The hard line follows news last week that the Indian income tax department had asked to see documents relating to the 2006-7 financial year.
The company has clarified that the inquiry relates to a 2012 law which seeks to tax prior year transactions under retrospective legislation.
No actual claim for back-tax has yet been made, and Edinburgh-based Cairn has not put a value on the potential hit it is facing. Some Indian reports have speculated that it be as much as $800 million (£486m).
The firm said: “Cairn has re-confirmed with its advisers that throughout its history of operating in India the company has been fully compliant with the tax legislation in force in each year.”
Cairn made its name with huge oil discoveries in India, which it later hived off as a separate company, Cairn India, which floated in 2006. It is thought that any possible tax liabilities may relate to the flotation. The Indian business is now majority owned by Vedanta Resources and Cairn Energy has been selling down its stake to fund its new exploratory ambitions in the Atlantic.
However, the Scots firm has now been restricted from selling its remaining shares in Cairn India, which are valued at about $1 billion.
The company, which is exploring for oil off the west coast of Africa and developing a large oil field in British waters, said that its activities elsewhere would continue as planned.
Cairn’s shares have fallen by almost a fifth since it first announced the tax probe on 24 January, but there was no further dramatic move today.
Broker Canaccord Genuity said that if the figures in the press reports are true, the tax hit would equate to about 80p a share for Cairn’s investors.
Analyst Thomas Martin said: “There remains limited visibility on this issue and we are left in the slightly absurd position of referring to press articles as the only estimate of a potentially large liability. “
Advising “caution” to potential investors, he added: “Cairn was already a high-risk, frontier exploration story and the risk profile has deteriorated further. Whilst a favourable resolution of this tax issue would result in a sharp upwards move in the shares we find it extremely difficult to assess the likelihood and remain cautious.”
Canaccord dropped its target price for Cairn from 285p to 230p, reflecting “50 per cent of an assumed $800m liability” and other tweaks to valuations.
The firm was expected to start selling its remaining shares in Cairn India this year in order to fund its extensive drilling plans, and the possibility of a drawn out dispute with the Indian authorities may therefore cause funding problems if the stock remains frozen.
Along with two wells in Senegal and one each off Morocco and Ireland, Cairn is planning a further five non-operated wells, including four in the North Sea, in what is described as its busiest year for a decade.
Martin said: “We estimate Cairn will need to either dispose of its remaining Cairn India stake, or draw down debt, to fund the North Sea development program before year-end 2015.”
Cairn’s finances are expected to receive a boost when its Catcher and Kraken projects in the North Sea begin production over the coming years. Shares closed down 1.3p or 0.6 per cent at 215.60p..