"I can confirm that Brunswick state prosecutors are leading an investigation on suspicion of fraud in connection with compensation for activities on the works council," a spokeswoman told AFP.
While prosecutors did not name any suspects, multiple sources pointed to works council chief Bernd Osterloh.
A statement from Volkswagen's supervisory board said the committee was "aware of an investigation in progress against current and former members of the board and human resources managers at the company."
Osterloh holds two roles at VW, serving both a member of the supervisory board and with a full-time job as head of the works council.
Both Volkswagen and the works council defended Osterloh's pay packet.
A spokesman for the firm said an internal evaluation had "concluded that the pay scale the company offered Bernd Osterloh meets the requirements of the law on works councils" and that VW was "cooperating fully" with the probe.
Volkswagen has suffered scandals before over its relations with powerful worker representatives.
Works council chief Klaus Volkert was jailed for almost three years for accepting millions of euros in bribes, exotic travel and visits to prostitutes from executives in exchange for smoothing industrial relations.
Human resources head Peter Hartz was slapped with a two-year suspended sentence and a fine over the same scandal, which came to light in 2005.
"A works council member ought to be paid as if they had had a normal career," labour law expert Professor Volker Rieble of Munich's Ludwig-Maximilian University told AFP.
"Extra compensation for works councillors is banned, because it's supposed to be an honorary position," Rieble added, arguing that extra payments could be part of a "culture of corruption".
A works council spokesman said that Osterloh was paid comparably to a VW divisional head, and had recently passed up an offer to become human resources director -- a job that would have come with a big pay rise.
"Especially in the coming years marked by uncertainty and change for employees, it's important" that the worker representative remain at the head of the council, he said.
VW has launched a massive restructuring that will see it shift much of its focus to electric vehicles in the coming years, responding to the "dieselgate" scandal which saw it install software designed to cheat regulatory emissions tests in 11 million vehicles worldwide.
Managers spent months hammering out an agreement with worker representatives over the change programme, which will see the car giant shed some 30,000 jobs by 2020.