How to Handle a Payroll Audit: Compliance Guide for Employers

Introduction

Payroll audits are one of the most disruptive and costly CRA compliance procedures for businesses. Unlike income tax or GST/HST audits, payroll audits involve trust funds — the CPP/QPP, EI/QPIP, and income tax amounts withheld from employees’ paycheques but not yet remitted to the government. CRA treats payroll non-compliance as a serious offence, often imposing penalties of 3–10 percent, daily compounding interest, retroactive assessments, and in extreme cases, director's liability. Whether you run a small business, restaurant, tech startup, professional corporation, construction company, clinic, or retail shop, understanding payroll audit requirements is essential to protect your business.

Why CRA Conducts Payroll Audits

CRA targets payroll when it suspects:
incorrect CPP/QPP or EI/QPIP calculations
late or missing source deduction remittances
contractor vs employee misclassification
taxable benefits not reported correctly
underreported employment income
T4/RL-1 mismatches
GST/HST audits revealing payroll inconsistencies
Payroll audits often occur after CRA reviews slips, GST/HST filings, or business expenses.

Key Payroll Obligations for Employers

Employers must:
deduct CPP/QPP, EI/QPIP, and income tax from employees
remit source deductions on time
report all taxable benefits
issue accurate T4/RL-1 slips
pay employer portions of CPP/QPP and EI/QPIP
maintain payroll records
CRA views payroll responsibilities as legal obligations, not optional procedures.

Top Payroll Audit Triggers

late or missing remittances
incorrect T4 or RL-1 slips
unfiled T4 Summary or RLZ-1.S-V
contractors who appear to be employees
cash wages
unreported tips
company vehicles or allowances not reported as taxable benefits
reimbursed expenses treated incorrectly
Shareholder withdrawals classified improperly
GST/HST audit uncovering payroll discrepancies

Payroll Audit Checklist

CRA commonly requests:
employee payroll registers
payroll summaries
source deduction remittance proof (PD7A)
T4 and T4 Summary
RL-1 and RL-1 Summary (Quebec)
employment contracts
timesheets and scheduling records
records of taxable benefits (vehicle, health benefits, allowances)
expense reimbursement logs
subcontractor invoices and agreements
insurer benefit plan documents
bank statements showing payroll payments
bookkeeping ledgers

Contractor vs Employee — CRA’s Most Common Payroll Audit Issue

CRA uses the following criteria:
degree of control
ownership of tools
opportunity for profit/risk of loss
integration into the business
If a “contractor” is deemed an employee:
employer owes full CPP/QPP and EI/QPIP
retroactive payroll taxes
penalties
interest
This is one of the most expensive outcomes.

Taxable Benefits That CRA Audits Carefully

company vehicles
cell phone reimbursements
parking
bonuses and gift cards
insurance benefits
rent-free living arrangements
meal allowances
travel reimbursements
Failure to record taxable benefits leads to reassessments and penalties.

Common Payroll Audit Errors

treating employees as contractors
missing CPP/QPP contributions
incorrect EI insurability
not reporting allowances
cash wages without records
incorrect vacation pay
missing T4 amendments
home-office reimbursements coded incorrectly
CRA audits payroll with strict interpretation — documentation must be exact.

How to Prepare for a Payroll Audit

organize all payroll records for the audit period
reconcile payroll registers with T4 slips
prepare summaries of taxable benefits
review contractor agreements
verify CPP/QPP and EI/QPIP contributions
reconcile PD7A remittances to payroll journals
prepare employer contribution calculations
let a CPA communicate with CRA
Preparing proactively reduces audit scope and reassessment risk.

What Happens During a Payroll Audit

CRA may:
interview payroll staff
request additional documents
review prior or subsequent years
contact subcontractors
reclassify workers
propose adjustments
Audits typically last 4–12 weeks depending on complexity.

Possible Payroll Audit Outcomes

1. No adjustments

All payroll records are compliant.

2. Adjustments for CPP/QPP, EI/QPIP, or taxable benefits

Employer must pay the difference.

3. Penalties and interest

Often significant due to trust funds and late remittances.

4. Contractor reclassification

Employer becomes liable for retroactive payroll taxes.

5. Director’s liability

Directors may become personally liable for unpaid source deductions.

If You Disagree With CRA’s Audit Results

You may:
file a Notice of Objection (90-day deadline)
request additional review
submit corrected records
challenge worker classification decisions
CRA Appeals often overturns weak payroll assessments when evidence contradicts assumptions.

When Taxpayer Relief or VDP Can Apply

Taxpayer Relief can reduce interest on payroll debts during:
illness
financial hardship
CRA delays
VDP can eliminate penalties if:
unreported wages
unremitted payroll
misclassified workers
were corrected before CRA contacted you.

How to Avoid Payroll Audits in the Future

use reputable payroll software
separate employees and contractors clearly
remit on time
review taxable benefits annually
prepare year-end slips early
conduct internal payroll audits
ensure bookkeeping and payroll entries match

Mackisen Strategy

At Mackisen CPA Montreal, we defend businesses during payroll audits by preparing complete payroll documentation, correcting classification issues, negotiating reductions in assessments, drafting objections, and implementing compliance systems to prevent future payroll risk. We protect directors and business owners from costly penalties and liability.

Real Client Experience

A Montreal construction company avoided significant reassessment after we proved subcontractors met CRA tests. A clinic corrected taxable benefit errors and eliminated penalties. A tech startup resolved payroll discrepancies discovered during a GST audit. A restaurant owner avoided director’s liability after implementing improved payroll controls.

Common Questions

Can CRA audit payroll without warning? Yes. Can I be personally liable? Yes — for source deductions. Do contractors need contracts? Absolutely. Can CRA reclassify workers? Yes, frequently. Do payroll audits trigger GST/HST audits? Often.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal provides comprehensive payroll audit defense, compliance strategies, and expert representation to protect employers and directors from CRA penalties.