More than a thousand environmental offset sites will be audited in a bid to rein in developers flouting the rules.
Environment Minister Tanya Plibersek on Thursday announced a full review of the offset sites approved over the past 20 years under national laws.
Companies have been warned to get their house in order and to be up-front about any issues before the review begins.
The audit will consider whether offset requirements have been met, and if they are delivering the environmental benefits claimed.
Only recently has reporting started tracking whether developers are meeting their responsibilities.
Penalties may be slapped on businesses for projects found to be in breach of their approval conditions.
Ms Plibersek said when developers agreed to offset their impacts, it wasn't a choice but a legal obligation.
"For too long, projects have gotten away with promising one thing and not following through," she said.
"I've been told of a car park being built where trees were meant to be planted to provide habitat for threatened species, and of unauthorised clearing of a site that was not properly protected.
"Approval holders should consider themselves on notice - deliver on your obligations for nature, or face penalties."
Ms Plibersek said the government wanted to protect nature, while also supporting sustainable development such as housing and renewable energy.
"Developers should do everything they can to avoid habitat destruction and reduce impacts on nature," she said.
Opposition environment spokesman Jonno Duniam said the coalition backed the audit, as long as it was "serious and well-targeted".
"If there are individuals or businesses doing the wrong thing, it's appropriate that they be held to account," he said.
The Australian Conservation Foundation's Brendan Sydes said that at best, offsets were ineffective but at worst they helped destroy irreplaceable habitat.
"It's beyond time this is addressed and new reforms, including an independent and well-funded national environment protection authority, are implemented to turn around the deeply entrenched belief that compliance with rules intended to protect the environment (is) optional," he said.
