India's tax authorities had contacted Cairn Energy in January to discuss income tax assessments dating back about seven years, making it the latest foreign firm to be embroiled in the country's tax crackdown to try to cut its budget deficit.
Other foreign multinational companies have also been targeted, including Anglo-Dutch oil major Shell, South Korea's LG Electronics and France's Capgemini .
Cairn Energy said it would suspend its buy-back as of March 21 in the light of the tax review, the outcome of which it said would shape the company's way forward beyond 2014. Cairn has completed about one third of the buy-back.
"Throughout its history of operating in India, Cairn has been fully compliant with the tax legislation in force," Cairn Energy Chief Executive Simon Thomson said on a conference call. "We intend to take whatever steps are necessary to protect our interests."
In January, India's tax authority had requested further information on Cairn Energy's 2006 income tax that pre-dated the flotation of its Cairn India business in 2007.
The company was ordered not to sell its shares in Cairn India during the investigation, limiting the firm's ability to raise cash from selling its 10 percent holding in Cairn India, valued at around $1 billion.
"Whilst this shouldn't be an issue in the near term, it may limit flexibility further down the line," equity analysts at Liberum said.
Cairn Energy's Chief Financial Officer Jann Brown said the company was in the process of compiling the information requested and would send it to the tax authority in April.
Cairn Energy shares were the biggest faller among London's FTSE 250 companies, down 11 percent at 1023 GMT.
The oil and gas explorer also announced annual results on Tuesday, where it reported a higher-than-expected loss after tax of $556 million due to soaring costs for unsuccessful exploration in Morocco and the North Sea.
The company's costs for unsuccessful exploration rose 34 percent year on year to $213 million, which included $107 million spent on drilling offshore Morocco and $81 million in the Norwegian and UK parts of the North Sea.
Cairn Energy said on Monday that it had plugged and abandoned a well in Morocco, a country whose offshore resources are tipped as one of this year's promising exploration areas.
The firm's 2014 exploration programme, which includes nine wells in places such as Senegal and Ireland, and the outcome of the Indian tax assessment will shape the company's trajectory beyond this year.
"Key risk is negative sentiment surrounding possible disappointing exploration results and an unresolved Indian Tax issue," Mark Wilson, equity analyst at Jefferies, said.