This decision follows a seven-month investigation by the Patent Office after the Princess' Memorial Fund wanted to take a share of the profits from anyone using her image to sell goods.
The civil servants blocked this fearing it would allow celebrities to stop anybody using pictures of them without permission.
Trustees of the memorial fund sent 26 well-known photographs of Diana to the Patent Office to register the pictures as intellectual property.
The fund could have made millions of pounds for charity by licensing her face on tea towels and mugs sold as souvenirs around the world.
A High Court ruling last year gave the Princess's executors powers to license or veto souvenirs and memorabilia.
But the Fund's attempt to control the use of pictures went beyond the powers granted then.
It has until the end of next month to come up with a revised proposal to satisfy civil servants and is confident that it will succeed.
Copyright
The Fund applied for protection in a huge variety of classes of goods, from kitchen utensils to Christmas tree decorations.
The list included items such as: yeasts, fire extinguishers and salad dressings, as well as advertising, clothing and games.
This application to the Patent Office has been watched by celebrities who want to control exploitation of their own faces.
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