The decision followed a month of violent demonstrations by evicted farmers and activists, who complained they had been forced to give up their land to make room for the high-profile factory.
The West Bengal government had acquired 1,000 acres of land for the Nano project in 2006.
At least 10,000 farmers accepted compensation for their land, but approximately 2,000 of them rejected it as inadequate and demanded 400 acres of land be returned.
During the protests, Tata's engineers and workers were attacked, prompting the group to stop work.
Gujarat is one of India's most industrialised states and has a relatively sound infrastructure that has already attracted a number of multinationals.
The car, the Nano, is expected to cost about $2,130 and has been billed as the world's cheapest car.
Tata currently controls more than half of India's truck market and nearly 20 per cent of its passenger car market, and is keen to expand beyond Asia.
The company, India's third-biggest car-maker, had planned to make 250,000 cars a year at the Singur plant in West Bengal, with plans to increase production to 350,000.
The dispute in West Bengal highlights a wider problem confronting India's growing industry.
It needs land but farmers are unwilling to surrender land in a country where two-thirds of the population depend on agriculture for a living.