106 T.C. No. 16
UNITED STATES TAX COURT
INTERGRAPH CORPORATION AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 21286-93. Filed May 8, 1996.
Held: Among other things, petitioner, in the year of payment, is not entitled to a claimed sec. 166, I.R.C., bad debt deduction with respect to its payment as guarantor of a Japanese-yen-denominated loan made to a Japanese subsidiary corporation. Where a guarantor has a right of subrogation against, or a right of reimbursement from, the primary obligor (regardless of whether that right is expressly stated in the guaranty agreement), the provisions of sec. 1.166-9(e)(2), Income Tax Regs., apply, and the guarantor is not entitled to a bad debt deduction until the right of subrogation, or the right of reimbursement, is shown to be worthless. - 2 -
James R. McCann, David G. Glickman, Geoffrey R. Polma, and
Sally C. Helppie, for petitioner.
Gary F. Walker, Kim Palmerino, and William T. Lundeen, for
respondent.
SWIFT, Judge: Respondent determined a deficiency of
$978,567 with respect to Intergraph Corp. (Intergraph) and its
subsidiaries' consolidated 1987 Federal income taxes.
After concessions, the issues for decision are: (1) The
deductibility of a claimed $1,923,103 foreign currency loss and
of a claimed $520,432 interest expense; and (2) if the first
issue is decided against petitioner, the deductibility in the
year of payment of a $6,484,169 bad debt deduction claimed with
respect to a payment Intergraph made of a Japanese-yen-
denominated debt obligation.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for 1987.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
At the time the petition was filed, Intergraph was a
publicly held Delaware corporation with its principal place of
business in Huntsville, Alabama. During the relevant years,
Intergraph was the common parent of a group of affiliated
corporations engaged in the business of designing, manufacturing,
and marketing computer graphics and data base management systems. - 3 -
In the early and mid 1980's, Intergraph’s business grew
rapidly in the United States and in Europe. Outside the United
States, Intergraph conducted most of its business through foreign
subsidiaries. Intergraph and its U.S.-based affiliated companies
used the U.S. dollar as its functional currency.
On May 14, 1985, Intergraph in Japan organized Nihon
Intergraph KK (Nihon Intergraph) as a wholly owned, third-tier
subsidiary to market, sell, and service Intergraph's products.
Nihon Intergraph’s principal place of business was located in
Tokyo, Japan, and Nihon Intergraph used the Japanese yen as its
functional currency.
The Japanese market constituted the third largest market in
the world for the type of products developed by Intergraph, and a
number of Japanese nationals were hired from Intergraph’s chief
competitor in Japan to manage Nihon Intergraph. Intergraph
representatives expected that within Nihon Intergraph's first
year of operation Nihon Intergraph would be profitable.
Upon Nihon Intergraph's organization, Intergraph contributed
to Nihon Intergraph ¥100 million ($392,000)1 as paid-in capital.
Nihon Intergraph representatives estimated to personnel at
Citibank Tokyo that Nihon Intergraph would have sales revenue in
1 Unless otherwise indicated, parenthetical references to U.S. dollars represent references either to Intergraph’s or to Nihon Intergraph’s historical U.S. dollar cost for the referred-to Japanese yen or to the historical U.S. dollar equivalent for the referred-to Japanese yen. - 4 -
1985 of approximately ¥800 million and in 1986 of approximately
¥2 billion.
Substantially all of the banking needs of Intergraph and of
its domestic and foreign subsidiaries were provided by Citicorp,
Inc. (Citicorp), and by Citicorp's banking and financial
subsidiaries. Intergraph’s banking relationship with Citicorp
was maintained primarily through Citicorp North America's2 office
located in Atlanta, Georgia (Citicorp Atlanta). Nihon
Intergraph's banking relationship was maintained primarily
through Citibank, N.A.3
On June 7, 1985, representatives of Nihon Intergraph entered
into an overdraft agreement (Overdraft Agreement) with
representatives of the Tokyo office of Citibank, N.A. (Citibank
Tokyo). Under the terms of the Overdraft Agreement, Nihon
Intergraph was permitted to overdraw its yen-denominated checking
account that was established at Citibank Tokyo by up to ¥300
million. This ¥300 million ceiling on the amount of the
overdraft was not tied to or further limited by the dollar-yen
exchange rate.
This overdraft privilege on Nihon Intergraph's checking
account with Citibank Tokyo was intended to provide a short-term
source of operating funds for Nihon Intergraph in the event Nihon
2 Citicorp North America, Inc., is a subsidiary of Citicorp. 3 Citibank, N.A., is a subsidiary of Citicorp. - 5 -
Intergraph experienced cash-flow problems in its initial months
of operation.
On the Overdraft Agreement, Nihon Intergraph was reflected
as the debtor, and Citibank Tokyo was reflected as the creditor.
Intergraph representatives did not sign, and Intergraph was not
reflected as a debtor, as a co-obligor, as a guarantor, nor in
any other capacity, on the Overdraft Agreement.
Due to Nihon Intergraph's affiliation with Intergraph and
Intergraph’s longstanding banking relationship with Citicorp, the
interest rate that was to be charged Nihon Intergraph by Citibank
Tokyo on the amount overdrawn on the checking account (overdraft
amount) reflected the best available short-term interest rate.
Interest that accrued on the overdraft amount was charged
directly to Nihon Intergraph's checking account, thereby
increasing the overdraft amount.
The overdraft amount was payable by Nihon Intergraph in yen
on demand from Citibank Tokyo.
On June 28, 1985 (with regard to the overdraft amount and
any other loans, advances, and overdrafts owed by Nihon
Intergraph to Citibank Tokyo), Intergraph entered into a guaranty
agreement (Guaranty Agreement) with Citibank, N.A., under which
Intergraph, among other things, guaranteed to repay to Citibank,
N.A., on demand the overdraft amount. The Guaranty Agreement was
similar to agreements that Intergraph entered into on behalf of
its other subsidiaries. - 6 -
On several occasions, from June of 1985 through November of
1987, operating receipts of Nihon Intergraph in the total
cumulative amount of ¥151,657,808 were deposited into Nihon
Intergraph's checking account at Citibank Tokyo thereby reducing
the balance of Nihon Intergraph's overdraft amount. In essence,
the overdraft privilege on Nihon Intergraph’s checking account at
Citibank Tokyo operated as a short-term line of credit for Nihon
Intergraph.
In 1985, 1986, and 1987, Nihon Intergraph did not perform as
well as expected and incurred net operating losses. By the end
of 1987, the overdraft amount, including principal and interest,
had increased to ¥823,943,385 ($4,561,066).
The chart below reflects for 1985, 1986, and 1987 Nihon
Intergraph’s gross receipts, net losses, and the incremental
increase that occurred each year in the yen and historical dollar
equivalent balance of the overdraft amount.
Increase in Balance of Gross Overdraft Amount Year Receipts Net Loss Yen Dollar*
1985 $ 823,000 $ 1,535,000 ¥361,572,000 $1,631,724 1986 1,194,000 4,354,000 341,884,041 2,094,214 1987 226,000 2,146,000 120,487,344 835,128
Total $2,243,000 $8,035,000 ¥823,943,385 $4,561,066
* The dollar equivalent amounts reflected in this chart reflect historical dollar-yen exchange rates as they existed at the end of each year or at the end of each month in which an increase in the overdraft amount occurred, not the dollar equivalent based on the Dec. 23, 1987, exchange rate. - 7 -
During 1985, 1986, and through November of 1987, on the
books and records of Nihon Intergraph, of Intergraph, and of
Citibank Tokyo, the principal and interest relating to the
overdraft amount were treated as a yen-denominated debt
obligation of Nihon Intergraph owed to Citibank Tokyo.
On Nihon Intergraph's 1985 and 1986 balance sheets, the
overdraft amount was reflected as a debt obligation of Nihon
Intergraph. The overdraft amount was not reflected as a debt
obligation of Intergraph nor as a capital contribution from
Intergraph to Nihon Intergraph.
For 1985, 1986, and through November of 1987, the overdraft
amount was reported by Nihon Intergraph to Japanese tax and
regulatory authorities as a debt obligation of Nihon Intergraph
to Citibank Tokyo.
For 1985, the overdraft amount was reported by Intergraph on
Form 5471 (Information Return with Respect to a Foreign
Corporation filed with respondent in regard to Nihon Intergraph)
as a debt obligation of Nihon Intergraph.4 The overdraft amount
was not reflected as a debt obligation of Intergraph, nor as a
capital contribution from Intergraph to Nihon Intergraph.
For 1985, 1986, and through November of 1987, with regard to
the overdraft amount, Intergraph reported to its stockholders and
to the U.S. Securities and Exchange Commission (SEC) that
4 Because Nihon Intergraph constituted a foreign corporation, it did not qualify as part of petitioner's consolidated group for purposes of filing a consolidated U.S. Federal income tax return. - 8 -
Intergraph had guaranteed a debt obligation of Nihon Intergraph.
During 1985, 1986, and 1987, Intergraph reported no increase in
the amount of its capital contribution to Nihon Intergraph over
and above its original ¥100 million ($392,000) initial capital
contribution.
On its financial statements for 1985, 1986, and through
November of 1987, Intergraph reflected no foreign currency
exposure with regard to the outstanding balance of the overdraft
amount.
From 1985 through the end of 1987, the dollar weakened
dramatically against the yen -- dropping from $1:¥249 to $1:¥126.
During 1985, 1986, and through November of 1987, at the end of
each month, on Nihon Intergraph's (not Intergraph's) books and
records, the amount of the monthly increase in the overdraft
amount was assigned a historical dollar equivalent based on the
then-prevailing exchange rate. As indicated above, on
December 23, 1987, the historical dollar equivalent of the total
¥823,943,385 balance of the overdraft amount equaled $4,561,066.
As stated, however, based on the dollar-yen exchange rate
that existed on December 23, 1987, the dollar equivalent of the
¥823,943,385 balance of the overdraft amount, as of December 23,
1987, equaled $6,484,169.
On or about December 23, 1987, based on a number of
considerations, Intergraph representatives decided to eliminate
the ¥823,943,385 balance of the overdraft amount. Accordingly, - 9 -
on December 23, 1987, Intergraph purchased from Citibank, N.A.’s,
New York City office ¥823,943,385 at a cost of $6,484,169 and
transferred the yen into Nihon Intergraph’s checking account at
Citibank Tokyo. As a result, the ¥823,943,385 debit balance of
Nihon Intergraph's checking account was reduced to zero. Nihon
Intergraph did not draw any checks on the checking account
thereafter, and the checking account was closed on April 20,
1988.
Although Citibank Tokyo apparently had concerns with regard
to the large amount of the overdraft, neither Citibank, N.A.,
Citicorp Atlanta, nor Citibank Tokyo ever made a demand, pursuant
to the Overdraft Agreement, for payment by Nihon Intergraph or by
Intergraph of the balance, or of any portion of the balance, of
the overdraft amount.
Similarly, neither Citibank, N.A., Citicorp Atlanta, nor
Citibank Tokyo ever made a demand, pursuant to the Guaranty
Agreement, for payment by Intergraph of the balance, or of any
portion of the balance, of the overdraft amount.
After the transfer of the ¥823,943,385 into Nihon
Intergraph’s checking account, Nihon Intergraph continued to
operate in Japan, and Intergraph provided additional funds to
Nihon Intergraph through intercompany loans. As of the date of
trial, Nihon Intergraph continues to operate in Japan.
On Nihon Intergraph’s 1987 yearend financial statements,
there was reflected an ¥823,943,385 increase in the intercompany - 10 -
debt owed by Nihon Intergraph to Intergraph and a reduction to
zero of Nihon Intergraph's third-party loan payable account
(reflecting the fact that the overdraft amount had been paid
off). Nihon Intergraph’s capital account continued to reflect
only Intergraph’s initial capital contribution of ¥100 million.
On Intergraph’s 1987 yearend financial statement,
Intergraph, in effect, was treated as subrogated to Citibank
Tokyo’s creditor rights with regard to the overdraft amount, and
Intergraph’s transfer of the ¥823,943,385 into Nihon Intergraph's
checking account to eliminate the overdraft amount was reflected
as an intercompany loan from Intergraph to Nihon Intergraph.
In March of 1988, on Nihon Intergraph’s balance sheet
attached to Intergraph's 1987 Form 5471 filed with respondent
with respect to Nihon Intergraph, Nihon Intergraph’s intercompany
debt to Intergraph in the amount of ¥823,943,385 ($6,484,169) was
reflected as paid off, and Intergraph's capital investment in
Nihon Intergraph was reflected as increased by the same amount.
For Japanese reporting purposes for 1987, Nihon Intergraph’s
financial statements continued to reflect that Intergraph's
payment of the overdraft amount gave rise to an intercompany debt
to Intergraph.
On petitioner's 1987 consolidated Federal income tax return,
however, petitioner treated the overdraft amount as a loan by
Citibank Tokyo to Intergraph, not as a loan to Nihon Intergraph,
and petitioner treated Intergraph's transfer of the ¥823,943,385 - 11 -
into Nihon Intergraph's checking account at Citibank Tokyo as
giving rise to a $1,923,103 foreign currency loss under section
988 and to a $520,432 interest deduction under section 163(a).
The claimed $1,923,103 foreign currency loss was computed by
subtracting from Intergraph's $6,484,169 cost of the ¥823,943,385
that it purchased on December 23, 1987, and transferred into
Nihon Intergraph's checking account, the historical $4,561,066
equivalent of the overdraft amount as reflected on Nihon
Intergraph's records. The $520,432 interest deduction that
petitioner claimed was based on interest that had accrued and
that was charged to the overdraft amount over the course of the
prior 2-1/2 years.
On audit of petitioner's 1987 consolidated Federal income
tax return, respondent determined that the overdraft amount
should be treated as a loan by Citibank Tokyo to Nihon
Intergraph, not as a loan to Intergraph, and thus that
Intergraph's transfer of the ¥823,943,385 into Nihon Intergraph's
checking account on December 23, 1987, should be treated as a
capital contribution to Nihon Intergraph and that Nihon
Intergraph, not Intergraph, should be treated as paying off the
overdraft amount. Because the mere purchase of foreign currency
to make a capital contribution to a corporation produces neither
a foreign currency loss nor an interest expense, respondent
disallowed Intergraph's claimed $1,923,103 foreign currency loss
under section 988 and Intergraph’s $520,432 claimed interest - 12 -
deduction under section 163(a). Respondent now argues that
Intergraph was a mere guarantor of the overdraft amount and
therefore that Intergraph is not entitled to the claimed foreign
currency loss under section 988 and the claimed interest expense
deduction under section 163(a).
OPINION
Foreign Currency Loss and Interest Expense
Generally, under section 988 a taxpayer is entitled to an
ordinary loss deduction for a foreign currency loss arising from
a “section 988 transaction”. Sec. 988(a)(1)(A). Where a
taxpayer is a primary obligor on a debt obligation that is
denominated in a nonfunctional currency, repayment of the debt
obligation generally qualifies as a “section 988 transaction”.
Sec. 988(c)(1)(A) and (B). A foreign currency loss occurs to the
extent a loss is realized by reason of a change in the exchange
rate between the obligor's functional currency and the
nonfunctional currency from the date the obligor becomes
obligated on the debt obligation to the date the obligor makes
payment on the debt obligation. Sec. 988(b)(2) and (c)(2)(A) and
(3)(A).
On brief, petitioner notes that the provisions of section
988 and the legislative regulations thereunder do not expressly
provide that a taxpayer's payment, as a mere guarantor, under a
guaranty agreement would not qualify as a "section 988
transaction" giving rise to a recognizable foreign currency loss. - 13 -
Petitioner and respondent, however, for purposes of this case,
treat a payment, as a mere guarantor, under a guaranty agreement
as not qualifying as a "section 988 transaction". See sec.
988(c)(1)(B)(i); sec. 1.988-1T(a)(2)(i), Temporary Income Tax
Regs., 54 Fed. Reg. 38824 (Sept. 21, 1989).
As a general rule, under section 163(a), a taxpayer is
permitted an interest expense deduction only if the interest
represented a debt obligation of the taxpayer, and a guarantor is
not entitled to an interest expense deduction with respect to
payments made in fulfillment of a mere guaranty obligation.
Hynes v. Commissioner, 74 T.C. 1266, 1287-1288 (1980).
Petitioner argues that Intergraph should be treated as the
primary debtor or obligor on the overdraft amount and that the
total ¥823,943,385 balance of the overdraft amount should be
regarded as a loan made directly to Intergraph. Petitioner
therefore argues that Intergraph, with regard to its payment of
the overdraft amount, should be entitled to deduct under section
988 a $1,923,103 foreign currency loss and under section 163(a) a
$520,432 accrued interest expense. Petitioner also argues that
even if the overdraft amount is to be treated as a loan made to
Nihon Intergraph, Intergraph should be regarded as a co-obligor
on the loan and should be entitled to the foreign currency loss
and interest expense deductions claimed under sections 988 and
163(a). - 14 -
Alternatively, petitioner argues that if Intergraph is not
entitled to the claimed foreign currency loss and interest
expense deductions, Nihon Intergraph’s obligation to reimburse
Intergraph for Intergraph’s payment of the overdraft amount
should be treated as worthless, and Intergraph should be entitled
for 1987 to a $6,484,169 bad debt deduction under section 166
with regard thereto.
Respondent argues that the form and substance of the
transaction relating to the overdraft amount establish that the
overdraft amount constituted a loan made to Nihon Intergraph, not
to Intergraph. Respondent therefore argues that Intergraph
should be treated as a mere guarantor of the overdraft amount and
that Intergraph is not entitled to the claimed foreign currency
loss and interest expense deductions.
Generally, whether the form of a loan made to a corporation
should be disregarded and whether the loan should be treated as
made to a shareholder of the corporation, followed by a capital
contribution of the loan proceeds to the corporation, is resolved
in light of traditional debt-equity principles. Santa Anita
Consol., Inc. v. Commissioner, 50 T.C. 536, 550 (1968); Atkinson
v. Commissioner, T.C. Memo. 1984-378. These principles include,
among others, whether the debt obligation relating to the loan
was subordinated to other debt obligations owed by the
corporation, the creditworthiness of the corporation, the
corporation’s payment history on the loan, the prospects that the - 15 -
corporation would pay off the loan, the extent to which the loan
proceeds were used to acquire capital assets for the corporation,
whether the corporation was thinly capitalized, and the intent of
representatives of the corporation and of the shareholder. See
Selfe v. United States, 778 F.2d 769, 773 n.9 (11th Cir. 1985);
In re Lane, 742 F.2d 1311, 1314-1315 (11th Cir. 1984); Georgia-
Pac. Corp. v. Commissioner, 63 T.C. 790, 796-800 (1975); Atkinson
v. Commissioner, supra.
No single factor is controlling, and each case is to be
decided upon its own facts. Plantation Patterns, Inc. v.
Commissioner, 462 F.2d 712, 719 (5th Cir. 1972), affg. T.C. Memo.
1970-182; Georgia-Pac. Corp. v. Commissioner, supra at 796; Blum
v. Commissioner, 59 T.C. 436, 440 (1972).
We agree with respondent in this case. The evidence is
compelling that the overdraft amount should be treated as a loan
made from Citibank Tokyo to Nihon Intergraph and not as a loan
made to Intergraph. Intergraph is to be regarded as a mere
guarantor, and its payment of ¥823,943,385 on December 23, 1987,
is to be regarded as a payment of Intergraph's obligation as
guarantor under the Guaranty Agreement. Accordingly, the foreign
currency loss and the interest expense deductions claimed by
Intergraph with regard thereto are disallowed.
The Overdraft Agreement created an unconditional debt
obligation on the part of Nihon Intergraph to pay off the
overdraft amount. Intergraph was not even mentioned in the - 16 -
Overdraft Agreement. Throughout 1985, 1986, and through November
of 1987, the overdraft amount was reported on Nihon Intergraph’s
financial statements as a debt obligation of Nihon Intergraph,
and Nihon Intergraph reported to Japanese tax and regulatory
authorities that the overdraft amount represented a loan from
Citibank Tokyo to Nihon Intergraph. On attachments to
petitioner's 1985 and 1986 consolidated U.S. Federal income tax
returns and on petitioner's 1985 and 1986 filings with the SEC,
the overdraft amount was reflected as Nihon Intergraph’s debt
obligation that was guaranteed by Intergraph. The overdraft
amount was reflected on Nihon Intergraph’s Japanese tax returns
as a debt obligation of Nihon Intergraph.
Citibank Tokyo looked primarily to Nihon Intergraph for
payment of the overdraft amount.
In 1985, 1986, and through November of 1987, not just the
form but also the substance of the loan reflects a loan to Nihon
Intergraph. For example, if the substance of the loan
constituted a loan made to Intergraph, Intergraph would have had
to reflect and would have so reflected on its financial
statements a foreign currency exposure with regard to the
overdraft amount and, in all likelihood, Intergraph would have
repaid the ¥823,943,385 directly to the creditor (namely, to
Citibank Tokyo). Intergraph would not have transferred the
¥823,943,385 into the checking account of Nihon Intergraph, an - 17 -
allegedly insolvent corporation. These are economic matters not
just of form but also of substance.
The evidence establishes that in both form and substance the
overdraft amount should be treated as a loan from Citibank Tokyo
to Nihon Intergraph and not as a loan from Citibank Tokyo to
Further, the evidence does not establish that, for purposes
of section 988 and section 163(a), Intergraph should be treated
as a co-obligor on the overdraft amount. The Overdraft Agreement
lists Nihon Intergraph as the only obligor on the overdraft
amount. Intergraph signed only the Guaranty Agreement and did
not sign the Overdraft Agreement as co-obligor.
Petitioner relies on Larson v. Commissioner, 44 B.T.A. 1094
(1941), affd. 131 F.2d 85 (9th Cir. 1942), and Rev. Rul. 71-179,
1971-1 C.B. 58. In Larson and in Rev. Rul. 71-179, the taxpayer
cosigned with her child a promissory note, and the taxpayer was
jointly and severally liable on the promissory note. In the
instant case, Intergraph did not cosign the Overdraft Agreement,
and Citibank Tokyo looked primarily to Nihon Intergraph and only
secondarily to Intergraph for payment of the overdraft amount.
After considering all of the facts and circumstances, we
conclude that the loan from Citibank Tokyo was made to Nihon
Intergraph. Intergraph's obligation thereon represented that of
a mere guarantor, and Intergraph's payment of the ¥823,943,385 to
eliminate the overdraft amount constituted Intergraph's payment - 18 -
as a guarantor. Accordingly, with respect to its transfer of the
¥823,943,385 into Nihon Intergraph's checking account at Citibank
Tokyo, Intergraph is not entitled to the claimed foreign currency
loss deduction under section 988, nor to the claimed interest
expense deduction under section 163(a).
Bad Debt Deduction
Alternatively, petitioner argues that Nihon Intergraph's
debt obligation to Intergraph that arose on Intergraph’s transfer
of the ¥823,943,385 into Nihon Intergraph's checking account was
worthless and that for 1987 Intergraph should be entitled to a
bad debt deduction under section 166 with regard thereto.
Where a taxpayer-guarantor pays the debt obligation of
another and where the taxpayer thereby becomes subrogated to the
rights of the original creditor and has a right of reimbursement
from the original debtor, the taxpayer becomes entitled to a bad
debt deduction under section 166(a)(1) only if and when the new
debt obligation to the taxpayer-guarantor (namely, the right of
reimbursement) becomes worthless. Putnam v. Commissioner, 352
U.S. 82, 85 (1956); Black Gold Energy Corp. v. Commissioner, 99
T.C. 482, 487 (1992), affd. without published opinion 33 F.3d 62
(10th Cir. 1994); Benak v. Commissioner, 77 T.C. 1213, 1218
(1981); see sec. 1.166-9(a), (d), and (e)(2), Income Tax Regs.
Insolvency is only one indication of the worthlessness of a
debt obligation. Roth Steel Tube Co. v. Commissioner, 620 F.2d
1176, 1181 (6th Cir. 1980), affg. 68 T.C. 213 (1977); Riss v. - 19 -
Commissioner, 56 T.C. 388, 408 (1971), affd. in part and remanded
478 F.2d 1160 (8th Cir. 1973). The mere fact that a business is
on the decline, that it has failed to make a profit, or that its
debt obligation may be difficult to collect does not necessarily
justify treating the debt obligation as worthless. Riss v.
Commissioner, supra at 407.
The fact that a debtor is able to continue business
operations in the face of operating losses and receives continued
financial backing of the creditor militates against a finding
that the debt obligation has become worthless. See Roth Steel
Tube Co. v. Commissioner, supra at 1182; Riss v. Commissioner,
supra at 408.
The record in this case does not establish that Nihon
Intergraph’s debt obligation to Intergraph became worthless in
1987. Although Nihon Intergraph’s liabilities may have exceeded
its assets during 1985, 1986, and 1987, Nihon Intergraph
continued to operate as a going concern, and Intergraph continued
to extend its guarantee in support of the overdraft privilege.
Even at the time of Intergraph’s transfer of the ¥823,943,385
into Nihon Intergraph's checking account, Intergraph intended for
Nihon Intergraph to continue operating in Japan, and Intergraph
continued to provide funds to Nihon Intergraph.
It has not been established that in 1987 there existed no
reasonable expectation that Intergraph would be repaid for - 20 -
transferring the ¥823,943,385 into Nihon Intergraph's overdraft
account.
Petitioner argues that under section 1.166-9(a) and (e)(2),
Income Tax Regs., because there was no right of subrogation
expressly stated in the Guaranty Agreement, Intergraph should be
entitled to the claimed bad debt deduction in 1987, the year in
which it made payment under the Guaranty Agreement, regardless of
whether Intergraph's right of reimbursement from Nihon Intergraph
was worthless. We believe petitioner misreads the referred-to
regulations.
Under section 1.166-9(a), Income Tax Regs., the right of a
guarantor to claim a bad debt deduction in the year of payment --
regardless of the solvency or financial status of the original
debtor -- applies only where the guarantor has no right of
subrogation against, and no right of reimbursement from, the
original debtor.
Section 1.166-9(a), (d), and (e)(2), Income Tax Regs.,
properly read, stands for the proposition that where a guarantor
does have rights of subrogation and reimbursement from the
original debtor (regardless of whether or not these rights are
expressly stated in the guaranty agreement), the provisions of
section 1.166-9(e)(2), Income Tax Regs., apply, and the guarantor
is not entitled to a bad debt deduction until the rights of
subrogation and reimbursement are shown to be worthless. See
Howell v. Commissioner, 69 F.2d 447, 451 (8th Cir. 1934), affg. - 21 -
22 B.T.A. 140 (1931); Martin v. Commissioner, 52 T.C. 140, 143
(1969), affd. per curiam 424 F.2d 1368 (9th Cir. 1970); Rietzke
v. Commissioner, 40 T.C. 443, 451 (1963); Bradford v.
Commissioner, 22 T.C. 1057, 1069 (1954), revd. on other issues
233 F.2d 935 (6th Cir. 1956); Standard Oil Co. v. Commissioner, 7
T.C. 1310, 1323 (1946), supplemented by 11 T.C. 843 (1948).
Petitioner appears to acknowledge in this case that
Intergraph had implied rights of subrogation and reimbursement
under the Guaranty Agreement. We agree. Intergraph's control of
Nihon Intergraph, if nothing else, would appear to provide
implied rights of subrogation against and reimbursement from
Nihon Intergraph.
Because it has not been established that Intergraph's rights
of subrogation and reimbursement from Nihon were worthless in
1987, Intergraph is not entitled to the claimed bad debt
deduction under section 166.
Decision will be entered
for respondent.