                       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

Intergraph.

     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.
