California Revenue and Taxation Code § 19774

(a) If a taxpayer has a noneconomic substance transaction understatement for any taxable year, there shall be added to the tax an amount equal to 40 percent of the amount of that understatement. (b) (1) Subdivision (a) shall be applied by substituting “20 percent” for “40 percent” with respect to the portion of any noneconomic substance transaction understatement with respect to which the relevant facts affecting the tax treatment of the item are adequately disclosed in the return or a statement attached to the return. (2) For taxable years beginning before January 1, 2003, “adequately disclosed” includes the disclosure of the tax shelter identification number on the taxpayer’s return as required by subdivision (c) of Section 18628, as applicable for the year in which the transaction was entered into. (c) For purposes of this section: (1) The term “noneconomic substance transaction understatement” means any amount which would be an understatement under Section 6662A(b) of the Internal Revenue Code, as modified by subdivision (b) of Section 19164.5 if Section 6662A(b) of the Internal Revenue Code were applied by taking into account items attributable to noneconomic substance transactions rather than items to which Section 6662A(b) applies. (2) A “noneconomic substance transaction” includes: (A) The disallowance of any loss, deduction or credit, or addition to income attributable to a determination that the disallowance or addition is attributable to a transaction or arrangement that lacks economic substance including a transaction or arrangement in which an entity is disregarded as lacking economic substance. A transaction shall be treated as lacking economic substance if the taxpayer does not have a valid nontax California business purpose for entering into the transaction. (B) Any disallowance of claimed tax benefits by reason of a transaction lacking economic substance, within the meaning of Section 7701(o) of the Internal Revenue Code, relating to clarification of economic substance doctrine, as added by Section 1409(a) of the Health Care and Education Reconciliation Act of 2010 (Public Law 111-152), except as otherwise provided. (i) For purposes of this subparagraph, the phrase “apart from state income tax effects” shall be substituted for the phrase “apart from Federal income tax effects” in each place it appears in Section 7701(o)(1) of the Internal Revenue Code. (ii) For purposes of this subparagraph, the phrase “any federal or local income tax effect which is related to a state income tax effect shall be treated in the same manner as a state income tax effect” is substituted for the phrase “any State or local income tax effect which is related to a Federal income tax effect shall be treated in the same manner as a Federal income tax effect” in Section 7701(o)(3) of the Internal Revenue Code. (d) (1) If the notice of proposed assessment of additional tax has been sent with respect to a penalty to which this section applies, only the Chief Counsel of the Franchise Tax Board may compromise all or any portion of that penalty. (2) The exercise of authority under paragraph (1) shall be at the sole discretion of the Chief Counsel of the Franchise Tax Board and may not be delegated. (3) Notwithstanding any other law or rule of law, any determination under this subdivision may not be reviewed in any administrative or judicial proceeding. (e) Notwithstanding anything to the contrary in this section, if a penalty has been assessed for federal income tax purposes pursuant to Section 6662(b)(6) of the Internal Revenue Code, as added by Section 1409(b) of the Health Care and Education Reconciliation Act of 2010 (Public Law 111-152), on an underpayment attributable to the disallowance of claimed tax benefits by reason of a transaction lacking economic substance, then a penalty shall be imposed under this section for that portion of an understatement attributable to that transaction, and shall not

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