Note 3 – Income Taxes

We account for income taxes in accordance with ASC Topic 740, Income Taxes. Deferred income taxes are recorded for the expected tax consequences of temporary differences between the tax basis of assets and liabilities for financial reporting purposes and amounts recognized for income tax purposes. As of September 30, 2020, and December 31, 2019, we recorded a valuation allowance equal to the full recorded amount of our net deferred tax assets related to deferred start-up costs and other minor temporary differences since it is more-likely-than-not that such benefits will not be realized. The valuation allowance is reviewed quarterly and is maintained until sufficient positive evidence exists to support its reversal.

A deferred tax liability was recorded on March 19, 2018 when we received CoNCERT’s license and “Know-How” in exchange for Processa stock that had been issued in the Internal Revenue Code Section 351 Transaction. The Section 351 Transaction treats the acquisition of the license and Know-How for stock as a tax-free exchange. As a result, under ASC 740-10-25-51 Income Taxes, we recorded a deferred tax liability of $3,037,147 for the acquired temporary difference between intangible assets for the financial reporting basis of $11,038,929 and the tax basis of $1,782. The deferred tax liability will be reduced for the effect of non-deductibility of the amortization of the intangible asset and may be offset by the deferred tax assets resulting from net operating tax losses.

Under ASC 740-270 Income Taxes – Interim Reporting, we are required to project our annual federal and state effective income tax rate and apply it to the year to date ordinary operating tax basis loss before income taxes. Based on the projection, we expect to recognize the tax benefit from our projected ordinary tax loss, which can be used to offset the deferred tax liabilities related to the intangible assets and resulted in the recognition of a deferred tax benefit shown in the condensed consolidated statements of operations for nine months ended September 30, 2020 and 2019. No current income tax expense is expected for the foreseeable future as we expect to generate taxable net operating losses.

In September 2020, we acquired PCS12852 from Yuhan Corporation for an initial purchase price of $2 million. We also acquired PCS6422 from Elion Oncology, Inc. for an initial purchase price of $3.4 million and PCS11T from Aposense Ltd. for $2.5 million during the fourth quarter of 2020. Our total acquired research and development for 2020 is expected to be $7.9 million. The assets acquired were determined to represent in-process research and development with no alternative future use, so we immediately expensed the full $7.9 million for book purposes and capitalized the amount for tax purposes, creating deferred tax assets. We also established a full valuation allowance against these deferred tax assets.

Under ASC 350-30-35-17A, a research and development asset acquired must be considered an indefinite-lived intangible asset until completion or abandonment of the R&D efforts. Only at that time can one accurately determine the useful life of the research and development asset and begin amortization. Due to their current indefinite lives, we did not offset the acquired in-process research and development assets against our existing deferred tax liability from the CoNCERT transaction explained above. We will determine the useful life of the R&D assets when the research and development efforts are complete.