The Australian Communications and Media Authority (ACMA) said Telstra did not properly inform around 50,000 people that the maximum internet speeds on their plans were not attainable.
The ACMA has ordered Telstra to remediate the customers who were misled and not able to get top internet speeds.
Under ACMA rules, telecommunication companies must verify maximum internet speeds and notify customers when speeds cannot meet those advertised in their plan.
When advertised speeds can’t be achieved customers need to be given the option to move to a lower speed plan at a cheaper price or be able to move to a different provider without cost.
"The ACMA is very concerned with this conduct as these customers have been paying for a level of service they were not receiving," ACMA chair Nerida O'Loughlin said in a statement on Wednesday.
"Telstra denied these customers the opportunity to downgrade their plan or exit their contract."
The ACMA expects Telstra to pay out around $25 million in refunds which includes other cases not included in the watchdog investigation.
The ACMA said Telstra also breached rules that don't allow a telco to charge for NBN services unless 10 working days have passed since customers were advised of their options and they have not taken up an available remedy.
Telstra will now have to commission an independent audit of the systems it uses to notify customers of their maximum attainable speeds.
The company must also implement a range of processes and reporting to assure future compliance with ACMA rules.
"We will take a very close look at the results of the independent audit to make sure we are satisfied that the action Telstra has taken will adequately address the flaws that led to the problems," O'Loughlin said.
Telstra faces penalties of up to $10 million if it doesn't comply with the direction.
How can you get your refund from Telstra?
If you're entitled to the refund, Telstra will be required to let you know and advise you of how much your refund will be.