Its 144-page final judgement document said there was no evidence of any attempt by the PMOI to "prepare" for terrorism or encourage others to commit acts of terrorism.
GOVERNMENT DEFIANT
In a letter to the PMOI last year, the home secretary said he recognised there had been a "temporary cessation of terrorist acts" but was "not satisfied that the organisation and its members have permanently renounced terrorism".
Home Office Minister Tony McNulty said on Friday the government did not accept the ruling.
"The government adopted a cautious approach in relation to the de-proscription of the People's Mujahideen Organisation of Iran," he said in a statement.
"I remain convinced that where terrorism is concerned, the rights of the law abiding majority and the overriding need to protect the public, both in the UK and abroad, must lead us to take such a cautious approach."
The PMOI, known as "the Mujahideen-e-Khalq", was added to the list of proscribed organisations under the Terrorism Act 2000 in March 2001. It first applied to be de-proscribed in June that year.
Earlier this year, it launched legal action to annul its listing as a terrorism group by the EU and to win damages.
The EU blacklist also includes the Palestinian Islamist group Hamas, Sri Lanka's Tamil Tigers and the Kurdistan Workers' Party. Blacklisting means groups are banned and have assets frozen.
The PMOI, which has bases in Iraq, began as a leftist-Islamist opposition to the late Shah of Iran, but fell out with Shi'ite clerics who took power after the 1979 Islamic revolution.
Western analysts say it has little support in Iran because of its collaboration with Iraq during the 1980-88 Iran-Iraq war.
