## Facts

- Swallows Holding, Ltd., a Barbados corporation, owned rental real property in San Diego, California and received U.S.-source rental income from 1993 to 1996.
- Swallows did not file U.S. income tax returns for those years until 1999.
- The IRS disallowed Swallows’s claimed deductions (including interest and property taxes) under Treas. Reg. § 1.882-4(a)(3)(i), which generally requires a foreign corporation to file within 18 months of the return’s due date to claim deductions, and issued deficiency notices.
- Swallows challenged the disallowance in the U.S. Tax Court, arguing the regulation exceeded I.R.C. § 882(c)(1), which allows deductions to foreign corporations engaged in a U.S. trade or business “but only if” they file a return “in the manner prescribed in subtitle F.”
- The Tax Court held the regulation invalid and ruled for Swallows.
- The Commissioner appealed to the Third Circuit.

## Issues

1. Whether the validity of Treas. Reg. § 1.882-4(a)(3)(i) is reviewed under Chevron rather than the National Muffler framework.
2. Whether I.R.C. § 882(c)(1) permits Treasury to condition deductions on timely filing, and whether the regulation’s 18-month deadline is a reasonable interpretation of the statute.

## Decision

- The Third Circuit reversed the Tax Court.
- The court held Chevron supplies the governing standard for review of the regulation.
- The court found § 882(c)(1) ambiguous as to whether “manner” of filing includes a timeliness condition.
- The court held the regulation is a reasonable construction of the statute and is entitled to Chevron deference.
- The IRS’s denial of deductions based on Swallows’s late filing was sustained.

## Legal Principles

- Treasury regulations carrying the force of law and issued under delegated authority are generally reviewed under Chevron’s two-step framework.
- When a statute conditions deductions on filing “in the manner” prescribed, the term “manner” may reasonably be read to include timing requirements if Congress has not clearly spoken to the contrary.
- At Chevron step one, statutory silence or ambiguity on a specific procedural condition can leave a gap for agency rulemaking.
- At Chevron step two, a regulation is upheld if it reasonably implements the statutory scheme, including measures aimed at administrability and preventing strategic late filings.
- Deductions for foreign corporations may be conditioned on compliance with regulatory filing requirements, including deadlines, where the statute makes deductions contingent on filing.

## Conclusion

The Third Circuit held that Chevron deference governed review of Treas. Reg. § 1.882-4(a)(3)(i) and upheld the regulation as a reasonable interpretation of I.R.C. § 882(c)(1), permitting the IRS to deny deductions to a foreign corporation that failed to file timely U.S. returns.


Swallows Holding, Ltd. v. Commissioner, 515 F.3d 162 (3d Cir. 2008)