Liam Og O hAnnaidh, who is also referred to by his anglicised name Liam O'Hanna and performs under the name Mo Chara, had been charged after waving a flag of the Lebanese militant group Hezbollah, which is banned in Britain as a terrorist organisation, during a London concert in 2024.
Chief magistrate Paul Goldspring sitting at Woolwich Crown Court said the case should be thrown out, agreeing with O'Hanna's lawyers that there was an error in the way the rapper was charged.
"These proceedings were instituted unlawfully and are null," he said on Friday.
The three-member Kneecap, which hails from Belfast, Northern Ireland, has faced criticism for political statements seeming to glorify militant groups including Hamas and Hezbollah. Canada and Hungary have previously banned the group.
Kneecap has accused critics of trying to silence the band because of its support for the Palestinian cause throughout the war in Gaza.
It says it does not support Hezbollah and Hamas, nor condone violence.
O'Hanna, 27, had claimed the prosecution was a politically motivated effort to silence the band's support for Palestinians.
"We will not be silent," the rapper told supporters outside the court after the charge against him was thrown out.
"This entire process was never about me. It was never about any threat to the public, it was never about terrorism - a word used by your government to discredit people you oppress.
"It was always about Gaza, about what happens if you dare to speak up."
Northern Ireland's First Minister Michelle O'Neill welcomed the move, saying the charges were part of "a calculated attempt to silence those who stand up and speak out against the Israeli genocide in Gaza".
"Kneecap have used their platform on stages across the world to expose this genocide, and it is the responsibility of all of us to continue speaking out and standing against injustice in Palestine," she said.
The Crown Prosecution Service said it was "reviewing the decision of the court carefully" and pointed out that it can be appealed.
London's Metropolitan Police said it was working with the prosecutors to "understand the potential implications of this ruling for us and how that might impact on the processing of such cases in the future".
