Iraqi-born Mullah Krekar was detained one year ago as part of a Europe-wide anti-terror raid.
Italian prosecutors accused Krekar of plotting attacks - which he denied - and asked for his extradition.
Norwegian prosecutors said Italy had sent a letter saying the request would be withdrawn.
In a statement, the Director of Public Prosecutors (DPP) said a letter from Italian prosecutors had made clear that the basis for the extradition was repealed by an Italian court in early March.
The DPP said no explanation was given for why the ruling was revoked, or why it took so long for Italy to tell the Norwegian authorities about it.
Mullah Krekar - born Najmaddin Faraj Ahmad - is the founder of the defunct Islamic group Ansar al-Islam, but distanced himself from the organisation in recent years.
Italy had accused him of being behind the European-wide network Rawti Shax, which seeks to establish a caliphate in Iraq's Kurdistan region.
He came to Norway as a refugee in 1991 from Iraq.
Norwegian authorities have been trying to deport him since 2003, after deeming him a threat to national security.
However, under Norwegian law, he cannot be deported to Iraq because he could face the death penalty there.
He has been jailed several times, including in 2012 for making death threats against officials and others, and again in February 2015 after praising the Charlie Hebdo attack in Paris.
Norway will release a controversial Iraqi cleric after Italian prosecutors suddenly dropped a long-standing extradition request.