A writedown to the business of 145 million pounds ($181 million), announced in October, has been increased by more than three times to around 530 million pounds.
According to a person familiar with the situation, staff had colluded with suppliers to inflate their accounts over a number of years, before a whistleblower contacted senior executives at BT headquarters last summer to make them aware of the practices.
"We are deeply disappointed with the improper practices which we have found in our Italian business," Chief Executive Gavin Patterson said.
BT also said it had seen a deterioration in its UK public sector business and international corporate markets. The news sent its shares tumbling, putting the firm on course for its biggest one-day drop since 2008 and to a 3.5-year low.
Group revenue will now not grow for the next two years while the guidance for core earnings, or earnings before interest, tax, depreciation and amortisation, has been cut to 7.6 billion pounds from a previous guidance of 7.9 billion pounds.
Normalised free cash flow for 2016/17 is expected to come in at 2.5 billion pounds, compared with a previous forecast of between 3.1 to 3.2 billion pounds. And free cash flow is also forecast to be lower than the guidance given for 2017/18.
The group said it had taken immediate steps to strengthen its processes and controls in Italy. It suspended a number of BT Italy's senior management team, who have now left the business, and appointed a new BT Italy CEO who will take charge on Feb. 1.
"Further, we are conducting a broader review of financial processes, systems and controls across the group," it said. "The BT Group Remuneration Committee will consider the wider implications of the BT Italy investigation."