Canada's mutual fund industry has joined in the nationwide movement to get Ottawa to rethink its proposed taxation of phantom capital gains on foreign investment entities (FIEs).

This comes on the eve of an expected announcement by the Department of Finance extending the Sept. 1 deadline for commentary and reinstating an exemption for U.S.-based registered investment corpations. That would likely cover mutual funds and exchange-traded funds (ETFs), the focus of a massive grassroots protest from small investors.

The Finance official responsible for FIEs said yesterday the government will "probably" extend the deadline and some of the legislation will be modified. "We were not aware of the popularity of ETFs with Canadian small investors," she said, until the department received several hundred letters, e-mails and faxes.

When draft legislation was announced late in June as the centrepiece of a campaign to thwart offshore tax evasion, some observers suggested the Canadian mutual fund industry seemed to be a net beneficiary. That's because U.S. or foreign equity funds provided by Canadian fund companies were not included in the definition of FIEs. The legislation seemed to target the fund industry's major emerging competition: low-cost ETFs sold by firms like Barclays Global Investors Canada Ltd.

Investors in the newer products would have been forced to pay annual capital gains taxes even if they did not actually sell and realize a profit. Those in Canadian-administered mutual funds would not have been subjected to the same unfair tax treatment.

The Investment Funds Institute of Canada did not meet Friday's deadline for comment but was due to post its position yesterday on its Web site (www.mutfunds.com).

"We think it's awfully unfair to investors," says John Mountain, IFIC's vice-president of regulation. "We're not out to win market share by shutting out legitimate competitors." He said the industry had its first meaningful discussions on the issue late in July. "At no point did anyone even half jokingly say we should support the legislation because the industry will benefit. The impact of this legislation goes way beyond ETFs. We're very concerned about it."

The law would even affect Canadian equity funds, since they can invest 25% in foreign stocks and Ottawa's definition of an FIE is so broad it could include such broadly held shares as Microsoft Corp. Mr. Mountain said.

Fund administrators would not know until financial statements were issued at the end of the fiscal year if a particular stock would be considered an FIE by the tax authorities, he said.

Financial planning groups such as the Canadian Association of Financial Planners and the Canadian Association of Financial and Insurance Advisors have also joined the chorus of protests, even though they too benefit from sale of mutual funds. CAIFA's submission focuses on the negative effects the legislation has on life insurance products.