Index participation units are the growth component of choice in the FPX indexes.

When Richard Croft and I designed the indexes, our decision to use IPUs was consistent with the passive investment philosophy we employed.

First, what are IPUs? They are exchange-traded securities that represent a specific underlying market index.

The IPUs included in the FPX indexes are the Canadian i60s, U.S. SPDRs and country-specific iShares. (The latter were previously known as Worldwide Equity Benchmark Shares --WEBS -- and are based on the relevant Morgan Stanley Capital International world composite index.) The combination of French, German, Japanese, Mexican and British iShares with the SPDRs (Standard & Poor's depositary receipts) was designed to have the global portfolio mimic the performance of the MSCI world index .

Why did we choose IPUs? We did so because they track indexes relatively closely and are generally cost-efficient because the portfolio turnover is relatively low.

Now, however, proposed legislation from the federal Department of Finance has raised understandable concerns on the part of IPU investors.

The June 22 draft legislation on the taxation of non-resident trusts and foreign investment entities (FIEs) was designed primarily as an anti-avoidance measure to deal with Canadians who use offshore trusts -- Canadians are, after all, taxable on worldwide income.

The legislation, however, also contains a provision requiring that Canadian investors include in taxable income an amount attributable to their annual share of the income earned by an FIE. The definition of an FIE would include all non-Canadian IPUs including SPDRs, iShares and (Dow-based) DIAMONDS, and other such index-related products.

How this so-called income earned is calculated is the crux of the problem. Under the proposed legislation, the investor theoretically can use either the accrual or the mark-to-market method for calculating the amount.

Using the accrual approach, the investor includes in income for the year an amount equal to the fund's realized capital gains, that is, the gains associated with the fund selling assets. In an index fund, this generally occurs when the index itself is adjusted. In recent years, the degree of index readjustment activity has been increasing. Nevertheless, in any given year the amount attributable to such gains would be a relatively small number, at least relative to the absolute movements in the products themselves.

So, for example, if you own 100 SPDRs at $140 a share and in a given year the SPDR trusts generates $1.10 per share in capital gains (due to trades within the portfolio), you would include $110 as income for the year.

The legislation goes on to say that if Canadian investors do not have sufficient information to calculate the accrued amount, they would be required to include in income the annual increase in the fair market value -- the mark-to-market approach.

This is what has caused the concern and where the danger lies of throwing the baby out with the bath water. If you had to use the mark-to-market approach, it would mean that if the IPU rose in value from, say, $140 to $150 per unit, you would have to include $10 per unit in your calculation of taxable income -- despite the fact that you had not transacted at all.

Obviously, this last approach is totally repugnant and would represent an unprecedented form of oppression for investors. My prediction, however, is that this is not likely to happen.

I and colleague David Louis, a tax lawyer at Minden Gross, were able to verify that most (if not all) of these IPUs distribute at least 90% of their gross income from dividends, interest and gains from the dispositions of stock. This means that under the accrual method, in general, the undeclared income from realized capital gains in the fund would be zero or close to zero.

Accordingly, we hope that the Department of Finance will automatically exempt all IPUs from the application of the rule, since it shouldn't ap