performs, the assets it employs, and the risks it assumes — is essential to its proper characterization under the transfer pricing regulations and to the determination of whether the cost + 8% markup produces an arm's-length result. The following analysis demonstrates that PMI is properly characterized as a limited-risk contract manufacturer, supporting the application of the cost-plus method with a routine manufacturing return.

A. Functions Performed

PMI's functions under the CMA are limited to routine contract manufacturing and related support activities. Specifically, PMI performs the following functions:

Manufacturing of Biological Pharmaceutical Products. PMI manufactures PPC's biologics at its facility at Ringaskiddy Industrial Estate, Co. Cork, Ireland. The principal products manufactured are oncology compounds, including Veritaxol; immunology products, including Imvara; and the rare disease therapeutic Cerulon. The manufacturing processes employed by PMI include fermentation, purification, and fill/finish operations, all of which are performed using processes and protocols developed by PPC and specified by PBI. PMI does not independently design, develop, or modify the manufacturing processes it employs; rather, PMI manufactures to PBI's specifications and in accordance with cGMP standards.

Quality Control and Quality Assurance. PMI maintains a quality control and quality assurance function at the Ringaskiddy facility, responsible for in-process testing, batch release testing, stability testing, and compliance with applicable regulatory standards. PMI's quality function operates in accordance with specifications, standard operating procedures, and quality manuals provided by PBI, and is subject to oversight by PBI's quality organization. PMI does not independently establish quality standards or specifications; it implements the standards established by PBI and PPC.

Packaging and Shipment Coordination. PMI performs packaging of finished goods in accordance with PBI's packaging specifications and coordinates the shipment of finished products to PBI's designated distribution points for non-Americas markets. PMI does not manage or control the downstream supply chain beyond the point of title transfer to PBI.

Routine Process Optimization. PMI performs routine process optimization activities within the parameters set by PPC and PBI. These activities include yield improvement efforts, equipment calibration and maintenance, and minor process adjustments to maintain or improve manufacturing efficiency. Importantly, these activities are conducted within the framework of processes and technologies developed and owned by PPC and do not constitute independent research and development or value-creating innovation.

Functions Not Performed by PMI. PMI does not perform any research and development functions. PMI does not engage in product development, formulation development, or clinical trials. PMI does not perform any commercial, marketing, sales, or distribution functions. PMI does not bear responsibility for regulatory submissions or regulatory strategy — all regulatory expenditures and submissions are the responsibility of PBI, which spent €47.2 million on a cumulative basis during the period 2017–2020 on regulatory activities. PMI does not participate in pricing decisions, market access strategies, or reimbursement negotiations.

Workforce. PMI employs approximately 620 individuals at the Ringaskiddy facility. These employees are primarily plant operators, quality control and quality assurance personnel, logistics and packaging staff, and plant-level management. The workforce composition is consistent with the labor-intensive nature of biologics manufacturing operations and does not indicate the performance of entrepreneurial, IP-creating, or strategic commercial functions.

B. Assets Employed

PMI employs the following assets in the performance of its manufacturing functions:

Manufacturing Facility. PMI's manufacturing operations are conducted at the Ringaskiddy Industrial Estate facility in Co. Cork, Ireland. The facility is held under a commercial lease arrangement and includes manufacturing suites, quality control laboratories, warehousing and logistics areas, and administrative offices. The facility is designed and equipped for the production of biological pharmaceutical products, including fermentation vessels, chromatography systems, ultrafiltration/diafiltration equipment, and fill/finish lines.

Specialized Biologic Manufacturing Equipment. PMI employs specialized equipment for the manufacture of biologics, including fermentation and cell culture systems, purification trains (protein A chromatography, ion exchange chromatography, viral inactivation and filtration), and aseptic fill/finish lines. This equipment represents a significant investment and is necessary for the scale and complexity of biologics manufacturing. However, the equipment is operated using processes and technology owned by PPC and licensed through the PBI/CSA structure; PMI does not own the intellectual property embodied in its manufacturing processes.

Working Capital. PMI maintains working capital in the form of inventories of raw materials and work-in-progress necessary for ongoing manufacturing operations. Finished goods inventory is not a significant asset of PMI, as title to finished goods transfers to PBI upon completion of manufacturing.

Intangible Property. PMI does not own any intangible property. All manufacturing processes, formulations, product-related know-how, trade secrets, patents, trademarks, and other intellectual property are owned by PPC and/or licensed through the CSA/PBI IP structure. PMI's manufacturing activities are entirely dependent on intellectual property owned by other group entities.

C. Risks Assumed

PMI's risk profile under the CMA is deliberately limited, consistent with its characterization as a contract manufacturer operating under the direction and control of PBI.

Risks Not Borne by PMI. PMI does not bear market risk — all production is undertaken pursuant to the CMA for PBI, and PMI does not independently seek customers or face demand uncertainty. PMI does not bear inventory risk on finished goods, as title to finished products passes to PBI upon completion of manufacturing. PMI does not bear product liability risk, which is assumed by PBI as the commercial principal for non-Americas territories. PMI does not bear foreign exchange risk on product sales, as it is compensated in euros on a cost-plus basis regardless of the currencies in which PBI's customers remit payment.

Risks Borne by PMI. PMI bears routine manufacturing execution risk, including the risk of plant downtime, equipment failure, yield variations, and batch failures. These risks are inherent in any manufacturing operation and are appropriately compensated through the cost-plus markup. PMI bears labor cost risk, including the risk of changes in wage rates, benefits costs, and workforce availability in the Irish labor market. PMI bears operational compliance risk — the risk that its manufacturing operations may fail to meet applicable regulatory standards, resulting in remediation costs, production delays, or regulatory action.

Capacity Utilization Risk. PMI's capacity utilization risk is limited by the long-term nature of the CMA and the dedicated character of PMI's manufacturing operations for PBI. While PMI could theoretically face periods of underutilization if PBI's demand for manufactured products were to decline, the indefinite term of the CMA, the ongoing commercial success of Veritaxol, Imvara, and Cerulon in non-Americas markets, and PBI's historical production volume commitments substantially mitigate this risk during the periods under examination.

D. Characterization. Based on the foregoing functional analysis, PMI is properly characterized as a contract manufacturer — also referred to in transfer pricing literature as a "toll manufacturer" or "limited-risk manufacturer" — that performs routine manufacturing functions, employs tangible manufacturing assets but no intangible property, and bears only limited manufacturing execution risks. PMI does not contribute significant intangible property to the controlled transaction, does not bear significant entrepreneurial or market risks, and operates under the direction and control of PBI.

This characterization is critical to the transfer pricing analysis because it determines the appropriate method for evaluating the arm's-length character of PMI's compensation, the relevant comparables, and the expected range of returns. As a limited-risk contract manufacturer, PMI is entitled to a routine return commensurate with its limited functions, assets, and risks. The residual profits attributable to the group's intangible property, market risk-bearing, and commercial activities should accrue to PBI as the IP owner and commercial principal. The cost-plus method, with an appropriate markup, is the most reliable method for determining PMI's arm's-length compensation.

V. Analysis of the Cost + 8% Markup

A. Description of the Cost Base

The cost base to which the 8% markup is applied under the CMA is composed of the following categories of costs incurred by PMI in the performance of its manufacturing functions:

Direct Costs. PMI's direct costs include raw materials, active pharmaceutical ingredients ("APIs"), direct manufacturing labor, and manufacturing overhead directly attributable to the production of finished goods. These costs represent the most significant component of PMI's total cost base and are directly traceable to specific production batches and product lines.

Indirect Costs. PMI's indirect costs include facility costs (rent, utilities, maintenance, depreciation of leasehold improvements), quality department overhead, plant-level administrative costs, and other costs that are not directly traceable to specific production batches but are necessary for the overall operation of the Ringaskiddy manufacturing facility. Indirect costs are allocated to products based on reasonable allocation methodologies (e.g., production volume, labor hours, or floor space, as appropriate).

Allocated Corporate Service Costs. Certain corporate service costs that are attributable to PMI's manufacturing function — such as IT support, human resources services, and general administrative services provided by other group entities — are allocated to PMI and included in the cost base. These allocated costs are determined in accordance with applicable intercompany service agreements and reflect the actual cost of services consumed by PMI.

Exclusions from the Cost Base. The cost base does not include PBI's royalty payments (to the extent PBI pays royalties under the CSA or other intercompany IP license arrangements), PBI's selling, general, and administrative expenses ("SG&A"), or any costs attributable to functions not performed by PMI (e.g., research and development, regulatory activities, marketing, or commercial functions). The exclusion of these costs from PMI's cost base is appropriate because PMI does not perform these functions, and the cost-plus method is intended to compensate PMI for the costs it actually incurs in performing its manufacturing function.

Regulatory Compliance. It is important to verify that the composition of PMI's cost base is consistent with the requirements of Treasury Regulation § 1.482-3(d)(2), which requires that the appropriate cost base for the cost-plus method include the costs incurred by the controlled manufacturer in producing the goods. We recommend that PMI's cost accounting practices and cost base definition be reviewed on a year-by-year basis for the periods under examination (2017–2020) to confirm consistency and completeness, and to ensure that no material cost items have been improperly included or excluded from the cost base.

B. Comparability Analysis — Preliminary Benchmarking Considerations

The arm's-length character of PMI's 8% markup must be evaluated by reference to the markups earned by comparable uncontrolled manufacturers — that is, independent companies performing comparable manufacturing functions, employing comparable assets, and bearing comparable risks under comparable contractual and economic conditions.

Comparable Markups for Contract Pharmaceutical Manufacturers. Based on publicly available data and our preliminary review of industry benchmarks, gross profit markups for contract manufacturers in the pharmaceutical and biologic manufacturing sector typically fall within a range of approximately 5% to 15% on total costs. This range reflects the variation in manufacturing complexity, scale, risk profile, geographic location, and the degree of specialization of the manufacturing function. At the lower end of the range are contract manufacturers performing relatively simple, high-volume manufacturing with minimal specialization. At the higher end are manufacturers performing complex manufacturing operations (such as biologics fill/finish or sterile manufacturing) with greater capital intensity and higher quality requirements.

PMI's Position Within the Range. PMI's 8% markup falls in the middle of the commonly observed range for limited-risk contract manufacturers in the pharmaceutical industry. This positioning is consistent with PMI's functional profile: PMI performs complex biologics manufacturing (which would tend to justify a markup toward the middle or upper portion of the range) but bears only limited risks and does not contribute intangible property (which would tend to constrain the markup toward the lower or middle portion of the range). The net result is that an 8% markup is reasonable and consistent with market practice.

Comparability Adjustments. Any formal benchmarking analysis will need to consider potential comparability adjustments to account for differences between PMI and the identified comparables. Key factors for adjustment consideration include:

(i) Geographic location. PMI is located in Ireland, which offers competitive labor costs and favorable infrastructure for pharmaceutical manufacturing relative to certain other jurisdictions (e.g., the United States, Switzerland, or Germany), but higher costs relative to certain emerging-market manufacturing locations (e.g., India or China).

(ii) Nature of biologics manufacturing. Biologics manufacturing — including fermentation, purification, and aseptic fill/finish — is inherently more complex and capital-intensive than small-molecule chemical synthesis or tablet manufacturing. Comparable markups for biologics manufacturers may be higher than those for manufacturers of simpler pharmaceutical dosage forms.

(iii) Scale of operations. PMI's 620-employee workforce and dedicated facility represent a substantial manufacturing operation. The scale of PMI's operations may provide cost efficiencies (economies of scale) or may require a higher absolute level of manufacturing infrastructure, both of which may affect comparability.

(iv) Dedicated vs. multi-client operations. PMI is a dedicated contract manufacturer serving a single principal (PBI). Many publicly available comparables are multi-client contract manufacturing organizations ("CMOs") that serve multiple pharmaceutical companies. Dedicated contract manufacturers may differ from multi-client CMOs in terms of capacity utilization risk, customer concentration risk, and the degree of operational flexibility. Adjustments may be necessary to account for these differences.

Engagement of Whitmore Valuation Group LLC. To support the formal benchmarking analysis, we have retained Whitmore Valuation Group LLC ("Whitmore") under a Kovel arrangement (Reference 1018-00009-KV, executed June 20, 2022). The engagement team at Whitmore is led by Dr. Helena Vasquez, Lead Economist, with support from Dr. Rohan Chakrabarti. Whitmore will conduct a comprehensive benchmarking study using standard commercial databases to identify comparable uncontrolled contract pharmaceutical manufacturers and to determine the interquartile range of gross profit markups on costs earned by such comparables. The results of Whitmore's benchmarking study will provide the quantitative foundation for confirming that PMI's 8% markup is within the arm's-length range.

C. Internal Comparables

Internal comparable uncontrolled transactions ("CUTs") are generally considered the most reliable form of comparable for transfer pricing purposes because they arise from transactions involving the same or similar products, functions, and risks, and because the taxpayer has detailed information regarding the terms and conditions of such transactions.

In the present case, however, internal CUTs are not available. The PPC group does not maintain uncontrolled manufacturing arrangements with third-party contract manufacturers for the same products (Veritaxol, Imvara, Cerulon) in non-Americas markets. PMI is the sole contract manufacturer for PBI's non-Americas biologics supply chain. PPC's U.S. manufacturing operations produce products for the Americas markets and are conducted through PPC's own facilities, not through arm's-length contract manufacturing arrangements.

The absence of internal CUTs does not preclude the application of the cost-plus method. The Treasury Regulations recognize that external comparables may be used where internal comparables are not available, provided that appropriate comparability adjustments are made. See Treas. Reg. § 1.482-3(d)(3). The external comparable search discussed below is designed to identify appropriate comparables for PMI's manufacturing function.

D. External Comparable Search

We recommend that Whitmore Valuation Group conduct a formal external benchmarking search for comparable contract pharmaceutical manufacturers to support the arm's-length character of PMI's 8% markup. The search should employ the following methodology:

Database Selection. The search should utilize standard commercial databases commonly accepted by the IRS and by the U.S. Tax Court for transfer pricing benchmarking purposes, including Bureau van Dijk's Orbis database, Drayton Services Inc., and other available databases containing financial data on global pharmaceutical manufacturers.

Search Criteria. The search criteria should be designed to identify companies with functional profiles comparable to PMI's. Recommended search criteria include:

(i) Industry classification. Companies classified under SIC codes 2833–2836 (pharmaceutical preparations, biological products) and/or NAICS codes 325411–325414 (pharmaceutical and medicine manufacturing, biological product manufacturing).

(ii) Functional profile. Companies that perform contract manufacturing functions without owning significant intangible property. The search should exclude companies that are integrated pharmaceutical manufacturers (i.e., companies that perform R&D, marketing, and distribution in addition to manufacturing), as such companies bear substantially different risks and perform substantially different functions than PMI.

(iii) Remuneration model. Companies that are compensated on a cost-plus or similar remuneration basis, or for which financial data is available to compute gross profit markups on cost of goods sold.

(iv) Geographic scope. The search should consider companies operating in OECD jurisdictions, with a preference for European-based manufacturers given PMI's Irish location.

(v) Financial data availability. Companies for which at least three years of financial data are available for the benchmark period (2017–2020) to permit multi-year averaging and to account for business cycle effects.

Preliminary Assessment. Based on our preliminary assessment of publicly available data and prior transfer pricing studies in the pharmaceutical manufacturing sector, we are confident that the 8% markup is within an acceptable arm's-length range. The formal benchmarking analysis to be performed by Whitmore will provide the quantitative support necessary to confirm this preliminary assessment and to establish the interquartile range of comparable markups.

E. Consistency with CPM/TNMM Analysis

The PMI cost-plus analysis should be evaluated in the context of the broader transfer pricing analysis being prepared for the PPC group. Whitmore Valuation Group is currently preparing a comprehensive comparable profits method ("CPM") / transactional net margin method ("TNMM") analysis for PBI, which tests PBI's operating margins against a set of 22 comparable distributors and IP-holding companies identified through a formal benchmarking search.

The PMI cost-plus arrangement and the PBI CPM/TNMM analysis are complementary components of the overall transfer pricing framework. Specifically, the residual profit remaining after compensating PMI at cost + 8% should accrue to PBI as the IP owner and risk-bearing commercial principal. If the 8% markup assigned to PMI is arm's length, the resulting allocation of residual profit to PBI should be consistent with PBI's economic substance, its DEMPE functions, and the returns earned by comparable IP-holding and commercial principal entities.

It is important that the results of the PMI cost-plus analysis and the PBI CPM/TNMM analysis be internally consistent — that is, the aggregate intercompany pricing framework should produce a coherent allocation of profits among the group entities that reflects the respective functions performed, assets employed, and risks assumed by each entity. Any inconsistency between the two analyses could undermine the overall credibility of the transfer pricing framework in the context of the IRS examination.

VI. Relevance to IRS Examination Defense

A. Supporting PBI's Economic Substance

The PMI contract manufacturing arrangement is a critical piece of evidence supporting PBI's characterization as a full-fledged IP owner and commercial principal with genuine economic substance in Ireland. The IRS examination has focused significant attention on whether PBI possesses the substance, personnel, and decision-making authority necessary to justify the allocation of IP-related returns to PBI. The CMA and PBI's management of the manufacturing relationship with PMI are directly relevant to this inquiry.

PBI contracts with PMI for the manufacture of all biologics products sold in non-Americas markets. PBI manages the supply chain for these territories, including issuing purchase orders to PMI, setting manufacturing specifications and quality standards, approving batch releases, scheduling production to meet commercial demand forecasts, and overseeing the logistics of finished goods distribution. This supply chain management function is documented through PBI's internal records, including board minutes from 42 meetings held between 2017 and 2020, all of which were convened in Dublin. PBI's supply chain management personnel, based in Ireland, exercise day-to-day oversight of the PMI manufacturing relationship, providing affirmative evidence that PBI performs substantive functions in connection with the exploitation and maintenance of the group's intangible property for non-Americas markets.

In this context, the CMA is not merely a transfer pricing arrangement — it is an integral component of PBI's operational framework and a tangible demonstration of the economic substance of PBI's Irish operations.

B. Interaction with CSA Cost-Sharing Adjustments

The IRS's most significant proposed adjustment in the current examination relates to the cost-sharing arrangement between PPC and PBI. The IRS has proposed adjustments to the CSA cost-sharing ratios totaling $235.01 million across the 2017–2020 tax years. These proposed adjustments, if sustained, would reallocate a portion of the IP-related returns from PBI to PPC, increasing PPC's U.S. taxable income.

The PMI manufacturing return, however, should be unaffected by any CSA adjustment. PMI is a cost-plus manufacturer whose return is determined by reference to its cost base and the 8% markup, without regard to the allocation of IP income between the CSA participants (PPC and PBI). Whether the IRS's proposed CSA adjustments are sustained, partially sustained, or reversed, PMI's manufacturing compensation remains the same — cost plus 8%.

It bears noting that the IRS has not separately challenged the PMI cost + 8% markup in the Notice of Proposed Adjustment ("NOPA") dated October 12, 2023. This is consistent with our assessment that the 8% markup is within the arm's-length range and does not present a separate basis for adjustment. Nevertheless, a well-supported PMI arrangement strengthens the overall coherence of PPC's intercompany pricing framework and reduces the risk that the IRS may revisit the PMI arrangement in subsequent examination cycles or in the context of Appeals proceedings.

C. Interaction with Royalty Rate Adjustments

The IRS's second major proposed adjustment targets the royalty rate on legacy compound net sales. The IRS proposes to increase the royalty rate from 4.5% to 11.0%, resulting in a proposed adjustment of $188.04 million across the 2017–2020 tax years. This adjustment, if sustained, would increase PPC's U.S. taxable income by increasing the deemed royalty payments from PBI to PPC for the use of pre-CSA legacy intangible property.

The royalty rate adjustment does not directly affect PMI's compensation under the CMA. PMI is compensated at cost plus 8% regardless of the royalty rate applied to PBI's sales. However, the royalty rate adjustment may indirectly affect the overall profitability allocation within the non-Americas value chain. To the extent that a higher royalty rate reduces PBI's residual profit, the consistency of the overall pricing framework may be affected. We should ensure that the PMI cost-plus analysis and the PBI profitability analysis are updated to reflect any changes in the royalty rate assumption, so that the overall framework remains internally consistent.

Regardless of the royalty rate outcome, PMI's limited-risk, cost-plus return remains the appropriate arm's-length compensation for its routine manufacturing functions. The characterization of PMI's functions, assets, and risks does not change based on the allocation of IP returns between PPC and PBI.

D. Penalty Protection Considerations

PPC maintained contemporaneous transfer pricing documentation for all four taxable years under examination (2017–2020), prepared by Crestfield & Associates LLP. The engagement was led by Martin Ogilvy, Engagement Partner, and Susan Lam, Transfer Pricing Partner. The contemporaneous documentation covers the PMI manufacturing arrangement, including a description of the cost-plus methodology, the composition of the cost base, PMI's functional profile, and the arm's-length justification for the 8% markup.

The maintenance of contemporaneous documentation that describes and substantiates the PMI cost-plus methodology supports PPC's reasonable-cause defense under IRC § 6662(e)(3)(B). Under Section 6662(e), a substantial valuation misstatement penalty may be imposed on the portion of an underpayment attributable to a transfer pricing adjustment. However, the penalty may be avoided if the taxpayer establishes that it acted with reasonable cause and in good faith, and that it maintained contemporaneous documentation that satisfies the requirements of Treasury Regulation § 1.6662-6(d). PPC's transfer pricing documentation, which includes the PMI cost-plus analysis, is designed to meet these requirements.

The IRS has proposed penalties of $15.98 million, representing 20% of the tax attributable to the $380.4 million in proposed adjustments. Although the IRS has not separately targeted the PMI arrangement for adjustment, a well-documented and defensible PMI cost-plus analysis strengthens the overall penalty protection argument. It demonstrates that PPC employed reasonable transfer pricing methodologies across the entirety of its intercompany pricing framework, including the contract manufacturing arrangement, and that PPC acted in good faith in establishing and maintaining its intercompany pricing.

VII. Potential Vulnerabilities and Risk Assessment

While we believe that the cost + 8% markup is defensible under the arm's-length standard, we identify the following potential vulnerabilities and associated risk factors that should be addressed in preparing the examination defense.

A. Cost Base Definition

There is a risk that the IRS could challenge the composition of PMI's cost base, arguing that certain cost items should be included in, or excluded from, the cost base. For example, the IRS could argue that certain allocated corporate service costs should not be included in the cost base (on the theory that they are duplicative of charges under separate intercompany service agreements) or that certain costs incurred by PBI on behalf of PMI should be included in PMI's cost base (on the theory that they represent costs of manufacturing functions performed by PMI). Any change in the composition of the cost base would change the effective markup percentage, even if the nominal 8% rate remained unchanged.

Recommendation. We recommend that the cost base definition be reviewed and confirmed for consistency across all four taxable years under examination (2017–2020). The review should confirm that the cost base includes all costs required to be included under Treasury Regulation § 1.482-3(d)(2) — specifically, all costs of producing the goods, including direct materials, direct labor, and applicable overhead — and that no material cost items have been improperly included or excluded. Particular attention should be paid to (i) the treatment of corporate service cost allocations, (ii) the treatment of idle capacity costs, and (iii) any year-over-year changes in cost accounting methodologies.

B. 620-Employee Workforce

PMI's workforce of approximately 620 employees represents a significant headcount by the standards of contract manufacturing arrangements. It is possible that the IRS could argue that the size of PMI's workforce indicates that PMI performs more than routine contract manufacturing functions — for example, that PMI performs substantial process development, quality innovation, or other value-creating functions that would warrant a higher characterization and a different transfer pricing analysis.

Counter-argument. Biologics manufacturing is inherently labor-intensive. The production of monoclonal antibodies, recombinant proteins, and other biologic therapies requires large numbers of skilled operators, quality control technicians, quality assurance professionals, and support personnel. PMI's headcount of 620 employees is consistent with the scale of its manufacturing operations — producing three major products (Veritaxol, Imvara, and Cerulon) for all non-Americas markets — and does not, in itself, indicate that PMI performs entrepreneurial, IP-creating, or strategic commercial functions. Moreover, an examination of PMI's employee roster and job descriptions will confirm that the vast majority of PMI's employees are engaged in production operations, quality testing, packaging, logistics, and plant maintenance — all of which are routine manufacturing functions.

The appropriate inquiry is not the absolute size of PMI's workforce but rather the nature and character of the functions performed by that workforce. A large workforce performing routine manufacturing functions is functionally indistinguishable from a smaller workforce performing the same functions on a smaller scale, and should receive the same type of arm's-length return — a routine cost-plus markup.

C. Manufacturing Complexity

Biologic pharmaceutical manufacturing — including cell culture fermentation, multi-step purification, viral clearance, and aseptic fill/finish — is considerably more complex than small-molecule chemical synthesis or traditional pharmaceutical tableting and packaging. This complexity is reflected in the capital intensity of biologics manufacturing facilities, the stringent regulatory requirements (including FDA and EMA cGMP standards), the specialized workforce required, and the lower batch-to-batch consistency compared to small-molecule manufacturing.

The manufacturing complexity factor could be raised by either party. The IRS could argue that PMI's complex manufacturing operations warrant a higher characterization (and potentially a different transfer pricing method or a higher tested markup). Alternatively, PPC could argue that the complexity of PMI's manufacturing supports a higher cost-plus markup, which would increase PMI's manufacturing cost and reduce PBI's residual profit — potentially benefiting PPC's U.S. tax position by increasing the deductible cost of goods for PBI.

Assessment. The 8% markup is moderate and appropriately accounts for the higher complexity of biologics manufacturing relative to simpler pharmaceutical manufacturing. Industry benchmarks for biologics contract manufacturers generally show markups in the middle to upper portion of the 5%–15% range. The 8% markup is consistent with this positioning. If anything, the complexity factor supports a markup at or slightly above 8%, which would marginally benefit PPC by increasing the manufacturing cost deduction for PBI. We do not view the complexity issue as a significant vulnerability, but it should be addressed in the benchmarking analysis to ensure that the selected comparables include companies performing manufacturing of comparable complexity.

D. Lack of Internal CUTs

As discussed in Section V.C above, the PPC group does not have uncontrolled manufacturing arrangements with third parties for the same products in non-Americas markets. The absence of internal CUTs means that the comparability analysis must rely entirely on external comparables, which generally provide a less reliable basis for comparison than internal CUTs because they involve different products, different companies, and potentially different economic conditions.

Mitigation. The absence of internal CUTs is a common feature of transfer pricing analyses for large multinational groups with vertically integrated supply chains. The Treasury Regulations expressly contemplate the use of external comparables where internal comparables are not available. See Treas. Reg. § 1.482-3(d)(3). The formal benchmarking analysis to be performed by Whitmore Valuation Group will identify external comparables with functional profiles as similar as practicable to PMI's profile, and will apply appropriate comparability adjustments to account for any material differences. We are confident that a robust external benchmarking analysis will adequately support the 8% markup.

VIII. Recommendations

Based on the foregoing analysis, we make the following recommendations:

1. Formal Benchmarking Study. We recommend that Whitmore Valuation Group LLC include a formal benchmarking study of PMI's cost + 8% markup in their overall economic analysis supporting PPC's examination defense. Although the IRS has not directly challenged the PMI manufacturing arrangement in the NOPA, proactive documentation of the arm's-length character of the PMI markup strengthens the overall defense posture and reduces the risk that the IRS may seek to challenge the arrangement at a later stage of the examination or in Appeals. Dr. Helena Vasquez and Dr. Rohan Chakrabarti should be instructed to include PMI in the scope of their engagement, and the benchmarking study should identify a set of comparable contract pharmaceutical manufacturers and determine the interquartile range of gross profit markups on costs.

2. Contemporaneous Documentation Review. We recommend that the contemporaneous transfer pricing documentation prepared by Crestfield & Associates LLP (Martin Ogilvy, Engagement Partner; Susan Lam, Transfer Pricing Partner) for taxable years 2017–2020 be reviewed to ensure that it adequately describes the PMI arrangement, the cost base composition, the functional analysis of PMI, and the arm's-length justification for the 8% markup. Any gaps or deficiencies in the documentation should be identified and addressed, within the bounds of applicable regulations regarding contemporaneous documentation.

3. IDR Response Strategy. In responding to Information Document Requests from the IRS (47 IDRs issued between June 2022 and September 2023), we recommend that the PMI arrangement be presented as evidence of PBI's substantive control over the non-Americas supply chain. Specifically, IDR responses should highlight PBI's management of the PMI manufacturing relationship — including purchase order issuance, quality oversight, production scheduling, and supply chain coordination — as affirmative evidence of PBI's economic substance and DEMPE functions in Ireland.

4. Coordination with Irish Tax Advisors. We recommend coordination with Thornbury & Keogh (Ciarán Thornbury, Lead Partner; 22 Fitzwilliam Square, Dublin 2, D02 YH68, Ireland) to ensure consistency between the U.S. and Irish transfer pricing positions for the PMI arrangement. Any inconsistency between the U.S. and Irish positions could undermine the credibility of PPC's transfer pricing framework and could create exposure to double taxation or competent authority disputes. Thornbury & Keogh should confirm that the Irish Revenue Commissioners' transfer pricing documentation requirements are being satisfied and that the cost + 8% markup is consistent with Irish transfer pricing rules.

5. Formal Protest and Appeals. For the formal Protest to be filed with the IRS (deadline extended to December 22, 2023) and for any subsequent Appeals proceedings, we recommend that the PMI arrangement

MEMORANDUM
PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT This memorandum was prepared by Calderwood & Harkness LLP at the direction of and for the benefit of Penterra Pharmaceuticals Corp. in connection with anticipated litigation and pending IRS examination proceedings. This memorandum reflects the mental impressions, conclusions, opinions, and legal theories of counsel and is protected from disclosure by the attorney-client privilege, the work-product doctrine, and all other applicable privileges.
FROM: Leila Nazari, Calderwood & Harkness LLP
TO: Leonard Cross, Sylvia Hartwell, Garrett Simmons
DATE: August 22, 2022
RE: Analysis of Intercompany Contract Manufacturing Agreement Between Penterra Biopharma International DAC and Penterra Manufacturing Ireland Ltd. — Arm's-Length Compliance Under the Cost-Plus Method
MATTER NO.: 1018-00009
CLIENT: Penterra Pharmaceuticals Corp. (EIN: 22-3741856)
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I. Executive Summary
This memorandum analyzes the contract manufacturing agreement (the "CMA" or the "Agreement") between Penterra Biopharma International DAC ("PBI") and Penterra Manufacturing Ireland Ltd. ("PMI") for compliance with the arm's-length standard under the cost-plus method prescribed by Treasury Regulation § 1.482-3(d). This analysis is undertaken in connection with the ongoing examination by the Internal Revenue Service Large Business & International Division (Exam Team LB&I-NE-TP-2022-00641) of the federal income tax returns of Penterra Pharmaceuticals Corp. ("PPC") for taxable years 2017 through 2020.
PMI is a wholly owned subsidiary of PBI, itself a designated activity company organized under Irish law. PMI operates as a contract manufacturer of PPC's oncology and immunology biologics for non-Americas markets under a cost-plus arrangement with a markup of cost plus eight percent (cost + 8%). PMI performs routine manufacturing functions at its facility in Ringaskiddy, Co. Cork, Ireland, does not own any intangible property, bears only limited manufacturing execution risks, and operates exclusively under the direction of and to the specifications of PBI.
Conclusion. Based on our review of the Agreement's terms, PMI's functions performed, assets employed, and risks assumed, as well as available benchmarking data and industry comparables, the cost + 8% markup is defensible as falling within the arm's-length range under Internal Revenue Code ("IRC") § 482 and the applicable Treasury Regulations. The cost-plus method is the best method for evaluating PMI's manufacturing compensation, and the 8% markup is consistent with markups observed among comparable uncontrolled contract pharmaceutical manufacturers.
Relevance to the Broader Examination. While the IRS's primary challenges in the current examination target the cost-sharing arrangement ("CSA") cost-sharing ratios and legacy intellectual property royalty rates — totaling $380.4 million in proposed adjustments across the four taxable years under examination — the PMI contract manufacturing arrangement forms an integral part of the intercompany pricing ecosystem within the PPC group. The CMA supports PBI's characterization as a full-fledged IP-holding company and commercial principal with genuine economic substance in Ireland. A well-documented and defensible contract manufacturing arrangement with PMI reinforces the coherence of PPC's overall transfer pricing framework and provides affirmative evidence of PBI's substantive management and control over the non-Americas supply chain.
This memorandum addresses the legal framework, functional analysis, cost base composition, preliminary benchmarking considerations, the arrangement's relevance to the broader IRS examination defense, potential vulnerabilities, and our recommendations for next steps.
II. Background
A. Parties to the Agreement
The CMA is entered into between two Irish entities within the PPC group: PBI, as the buyer and commercial principal, and PMI, as the contract manufacturer. The relevant characteristics of each entity are summarized below.
Penterra Biopharma International DAC ("PBI"). PBI is a designated activity company organized under the laws of Ireland, with its registered office at 4th Floor, Claremont House, Sandyford Business Park, Dublin D18 K7T4, Ireland. PBI serves as the intellectual property holding company and commercial principal for the non-Americas commercialization of PPC's pharmaceutical products. PBI holds rights to PPC's intangible property for non-Americas territories under a cost-sharing arrangement entered into with PPC effective July 1, 2012.
For the fiscal year ended December 31, 2020, PBI reported revenue of approximately €2.14 billion and pre-tax income of approximately €1.06 billion. As of December 31, 2020, PBI employed 185 individuals, a substantial increase from the 52 employees at the time of its establishment in 2012. PBI's Managing Director is Aidan Naughton, who is resident in Ireland and reports to PPC's global executive leadership. PBI is subject to the standard Irish corporation tax rate of 12.5% on trading income, and claims the benefit of Ireland's Knowledge Development box regime (effective from fiscal year 2016 onward) at a rate of 6.25% on qualifying income attributable to qualifying intellectual property assets. PBI's Irish tax advisor is Thornbury & Keogh, Dublin, with Ciarán Thornbury serving as lead partner. PBI's principal Irish banking relationship is maintained with Glenmore Bank Ireland plc.
Penterra Manufacturing Ireland Ltd. ("PMI"). PMI is an Irish private limited company, registered with the Companies Registration Office under CRO Number 512347. Its registered office is located at Unit 7, Ringaskiddy Industrial Estate, Co. Cork T12 PX29, Ireland. PMI's sole function is the contract manufacture of PPC's oncology and immunology biologics for non-Americas markets, under the direction and to the specifications of PBI.
As of the most recent period under examination, PMI employs approximately 620 individuals at its Ringaskiddy facility. These employees are principally comprised of plant operators, quality control and quality assurance personnel, logistics and packaging staff, and plant-level management. PMI operates under the CMA with PBI and is compensated on a cost-plus basis, receiving a markup of 8% on its allowable cost base for manufacturing services rendered.
B. Corporate Ownership Structure
The corporate ownership structure relevant to the CMA is as follows:
• Penterra Pharmaceuticals Corp. ("PPC") is a Delaware corporation headquartered at 2200 Independence Boulevard, Princeton Junction, New Jersey 08550. PPC's common stock is listed on the Nasdaq Stock Market under the ticker symbol PPCA. PPC is the ultimate parent of the multinational group and the U.S. taxpayer whose returns are under examination.
• PPC is the 100% shareholder of Penterra Holdings Luxembourg S.à r.l. ("PHL"), a société à responsabilité limitée organized under Luxembourg law with its registered office at 14, rue Aldringen, L-1118 Luxembourg. PHL is treated as a disregarded entity for U.S. federal income tax purposes pursuant to Treasury Regulation § 301.7701-3.
• PHL is the 100% shareholder of Penterra Biopharma International DAC ("PBI"). Because PHL is disregarded for U.S. tax purposes, PBI is treated as directly owned by PPC for purposes of IRC § 482 and the controlled transaction analysis.
• Penterra Manufacturing Ireland Ltd. ("PMI") is a subsidiary of PBI. PMI is wholly owned, directly or indirectly, by PBI.
Both PBI and PMI are Irish-resident entities. Transactions between PBI and PMI are intercompany transactions between commonly controlled entities within the meaning of IRC § 482, as they are ultimately under common control of PPC. The U.S. federal income tax consequences of the CMA flow through PHL (as a disregarded entity) and are reflected on PPC's consolidated U.S. federal income tax return.
C. The Contract Manufacturing Agreement
The CMA was entered into effective concurrent with the establishment of PBI's commercial operations following the effective date of the cost-sharing arrangement on July 1, 2012. The principal terms and provisions of the Agreement are summarized below. A more detailed summary is attached hereto as Appendix A.
Scope of Manufacturing. Under the CMA, PMI manufactures biological pharmaceutical products exclusively for PBI's non-Americas distribution network. The products manufactured by PMI include PPC's flagship oncology biologics — most significantly, Veritaxol — as well as immunology products, including Imvara, and the rare disease therapeutic Cerulon. PMI manufactures these products to PBI's specifications and in accordance with current Good Manufacturing Practice ("cGMP") standards and regulatory requirements applicable in the territories served by PBI.
The key products manufactured by PMI and their approximate non-Americas net sales for fiscal year 2020 are as follows:
Compensation Structure. PMI is compensated under the cost-plus method. Specifically, PMI receives reimbursement for its allowable cost base plus a markup of 8%. The cost base is composed of direct manufacturing costs (including raw materials, active pharmaceutical ingredients, direct labor, and facility overhead directly attributable to production), indirect manufacturing costs (including facility costs such as rent, utilities, and maintenance, quality department overhead, and plant-level administrative costs), and certain allocated corporate service costs that are attributable to PMI's manufacturing function. The cost base composition and the application of the 8% markup are discussed in greater detail in Section V below.
Title and Risk. Title to manufactured goods passes from PMI to PBI upon completion of the manufacturing process, at which point the goods are held for PBI's account pending shipment instructions. PBI bears all inventory risk on finished goods from the point of title transfer, all market risk related to the sale and distribution of products in non-Americas territories, and all product liability risk arising from the commercial exploitation of the products. PMI's risk profile under the Agreement is limited to routine manufacturing execution risk, as discussed further in Section IV.C below.
intellectual Property. PMI does not own any intellectual property. All manufacturing know-how, process technology, formulations, and product-related IP is owned by PPC and/or licensed through the CSA/PBI IP structure. PMI manufactures to specifications provided by PBI and PPC and does not independently develop, enhance, maintain, protect, or exploit any intangible property. PMI's use of PPC's manufacturing processes and technology is authorized under the CMA and related intragroup arrangements, without separate royalty or license payment from PMI — the compensation for PMI's use of such processes is implicit in the cost-plus pricing structure.
Term and Termination. The Agreement has an indefinite term, subject to annual renewal and a 12-month advance written notice period for termination by either party. This arrangement provides operational continuity while preserving contractual flexibility consistent with arm's-length commercial arrangements.
III. Applicable Legal and Regulatory Framework
A. IRC § 482 — General Authority
Section 482 of the Internal Revenue Code grants the Secretary of the Treasury (and by delegation, the Commissioner of Internal Revenue) broad authority to distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among two or more organizations, trades, or businesses owned or controlled directly or indirectly by the same interests, if the Secretary determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades, or businesses.
The foundational principle underlying IRC § 482 is the arm's-length standard. Under Treasury Regulation § 1.482-1(b)(1), a controlled transaction meets the arm's-length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances. In determining whether a controlled transaction produces an arm's-length result, the standard of comparison is the results of transactions between unrelated parties dealing at arm's length. The regulations identify several specified methods for evaluating whether the results of controlled transactions satisfy this standard, including the comparable uncontrolled price method, the resale price method, the cost-plus method, the comparable profits method, and the profit split method. See Treas. Reg. §§ 1.482-3, 1.482-5, 1.482-6.
Importantly, Treasury Regulation § 1.482-1(d) articulates the "best method rule," which requires that the arm's-length result of a controlled transaction be determined under the method that, under the facts and circumstances, provides the most reliable measure of an arm's-length result. There is no strict priority or hierarchy among the specified methods; rather, the reliability of each method depends on the degree of comparability between the controlled transaction and uncontrolled comparables, and the quality of the data and assumptions used in the analysis. The best method rule is discussed further in Section III.C below.
B. Treas. Reg. § 1.482-3(d) — Cost-Plus Method
Treasury Regulation § 1.482-3(d) prescribes the cost-plus method as one of the specified methods for determining whether the amount charged in a controlled transaction involving the transfer of tangible property is consistent with the arm's-length standard. The cost-plus method evaluates the arm's-length character of a controlled transaction by reference to the gross profit markup earned on costs by the seller (or service provider) in the controlled transaction. The method compares the gross profit markup on costs earned by the controlled manufacturer to the markups earned by comparable uncontrolled manufacturers performing similar functions, employing similar assets, and bearing similar risks.
Under the cost-plus method, the gross profit markup is calculated as follows:
Gross Profit Markup = Gross Profit / Cost of Goods Sold
The arm's-length price is determined by adding an appropriate gross profit markup to the controlled manufacturer's costs of producing the goods. The gross profit markup is considered arm's length if it falls within the interquartile range of markups earned by comparable uncontrolled manufacturers identified through a comparability analysis.
The cost-plus method is most appropriately applied in circumstances where the controlled manufacturer performs manufacturing, production, or assembly functions using property or materials furnished by the buyer (or procured to the buyer's specifications), and where the manufacturer does not contribute significant intangible property to the controlled transaction. See Treas. Reg. § 1.482-3(d)(1). In such circumstances, the cost-plus method provides a direct measure of the manufacturing return that an unrelated party would earn for performing comparable functions.
The regulations identify several comparability factors that must be considered in selecting and evaluating comparable uncontrolled transactions for purposes of the cost-plus method. These factors include, but are not limited to:
(i) Functions performed by the controlled and uncontrolled manufacturers, including the nature and complexity of the manufacturing process;
(ii) Risks assumed by the parties, including product liability risk, inventory risk, capacity utilization risk, and manufacturing execution risk;
(iii) Assets employed, including tangible assets (plant, equipment) and intangible assets, as well as working capital requirements;
(iv) Contractual terms of the arrangement, including pricing, title transfer, risk allocation, and termination provisions;
(v) Economic conditions, including market conditions, geographic factors, and industry-specific considerations; and
(vi) The nature of the products manufactured and the level of manufacturing specialization required.
Under Treasury Regulation § 1.482-3(d)(2), the appropriate cost base for the cost-plus method includes the costs of producing the product — generally, cost of goods sold — and must be consistently determined between the controlled and uncontrolled transactions being compared. The regulations further require that the cost base be defined in a manner that captures all costs incurred in performing the manufacturing function being tested.
Where the controlled transaction falls within the interquartile range of comparable uncontrolled markups, the IRS generally will not make an allocation under IRC § 482. See Treas. Reg. § 1.482-1(e)(2)(iii)(B).
C. Treas. Reg. § 1.482-1(d) — Best Method Rule
As noted above, the best method rule under Treasury Regulation § 1.482-1(d) requires that the transfer pricing method selected for evaluating a controlled transaction be the method that provides the most reliable measure of the arm's-length result. The reliability of a method depends on two principal factors: (1) the degree of comparability between the controlled transaction and uncontrolled comparables, considering functional comparability, risk comparability, and contractual and economic conditions; and (2) the quality of the data and assumptions used in the analysis.
For PMI's contract manufacturing arrangement, the cost-plus method is the best method for the following reasons:
First, PMI is a routine contract manufacturer that performs manufacturing to PBI's specifications without contributing intangible property to the controlled transaction. The cost-plus method is specifically designed to test the arm's-length character of controlled transactions in which the tested party performs manufacturing or production functions without contributing significant intangibles, and in which the tested party's value contribution is principally in the form of manufacturing services applied to costs of production. See Treas. Reg. § 1.482-3(d)(1).
Second, the cost-plus method directly tests the manufacturing return (i.e., the gross profit markup on costs) earned by PMI, which is the most relevant profit level indicator for a limited-risk contract manufacturer. Alternative methods — such as the comparable profits method or the profit split method — would introduce additional complexity and potential sources of error without improving the reliability of the analysis.
Third, the cost-plus method is consistent with the economic substance of the CMA. PMI is compensated on a cost-plus basis under the Agreement, and the cost-plus method directly evaluates whether the contractual markup (8%) produces an arm's-length result. This alignment between the contractual pricing mechanism and the testing method enhances reliability.
Fourth, reliable data on comparable uncontrolled manufacturers' cost-plus markups in the pharmaceutical manufacturing sector is available through commercial databases and industry studies, providing a sound basis for comparability analysis.
For these reasons, the cost-plus method is the best method for evaluating the arm's-length character of PMI's manufacturing compensation under the CMA.
D. OECD Transfer Pricing Guidelines — Chapter II (Methods), Chapter I (Arm's-Length Principle)
Although the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations are not binding authority for purposes of U.S. federal income tax law, they are widely recognized as persuasive authority and are frequently referenced by the IRS, the U.S. Tax Court, and other tribunals in transfer pricing disputes. The OECD Guidelines articulate the arm's-length principle in terms substantially similar to those of the U.S. Treasury Regulations and provide detailed guidance on the application of transfer pricing methods, including the cost-plus method.
Chapter I of the OECD Guidelines sets forth the arm's-length principle as the international standard for determining transfer prices between associated enterprises. The arm's-length principle requires that conditions between associated enterprises in their commercial and financial relations be consistent with those that would be made between independent enterprises.
Chapter II of the OECD Guidelines discusses the application of transfer pricing methods, including the cost-plus method. The OECD Guidelines recognize the cost-plus method as appropriate for testing the arm's-length character of controlled manufacturing transactions, particularly in the context of contract or toll manufacturing arrangements where the manufacturer performs routine functions, does not contribute valuable intangibles, and does not bear significant entrepreneurial risks.
Of particular relevance to the present analysis is the OECD's DEMPE framework — that is, the framework for analyzing the functions of Development, Enhancement, Maintenance, Protection, and Exploitation of intangible property. Under the DEMPE framework, the returns attributable to intangible property should be allocated to the entity (or entities) that perform the DEMPE functions, control the risks associated with those functions, and bear the costs of those functions. In the PBI/PMI context, PMI performs a limited DEMPE function — specifically, manufacturing (which may relate to the "Maintenance" and "Enhancement" of product quality and supply, but only in a routine, non-entrepreneurial capacity). PBI, by contrast, controls the Development, Enhancement, Maintenance, Protection, and Exploitation of the group's intangible property for non-Americas markets. This functional allocation is consistent with PMI's characterization as a limited-risk contract manufacturer entitled to a routine return, with residual profits accruing to PBI as the IP owner and commercial principal.
The consistency between the U.S. regulatory framework and the OECD Guidelines supports the defensibility of the cost-plus method and the 8% markup under both U.S. and international transfer pricing principles.
IV. Functional Analysis of PMI
A thorough functional analysis of PMI — encompassing the functions it performs, the assets it employs, and the risks it assumes — is essential to its proper characterization under the transfer pricing regulations and to the determination of whether the cost + 8% markup produces an arm's-length result. The following analysis demonstrates that PMI is properly characterized as a limited-risk contract manufacturer, supporting the application of the cost-plus method with a routine manufacturing return.
A. Functions Performed
PMI's functions under the CMA are limited to routine contract manufacturing and related support activities. Specifically, PMI performs the following functions:
Manufacturing of Biological Pharmaceutical Products. PMI manufactures PPC's biologics at its facility at Ringaskiddy Industrial Estate, Co. Cork, Ireland. The principal products manufactured are oncology compounds, including Veritaxol; immunology products, including Imvara; and the rare disease therapeutic Cerulon. The manufacturing processes employed by PMI include fermentation, purification, and fill/finish operations, all of which are performed using processes and protocols developed by PPC and specified by PBI. PMI does not independently design, develop, or modify the manufacturing processes it employs; rather, PMI manufactures to PBI's specifications and in accordance with cGMP standards.
Quality Control and Quality Assurance. PMI maintains a quality control and quality assurance function at the Ringaskiddy facility, responsible for in-process testing, batch release testing, stability testing, and compliance with applicable regulatory standards. PMI's quality function operates in accordance with specifications, standard operating procedures, and quality manuals provided by PBI, and is subject to oversight by PBI's quality organization. PMI does not independently establish quality standards or specifications; it implements the standards established by PBI and PPC.
Packaging and Shipment Coordination. PMI performs packaging of finished goods in accordance with PBI's packaging specifications and coordinates the shipment of finished products to PBI's designated distribution points for non-Americas markets. PMI does not manage or control the downstream supply chain beyond the point of title transfer to PBI.
Routine Process Optimization. PMI performs routine process optimization activities within the parameters set by PPC and PBI. These activities include yield improvement efforts, equipment calibration and maintenance, and minor process adjustments to maintain or improve manufacturing efficiency. Importantly, these activities are conducted within the framework of processes and technologies developed and owned by PPC and do not constitute independent research and development or value-creating innovation.
Functions Not Performed by PMI. PMI does not perform any research and development functions. PMI does not engage in product development, formulation development, or clinical trials. PMI does not perform any commercial, marketing, sales, or distribution functions. PMI does not bear responsibility for regulatory submissions or regulatory strategy — all regulatory expenditures and submissions are the responsibility of PBI, which spent €47.2 million on a cumulative basis during the period 2017–2020 on regulatory activities. PMI does not participate in pricing decisions, market access strategies, or reimbursement negotiations.
Workforce. PMI employs approximately 620 individuals at the Ringaskiddy facility. These employees are primarily plant operators, quality control and quality assurance personnel, logistics and packaging staff, and plant-level management. The workforce composition is consistent with the labor-intensive nature of biologics manufacturing operations and does not indicate the performance of entrepreneurial, IP-creating, or strategic commercial functions.
B. Assets Employed
PMI employs the following assets in the performance of its manufacturing functions:
Manufacturing Facility. PMI's manufacturing operations are conducted at the Ringaskiddy Industrial Estate facility in Co. Cork, Ireland. The facility is held under a commercial lease arrangement and includes manufacturing suites, quality control laboratories, warehousing and logistics areas, and administrative offices. The facility is designed and equipped for the production of biological pharmaceutical products, including fermentation vessels, chromatography systems, ultrafiltration/diafiltration equipment, and fill/finish lines.
Specialized Biologic Manufacturing Equipment. PMI employs specialized equipment for the manufacture of biologics, including fermentation and cell culture systems, purification trains (protein A chromatography, ion exchange chromatography, viral inactivation and filtration), and aseptic fill/finish lines. This equipment represents a significant investment and is necessary for the scale and complexity of biologics manufacturing. However, the equipment is operated using processes and technology owned by PPC and licensed through the PBI/CSA structure; PMI does not own the intellectual property embodied in its manufacturing processes.
Working Capital. PMI maintains working capital in the form of inventories of raw materials and work-in-progress necessary for ongoing manufacturing operations. Finished goods inventory is not a significant asset of PMI, as title to finished goods transfers to PBI upon completion of manufacturing.
Intangible Property. PMI does not own any intangible property. All manufacturing processes, formulations, product-related know-how, trade secrets, patents, trademarks, and other intellectual property are owned by PPC and/or licensed through the CSA/PBI IP structure. PMI's manufacturing activities are entirely dependent on intellectual property owned by other group entities.
C. Risks Assumed
PMI's risk profile under the CMA is deliberately limited, consistent with its characterization as a contract manufacturer operating under the direction and control of PBI.
Risks Not Borne by PMI. PMI does not bear market risk — all production is undertaken pursuant to the CMA for PBI, and PMI does not independently seek customers or face demand uncertainty. PMI does not bear inventory risk on finished goods, as title to finished products passes to PBI upon completion of manufacturing. PMI does not bear product liability risk, which is assumed by PBI as the commercial principal for non-Americas territories. PMI does not bear foreign exchange risk on product sales, as it is compensated in euros on a cost-plus basis regardless of the currencies in which PBI's customers remit payment.
Risks Borne by PMI. PMI bears routine manufacturing execution risk, including the risk of plant downtime, equipment failure, yield variations, and batch failures. These risks are inherent in any manufacturing operation and are appropriately compensated through the cost-plus markup. PMI bears labor cost risk, including the risk of changes in wage rates, benefits costs, and workforce availability in the Irish labor market. PMI bears operational compliance risk — the risk that its manufacturing operations may fail to meet applicable regulatory standards, resulting in remediation costs, production delays, or regulatory action.
Capacity Utilization Risk. PMI's capacity utilization risk is limited by the long-term nature of the CMA and the dedicated character of PMI's manufacturing operations for PBI. While PMI could theoretically face periods of underutilization if PBI's demand for manufactured products were to decline, the indefinite term of the CMA, the ongoing commercial success of Veritaxol, Imvara, and Cerulon in non-Americas markets, and PBI's historical production volume commitments substantially mitigate this risk during the periods under examination.
D. Characterization. Based on the foregoing functional analysis, PMI is properly characterized as a contract manufacturer — also referred to in transfer pricing literature as a "toll manufacturer" or "limited-risk manufacturer" — that performs routine manufacturing functions, employs tangible manufacturing assets but no intangible property, and bears only limited manufacturing execution risks. PMI does not contribute significant intangible property to the controlled transaction, does not bear significant entrepreneurial or market risks, and operates under the direction and control of PBI.
This characterization is critical to the transfer pricing analysis because it determines the appropriate method for evaluating the arm's-length character of PMI's compensation, the relevant comparables, and the expected range of returns. As a limited-risk contract manufacturer, PMI is entitled to a routine return commensurate with its limited functions, assets, and risks. The residual profits attributable to the group's intangible property, market risk-bearing, and commercial activities should accrue to PBI as the IP owner and commercial principal. The cost-plus method, with an appropriate markup, is the most reliable method for determining PMI's arm's-length compensation.
V. Analysis of the Cost + 8% Markup
A. Description of the Cost Base
The cost base to which the 8% markup is applied under the CMA is composed of the following categories of costs incurred by PMI in the performance of its manufacturing functions:
Direct Costs. PMI's direct costs include raw materials, active pharmaceutical ingredients ("APIs"), direct manufacturing labor, and manufacturing overhead directly attributable to the production of finished goods. These costs represent the most significant component of PMI's total cost base and are directly traceable to specific production batches and product lines.
Indirect Costs. PMI's indirect costs include facility costs (rent, utilities, maintenance, depreciation of leasehold improvements), quality department overhead, plant-level administrative costs, and other costs that are not directly traceable to specific production batches but are necessary for the overall operation of the Ringaskiddy manufacturing facility. Indirect costs are allocated to products based on reasonable allocation methodologies (e.g., production volume, labor hours, or floor space, as appropriate).
Allocated Corporate Service Costs. Certain corporate service costs that are attributable to PMI's manufacturing function — such as IT support, human resources services, and general administrative services provided by other group entities — are allocated to PMI and included in the cost base. These allocated costs are determined in accordance with applicable intercompany service agreements and reflect the actual cost of services consumed by PMI.
Exclusions from the Cost Base. The cost base does not include PBI's royalty payments (to the extent PBI pays royalties under the CSA or other intercompany IP license arrangements), PBI's selling, general, and administrative expenses ("SG&A"), or any costs attributable to functions not performed by PMI (e.g., research and development, regulatory activities, marketing, or commercial functions). The exclusion of these costs from PMI's cost base is appropriate because PMI does not perform these functions, and the cost-plus method is intended to compensate PMI for the costs it actually incurs in performing its manufacturing function.
Regulatory Compliance. It is important to verify that the composition of PMI's cost base is consistent with the requirements of Treasury Regulation § 1.482-3(d)(2), which requires that the appropriate cost base for the cost-plus method include the costs incurred by the controlled manufacturer in producing the goods. We recommend that PMI's cost accounting practices and cost base definition be reviewed on a year-by-year basis for the periods under examination (2017–2020) to confirm consistency and completeness, and to ensure that no material cost items have been improperly included or excluded from the cost base.
B. Comparability Analysis — Preliminary Benchmarking Considerations
The arm's-length character of PMI's 8% markup must be evaluated by reference to the markups earned by comparable uncontrolled manufacturers — that is, independent companies performing comparable manufacturing functions, employing comparable assets, and bearing comparable risks under comparable contractual and economic conditions.
Comparable Markups for Contract Pharmaceutical Manufacturers. Based on publicly available data and our preliminary review of industry benchmarks, gross profit markups for contract manufacturers in the pharmaceutical and biologic manufacturing sector typically fall within a range of approximately 5% to 15% on total costs. This range reflects the variation in manufacturing complexity, scale, risk profile, geographic location, and the degree of specialization of the manufacturing function. At the lower end of the range are contract manufacturers performing relatively simple, high-volume manufacturing with minimal specialization. At the higher end are manufacturers performing complex manufacturing operations (such as biologics fill/finish or sterile manufacturing) with greater capital intensity and higher quality requirements.
PMI's Position Within the Range. PMI's 8% markup falls in the middle of the commonly observed range for limited-risk contract manufacturers in the pharmaceutical industry. This positioning is consistent with PMI's functional profile: PMI performs complex biologics manufacturing (which would tend to justify a markup toward the middle or upper portion of the range) but bears only limited risks and does not contribute intangible property (which would tend to constrain the markup toward the lower or middle portion of the range). The net result is that an 8% markup is reasonable and consistent with market practice.
Comparability Adjustments. Any formal benchmarking analysis will need to consider potential comparability adjustments to account for differences between PMI and the identified comparables. Key factors for adjustment consideration include:
(i) Geographic location. PMI is located in Ireland, which offers competitive labor costs and favorable infrastructure for pharmaceutical manufacturing relative to certain other jurisdictions (e.g., the United States, Switzerland, or Germany), but higher costs relative to certain emerging-market manufacturing locations (e.g., India or China).
(ii) Nature of biologics manufacturing. Biologics manufacturing — including fermentation, purification, and aseptic fill/finish — is inherently more complex and capital-intensive than small-molecule chemical synthesis or tablet manufacturing. Comparable markups for biologics manufacturers may be higher than those for manufacturers of simpler pharmaceutical dosage forms.
(iii) Scale of operations. PMI's 620-employee workforce and dedicated facility represent a substantial manufacturing operation. The scale of PMI's operations may provide cost efficiencies (economies of scale) or may require a higher absolute level of manufacturing infrastructure, both of which may affect comparability.
(iv) Dedicated vs. multi-client operations. PMI is a dedicated contract manufacturer serving a single principal (PBI). Many publicly available comparables are multi-client contract manufacturing organizations ("CMOs") that serve multiple pharmaceutical companies. Dedicated contract manufacturers may differ from multi-client CMOs in terms of capacity utilization risk, customer concentration risk, and the degree of operational flexibility. Adjustments may be necessary to account for these differences.
Engagement of Whitmore Valuation Group LLC. To support the formal benchmarking analysis, we have retained Whitmore Valuation Group LLC ("Whitmore") under a Kovel arrangement (Reference 1018-00009-KV, executed June 20, 2022). The engagement team at Whitmore is led by Dr. Helena Vasquez, Lead Economist, with support from Dr. Rohan Chakrabarti. Whitmore will conduct a comprehensive benchmarking study using standard commercial databases to identify comparable uncontrolled contract pharmaceutical manufacturers and to determine the interquartile range of gross profit markups on costs earned by such comparables. The results of Whitmore's benchmarking study will provide the quantitative foundation for confirming that PMI's 8% markup is within the arm's-length range.
C. Internal Comparables
Internal comparable uncontrolled transactions ("CUTs") are generally considered the most reliable form of comparable for transfer pricing purposes because they arise from transactions involving the same or similar products, functions, and risks, and because the taxpayer has detailed information regarding the terms and conditions of such transactions.
In the present case, however, internal CUTs are not available. The PPC group does not maintain uncontrolled manufacturing arrangements with third-party contract manufacturers for the same products (Veritaxol, Imvara, Cerulon) in non-Americas markets. PMI is the sole contract manufacturer for PBI's non-Americas biologics supply chain. PPC's U.S. manufacturing operations produce products for the Americas markets and are conducted through PPC's own facilities, not through arm's-length contract manufacturing arrangements.
The absence of internal CUTs does not preclude the application of the cost-plus method. The Treasury Regulations recognize that external comparables may be used where internal comparables are not available, provided that appropriate comparability adjustments are made. See Treas. Reg. § 1.482-3(d)(3). The external comparable search discussed below is designed to identify appropriate comparables for PMI's manufacturing function.
D. External Comparable Search
We recommend that Whitmore Valuation Group conduct a formal external benchmarking search for comparable contract pharmaceutical manufacturers to support the arm's-length character of PMI's 8% markup. The search should employ the following methodology:
Database Selection. The search should utilize standard commercial databases commonly accepted by the IRS and by the U.S. Tax Court for transfer pricing benchmarking purposes, including Bureau van Dijk's Orbis database, Drayton Services Inc., and other available databases containing financial data on global pharmaceutical manufacturers.
Search Criteria. The search criteria should be designed to identify companies with functional profiles comparable to PMI's. Recommended search criteria include:
(i) Industry classification. Companies classified under SIC codes 2833–2836 (pharmaceutical preparations, biological products) and/or NAICS codes 325411–325414 (pharmaceutical and medicine manufacturing, biological product manufacturing).
(ii) Functional profile. Companies that perform contract manufacturing functions without owning significant intangible property. The search should exclude companies that are integrated pharmaceutical manufacturers (i.e., companies that perform R&D, marketing, and distribution in addition to manufacturing), as such companies bear substantially different risks and perform substantially different functions than PMI.
(iii) Remuneration model. Companies that are compensated on a cost-plus or similar remuneration basis, or for which financial data is available to compute gross profit markups on cost of goods sold.
(iv) Geographic scope. The search should consider companies operating in OECD jurisdictions, with a preference for European-based manufacturers given PMI's Irish location.
(v) Financial data availability. Companies for which at least three years of financial data are available for the benchmark period (2017–2020) to permit multi-year averaging and to account for business cycle effects.
Preliminary Assessment. Based on our preliminary assessment of publicly available data and prior transfer pricing studies in the pharmaceutical manufacturing sector, we are confident that the 8% markup is within an acceptable arm's-length range. The formal benchmarking analysis to be performed by Whitmore will provide the quantitative support necessary to confirm this preliminary assessment and to establish the interquartile range of comparable markups.
E. Consistency with CPM/TNMM Analysis
The PMI cost-plus analysis should be evaluated in the context of the broader transfer pricing analysis being prepared for the PPC group. Whitmore Valuation Group is currently preparing a comprehensive comparable profits method ("CPM") / transactional net margin method ("TNMM") analysis for PBI, which tests PBI's operating margins against a set of 22 comparable distributors and IP-holding companies identified through a formal benchmarking search.
The PMI cost-plus arrangement and the PBI CPM/TNMM analysis are complementary components of the overall transfer pricing framework. Specifically, the residual profit remaining after compensating PMI at cost + 8% should accrue to PBI as the IP owner and risk-bearing commercial principal. If the 8% markup assigned to PMI is arm's length, the resulting allocation of residual profit to PBI should be consistent with PBI's economic substance, its DEMPE functions, and the returns earned by comparable IP-holding and commercial principal entities.
It is important that the results of the PMI cost-plus analysis and the PBI CPM/TNMM analysis be internally consistent — that is, the aggregate intercompany pricing framework should produce a coherent allocation of profits among the group entities that reflects the respective functions performed, assets employed, and risks assumed by each entity. Any inconsistency between the two analyses could undermine the overall credibility of the transfer pricing framework in the context of the IRS examination.
VI. Relevance to IRS Examination Defense
A. Supporting PBI's Economic Substance
The PMI contract manufacturing arrangement is a critical piece of evidence supporting PBI's characterization as a full-fledged IP owner and commercial principal with genuine economic substance in Ireland. The IRS examination has focused significant attention on whether PBI possesses the substance, personnel, and decision-making authority necessary to justify the allocation of IP-related returns to PBI. The CMA and PBI's management of the manufacturing relationship with PMI are directly relevant to this inquiry.
PBI contracts with PMI for the manufacture of all biologics products sold in non-Americas markets. PBI manages the supply chain for these territories, including issuing purchase orders to PMI, setting manufacturing specifications and quality standards, approving batch releases, scheduling production to meet commercial demand forecasts, and overseeing the logistics of finished goods distribution. This supply chain management function is documented through PBI's internal records, including board minutes from 42 meetings held between 2017 and 2020, all of which were convened in Dublin. PBI's supply chain management personnel, based in Ireland, exercise day-to-day oversight of the PMI manufacturing relationship, providing affirmative evidence that PBI performs substantive functions in connection with the exploitation and maintenance of the group's intangible property for non-Americas markets.
In this context, the CMA is not merely a transfer pricing arrangement — it is an integral component of PBI's operational framework and a tangible demonstration of the economic substance of PBI's Irish operations.
B. Interaction with CSA Cost-Sharing Adjustments
The IRS's most significant proposed adjustment in the current examination relates to the cost-sharing arrangement between PPC and PBI. The IRS has proposed adjustments to the CSA cost-sharing ratios totaling $235.01 million across the 2017–2020 tax years. These proposed adjustments, if sustained, would reallocate a portion of the IP-related returns from PBI to PPC, increasing PPC's U.S. taxable income.
The PMI manufacturing return, however, should be unaffected by any CSA adjustment. PMI is a cost-plus manufacturer whose return is determined by reference to its cost base and the 8% markup, without regard to the allocation of IP income between the CSA participants (PPC and PBI). Whether the IRS's proposed CSA adjustments are sustained, partially sustained, or reversed, PMI's manufacturing compensation remains the same — cost plus 8%.
It bears noting that the IRS has not separately challenged the PMI cost + 8% markup in the Notice of Proposed Adjustment ("NOPA") dated October 12, 2023. This is consistent with our assessment that the 8% markup is within the arm's-length range and does not present a separate basis for adjustment. Nevertheless, a well-supported PMI arrangement strengthens the overall coherence of PPC's intercompany pricing framework and reduces the risk that the IRS may revisit the PMI arrangement in subsequent examination cycles or in the context of Appeals proceedings.
C. Interaction with Royalty Rate Adjustments
The IRS's second major proposed adjustment targets the royalty rate on legacy compound net sales. The IRS proposes to increase the royalty rate from 4.5% to 11.0%, resulting in a proposed adjustment of $188.04 million across the 2017–2020 tax years. This adjustment, if sustained, would increase PPC's U.S. taxable income by increasing the deemed royalty payments from PBI to PPC for the use of pre-CSA legacy intangible property.
The royalty rate adjustment does not directly affect PMI's compensation under the CMA. PMI is compensated at cost plus 8% regardless of the royalty rate applied to PBI's sales. However, the royalty rate adjustment may indirectly affect the overall profitability allocation within the non-Americas value chain. To the extent that a higher royalty rate reduces PBI's residual profit, the consistency of the overall pricing framework may be affected. We should ensure that the PMI cost-plus analysis and the PBI profitability analysis are updated to reflect any changes in the royalty rate assumption, so that the overall framework remains internally consistent.
Regardless of the royalty rate outcome, PMI's limited-risk, cost-plus return remains the appropriate arm's-length compensation for its routine manufacturing functions. The characterization of PMI's functions, assets, and risks does not change based on the allocation of IP returns between PPC and PBI.
D. Penalty Protection Considerations
PPC maintained contemporaneous transfer pricing documentation for all four taxable years under examination (2017–2020), prepared by Crestfield & Associates LLP. The engagement was led by Martin Ogilvy, Engagement Partner, and Susan Lam, Transfer Pricing Partner. The contemporaneous documentation covers the PMI manufacturing arrangement, including a description of the cost-plus methodology, the composition of the cost base, PMI's functional profile, and the arm's-length justification for the 8% markup.
The maintenance of contemporaneous documentation that describes and substantiates the PMI cost-plus methodology supports PPC's reasonable-cause defense under IRC § 6662(e)(3)(B). Under Section 6662(e), a substantial valuation misstatement penalty may be imposed on the portion of an underpayment attributable to a transfer pricing adjustment. However, the penalty may be avoided if the taxpayer establishes that it acted with reasonable cause and in good faith, and that it maintained contemporaneous documentation that satisfies the requirements of Treasury Regulation § 1.6662-6(d). PPC's transfer pricing documentation, which includes the PMI cost-plus analysis, is designed to meet these requirements.
The IRS has proposed penalties of $15.98 million, representing 20% of the tax attributable to the $380.4 million in proposed adjustments. Although the IRS has not separately targeted the PMI arrangement for adjustment, a well-documented and defensible PMI cost-plus analysis strengthens the overall penalty protection argument. It demonstrates that PPC employed reasonable transfer pricing methodologies across the entirety of its intercompany pricing framework, including the contract manufacturing arrangement, and that PPC acted in good faith in establishing and maintaining its intercompany pricing.
VII. Potential Vulnerabilities and Risk Assessment
While we believe that the cost + 8% markup is defensible under the arm's-length standard, we identify the following potential vulnerabilities and associated risk factors that should be addressed in preparing the examination defense.
A. Cost Base Definition
There is a risk that the IRS could challenge the composition of PMI's cost base, arguing that certain cost items should be included in, or excluded from, the cost base. For example, the IRS could argue that certain allocated corporate service costs should not be included in the cost base (on the theory that they are duplicative of charges under separate intercompany service agreements) or that certain costs incurred by PBI on behalf of PMI should be included in PMI's cost base (on the theory that they represent costs of manufacturing functions performed by PMI). Any change in the composition of the cost base would change the effective markup percentage, even if the nominal 8% rate remained unchanged.
Recommendation. We recommend that the cost base definition be reviewed and confirmed for consistency across all four taxable years under examination (2017–2020). The review should confirm that the cost base includes all costs required to be included under Treasury Regulation § 1.482-3(d)(2) — specifically, all costs of producing the goods, including direct materials, direct labor, and applicable overhead — and that no material cost items have been improperly included or excluded. Particular attention should be paid to (i) the treatment of corporate service cost allocations, (ii) the treatment of idle capacity costs, and (iii) any year-over-year changes in cost accounting methodologies.
B. 620-Employee Workforce
PMI's workforce of approximately 620 employees represents a significant headcount by the standards of contract manufacturing arrangements. It is possible that the IRS could argue that the size of PMI's workforce indicates that PMI performs more than routine contract manufacturing functions — for example, that PMI performs substantial process development, quality innovation, or other value-creating functions that would warrant a higher characterization and a different transfer pricing analysis.
Counter-argument. Biologics manufacturing is inherently labor-intensive. The production of monoclonal antibodies, recombinant proteins, and other biologic therapies requires large numbers of skilled operators, quality control technicians, quality assurance professionals, and support personnel. PMI's headcount of 620 employees is consistent with the scale of its manufacturing operations — producing three major products (Veritaxol, Imvara, and Cerulon) for all non-Americas markets — and does not, in itself, indicate that PMI performs entrepreneurial, IP-creating, or strategic commercial functions. Moreover, an examination of PMI's employee roster and job descriptions will confirm that the vast majority of PMI's employees are engaged in production operations, quality testing, packaging, logistics, and plant maintenance — all of which are routine manufacturing functions.
The appropriate inquiry is not the absolute size of PMI's workforce but rather the nature and character of the functions performed by that workforce. A large workforce performing routine manufacturing functions is functionally indistinguishable from a smaller workforce performing the same functions on a smaller scale, and should receive the same type of arm's-length return — a routine cost-plus markup.
C. Manufacturing Complexity
Biologic pharmaceutical manufacturing — including cell culture fermentation, multi-step purification, viral clearance, and aseptic fill/finish — is considerably more complex than small-molecule chemical synthesis or traditional pharmaceutical tableting and packaging. This complexity is reflected in the capital intensity of biologics manufacturing facilities, the stringent regulatory requirements (including FDA and EMA cGMP standards), the specialized workforce required, and the lower batch-to-batch consistency compared to small-molecule manufacturing.
The manufacturing complexity factor could be raised by either party. The IRS could argue that PMI's complex manufacturing operations warrant a higher characterization (and potentially a different transfer pricing method or a higher tested markup). Alternatively, PPC could argue that the complexity of PMI's manufacturing supports a higher cost-plus markup, which would increase PMI's manufacturing cost and reduce PBI's residual profit — potentially benefiting PPC's U.S. tax position by increasing the deductible cost of goods for PBI.
Assessment. The 8% markup is moderate and appropriately accounts for the higher complexity of biologics manufacturing relative to simpler pharmaceutical manufacturing. Industry benchmarks for biologics contract manufacturers generally show markups in the middle to upper portion of the 5%–15% range. The 8% markup is consistent with this positioning. If anything, the complexity factor supports a markup at or slightly above 8%, which would marginally benefit PPC by increasing the manufacturing cost deduction for PBI. We do not view the complexity issue as a significant vulnerability, but it should be addressed in the benchmarking analysis to ensure that the selected comparables include companies performing manufacturing of comparable complexity.
D. Lack of Internal CUTs
As discussed in Section V.C above, the PPC group does not have uncontrolled manufacturing arrangements with third parties for the same products in non-Americas markets. The absence of internal CUTs means that the comparability analysis must rely entirely on external comparables, which generally provide a less reliable basis for comparison than internal CUTs because they involve different products, different companies, and potentially different economic conditions.
Mitigation. The absence of internal CUTs is a common feature of transfer pricing analyses for large multinational groups with vertically integrated supply chains. The Treasury Regulations expressly contemplate the use of external comparables where internal comparables are not available. See Treas. Reg. § 1.482-3(d)(3). The formal benchmarking analysis to be performed by Whitmore Valuation Group will identify external comparables with functional profiles as similar as practicable to PMI's profile, and will apply appropriate comparability adjustments to account for any material differences. We are confident that a robust external benchmarking analysis will adequately support the 8% markup.
VIII. Recommendations
Based on the foregoing analysis, we make the following recommendations:
1. Formal Benchmarking Study. We recommend that Whitmore Valuation Group LLC include a formal benchmarking study of PMI's cost + 8% markup in their overall economic analysis supporting PPC's examination defense. Although the IRS has not directly challenged the PMI manufacturing arrangement in the NOPA, proactive documentation of the arm's-length character of the PMI markup strengthens the overall defense posture and reduces the risk that the IRS may seek to challenge the arrangement at a later stage of the examination or in Appeals. Dr. Helena Vasquez and Dr. Rohan Chakrabarti should be instructed to include PMI in the scope of their engagement, and the benchmarking study should identify a set of comparable contract pharmaceutical manufacturers and determine the interquartile range of gross profit markups on costs.
2. Contemporaneous Documentation Review. We recommend that the contemporaneous transfer pricing documentation prepared by Crestfield & Associates LLP (Martin Ogilvy, Engagement Partner; Susan Lam, Transfer Pricing Partner) for taxable years 2017–2020 be reviewed to ensure that it adequately describes the PMI arrangement, the cost base composition, the functional analysis of PMI, and the arm's-length justification for the 8% markup. Any gaps or deficiencies in the documentation should be identified and addressed, within the bounds of applicable regulations regarding contemporaneous documentation.
3. IDR Response Strategy. In responding to Information Document Requests from the IRS (47 IDRs issued between June 2022 and September 2023), we recommend that the PMI arrangement be presented as evidence of PBI's substantive control over the non-Americas supply chain. Specifically, IDR responses should highlight PBI's management of the PMI manufacturing relationship — including purchase order issuance, quality oversight, production scheduling, and supply chain coordination — as affirmative evidence of PBI's economic substance and DEMPE functions in Ireland.
4. Coordination with Irish Tax Advisors. We recommend coordination with Thornbury & Keogh (Ciarán Thornbury, Lead Partner; 22 Fitzwilliam Square, Dublin 2, D02 YH68, Ireland) to ensure consistency between the U.S. and Irish transfer pricing positions for the PMI arrangement. Any inconsistency between the U.S. and Irish positions could undermine the credibility of PPC's transfer pricing framework and could create exposure to double taxation or competent authority disputes. Thornbury & Keogh should confirm that the Irish Revenue Commissioners' transfer pricing documentation requirements are being satisfied and that the cost + 8% markup is consistent with Irish transfer pricing rules.
5. Formal Protest and Appeals. For the formal Protest to be filed with the IRS (deadline extended to December 22, 2023) and for any subsequent Appeals proceedings, we recommend that the PMI arrangement

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