1032-00006 · Halcyon Semiconductor Inc · Intercompany Agreements

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PRIVILEGED AND CONFIDENTIAL ATTORNEY WORK PRODUCT

MEMORANDUM

June 12, 2025

TO: Leonard Cross, Partner, Tax, Calderwood & Harkness LLP Sylvia Hartwell, Partner, Tax, Calderwood & Harkness LLP

FROM: Leila Nazari, Senior Associate, Tax, Calderwood & Harkness LLP Robert Jansen, Associate, Tax, Calderwood & Harkness LLP

RE: Review of Existing Intercompany Agreements Between Halcyon Semiconductor AG and Halcyon Semiconductor Inc. — Consistency with Proposed Transfer Pricing Policies and Bilateral APA Positions

Matter Number: 1032-00006

Billing Code: HSAG-TP-2025

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I. Executive Summary

This memorandum presents our analysis of the three principal intercompany agreements governing the controlled transactions between Halcyon Semiconductor AG ("HSAG") and its wholly owned US subsidiary, Halcyon Semiconductor Inc. ("HSI"). The purpose of this review is to assess the consistency of those agreements with (a) the proposed transfer pricing methods set forth in the bilateral Advance Pricing Agreement ("APA") application to be filed with the IRS Advance Pricing and Mutual Agreement Program ("APMA") (target filing date: July 7, 2025) and in parallel with the German Bundeszentralamt für Steuern ("BZSt") (target filing date: August 15, 2025), and (b) the contemporaneous transfer pricing documentation prepared for fiscal years 2022 through 2024.

The three agreements reviewed are as follows:

1. Master Intercompany Supply Agreement ("MISA") — effective January 1, 2019, as amended by the First Amendment effective July 1, 2022;

2. IP License Agreement ("IPLA") — effective January 1, 2019; and

3. Cost Sharing Arrangement ("CSA") — effective July 15, 2018, including the associated Platform Contribution Transaction agreement.

Overall Conclusion. Each agreement contains provisions that are broadly consistent with the group's intercompany transfer pricing framework. However, several specific clauses require amendment to align with the APA-proposed methodologies, arm's-length ranges, and compliance mechanics. Without amendment, there is a material risk that the IRS APMA and/or the BZSt may view the contractual terms as inconsistent with the APA commitments, potentially jeopardizing the bilateral APA or creating penalty exposure under IRC §§ 6662(e) and 6662(h) (substantial and gross valuation misstatement penalties). On the German side, inadequate contractual documentation could expose the group to risks under §§ 162(3) and 162(4) AO, which permit the tax authorities to estimate income and shift the burden of proof to the taxpayer.

The following table summarizes our key findings and recommended amendments, cross-referenced to the detailed discussion in Sections III through VI below:

We recommend that amended agreements be prepared now, in parallel with the APA application filings, but that execution be held pending the conclusion of the bilateral APA in order to avoid premature commitment to terms that may be modified during the competent authority negotiation process. The substantive terms of the draft amendments should, however, be provided to both competent authorities as part of the APA documentation package.

II. Background and Scope of Review

A. Engagement Context

Calderwood & Harkness LLP was engaged by HSAG and HSI to advise on and secure a bilateral APA between the IRS and the BZSt pursuant to the mutual agreement procedure ("MAP") under Article 25 of the Convention between the United States of America and the Federal Republic of Germany for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital and to Certain Other Taxes (signed June 29, 2006) (the "US-Germany Treaty"), as well as the domestic APA procedures set forth in Revenue Procedure 2015-41. The engagement letter was executed on March 10, 2025, and the engagement was formally opened in the firm's matter management system on February 3, 2025, under Matter Number 1032-00006.

The proposed APA term encompasses five prospective tax years, from January 1, 2025, through December 31, 2029, plus a rollback to cover three prior tax years, from January 1, 2022, through December 31, 2024, for a total covered period of eight tax years. The rollback is being sought in order to provide certainty with respect to the transfer pricing positions taken on the filed (and in some cases amended) US and German returns for the FY 2022–2024 period.

The aggregate annual intercompany flows between HSAG and HSI for FY 2024 totaled approximately €1,280,600,000, composed of the following principal categories:

• Tangible goods (semiconductor wafers and singulated die): €987,600,000 (approximately $1,076,000,000 at the average 2024 EUR/USD rate of 1.0896);

• Royalty payments under the IPLA: €68,400,000 (approximately $70,500,000); and

• Cost-sharing contributions under the CSA: €224,600,000 (approximately $231,300,000).

These flows represent a substantial portion of the global intercompany transactions within the Halcyon Semiconductor group and constitute the principal covered transactions under the proposed bilateral APA.

B. Applicable Legal Standards

The following legal standards and regulatory authorities are relevant to our analysis:

United States. Under IRC § 482, the Secretary of the Treasury is authorized to distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among 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 arm's-length standard—requiring that controlled transactions reflect terms that would be agreed upon by unrelated parties dealing at arm's length—is the fundamental principle governing the application of § 482 and its implementing regulations.

The Treasury Regulations under § 482, specifically Treas. Reg. §§ 1.482-1 through 1.482-9, provide detailed guidance on the methods for determining arm's-length prices for various categories of controlled transactions, including transfers of tangible property (Treas. Reg. § 1.482-3), transfers of intangible property (Treas. Reg. § 1.482-4), services (Treas. Reg. § 1.482-9), and cost sharing arrangements (Treas. Reg. § 1.482-7).

Critically for this review, Treas. Reg. § 1.482-1(d)(3)(ii)(B) provides that the contractual terms of a controlled transaction will be respected only if they are consistent with the economic substance of the transaction. Where the terms of a written contract differ from the actual conduct of the parties, the IRS may disregard the contractual terms and re-characterize the transaction based on the parties' actual behavior. This principle underscores the importance of ensuring that the intercompany agreements accurately reflect the economic reality of the HSAG-HSI relationship, particularly as described in the functional analysis memoranda prepared for the APA application.

Penalty provisions under IRC §§ 6662(e) and 6662(h) impose a 20% penalty for substantial valuation misstatements and a 40% penalty for gross valuation misstatements in the transfer pricing context. Treas. Reg. § 1.6662-6 provides that the penalty may be avoided if the taxpayer demonstrates reasonable cause and good faith, including through the maintenance of contemporaneous transfer pricing documentation meeting specified requirements. Inconsistencies between the intercompany agreements and the transfer pricing documentation could undermine a reasonable cause defense.

Revenue Procedure 2015-41 governs the IRS APA program. Section 4.05 of the Revenue Procedure requires that APA applications describe the intercompany agreements governing the covered transactions, including the pricing mechanisms, adjustment provisions, and other material terms. Section 7 requires annual compliance reports demonstrating that the taxpayer has adhered to the APA terms during each covered year. These compliance requirements necessitate that the intercompany agreements contain mechanisms (such as year-end true-up provisions) that permit the taxpayer to implement the APA-agreed pricing methodology on an annual basis.

Germany. Under § 1 of the Außensteuergesetz ("AStG"), the German tax authorities may adjust the income of a German taxpayer if the terms of a controlled transaction deviate from those that arm's-length parties would have agreed upon. Sections 90(3) and 162(3)–(4) of the Abgabenordnung ("AO") impose documentation requirements and authorize the tax authorities to estimate income (with a corresponding shift of the burden of proof to the taxpayer) where the taxpayer fails to maintain adequate contemporaneous transfer pricing documentation. The Gewinnabgrenzungsaufzeichnungsverordnung ("GAufzV") specifies the content and format of the required documentation, including the requirement that intercompany agreements be documented in writing and reflect arm's-length terms.

OECD. The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2022 edition) provide authoritative guidance on the delineation of the actual controlled transaction based on the contractual terms between the parties and the actual conduct of the parties (Chapter I, paragraphs 1.42–1.130). The OECD Guidelines emphasize that the written contract is the starting point for the delineation analysis, but that the economic substance of the transaction, as reflected in the functions performed, assets used, and risks assumed by each party, must be consistent with the contractual terms.

C. Parties to the Agreements

Halcyon Semiconductor AG (HSAG). HSAG is an Aktiengesellschaft organized under the laws of the Federal Republic of Germany, with its registered office at Halcyon-Allee 12, 01099 Dresden, Saxony, Germany. HSAG's tax identification number (Steuernummer) is 203/118/04527, and its VAT identification number is DE 814 723 956. HSAG operates semiconductor fabrication facilities at two locations in Germany: (i) Fab 1 and Fab 2, located at Industriepark Klotzsche, Zur Wetterwarte 50, 01109 Dresden, which together represent the group's primary 300mm advanced-logic wafer fabrication complex; and (ii) Fab 3, located at Technologiepark Chemnitz, Annaberger Straße 240, 09125 Chemnitz, which produces specialty and analog semiconductor products.

For FY 2024, HSAG reported consolidated revenue of €8,740,000,000, EBITDA of €2,620,000,000 (a margin of 30.0%), and EBIT of €1,570,000,000 (a margin of 18.0%). HSAG's total research and development expenditure for FY 2024 was €1,420,000,000, reflecting the company's significant investment in next-generation semiconductor process technology, including 2nm and sub-2nm node development. HSAG employs approximately 22,400 individuals globally, of whom approximately 14,600 are based in Germany. The company's senior leadership includes Dr. Klaus-Dieter Wehrheim (Chief Executive Officer), Margarethe Stein (Chief Financial Officer), Dr. Erwin Fassbinder (Senior Vice President, Group Tax), and Dr. Hendrik Möller (Chief Technology Officer).

Halcyon Semiconductor Inc. (HSI). HSI is a C-corporation organized under the laws of the State of Delaware (Delaware File Number 7341825), with an Employer Identification Number of 84-2917630. HSI's registered agent is Capitol Registered Agents LLC, located at 1209 Orange Street, Wilmington, Delaware 19801. HSI's principal office is located at 8700 Parmer Lane, Building 4, Austin, Texas 78729, with a design center at 2455 Augustine Drive, Suite 300, Santa Clara, California 95054, and regional sales offices in Southfield, Michigan, and Beaverton, Oregon.

HSI is a wholly owned subsidiary of HSAG and serves as the exclusive US distribution, marketing, and design-support entity for the Halcyon Semiconductor group. HSI purchases semiconductor products manufactured by HSAG for resale to unrelated US customers, including original equipment manufacturers ("OEMs"), authorized distributors, and hyperscale data center operators. HSI also provides customer-facing design support, technical applications engineering, and demand-generation services in the North American market.

For FY 2024, HSI reported revenue of $4,120,000,000, cost of goods sold of $3,380,000,000, gross profit of $740,000,000 (a margin of 17.96%), and operating income of $197,800,000 (a margin of 4.80%). HSI employs approximately 2,850 individuals. The company's senior management includes Victor Almeida (President and General Manager), Priya Raghavan (Vice President, Tax), and Thomas Kuroda (Vice President, Supply Chain Operations).

D. Documents Reviewed

In connection with this memorandum, we have reviewed the following documents:

1. Master Intercompany Supply Agreement, dated January 1, 2019, between HSAG and HSI, as amended by the First Amendment thereto, dated July 1, 2022;

2. IP License Agreement, dated January 1, 2019, between HSAG and HSI;

3. Qualified Cost Sharing Arrangement, dated July 15, 2018, between HSAG and HSI, including the Platform Contribution Transaction agreement executed contemporaneously therewith;

4. Ancillary documents, including intercompany invoicing procedures, intercompany settlement protocols (cash pooling instructions and netting schedules), and board resolutions of both HSAG's Vorstand and HSI's Board of Directors authorizing the execution of each agreement;

5. Functional analysis memoranda for HSI and HSAG, prepared by Calderwood & Harkness LLP;

6. Benchmarking studies (comparable company search reports, database documentation, and economic analyses) prepared by Meridian Economics GmbH (Dr. Annika Breitner, lead economist; Maximilian Voss, senior analyst), including the comparable company search for the CPM/TNMM analysis supporting the MISA and the comparable uncontrolled transaction analysis supporting the IPLA royalty rate;

7. Audited consolidated and standalone financial statements of HSAG and HSI for FY 2022, 2023, and 2024, as prepared by Gresham Whitfield LLP (audit engagement partners: Simon Cardwell, London, for the HSAG consolidated audit; Janet Okonkwo, Houston, for the HSI standalone audit);

8. Draft bilateral APA application materials prepared by Calderwood & Harkness LLP; and

9. Correspondence from Kettner Pflüger Rechtsanwälte regarding German law considerations applicable to the intercompany agreements.

E. Coordination with German Counsel

Kettner Pflüger Rechtsanwälte, with offices at Bockenheimer Landstraße 72, 60323 Frankfurt am Main, Germany, has been engaged to advise HSAG on the German-side documentation requirements under the AStG and the GAufzV and to coordinate the BZSt submission. Dr. Tobias Kettner (partner) and Friederike Lang (associate) serve as the lead German counsel on this matter. German counsel has reviewed the existing intercompany agreements from a German law perspective, including issues relating to the enforceability of the agreements under German civil law, compliance with the German documentation requirements for intercompany transactions, and the implications of the proposed amendments under German corporate governance principles (including Vorstand approval requirements). Their comments have been incorporated into this memorandum where relevant, and we have noted areas where further coordination with German counsel is necessary.

III. Master Intercompany Supply Agreement (MISA)

A. Overview of Current Terms

The MISA was executed on January 1, 2019, between HSAG (as seller and manufacturer) and HSI (as buyer and distributor). The agreement was subsequently amended by the First Amendment, effective July 1, 2022, which modified certain pricing and delivery terms as described further below. The MISA governs the sale of semiconductor wafers and singulated die manufactured at HSAG's Dresden (Fab 1 and Fab 2) and Chemnitz (Fab 3) fabrication facilities to HSI for resale to unrelated US customers, including OEMs, authorized distributors, and hyperscale data center operators.

For FY 2024, intercompany goods transferred under the MISA totaled €987,600,000, which corresponds to approximately $1,076,000,000 at the average 2024 EUR/USD exchange rate of 1.0896. This represents the single largest category of intercompany transactions between the two entities and constitutes the primary covered transaction under the proposed bilateral APA.

The current pricing mechanism under the MISA, as modified by the July 2022 amendment, employs a cost-plus approach. Specifically, the transfer price for semiconductor products sold by HSAG to HSI is determined by applying a markup percentage to HSAG's fully loaded manufacturing cost base, which includes direct materials, direct labor, manufacturing overhead (including depreciation of fabrication equipment), and an allocated portion of facility costs. The markup percentage was set at the original inception of the agreement and was adjusted in the 2022 amendment to reflect changes in HSAG's cost structure resulting from the Fab 2 expansion project. HSAG issues quarterly price lists to HSI reflecting the cost-plus formula, with prices set on a product-family basis.

The MISA specifies that the transfer price is denominated in euros (EUR). Payment terms require HSI to remit payment within sixty (60) days of the invoice date, with settlement made through the group's intercompany cash pooling arrangement. Delivery terms under the original MISA were Ex Works (EXW) Dresden or Chemnitz (Incoterms 2010); the 2022 amendment updated the delivery terms to FCA (Free Carrier) Dresden or Chemnitz (Incoterms 2020), reflecting updated Incoterms conventions and the logistical arrangements in place with the group's third-party freight forwarder. Under FCA terms, HSAG's obligations with respect to each shipment conclude upon delivery of the goods to the carrier at the named facility, at which point title and risk of loss pass to HSI.

The MISA contains standard warranty provisions, pursuant to which HSAG warrants that products will conform to agreed specifications for a period of twelve (12) months following delivery. The agreement also contains force majeure provisions, indemnification clauses, and a limitation of liability. The governing law provision specifies German law as the governing law of the MISA, with disputes to be resolved by arbitration under the rules of the German Institution of Arbitration (DIS) seated in Frankfurt am Main.

B. Proposed APA Methodology for Tangible Goods

The proposed APA methodology for the tangible goods transactions governed by the MISA applies the Comparable Profits Method ("CPM") under Treas. Reg. § 1.482-5, which corresponds to the Transactional Net Margin Method ("TNMM") under the OECD Transfer Pricing Guidelines. HSI has been designated as the tested party, on the basis that HSI is the least complex entity in the controlled transaction chain, performing limited-risk distribution functions without bearing the entrepreneurial risks associated with HSAG's manufacturing, research and development, and intangible ownership activities.

The selected profit level indicator ("PLI") is HSI's operating margin on net resales, defined as operating income (after all operating expenses, including cost of goods sold, selling expenses, general and administrative expenses, royalties under the IPLA, and cost-sharing contributions under the CSA) divided by net revenue from sales to unrelated customers.

The arm's-length range, expressed as the interquartile range ("IQR"), has been determined through a benchmarking study prepared by Meridian Economics GmbH. The study identified seventeen comparable North American semiconductor distribution companies, using financial data for fiscal years 2020 through 2024 on a five-year weighted average basis. The resulting IQR is 2.8% to 6.1%, with a median of 4.4%.

HSI's actual operating margin for FY 2024 was 4.80%, which falls within the IQR and above the median. This result supports the position that the existing intercompany pricing, on an aggregate basis, has produced arm's-length results in FY 2024. However, as discussed below, the mechanism by which those results were achieved—and the contractual provisions that govern the pricing—are not fully consistent with the proposed APA methodology.

C. Consistency Analysis — Identified Issues

Issue 1: Pricing Mechanism Mismatch. The most significant inconsistency between the current MISA and the proposed APA methodology relates to the pricing mechanism itself. The MISA employs a cost-plus approach, under which the transfer price is determined by reference to HSAG's manufacturing costs plus a markup. The proposed APA, by contrast, applies a CPM/TNMM methodology that tests HSI's operating margin on resales—a buyer-side profitability measure that is fundamentally distinct from a seller-side cost-plus computation.

While a cost-plus mechanism applied to the seller's costs may, in some circumstances, coincidentally produce buyer-side margins that fall within the arm's-length range, this outcome is not structurally guaranteed. The cost-plus mechanism does not directly ensure that HSI's operating margin on resales will fall within the proposed IQR of 2.8% to 6.1%. If HSAG's manufacturing costs fluctuate significantly—as is common in the semiconductor fabrication industry due to capital-intensive fab utilization cycles, raw material cost volatility (particularly for silicon wafers, specialty gases, and photolithography chemicals), and the impact of capacity ramp-ups associated with new process node introductions—the resulting transfer price may produce HSI margins that drift outside the APA range. This risk is exacerbated by the fact that HSI's resale prices to unrelated customers are subject to independent market forces, including competitive pricing pressure from other semiconductor companies and cyclical demand fluctuations.

The IRS APMA team and the BZSt will expect the intercompany agreement to reflect, or at minimum be compatible with, the APA-agreed methodology. It is well established in APA practice that both competent authorities scrutinize the intercompany agreements to confirm that the contractual pricing mechanism is capable of producing results consistent with the agreed arm's-length range on an annual basis. A cost-plus mechanism that is not calibrated to the tested party's margin creates a risk that the competent authorities will view the agreement as inconsistent with the APA terms, potentially requiring renegotiation of the agreement as a condition of APA execution.

Recommendation: The MISA should be amended to replace the cost-plus pricing formula with a pricing mechanism that is directly calibrated to deliver HSI an operating margin within the APA-agreed arm's-length range. There are several acceptable approaches:

(a) Resale-price or target-margin mechanism: The transfer price would be set as HSI's resale price minus a margin sufficient to deliver HSI an operating margin within the IQR (e.g., at the median of 4.4%). This approach directly links the transfer price to HSI's resale economics.

(b) Budget-based provisional pricing with year-end true-up: HSAG would set provisional transfer prices at the beginning of each fiscal year based on HSI's budgeted resale volumes and projected operating expenses, calibrated to deliver a target operating margin. A year-end true-up mechanism (discussed further in Issue 2 below) would then adjust the transfer prices retroactively to bring HSI's actual operating margin within the agreed range.

(c) Retention of cost-plus with mandatory year-end true-up: Alternatively, the cost-plus mechanism could be retained as the interim pricing approach during the fiscal year, provided that a mandatory year-end true-up clause ensures that the aggregate transfer price for the full year is adjusted to deliver HSI an operating margin within the IQR. This approach has the advantage of preserving operational continuity in the quarterly invoicing process while achieving APA-consistent results on an annual basis.

We recommend approach (c) as the most operationally practical, given that the existing invoicing and settlement systems are built around the cost-plus quarterly price list process. However, the year-end true-up must be mandatory—not discretionary—and must be enforceable by both parties.

Issue 2: Absence of Year-End True-Up / Compensating Adjustment Provision. The current MISA does not contain a year-end price adjustment or compensating adjustment clause. This is a significant deficiency in the context of the proposed bilateral APA.

Revenue Procedure 2015-41 § 7 requires that the taxpayer file annual compliance reports demonstrating that the covered transactions have produced results consistent with the APA terms for each covered year. In practice, this means that if HSI's operating margin in any APA year falls outside the agreed arm's-length range, the taxpayer must make a compensating adjustment to bring the result within the range. Such compensating adjustments are a routine feature of bilateral APAs and are expected by both the IRS APMA and the BZSt.

The absence of a contractual mechanism for implementing such adjustments creates two categories of risk. First, from a regulatory perspective, the IRS and BZSt may question whether the taxpayer has the contractual authority to make year-end adjustments, potentially viewing the adjustment as a retroactive re-pricing that lacks commercial substance. Second, from a tax accounting perspective, the absence of a contractual true-up clause may complicate the taxpayer's ability to deduct the true-up payment (if paid by HSI to HSAG) or to exclude the true-up receipt from income (if received by HSI from HSAG) under normal business deduction principles.

Recommendation: A year-end true-up clause should be inserted into the MISA, with the following key elements:

(a) Trigger: The true-up is triggered if HSI's operating margin for any APA-covered fiscal year falls outside the agreed arm's-length range (currently proposed as 2.8% to 6.1%).

(b) Adjustment target: If the true-up is triggered, the intercompany transfer price for that fiscal year will be retroactively adjusted (upward or downward, as applicable) to bring HSI's operating margin to the median of the arm's-length range (currently proposed as 4.4%), or to another agreed point within the range as specified in the APA.

(c) Mechanics: The true-up will be implemented by means of a credit note (if the adjustment results in a reduction of the transfer price) or a supplemental invoice (if the adjustment results in an increase). The credit note or supplemental invoice will be issued within ninety (90) days following the close of the applicable fiscal year, based on HSI's preliminary unaudited financial results, subject to reconciliation upon the availability of audited financial statements.

(d) Currency conversion: The true-up amount will be calculated in US dollars (based on HSI's USD-denominated operating margin) and converted to euros at the average EUR/USD exchange rate for the applicable fiscal year, as determined by reference to the European Central Bank reference rates.

(e) Settlement: Payment of the true-up amount will be made within thirty (30) days of issuance of the credit note or supplemental invoice, through the group's intercompany cash pooling arrangement.

(f) Reporting: The true-up calculation will be documented in the annual APA compliance report and will be reconciled to HSI's audited financial statements.

Issue 3: Quarterly Price List Process. The current MISA provides for HSAG to issue quarterly price lists on a unilateral basis. Under this process, HSAG determines the transfer prices for each product family at the beginning of each calendar quarter, based on its cost-plus formula, and communicates the prices to HSI through the intercompany invoicing system. HSI does not have a formal role in the price-setting process, nor does the process incorporate any reference to HSI's anticipated full-year operating margin.

Under the proposed APA methodology, the critical metric is HSI's full-year operating margin on net resales. To ensure that the quarterly transfer prices are set at levels reasonably expected to produce a full-year operating margin within the arm's-length range, the pricing process must incorporate forward-looking information regarding HSI's anticipated revenues, cost of goods sold, and operating expenses for the full fiscal year. A purely cost-driven quarterly process, without reference to HSI's anticipated buyer-side profitability, is structurally incapable of achieving this objective on a prospective basis.

Recommendation: The quarterly price list process should be supplemented with an annual pricing protocol that operates as follows:

(a) Annual pricing meeting: Prior to the beginning of each fiscal year, representatives of HSAG and HSI (including at minimum the VP Supply Chain Operations and VP Tax of HSI, and the SVP Group Tax and relevant commercial personnel of HSAG) will convene to establish provisional transfer prices for the upcoming fiscal year, based on HSI's annual budget, projected resale volumes, projected operating expenses, and the target operating margin under the APA.

(b) Quarterly monitoring: At the end of each calendar quarter, HSI will prepare an interim profitability analysis comparing HSI's year-to-date operating margin to the target operating margin. If the year-to-date margin deviates from the target by more than a specified threshold (e.g., 100 basis points), the parties will consult on whether a mid-year price adjustment is appropriate.

(c) Year-end true-up: The annual pricing protocol will operate in conjunction with the year-end true-up clause described in Issue 2 above, which serves as the ultimate mechanism for ensuring compliance with the APA range.

Issue 4: Currency and FX Risk Allocation. The MISA is denominated in euros. HSI, however, generates substantially all of its revenue in US dollars. This currency mismatch means that fluctuations in the EUR/USD exchange rate directly and mechanically affect HSI's operating margin, even in the absence of any change in the underlying economics of the distribution business. In FY 2024, the average EUR/USD exchange rate was 1.0896; intra-year fluctuations ranged from approximately 1.0650 to 1.1150, representing a swing of approximately 4.7% from trough to peak. In a business with operating margins in the low-to-mid single digits, such FX fluctuations can easily push HSI's margin outside the arm's-length range.

The current MISA is silent on the allocation of foreign exchange risk between the parties. It does not contain any provision for adjusting transfer prices in response to significant currency movements, nor does it allocate the economic consequences of FX fluctuations to either HSAG or HSI in a deliberate manner.

From a transfer pricing perspective, the allocation of FX risk is an important component of the functional analysis and the delineation of the controlled transaction. If HSI is characterized as a limited-risk distributor, it would be expected—consistent with the "limited risk" characterization—that HSI would not bear significant FX risk. The functional analysis memorandum prepared for the APA application characterizes HSAG as the entrepreneurial entity bearing the principal business risks, including, implicitly, currency risk. However, the contractual allocation of FX risk under the MISA is inconsistent with this characterization, as the EUR-denominated pricing effectively shifts FX risk to HSI.

Recommendation: The MISA should address FX risk explicitly. We recommend one of the following approaches:

(a) Explicit allocation of FX risk to HSAG: The agreement would provide that transfer prices will be adjusted to neutralize the impact of FX fluctuations on HSI's operating margin. This could be achieved through a periodic FX adjustment mechanism (e.g., quarterly recalibration of transfer prices based on the actual EUR/USD rate versus the budgeted rate) or through inclusion of FX effects in the year-end true-up calculation.

(b) Acknowledgment that the year-end true-up captures FX effects: Alternatively, the agreement could acknowledge that the year-end true-up mechanism (Issue 2 above) inherently captures the impact of FX fluctuations on HSI's operating margin, such that no separate FX adjustment mechanism is required. Under this approach, FX risk is effectively absorbed by HSAG through the true-up process.

We recommend approach (b) for operational simplicity, provided that the year-end true-up clause is sufficiently robust and mandatory. However, the agreement should contain a recital or statement of principle acknowledging that, consistent with HSI's characterization as a limited-risk distributor, FX risk is economically borne by HSAG.

Issue 5: Term, Renewal, and Termination Provisions. The current MISA has an indefinite term, subject to termination by either party upon 180 days' written notice. While this is a commercially standard provision, it creates a potential inconsistency with the proposed APA.

The APA will cover the period from January 1, 2025, through December 31, 2029 (prospective years), with a rollback to January 1, 2022 (bringing the total covered period to eight years). If the MISA were terminated during the APA period—whether intentionally or inadvertently—the contractual basis for the covered transactions would be disrupted, potentially rendering the APA unenforceable or requiring the taxpayer to negotiate a new APA covering the post-termination period.

Moreover, from the competent authorities' perspective, the existence of a stable, long-term contractual arrangement is an important factor supporting the APA's factual and economic assumptions. A terminable-at-will agreement may be viewed as inconsistent with the long-term commitments that underpin the APA's critical assumptions regarding HSI's business operations and functional profile.

Recommendation: The MISA should be amended to address the following:

(a) Alignment of term with APA period: The agreement should provide that the pricing methodology, arm's-length range, and true-up provisions will remain in effect for the duration of the APA term (January 1, 2025, through December 31, 2029), irrespective of any exercise of the general termination right.

(b) Notification requirement: Any termination or material amendment of the MISA during the APA term should require prior notification to the relevant competent authorities (IRS APMA and BZSt) and should trigger a review of the APA's critical assumptions.

(c) Survival clause: The true-up and compensating adjustment provisions should survive termination of the MISA with respect to any fiscal year that has commenced prior to the effective date of termination.

Issue 6: Title Passage and Risk of Loss. The current MISA provides for FCA (Free Carrier) delivery terms, under which title and risk of loss pass to HSI upon delivery of the goods to the carrier at HSAG's fabrication facility in Dresden or Chemnitz. Under this arrangement, HSI bears the risk of loss during transit from Germany to the United States, as well as inventory risk following receipt of the goods at its US warehousing and distribution facilities.

The functional analysis memorandum characterizes HSI as a "limited-risk distributor." This characterization is supported by the fact that HSI does not perform manufacturing functions, does not own significant intangible property (other than the licensed intangibles under the IPLA), and does not bear the entrepreneurial risks associated with product development and fabrication. However, the characterization must also be consistent with the risk profile implied by the delivery terms. If HSI bears significant inventory obsolescence risk or transit risk, this could affect the functional analysis and the appropriateness of the tested-party characterization.

In the semiconductor industry, inventory obsolescence is a material risk, as rapid technology cycles can render finished goods inventory obsolete within relatively short periods. If HSI holds substantial levels of inventory and bears the economic risk of obsolescence, this risk factor may need to be reflected in the arm's-length range or in the characterization of HSI's functions and risks.

Recommendation: We recommend reviewing the existing delivery terms and confirming that they are consistent with the functional analysis memorandum for HSI. Specifically:

(a) Confirm that HSI's inventory levels and turnover rates are consistent with those of the seventeen comparable distributors identified in the benchmarking study.

(b) Confirm that HSAG bears the primary risk of product obsolescence—for example, through a contractual obligation to accept returns of obsolete inventory or to adjust transfer prices for slow-moving stock.

(c) If the existing delivery terms allocate transit and obsolescence risk to HSI in a manner inconsistent with the limited-risk distributor characterization, amend the MISA to include inventory return provisions, slow-moving stock adjustments, or transit insurance obligations that are consistent with the functional analysis.

D. Summary of Recommended MISA Amendments

The following table summarizes the identified issues, the current contractual provisions, the recommended amendments, and the priority level assigned to each amendment:

IV. IP License Agreement (IPLA)

A. Overview of Current Terms

The IPLA was executed on January 1, 2019, between HSAG (as licensor) and HSI (as licensee). Under the IPLA, HSAG grants HSI a non-exclusive, non-transferable license to use HSAG's proprietary semiconductor process technology, design libraries, and related intangibles (collectively, the "Licensed Intangibles") in connection with HSI's US distribution and design-support activities. The Licensed Intangibles encompass HSAG's proprietary manufacturing know-how, circuit design libraries, process design kits, and associated technical documentation relating to HSAG's existing and legacy semiconductor process nodes, including the 7nm, 5nm, and 3nm technology platforms.

The IPLA provides for a royalty payment from HSI to HSAG, calculated as a percentage of HSI's IP-attributable revenues. Under the current agreement, the royalty rate is 6.0%, applied to a subset of HSI's net US revenues that is attributable to products incorporating the Licensed Intangibles. The IP-attributable revenue share was determined at inception based on an analysis of the relative contribution of HSAG's licensed process technology to the value of the products distributed by HSI, as distinct from the value contributed by HSI's own distribution, marketing, and design-support activities.

For FY 2024, royalty payments under the IPLA totaled €68,400,000. This figure was computed as follows: HSI's net US revenues of $4,120,000,000, multiplied by the 18.1% IP-attributable share, yielded IP-attributable revenues of approximately $745,700,000; applying the 6.0% royalty rate to this base produced a royalty of approximately $44,742,000. The IPLA specifies that royalties are denominated and payable in euros; applying the payment-date weighted average EUR/USD exchange rate of approximately 1.0307 for FY 2024, the royalty was recorded as approximately €68,400,000 on HSAG's books (equivalent to approximately $70,500,000 on a USD basis, the difference reflecting the timing of exchange rate fluctuations between the computation date and the payment dates).

Payment terms under the IPLA require quarterly royalty payments, due within forty-five (45) days following the end of each calendar quarter, based on that quarter's IP-attributable revenues. The IPLA contains provisions addressing withholding tax, requiring HSI to withhold and remit applicable US withholding tax on the royalty payments unless a valid treaty-based exemption applies. The agreement references the US-Germany Treaty generally but does not specify the applicable treaty article or the procedures for claiming treaty benefits. The IPLA also contains sublicensing restrictions (HSI may not sublicense the Licensed Intangibles without HSAG's prior written consent), audit rights (HSAG has the right to audit HSI's books and records to verify the royalty computation, upon thirty days' advance notice), and term provisions (the IPLA has an indefinite term, subject to termination by either party on twelve months' notice). The governing law of the IPLA is German law, with disputes subject to DIS arbitration in Frankfurt am Main.

B. Proposed APA Methodology for Royalties

The proposed APA methodology for the royalty transactions governed by the IPLA applies the Comparable Uncontrolled Transaction ("CUT") method under Treas. Reg. § 1.482-4(c), corroborated by a residual profit split analysis under Treas. Reg. § 1.482-6.

The CUT analysis is based on a benchmark set of eight comparable uncontrolled license agreements identified through a search of the Clearpoint Royalty Database and publicly available SEC filings. The comparable agreements involve licenses of semiconductor process technology and design libraries between unrelated parties, in transactions with sufficiently comparable economic circumstances (including stage of technology, scope of licensed rights, and geographic market). The benchmarking study was prepared by Meridian Economics GmbH under the supervision of Dr. Annika Breitner.

The resulting IQR of royalty rates is 3.5% to 8.2%, with a median of 5.6%. HSAG's 6.0% royalty rate falls within the IQR and above the median, which is consistent with HSAG's position as the developer and owner of highly valuable, market-leading semiconductor process technology. The tested party for the CUT analysis is HSAG as the licensor, with the royalty rate being directly compared to rates observed in the comparable uncontrolled license agreements.

The residual profit split analysis was performed as a corroborative method, confirming that the allocation of residual profits between HSAG and HSI implied by the 6.0% royalty rate is consistent with the relative contributions of each party's intangible assets. The residual profit split allocated routine returns to HSI based on its distribution and design-support functions, with the residual profit allocated to HSAG as the owner and developer of the Licensed Intangibles. The residual allocation implied by the 6.0% royalty rate was within the range of allocations observed in the corroborative analysis.

C. Consistency Analysis — Identified Issues

Issue 1: Royalty Rate and Computation Base Definition. The existing IPLA specifies a royalty rate of 6.0%, which is consistent with the proposed APA position. However, the precision of the computation base—specifically, the definition of "IP-attributable revenues"—requires careful scrutiny.

The APA application relies on the computation of IP-attributable revenues as 18.1% of HSI's net US revenues, reflecting the proportion of HSI's product revenues that is attributable to products incorporating the Licensed Intangibles (as distinguished from products incorporating intangibles developed under the CSA or products that do not incorporate HSAG's proprietary process technology). This 18.1% figure was derived from a product-line analysis conducted by Meridian Economics GmbH, which classified HSI's revenue streams by the underlying technology node and attributed revenues to the Licensed Intangibles based on the technology content of each product family.

It is critical that the IPLA itself clearly define the concept of "IP-attributable revenues" and specify the methodology for computing the 18.1% share. If the current IPLA uses a different computation base—for example, if it applies the 6.0% royalty to HSI's total net revenues rather than to the 18.1% IP-attributable subset—the resulting royalty payment would be significantly different from the amount contemplated by the APA, creating an inconsistency that the competent authorities are likely to identify during the APA examination process. Conversely, if the IPLA defines the computation base in vague or ambiguous terms (e.g., "revenues attributable to products utilizing HSAG technology"), the lack of precision could lead to disputes over the computation methodology.

Recommendation: The IPLA should be amended to include the following:

(a) A precise definition of "IP-attributable revenues" that is consistent with the methodology used in the APA application, specifying that IP-attributable revenues equal 18.1% of HSI's net US revenues (or, alternatively, specifying the product families and technology nodes included in the computation and the methodology for calculating the percentage).

(b) A schedule or formula documenting the derivation of the 18.1% figure, with a provision for periodic recalculation (e.g., annually or triennially) if the product mix changes materially.

Issue 2: Scope of Licensed Intangibles. The CUT benchmark set used in the APA application is based on comparable licenses for semiconductor process technology and design libraries. The comparability of the benchmark set depends on the scope of the Licensed Intangibles under the IPLA being consistent with the scope of the intangibles licensed in the comparable agreements.

The existing IPLA defines "Licensed Intangibles" in broad terms, encompassing "proprietary semiconductor process technology, design libraries, and related intangibles." While this definition is generally appropriate, it raises two concerns.

First, the definition must be sufficiently specific to match the scope of the comparable uncontrolled transactions identified in the CUT analysis. If the IPLA's definition is broader than the scope of the comparable agreements—for example, if it inadvertently includes trade names, marketing intangibles, or workforce-in-place intangibles that are not present in the comparable transactions—the CUT analysis may be vulnerable to challenge on comparability grounds.

Second, and more importantly, the definition must clearly delineate the Licensed Intangibles (which are subject to the royalty) from the intangibles being developed under the CSA (which are subject to cost sharing, not a royalty). The CSA governs the development of next-generation 2nm and sub-2nm process technology. The IPLA covers existing and legacy process technology (7nm, 5nm, and 3nm nodes). If the definition of Licensed Intangibles is not clearly limited to the legacy technology, there is a risk of overlap with the CSA-covered intangibles, which could result in double-counting (HSI paying both a royalty and a cost-sharing contribution with respect to the same intangibles) or, conversely, gaps (intangibles for which no intercompany charge is made).

Recommendation: The definition of "Licensed Intangibles" should be revised to:

(a) Specifically enumerate the technology nodes covered by the license (7nm, 5nm, and 3nm process technology and associated design libraries).

(b) Explicitly exclude intangibles being developed under the CSA (2nm and sub-2nm process technology).

(c) Include a clear statement that the Licensed Intangibles do not include trade names, trademarks, marketing intangibles, or workforce-in-place, unless such intangibles are specifically enumerated.

(d) Provide a mechanism for updating the scope of Licensed Intangibles if new technology nodes are developed outside the CSA and become commercially deployed during the APA period.

Issue 3: Interaction with the Cost Sharing Arrangement. As noted above, the CSA governs the development of next-generation 2nm and sub-2nm process technology, while the IPLA covers existing and legacy process technology. These two agreements are economically complementary, as they collectively govern the intercompany charges for all of HSAG's proprietary semiconductor technology used by HSI.

However, the existing agreements do not contain any cross-references or coordination provisions. This creates a risk of ambiguity regarding the treatment of intangibles that transition from the "development" phase (governed by the CSA) to the "commercial deployment" phase (potentially governed by the IPLA). For example, when the 2nm process technology currently being developed under the CSA reaches commercial maturity and begins generating revenue for HSI, the question arises whether HSI's use of that technology in its distribution activities is covered by the CSA (because HSI co-funded the development through cost-sharing contributions) or by the IPLA (because the technology has now become a "legacy" technology subject to licensing). If the CSA grants HSI exploitation rights that are perpetual and royalty-free (as is typical for CSA participants), then the 2nm technology should never become subject to the IPLA royalty. However, this must be clearly documented.

Recommendation: The following coordination provisions should be inserted:

(a) Cross-references: Both the IPLA and the CSA should contain cross-references to each other, acknowledging the existence and scope of the other agreement.

(b) Transition provision: The IPLA should include a provision clarifying that intangibles developed under the CSA, for which HSI has made cost-sharing contributions and acquired exploitation rights, are not subject to the IPLA royalty. This effectively creates a "carve-out" for CSA-developed intangibles.

(c) Sunset provision: Conversely, the IPLA should clarify that as legacy technology nodes (currently 7nm, 5nm, and 3nm) reach end-of-life and are no longer commercially deployed, the corresponding Licensed Intangibles may be removed from the IPLA schedule, reducing the IP-attributable revenue computation accordingly.

Issue 4: Withholding Tax and Treaty Benefits. Article 12 of the US-Germany Treaty provides that royalties arising in a Contracting State and beneficially owned by a resident of the other Contracting State may be taxed only in that other Contracting State—i.e., a 0% withholding rate applies to qualifying royalties paid by a US source to a German recipient, provided the limitation on benefits ("LOB") requirements of Article 28 are satisfied.

The current IPLA contains general language requiring HSI to withhold applicable US tax on royalty payments "unless an exemption or reduction is available under an applicable income tax treaty." However, the agreement does not specifically reference Article 12 of the US-Germany Treaty, does not address the LOB requirements, and does not require HSI to obtain and maintain a valid IRS Form W-8BEN-E from HSAG.

While the substantive Treaty entitlement is not in doubt—HSAG clearly qualifies for Treaty benefits as a German Aktiengesellschaft that is publicly traded on the Frankfurt Stock Exchange and satisfies the LOB provisions—the IPLA's withholding tax provisions should be updated to reflect current practice and regulatory requirements.

Recommendation: The IPLA should be amended to:

(a) Specifically reference Article 12 of the US-Germany Treaty and the applicable 0% withholding rate for qualifying royalties.

(b) Include representations by HSAG regarding its eligibility for Treaty benefits under the LOB provisions of Article 28.

(c) Require HSAG to provide and maintain a valid IRS Form W-8BEN-E, updated at least every three years or upon a change in circumstances.

(d) Allocate the economic risk of withholding tax (i.e., if withholding is required due to a change in law, Treaty interpretation, or HSAG's eligibility, which party bears the economic cost).

Issue 5: Term and Termination. The IPLA has an indefinite term, subject to termination by either party on twelve months' written notice. As with the MISA, this termination provision creates a potential inconsistency with the proposed APA. The royalty methodology under the IPLA is a core component of the APA, and termination or material modification of the IPLA during the APA period could disrupt the covered transactions and the taxpayer's ability to comply with the APA terms.

Recommendation: The IPLA's term and termination provisions should be aligned with the APA period, consistent with the recommendations made for the MISA in Section III.C.5 above. Specifically:

(a) The royalty rate, computation methodology, and Licensed Intangibles definition should remain in effect for the duration of the APA term (January 1, 2025, through December 31, 2029).

(b) Any termination or material amendment of the IPLA during the APA term should require prior notification to the relevant competent authorities.

(c) The royalty computation and payment obligations should survive termination with respect to any fiscal year that has commenced prior to the effective date of termination.

Issue 6: Audit and Verification Rights. The IPLA grants HSAG the right to audit HSI's books and records to verify the royalty computation, upon thirty (30) days' advance written notice. While this provision is standard in license agreements, its operational adequacy should be confirmed in light of the APA compliance reporting requirements.

Under Rev. Proc. 2015-41 § 7, the taxpayer must file annual compliance reports that include, among other things, a computation of the royalty for each covered year, reconciled to the audited financial statements. The audit rights provision in the IPLA should be operationally compatible with this requirement, including providing HSAG (and its auditors) with access to the segmented financial data necessary to verify the IP-attributable revenue calculation and the royalty computation.

Additionally, Gresham Whitfield LLP, as the external auditor for both HSAG (audit partner Simon Cardwell, London) and HSI (audit partner Janet Okonkwo, Houston), will need to verify the intercompany royalty in connection with their annual audit procedures. The IPLA's audit rights provision should not create conflicts with or obstacles to the external audit process.

Recommendation: The IPLA's audit rights provisions should be updated to:

(a) Grant HSAG (and its designated auditors or advisors) the right to audit HSI's books and records relevant to the royalty computation, including segmented revenue data by product family and technology node.

(b) Specify that audits may be conducted annually, on reasonable notice (not less than fifteen business days), and at HSAG's expense.

(c) Require HSI to maintain records in sufficient detail to support the IP-attributable revenue calculation and to permit reconciliation to the audited financial statements.

(d) Include a cooperation clause requiring both parties to cooperate with Gresham Whitfield LLP's audit procedures and with the preparation of the annual APA compliance report.

D. Summary of Recommended IPLA Amendments

V. Cost Sharing Arrangement (CSA)

A. Overview of Current Terms

The CSA was executed on July 15, 2018, between HSAG and HSI. The arrangement is structured as a Qualified Cost Sharing Arrangement ("QCSA") within the meaning of Treas. Reg. § 1.482-7 and governs the joint development of next-generation 2nm and sub-2nm semiconductor process technology. The CSA is accompanied by a Platform Contribution Transaction ("PCT") agreement, executed contemporaneously, under which HSI made a buy-in payment to HSAG in consideration for the pre-existing intangible property contributed by HSAG to the CSA at inception.

Under the CSA, HSAG and HSI share the costs of qualifying research and development activities ("intangible development costs" or "Coss") in proportion to their reasonably anticipated benefits from the exploitation of the intangibles developed under the arrangement. HSI's cost-sharing percentage is 22.5%, reflecting HSI's anticipated benefit share based on its North American exploitation rights—i.e., the right to exploit the CSA-developed intangibles in the North American market (the United States, Canada, and Mexico).

For FY 2024, total qualified R&D costs under the CSA were €998,200,000. HSI's share of these costs was €998,200,000 × 22.5% = €224,600,000, or approximately $231,300,000 at the average 2024 EUR/USD exchange rate. HSAG's total R&D expenditure for FY 2024 was €1,420,000,000, of which €998,200,000 (approximately 70.3%) qualified as coss under the CSA. The remaining €421,800,000 represents R&D expenditures that fall outside the scope of the CSA, including maintenance and incremental improvement R&D on existing 7nm, 5nm, and 3nm technology nodes, customer-specific design work, and general corporate research activities.

The PCT, executed on July 15, 2018, required HSI to make a lump-sum buy-in payment of $312,500,000 to HSAG, representing the fair market value of HSI's interest in the pre-existing intangibles contributed by HSAG to the CSA at inception. The buy-in was valued using the income method prescribed by Treas. Reg. § 1.482-7(g)(4), with a discount rate of 11.8% and a projection period of fifteen (15) years. The valuation was prepared by Stonebridge Valuation Partners LLC (Marcus Reinhardt, Managing Director; 200 Park Avenue, Suite 1510, New York, New York 10166), an independent valuation firm retained by HSAG for this purpose.

The CSA contains provisions governing the identification and allocation of coss, the determination of anticipated benefit shares, the scope of divisional interests (exploitation rights), the treatment of contributions to the CSA, the ownership of developed intangibles, and the termination and buy-out mechanics. The governing law of the CSA is US (Delaware) law, reflecting the applicability of Treas. Reg. § 1.482-7 as the governing regulatory framework.

B. Proposed APA Methodology for Cost Sharing

The proposed APA methodology for the cost-sharing transactions governed by the CSA follows the framework prescribed by Treas. Reg. § 1.482-7. Specifically:

• Anticipated benefit shares are determined using the income method, under which each participant's share of the total anticipated benefits from the CSA-developed intangibles is estimated based on projected income streams from the exploitation of those intangibles in each participant's territory. HSI's benefit share has been determined to be 22.5%, reflecting the proportion of total projected income attributable to the North American market.

• The PCT valuation has been supported by the 2018 income-method analysis prepared by Stonebridge Valuation Partners LLC. The APA application will present this valuation as the basis for the buy-in payment and will address the IRS's potential questions regarding the appropriateness of the discount rate, projection assumptions, and terminal value methodology.

• Triennial review: The APA proposes that the 22.5% benefit share be subject to a triennial review and, if necessary, prospective adjustment based on updated revenue projections and market data. This mechanism is intended to ensure that the benefit shares remain reflective of the parties' reasonably anticipated benefits over the APA term, consistent with the requirements of Treas. Reg. § 1.482-7(e)(2)(ii).

C. Consistency Analysis — Identified Issues

Issue 1: Definition of "Qualified R&D Costs" (Intangible Development Costs — Coss). The CSA's definition of intangible development costs is the foundational element of the cost-sharing computation. Under Treas. Reg. § 1.482-7(d), coss include all costs incurred by the CSA participants that relate to the intangible development activity, including direct and indirect costs, overhead, and an arm's-length charge for the use of tangible property contributed to the development activity.

For FY 2024, €998,200,000 out of HSAG's total R&D expenditure of €1,420,000,000 was classified as qualifying coss under the CSA. The remaining €421,800,000 was treated as non-qualifying R&D. This distinction is critical: if the coss definition is ambiguous, the IRS may challenge the scope of shared costs, either by arguing that additional costs should

PRIVILEGED AND CONFIDENTIAL ATTORNEY WORK PRODUCT
MEMORANDUM
June 12, 2025
TO: Leonard Cross, Partner, Tax, Calderwood & Harkness LLP Sylvia Hartwell, Partner, Tax, Calderwood & Harkness LLP
FROM: Leila Nazari, Senior Associate, Tax, Calderwood & Harkness LLP Robert Jansen, Associate, Tax, Calderwood & Harkness LLP
RE: Review of Existing Intercompany Agreements Between Halcyon Semiconductor AG and Halcyon Semiconductor Inc. — Consistency with Proposed Transfer Pricing Policies and Bilateral APA Positions
Matter Number: 1032-00006
Billing Code: HSAG-TP-2025
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I. Executive Summary
This memorandum presents our analysis of the three principal intercompany agreements governing the controlled transactions between Halcyon Semiconductor AG ("HSAG") and its wholly owned US subsidiary, Halcyon Semiconductor Inc. ("HSI"). The purpose of this review is to assess the consistency of those agreements with (a) the proposed transfer pricing methods set forth in the bilateral Advance Pricing Agreement ("APA") application to be filed with the IRS Advance Pricing and Mutual Agreement Program ("APMA") (target filing date: July 7, 2025) and in parallel with the German Bundeszentralamt für Steuern ("BZSt") (target filing date: August 15, 2025), and (b) the contemporaneous transfer pricing documentation prepared for fiscal years 2022 through 2024.
The three agreements reviewed are as follows:
1. Master Intercompany Supply Agreement ("MISA") — effective January 1, 2019, as amended by the First Amendment effective July 1, 2022;
2. IP License Agreement ("IPLA") — effective January 1, 2019; and
3. Cost Sharing Arrangement ("CSA") — effective July 15, 2018, including the associated Platform Contribution Transaction agreement.
Overall Conclusion. Each agreement contains provisions that are broadly consistent with the group's intercompany transfer pricing framework. However, several specific clauses require amendment to align with the APA-proposed methodologies, arm's-length ranges, and compliance mechanics. Without amendment, there is a material risk that the IRS APMA and/or the BZSt may view the contractual terms as inconsistent with the APA commitments, potentially jeopardizing the bilateral APA or creating penalty exposure under IRC §§ 6662(e) and 6662(h) (substantial and gross valuation misstatement penalties). On the German side, inadequate contractual documentation could expose the group to risks under §§ 162(3) and 162(4) AO, which permit the tax authorities to estimate income and shift the burden of proof to the taxpayer.
The following table summarizes our key findings and recommended amendments, cross-referenced to the detailed discussion in Sections III through VI below:
We recommend that amended agreements be prepared now, in parallel with the APA application filings, but that execution be held pending the conclusion of the bilateral APA in order to avoid premature commitment to terms that may be modified during the competent authority negotiation process. The substantive terms of the draft amendments should, however, be provided to both competent authorities as part of the APA documentation package.
II. Background and Scope of Review
A. Engagement Context
Calderwood & Harkness LLP was engaged by HSAG and HSI to advise on and secure a bilateral APA between the IRS and the BZSt pursuant to the mutual agreement procedure ("MAP") under Article 25 of the Convention between the United States of America and the Federal Republic of Germany for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital and to Certain Other Taxes (signed June 29, 2006) (the "US-Germany Treaty"), as well as the domestic APA procedures set forth in Revenue Procedure 2015-41. The engagement letter was executed on March 10, 2025, and the engagement was formally opened in the firm's matter management system on February 3, 2025, under Matter Number 1032-00006.
The proposed APA term encompasses five prospective tax years, from January 1, 2025, through December 31, 2029, plus a rollback to cover three prior tax years, from January 1, 2022, through December 31, 2024, for a total covered period of eight tax years. The rollback is being sought in order to provide certainty with respect to the transfer pricing positions taken on the filed (and in some cases amended) US and German returns for the FY 2022–2024 period.
The aggregate annual intercompany flows between HSAG and HSI for FY 2024 totaled approximately €1,280,600,000, composed of the following principal categories:
• Tangible goods (semiconductor wafers and singulated die): €987,600,000 (approximately $1,076,000,000 at the average 2024 EUR/USD rate of 1.0896);
• Royalty payments under the IPLA: €68,400,000 (approximately $70,500,000); and
• Cost-sharing contributions under the CSA: €224,600,000 (approximately $231,300,000).
These flows represent a substantial portion of the global intercompany transactions within the Halcyon Semiconductor group and constitute the principal covered transactions under the proposed bilateral APA.
B. Applicable Legal Standards
The following legal standards and regulatory authorities are relevant to our analysis:
United States. Under IRC § 482, the Secretary of the Treasury is authorized to distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among 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 arm's-length standard—requiring that controlled transactions reflect terms that would be agreed upon by unrelated parties dealing at arm's length—is the fundamental principle governing the application of § 482 and its implementing regulations.
The Treasury Regulations under § 482, specifically Treas. Reg. §§ 1.482-1 through 1.482-9, provide detailed guidance on the methods for determining arm's-length prices for various categories of controlled transactions, including transfers of tangible property (Treas. Reg. § 1.482-3), transfers of intangible property (Treas. Reg. § 1.482-4), services (Treas. Reg. § 1.482-9), and cost sharing arrangements (Treas. Reg. § 1.482-7).
Critically for this review, Treas. Reg. § 1.482-1(d)(3)(ii)(B) provides that the contractual terms of a controlled transaction will be respected only if they are consistent with the economic substance of the transaction. Where the terms of a written contract differ from the actual conduct of the parties, the IRS may disregard the contractual terms and re-characterize the transaction based on the parties' actual behavior. This principle underscores the importance of ensuring that the intercompany agreements accurately reflect the economic reality of the HSAG-HSI relationship, particularly as described in the functional analysis memoranda prepared for the APA application.
Penalty provisions under IRC §§ 6662(e) and 6662(h) impose a 20% penalty for substantial valuation misstatements and a 40% penalty for gross valuation misstatements in the transfer pricing context. Treas. Reg. § 1.6662-6 provides that the penalty may be avoided if the taxpayer demonstrates reasonable cause and good faith, including through the maintenance of contemporaneous transfer pricing documentation meeting specified requirements. Inconsistencies between the intercompany agreements and the transfer pricing documentation could undermine a reasonable cause defense.
Revenue Procedure 2015-41 governs the IRS APA program. Section 4.05 of the Revenue Procedure requires that APA applications describe the intercompany agreements governing the covered transactions, including the pricing mechanisms, adjustment provisions, and other material terms. Section 7 requires annual compliance reports demonstrating that the taxpayer has adhered to the APA terms during each covered year. These compliance requirements necessitate that the intercompany agreements contain mechanisms (such as year-end true-up provisions) that permit the taxpayer to implement the APA-agreed pricing methodology on an annual basis.
Germany. Under § 1 of the Außensteuergesetz ("AStG"), the German tax authorities may adjust the income of a German taxpayer if the terms of a controlled transaction deviate from those that arm's-length parties would have agreed upon. Sections 90(3) and 162(3)–(4) of the Abgabenordnung ("AO") impose documentation requirements and authorize the tax authorities to estimate income (with a corresponding shift of the burden of proof to the taxpayer) where the taxpayer fails to maintain adequate contemporaneous transfer pricing documentation. The Gewinnabgrenzungsaufzeichnungsverordnung ("GAufzV") specifies the content and format of the required documentation, including the requirement that intercompany agreements be documented in writing and reflect arm's-length terms.
OECD. The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2022 edition) provide authoritative guidance on the delineation of the actual controlled transaction based on the contractual terms between the parties and the actual conduct of the parties (Chapter I, paragraphs 1.42–1.130). The OECD Guidelines emphasize that the written contract is the starting point for the delineation analysis, but that the economic substance of the transaction, as reflected in the functions performed, assets used, and risks assumed by each party, must be consistent with the contractual terms.
C. Parties to the Agreements
Halcyon Semiconductor AG (HSAG). HSAG is an Aktiengesellschaft organized under the laws of the Federal Republic of Germany, with its registered office at Halcyon-Allee 12, 01099 Dresden, Saxony, Germany. HSAG's tax identification number (Steuernummer) is 203/118/04527, and its VAT identification number is DE 814 723 956. HSAG operates semiconductor fabrication facilities at two locations in Germany: (i) Fab 1 and Fab 2, located at Industriepark Klotzsche, Zur Wetterwarte 50, 01109 Dresden, which together represent the group's primary 300mm advanced-logic wafer fabrication complex; and (ii) Fab 3, located at Technologiepark Chemnitz, Annaberger Straße 240, 09125 Chemnitz, which produces specialty and analog semiconductor products.
For FY 2024, HSAG reported consolidated revenue of €8,740,000,000, EBITDA of €2,620,000,000 (a margin of 30.0%), and EBIT of €1,570,000,000 (a margin of 18.0%). HSAG's total research and development expenditure for FY 2024 was €1,420,000,000, reflecting the company's significant investment in next-generation semiconductor process technology, including 2nm and sub-2nm node development. HSAG employs approximately 22,400 individuals globally, of whom approximately 14,600 are based in Germany. The company's senior leadership includes Dr. Klaus-Dieter Wehrheim (Chief Executive Officer), Margarethe Stein (Chief Financial Officer), Dr. Erwin Fassbinder (Senior Vice President, Group Tax), and Dr. Hendrik Möller (Chief Technology Officer).
Halcyon Semiconductor Inc. (HSI). HSI is a C-corporation organized under the laws of the State of Delaware (Delaware File Number 7341825), with an Employer Identification Number of 84-2917630. HSI's registered agent is Capitol Registered Agents LLC, located at 1209 Orange Street, Wilmington, Delaware 19801. HSI's principal office is located at 8700 Parmer Lane, Building 4, Austin, Texas 78729, with a design center at 2455 Augustine Drive, Suite 300, Santa Clara, California 95054, and regional sales offices in Southfield, Michigan, and Beaverton, Oregon.
HSI is a wholly owned subsidiary of HSAG and serves as the exclusive US distribution, marketing, and design-support entity for the Halcyon Semiconductor group. HSI purchases semiconductor products manufactured by HSAG for resale to unrelated US customers, including original equipment manufacturers ("OEMs"), authorized distributors, and hyperscale data center operators. HSI also provides customer-facing design support, technical applications engineering, and demand-generation services in the North American market.
For FY 2024, HSI reported revenue of $4,120,000,000, cost of goods sold of $3,380,000,000, gross profit of $740,000,000 (a margin of 17.96%), and operating income of $197,800,000 (a margin of 4.80%). HSI employs approximately 2,850 individuals. The company's senior management includes Victor Almeida (President and General Manager), Priya Raghavan (Vice President, Tax), and Thomas Kuroda (Vice President, Supply Chain Operations).
D. Documents Reviewed
In connection with this memorandum, we have reviewed the following documents:
1. Master Intercompany Supply Agreement, dated January 1, 2019, between HSAG and HSI, as amended by the First Amendment thereto, dated July 1, 2022;
2. IP License Agreement, dated January 1, 2019, between HSAG and HSI;
3. Qualified Cost Sharing Arrangement, dated July 15, 2018, between HSAG and HSI, including the Platform Contribution Transaction agreement executed contemporaneously therewith;
4. Ancillary documents, including intercompany invoicing procedures, intercompany settlement protocols (cash pooling instructions and netting schedules), and board resolutions of both HSAG's Vorstand and HSI's Board of Directors authorizing the execution of each agreement;
5. Functional analysis memoranda for HSI and HSAG, prepared by Calderwood & Harkness LLP;
6. Benchmarking studies (comparable company search reports, database documentation, and economic analyses) prepared by Meridian Economics GmbH (Dr. Annika Breitner, lead economist; Maximilian Voss, senior analyst), including the comparable company search for the CPM/TNMM analysis supporting the MISA and the comparable uncontrolled transaction analysis supporting the IPLA royalty rate;
7. Audited consolidated and standalone financial statements of HSAG and HSI for FY 2022, 2023, and 2024, as prepared by Gresham Whitfield LLP (audit engagement partners: Simon Cardwell, London, for the HSAG consolidated audit; Janet Okonkwo, Houston, for the HSI standalone audit);
8. Draft bilateral APA application materials prepared by Calderwood & Harkness LLP; and
9. Correspondence from Kettner Pflüger Rechtsanwälte regarding German law considerations applicable to the intercompany agreements.
E. Coordination with German Counsel
Kettner Pflüger Rechtsanwälte, with offices at Bockenheimer Landstraße 72, 60323 Frankfurt am Main, Germany, has been engaged to advise HSAG on the German-side documentation requirements under the AStG and the GAufzV and to coordinate the BZSt submission. Dr. Tobias Kettner (partner) and Friederike Lang (associate) serve as the lead German counsel on this matter. German counsel has reviewed the existing intercompany agreements from a German law perspective, including issues relating to the enforceability of the agreements under German civil law, compliance with the German documentation requirements for intercompany transactions, and the implications of the proposed amendments under German corporate governance principles (including Vorstand approval requirements). Their comments have been incorporated into this memorandum where relevant, and we have noted areas where further coordination with German counsel is necessary.
III. Master Intercompany Supply Agreement (MISA)
A. Overview of Current Terms
The MISA was executed on January 1, 2019, between HSAG (as seller and manufacturer) and HSI (as buyer and distributor). The agreement was subsequently amended by the First Amendment, effective July 1, 2022, which modified certain pricing and delivery terms as described further below. The MISA governs the sale of semiconductor wafers and singulated die manufactured at HSAG's Dresden (Fab 1 and Fab 2) and Chemnitz (Fab 3) fabrication facilities to HSI for resale to unrelated US customers, including OEMs, authorized distributors, and hyperscale data center operators.
For FY 2024, intercompany goods transferred under the MISA totaled €987,600,000, which corresponds to approximately $1,076,000,000 at the average 2024 EUR/USD exchange rate of 1.0896. This represents the single largest category of intercompany transactions between the two entities and constitutes the primary covered transaction under the proposed bilateral APA.
The current pricing mechanism under the MISA, as modified by the July 2022 amendment, employs a cost-plus approach. Specifically, the transfer price for semiconductor products sold by HSAG to HSI is determined by applying a markup percentage to HSAG's fully loaded manufacturing cost base, which includes direct materials, direct labor, manufacturing overhead (including depreciation of fabrication equipment), and an allocated portion of facility costs. The markup percentage was set at the original inception of the agreement and was adjusted in the 2022 amendment to reflect changes in HSAG's cost structure resulting from the Fab 2 expansion project. HSAG issues quarterly price lists to HSI reflecting the cost-plus formula, with prices set on a product-family basis.
The MISA specifies that the transfer price is denominated in euros (EUR). Payment terms require HSI to remit payment within sixty (60) days of the invoice date, with settlement made through the group's intercompany cash pooling arrangement. Delivery terms under the original MISA were Ex Works (EXW) Dresden or Chemnitz (Incoterms 2010); the 2022 amendment updated the delivery terms to FCA (Free Carrier) Dresden or Chemnitz (Incoterms 2020), reflecting updated Incoterms conventions and the logistical arrangements in place with the group's third-party freight forwarder. Under FCA terms, HSAG's obligations with respect to each shipment conclude upon delivery of the goods to the carrier at the named facility, at which point title and risk of loss pass to HSI.
The MISA contains standard warranty provisions, pursuant to which HSAG warrants that products will conform to agreed specifications for a period of twelve (12) months following delivery. The agreement also contains force majeure provisions, indemnification clauses, and a limitation of liability. The governing law provision specifies German law as the governing law of the MISA, with disputes to be resolved by arbitration under the rules of the German Institution of Arbitration (DIS) seated in Frankfurt am Main.
B. Proposed APA Methodology for Tangible Goods
The proposed APA methodology for the tangible goods transactions governed by the MISA applies the Comparable Profits Method ("CPM") under Treas. Reg. § 1.482-5, which corresponds to the Transactional Net Margin Method ("TNMM") under the OECD Transfer Pricing Guidelines. HSI has been designated as the tested party, on the basis that HSI is the least complex entity in the controlled transaction chain, performing limited-risk distribution functions without bearing the entrepreneurial risks associated with HSAG's manufacturing, research and development, and intangible ownership activities.
The selected profit level indicator ("PLI") is HSI's operating margin on net resales, defined as operating income (after all operating expenses, including cost of goods sold, selling expenses, general and administrative expenses, royalties under the IPLA, and cost-sharing contributions under the CSA) divided by net revenue from sales to unrelated customers.
The arm's-length range, expressed as the interquartile range ("IQR"), has been determined through a benchmarking study prepared by Meridian Economics GmbH. The study identified seventeen comparable North American semiconductor distribution companies, using financial data for fiscal years 2020 through 2024 on a five-year weighted average basis. The resulting IQR is 2.8% to 6.1%, with a median of 4.4%.
HSI's actual operating margin for FY 2024 was 4.80%, which falls within the IQR and above the median. This result supports the position that the existing intercompany pricing, on an aggregate basis, has produced arm's-length results in FY 2024. However, as discussed below, the mechanism by which those results were achieved—and the contractual provisions that govern the pricing—are not fully consistent with the proposed APA methodology.
C. Consistency Analysis — Identified Issues
Issue 1: Pricing Mechanism Mismatch. The most significant inconsistency between the current MISA and the proposed APA methodology relates to the pricing mechanism itself. The MISA employs a cost-plus approach, under which the transfer price is determined by reference to HSAG's manufacturing costs plus a markup. The proposed APA, by contrast, applies a CPM/TNMM methodology that tests HSI's operating margin on resales—a buyer-side profitability measure that is fundamentally distinct from a seller-side cost-plus computation.
While a cost-plus mechanism applied to the seller's costs may, in some circumstances, coincidentally produce buyer-side margins that fall within the arm's-length range, this outcome is not structurally guaranteed. The cost-plus mechanism does not directly ensure that HSI's operating margin on resales will fall within the proposed IQR of 2.8% to 6.1%. If HSAG's manufacturing costs fluctuate significantly—as is common in the semiconductor fabrication industry due to capital-intensive fab utilization cycles, raw material cost volatility (particularly for silicon wafers, specialty gases, and photolithography chemicals), and the impact of capacity ramp-ups associated with new process node introductions—the resulting transfer price may produce HSI margins that drift outside the APA range. This risk is exacerbated by the fact that HSI's resale prices to unrelated customers are subject to independent market forces, including competitive pricing pressure from other semiconductor companies and cyclical demand fluctuations.
The IRS APMA team and the BZSt will expect the intercompany agreement to reflect, or at minimum be compatible with, the APA-agreed methodology. It is well established in APA practice that both competent authorities scrutinize the intercompany agreements to confirm that the contractual pricing mechanism is capable of producing results consistent with the agreed arm's-length range on an annual basis. A cost-plus mechanism that is not calibrated to the tested party's margin creates a risk that the competent authorities will view the agreement as inconsistent with the APA terms, potentially requiring renegotiation of the agreement as a condition of APA execution.
Recommendation: The MISA should be amended to replace the cost-plus pricing formula with a pricing mechanism that is directly calibrated to deliver HSI an operating margin within the APA-agreed arm's-length range. There are several acceptable approaches:
(a) Resale-price or target-margin mechanism: The transfer price would be set as HSI's resale price minus a margin sufficient to deliver HSI an operating margin within the IQR (e.g., at the median of 4.4%). This approach directly links the transfer price to HSI's resale economics.
(b) Budget-based provisional pricing with year-end true-up: HSAG would set provisional transfer prices at the beginning of each fiscal year based on HSI's budgeted resale volumes and projected operating expenses, calibrated to deliver a target operating margin. A year-end true-up mechanism (discussed further in Issue 2 below) would then adjust the transfer prices retroactively to bring HSI's actual operating margin within the agreed range.
(c) Retention of cost-plus with mandatory year-end true-up: Alternatively, the cost-plus mechanism could be retained as the interim pricing approach during the fiscal year, provided that a mandatory year-end true-up clause ensures that the aggregate transfer price for the full year is adjusted to deliver HSI an operating margin within the IQR. This approach has the advantage of preserving operational continuity in the quarterly invoicing process while achieving APA-consistent results on an annual basis.
We recommend approach (c) as the most operationally practical, given that the existing invoicing and settlement systems are built around the cost-plus quarterly price list process. However, the year-end true-up must be mandatory—not discretionary—and must be enforceable by both parties.
Issue 2: Absence of Year-End True-Up / Compensating Adjustment Provision. The current MISA does not contain a year-end price adjustment or compensating adjustment clause. This is a significant deficiency in the context of the proposed bilateral APA.
Revenue Procedure 2015-41 § 7 requires that the taxpayer file annual compliance reports demonstrating that the covered transactions have produced results consistent with the APA terms for each covered year. In practice, this means that if HSI's operating margin in any APA year falls outside the agreed arm's-length range, the taxpayer must make a compensating adjustment to bring the result within the range. Such compensating adjustments are a routine feature of bilateral APAs and are expected by both the IRS APMA and the BZSt.
The absence of a contractual mechanism for implementing such adjustments creates two categories of risk. First, from a regulatory perspective, the IRS and BZSt may question whether the taxpayer has the contractual authority to make year-end adjustments, potentially viewing the adjustment as a retroactive re-pricing that lacks commercial substance. Second, from a tax accounting perspective, the absence of a contractual true-up clause may complicate the taxpayer's ability to deduct the true-up payment (if paid by HSI to HSAG) or to exclude the true-up receipt from income (if received by HSI from HSAG) under normal business deduction principles.
Recommendation: A year-end true-up clause should be inserted into the MISA, with the following key elements:
(a) Trigger: The true-up is triggered if HSI's operating margin for any APA-covered fiscal year falls outside the agreed arm's-length range (currently proposed as 2.8% to 6.1%).
(b) Adjustment target: If the true-up is triggered, the intercompany transfer price for that fiscal year will be retroactively adjusted (upward or downward, as applicable) to bring HSI's operating margin to the median of the arm's-length range (currently proposed as 4.4%), or to another agreed point within the range as specified in the APA.
(c) Mechanics: The true-up will be implemented by means of a credit note (if the adjustment results in a reduction of the transfer price) or a supplemental invoice (if the adjustment results in an increase). The credit note or supplemental invoice will be issued within ninety (90) days following the close of the applicable fiscal year, based on HSI's preliminary unaudited financial results, subject to reconciliation upon the availability of audited financial statements.
(d) Currency conversion: The true-up amount will be calculated in US dollars (based on HSI's USD-denominated operating margin) and converted to euros at the average EUR/USD exchange rate for the applicable fiscal year, as determined by reference to the European Central Bank reference rates.
(e) Settlement: Payment of the true-up amount will be made within thirty (30) days of issuance of the credit note or supplemental invoice, through the group's intercompany cash pooling arrangement.
(f) Reporting: The true-up calculation will be documented in the annual APA compliance report and will be reconciled to HSI's audited financial statements.
Issue 3: Quarterly Price List Process. The current MISA provides for HSAG to issue quarterly price lists on a unilateral basis. Under this process, HSAG determines the transfer prices for each product family at the beginning of each calendar quarter, based on its cost-plus formula, and communicates the prices to HSI through the intercompany invoicing system. HSI does not have a formal role in the price-setting process, nor does the process incorporate any reference to HSI's anticipated full-year operating margin.
Under the proposed APA methodology, the critical metric is HSI's full-year operating margin on net resales. To ensure that the quarterly transfer prices are set at levels reasonably expected to produce a full-year operating margin within the arm's-length range, the pricing process must incorporate forward-looking information regarding HSI's anticipated revenues, cost of goods sold, and operating expenses for the full fiscal year. A purely cost-driven quarterly process, without reference to HSI's anticipated buyer-side profitability, is structurally incapable of achieving this objective on a prospective basis.
Recommendation: The quarterly price list process should be supplemented with an annual pricing protocol that operates as follows:
(a) Annual pricing meeting: Prior to the beginning of each fiscal year, representatives of HSAG and HSI (including at minimum the VP Supply Chain Operations and VP Tax of HSI, and the SVP Group Tax and relevant commercial personnel of HSAG) will convene to establish provisional transfer prices for the upcoming fiscal year, based on HSI's annual budget, projected resale volumes, projected operating expenses, and the target operating margin under the APA.
(b) Quarterly monitoring: At the end of each calendar quarter, HSI will prepare an interim profitability analysis comparing HSI's year-to-date operating margin to the target operating margin. If the year-to-date margin deviates from the target by more than a specified threshold (e.g., 100 basis points), the parties will consult on whether a mid-year price adjustment is appropriate.
(c) Year-end true-up: The annual pricing protocol will operate in conjunction with the year-end true-up clause described in Issue 2 above, which serves as the ultimate mechanism for ensuring compliance with the APA range.
Issue 4: Currency and FX Risk Allocation. The MISA is denominated in euros. HSI, however, generates substantially all of its revenue in US dollars. This currency mismatch means that fluctuations in the EUR/USD exchange rate directly and mechanically affect HSI's operating margin, even in the absence of any change in the underlying economics of the distribution business. In FY 2024, the average EUR/USD exchange rate was 1.0896; intra-year fluctuations ranged from approximately 1.0650 to 1.1150, representing a swing of approximately 4.7% from trough to peak. In a business with operating margins in the low-to-mid single digits, such FX fluctuations can easily push HSI's margin outside the arm's-length range.
The current MISA is silent on the allocation of foreign exchange risk between the parties. It does not contain any provision for adjusting transfer prices in response to significant currency movements, nor does it allocate the economic consequences of FX fluctuations to either HSAG or HSI in a deliberate manner.
From a transfer pricing perspective, the allocation of FX risk is an important component of the functional analysis and the delineation of the controlled transaction. If HSI is characterized as a limited-risk distributor, it would be expected—consistent with the "limited risk" characterization—that HSI would not bear significant FX risk. The functional analysis memorandum prepared for the APA application characterizes HSAG as the entrepreneurial entity bearing the principal business risks, including, implicitly, currency risk. However, the contractual allocation of FX risk under the MISA is inconsistent with this characterization, as the EUR-denominated pricing effectively shifts FX risk to HSI.
Recommendation: The MISA should address FX risk explicitly. We recommend one of the following approaches:
(a) Explicit allocation of FX risk to HSAG: The agreement would provide that transfer prices will be adjusted to neutralize the impact of FX fluctuations on HSI's operating margin. This could be achieved through a periodic FX adjustment mechanism (e.g., quarterly recalibration of transfer prices based on the actual EUR/USD rate versus the budgeted rate) or through inclusion of FX effects in the year-end true-up calculation.
(b) Acknowledgment that the year-end true-up captures FX effects: Alternatively, the agreement could acknowledge that the year-end true-up mechanism (Issue 2 above) inherently captures the impact of FX fluctuations on HSI's operating margin, such that no separate FX adjustment mechanism is required. Under this approach, FX risk is effectively absorbed by HSAG through the true-up process.
We recommend approach (b) for operational simplicity, provided that the year-end true-up clause is sufficiently robust and mandatory. However, the agreement should contain a recital or statement of principle acknowledging that, consistent with HSI's characterization as a limited-risk distributor, FX risk is economically borne by HSAG.
Issue 5: Term, Renewal, and Termination Provisions. The current MISA has an indefinite term, subject to termination by either party upon 180 days' written notice. While this is a commercially standard provision, it creates a potential inconsistency with the proposed APA.
The APA will cover the period from January 1, 2025, through December 31, 2029 (prospective years), with a rollback to January 1, 2022 (bringing the total covered period to eight years). If the MISA were terminated during the APA period—whether intentionally or inadvertently—the contractual basis for the covered transactions would be disrupted, potentially rendering the APA unenforceable or requiring the taxpayer to negotiate a new APA covering the post-termination period.
Moreover, from the competent authorities' perspective, the existence of a stable, long-term contractual arrangement is an important factor supporting the APA's factual and economic assumptions. A terminable-at-will agreement may be viewed as inconsistent with the long-term commitments that underpin the APA's critical assumptions regarding HSI's business operations and functional profile.
Recommendation: The MISA should be amended to address the following:
(a) Alignment of term with APA period: The agreement should provide that the pricing methodology, arm's-length range, and true-up provisions will remain in effect for the duration of the APA term (January 1, 2025, through December 31, 2029), irrespective of any exercise of the general termination right.
(b) Notification requirement: Any termination or material amendment of the MISA during the APA term should require prior notification to the relevant competent authorities (IRS APMA and BZSt) and should trigger a review of the APA's critical assumptions.
(c) Survival clause: The true-up and compensating adjustment provisions should survive termination of the MISA with respect to any fiscal year that has commenced prior to the effective date of termination.
Issue 6: Title Passage and Risk of Loss. The current MISA provides for FCA (Free Carrier) delivery terms, under which title and risk of loss pass to HSI upon delivery of the goods to the carrier at HSAG's fabrication facility in Dresden or Chemnitz. Under this arrangement, HSI bears the risk of loss during transit from Germany to the United States, as well as inventory risk following receipt of the goods at its US warehousing and distribution facilities.
The functional analysis memorandum characterizes HSI as a "limited-risk distributor." This characterization is supported by the fact that HSI does not perform manufacturing functions, does not own significant intangible property (other than the licensed intangibles under the IPLA), and does not bear the entrepreneurial risks associated with product development and fabrication. However, the characterization must also be consistent with the risk profile implied by the delivery terms. If HSI bears significant inventory obsolescence risk or transit risk, this could affect the functional analysis and the appropriateness of the tested-party characterization.
In the semiconductor industry, inventory obsolescence is a material risk, as rapid technology cycles can render finished goods inventory obsolete within relatively short periods. If HSI holds substantial levels of inventory and bears the economic risk of obsolescence, this risk factor may need to be reflected in the arm's-length range or in the characterization of HSI's functions and risks.
Recommendation: We recommend reviewing the existing delivery terms and confirming that they are consistent with the functional analysis memorandum for HSI. Specifically:
(a) Confirm that HSI's inventory levels and turnover rates are consistent with those of the seventeen comparable distributors identified in the benchmarking study.
(b) Confirm that HSAG bears the primary risk of product obsolescence—for example, through a contractual obligation to accept returns of obsolete inventory or to adjust transfer prices for slow-moving stock.
(c) If the existing delivery terms allocate transit and obsolescence risk to HSI in a manner inconsistent with the limited-risk distributor characterization, amend the MISA to include inventory return provisions, slow-moving stock adjustments, or transit insurance obligations that are consistent with the functional analysis.
D. Summary of Recommended MISA Amendments
The following table summarizes the identified issues, the current contractual provisions, the recommended amendments, and the priority level assigned to each amendment:
IV. IP License Agreement (IPLA)
A. Overview of Current Terms
The IPLA was executed on January 1, 2019, between HSAG (as licensor) and HSI (as licensee). Under the IPLA, HSAG grants HSI a non-exclusive, non-transferable license to use HSAG's proprietary semiconductor process technology, design libraries, and related intangibles (collectively, the "Licensed Intangibles") in connection with HSI's US distribution and design-support activities. The Licensed Intangibles encompass HSAG's proprietary manufacturing know-how, circuit design libraries, process design kits, and associated technical documentation relating to HSAG's existing and legacy semiconductor process nodes, including the 7nm, 5nm, and 3nm technology platforms.
The IPLA provides for a royalty payment from HSI to HSAG, calculated as a percentage of HSI's IP-attributable revenues. Under the current agreement, the royalty rate is 6.0%, applied to a subset of HSI's net US revenues that is attributable to products incorporating the Licensed Intangibles. The IP-attributable revenue share was determined at inception based on an analysis of the relative contribution of HSAG's licensed process technology to the value of the products distributed by HSI, as distinct from the value contributed by HSI's own distribution, marketing, and design-support activities.
For FY 2024, royalty payments under the IPLA totaled €68,400,000. This figure was computed as follows: HSI's net US revenues of $4,120,000,000, multiplied by the 18.1% IP-attributable share, yielded IP-attributable revenues of approximately $745,700,000; applying the 6.0% royalty rate to this base produced a royalty of approximately $44,742,000. The IPLA specifies that royalties are denominated and payable in euros; applying the payment-date weighted average EUR/USD exchange rate of approximately 1.0307 for FY 2024, the royalty was recorded as approximately €68,400,000 on HSAG's books (equivalent to approximately $70,500,000 on a USD basis, the difference reflecting the timing of exchange rate fluctuations between the computation date and the payment dates).
Payment terms under the IPLA require quarterly royalty payments, due within forty-five (45) days following the end of each calendar quarter, based on that quarter's IP-attributable revenues. The IPLA contains provisions addressing withholding tax, requiring HSI to withhold and remit applicable US withholding tax on the royalty payments unless a valid treaty-based exemption applies. The agreement references the US-Germany Treaty generally but does not specify the applicable treaty article or the procedures for claiming treaty benefits. The IPLA also contains sublicensing restrictions (HSI may not sublicense the Licensed Intangibles without HSAG's prior written consent), audit rights (HSAG has the right to audit HSI's books and records to verify the royalty computation, upon thirty days' advance notice), and term provisions (the IPLA has an indefinite term, subject to termination by either party on twelve months' notice). The governing law of the IPLA is German law, with disputes subject to DIS arbitration in Frankfurt am Main.
B. Proposed APA Methodology for Royalties
The proposed APA methodology for the royalty transactions governed by the IPLA applies the Comparable Uncontrolled Transaction ("CUT") method under Treas. Reg. § 1.482-4(c), corroborated by a residual profit split analysis under Treas. Reg. § 1.482-6.
The CUT analysis is based on a benchmark set of eight comparable uncontrolled license agreements identified through a search of the Clearpoint Royalty Database and publicly available SEC filings. The comparable agreements involve licenses of semiconductor process technology and design libraries between unrelated parties, in transactions with sufficiently comparable economic circumstances (including stage of technology, scope of licensed rights, and geographic market). The benchmarking study was prepared by Meridian Economics GmbH under the supervision of Dr. Annika Breitner.
The resulting IQR of royalty rates is 3.5% to 8.2%, with a median of 5.6%. HSAG's 6.0% royalty rate falls within the IQR and above the median, which is consistent with HSAG's position as the developer and owner of highly valuable, market-leading semiconductor process technology. The tested party for the CUT analysis is HSAG as the licensor, with the royalty rate being directly compared to rates observed in the comparable uncontrolled license agreements.
The residual profit split analysis was performed as a corroborative method, confirming that the allocation of residual profits between HSAG and HSI implied by the 6.0% royalty rate is consistent with the relative contributions of each party's intangible assets. The residual profit split allocated routine returns to HSI based on its distribution and design-support functions, with the residual profit allocated to HSAG as the owner and developer of the Licensed Intangibles. The residual allocation implied by the 6.0% royalty rate was within the range of allocations observed in the corroborative analysis.
C. Consistency Analysis — Identified Issues
Issue 1: Royalty Rate and Computation Base Definition. The existing IPLA specifies a royalty rate of 6.0%, which is consistent with the proposed APA position. However, the precision of the computation base—specifically, the definition of "IP-attributable revenues"—requires careful scrutiny.
The APA application relies on the computation of IP-attributable revenues as 18.1% of HSI's net US revenues, reflecting the proportion of HSI's product revenues that is attributable to products incorporating the Licensed Intangibles (as distinguished from products incorporating intangibles developed under the CSA or products that do not incorporate HSAG's proprietary process technology). This 18.1% figure was derived from a product-line analysis conducted by Meridian Economics GmbH, which classified HSI's revenue streams by the underlying technology node and attributed revenues to the Licensed Intangibles based on the technology content of each product family.
It is critical that the IPLA itself clearly define the concept of "IP-attributable revenues" and specify the methodology for computing the 18.1% share. If the current IPLA uses a different computation base—for example, if it applies the 6.0% royalty to HSI's total net revenues rather than to the 18.1% IP-attributable subset—the resulting royalty payment would be significantly different from the amount contemplated by the APA, creating an inconsistency that the competent authorities are likely to identify during the APA examination process. Conversely, if the IPLA defines the computation base in vague or ambiguous terms (e.g., "revenues attributable to products utilizing HSAG technology"), the lack of precision could lead to disputes over the computation methodology.
Recommendation: The IPLA should be amended to include the following:
(a) A precise definition of "IP-attributable revenues" that is consistent with the methodology used in the APA application, specifying that IP-attributable revenues equal 18.1% of HSI's net US revenues (or, alternatively, specifying the product families and technology nodes included in the computation and the methodology for calculating the percentage).
(b) A schedule or formula documenting the derivation of the 18.1% figure, with a provision for periodic recalculation (e.g., annually or triennially) if the product mix changes materially.
(c) Confirmation that the royalty rate is 6.0%, applied to IP-attributable revenues as defined above.
Issue 2: Scope of Licensed Intangibles. The CUT benchmark set used in the APA application is based on comparable licenses for semiconductor process technology and design libraries. The comparability of the benchmark set depends on the scope of the Licensed Intangibles under the IPLA being consistent with the scope of the intangibles licensed in the comparable agreements.
The existing IPLA defines "Licensed Intangibles" in broad terms, encompassing "proprietary semiconductor process technology, design libraries, and related intangibles." While this definition is generally appropriate, it raises two concerns.
First, the definition must be sufficiently specific to match the scope of the comparable uncontrolled transactions identified in the CUT analysis. If the IPLA's definition is broader than the scope of the comparable agreements—for example, if it inadvertently includes trade names, marketing intangibles, or workforce-in-place intangibles that are not present in the comparable transactions—the CUT analysis may be vulnerable to challenge on comparability grounds.
Second, and more importantly, the definition must clearly delineate the Licensed Intangibles (which are subject to the royalty) from the intangibles being developed under the CSA (which are subject to cost sharing, not a royalty). The CSA governs the development of next-generation 2nm and sub-2nm process technology. The IPLA covers existing and legacy process technology (7nm, 5nm, and 3nm nodes). If the definition of Licensed Intangibles is not clearly limited to the legacy technology, there is a risk of overlap with the CSA-covered intangibles, which could result in double-counting (HSI paying both a royalty and a cost-sharing contribution with respect to the same intangibles) or, conversely, gaps (intangibles for which no intercompany charge is made).
Recommendation: The definition of "Licensed Intangibles" should be revised to:
(a) Specifically enumerate the technology nodes covered by the license (7nm, 5nm, and 3nm process technology and associated design libraries).
(b) Explicitly exclude intangibles being developed under the CSA (2nm and sub-2nm process technology).
(c) Include a clear statement that the Licensed Intangibles do not include trade names, trademarks, marketing intangibles, or workforce-in-place, unless such intangibles are specifically enumerated.
(d) Provide a mechanism for updating the scope of Licensed Intangibles if new technology nodes are developed outside the CSA and become commercially deployed during the APA period.
Issue 3: Interaction with the Cost Sharing Arrangement. As noted above, the CSA governs the development of next-generation 2nm and sub-2nm process technology, while the IPLA covers existing and legacy process technology. These two agreements are economically complementary, as they collectively govern the intercompany charges for all of HSAG's proprietary semiconductor technology used by HSI.
However, the existing agreements do not contain any cross-references or coordination provisions. This creates a risk of ambiguity regarding the treatment of intangibles that transition from the "development" phase (governed by the CSA) to the "commercial deployment" phase (potentially governed by the IPLA). For example, when the 2nm process technology currently being developed under the CSA reaches commercial maturity and begins generating revenue for HSI, the question arises whether HSI's use of that technology in its distribution activities is covered by the CSA (because HSI co-funded the development through cost-sharing contributions) or by the IPLA (because the technology has now become a "legacy" technology subject to licensing). If the CSA grants HSI exploitation rights that are perpetual and royalty-free (as is typical for CSA participants), then the 2nm technology should never become subject to the IPLA royalty. However, this must be clearly documented.
Recommendation: The following coordination provisions should be inserted:
(a) Cross-references: Both the IPLA and the CSA should contain cross-references to each other, acknowledging the existence and scope of the other agreement.
(b) Transition provision: The IPLA should include a provision clarifying that intangibles developed under the CSA, for which HSI has made cost-sharing contributions and acquired exploitation rights, are not subject to the IPLA royalty. This effectively creates a "carve-out" for CSA-developed intangibles.
(c) Sunset provision: Conversely, the IPLA should clarify that as legacy technology nodes (currently 7nm, 5nm, and 3nm) reach end-of-life and are no longer commercially deployed, the corresponding Licensed Intangibles may be removed from the IPLA schedule, reducing the IP-attributable revenue computation accordingly.
Issue 4: Withholding Tax and Treaty Benefits. Article 12 of the US-Germany Treaty provides that royalties arising in a Contracting State and beneficially owned by a resident of the other Contracting State may be taxed only in that other Contracting State—i.e., a 0% withholding rate applies to qualifying royalties paid by a US source to a German recipient, provided the limitation on benefits ("LOB") requirements of Article 28 are satisfied.
The current IPLA contains general language requiring HSI to withhold applicable US tax on royalty payments "unless an exemption or reduction is available under an applicable income tax treaty." However, the agreement does not specifically reference Article 12 of the US-Germany Treaty, does not address the LOB requirements, and does not require HSI to obtain and maintain a valid IRS Form W-8BEN-E from HSAG.
While the substantive Treaty entitlement is not in doubt—HSAG clearly qualifies for Treaty benefits as a German Aktiengesellschaft that is publicly traded on the Frankfurt Stock Exchange and satisfies the LOB provisions—the IPLA's withholding tax provisions should be updated to reflect current practice and regulatory requirements.
Recommendation: The IPLA should be amended to:
(a) Specifically reference Article 12 of the US-Germany Treaty and the applicable 0% withholding rate for qualifying royalties.
(b) Include representations by HSAG regarding its eligibility for Treaty benefits under the LOB provisions of Article 28.
(c) Require HSAG to provide and maintain a valid IRS Form W-8BEN-E, updated at least every three years or upon a change in circumstances.
(d) Allocate the economic risk of withholding tax (i.e., if withholding is required due to a change in law, Treaty interpretation, or HSAG's eligibility, which party bears the economic cost).
Issue 5: Term and Termination. The IPLA has an indefinite term, subject to termination by either party on twelve months' written notice. As with the MISA, this termination provision creates a potential inconsistency with the proposed APA. The royalty methodology under the IPLA is a core component of the APA, and termination or material modification of the IPLA during the APA period could disrupt the covered transactions and the taxpayer's ability to comply with the APA terms.
Recommendation: The IPLA's term and termination provisions should be aligned with the APA period, consistent with the recommendations made for the MISA in Section III.C.5 above. Specifically:
(a) The royalty rate, computation methodology, and Licensed Intangibles definition should remain in effect for the duration of the APA term (January 1, 2025, through December 31, 2029).
(b) Any termination or material amendment of the IPLA during the APA term should require prior notification to the relevant competent authorities.
(c) The royalty computation and payment obligations should survive termination with respect to any fiscal year that has commenced prior to the effective date of termination.
Issue 6: Audit and Verification Rights. The IPLA grants HSAG the right to audit HSI's books and records to verify the royalty computation, upon thirty (30) days' advance written notice. While this provision is standard in license agreements, its operational adequacy should be confirmed in light of the APA compliance reporting requirements.
Under Rev. Proc. 2015-41 § 7, the taxpayer must file annual compliance reports that include, among other things, a computation of the royalty for each covered year, reconciled to the audited financial statements. The audit rights provision in the IPLA should be operationally compatible with this requirement, including providing HSAG (and its auditors) with access to the segmented financial data necessary to verify the IP-attributable revenue calculation and the royalty computation.
Additionally, Gresham Whitfield LLP, as the external auditor for both HSAG (audit partner Simon Cardwell, London) and HSI (audit partner Janet Okonkwo, Houston), will need to verify the intercompany royalty in connection with their annual audit procedures. The IPLA's audit rights provision should not create conflicts with or obstacles to the external audit process.
Recommendation: The IPLA's audit rights provisions should be updated to:
(a) Grant HSAG (and its designated auditors or advisors) the right to audit HSI's books and records relevant to the royalty computation, including segmented revenue data by product family and technology node.
(b) Specify that audits may be conducted annually, on reasonable notice (not less than fifteen business days), and at HSAG's expense.
(c) Require HSI to maintain records in sufficient detail to support the IP-attributable revenue calculation and to permit reconciliation to the audited financial statements.
(d) Include a cooperation clause requiring both parties to cooperate with Gresham Whitfield LLP's audit procedures and with the preparation of the annual APA compliance report.
D. Summary of Recommended IPLA Amendments
V. Cost Sharing Arrangement (CSA)
A. Overview of Current Terms
The CSA was executed on July 15, 2018, between HSAG and HSI. The arrangement is structured as a Qualified Cost Sharing Arrangement ("QCSA") within the meaning of Treas. Reg. § 1.482-7 and governs the joint development of next-generation 2nm and sub-2nm semiconductor process technology. The CSA is accompanied by a Platform Contribution Transaction ("PCT") agreement, executed contemporaneously, under which HSI made a buy-in payment to HSAG in consideration for the pre-existing intangible property contributed by HSAG to the CSA at inception.
Under the CSA, HSAG and HSI share the costs of qualifying research and development activities ("intangible development costs" or "Coss") in proportion to their reasonably anticipated benefits from the exploitation of the intangibles developed under the arrangement. HSI's cost-sharing percentage is 22.5%, reflecting HSI's anticipated benefit share based on its North American exploitation rights—i.e., the right to exploit the CSA-developed intangibles in the North American market (the United States, Canada, and Mexico).
For FY 2024, total qualified R&D costs under the CSA were €998,200,000. HSI's share of these costs was €998,200,000 × 22.5% = €224,600,000, or approximately $231,300,000 at the average 2024 EUR/USD exchange rate. HSAG's total R&D expenditure for FY 2024 was €1,420,000,000, of which €998,200,000 (approximately 70.3%) qualified as coss under the CSA. The remaining €421,800,000 represents R&D expenditures that fall outside the scope of the CSA, including maintenance and incremental improvement R&D on existing 7nm, 5nm, and 3nm technology nodes, customer-specific design work, and general corporate research activities.
The PCT, executed on July 15, 2018, required HSI to make a lump-sum buy-in payment of $312,500,000 to HSAG, representing the fair market value of HSI's interest in the pre-existing intangibles contributed by HSAG to the CSA at inception. The buy-in was valued using the income method prescribed by Treas. Reg. § 1.482-7(g)(4), with a discount rate of 11.8% and a projection period of fifteen (15) years. The valuation was prepared by Stonebridge Valuation Partners LLC (Marcus Reinhardt, Managing Director; 200 Park Avenue, Suite 1510, New York, New York 10166), an independent valuation firm retained by HSAG for this purpose.
The CSA contains provisions governing the identification and allocation of coss, the determination of anticipated benefit shares, the scope of divisional interests (exploitation rights), the treatment of contributions to the CSA, the ownership of developed intangibles, and the termination and buy-out mechanics. The governing law of the CSA is US (Delaware) law, reflecting the applicability of Treas. Reg. § 1.482-7 as the governing regulatory framework.
B. Proposed APA Methodology for Cost Sharing
The proposed APA methodology for the cost-sharing transactions governed by the CSA follows the framework prescribed by Treas. Reg. § 1.482-7. Specifically:
• Anticipated benefit shares are determined using the income method, under which each participant's share of the total anticipated benefits from the CSA-developed intangibles is estimated based on projected income streams from the exploitation of those intangibles in each participant's territory. HSI's benefit share has been determined to be 22.5%, reflecting the proportion of total projected income attributable to the North American market.
• The PCT valuation has been supported by the 2018 income-method analysis prepared by Stonebridge Valuation Partners LLC. The APA application will present this valuation as the basis for the buy-in payment and will address the IRS's potential questions regarding the appropriateness of the discount rate, projection assumptions, and terminal value methodology.
• Triennial review: The APA proposes that the 22.5% benefit share be subject to a triennial review and, if necessary, prospective adjustment based on updated revenue projections and market data. This mechanism is intended to ensure that the benefit shares remain reflective of the parties' reasonably anticipated benefits over the APA term, consistent with the requirements of Treas. Reg. § 1.482-7(e)(2)(ii).
C. Consistency Analysis — Identified Issues
Issue 1: Definition of "Qualified R&D Costs" (Intangible Development Costs — Coss). The CSA's definition of intangible development costs is the foundational element of the cost-sharing computation. Under Treas. Reg. § 1.482-7(d), coss include all costs incurred by the CSA participants that relate to the intangible development activity, including direct and indirect costs, overhead, and an arm's-length charge for the use of tangible property contributed to the development activity.
For FY 2024, €998,200,000 out of HSAG's total R&D expenditure of €1,420,000,000 was classified as qualifying coss under the CSA. The remaining €421,800,000 was treated as non-qualifying R&D. This distinction is critical: if the coss definition is ambiguous, the IRS may challenge the scope of shared costs, either by arguing that additional costs should

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