SHARES in Cairn Energy have plunged 15 per cent after the company was landed with a $1.6 billion (£1bn) tax demand by the Indian authorities.

Investors apparently took fright after the company announced on Tuesday afternoon that the Indian income tax department had submitted a claim for back taxes, which was much bigger than analysts had expected.

The retrospective claim was a surprise move in a long-running tax dispute that concerns the 2006-07 tax year, during which Cairn floated its Indian subsidiary.

Cairn has been prevented from selling its remaining 10% stake in Cairn India pending resolution of the dispute. The stake was valued at $700m at Cairn's 31 December year end.

Announcing the claim had been received, Cairn's chief executive Simon Thomson said:

"Cairn has consistently confirmed that it has been fully compliant with all relevant legislation and paid all applicable taxes in India and we are confident of our position under the UK-India Investment Treaty"

The company is seeking arbitration of the tax issue under the treaty.

However, Stephane Foucaud, an analyst at First Energy Capital, said with Cairn facing potentially lengthy legal proceedings the claim could pose big challenges for the company.

"The bill is well above what we expected ($200m) and well above the value of Cairn's stake in Cairn India," he said.

Mr Foucaud raised the prospect Cairn could sustain hefty losses and may have to curb activity as a result of the dispute. Cairn is investing heavily in exploration work in areas including offshore West Africa and developing two giant fields in the North Sea.

"Fifty fifty you would be looking at a write off of the $700m Cairn India stake but there's a risk it could go deeper," said Mr Foucaud.

Cairn had $869m cash at 31 December, and a $575m undrawn lending facility. It expects to generate significant cash from its North Sea developments from 2017.

Shares in Cairn Energy fell by 20 per cent initially before recovering some ground. They closed down 28.4p at 155p.

Cairn announced Mr Thomson yesterday bought 50,000 shares in the company at 149.787p each, for an outlay of around £75,000. He has 507,567 shares in total.