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The Rugby Football Union made the announcement at Twickenham after a three-hour meeting with the London Wasps star at a secret location in London on Monday.
The 26-year-old told the RFU he would be withdrawing from the England squad to tour Australia this summer after the News of the World reported that he had admitted he had used and sold drugs before taking up rugby.
The tabloid newspaper also reported he had boasted of taking drugs at a party during the Lions' successful tour of South Africa.
Dallaglio "categorically denied" the principal claims in the News of the World that he had dealt in drugs, including cocaine and ecstasy.
In a statement he added that "the circumstances in which the supposed admissions were obtained amounted to an elaborate set-up".
But News of the World editor Phil Hall said: "We stand by our story. Lawrence Dallaglio is damned in his own words and frankly, we are amazed at his denial."
The RFU has launched an immediate investigation into the affair. Any disciplinary action against Dallaglio will be considered only when the inquiry has been completed, according to RFU chairman Brian Baister.
Dallaglio has provided the authorities with blood and urine samples and the RFU announced that every member of the touring party will also be tested for drugs.
England coach Clive Woodward, who was among the panel of six senior RFU figures who met Dallaglio, said he was "bitterly disappointed" for the player and his family but was confident he would be "proved innocent" by the investigation.
Leicester lock forward and British Lions skipper Martin Johnson has been appointed England captain until the end of the Rugby World Cup this autumn.
The Dallaglio affair severely dented the image of a man widely regarded as a clean-cut hero and saviour of English rugby.
It also attracted yet more unwelcome publicity for the game that was still reeling from the furore surrounding the personal life of Will Carling - one of Dallaglio's illustrious predecessors.
On 23 August the RFU dropped drugs charges against Dallaglio - much to his relief - after "new evidence" emerged during an open hearing chaired by a high court judge.
It decided not to ban him but instead imposed a fine of £15,000 for bringing the game into disrepute - on top of legal costs amounting to £10,000.
Dallaglio has since emerged from the scandal with honours. He was part of the World Cup-winning team in 2003 and he was re-appointed England captain following Martin Johnson's retirement from the role in 2004.
Dallaglio announced his retirement from international rugby a few months later and was replaced as captain in October 2004 by Johnny Wilkinson.
However, he was persuaded out of retirement to play in the British and Irish Lions tour of 2005 and he also played for England during the 2006 Six Nations Championship.
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