How to Handle a Payroll Audit: Compliance Guide for Employers – A Complete Guide by a Montreal CPA Firm Near You

Introduction

A CRA payroll audit (or Revenu Québec payroll audit) is one of the most serious compliance checks a business can face. Payroll errors—such as incorrect source deductions, misclassified workers, unreported taxable benefits, and late remittances—can result in significant reassessments, penalties, and interest. Many employers incorrectly assume payroll is simple, yet payroll audits are among the most common audits in Canada. This guide explains how payroll audits work, what CRA and Revenu Québec look for, how to prepare your records, and how to protect your business from costly assessments.

Legal and Regulatory Framework

Payroll compliance is governed by the Income Tax Act, the Excise Tax Act (for GST/HST impact on benefits), the Quebec Taxation Act, EI Act, CPP/QPP Acts, and provincial employment laws. CRA and Revenu Québec verify: income tax withholdings, CPP/QPP contributions, EI/QPIP premiums, taxable benefits, T4/RL-1 reporting, subcontractor rules, and remittance timing. Employers must keep detailed books, timesheets, payroll registers, employment contracts, benefit records, and proof of remittances for at least six years.

Key Court Decisions

In Royal Winnipeg Ballet v. MNR, the court examined worker classification and emphasized the need for proper determination of employee vs. contractor status. In Connor Homes v. Canada, CRA’s authority to reassess based on misclassification was upheld. In Kerry (Canada) Inc. v. Canada, pension and benefit misreporting resulted in major reassessments. These cases show that payroll compliance requires strict adherence to CRA and Revenu Québec rules.

What Triggers a Payroll Audit

CRA and Revenu Québec often begin payroll audits when they detect: large subcontractor payments, inconsistent T4/RL-1 reporting, missing remittances, late payroll filings, high employee turnover, benefits not reported, cash payments, unreported taxable benefits, mismatched GST/HST filings, or discrepancies between payroll and corporate financial statements. Government agencies also compare payroll filings to GST/HST, T2, and WSIB/CNESST filings.

Documents CRA Will Request During a Payroll Audit

• Payroll registers

• T4 and RL-1 slips

• PD7A forms and remittance confirmations

• Employment contracts

• Worker agreements and subcontractor contracts

• Timesheets and job records

• Records of taxable benefits (vehicles, allowances, insurance, gifts, lodging)

• Mileage logs

• Shareholder loan history

• Accounting ledgers and bank statements

• GST/HST and QST returns (for cross-checks)

• Vacation pay calculations

• Bonuses, commissions, and severance documentation
  CRA may also request interviews with payroll staff or management.

Key Areas CRA Examines

1. Worker Classification (Employee vs Contractor)

Misclassification is one of the most common and expensive payroll audit issues. CRA examines control, ownership of tools, chance of profit, and integration. If CRA reclassifies contractors as employees, the employer owes full source deductions plus penalties and interest.

2. Source Deductions

CRA confirms whether employers withheld and remitted: federal/provincial income tax, CPP/QPP, EI/QPIP. Even a few late remittances can trigger penalties.

3. Taxable Benefits

Common benefits audited include vehicle benefits, allowances, reimbursements, group insurance, parking, cellphones, travel, housing, and gift cards. CRA checks whether these were correctly included on T4s and RL-1s.

4. Bonuses, Commissions, and Severance

CRA verifies correct withholding and reporting for lump-sum payments.

5. Shareholder Wages

CRA checks whether wages to shareholder-employees are reasonable and properly reported.

6. Payroll vs Bank Reconciliation

Unexplained withdrawals, cash payments, or off-book transactions raise red flags.

Do’s During a Payroll Audit

Respond on time, provide organized documents, allow your CPA to handle communication, ensure payroll records reconcile to T4s/RL-1s, demonstrate internal controls, and remain professional and factual. Provide only what CRA requests.

Don’ts During a Payroll Audit

Do not guess numbers, do not provide personal bank statements, do not provide extra documents beyond the audit scope, do not argue directly with auditors, do not amend payroll without guidance, and do not ignore taxable benefits.

If CRA Finds Errors

CRA may reassess: unpaid source deductions, EI/QPIP premiums, CPP/QPP contributions, taxable benefits, vacation pay, and penalties for late or missing remittances. Payroll penalties include:

• 3%–20% late remittance penalties

• Gross negligence penalties in severe cases

• Interest on all overdue amounts
  Revenu Québec may impose additional penalties.

If You Disagree With CRA’s Assessments

You may challenge the findings through:

• A rebuttal letter to the auditor

• Escalation to the team leader

• A Notice of Objection (within 90 days)

• Appeals or judicial review in Tax Court (if needed)
  Proper documentation and legal arguments are essential.

How to Prevent Payroll Audit Problems

Maintain accurate payroll records, use reputable payroll software, ensure timely remittances, classify workers properly, track taxable benefits clearly, reconcile payroll and bank accounts, and consult a CPA regularly. For Quebec employers, keep QPIP, CNESST, and RL-1 rules in mind.

Mackisen Strategy

At Mackisen CPA Montreal, we help employers navigate payroll audits with confidence. We manage all communications with CRA and Revenu Québec, prepare complete audit documentation packages, defend against misclassification findings, correct payroll errors, negotiate adjustments, and file objections when needed. We also help businesses build compliant payroll systems to prevent future audits.

Real Client Experience

A Montreal construction firm avoided $95,000 in payroll reassessments after we proved subcontractors were properly classified. A restaurant resolved taxable benefit issues after we reconstructed missing records. A tech company passed a payroll audit after we reconciled all remittances and corrected T4/RL-1 filing errors. A retail business avoided late remittance penalties with our compliance calendar.

Common Questions

Can CRA make me reclassify contractors as employees? Yes—if criteria indicate employment. Can a payroll audit trigger GST/HST reassessments? Yes. Can I negotiate penalties? Sometimes, through relief or objection. How long do payroll audits take? One month to one year, depending on complexity.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal protects employers during payroll audits with expert documentation, strong legal arguments, and proactive compliance strategies. We ensure payroll accuracy and defend your business from costly assessments.