How to Handle Payroll Audits

Key Takeaways

• Payroll audits help ensure that businesses comply with tax, employment, and payroll regulations across Canada.
  
• The most common audit triggers include late remittances, classification errors, or employee complaints.
  
• Employers must keep accurate and accessible payroll records for the required retention period.
  
• Understanding the audit process—from notification to resolution—reduces stress and risk.
  
• Working with a qualified payroll service provider can minimize errors and maintain continuous compliance.
  

  Understanding Payroll Audits

A payroll audit is an official review of your organization’s payroll records and procedures. The objective is to confirm that all employees are paid correctly and that payroll deductions, remittances, and employment standards are followed.

Audits are typically conducted by one of three authorities:

• Canada Revenue Agency (CRA): Reviews income tax, Employment Insurance (EI), and Canada Pension Plan (CPP) compliance.
  
• Provincial Employment Standards Branches: Examine wage calculations, overtime, and vacation pay compliance.
  
• Employment and Social Development Canada (ESDC): Oversees federally regulated employers under the Canada Labour Code.
  

When approached correctly, audits serve as a valuable opportunity to strengthen your payroll management and demonstrate your commitment to legal compliance.

Why Payroll Audits Occur

Payroll audits can be initiated randomly or triggered by specific warning signs. Some of the most common causes include:

• Late or missing remittances to the CRA.
  
• Frequent amendments to T4 slips or Records of Employment (ROEs).
  
• High contractor-to-employee ratios suggesting possible misclassification.
  
• Discrepancies between reported income and deductions.
  
• Employee complaints filed with employment standards.
  

Proactive payroll reviews can often identify and resolve such issues before an official audit occurs.

Step-by-Step Guide to Handling a Payroll Audit

Step 1: Identify the Type of Audit

First, determine which agency has initiated the audit. The required documents and regulations differ depending on the auditor.

Understanding the scope of the audit helps you prepare the correct set of payroll records and responses.

Step 2: Review the Audit Notice and Timeline

An audit letter typically includes:

• The time period under review (e.g., January 1, 2022 – December 31, 2023).
  
• The specific records required.
  
• The submission deadline and format (digital or physical).
  
• Whether the audit will be onsite or remote.

Tip: Respond promptly. Late responses may raise further questions or trigger additional verification requests.

Step 3: Gather and Organize Payroll Records

The most important step in audit readiness is documentation. Ensure you have easy access to:

• Payroll journals and pay summaries.
  
• T4s, T4 Summaries, and ROEs.
  
• Time sheets, schedules, and overtime logs.
  
• Pay stubs and deduction details.
  
• Employment agreements and contractor invoices.
  
• Remittance confirmations (PD7As and payment proofs).
  
• Records of vacation, statutory holidays, and bonuses.
  

Retention Requirements by Jurisdiction

Maintaining digital copies through secure payroll software is acceptable as long as the records are printable, readable, and accessible upon request.

Step 4: Conduct a Pre-Audit Internal Review

Before submitting any documentation, perform a self-audit to identify potential issues. This proactive review shows good faith and allows you to correct small errors before they become major findings.

Key areas to assess:

• Are all workers correctly classified as employees or independent contractors?
• Are CPP, EI, and income taxes accurately deducted and remitted?
  
• Do payroll records align with CRA filings?
  
• Are vacation and overtime calculations consistent with provincial standards?
  
• Do pay stubs match actual deposits?
  

If discrepancies are found, note them clearly and prepare explanations or correction plans.

Step 5: Cooperate with the Auditor

During the audit process:

• Be transparent and professional in all communications.
• Provide accurate and complete records without unnecessary delay.
• If unsure about a question, request clarification rather than guessing.
• For onsite audits, prepare a quiet workspace and designate one contact person.

Auditors may also request staff interviews or follow-up documentation. Cooperation demonstrates compliance and reduces the likelihood of additional penalties.

Step 6: Review and Respond to Audit Findings

Once the audit concludes, you will receive a report summarizing any discrepancies and recommendations.

This report may include:

• Areas of non-compliance.
  
• Required payments (e.g., back pay or penalties).
  
• Proposed corrections for internal processes.
  

In some cases, you might receive a Notice of Assessment or Reassessment from the CRA, or a Compliance Order from a provincial authority.

If you disagree with the findings, you may file an appeal:

• CRA: File an objection within 90 days.
  
• Ontario ESA: Request a review within 30 days.
  

Always document your response process and keep copies of all correspondence.

Step 7: Implement Corrective Measures

If the audit uncovers issues, take immediate action to correct them:

• Issue any back payments owed to employees.
  
• File amended T4s or ROEs as needed.
  
• Update internal payroll systems to prevent recurrence.
  
• Retrain payroll and HR teams on compliance obligations.
  
• Create a compliance calendar for ongoing monitoring.
  

Demonstrating proactive correction can reduce future penalties and build trust with auditors.

How to Reduce the Risk of Future Audits

While random audits cannot be entirely prevented, maintaining good payroll governance significantly lowers your risk.

Best Practices for Audit Prevention

• Use CRA-approved payroll software to automate tax calculations.
  
• Reconcile payroll data with accounting records monthly.
  
• Stay updated on federal and provincial legislation changes.
  
• Provide regular training for HR and payroll teams.
  
• Conduct annual internal payroll audits to verify compliance.
  
• Clearly document all contractor relationships and service agreements.
  
• Maintain a checklist for timely CRA remittances.
  

Sample Audit Readiness Checklist

The Value of Staying Prepared

Payroll audits can be stressful, but employers who maintain organized records, use compliant software, and stay informed about evolving legislation rarely face serious issues. An audit-ready business demonstrates professionalism, builds employee confidence, and avoids unnecessary financial risk.

Conclusion

Payroll audits are part of responsible business operations in Canada. By maintaining accurate payroll documentation, implementing proactive internal checks, and responding cooperatively to auditors, employers can navigate audits confidently and efficiently.

Preparation, transparency, and ongoing compliance are your best tools for ensuring peace of mind and maintaining trust with regulatory agencies.

Need Help Navigating Payroll Compliance?

At Outsource Payroll Solution, we specialize in payroll audit readiness and compliance support. Our services include:

• Comprehensive payroll processing and recordkeeping
  
• CRA-aligned reporting and remittance management
  
• Contractor classification reviews
  
• Year-end documentation and audit assistance
  

Let our experts handle the complexity so you can focus on your business.

Visit www.payrollsolution.ca to learn more or connect with a payroll specialist today.