"I am very sad, disappointed. I was so happy that with this prize I finally get a reward for working in difficult conditions," the 33-year-old photographer who won the Carmignac Gestion photojournalism award in October 2013 told AFP.
The brief of her project was to investigate "the burnt generation... whose parents made a (1979 Islamic) revolution which shocked the world, and now have to cope with its consequences".
In her proposal, Tavakolian said "together this group of 25-35-year-olds forms a silent majority in Iran, rarely seen or heard of outside of the country. Not extremist Islamic or fashionably 'underground', they are often overlooked."
But earlier this month, she announced on her Facebook page that she was bowing out due to "irreconcilable differences over the presentation of my work" and was returning the award from the foundation, whose patron is French investment banker Edouard Carmignac.
The foundation denies trying to censor her work and said the award was suspended because the Iranian government was exerting "heavy pressure" on the artist and her family.
"Tavakolian traces the dispute back to a conversation about 'artistic freedom'"
Tavakolian traces the dispute back to a conversation about "artistic freedom... when Mr Carmignac wanted to change the name of the project to 'Lost Generation', from her title: 'Blank pages of an Iranian photo album'".
"He wanted to change the whole nature of the project, with other pictures, with another title," she said.
"I said from the beginning that the new title would get me into trouble (with the Iranian authorities), but the most important was my artistic freedom," said the photographer.
"I said: 'You are trying to censor my work'.'"
Signup to our newsletter and follow us on Facebook and Twitter!
Tavakolian said the foundation withdrew its offer to exhibit her work and publish it in book form on "security" grounds, but that in reality there had been a disagreement over artistic freedom.
Iran's moderate President Hassan Rouhani advocates greater cultural and social freedom within the bounds of Islamic values, but he often comes in for criticism from the country's strong conservative wing which fiercely opposes Western cultural encroachment.
In a sign of the red lines in the Islamic republic, seven young Iranians featured dancing to Pharrell Williams' hit "Happy" in a video which went viral on the Internet were earlier this month given suspended jail and lashing sentences, their lawyer said.
The foundation's Ivan Moneme said the photographer changed course between the time of her presentation to when she delivered the project, which had become "more aesthetic rather than a photo reportage".
He denied the charge of censorship and said it was more a case of a heated meeting between "a patron who intervenes a little too much and a laureate who is a little too young."
The artist had herself agreed to the new title before changing her mind, he said.
As for Tavakolian, she has returned the 25,000 euro ($32,000) advance for the award.
"No matter what, I will publish my work the way I want and with the title I want. I want to be proud of my first book," she said.