An announcement after the market close last night that it has been served with a $1.6 billion bill for unpaid tax in India is causing panic among shareholders in oil company Cairn Energy (CNE). It dives 17.1% to 152p this morning.

Web chart - Cairn - March 15

We were right to say the focus would be on India when we previewed yesterday's full-year results from the company but wrong to guess a more business-friendly regime in the country might lead to a positive resolution of the issue.

The probe into Cairn's Indian tax affairs was launched in January 2014 and has prevented the company from realising the estimated $702 million value of its 10% holding in former subsidiary Cairn India. Cairn eventually rose all the way to the FTSE 100 after it made India's largest-ever oil discovery in the Rajasthani desert all the way back in 2004.

It subsequently sold most of the Cairn India business, distributing funds to shareholders and keeping back some of the proceeds to fund ultimately unsuccessful exploration offshore Greenland, developments in the North Sea and drilling off the west African coast. As at the end of 2014 it had net cash of $869 million.

The tax bill covers the tax year 2006-07, when it was preparing to float Cairn India on the Mumbai stock exchange. Cairn's response is to lodge a Notice of Dispute under the terms of the UK-India trade treaty, saying it has detailed legal advice on the strength of its case under international law.

The Indian government and Cairn are now required to negotiate to seek a resolution to the dispute. If there is no agreement, an international arbitration panel will adjudicate. In the mean time the potential liability is likely to weigh on the shares.

Investec reiterates its 'buy' take but cuts its price target by 40p to 185p noting it should still be able to get its key North Sea projects - Kraken and Catcher - on stream. Analyst Brian Gallagher comments: 'Yesterday’s news broadsided the market and CNE itself with both, in our view, expecting a 2015 return of the Cairn India stake.

'We were also beginning to assume such an outcome, a view which was underpinned by commentary and rhetoric coming out of the Modi administration with regards to retrospective taxation. This rhetoric had intensified in and around the Indian budget (28 February).'

Find out how to deal online from £1.50 in a SIPP, ISA or Dealing account. AJBell logo

Issue Date: 11 Mar 2015