(5) the ceding insurer can be deprived of surplus at the reinsurer's option or automatically upon the occurrence of some event, such as the insolvency of the ceding insurer, except that termination of the reinsurance agreement by the reinsurer for non-payment of reinsurance premiums shall not be considered to be such a deprivation of surplus; (6) the ceding insurer must, at specific points in time scheduled in the agreement, terminate or automatically recapture all or part of the reinsurance ceded; (7) no cash payment is due from the reinsurer, throughout the lifetime of the reinsurance agreement, with all settlements prior to the termination date of the agreement made only in a "reinsurance account," and no funds in such account are available for the payment of benefits; or (8) the reinsurance agreement involves the possible payment by the ceding insurer to the reinsurer of amounts other than from income reasonably expected from the reinsured policies.[17] The NAIC issued the 1985 model regulation primarily to distinguish reinsurance agreements that legitimately transferred risk from those that did not. The NAIC was concerned that affording reinsurance treatment for regulatory purposes absent a meaningful transfer of risk did not fairly represent the financial condition of the parties to the reinsurance agreement. The 1985 model regulation sets forth rules for a ceding company's transfer of its reserves to a reinsurer. These rules have similarities to the factors identified by the Congress in the conference report on DEFRA, with the notable exception of the factor involving the relative tax positions of the parties (with which the NAIC would not be concerned). This factor favors petitioner. ix. State Determinations The 1989 agreement was examined for risk transfer by the Arizona Department of Insurance and found to have transferred risk. This factor favors petitioner. x. Conclusion We have analyzed the factors mentioned above. Most of these factors favor petitioner. None of these factors favors respondent's determination. We conclude that the factors show that the agreements did not have a significant tax 17 In 1992, the NAIC issued another regulation that generally updated the model regulation. As of Aug. 16, 1993, 42 States had adopted a version of the model regulation or its successor, or had legislation pending. avoidance effect within the meaning of section 845(b). We conclude that respondent's determination to the contrary amounted to an abuse of discretion. We hold for petitioner on this issue. We have considered all arguments made by respondent for a contrary holding and, to the extent not discussed above, find them to be without merit. 4. Amortization of Ceding Commissions We turn to the final issue. Respondent asserted in her amendments that petitioner was not entitled to deduct or amortize any part of the ceding commissions. Respondent alleges that these commissions were not paid to acquire income-producing capital assets, unlike the ceding commissions in Colonial Am. Life Ins. Co. v. Commissioner, 491 U.S. 244 (1989). In Colonial American, the Supreme Court stated that a ceding commission is "an up-front, one-time payment to secure a share in a future income stream." Id. at 260. According to respondent, the ceding commissions were not paid by petitioner for the right to realize income from the reinsured policies because the agreements were designed to return to petitioner income approximately equal to the amount of the commissions. Respondent bears the burden of proof on this issue. Rule 142(a); Estate of Bowers v. Commissioner, 94 T.C. 582, 595 (1990). We find respondent's argument unpersuasive. The short answer to this question is that the ceding commissions were paid to allow petitioner to share in the future income stream from the reinsured policies. Petitioner entered into the agreements and incurred the related commissions for valid and substantial business reasons. The ceding commissions were incurred in arm's-length transactions between unrelated parties. We find that these ceding commissions were "part of the purchase price to acquire the right to a share of future profits", Colonial Am. Life Ins. Co. v. Commissioner, supra at 251, and, as such, were capital expenditures that must be amortized over the life of the agreements, id. at 252–253. Respondent has not proven otherwise. We have considered all arguments made by respondent for a contrary holding and, to the extent not discussed above, find them to be without merit. To reflect the foregoing, Decision will be entered for petitioner. 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. 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. 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, thirdtier 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 paidin 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's 2 office located in Atlanta, Georgia (Citicorp 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. 2 Citicorp North America, Inc., is a subsidiary of 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 yendenominated 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 coobligor, 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 shortterm 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 3 Citibank, N.A., is a subsidiary of Citicorp. |