New residential service, 600amps. We will be doing the power lines from the transformer to the main disco. Utility says we can run a parallel set of 2-350mcm black and one 4ot white.

Why is the undersized neutral ok?

Canadian Electrical Code Rule 4-022 provides for sizing the neutral. It's a trade practice to reduce by two sizes instead of doing the calculation. For example, a 100 amp service with #3 hots has a #6 neutral.

I'll chime in here. If you decide to reduce the neutral I want calculations and no rule of thumb or trade practice is acceptable in determining the correct size.
Second. If you run parallel in more than 1 raceway then 2 neutrals are going in. 1 for each pipe. See 12-108 for parallel runs. If you can reduce the neutral you can divide the ampacity and install 2 conductors smaller than 1/0 to provide the neutral but there must be a neutral in each pipe as well as bonding conductors if the raceway cannot be used as a bonding method like when using PVC. As stated the rule for reducing neutral is 4-022. Reducing the neutral for resistive 240 volt loads makes sense especially in residential applications where harmonics are almost a non- existent problem.

A 1000 sq ft house with a full basement, a 12000 watt range and a 6000 watt dryer has a demand of 13500 watts, or 56 amps. It gets a 100 amp service with #6 neutral.

If the same house has an 18 kw electric furnace, it's demand is 31500 watts, or 132 amps. It gets a 200 amp service fed with 2/0 hots. The neutral load is still 56 amps. The ampacity of a 2/0 in a house is 200 amps (note to table 2) and table 17 requires a grounding conductor of 6 awg.

Therefore, this 200 amp service should get a 6 awg neutral.

However, the inspection department has a rule of thumb where they only allow a reduction of two trade sizes, so we must install the larger 1 awg neutral.

I want to do the calculation and install even smaller neutrals. It's in the code.

http://www.codemath.com/cgi-bin/Run.pl?script=Cec8_200

I would have to agree with mikesh, harmonics for residential housing are generally not a issue so a smaller neutral is a way to keep costs down. I must say that a 600 amp service for a residence is on the unique side (big). Maybe you should check and see what kind of "harmonic" loads this installation will be running... a smaller neutral may not be a good idea.

Table 17 in BC is #3 Ground for a 200 amp service. No rule of thumb in the code book here.
I take it that table 16 and 17 have changed in Sask since the 2002 code. The new values in the 2006 code were not adopted here.

We haven't adopted the 2006 but the inspection department has been allowing us to use either. In 2006, Table 18 is gone and table 17 is changed.

If you calculate the size of neutral for every house, I would expect that, in most cases, the neutral would be reduced and in many cases by more than two trade sizes. I've reduced the neutral by two sizes for so many years that I can't imagine not reducing the neutral. Reducing by more than two sizes seems odd, but it must be okay or it wouldn't be in the code.