Tax Law | Expert Legal Commentary

November 17, 2008

Swallows Holding: 3rd Circuit Applies Chevron Deference to Uphold IRS Regulation

Swallows Holding, Ltd. V. Commissioner

By H. Jacob Lager of Zuber Lawler & Del Duca

Swallows Holding: 3rd Circuit Applies Chevron Deference to Uphold IRS Regulation

The recent win for the IRS in Swallows Holding, Ltd. V. Commissioner, 515 F.3d 162 (3rd Cir. 2008), elucidates the ongoing debate over the appropriate standard for judicial review of Treasury regulations. In Swallows, the Third Circuit reversed a Tax Court decision and applied the highly deferential standard set forth in Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984) to uphold a Treasury regulation, finding that Congress intended for the agency action to have the force of law. While the decision is notable for its deferential treatment of the IRS regulation, it is equally notable for the unanswered questions left in its wake.


The taxpayer in Swallows was a Barbados corporation that held real property located in the U.S. The taxpayer earned rental income from the real property from 1993 through 1196, but it did not file U.S. tax returns for those taxable years until 1999. When it did file returns, the taxpayer claimed deductions that were disallowed by the IRS because the returns were filed late.

Specifically, the IRS relied upon 26 U.S.C. section 882(c)(2) and Treasury regulations section 1.882-4(a)(3)(i). Section 882(c)(2) generally provides that a foreign corporation may only receive the allowable deductions, credits and related benefits if it files a true and accurate tax return in the “manner” prescribed by subtitle F. The Treasury secretary later promulgated regulations under I.R.C. section 7805—including 1.882-4(a)(3)(i)—to supplement this statutory provision. Regulation section 1.882-4(a)(3)(i) requires a foreign corporation to file a tax return within 18 months of when the taxes came due. It was undisputed that the Swallows taxpayer did not file its return within 18 months of when the taxes came due; because it was late and therefore not filed in the “manner” prescribed, the IRS disallowed the claimed deductions.

The taxpayer argued that Section 882(c)(2) imposes no timely filing requirement that would preclude the claiming of deductions—the statute only refers to the “manner” prescribed for filing, rather than the “time and manner,” a specific phrase used in various Code sections. On this basis, the taxpayer argued that the Treasury regulation was invalid as inconsistent with Section 882(c)(2).

The Tax Court ruled in favor of the taxpayer

In 2006, the Tax Court agreed that the IRS regulation was invalid because the plain meaning of Section 882(c)(2) imposed no temporal requirement in connection with a foreign corporationÕs ability to obtain deductions and credits. See Swallows Holding, Ltd. v. Commissioner, 126 T.C. 96, 134-146 (2006).

The Tax Court primarily relied upon the holding of National Muffler Dealers Association v. United States, 440 U.S. 472 (1979), which established factors for the court to review in determining whether Treasury regulations are reasonable interpretations of a statute. The Tax Court determined that regulation section 1.882-4(a)(3)(i) failed to meet a number of those factors, including that the regulation was not promulgated contemporaneously with the statute, and the courts have consistently held that the statute and its predecessors did not include a timely filing requirement. 126 T.C. at 137-138.

The Tax Court considered the two-prong test of Chevron U.S.A. Inc. v. Natural Resources Defense Counsel Inc., 467 U.S. 837 (1984)i, but determined that National Muffler was the appropriate standard for reviewing interpretive tax regulations while Chevron applied to “legislative” regulations issued under a specific delegation of authority from the Congress to Treasury.  In any event, the Tax Court opined that Chevron was really just a restatement of the National Muffler holding, and that the court would have reached the same conclusion under either analysis. 126 T.C. at 131.

The Third Circuit overturns the Tax Court, applies Chevron to uphold IRS regulation

On appeal, the Third Circuit reversed the decision of the Tax Court, upholding the IRS regulation as valid. The Third Circuit first stated that National Muffler and Chevron articulated distinct standards that would produce different results. 515 F.3d at 167-168. The Third Circuit stated that the Chevron standard of deference applied because the government put the regulation at issue through the process of public notice and comment, “a move that is indicative of agency action that carries the force of law.” 515 F.3d at 168 (citing United States v. Mead Corp., 533 U.S. 218, 229 (2001)). When Congress does not intend for an agency action to wield the force of law as defined by Mead, a lower deference may be warranted under the Skidmore standard set forth in Skidmore v. Swift & Co., 323 U.S. 134 (1944). Id. Courts have often regarded notice-and-comment as synonymous with Chevron‘s applicability; the Third Circuit was no exception. Id. at 169- 170.

The Third Circuit then analyzed the regulation at issue in Swallows under the Chevron two-part test, and upheld the regulation (see endnote 1). First, the court determined that the statutory provision was ambiguous, as “manner” could include a time element. 515 F.3d at 171. As a result, there was an implicit delegation of authority to the Treasure to fill the gap with a reasonable regulation.  Id.

Second, the court held that deference to the IRS was warranted because the regulation represented a permissible construction of the statute. Id. at 171-172. The court determined that the regulation reasonably balanced the IRSÕs interest in obtaining tax compliance with the foreign corporation’s interest in claiming deductions. Id. at 172. The court noted that Chevron deference is particularly appropriate for extremely complex, technical regulatory schemes like tax laws, and that the IRS is better positioned to make judgments about tax law administration (such as when to draw a “temporal line”) than the courts. Id. at 171-172.


At a minimum, the Swallows decision indicates that foreign corporations seeking tax deductions and credits in the Third Circuit must heed the timely filing requirement of Treasury regulations section 1.882-4(a)(3)(i). This may prove somewhat moot in the future because Forms 1120-F, U.S. Income Tax Return of a Foreign Corporation, must now be filed in Utah (the Tenth Circuit) instead of Philadelphia (the Third Circuit, where the Swallows taxpayer filed its returns. It’s unclear whether the Tenth Circuit Court would follow the lead of the Third Circuit in this opinion.

But Swallows leaves open numerous questions. For example, the Third Circuit reached this decision in large part due to the notice-and-comment process utilized with this particular regulation. It’s unclear, however, what deference the Third Circuit might apply to regulations promulgated under I.R.C. section 7805 without notice-and-comment, but which still arguably carry legal force. The limited Swallows holding may set the stage for an argument that a less deferential standard should apply to regulations promulgated without notice and comment—meaning that future applications of National Muffler and Skidmore in Tax Court and other jurisdictions are similarly unclear.

About the Author

H. Jacob Lager is a Partner of Zuber Lawler & Del Duca, focusing on tax law.

1 The two-prong test of Chevron requires that a Court determine 1) whether Congress has directly spoken to the precise question at issue (in which case the inquiry ends), and 2) if the intent of Congress is unclear, in that the statute is ambiguous or silent as to the particular issue, whether the agency’s regulation is based on a permissible construction of the statute.

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H. Jacob Lager

Companies Mentioned

Internal Revenue Service

Swallows Holding, Inc.

Also See:

In re Quality Stores, Inc.: Sixth Circuit Excludes Some Severance Payments from FICA Tax

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Klauer v. Commissioner: Step Transaction Doctrine Does Not Apply to Multi-Step Bargain Sales to Charity

Holman v. CIR: Valuation of Gifted LLP Shares

Steinhart v. Co. of Los Angeles: Transfer of Life Estate is a “Change in Ownership” of Real Property

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The following companies are mentioned in Tax Law Updates:

Internal Revenue Service

Swallows Holding, Inc.

The State of New York

New York State Department of Taxation and Finance LLC

Amazon Services, LLC

Agere Systems, Inc. f.k.a. Lucent Technologies, Inc.

Detroit Medical Center

Department of Justice

Santini Stone LLC

City of Chicago

StubHub, Inc.

Mayer Brown LLP d.b.a. Mayer, Brown, Rowe & Maw LLP

Textron Inc.

County of Los Angeles


Quality Stores, Inc.

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