Intergraph Corp. v. Comm'r of Internal Revenue, 21286-93.
| Citation | 106 T.C. No. 16,106 T.C. 312 |
| Decision Date | 08 May 1996 |
| Docket Number | No. 21286-93.,21286-93. |
| Parties | INTERGRAPH CORPORATION and Subsidiaries, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | United States Tax Court |
OPINION TEXT STARTS HERE
James R. McCann, Chicago, IL, David G. Glickman, Geoffrey R. Polma, and Sally C. Helppie, Dallas, TX, for petitioner.
Gary F. Walker, Greensboro, NC, Kim Palmerino, and William T. Lundeen, Washington, DC, for respondent.
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.
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.
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.
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 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 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.
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¦
+-----+----------+----------+------------+----------¦
¦ ¦ ¦ ¦ ¦ ¦
+---------------------------------------------------+
FN* 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.
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 Intergraph had guaranteed a debt obligation of Nihon...
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