From our Canadian Bureau:          Page 2 Tax Proposal in Canada Raises Questions

How does it affect your portfolio if you are a Canadian citizen?

This all-encompassing definition catches, among other things, investment funds based in the U.S. that are both open-ended (i.e. regular U.S. mutual funds) and funds traded on stock exchanges (aka ETFs: exchange-traded funds). ETFs include index products like "Diamonds" (DIA - ETF that tracks the Dow Jones 30), "Spiders" (SPY - ETF that tracks the S&P 500) and "Cubes" (QQQ - ETF that tracks the Nasdaq).

Traded on the American Stock Exchange, these can be purchased from Canadian brokerage firms and appeal to a growing number of thrifty investors wanting to replicate market performance with razor thin fees of about 0.18% per year.

Regardless of one's opinion of the indexing versus active-management debate, the U.S. is the world's best example of the benefits of indexing. But this new legislation will put an end to Canadians' freedom of choice. Canadian indexers will be forced to buy more expensive Canadian-based index mutual funds, which range in cost from 0.29% to 1.34% per year.

But wait - it gets worse.

The definition runs the risk of also catching some foreign stocks. So, if you live in Canada, those shares of Microsoft in your taxable account may not be as attractive as you once thought.

Microsoft currently holds a warchest of about $23 billion in cash and cash equivalents. Microsoft also has substantial dealings in derivative securities like put options. Cash (i.e. T-bills and other short-term debt securities) and derivatives fall into the investment-property definition above. If this law affects foreign stocks, it will also impact Canadian-based mutual funds holding such stocks, rendering those funds less tax-efficient.

Fidelity Far East, because of its holdings, is one fund that would be adversely affected by this proposed law. It holds more than half of its assets in holding companies Hutchison Whampoa Ltd., HSBC Holdings, Cheung Kong Holdings Ltd., and Sun Hung Kai Properties Ltd. Since these companies all hold investments in other companies and real estate, they would be considered
"foreign-investment entities".
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