BILL NUMBER: AB 1601 CHAPTERED 10/02/03 CHAPTER 654 FILED WITH SECRETARY OF STATE OCTOBER 2, 2003 APPROVED BY GOVERNOR OCTOBER 2, 2003 PASSED THE ASSEMBLY SEPTEMBER 11, 2003 PASSED THE SENATE SEPTEMBER 10, 2003 AMENDED IN SENATE SEPTEMBER 8, 2003 AMENDED IN SENATE SEPTEMBER 2, 2003 AMENDED IN SENATE AUGUST 18, 2003 AMENDED IN SENATE JULY 16, 2003 AMENDED IN SENATE JULY 3, 2003 AMENDED IN ASSEMBLY MAY 19, 2003 AMENDED IN ASSEMBLY APRIL 10, 2003 INTRODUCED BY Assembly Member Frommer (Principal coauthors: Senators Burton and Cedillo) FEBRUARY 21, 2003 An act to amend Sections 18628, 19116, 19164, 19166, 19173, 19177, 19179, 19504, 19715, and 21028 of, to add Section 18407 to, to add Chapter 9.5 (commencing with Section 19751) to Part 10.2 of, and to repeal and add Section 18648 of, the Revenue and Taxation Code, relating to taxation. LEGISLATIVE COUNSEL'S DIGEST AB 1601, Frommer. Administration of taxes: tax shelters: penalties. Existing law imposes various taxes and fees, and certain penalties on late payments of those taxes and fees. Existing law provides specified conformity to federal income tax laws with respect to penalties imposed in connection with tax avoidance and abusive tax shelters. This bill would, in modified conformity with federal income tax laws, increase the penalties imposed with respect to tax avoidance and abusive tax shelters, as provided. This bill would require the Franchise Tax Board to develop and administer a voluntary compliance initiative, as specified, to be conducted during the period from January 1, 2004, to April 15, 2004, inclusive, and to apply to tax liabilities attributable to the use of abusive tax avoidance transactions, as specified, for taxable years beginning before January 1, 2003. This would generally authorize a taxpayer utilizing the voluntary compliance initiative to comply, with or without right to appeal, with the reporting and payment of taxes with respect to a previously filed tax return that used an abusive tax avoidance transaction to underreport tax liability. For a taxpayer who elects to comply without right to appeal, this bill would waive all penalties. For a taxpayer who elects to comply with right to appeal, this bill would waive only the new or increased penalties. This bill would, except as provided, apply with respect to any penalty assessed on or after January 1, 2004, on any return for which the statute of limitations on assessment has not expired, and would otherwise apply on and after January 1, 2004. This bill would require the Franchise Tax Board and the Legislative Analyst to report to the Legislature regarding the bill, as provided. The bill would become operative only if SB 614 of the 2003-04 Regular Session is chaptered. THE PEOPLE OF THE STATE OF CALIFORNIA DO ENACT AS FOLLOWS: SECTION 1. Section 18407 is added to the Revenue and Taxation Code, to read: 18407. Section 6011 of the Internal Revenue Code, relating to general requirement of return, statement, or list, shall apply, except as otherwise provided. (a) Section 6011(a) of the Internal Revenue Code, relating to general rule, is modified as follows: (1) The phrase "any person liable for any tax imposed by Part 10 (commencing with Section 17001), Part 11 (commencing with Section 23001) or this part," shall be substituted for the phrase "when required by regulations prescribed by the Secretary any person made liable for any tax imposed by this title," contained therein. (2) "Secretary of the Treasury under Section 6011 of the Internal Revenue Code for federal income tax purposes or by the Franchise Tax Board" shall be substituted for "Secretary." (3) To additionally provide that "reportable transaction" includes any transaction of a type that the Secretary of the Treasury under Section 6011 of the Internal Revenue Code for federal income tax purposes or the Franchise Tax Board under this section for California income or franchise tax purposes determines as having a potential for tax avoidance or evasion including deductions, basis, credits, entity classification, dividend elimination, or omission of income, and shall be reported on the return or the statement required to be made. (4) To additionally provide that "listed transaction" includes any transaction that is the same as, or substantially similar to, a transaction specifically identified by the Secretary of the Treasury under Section 6011 of the Internal Revenue Code for federal income tax purposes or by the Franchise Tax Board under this section for California income or franchise tax purposes, as a tax avoidance transaction including deductions, basis, credits, entity classification, dividend elimination, or omission of income and shall be reported on the return or statement required to be made. (A) The Franchise Tax Board shall identify and publish "listed transactions" (whether identified by the Secretary of the Treasury under Section 6011 of the Internal Revenue Code for federal income tax purposes or by the Franchise Tax Board) through the use of Franchise Tax Board Notices or other published positions. In addition, the "listed transactions" identified and published pursuant to the preceding sentence shall be published on the Web site of the Franchise Tax Board. (B) The Franchise Tax Board shall conduct a public outreach program to make taxpayers aware of the new and increased penalties associated with the use of tax avoidance transactions including deductions, basis, credits, entity classification, dividend elimination, or omission of income. (5) Chapter 3.5 (commencing with Section 11340) of Part 1 of Division 3 of Title 2 of the Government Code does not apply to any standard, criterion, procedure, determination, rule, notice, or guideline established or issued by the Franchise Tax Board pursuant to paragraph (4). (b) Section 6011(b) of the Internal Revenue Code, relating to identification of taxpayer, does not apply and, in lieu thereof Section 18408 shall apply. (c) Section 6011(c) of the Internal Revenue Code, relating to returns, etc., of DISCS and former DISCS and FSC's and former FSC's, does not apply. (d) Section 6011(d) of the Internal Revenue Code, relating to authority to require information concerning Section 912 allowances, does not apply. (e) Section 6011(e) of the Internal Revenue Code, relating to regulations requiring returns on magnetic media, etc., shall take into account Section 18408 and shall also include the modifications made to Section 6011(e) of the Internal Revenue Code by Section 18408. (f) Section 6011(f)(2) of the Internal Revenue Code, relating to incentives, does not apply. SEC. 2. Section 18628 of the Revenue and Taxation Code is amended to read: 18628. (a) Section 6111 of the Internal Revenue Code, relating to registration of tax shelters, applies, except as otherwise provided. (b) (1) Except as provided in subdivision (g), a tax shelter organizer is required to send a duplicate of the federal registration information, if applicable, or the same information required for federal tax shelters for California tax shelters to the Franchise Tax Board not later than the day on which the first offering for sale of interests in that tax shelter occurs. (2) (A) The information provided to the Franchise Tax Board pursuant to paragraph (1) shall also include any other information required by a Franchise Tax Board Notice. (B) Chapter 3.5 (commencing with Section 11340) of Part 1 of Division 3 of Title 2 of the Government Code does not apply to any additional information requested under this section. (c) Any person required to register under Section 6111 of the Internal Revenue Code who receives a tax registration number from the Secretary of the Treasury shall, within 30 days after request by the Franchise Tax Board, file a statement of that registration number. (d) Section 6111(b) of the Internal Revenue Code, relating to inclusion of tax shelter identification numbers on returns, applies. (e) Section 6111(c)(2)(A) of the Internal Revenue Code is amended by substituting the phrase "under subtitle A of the Internal Revenue Code or under this part, Part 10 (commencing with Section 17001), or Part 11 (commencing with Section 23001) of the Revenue and Taxation Code" for "under subtitle A." (f) (1) Section 6111(d) of the Internal Revenue Code is modified to further provide that, for purposes of this section and Section 18648, the term "tax shelter" includes any listed transaction (as defined under subdivision (a) of Section 18407). (2) Section 6111(d)(1)(A) of the Internal Revenue Code is amended by substituting the phrase "avoidance or evasion of federal income tax or California income or franchise tax" for "avoidance or evasion of Federal income tax." (g) The registration requirements of this section apply to any tax shelter (within the meaning of Section 6111 of the Internal Revenue Code, as modified by this section) that additionally satisfies any of the following conditions: (1) Organized in this state. (2) Doing business in this state. (3) Deriving income from sources in this state. (4) At least one of its investors is a California taxpayer. (h) In addition to the requirements set forth in subdivision (a), for any transactions entered into on or after February 28, 2000, that become listed transactions (as defined under Section 6011(a) of the Internal Revenue Code) at any time, those transactions shall be required to be registered with the Franchise Tax Board by the later of: (1) Sixty days after entering into the transaction. (2) Sixty days after the transaction becomes a listed transaction, or (i) In addition to the requirements set forth in subdivisions (a) and (h), for any transactions entered into on or after September 2, 2003, that are specifically identified by the Franchise Tax Board for California income or franchise tax purposes (under the authority of paragraph (4) of subdivision (a) of Section 18407) as a "listed transaction" at any time those transactions shall be required to be registered with the Franchise Tax Board by the later of: (1) Sixty days after entering into the transaction. (2) Sixty days after the transaction becomes a listed transaction. (3) April 30, 2004. (3) April 30, 2004. SEC. 3. Section 18648 of the Revenue and Taxation Code is repealed. SEC. 4. Section 18648 is added to the Revenue and Taxation Code, to read: 18648. (a) Section 6112 of the Internal Revenue Code, relating to organizers and sellers of potentially abusive tax shelters that must keep lists of investors, applies, except as otherwise provided. (b) Section 6112 of the Internal Revenue Code is modified by substituting the phrase "Secretary or the Franchise Tax Board" for the word "Secretary" each place it appears. (c) The requirement to maintain lists under this section shall apply to any organizer, seller, or material advisor of a potentially abusive tax shelter (within the meaning of Section 6112 of the Internal Revenue Code, as modified by this section) that additionally satisfies any of the following conditions: (1) Organized in this state. (2) Doing business in this state. (3) Deriving income from sources in this state. (4) At least one of its investors is a California taxpayer. (d) (1) Notwithstanding any regulation issued under Section 6112 of the Internal Revenue Code, the list required to be maintained by this section for listed transactions, as defined in subdivision (a) Section 18407, shall be maintained in the form and manner prescribed by the Franchise Tax Board. (2) Chapter 3.5 (commencing with Section 11340) of Part 1 of Division 3 of Title 2 of the Government Code does not apply to any requirement prescribed by the Franchise Tax Board under this section. (3) For transactions entered into on or after February 28, 2000, that become listed transactions (as defined under Section 6011(a) of the Internal Revenue Service at any time, the lists shall be provided to the Franchise Tax Board by the later of: (A) Sixty days after entering into the transaction. (B) Sixty days after the transaction becomes a listed transaction; or (C) April 30, 2004. (4) For transactions entered into on or after September 2, 2003, that are specifically identified by the Franchise Tax Board of California income or franchise tax purposes (under the authority of paragraph (4) of subdivision (a) of Section 18407) as a "listed transaction" at any time, the list shall be provided to the Franchise Tax Board by the later of: (A) Sixty days after entering into the transaction. (B) Sixty days after the transaction becomes a listed transaction. (C) April 30, 2004. (e) The terms "organizer," "seller," and "material advisor" mean a person that meets any of the requirements of this section or Section 6112 of the Internal Revenue Code or regulations issued thereunder. SEC. 5. Section 19116 of the Revenue and Taxation Code is amended to read: 19116. (a) In the case of an individual who files a return of tax imposed under Part 10 (commencing with Section 17001) for a taxable year on or before the due date for the return, including extensions, if the Franchise Tax Board does not provide a notice to the taxpayer specifically stating the taxpayer's liability and the basis of the liability before the close of the notification period, the Franchise Tax Board shall suspend the imposition of any interest, penalty, addition to tax, or additional amount with respect to any failure relating to the return which is computed by reference to the period of time the failure continues to exist and which is properly allocable to the suspension period. (b) For purposes of this section: (1) Except as provided in subdivision (e), "notification period" means the 18-month period beginning on the later of either of the following: (A) The date on which the return is filed. (B) The due date of the return without regard to extensions. (2) "Suspension period" means the period beginning on the day after the close of the notification period and ending on the date which is 15 days after the date on which notice described in subdivision (a) is provided by the Franchise Tax Board. (c) This section shall be applied separately with respect to each item or adjustment. (d) This section shall not apply to any of the following: (1) Any penalty imposed by Section 19131. (2) Any penalty imposed by Section 19132. (3) Any interest, penalty, addition to tax, or additional amount involving fraud. (4) Any interest, penalty, addition to tax, or additional amount with respect to any tax liability shown on the return. (5) Any criminal penalty. (e) For taxpayers required by subdivision (a) of Section 18622 to report a change or correction by the Commissioner of Internal Revenue or other officer of the United States or other competent authority the following rules shall apply: (1) The notification period under subdivision (a) shall be either of the following: (A) One year from the date the notice required by Section 18622 is filed with the Franchise Tax Board by the taxpayer or the Internal Revenue Service, if the taxpayer or the Internal Revenue Service reports that change or correction within six months after the final federal determination. (B) Two years from the date when the notice required by Section 18622 is filed with the Franchise Tax Board by the taxpayer or the Internal Revenue Service, if after the six-month period required in Section 18622, a taxpayer or the Internal Revenue Service reports a change or correction. (2) The suspension period under subdivision (a) shall mean the period beginning on the day after the close of the notification period under paragraph (1) and ending on the date which is 15 days after the date on which notice described in subdivision (a) is provided by the Franchise Tax Board. (f) For notices sent after January 1, 2004, this section does not apply to taxpayers with taxable income greater than two hundred thousand dollars ($200,000) that have been contacted by the Franchise Tax Board regarding the use of a potentially abusive tax shelter (within the meaning of Section 19777). (g) This section shall apply to taxable years ending after October 10, 1999. SEC. 6. Section 19164 of the Revenue and Taxation Code is amended to read: 19164. (a) (1) An accuracy-related penalty shall be imposed under this part and shall be determined in accordance with Section 6662 of the Internal Revenue Code, relating to imposition of accuracy-related penalty, except as otherwise provided. (2) With respect to corporations, this subdivision shall apply to all of the following: (A) All taxable years beginning on or after January 1, 1990. (B) Any other taxable year for which an assessment is made after July 16, 1991. (C) For purposes of this section, references in Section 6662(e) of the Internal Revenue Code and the regulations thereunder, relating to treatment of an affiliated group that files a consolidated federal return, are modified to apply to those entities required to be included in a combined report under Section 25101 or 25110. For these purposes, entities included in a combined report pursuant to paragraph (4) or (6) of subdivision (a) of Section 25110 shall be considered only to the extent required to be included in the combined report. (3) Section 6662(d)(1)(B) of the Internal Revenue Code is modified to provide that in the case of a corporation, other than an S corporation, that has been contacted by the Franchise Tax Board regarding the use of a potentially abusive tax shelter (within the meaning of Section 19777), there is a substantial understatement of tax for any taxable year if the amount of the understatement for the taxable year exceeds the lesser of: (A) Ten percent of the tax required to be shown on the return for the taxable year (or, if greater, two thousand five hundred dollars ($2,500)), or (B) Five million dollars ($5,000,000). (4) Section 6662(d)(2)(A) of the Internal Revenue Code is modified to additionally provide that the excess determined under Section 6662(d)(2)(A) of the Internal Revenue Code shall be determined without regard to items to which Section 19773 applies and without regard to items with respect to which a penalty is imposed by Section 19774. (5) For taxpayers that have been contacted by the Franchise Tax Board regarding the use of a potentially abusive tax shelter (within the meaning of Section 19777), Section 6662(d)(2)(B)(i) of the Internal Revenue Code is modified to substitute the phrase "the tax treatment of any item by the taxpayer if the taxpayer had reasonable belief that the tax treatment was more likely than not the proper treatment" for the phrase "the tax treatment of any item by the taxpayer if there is or was substantial authority for such treatment" contained therein. (b) For purposes of Section 6662(d) of the Internal Revenue Code, Section 6664 of the Internal Revenue Code (as modified by subdivision (d)), Section 6694(a)(1) of the Internal Revenue Code, and this part, the Franchise Tax Board may prescribe a list of positions for which the Franchise Tax Board believes there is not substantial authority or there is no reasonable belief that the tax treatment is more likely than not the proper tax treatment. That list (and any revisions thereof) shall be published through the use of Franchise Tax Board Notices or other published positions. In addition, the "listed transactions" identified and published pursuant to the preceding sentence shall be published on the Web site of the Franchise Tax Board. This subdivision applies only to the list of positions relating to abusive tax shelters, within the meaning of Section 19777. (c) A fraud penalty shall be imposed under this part and shall be determined in accordance with Section 6663 of the Internal Revenue Code, relating to imposition of fraud penalty, except as otherwise provided. (d) Section 6664 of the Internal Revenue Code, relating to definitions and special rules, shall apply, except as otherwise provided. (1) For taxpayers that have been contacted by the Franchise Tax Board regarding the use of a potentially abusive tax shelter (within the meaning of Section 19777), Section 6664 of the Internal Revenue Code is modified to additionally provide that no penalty shall be imposed under Section 19773 with respect to any portion of a reportable transaction understatement if it is shown that there was a reasonable cause for that portion and that the taxpayer acted in good faith with respect to that portion. (2) Paragraph (1) does not apply to any reportable transaction understatement unless all of the following requirements are met: (A) (i) The relevant facts affecting the tax treatment of the item are adequately disclosed in accordance with the regulations prescribed under Section 6011 of the Internal Revenue Code, as modified by Section 18407. (ii) A taxpayer failing to adequately disclose in accordance with Section 6011 of the Internal Revenue Code, as modified by Section 18407, shall be treated as meeting the requirements of this subparagraph, if the penalty for that failure was rescinded under subdivision (e) of Section 19772. (iii) For taxable years beginning on or 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. (B) There is or was substantial authority for that treatment. (C) The taxpayer reasonably believed that that treatment was more likely than not the proper treatment. (3) For purposes of subparagraph (C) of paragraph (2) all of the following shall apply: (A) A taxpayer shall be treated as having a reasonable belief with respect to the tax treatment of an item only if that belief meets both of the following requirements: (i) Is based on the facts and law that exist at the time the return of tax that includes that tax treatment is filed. (ii) Relates solely to the taxpayer's chances of success on the merits of that treatment and does not take into account the possibility that the return will not be audited, that the treatment will not be raised on audit, or that the treatment will be resolved through settlement if it is raised. (B) (i) An opinion of a tax advisor may not be relied upon to establish the reasonable belief of a taxpayer if either of the following conditions are met: (I) The tax advisor is described in clause (ii). (II) The opinion is described in clause (iii). (ii) A tax advisor is described in this clause if the tax advisor meets any of the following conditions: (I) Is a material advisor (within the meaning of subdivision (d) of Section 18648) who participates in the organization, management, promotion, or sale of the transaction or who is related (within the meaning of Sections 267(b) or 707(b)(1) of the Internal Revenue Code) to any person who so participates. (II) Is compensated directly or indirectly by a material advisor with respect to the transaction. (III) Has a fee arrangement with respect to the transaction that is contingent on all or part of the intended tax benefits from the transaction being sustained. (IV) As determined under regulations prescribed by either the Secretary of the Treasury for federal income tax purposes or the Franchise Tax Board, has a continuing financial interest with respect to the transaction. (iii) For purposes of clause (i), an opinion is disqualified if the opinion meets any of the following conditions: (I) Is based on unreasonable, factual, or legal assumptions (including assumptions as to future events). (II) Unreasonably relies on representations, statements, findings, or agreements of the taxpayer or any other person. (III) Does not identify and consider all relevant facts. (IV) Fails to meet any other requirement as either the Secretary of the Treasury for federal income tax purposes or the Franchise Tax Board may by forms and instructions prescribe. (e) Section 6665 of the Internal Revenue Code, relating to applicable rules, shall apply, except as otherwise provided. (f) For taxpayers that have been contacted by the Franchise Tax Board regarding the use of a potentially abusive tax shelter (within the meaning of Section 19777), Section 461(i)(3)(C) of the Internal Revenue Code is modified by substituting a reference to "Section 1274 (b)(3)(B) of the Internal Revenue Code, as modified by subdivision (g) of Section 19164" instead of the reference to "Section 6662(d)(2) (C)(iii)" contained therein. (g) For taxpayers that have been contacted by the Franchise Tax Board regarding the use of a potentially abusive tax shelter (within the meaning of Section 19777), Section 1274(b)(3)(B)(i) of the Internal Revenue Code is modified to provide that for purposes of Section 1274(b)(3)(B) of the Internal Revenue Code, the term "tax shelter" means (1) a partnership or other entity, (2) any investment plan or arrangement, or (3) any other plan or arrangement, if a significant purpose of the partnership, entity, plan, or arrangement is the avoidance or evasion of federal income tax or the tax imposed under Part 10 (commencing with Section 17001) or Part 11 (commencing with Section 23001). SEC. 7. Section 19166 of the Revenue and Taxation Code is amended to read: 19166. A penalty shall be imposed for understatement of any taxpayer's liability by a tax return preparer. The penalty shall be determined in accordance with Section 6694 of the Internal Revenue Code, except as otherwise provided. (a) (1) For taxpayers that have been contacted by the Franchise Tax Board regarding the use of a potentially abusive tax shelter (within the meaning of Section 19777), Section 6694(a) of the Internal Revenue Code is modified to substitute "one thousand dollars ($1,000)" for "two hundred fifty dollars ($250)." (2) Section 6694(a)(1) of the Internal Revenue Code is modified to substitute the phrase "reasonable belief that the tax treatment in that position was more likely than not the proper treatment" instead of the phrase "realistic possibility of being sustained on its merits" contained therein. (3) Section 6694(a)(3) of the Internal Revenue Code is modified to substitute the phrase "or there was no reasonable basis for the tax treatment of that position" instead of the phrase "or was frivolous" contained therein. (b) Section 6694(b) of the Internal Revenue Code is modified to substitute "$5,000" for "$1,000." (c) Section 6694(c) of the Internal Revenue Code shall not apply and, in lieu thereof, the following shall apply: (1) If, within 30 days after the day on which notice and demand of any penalty under Section 6694(a) or 6694(b) of the Internal Revenue Code is made against any person who is an income tax return preparer, that person pays an amount which is not less than 15 percent of the amount of that penalty and files a claim for refund of the amount so paid, no levy or proceeding in court for the collection of the remainder of that penalty shall be made, begun, or prosecuted until the final resolution of a proceeding begun as provided in paragraph (2). Notwithstanding Section 19381, the beginning of that proceeding or levy during the time that prohibition is in force may be enjoined in a proceeding in the superior court. (2) If, within 30 days after the day on which a claim for refund of any partial payment of any penalty under Section 6694(a) or 6694 (b) of the Internal Revenue Code is denied (or, if earlier, within 30 days after the expiration of six months after the day on which the claim for refund has been filed), the income tax return preparer fails to begin a proceeding in the superior court for the determination of his or her liability for that penalty, paragraph (1) shall cease to apply with respect to that penalty, effective on the day following the close of the applicable 30-day period referred to in this subdivision. (3) The running of the period of limitations provided in Section 19371 on the collection by levy or by a proceeding in court in respect of any penalty described in paragraph (1) shall be suspended for the period during which the Franchise Tax Board is prohibited from collecting by levy or a proceeding in court. SEC. 8. Section 19173 of the Revenue and Taxation Code is amended to read: 19173. (a) (1) Any person required to register under Section 18628 or maintain and provide a list under Section 18648, for any calendar year, is liable for a penalty as determined under subdivision (b) if that person does any of the following: (A) (i) Fails to register under Section 18628 on or before the date prescribed therefor. (ii) For reportable transactions (as defined under Section 18407), fails to furnish the list within 20 days of a request. (iii) For listed transactions, fails to provide the list on or before the date prescribed therefor in Section 18648. (B) Registers a tax shelter or provides a list which fails to show the information required under Section 18628 or Section 18648. (C) Fails to furnish the required statement to each investor. (2) Paragraph (1) of this subdivision does not apply if it is shown that subdivision (d) applies or that the information required under paragraph (2) of subdivision (b) of Section 18628 was not identified in a Franchise Tax Board Notice issued prior to the date the transaction or shelter was entered into. (b) (1) (A) For purposes of subdivision (a), the amount determined under this subdivision for a tax shelter required to be registered under Section 18628 is, except as provided in subparagraph (B), fifteen thousand dollars ($15,000). (B) If the penalty is with respect to a listed transaction (as defined under Section 18407), the amount determined under this subdivision for a tax shelter required to be registered under Section 18628 shall be the greater of: (i) One hundred thousand dollars ($100,000). (ii) Fifty percent of the gross income that the organizer or material advisor derived from that activity. (C) In the case of intentional disregard by an organizer or material advisor of the requirement to maintain and provide information regarding a listed transaction (as defined under Section 18407) the percentage of gross income under clause (ii) of subparagraph (B) is "75 percent" instead of "50 percent." (2) For purposes of subdivision (a), the amount determined under this subdivision for the failure to provide a list required to be maintained under Section 18648 is as follows: (A) For reportable transactions, the penalty amount shall be ten thousand dollars ($10,000) for each day after the 20th day that the organizer or material advisor has failed to make the list available to the Franchise Tax Board after written request for that list was made by the Franchise Tax Board. (B) For listed transactions, the penalty amount shall be determined under subparagraph (B) of paragraph (1). (c) The penalty imposed by subdivision (a) shall be assessed against the person required to file a copy of the federal registration or required to register under Section 18628, or the person required to maintain or provide a list under Section 18648. The penalty may be assessed at any time during the period ending eight years after the failure has occurred. (d) (1) The Chief Counsel of the Franchise Tax Board may rescind all or any portion of any penalty imposed by subdivision (a) with respect to any violation with respect to a tax shelter required to be registered under Section 18628, or a list required to be maintained or provided under Section 18648, if all of the following apply: (A) The violation is with respect to a reportable transaction, other than a listed transaction (as defined under subdivision (a) of Section 18407). (B) The person on whom the penalty is imposed has a history of complying with the requirements of this part and Part 10 (commencing with Section 17001) or Part 11 (commencing with Section 23001). (C) It is shown that the violation is due to an unintentional mistake of fact. (D) Imposing the penalty would be against equity and good conscience. (E) Rescinding the penalty would promote compliance with the requirements of this part and Part 10 (commencing with Section 17001) or Part 11 (commencing with Section 23001) and effective tax administration. (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) Article 3 (commencing with Section 19031) of this chapter (relating to deficiency assessments) shall not apply with respect to the assessment or collection of any penalty imposed by subdivision (a). (f) The penalty imposed by this section is in addition to any penalty imposed under Part 10 (commencing with Section 17001), Part 11 (commencing with Section 23001), or this part. SEC. 9. Section 19177 of the Revenue and Taxation Code is amended to read: 19177. (a) A penalty shall be imposed for promoting abusive tax shelters. The penalty shall be determined in accordance with the provisions of Section 6700 of the Internal Revenue Code, except as otherwise provided. (b) Notwithstanding Section 6700(a) of the Internal Revenue Code, if an activity with respect to which a penalty imposed under Section 6700(a) of the Internal Revenue Code involves a statement described in Section 6700(a)(2)(A) of the Internal Revenue Code, the amount of the penalty imposed under subdivision (a) shall be equal to 50 percent of the gross income derived (or to be derived) from that activity by the person on which the penalty is imposed. SEC. 10. Section 19179 of the Revenue and Taxation Code is amended to read: 19179. A penalty shall be imposed for filing a frivolous return. The penalty shall be determined in accordance with Section 6702 of the Internal Revenue Code, except as otherwise provided. (a) Section 6702 of the Internal Revenue Code shall be applied to returns required to be filed under this part. (b) For taxpayers that have been contacted by the Franchise Tax Board regarding the use of a potentially abusive tax shelter (within the meaning of Section 19777), Section 6702(a) of the Internal Revenue Code is modified as follows: (1) By substituting "$5,000" instead of "$500." (2) By substituting the phrase "person" instead of the phrase "individual" in each place that it appears. (3) By substituting "tax imposed under Part 10 (commencing with Section 17001), Part 11 (commencing with Section 23001) or this part" instead of the phrase "tax imposed by subtitle A" contained therein. (4) By substituting the phrase "is based on" instead of the phrase "is due to" contained therein. (5) By substituting the phrase "frivolous or is based on a position that the Franchise Tax Board has identified as frivolous under subdivision (c) of Section 19179" instead of the phrase "frivolous" contained therein. (6) By substituting the phrase "reflects a desire to delay or impede the administration of federal income tax laws as determined by the Secretary of the Treasury or the administration of the tax imposed under Part 10 (commencing with Section 17001), Part 11 (commencing with Section 23001) or this part as determined by the Franchise Tax Board" instead of the phrase "a desire (which appears on the purported return) to delay or impede the administration of Federal income tax laws" contained therein. (c) (1) The Franchise Tax Board shall prescribe (and periodically revise) a list of positions which the Secretary of the Treasury for federal income tax purposes or the Franchise Tax Board has identified as being frivolous for purposes of this section. (2) Chapter 3.5 (commencing with Section 11340) of Part 1 of Division 3 of Title 2 of the Government Code does not apply to any standard, criterion, procedure, determination, rule, notice, or guideline established or prescribed by the Franchise Tax Board pursuant to paragraph (1). (d) (1) Except as provided in paragraph (3), any person who submits a specified frivolous submission shall pay a penalty of five thousand dollars ($5,000). (2) For purposes of this section, all of the following shall apply: (A) The term "specified frivolous submission" means a specified submission if any portion of that submission meets any of the following conditions: (i) Is based on a position which the Franchise Tax Board has identified as frivolous under subdivision (c). (ii) Reflects a desire to delay or impede the administration of federal income tax laws as determined by the Secretary of the Treasury or the administration of the tax imposed under Part 10 (commencing with Section 17001), Part 11 (commencing with Section 23001) or this part as determined by the Franchise Tax Board. (B) The term "specified submission" means any of the following: (i) A protest under Section 19041. (ii) A request for a hearing under Section 19044. (iii) An application under any of the following sections: (I) Section 19008 (relating to agreements for payment of tax liability in installments). (II) Section 19443 (relating to compromises). (III) Section 21004 (relating to actions of the Taxpayer Right's Advocate). (3) If the Franchise Tax Board provides a person with notice that a submission is a specified frivolous submission and the person withdraws that submission within 30 days after the notice, the penalty imposed under paragraph (1) does not apply with respect to that submission. (e) (1) The Chief Counsel of the Franchise Tax Board may rescind all or any portion of any penalty imposed by this section if both of the following apply: (A) Imposing the penalty would be against equity and good conscience. (B) Rescinding the penalty would promote compliance with the requirements of this part and Part 10 (commencing with Section 17001) or Part 11 (commencing with Section 23001) and effective tax administration. (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. (f) The penalties imposed by this section shall be in addition to any other penalty provided by law. SEC. 11. Section 19504 of the Revenue and Taxation Code is amended to read: 19504. (a) The Franchise Tax Board, for the purpose of administering its duties under this part, including ascertaining the correctness of any return; making a return where none has been made; determining or collecting the liability of any person in respect of any liability imposed by Part 10 (commencing with Section 17001), Part 11 (commencing with Section 23001), or this part (or the liability at law or in equity of any transferee in respect of that liability); shall have the power to require by demand, that an entity of any kind including, but not limited to, employers, persons, or financial institutions provide information or make available for examination or copying at a specified time and place, or both, any book, papers, or other data which may be relevant to that purpose. Any demand to a financial institution shall comply with the California Right to Financial Privacy Act set forth in Chapter 20 (commencing with Section 7460) of Division 7 of Title 1 of the Government Code. Information that may be required upon demand includes, but is not limited to, any of the following: (1) Addresses and telephone numbers of persons designated by the Franchise Tax Board. (2) Information contained on Federal Form W-2 (Wage and Tax Statement), Federal Form W-4 (Employee's Withholding Allowance Certificate), or State Form DE-4 (Employee's Withholding Allowance Certificate). (b) The Franchise Tax Board may require the attendance of the taxpayer or of any other person having knowledge in the premises and may take testimony and require material proof for its information and administer oaths to carry out this part. (c) (1) The Franchise Tax Board may issue subpoenas or subpoenas duces tecum, which subpoenas must be signed by any member of the Franchise Tax Board and may be served on any person for any purpose. (2) For taxpayers that have been contacted by the Franchise Tax Board regarding the use of a potentially abusive tax shelter (within the meaning of Section 19777), the subpoena may be signed by any member of the Franchise Tax Board, the Executive Officer of the Franchise Tax Board, or any designee. (d) Obedience to subpoenas or subpoenas duces tecum issued in accordance with this section may be enforced by application to the superior court as set forth in Article 2 (commencing with Section 11180) of Chapter 2 of Part 1 of Division 3 of Title 2 of the Government Code. (e) When examining a return, the Franchise Tax Board shall not use financial status or economic reality examination techniques to determine the existence of unreported income of any taxpayer unless the Franchise Tax Board has a reasonable indication that there is a likelihood of unreported income. This subdivision applies to any examination beginning on or after October 10, 1999. SEC. 12. Section 19715 of the Revenue and Taxation Code is amended to read: 19715. (a) A civil action in the name of the State of California to enjoin any person from further engaging in specified conduct may be commenced at the request of the Franchise Tax Board. Any action under this section shall be brought in accordance with Section 19707. The court may exercise its jurisdiction over that action separate and apart from any other action brought by the State of California against that person. (b) In any action under subdivision (a), the court may enjoin the person from engaging in the specified conduct or in any other activity subject to penalty under this part, if the court finds both of the following: (1) That the person has engaged in any specified conduct. (2) That injunctive relief is appropriate to prevent recurrence of that specified conduct. (c) For purposes of this section, the term "specified conduct" means any action, or failure to take action, subject to penalty under Section 19173, 19174, 19177, or 19178. SEC. 13. Chapter 9.5 (commencing with Section 19751) is added to Part 10.2 of Division 2 of the Revenue and Taxation Code, to read: CHAPTER 9.5. TAX SHELTERS 19751. (a) The Franchise Tax Board shall develop and administer a voluntary compliance initiative for taxpayers subject to Part 10 (commencing with Section 17001) and Part 11 (commencing with Section 23001), as provided in this chapter. (b) The voluntary compliance initiative shall be conducted during the period from January 1, 2004, to April 15, 2004, inclusive, pursuant to Section 19754. This initiative shall apply to tax liabilities attributable to the use of abusive tax avoidance transactions for taxable years beginning before January 1, 2003. (c) The Franchise Tax Board shall issue forms and instructions and may take any other actions necessary, including the use of closing agreements, to implement this chapter. (d) The Franchise Tax Board shall publicize the voluntary compliance initiative so as to maximize public awareness of and participation in the initiative. The Franchise Tax Board shall coordinate to the highest degree possible its publicity efforts and other actions taken in implementing this chapter. (e) Any correspondence mailed by the Franchise Tax Board to a taxpayer at the taxpayer's last known address outlining the voluntary compliance initiative under this chapter constitutes "contact" within the meaning of Treasury Regulation Section 1.6664-2(c)(3), relating to qualified amended returns, and paragraph (3) of subdivision (e) of Section 19773 and Section 19777, regarding increased interest rate. 19752. Any taxpayer who meets the requirements of Section 19754 may elect the application of either, but not both, of the following: (a) Voluntary compliance without appeal. If this option is elected, then each of the following shall apply: (1) The Franchise Tax Board shall waive or abate all penalties imposed by this part, for all taxable years where the taxpayer elects to participate in the initiative, as a result of the underreporting of tax liabilities attributable to the use of abusive tax avoidance transactions. (2) Except as provided in Section 19753, no criminal action shall be brought against the taxpayer for the taxable years with respect to issues for which the taxpayer voluntarily complies under this chapter. (3) No penalty may be waived or abated under this chapter if the penalty imposed is attributable to an assessment of taxes that became final prior to December 31, 2003. (4) Notwithstanding Chapter 6 (commencing with Section 19301) of this part, the taxpayer may not file a claim for refund for the amounts paid in connection with abusive tax avoidance transactions under this chapter. (b) Voluntary compliance with appeal. If this option is elected, then each of the following shall apply: (1) The Franchise Tax Board shall waive or abate all penalties, except the accuracy-related penalty under Section 19164 (as in effect immediately before enactment of the act adding this section), imposed by this part, for each of the taxable years for which the taxpayer elects to participate in the initiative, that are owed as a result of the underreporting of tax liabilities attributable to the use of abusive tax avoidance transactions. (2) Except as provided in Section 19753, no criminal action may be brought against the taxpayer for each of the taxable years for which the taxpayer voluntarily complies under this section. (3) No penalty may be waived under this chapter if the penalty imposed is attributable to an assessment of taxes that became due and payable prior to December 31, 2003. (4) The taxpayer may file a claim for refund under Chapter 6 (commencing with Section 19301) of this part. Notwithstanding Section 19331, the taxpayer may not file an appeal to the board until after either of the following: (A) The date the Franchise Tax Board takes action on the claim for refund for the tax year to which this chapter applies. (B) The later of either of the following dates: (i) The date that is 180 days after the date of a final determination by the Internal Revenue Service with respect to the transaction or transactions to which this chapter applies. (ii) The date that is four years after the date the claim for refund was filed or one year after full payment of all tax, including penalty and interest was made, whichever date is later. (5) The taxpayer shall be subject to the accuracy-related penalty under Section 19164. (A) The penalty may be assessed: (i) When the Franchise Tax Board takes action on the claim for refund. (ii) When a federal determination becomes final for the same issue, in which case the penalty shall be assessed (and may not be abated) if the penalty was assessed at the federal level. (B) In determining the amount of the underpayment of tax, Treasury Regulation Section 1.6664-2(c)(2), as promulgated under Section 6664 of the Internal Revenue Code, relating to qualified amended returns, shall not apply. The amount of the underpayment is the difference between the amount of tax shown on the original return and the correct amount of tax for the taxable year. The underpayment amount shall not be less than the amount of the claim for refund filed by the taxpayer under paragraph (4) that was denied. (C) The penalty is due and payable upon notice and demand pursuant to Section 19049. Only after the taxpayer has paid all amounts due, including the penalty, and the claim is denied in whole or in part, may the taxpayer file an appeal under Chapter 6 (commencing with Section 19301), of this part in conjunction with the appeal filed under paragraph (4). (c) A taxpayer's election under this section shall be made for all taxable years of the taxpayer governed by this chapter. A separate election for each taxable year governed by this chapter is not allowed. 19753. (a) This chapter does not apply to violations of this part for which, as of December 31, 2003, any of the following applies: (1) A criminal complaint was filed against the taxpayer in connection with an abusive tax avoidance transaction or transactions. (2) The taxpayer is the subject of a criminal investigation in connection with an abusive tax avoidance transaction or transactions. (b) No refund or credit shall be granted with respect to any penalty paid prior to the time the taxpayer participates in the voluntary compliance initiative authorized by this chapter. (c) For purposes of this chapter, an "abusive tax avoidance transaction" means a plan or arrangement devised for the principal purpose of avoiding tax. Abusive tax avoidance transactions include, but are not limited to, "listed transactions" as described in subdivision (a) of Section 18407. 19754. (a) The voluntary compliance initiative described in this chapter applies to any taxpayer who was not eligible to participate in the Internal Revenue Service's Offshore Voluntary Compliance Initiative described in Revenue Procedure 2003-11, and during the period from January 1, 2004, to April 15, 2004, does both of the following: (1) Files an amended tax return under this part for each taxable year for which the taxpayer has previously filed a tax return using an abusive tax avoidance transaction to underreport the taxpayer's tax liability for that taxable year. Each amended return shall report all income from all sources, without regard to the abusive tax avoidance transaction. (2) Except as provided in subdivision (b), pays in full all taxes and interest due. (b) The Franchise Tax Board may enter into an installment payment agreement in lieu of the full payment required under paragraph (2) of subdivision (a). Any installment payment agreement authorized by this subdivision shall include interest on the unpaid amount at the rate prescribed in Section 19521. Failure by the taxpayer to fully comply with the terms of the installment payment agreement shall render the waiver of penalties null and void, and the total amount of tax, interest, and all penalties shall be immediately due and payable. (c) After April 15, 2004, the Franchise Tax Board may issue a deficiency assessment upon an amended return filed pursuant to subdivision (a), impose penalties, or initiate criminal action under this part with respect to the difference between the amount shown on that return and the correct amount of tax. This action shall not invalidate any waivers granted under Section 19752. (d) In addition to any other authority to examine returns, for the purpose of improving state tax administration, the Franchise Tax Board may inquire into the facts and circumstances related to the use of abusive tax avoidance transactions to underreport the tax liabilities for which a taxpayer has participated in the voluntary compliance initiative under this chapter. Taxpayers shall cooperate fully with inquiries described in this subdivision. Failure by a taxpayer to fully cooperate in an inquiry described in this subdivision shall render the waiver of penalties under this chapter null and void and the taxpayer may be assessed any penalties that may apply. 19755. (a) Notwithstanding Section 19057, with respect to proposed deficiency assessments related to an abusive tax avoidance transaction, as defined in subdivision (c) of Section 19753, a notice of a proposed deficiency assessment may be mailed to the taxpayer within eight years after the return was filed, or within the period otherwise provided in Article 3 (commencing with Section 19031) of Chapter 4 of this part, whichever expires later. (b) This section shall apply to any return filed under this part on or after January 1, 2000. 19772. (a) Any large entity or high net worth individual who fails to include on any return or statement any information with respect to a reportable transaction that is required under Section 6011 of the Internal Revenue Code, as modified by Section 18407, to be included with that return or statement shall pay a penalty for each omission in the amount determined under subdivision (b). (b) (1) Except as provided in paragraph (2), the amount of the penalty under subdivision (a) shall be fifteen thousand dollars ($15,000). (2) The amount of the penalty under subdivision (a) with respect to a listed transaction shall be thirty thousand dollars ($30,000). (c) For purposes of this section: (1) The term "high net worth individual" means, with respect to a transaction, an individual whose net worth exceeds two million dollars ($2,000,000) immediately before the transaction. (2) The term "large entity" means, with respect to any taxable year, a person (other than an individual) with gross receipts in excess of ten million dollars ($10,000,000) for either the taxable year in which the reportable transaction occurs or in the preceding taxable year. Rules similar to the rules of Section 448(c)(2) and 448(c)(3) of the Internal Revenue Code, other than Section 448(c)(3) (A) of the Internal Revenue Code, shall apply for purposes of this paragraph. (d) For purposes of this section: (1) The term "reportable transaction" means any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed by the Secretary of the Treasury under Section 6011 of the Internal Revenue Code for federal income tax purposes or by the Franchise Tax Board under Section 18407, that transaction is of a type that the Secretary of the Treasury for federal income tax purposes or the Franchise Tax Board determines as having a potential for tax avoidance or evasion. (2) Except as provided in regulations prescribed by the Secretary of the Treasury or by the Franchise Tax Board, the term "listed transaction" means a reportable transaction (as defined in paragraph (1)) that is the same as, or substantially similar to, a transaction specifically identified by the Secretary of the Treasury for purposes of Section 6011 of the Internal Revenue Code for federal income tax purposes or by the Franchise Tax Board for purposes of Section 6011 of the Internal Revenue Code or Section 18407, as a tax avoidance transaction. (e) (1) The Chief Counsel of the Franchise Tax Board may rescind all or any portion of any penalty imposed by this section with respect to any violation if all of the following apply: (A) The violation is with respect to a reportable transaction other than a listed transaction. (B) The person on whom the penalty is imposed has a history of complying with the requirements of this part and Part 10 (commencing with Section 17001) or Part 11 (commencing with Section 23001). (C) It is shown that the violation is due to an unintentional mistake of fact. (D) Imposing the penalty would be against equity and good conscience. (E) Rescinding the penalty would promote compliance with the requirements of this part and Part 10 (commencing with Section 17001) or Part 11 (commencing with Section 23001) and effective tax administration. (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. (f) Article 3 (commencing with Section 19031) of Chapter 4 (relating to deficiency assessments) shall not apply with respect to the assessment or collection of any penalty imposed under this section. (g) The penalty imposed by this section is in addition to any penalty imposed under Part 10 (commencing with Section 17001), Part 11 (commencing with Section 23001), or this part. 19773. (a) If a taxpayer has a reportable transaction understatement for any taxable year, there shall be added to the tax an amount equal to 20 percent of the amount of that understatement. (b) For purposes of this section, both of the following shall apply: (1) The term "reportable transaction understatement" means the sum of subparagraphs (A) and (B). (A) The product of: (i) The amount of the increase (if any) in taxable income which results from a difference between the proper tax treatment of an item to which this section applies and the taxpayer's treatment of that item (as shown on the taxpayer's return of tax). (ii) The highest rate of tax imposed on the taxpayer under Part 10 (commencing with Section 17001) in the case of a taxpayer subject to tax under that part or under Part 11 (commencing with Section 23001) in the case of a taxpayer that is subject to tax under that part. (B) The amount of the decrease (if any) in the aggregate amount of credits determined under Part 10 (commencing with Section 17001) or Part 11 (commencing with Section 23001), as applicable, that results from a difference between the taxpayer's treatment of an item to which this section applies (as shown on the taxpayer's return of tax) and the proper tax treatment of that item. (C) For purposes of subparagraph (A), any reduction of the excess of deductions allowed for the taxable year over gross income for that year, and any reduction in the amount of capital losses which would (without regard to Section 1211 of the Internal Revenue Code) be allowed for that year, shall be treated as an increase in taxable income. (2) This section shall apply to any item that is attributable to either of the following: (A) Any listed transaction. (B) Any reportable transaction (other than a listed transaction) if a significant purpose of that transaction is the avoidance or evasion of tax imposed under Part 10 (commencing with Section 17001) or Part 11 (commencing with Section 23001). (c) (1) Subdivision (a) shall be applied by substituting "30 percent" for "20 percent" with respect to the portion of any reportable transaction understatement with respect to which the requirement of Section 6664 of the Internal Revenue Code, as modified by subparagraph (A) of paragraph (2) of subdivision (d) of Section 19164, is not met. (2) (A) 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. (B) The exercise of authority under subparagraph (A) shall be at the sole discretion of the Chief Counsel of the Franchise Tax Board and may not be delegated. (C) Notwithstanding any other law or rule of law, any determination under this subdivision may not be reviewed in any administrative or judicial proceeding. (d) For purposes of this section, the terms "reportable transaction" and "listed transaction" have the respective meanings given to those terms by subdivision (a) of Section 18407. (e) (1) In the case of an understatement (as defined in Section 6662(d)(2) of the Internal Revenue Code) all of the following shall apply: (A) The amount of the understatement (determined without regard to this paragraph) shall be increased by the aggregate amount of reportable transaction understatements and noneconomic substance transaction understatements for purposes of determining whether the understatement is a substantial understatement under Section 6662(d) (1) of the Internal Revenue Code. (B) The addition to tax under subdivision (a) of Section 19164 shall apply only to the excess of the amount of the substantial understatement (if any) after the application of subparagraph (A) over the aggregate amount of reportable transaction understatements and noneconomic substance transaction understatements. (2) (A) In determining the fraud penalty imposed under subdivision (c) of Section 19164, references to an underpayment in Section 6663 of the Internal Revenue Code shall be treated as including references to a reportable transaction understatement and a noneconomic substance transaction understatement. (B) This section does not apply to any portion of an understatement on which a penalty is imposed under Section 19774. (3) Except as provided in regulations, in no event may any tax treatment included with an amendment or supplement to a return of tax be taken into account in determining the amount of any reportable transaction understatement or noneconomic substance transaction understatement, if the amendment or supplement is filed after the earlier of the date the taxpayer is first contacted by either the Secretary of the Treasury for federal income tax purposes or the Franchise Tax Board regarding the examination of the return or such other date as is specified by the Franchise Tax Board. (4) For purposes of this subdivision, the term "noneconomic substance transaction understatement" has the meaning given that term by subdivision (c) of Section 19774. 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. (c) For purposes of this section: (1) The term "noneconomic substance transaction understatement" means any amount which would be an understatement under paragraph (1) of subdivision (b) of Section 19773 if Section 19773 were applied by taking into account items attributable to noneconomic substance transactions rather than items to which Section 19773 applies. (2) A "noneconomic substance transaction" includes 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. (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. 19777. (a) If a taxpayer has been contacted by the Franchise Tax Board regarding the use of a potentially abusive tax shelter, and has a deficiency, there shall be added to the tax an amount equal to 100 percent of the interest payable under Section 19101 for the period beginning on the last date prescribed by law for the payment of that tax (determined without regard to extensions) and ending on the date the notice of proposed assessment is mailed. (b) "Potentially abusive tax shelter" means: (1) Any tax shelter (as defined in Section 6111 of the Internal Revenue Code) with respect to which registration is required under Section 6111 of the Internal Revenue Code. (2) Any entity, investment plan or arrangement, or other plan or arrangement which is of a type that the Secretary of the Treasury or the Franchise Tax Board determines by regulations as having a potential for tax avoidance or evasion. (c) The penalty imposed by this section is in addition to any other penalty imposed under Part 10 (commencing with Section 17001), Part 11 (commencing with Section 23000), or this part. (d) This section shall apply to notices of proposed assessments mailed after the effective date of the act adding this section. 19778. For any amended return filed after April 15, 2004, and before the taxpayer is contacted by the Internal Revenue Service or the Franchise Tax Board regarding a potentially abusive tax shelter, then, for taxable years beginning after December 31, 1998, with respect to any understatement of tax related to using reportable transactions as defined in Section 18407, as added by the act adding this section, the taxpayer is subject to interest as provided under Section 19101 but at a rate of 150 percent of the adjusted annual rate established under Section 19521. SEC. 14. Section 21028 of the Revenue and Taxation Code is amended to read: 21028. (a) (1) With respect to tax advice, the protections of confidentiality that apply to a communication between a client and an attorney, as set forth in Article 3 (commencing with Section 950) of Chapter 4 of Division 8 of the Evidence Code, shall also apply to a communication between a taxpayer and any federally authorized tax practitioner to the extent the communication would be considered a privileged communication if it were between a client and an attorney. (2) Paragraph (1) may only be asserted in any noncriminal tax matter before the Franchise Tax Board. (3) For purposes of this section: (A) "Federally authorized tax practitioner" means any individual who is authorized under federal law to practice before the Internal Revenue Service if the practice is subject to federal regulation under Section 330 of Title 31 of the United States Code, as provided by federal law as of January 1, 2000. (B) "Tax advice" means advice given by an individual with respect to a state tax matter, which may include federal tax advice if it relates to the state tax matter. For purposes of this subparagraph, "federal tax advice" means advice given by an individual within the scope of his or her authority to practice before the federal Internal Revenue Service on noncriminal tax matters. (C) "Tax shelter" means a partnership or other entity, any investment plan or arrangement, or any other plan or arrangement if a significant purpose of that partnership, entity, plan, or arrangement is the avoidance or evasion of federal income tax or the avoidance or evasion of the tax imposed under Part 10 (commencing with Section 17001) or Part 11 (commencing with Section 23001). (b) The privilege under subdivision (a) does not apply to any written communication between a federally authorized tax practitioner and any person, or any director, officer, employee, agent, or representative of the person, or any other person holding a capital or profits interest in the person in connection with the promotion of the direct or indirect participation of the person in any tax shelter (as defined in Section 1274(b)(3)(B) of the Internal Revenue Code, as modified by subdivision (g) of Section 19164), or in any proceeding to revoke or otherwise discipline any license or right to practice by any governmental agency. (c) This section shall be operative for communications made on or after the effective date of the act adding this section. (d) This section shall remain in effect only until January 1, 2005, and as of that date is repealed, unless a later enacted statute, that is enacted before January 1, 2005, deletes or extends that date. SEC. 15. (a) Unless otherwise provided, this act shall apply with respect to any penalty assessed on or after January 1, 2004, on any return for which the statute of limitations on assessment has not expired. All other provisions of this act shall apply on and after January 1, 2004. (b) Except as provided in subdivision (c), Sections 18407, 19772, and 19773 of the Revenue and Taxation Code, as amended or added by this act, apply to taxable years beginning on or after January 1, 2003. (c) (1) The penalty provisions of Section 19772 apply to any person that satisfies both of the following: (A) The person is subject to the provisions of Sections 18407 and 19772. (B) The person has invested in a transaction after February 28, 2000, and before January 1, 2004, where that transaction becomes a listed transaction at any time. (2) (A) A person that is subject to the provisions of Section 6111 of the Internal Revenue Code, as incorporated and modified by Section 18648, must register a tax shelter with the Franchise Tax Board before April 30, 2004, if that tax shelter was offered for sale between February 28, 2000, and January 1, 2004 and becomes a listed transaction on or before January 1, 2004. (B) The penalty under Section 19173 applies for a failure to register the tax shelter under subparagraph (A). (3) (A) Subdivision (c) of Section 18648 does not apply to licensed attorneys in the case of a transaction that was entered into before January 1, 2004, if the attorney is considered a material advisor solely due to the practice of law. (B) The provisions of subparagraph (A) shall only apply to an attorney offering advice in an attorney-client relationship where: (i) Legal advice of any kind is sought from a professional legal adviser in his or her capacity as a professional legal adviser; (ii) The communications are made in confidence and relate to that purpose; and (iii) The communications are made or received by the client. (4) For purposes of applying Section 19778 of the Revenue and Taxation Code, Section 18407 of the Revenue and Taxation Code, as added by this act, applies for taxable years beginning after December 31, 1998. SEC. 16. The Legislative Analyst, based on the information provided to it by the Franchise Tax Board and other available information, shall report to the Legislature within two years of the effective date of this act regarding the impact of the act. To the extent feasible, this report shall include observations regarding the impact of the act on tax shelters, state tax collections, and the state's business climate. SEC. 17. This act shall become operative only if Senate Bill 614 of the 2003-04 Regular Session is chaptered.