* Crossover site decision could take until end-June
* Level-pegging between Chattanooga and Mexico
* Audi's new Mexico SUV plant also a candidate
BERLIN, June 2 (Reuters) - A tug-of-war between Mexico and Tennessee over incentives is delaying Volkswagen's decision on where to build a make-or-break vehicle in North America, sources said, delaying the German group's efforts to fix its ailing U.S. business.
Last week, the state of Tennessee reopened talks with VW on tax breaks and infrastructure to lure the firm to build a midsize crossover at its Chattanooga plant, after a pitch by Mexican authorities, sources told Reuters on Monday.
Level-pegging between Chattanooga and Mexico means it could take at least until the end of June for VW to pick a production venue, either its $1 billion Chattanooga plant or a site in Mexico, two sources familiar with the matter said.
VW had initially hoped to take the decision by now, sources said. It announced the crossover - combining features of a car and a sport utility vehicle - at the Detroit auto show in January as part of a $7 billion investment package for North America.
"VW is taking way too long again to tackle another pressing U.S. problem," said Arndt Ellinghorst, London-based analyst at ISI Group. "The crossover will be a gainful addition to their portfolio, VW has got no time to waste."
Following a 2011-12 sales surge, U.S. deliveries of VW's core passenger car brand slumped 7 percent last year and were 10 percent down in the January-April period this year at 118,154 vehicles, even as the world's No. 2 auto market kept growing.
Given typical development cycles, the crossover might not go on sale in the United States until 2016, five years after VW launched its locally-made midsize Passat saloon.
Analysts have long urged VW to expand its U.S. lineup, especially on SUVs where offerings are confined to the compact Tiguan and the mid-size Touareg, which at $44,570 is almost 10 percent more expensive than the premium Lexus RX from Toyota.
The German group, seeking to almost double sales of VW-badged vehicles to 800,000 by 2018, hopes to eclipse Toyota as the world's biggest carmaker.
Tennessee had offered the German manufacturer a $300 million package of incentives to assign the vehicle to its only U.S. plant. But state governor Bill Haslam withdrew the offer amid a February vote by factory workers on unionization.
Sources gave no information about details of incentives discussed between VW and Tennessee officials, but said the state needed to top a package already pledged by authorities in Mexico.
VW confirmed that incentive talks with Tennessee were under way, declining to elaborate.
VW recently spent $700 million to upgrade its Mexican plant in Puebla for assembly of the revamped Golf hatchback, which started in January. The plant employs about 15,000 workers who also assemble the Jetta and Beetle models.
A decision to manufacture the crossover in Puebla would be a surprise as VW's management has all along prefered its Tennessee plant over the 50-year-old factory, sources said.
Assigning the model to Chattanooga would be good news for a site where dwindling demand for the Passat last year caused VW to cut about 500 jobs.
One of the sources said it was also conceivable that VW might give the nod to a new factory built by its luxury division Audi in San Jose Chiapa, about 35 miles from its ageing Puebla facility. The Audi plant will be designed to assemble the Q5 SUV from 2016.
Audi declined to comment.
(Reporting by Andreas Cremer)