Swallows Holding, Ltd. v. C.I.R.

• Decision Date: 15 February 2008
• Docket Number: No. 06-3388.,06-3388.
• Citation: 515 F.3d 162
• Parties: SWALLOWS HOLDING, LTD. v. COMMISSIONER of INTERNAL REVENUE, Appellant.
• Court: U.S. Court of Appeals — Third Circuit

515 F.3d 162

SWALLOWS HOLDING, LTD. v. COMMISSIONER of INTERNAL REVENUE, Appellant.

No. 06-3388.

United States Court of Appeals, Third Circuit.

Argued on September 25, 2007.

Opinion Filed February 15, 2008.

Gilbert S. Rothenberg, Esquire (Argued), United States Department of Justice, Appellate Section, Eileen J. O'Connor, Esquire, Assistant Attorney General, Richard T. Morrison, Esquire, Deputy Assistant Attorney General, Jonathan S. Cohen, Esquire, Steven W. Parks, Esquire, Attorneys, Tax Division, United States Department of Justice, Washington, DC, for Appellant.

Philip L. Jelsma, Esquire, (Argued), Luce, Forward, Hamilton & Scripps, LLP, San Diego, CA, for Appellee.

Before: AMBRO, JORDAN and ROTH, Circuit Judges.

OPINION

ROTH, Circuit Judge:

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, 99 S.Ct. 1304, 59 L.Ed.2d 519 (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 In coming to this conclusion, the Tax Court explained that the standard established in National Muffler had not been replaced by Chevron USA, Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984), and that the result under either standard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.

I. Factual and Procedural Background

The IRS has appealed a United States Tax Court decision that held Treas. Reg. 1.882-4(a)(3)(i) to be invalid. Petitioner-appellee Swallows Holdings, Ltd. (Taxpayer) is a Barbados corporation with two principal shareholders, Raimundo Arnaiz-Rosas and Aurora Elsa Arnaiz. On September 14, 1992, Taxpayer filed its first federal income tax return. In its return, Taxpayer reported that it held real property in San Diego, California. Between 1993 and 1996, Taxpayer generated rental income from the San Diego property.¹ It was not until 1999, however, that Taxpayer filed returns for tax years 1993, 1994, 1995 and 1996.

A foreign corporation, engaging in trade or business in the United States, is taxed on its taxable income that is connected with the conduct of that trade or business. 26 U.S.C. § 882(a). Deductions from income are allowed only if they are connected with the "income which is effectively connected with the conduct of a trade or business within the United States." Section 882(c)(1)(a). However, foreign corporations that do not engage in a trade or business in the United States are taxed at a flat rate of thirty percent of any amount received from sources within the United States. Section 881(a). The Internal Revenue Code, generally speaking, does not allow these foreign corporations to claim deductions. Section 882(c)(2). Nevertheless, if a foreign corporation conducts real property activity in the United States, the foreign corporation can treat the income derived from the real property activity as income from a "trade or business," thus qualifying the foreign corporation to claim tax deductions (e.g., interest and taxes) that are otherwise unavailable. Section 882(d)(1).

The dispute in this case arises from the filing deadlines set forth in Treas. Reg. 1.882-4(a)(3)(i),² which the Secretary of the Treasury promulgated to supplement section 882(c)(2). The regulation requires that a foreign corporation file a return within eighteen months of the filing deadline set in section 6072 in order to claim the real property activity tax deductions. Here, Taxpayer filed the tax returns in question well after the expiration of the eighteen-month filing period. The Commissioner assessed tax deficiencies accordingly.³

Taxpayer challenged the Commissioner's findings in the United States Tax Court, arguing that Treas. Reg. 1.882-4(a)(3)(i) was an invalid exercise of the Secretary's rule-making authority. See Swallows Holding, Ltd. v. C.I.R. 126 T.C. 96 (2006). The Tax Court granted judgment in favor of Taxpayer, focusing its inquiry on the plain meaning of I.R.C. § 882(c)(2). Specifically, the court held that section 882(c)(2) requires that foreign corporations file "in the manner prescribed by subtitle F . . . ." Id. at 107. The Tax Court's interpretation of the statute centered on the meaning of the word "manner" in the absence of any explicit textual reference to "time." The court found it persuasive that Congress did not draft the statute with the familiar phrase "time and manner." The court noted that Congress placed "time" and "manner" together in several Code sections, indicating that when Congress intended a time limit to apply, it did so with the phrase "time and manner." Because the court found that the plain meaning of "manner" did not inherently include an element of time, the court concluded that Congress did not intend section 882(c)(2) to embody a filing deadline. Id. at 134-46. The court found that the meaning of the statutory text was plain and unambiguous. Id. at 135. The court nonetheless continued its analysis and held that the Secretary's interpretation of the statute to include a timely filing requirement in the language of Treas. Reg. 1.882-4(a)(3)(i) was unreasonable. 126 T.C. at 137.

Relying on its earlier opinion in Central Pa. Sav. Association & Subs. v. Commissioner, 104 T.C. 384, 392 (1995), the Tax Court determined that the standard established in National Muffler had not been replaced by Chevron and that the result under either standard would be the same. Id. at 131. The court concluded that a consideration of the National Muffler factors demonstrated the unreasonableness of the Secretary's interpretation of section 882(c)(2) to include the timely filing requirement. Id. at 137. The Tax Court listed the six factors set out in National Muffler to consider in assessing the reasonableness of the agency action. The Tax Court described these factors as follows:

(1) whether the regulation is a substantially contemporaneous construction of the statute by those presumed to have been aware of congressional intent; (2) the manner in which a regulation dating from a later period evolved; (3) the length of time that the regulation has been in effect; (4) the reliance placed upon the regulation; (5) the consistency of the Secretary's interpretations; and (6) the degree of scrutiny Congress has devoted to the regulation during subsequent reenactments of this statute.

Id. at 137 (citing National Muffler, 440 U.S. at 477, 99 S.Ct. 1304).

The Tax Court found that the Secretary's action failed to meet several of the National Muffler factors: the regulation was not a substantially contemporaneous construction of the statute; the regulation evolved after the Fourth Circuit Court of Appeals and the Board of Tax Appeals had repeatedly and consistently held that the statute did not include a timely filing requirement;⁴ the regulations were issued after multiple reenactments of the statutory text; the Secretary's statement accompanying the issuance of the regulations flew in the face of the prior court holdings and was a departure from the Secretary's previous interpretation of the 1957 regulations; and the statute had been reenacted several times without change to the governing statutory language. Id. at 137-38. As a result, the court held that the regulation was an unreasonable exercise of the Secretary's statutory power. Thus, the Tax Court ruled in favor of Taxpayer, holding that I.R.C. § 882(c)(2) did not include a filing deadline and that Taxpayer was entitled to the rental activity deductions. The IRS appealed.

II. Discussion

A. Jurisdiction

We have jurisdiction to review the final judgment of the Tax Court pursuant to I.R.C. § 7482(a)(1); see also New York Football Giants, Inc. v. C.I.R., 349 F.3d 102, 105-06 (3d Cir.2003). We exercise plenary review over the Tax Court's legal conclusions but will only set aside factual findings that are clearly erroneous. Capital Blue Cross v. C.I.R., 431 F.3d 117, 123-24 (3d Cir.2005).

B. Applicability of Chevron

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.

In Chevron, the Supreme Court reasoned that the judiciary was to afford an agency discretion to interpret ambiguous provisions of the agency's organic or enabling statute. In what has become familiar administrative law parlance, the Chevron Court set forth a two step analysis:

When a court reviews an agency's construction of the statute which it administers, it is confronted with two questions. First, always, is the question whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, that is the, end of the matter; for the court, as well as the agency must give effect to the unambiguously expressed intent of Congress [Chevron Step one]. If, however, the court determines Congress has not directly addressed the precise question at issue, the court does not simply impose its own construction of the statute, as would be necessary in the absence of an administrative interpretation. Rather, if the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency's answer is based on a permissible construction of the statute [Chevron Step two].

Chevron, 467 U.S. at 842-43, 104 S.Ct. 2778. Courts, including the. Supreme Court, have operated under this general framework post-Chevron. See, e.g., Nat'l Cable & Telecomm. Ass'n. v. Brand X...