Shares in the bank, National Societe Generale Bank, which is being taken over by Qatar National Bank, tumbled by their legal limit of 10 percent and helped pushed Cairo's benchmark index down to its lowest level since December.

Cairo announced plans in December to introduce a 10 percent tax on major transactions on the stock market, including IPOs and takeovers - one of a number of new taxes to boost depleted government revenues - but had given no indication of when it would take effect.

On Tuesday the tax authority issued a statement saying shareholders and investment funds that make capital gains from Qatar National Bank's (QNB) bid for National Societe Generale Bank (NSGB) would face a 10 percent levy.

The announcement caught investors off guard as Egypt's regulator had only approved the takeover last month. Analysts said introducing the tax without warning risked scaring off foreign investors just as Egypt is trying to restore investor confidence shattered by two years of political and economic turmoil.

"It (the tax) was the wrong decision at the wrong time," said Nader Ibrahim, managing director at Acher Consulting in Cairo. "It will scare off foreign investors. We badly need foreign investment."

The plunge in National Societe Generale Bank's shares helped drag the Cairo stock market's benchmark index down 1.9 percent on Tuesday to its lowest level since December 11.

"This is like robbing investors," Cairo-based economist Osama Mourad said of the decision to impose the tax.

The Cairo stock market is down 6.1 percent this year, the worst performer in the Middle east due to political turmoil and policy uncertainty.

SHATTERED CONFIDENCE

Egypt's regulator approved QNB's offer for NSGB in February after insisting that the Qatari lender buy 100 percent of Egypt's second-largest private sector bank by market value.

QNB had said in December it planned to buy only the 77 percent stake in NSGB held by its French parent Societe Generale.

The sharp drop in the Egyptian bank's shares on Tuesday may make QNB question whether it had overpaid. QNB, 50 percent owned by Qatar's sovereign wealth fund that has led the bulk of the gas-rich Gulf state's international acquisitions in recent years, had offered 38.65 Egyptian pounds per share for NSGB, which at the time was a small premium to NSGB's share price.

After Tuesday's battering NSGB is worth only 34.65 pounds.

Hani Helmy, chairman of El Shorouq Brokerage in Cairo, said the decision to apply the tax was "very, very bad and undermines confidence (in the market)".

Struggling to contain a soaring budget deficit, a weakening currency and political turmoil which are battering the economy, President Mohamed Mursi's government needs to raise revenues.

Helmy, however, said it was unfair to impose a tax on investors after they had already decided whether to accept the bid.

"No investor will believe anyone anything after that," he said.

(Additional reporting by Marwa Rashad in Riyadh; Editing by Susan Fenton)

By Ulf Laessing and Nadia El-Gowely