The June 22 draft legislation dealing with non-resident trusts and foreign investment entities is just another in a series of initiatives by the Department of Finance to crush any resilience the compliant taxpayer may have.

The Canadian taxpayer has endured a veritable barrage of initiatives over the last decades having the effect of constraining individual economic development. Now proper market response to the already confined investment environment faces a direct hit. It seems not enough that the Canadian taxpayer:

1. Already suffers comparatively higher tax rates.
2. Suffers impoverishment due to the 27 per cent decline of the Canadian dollar over the last 30 years.
3. Has flat disposable incomes over the last 15 years.

Now the Department of Finance proposes to catch up exchange-traded funds in its broad-ranging attack on foreign investment entities, ostensibly to gain better opportunity to the tax offshore investments -- offshore meaning anywhere outside of Canada.

The odiousness of this legislative proposal stems from its breadth which is such that the average Canadian taxpayer will easily find themselves in its clutches, and very likely, unsuspectingly so.

Canadian taxpayers over the last decades have had to endure very high personal taxation and severe governmental fiscal mismanagement. During this time they have been comparatively restricted on how much they could contribute to RRSPs and the extent to which these retirement savings could be invested abroad. All the while Canada's share of world market capitalization was declining and now is less than three per cent.

While Canadian investors initially found themselves captive to the Canadian mutual industry for a diversified program of foreign investments, innovative market entrepreneurs soon devised exchange-traded funds that performed as well as managed mutual funds, at a much lower management cost and very often at much better tax efficiency.

The i60s (XIU-TSE) is a Canadian version of an ETF and SPIDERS (SPY-Amex), reflecting the S&P500, is a foreign version.

The government seems to ignore why Canadians are moving funds offshore and rather focuses on symptoms, seeking taxpayer compliance by coercive means. If you pluck the goose at high rates for a long period of time it is bound to notice and modify its position. Current government surpluses have come from taxpayers, not reduced government spending and, still no substantive dividend.

Employment Insurance surpluses abound yet there have been only meagre reductions in EI premiums. Special privileges granted a wealthy family's trust on the trust's departure from Canada, the Human Resources ministry mismanagement and the granting, to the tune of a billion dollars, an unrequested benefit package to civil servants by the prime minister's office, all suggest an improper respect for the ordinary taxpayer.

Taxpayers, accordingly, have every right to be skeptical. When you travel abroad you discover you are a second class citizen of the world. It is government policy that has encouraged relief-seeking behaviour.

The proposed legislation would tax ETFs, of the foreign variety, on an accrual basis when the taxpayer cannot demonstrate it should be taxed otherwise. The ETF will be taxed on the "mark-to-market" method where annual increases or decreases in the year-end fair market value are included in income or allowed as a deduction, respectively. Note here the gain is not taxable as a capital gain but as ordinary income, and that is not the half of it.

Where foreign investment entities held prior to the introduction of this legislative proposal are capital property, the deferred amount accrued to the commencement of the first year in which the "mark-to-market" rules apply is not recognized until disposition. While the taxable amount then determined will be based on the two-thirds capital gains inclusion rate, the amount will not retain its identity as a capital gain. Further, where an individual taxpayer has an interest in a foreign investment entity at death, there is no provision for spousal rollover and taxes will be due in the deceased's final return.

So what kind of investment is embraced in the definition of foreign investment entity? Here we encounter complex definitions within definitions. Certainly, it includes foreign mutual funds, foreign exchange-traded funds, closed-end funds traded on foreign stock exchanges (and might even include the stock of Warren Buffet's Berkshire Hathaway Inc.), shares in foreign private corporations, interests in partnerships or trusts holding significant real estate, just to cite a few. This all arises through the definition of "investment property" for the purposes of this revised section of the Income Tax Act.

This legislative proposal will be dangerous and problematic for retail investors and tax return preparers. This comes on the heels of the recent introduction of Section 163.2 of the Income Tax Act regarding third party liability for those who advise taxpayers on tax matters and/or are involved in return preparation. The natural consequence of introducing more risk is that costs will naturally go up. More time is needed to assess exactly what the taxpayer is involved in or may become involved in.

The upshot of this proposed new regime is to restrict and further confine Canadian investment activity even more, driving the retail investor into the waiting arms of the Canadian mutual fund industry when the Canada Customs and Revenue Agency (Revenue Canada) is not prematurely picking the pockets of the taxpayer at punitive rates.

What is more, the proposal creates disparity of tax treatment and interferes with the efficient functioning of capital markets. Whatever intractable contest the Department of Finance has with sophisticated tax-planning Canadians, it should not be carried on the backs of the conscientious average taxpayer. A proper dose of basic fairness needs to be introduced.

David Shymko is a partner with Macdonald, Shymko & Co., fee-only financial advisers and investment counsel in Vancouver.