Payroll Audit in Canada: What You Need To Know

A recent survey conducted on behalf of the Canadian Payroll Association (CPA) revealed that 54% of business leaders and 66% of those with direct payroll responsibilities wouldn’t know how to prepare for a payroll audit.

Most payroll audits are carried out to promote tax compliance and ensure payroll systems and procedures are set up correctly. If you’re a small business owner flagged for review, don’t assume it’s because you’ve done something wrong. Payroll audits in Canada are comprehensive examinations of an employer's payroll records by governmental agencies to ensure compliance with federal and provincial laws. These audits verify that employers are accurately calculating and remitting payroll deductions, such as income taxes, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums. Understanding what payroll audits entail, what can trigger them, and how to prepare is crucial for businesses to maintain compliance and avoid potential penalties.

What Triggers Payroll Audits in Canada?

Several factors can prompt a payroll audit. Understanding these triggers can help businesses mitigate risks.

1. Inconsistencies in Reporting

Discrepancies in Tax Filings: Mismatches between reported income on T4 slips and amounts reported in business tax returns.
Unusual Fluctuations: Significant changes in payroll amounts without clear justification.

2. Late or Incorrect Remittances

Delinquent Payments: Frequent late submissions of payroll deductions to the CRA.
Incorrect Amounts: Underpayment or overpayment of required remittances.

3. Employee Complaints

Whistleblower Reports: Employees report issues such as unpaid wages, incorrect deductions, or misclassification.
Labour Standards Violations: Complaints filed with provincial employment standards offices.

4. Misclassification of Workers

Independent Contractors vs. Employees: Misclassifying employees as contractors to avoid payroll taxes can trigger audits.
Subcontractor Payments: Large payments to individuals classified as contractors may raise red flags.

5. Random Selection

Routine Checks: The CRA and other agencies conduct random audits to ensure overall compliance.
Industry Focus: Industries with high rates of non-compliance may be targeted more frequently.

6. Failure to Issue Required Documents

Record of Employment (ROE) Issues: Failing to issue ROEs promptly or accurately.
Missing T4 Slips: Failure to provide employees and the CRA with annual T4 slips.

7. Significant Deductions or Credits Claimed

Unusual Tax Claims: Large or unusual deductions on corporate tax returns related to payroll expenses.
Benefit Programs: Offering complex employee benefits without proper reporting.

8. Third-Party Information

Information Sharing: Data received from other government agencies or financial institutions indicating potential non-compliance.
Audit Results from Business Partners: Issues found during audits of suppliers or contractors connected to your business.

Here’s what you need to know about the various types of external payroll audits in Canada and how to prepare your business for the audit process.

There’s More Than One Type of Payroll Audit

The first thing you should understand about payroll audits is that different types of payroll audits exist - and not all of them are driven by the Canada Revenue Agency (CRA). Several organizations in Canada have the right to inspect your company’s financial records. Different information may be required depending on which agency has elected to conduct the audit.

Canada Revenue Agency Audit

CRA audits are the most common business audits. The CRA auditor’s responsibilities include confirming compliance in making, remitting, and reporting statutory payroll deductions. Therefore, they’ll typically perform a payroll tax audit to review your payroll reports and verify your financial records match the amounts you’ve reported. You may be asked to share employee T4s, T4As, and data pertaining to taxable benefits your company provides.

Workers’ Compensation Board Audit

In British Columbia, Workers’ Compensation Board (WCB) matters fall under the jurisdiction of WorkSafeBC. This is a self-regulating system, so businesses are often audited to ensure they pay the correct premium amounts. WorkSafeBC auditors will want to verify your assessable payroll and industry classification and ensure you report your payroll correctly.

Union/Collective Agreement Audit

If your employees are part of a trade union - and you deduct union dues from their pay on behalf of a bargaining agent - your business may be subject to audit under the Canada Labour Code. Inspections usually include examining your employee and payroll records to ensure the collected and remitted amounts are in line with the collective agreement.

Employment Standards Board Audit

British Columbia sets provincial standards for employee payment, compensation, and working conditions in most workplaces. Audits conducted under the BC Employment Standards Act may include reviewing your company’s employment records to determine how much you pay employees for regular hours, overtime, and vacation pay.

Ministry of Finance Provincial Health Tax Audit

As of January 1, 2019, BC-based businesses with employee remuneration exceeding $500,000 in a calendar year must register to pay the Employer Health Tax (EHT). British Columbia's Ministry of Finance can audit your financial records to ensure you’re calculating and remitting the correct amount of tax based on your company’s annual payroll.

How to Prepare for a Payroll Audit

Here are some best practices if an authorized agency contacts your business about conducting a payroll audit. They’ll usually provide a specific start date and supply you with a list of records the auditor will want to see. You should immediately inform your company’s payroll practitioners and human resources team about the pending audit to give them ample time to gather the appropriate files and documentation.

The CRA or provincial authority often conduct the audit at your place of business. You should be prepared to:

Meet with the auditor personally when they arrive to discuss your operations,
have the auditor tour your business premises and
provide a private space where the auditor can readily access your company files and carry out their inspection

Each agency will have its requirements in terms of the data they will want to review. But as a general rule, here’s what you can be expected to share during a typical payroll audit procedure.

Documents for CRA Audits

If your business is selected for a Canada Revenue Agency audit, make sure you have these records – along with any relevant source documents – readily available:

General Ledgers
General Accounting Journals
Bank Account Statements
Sales Invoices
Purchase Invoices and Receipts
Expense Account Statements
CRA Payroll Deduction Remittance Reports

Documents for WCB Audits

If you’re audited by WorkSafeBC, make sure these files are ready for their review:

General Ledgers
Financial Statements
Tax Returns and Information Slips
Sales Records
Affiliates’ and Shareholders’ Records

Documents for Union Audits

If your business is selected for a union audit, ensure the remittance slips for union dues and other required amounts listed in your employees’ collective agreement are prepared and organized.

Once you clearly understand why your business is being audited, it will be easier to direct the agency representative auditor to the records they need. You and your payroll personnel must also be available during the review to answer any questions the auditor may have and to dig out any missing information.

Best Practices to Make a Payroll Audit as Painless as Possible

Prepare for the Audit

Audit Notification: Respond promptly and professionally if notified of an impending payroll audit.
Gather Documentation: Collect all requested records and ensure they are complete and well-organized.
Designate a Point Person: Assign a knowledgeable staff member to liaise with the auditor.

Cooperate During the Audit

Professionalism: Treat auditors with respect and provide information as requested.
Transparency: Be honest about any issues or discrepancies found. This is SUPER IMPORTANT!
Ask for Clarifications: If unsure about a request, seek clarification to provide accurate information.

Review and Implement Audit Findings

Address Issues: If the audit identifies compliance issues, take immediate steps to correct them.
Payment Plans: If additional taxes or penalties are assessed, discuss payment options if necessary.
Process Improvements: Implement recommendations to prevent future non-compliance.

Maintain Open Communication

Employee Awareness: Inform employees about payroll practices and encourage them to report discrepancies.
Documentation of Policies: Keep written payroll policies and procedures accessible.
Regular Updates: Communicate any changes in payroll processes to relevant staff.

A typical payroll audit can take 1 to 2 weeks to complete. Once the audit is complete, you can expect the auditor to:

present their findings and identify any financial or reporting discrepancies,
advise you of any outstanding amounts, fines, or penalties owing, and
explain how your business can go about appealing the audit if you disagree with the results

The audit process doesn’t end until you’ve paid any amounts you might owe and have amended or adjusted your financial records.

How To Reduce the Odds of a Payroll Audit

1. Maintain Accurate and Organized Records

Record-Keeping Compliance: Keep all payroll records for at least six years as required by the CRA.
Document Retention: Store records of wages, hours worked, deductions, remittances, T4 slips, ROEs, and employee contracts.
Organization: Use a consistent filing system, whether digital or physical, to ensure easy retrieval of documents.

2. Conduct Regular Internal Payroll Audits

Periodic Reviews: Regularly review payroll processes and records to identify and correct errors.
Checklists: Use audit checklists to ensure all aspects of payroll compliance are covered.
Third-Party Audits: Consider hiring external auditors for an objective assessment. Think of this as a pre-emptive audit, and it would be positively noted by the auditors if your business was put through a payroll audit.

3. Ensure Compliance with Tax Laws and Regulations

Stay Informed: Keep up-to-date with changes in federal and provincial payroll regulations.
Employee Classification: Verify that all workers are correctly classified according to CRA guidelines.
Taxable Benefits: Accurately calculate and report taxable benefits provided to employees.

4. Use Reliable Payroll Software or Services

Automation: Utilize payroll software that automatically updates tax tables and compliance requirements.
Integration: Ensure the software integrates with accounting systems for seamless data flow.
Vendor Selection: Choose reputable providers with a track record of compliance support.

5. Provide Training for Payroll Staff

Professional Development: Invest in ongoing training for staff responsible for payroll.
Regulatory Updates: Encourage attendance at workshops or webinars on payroll legislation.
Cross-Training: Ensure multiple staff members understand payroll processes to prevent knowledge gaps.

6. Consult with Professionals

Accountants and Tax Advisors: Work with professionals specializing in payroll and taxation.
Legal Counsel: Consult employment lawyers for advice on complex employment standards issues.
Payroll Associations: Engage with organizations like the Canadian Payroll Association for resources and guidance.

If you’re uncertain about what you need to know before, during, or after a payroll audit, you should get clarification from the auditor or agency involved, your payroll service provider, or your accounting professional.