It's once again safe for Canadians to invest in the increasingly popular U.S. exchange-traded funds.

The Finance Department confirmed yesterday that this investment product, essentially a supercheap mutual fund that trades like a stock, will not be targeted in new legislation designed to catch people who duck taxes by putting money in foreign investment funds.

More changes seem likely for the proposed new rules, which generated hundreds of letters and submissions from angry investors and the investment industry. The department said it has extended the comment period on the legislation to Dec. 31 from Sept. 1, and will delay implementation by 12 months to the taxation years beginning after 2001.

The department's about-face means investors will be able to buy U.S. exchange-traded funds for their non-registered investment accounts without bearing a prohibitively heavy tax burden.

The proposed new rules would have required people to report the gains from exchange-traded funds each year and to pay tax on them even if they were only paper profits. Any gains would have been taxed as ordinary income, which means they wouldn't have benefited from the two-thirds capital gains inclusion rate.

The Finance Department said the test for determining whether a fund can be exempt from the new law is whether it qualifies under U.S. law as a regulated investment company and thus distributes 90 per cent or more of its income to unitholders. If that's the case, then there's no tax sheltering going on.

Two of the biggest players in exchange-traded funds -- State Street Global Advisors and Barclays Global Investors -- have said their products are regulated investment companies.

Canada's menu of exchange-traded funds is limited to the i60 (XIU-TSE) right now, but there are dozens listed on the American Stock Exchange that can give investors exposure to all major U.S. stock indexes, as well as indexes that represent many economic sectors and the stock markets of countries around the world.

The reversal on exchange-traded funds can be directly attributed to the many people who contacted Finance to say the proposed treatment of these products was unfair, a department official said.

"We consulted on this stuff during the process of putting together the legislation and as far as I know, the issue was never raised," he said. "If we had known, we would have reacted to this sooner, before the legislation went out."

The new tax rules as they were presented last June would also slap a heavy tax burden on Canadians who own regular U.S. mutual funds outside their registered retirement accounts.

The Finance Department did not specifically exclude regular U.S. mutual funds yesterday, but it did indicate these funds would not be affected as long as they qualified as regulated investment companies.

John Mountain, vice-president of regulation for the Investment Funds Institute of Canada, has said the vast majority of U.S. funds that a Canadian might hold would be regulated investment companies.

Investors who aren't sure about this issue should check with their brokers, or with the fund companies themselves.

There has been concern that the new tax rules would also hit investors who hold shares of companies that keep a majority of their assets in shares, resource properties or other assets.

However, Finance said yesterday that the shares of a company that is widely held and actively traded would be exempt as long as the company's main business was not investments. There are also specific exclusions to cover the shares of technology companies in the business of developing property such as computer software.