Doh - I started to answer this one and Winblow$ fell over on me, now back in trusy Linux. That'll teach me
IP Masquerading is what everyone else calls Network Address Translation (NAT). If you have a Linux box that is Masquerading your network traffic out onto the Internet all traffic appears to come from that Linux box, but your machine on the internal network still thinks it has a directly connection to the web.
What happens is the linux box swaps the source IP addresses so that it appears to originate from your linux box, not the machine on your internal network, when the relative response if received the opposite is done, the destination IP address is changed from the linux box's IP address to the IP address of the machine on the internal network that originated the request.
When you use a proxy (an http one in this example) your browser sends the request to the proxy, the proxy gets the requested item and returns it to the browser. The big difference is that with a proxy your client software has to understand how to use that proxy, with IP masquerading its transparent. Niffty eh? A proxy gives you the ability to do nice things like caching and controlling what can be accessed.
HTH
Jamie...