‘‘(B) is identified as restitution in the 
court order or settlement agreement. 
Identification pursuant to subparagraph (B) alone 
shall not satisfy the requirement under subpara-
graph (A). This paragraph shall not apply to any 
amount paid or incurred as reimbursement to the 
government or entity for the costs of any investiga-
tion or litigation. 
‘‘(3) EXCEPTION FOR AMOUNTS PAID OR IN-
CURRED AS THE RESULT OF CERTAIN COURT OR-
DERS.—Paragraph (1) shall not apply to any 
amount paid or incurred by order of a court in a 
suit in which no government or entity described in 
paragraph (4) is a party. 
‘‘(4) 
CERTAIN
NONGOVERNMENTAL
REGU-
LATORY ENTITIES.—An entity is described in this 
paragraph if it is— 
‘‘(A) a nongovernmental entity which exer-
cises self-regulatory powers (including imposing 
sanctions) in connection with a qualified board 
or exchange (as defined in section 1256(g)(7)), 
or 
‘‘(B) to the extent provided in regulations, 
a nongovernmental entity which exercises self- 
regulatory powers (including imposing sanc-
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tions) as part of performing an essential gov-
ernmental function. 
‘‘(5) EXCEPTION FOR TAXES DUE.—Paragraph 
(1) shall not apply to any amount paid or incurred 
as taxes due.’’. 
(b) EFFECTIVE DATE.—The amendment made by 
this section shall apply to amounts paid or incurred on 
or after the date of the enactment of this Act, except that 
such amendment shall not apply to amounts paid or in-
curred under any binding order or agreement entered into 
before such date. Such exception shall not apply to an 
order or agreement requiring court approval unless the ap-
proval was obtained before such date. 
TITLE IV—REQUIRING 
ECONOMIC SUBSTANCE 
SEC. 401. CLARIFICATION OF ECONOMIC SUBSTANCE DOC-
TRINE. 
(a) IN GENERAL.—Section 7701 is amended by re-
designating subsection (p) as subsection (q) and by insert-
ing after subsection (o) the following new subsection: 
‘‘(p) CLARIFICATION
OF
ECONOMIC
SUBSTANCE 
DOCTRINE; ETC.— 
‘‘(1) GENERAL RULES.— 
‘‘(A) IN GENERAL.—In any case in which 
a court determines that the economic substance 
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doctrine is relevant for purposes of this title to 
a transaction (or series of transactions), such 
transaction (or series of transactions) shall have 
economic substance only if the requirements of 
this paragraph are met. 
‘‘(B) DEFINITION
OF
ECONOMIC
SUB-
STANCE.—For purposes of subparagraph (A)— 
‘‘(i) IN GENERAL.—A transaction has 
economic substance only if— 
‘‘(I) the transaction changes in a 
meaningful way (apart from Federal 
tax effects) the taxpayer’s economic 
position, and 
‘‘(II) the taxpayer has a substan-
tial nontax purpose for entering into 
such transaction and the transaction 
is a reasonable means of accom-
plishing such purpose. 
In applying subclause (II), a purpose of 
achieving a financial accounting benefit 
shall not be taken into account in deter-
mining whether a transaction has a sub-
stantial nontax purpose if the origin of 
such financial accounting benefit is a re-
duction of income tax. 
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‘‘(ii) SPECIAL
RULE
WHERE
TAX-
PAYER RELIES ON PROFIT POTENTIAL.—A 
transaction shall not be treated as having 
economic substance by reason of having a 
potential for profit unless— 
‘‘(I) the present value of the rea-
sonably expected pre-tax profit from 
the transaction is substantial in rela-
tion to the present value of the ex-
pected net tax benefits that would be 
allowed if the transaction were re-
spected, and 
‘‘(II) the reasonably expected 
pre-tax profit from the transaction ex-
ceeds a risk-free rate of return. 
‘‘(C) TREATMENT OF FEES AND FOREIGN 
TAXES.—Fees and other transaction expenses 
and foreign taxes shall be taken into account as 
expenses in determining pre-tax profit under 
subparagraph (B)(ii). 
‘‘(2) SPECIAL RULES FOR TRANSACTIONS WITH 
TAX-INDIFFERENT PARTIES.— 
‘‘(A) SPECIAL
RULES
FOR
FINANCING 
TRANSACTIONS.—The form of a transaction 
which is in substance the borrowing of money 
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or the acquisition of financial capital directly or 
indirectly from a tax-indifferent party shall not 
be respected if the present value of the deduc-
tions to be claimed with respect to the trans-
action is substantially in excess of the present 
value of the anticipated economic returns of the 
person lending the money or providing the fi-
nancial capital. A public offering shall be treat-
ed as a borrowing, or an acquisition of financial 
capital, from a tax-indifferent party if it is rea-
sonably expected that at least 50 percent of the 
offering will be placed with tax-indifferent par-
ties. 
‘‘(B) ARTIFICIAL INCOME SHIFTING AND 
BASIS
ADJUSTMENTS.—The form of a trans-
action with a tax-indifferent party shall not be 
respected if— 
‘‘(i) it results in an allocation of in-
come or gain to the tax-indifferent party in 
excess of such party’s economic income or 
gain, or 
‘‘(ii) it results in a basis adjustment 
or shifting of basis on account of over-
stating the income or gain of the tax-indif-
ferent party. 
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‘‘(3) DEFINITIONS AND SPECIAL RULES.—For 
purposes of this subsection— 
‘‘(A) ECONOMIC SUBSTANCE DOCTRINE.— 
The term ‘economic substance doctrine’ means 
the common law doctrine under which tax bene-
fits under subtitle A with respect to a trans-
action are not allowable if the transaction does 
not have economic substance or lacks a business 
purpose. 
‘‘(B) 
TAX-INDIFFERENT
PARTY.—The 
term ‘tax-indifferent party’ means any person 
or entity not subject to tax imposed by subtitle 
A. A person shall be treated as a tax-indifferent 
party with respect to a transaction if the items 
taken into account with respect to the trans-
action have no substantial impact on such per-
son’s liability under subtitle A. 
‘‘(C) EXCEPTION FOR PERSONAL TRANS-
ACTIONS OF INDIVIDUALS.—In the case of an 
individual, this subsection shall apply only to 
transactions entered into in connection with a 
trade or business or an activity engaged in for 
the production of income. 
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‘‘(D) TREATMENT OF LESSORS.—In apply-
ing paragraph (1)(B)(ii) to the lessor of tan-
gible property subject to a lease— 
‘‘(i) the expected net tax benefits with 
respect to the leased property shall not in-
clude the benefits of— 
‘‘(I) depreciation, 
‘‘(II) any tax credit, or 
‘‘(III) any other deduction as 
provided in guidance by the Secretary, 
and 
‘‘(ii) subclause (II) of paragraph 
(1)(B)(ii) shall be disregarded in deter-
mining whether any of such benefits are al-
lowable. 
‘‘(4) OTHER COMMON LAW DOCTRINES NOT AF-
FECTED.—Except as specifically provided in this 
subsection, the provisions of this subsection shall not 
be construed as altering or supplanting any other 
rule of law, and the requirements of this subsection 
shall be construed as being in addition to any such 
other rule of law. 
‘‘(5) REGULATIONS.—The Secretary shall pre-
scribe such regulations as may be necessary or ap-
propriate to carry out the purposes of this sub-
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section. Such regulations may include exemptions 
from the application of this subsection.’’. 
(b) EFFECTIVE DATE.—The amendments made by 
this section shall apply to transactions entered into after 
the date of the enactment of this Act. 
SEC. 402. PENALTY FOR UNDERSTATEMENTS ATTRIB-
UTABLE TO TRANSACTIONS LACKING ECO-
NOMIC SUBSTANCE, ETC. 
(a) IN GENERAL.—Subchapter A of chapter 68 is 
amended by inserting after section 6662A the following 
new section: 
‘‘SEC. 6662B. PENALTY FOR UNDERSTATEMENTS ATTRIB-
UTABLE TO TRANSACTIONS LACKING ECO-
NOMIC SUBSTANCE, ETC. 
‘‘(a) IMPOSITION OF PENALTY.—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 such under-
statement. 
‘‘(b) REDUCTION
OF PENALTY
FOR DISCLOSED 
TRANSACTIONS.—Subsection (a) shall be applied by sub-
stituting ‘20 percent’ for ‘40 percent’ with respect to the 
portion of any noneconomic substance transaction under-
statement with respect to which the relevant facts affect-
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ing the tax treatment of the item are adequately disclosed 
in the return or a statement attached to the return. 
‘‘(c) NONECONOMIC SUBSTANCE TRANSACTION UN-
DERSTATEMENT.—For purposes of this section— 
‘‘(1) IN
GENERAL.—The term ‘noneconomic 
substance transaction understatement’ means any 
amount which would be an understatement under 
section 6662A(b)(1) if section 6662A were applied 
by taking into account items attributable to non-
economic substance transactions rather than items 
to which section 6662A would apply without regard 
to this paragraph. 
‘‘(2) 
NONECONOMIC
SUBSTANCE
TRANS-
ACTION.—The term ‘noneconomic substance trans-
action’ means any transaction if— 
‘‘(A) there is a lack of economic substance 
(within the meaning of section 7701(p)(1)) for 
the transaction giving rise to the claimed ben-
efit or the transaction was not respected under 
section 7701(p)(2), or 
‘‘(B) the transaction fails to meet the re-
quirements of any similar rule of law. 
‘‘(d) RULES APPLICABLE TO COMPROMISE OF PEN-
ALTY.— 
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‘‘(1) IN GENERAL.—If the first letter of pro-
posed deficiency which allows the taxpayer an oppor-
tunity for administrative review in the Internal Rev-
enue Service Office of Appeals has been sent with 
respect to a penalty to which this section applies, 
only the Commissioner of Internal Revenue may 
compromise all or any portion of such penalty. 
‘‘(2) APPLICABLE RULES.—The rules of para-
graphs (2) and (3) of section 6707A(d) shall apply 
for purposes of paragraph (1). 
‘‘(e) COORDINATION WITH OTHER PENALTIES.—Ex-
cept as otherwise provided in this part, the penalty im-
posed by this section shall be in addition to any other pen-
alty imposed by this title. 
‘‘(f) CROSS REFERENCES.— 
‘‘(1) For coordination of penalty with understatements 
under section 6662 and other special rules, see section 
6662A(e). 
‘‘(2) For reporting of penalty imposed under this section 
to the Securities and Exchange Commission, see section 
6707A(e).’’. 
(b) COORDINATION WITH OTHER UNDERSTATE-
MENTS AND PENALTIES.— 
(1) 
The 
second 
sentence 
of 
section 
6662(d)(2)(A) is amended by inserting ‘‘and without 
regard to items with respect to which a penalty is 
imposed by section 6662B’’ before the period at the 
end. 
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(2) Subsection (e) of section 6662A is amend-
ed— 
(A) in paragraph (1), by inserting ‘‘and 
noneconomic substance transaction understate-
ments’’ after ‘‘reportable transaction under-
statements’’ both places it appears, 
(B) in paragraph (2)(A), by inserting ‘‘and 
a noneconomic substance transaction under-
statement’’ after ‘‘reportable transaction under-
statement’’, 
(C) in paragraph (2)(B), by inserting 
‘‘6662B or’’ before ‘‘6663’’, 
(D) in paragraph (2)(C)(i), by inserting 
‘‘or section 6662B’’ before the period at the 
end, 
(E) in paragraph (2)(C)(ii), by inserting 
‘‘and section 6662B’’ after ‘‘This section’’, 
(F) in paragraph (3), by inserting ‘‘or non-
economic substance transaction understate-
ment’’ after ‘‘reportable transaction understate-
ment’’, and 
(G) by adding at the end the following new 
paragraph: 
‘‘(4) NONECONOMIC SUBSTANCE TRANSACTION 
UNDERSTATEMENT.—For purposes of this sub-
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section, the term ‘noneconomic substance trans-
action understatement’ has the meaning given such 
term by section 6662B(c).’’. 
(3) Subsection (e) of section 6707A is amend-
ed— 
(A) by striking ‘‘or’’ at the end of subpara-
graph (B), and 
(B) by striking subparagraph (C) and in-
serting the following new subparagraphs: 
‘‘(C) is required to pay a penalty under 
section 6662B with respect to any noneconomic 
substance transaction, or 
‘‘(D) is required to pay a penalty under 
section 6662(h) with respect to any transaction 
and would (but for section 6662A(e)(2)(C)) 
have been subject to penalty under section 
6662A at a rate prescribed under section 
6662A(c) or under section 6662B,’’. 
(c) CLERICAL AMENDMENT.—The table of sections 
for part II of subchapter A of chapter 68 is amended by 
inserting after the item relating to section 6662A the fol-
lowing new item: 
‘‘Sec. 6662B. Penalty for understatements attributable to transactions lacking 
economic substance, etc.’’. 
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(d) EFFECTIVE DATE.—The amendments made by 
this section shall apply to transactions entered into after 
the date of the enactment of this Act. 
SEC. 403. DENIAL OF DEDUCTION FOR INTEREST ON UN-
DERPAYMENTS 
ATTRIBUTABLE 
TO 
NON-
ECONOMIC SUBSTANCE TRANSACTIONS. 
(a) IN GENERAL.—Section 163(m) (relating to inter-
est on unpaid taxes attributable to nondisclosed reportable 
transactions) is amended— 
(1) by striking ‘‘attributable’’ and all that fol-
lows and inserting the following: ‘‘attributable to— 
‘‘(1) the portion of any reportable transaction 
understatement (as defined in section 6662A(b)) 
with respect to which the requirement of section 
6664(d)(2)(A) is not met, or 
‘‘(2) any noneconomic substance transaction 
understatement (as defined in section 6662B(c)).’’, 
and 
(2) by inserting ‘‘AND NONECONOMIC SUB-
STANCE TRANSACTIONS’’ after ‘‘TRANSACTIONS’’. 
(b) EFFECTIVE DATE.—The amendments made by 
this section shall apply to transactions after the date of 
the enactment of this Act in taxable years ending after 
such date. 
Æ 
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