CRA Source Deductions Audit: The Ultimate Employer Survival Guide — Protect Your Business Before CRA Strikes

A CRA source deductions audit is one of the most dangerous audits a business can face. Unlike income tax reviews, source deductions audits attack the core of payroll — the one area where CRA imposes the highest penalties in the entire system. A single mistake in CPP/QPP, EI, taxable benefits, or employee classification can create years of retroactive liabilities, plus interest and penalties that compound aggressively.

For thousands of Canadian employers, these audits lead to shockingly high reassessments because payroll rules are complex, and CRA auditors apply them with zero flexibility. This guide provides employers with a complete, CPA-level understanding of how these audits work, why CRA targets businesses, what legal frameworks apply, and how Mackisen CPA — a Montreal CPA firm near you — protects companies from devastating consequences.

Legal and Regulatory Framework

Every employer in Canada must comply with three key laws:

·         The Income Tax Act (ITA) for tax withholdings

·         The Canada Pension Plan Act (CPP) or QPP Act for pension contributions

·         The Employment Insurance Act (EI) for insurable earnings

CRA enforces strict obligations:

·         correct calculation of CPP/QPP, EI, and income tax

·         timely remittance of payroll deductions

·         accurate T4, T4A, RL-1, and summary filings

·         proper classification of workers (employee vs contractor)

·         correct valuation and reporting of taxable benefits

Under the law, employers are fully liable for any errors — even if the payroll provider made the mistake. CRA can reassess up to four years back, or more if they claim gross negligence. These audits are not random; they are data-driven and backed by powerful analytics comparing payroll accounts nationwide.

Key Court Decisions

Canadian courts consistently support CRA when employers fail to meet payroll obligations. Important rulings reinforce that:

·         Worker classification must reflect substance over form — even if both parties sign a contractor agreement, courts may still rule it is an employment relationship.

·         Employers bear the responsibility for proving CPP/EI treatment with documentation.

·         T4 inconsistencies, missing records, or contradictory explanations justify a reassessment.

The message from jurisprudence is clear:
If your documents are not perfect, CRA wins.

That is why businesses rely on CPA firms like Mackisen to construct a bulletproof payroll compliance file before CRA arrives.

Why CRA Targets This Issue

CRA treats payroll as a high-risk, high-priority enforcement area for several reasons:

1.      Government Revenue Protection
Source deductions are mandatory trust funds. CRA considers late or incorrect remittances a serious infraction.

2.      High Error Rates Among Small and Medium-Sized Businesses
Most employers unknowingly make mistakes in benefit valuation, CPP/QPP adjustments, vacation pay, overtime treatment, or taxable allowances.

3.      Industries with Known Non-Compliance
Construction, transportation, consulting, restaurants, cleaning, subcontracting, and e-commerce businesses are audited frequently.

4.      Data Analytics Flags
CRA compares:

·         T4 totals vs payroll remittances

·         contractor payments vs subcontracting trends

·         sudden payroll drops

·         mismatched bank deposits
When something doesn’t match, they launch a source deductions audit.

5.      Misclassified Workers
This is the most expensive payroll mistake.
If CRA claims your subcontractors are actually employees, they will reassess:

·         CPP/QPP (both employer + employee portions)

·         EI (both employer + employee portions)

·         penalties

·         interest
for up to four years or more.

The result can easily reach tens or hundreds of thousands of dollars.

Mackisen Strategy

Mackisen CPA’s approach is engineered to eliminate audit exposure before CRA intervenes. Our strategy includes:

1. Full Payroll Forensic Review

We analyze every component of payroll:

·         worker classification

·         CPP/QPP/EI calculations

·         taxable benefits

·         car benefits

·         allowances

·         vacation pay

·         overtime

·         bonuses

·         shareholder payroll

·         director fees

We identify exposure points before CRA finds them.

2. Payroll–T4–General Ledger Reconciliation

CRA auditors rely on reconciliation inconsistencies to trigger audits.
Mackisen performs a full matching exercise so the numbers are airtight.

3. Evidence File Creation

We prepare a complete audit-ready binder:

·         signed contracts

·         job descriptions

·         proof of subcontractor independence

·         calculation sheets

·         benefit support

·         policy documents

This gives CRA no room to assume wrongdoing.

4. Correction and Mitigation

If errors exist, Mackisen corrects filings and negotiates with CRA to limit penalties.

5. Representation and Audit Defense

Our CPAs handle all communication with CRA to protect employers from misinterpretation, overreaching assessments, or aggressive enforcement.

Why This Matters

A payroll audit is not technical — it is legal, financial, and strategic.
Businesses need a firm that understands all three.

Real Client Experience

A growing service company received a CRA payroll audit notice covering three years. CRA initially alleged:

·         misclassified contractors

·         unpaid CPP/QPP and EI

·         incorrect taxable benefit reporting

·         discrepancies between T4 totals and remittances

CRA’s first proposal assessed $148,000 in liabilities.
Mackisen intervened, reconstructed the payroll file, corrected classification errors, presented case law supporting contractor independence, and provided reconciled schedules. The final reassessment was reduced to $0, and CRA closed the audit without penalties.

This is the value of expert CPA intervention: we know the laws, the regulations, the jurisprudence, and CRA’s internal methodology.

Common Questions

What triggers a source deductions audit?
Late remittances, mismatched payroll totals, inconsistent T4s, contractor payments, or industry risk.

How does CRA determine if a worker is an employee?
They analyze control, integration, ownership of tools, financial risk, and dependence.

What penalties apply?

·         10% penalty for first late remittance

·         20% penalty for repeated late remittances

·         interest on unpaid amounts

·         retroactive CPP/QPP and EI assessments

How far back can CRA reassess?
Normally four years, but unlimited if they allege gross negligence.

Can employers fix payroll errors before an audit?
Yes — and doing so dramatically reduces penalties. Mackisen handles all voluntary corrections.

What if CRA already sent an audit letter?
Contact us immediately. Early CPA involvement prevents misinterpretation of payroll data.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps businesses stay compliant while recovering the taxes they’re entitled to. Whether you’re filing your first GST/QST return or optimizing multi-year refunds, our expert team ensures precision, transparency, and protection from audit risk.

Mackisen is not just an accounting firm — it is your defense against one of CRA’s most aggressive audit programs.