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Editor: Paul L. Caron, Dean
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Tuesday, February 19, 2008

3d Circuit Reverses Tax Court, Revitalizes Chevron Deference in Tax Cases

In a major decision, the Third Circuit on Friday (No. 06-3388) reversed the Tax Court's decision in Swallows Holding, Ltd. v. Commissioner, 126 T.C. 96 (2006), which had invalidated Treas. Reg. § 1.882-4(a)(3)(i).  The Third Circuit held that the Tax Court had failed to give proper Chevron deference to the regulation:

This case, grounded in the principles of administrative law, requires that we review the validity of an Internal Revenue Service (IRS) regulation. The Tax Court, in considering this regulation, analyzed it under the factors provided in National Muffler Dealers Ass’n v. United States, 440 U.S. 472, 477 (1979), and concluded that the regulation was invalid. In coming to this conclusion, the Tax Court explained that the standard established in National Muffler had not been replaced by Chevron U.S.A., Inc. v. Natural Resources Defense Counsel, Inc., 467 U.S. 837 (1984), and that the result under either standard would be the same. We do not agree with the outcome reached by the Tax Court. We have determined that the result would not be the same under Chevron analysis as it would be under National Muffler and that the regulation here should be given Chevron deference. ...

The crucial issue before us is whether the Tax Court erred in applying National Muffler rather than Chevron when evaluating the validity of Treas. Reg. 1.882-4(a)(3)(i). We hold that the Tax Court erred in applying National Muffler to the extent that the National Muffler factors are inconsistent with Chevron analysis. ...

We note that Chevron deference will not be extended to all agency action. Mead, 533 U.S. at 229-31. Mead teaches that Chevron deference is appropriate only in situations where “Congress would expect the agency to be able to speak with the force of law . . ..” Id. at 229 (emphasis added). When Congress does not intend a particular agency action to wield the force of law, Skidmore deference may be appropriate. Thus, Mead requires that we assess the legal effect of Treas. Reg. 1.882- 4(a)(3)(i), which was promulgated under I.R.C. § 7805. ...

Taxpayer argues ... that the Secretary promulgated an interpretive regulation and that interpretive regulations, as a class, do not merit Chevron deference. We disagree. When determining whether Congress intends a particular agency action to carry the force of law, our inquiry does not hinge solely on the type of agency action involved. Rather, “[d]elegation of such authority may be shown in a variety of ways, as by an agency’s power to engage in adjudication or notice-and-comment rule-making, or by some other indication of a comparable congressional intent.” Mead, 533 U.S. at 227. There is no per se rule that relegates interpretive rules to the realm of Skidmore. Here, the Secretary opened the rule to public comment, a move that is indicative of agency action that carries the force of law. Id. at 229-30; Cleary v. Waldman, 167 F.3d 801, 808 (3d Cir.1999). Accordingly, the resulting regulation is entitled to Chevron deference if it survives Chevron’s two prong inquiry.

1.  Chevron Step One: Ambiguity of the Statutory Text. ...  Our inquiry focuses on the requirement that foreign companies file “with the Secretary a true and accurate return, in the manner prescribed in subtitle F.” Taxpayer argues that the word “manner” does not by its nature include a timing element, thus indicating that Congress did not intend for a filing deadline to exist. This is an overly narrow interpretation of “manner.” Courts that have interpreted “manner” as used in I.R.C. § 882(c)(2) and its predecessors have struggled over whether “manner” includes a timing element, which indicates that the language is not clear and unambiguous. ...

[W]e hold that Congress’s use of the word “manner” creates ambiguity. Therefore, Congress has not “spoken to the precise question at issue.” Chevron, 467 U.S. at 843. Rather, because we find I.R.C. § 882(c)(2) to be ambiguous, the Secretary was justified in promulgating a rule that prescribed a filing deadline.

2.  Chevron Step Two: Reasonableness of the Secretary's Action.   Our inquiry is not yet at its end, as we will only defer to the Secretary’s action if it is a permissible construction of I.R.C. § 882(c)(2). We “need not conclude that the agency construction was the only one it permissibly could have adopted to uphold the construction, or even the reading the court would have reached if the question had arisen in a judicial proceeding.” Chevron, 467 U.S. at 843 n.11. ...

In this case, the Secretary has promulgated a rule that creates an eighteen-month window within which foreign companies must file a federal tax return in order to claim rental activity tax deductions. Taxpayer argues that previous cases upholding the disallowance of deductions under I.R.C. § 882(c)(2) involved filing deadlines that permitted at least a two year window within which foreign corporations could have filed timely tax returns. From this, Taxpayer draws the conclusion that it is unreasonable for the Secretary to promulgate a rule with a filing period of less than two years. We find Taxpayer’s argument to be unpersuasive. ...

[W]e believe that drawing this temporal line is a task properly within the powers and expertise of the IRS. Chevron recognizes the notion that the IRS is in a superior position to make judgments concerning the administration of the ambiguities in its enabling statute. In this case, the IRS found that eighteen months served as a balance between its desire for compliance with the federal tax laws and a foreign corporation’s desire to obtain valuable tax deductions. Therefore, we hold that the eighteen-month filing window created by Treas. Reg. 1.882-4(a)(3)(i) is a reasonable exercise of the Secretary’s authority.

For an extended discussion of the application of Chevron, Mead, National Muffler, and Skidmore in the tax context, see the series of articles by Kristin E. Hickman (Minnesota):

For prior TaxProf Blog coverage of Swallows Holding, see here.

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Tracked on Feb 19, 2008 4:44:28 AM


This case seems very cert-worthy, if the taxpayer goes that route. Not because the taxpayer has any chance of winning at the Supreme Court (I highly doubt that the Court will endorse a "tax exception" to the Chevron doctrine, notwithstanding the lower courts' tendency to do so), but because the Solicitor General risks little from acquiescence (he can't lose on this) and it would be good for everyone if the Court squarely settled the issue.

Too much time and ink is spent on the National Mufflers versus Chevron standard, and seeing that the 3d circuit said the standard of review in this case was determinative (i.e. TP would have won if Mufflers applied), this is a perfect vehicle for resolving that confusion.

Posted by: andy | Feb 19, 2008 9:05:19 AM

I was very surpirsed by this result.

Posted by: Anthony | Feb 19, 2008 11:53:07 AM