The incident in Baghdad in September 2007 caused anger across Iraq
Iraq will not renew the licence of US security firm Blackwater, which was involved in an 2007 incident in which at least 14 civilians were killed.
An interior ministry spokesman said the US embassy had been told it will have to use another security company.
Five former Blackwater guards have gone on trial in the United States over the killings in Baghdad.
They have pleaded not guilty to killing 14 Iraqi civilians and wounding 18 others by gunfire and grenades.
"The contract is finished and will be not be renewed by order of the minister of the interior," said interior ministry spokesman Maj Gen Abdel Karim Khalaf.
He said the decision had been sent to the US embassy in Baghdad and "they have to find a new security company".
He added that the decision had been prompted by the incident on 16 September 2007.
The killings took place when Blackwater guards opened fire in Nisoor Square, Baghdad, while escorting an American diplomatic convoy.
The firm says its guards were acting in self-defence but witnesses and relatives of those killed maintain that the shooting was unprovoked.
Children were among the victims.
The killings strained Iraq-US relations and raised questions about the oversight of US contractors operating in war zones.
After the incident, the Iraqi government pressed Washington to withdraw Blackwater from the country, but the security firm's contract was renewed in 2008.
A new US-Iraqi security agreement gives Baghdad the authority to determine which Western security companies operate in the country.
A US embassy official confirmed it had received the Iraqi decision, and said US officials were working with the Iraqi government and its contractors to address the "implications of this decision".