The government has lost a bid to keep Iran's main opposition body on its list of banned terrorist groups.
The People's Mujahideen is opposed to Iran's Government
The People's Mujahideen Organisation of Iran (PMOI) is illegal in the European Union and the United States.
But the Proscribed Organisations Appeal Commission in London ruled ministers must remove it from their blacklist.
After the verdict, Home Office Minister Tony McNulty said: "I am disappointed at this judgement. We don't accept it and we intend to appeal."
The Home Office said that the PMOI would remain a proscribed organisation during the appeal by the government.
The PMOI, or Mujahideen-e Khalq, which operates in exile, says it has renounced violence since 2001. The opposition group has been a thorn in Tehran's side for more than two decades.
A militant organisation, whose ideology combines elements of both Marxism and Islam, the group based itself in Iraq after being expelled from Iran.
For more than 15 years before the fall of Saddam Hussein, it used bases in Iraq to launch attacks against Iran.
Sixteen MPs and 19 members of the House of Lords appealed against the proscription in the first case to be heard by the POAC.
They argued that there rights to support and promote what they said was a democratic and peaceful opposition to the regime in Tehran had been infringed.
Lord Corbett, chairman of the Committee for Iran Freedom, claimed the banning had been tied up with international diplomatic attempts to stop Iran developing nuclear weapons.