Yes, because the original contributions to the HSA are not deductible (therefore have to be added back to state income), this affects the tax treatment of distributions. Distributions for not-qualified medical expenses, which are taxed as income on the federal return and are hit with a 20% penalty, are not taxed in CA nor hit with a penalty.
To your point, CA wants to back out the federal deduction for medical expenses reimbursed by your HSA, because it is going to handle those medical expenses elsewhere. The reference to the 7.5% is to make sure that you enter only those expenses which actually made a difference on Schedule A - any medical expenses less than 7.5% of your AGI doesn't count anyway.
So, technically, it's not that the distribution for qualified medical expenses that is being handled differently in this case, but certain medical expenses themselves.
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