Toy manufacturers are furious at the decision - they are demanding to know why Brussels officials took five years to reach their verdict and how it can be justified when the ban is constantly circumvented by children's advertising beamed into the country by satellite channels.
Ad industry bodies are also disturbed by the outcome, claiming it as further evidence of the commission's reluctance to get embroiled in difficult and controversial cases.
Andrew Brown, the director-general of the Advertising Association, said: "This is a political, rather than a legal, decision."
The commission's ruling follows a complaint made in December 1997 when the Swedish channel TV4 refused to screen a commercial by a Danish agency for Hasbro's Action Man.
Toy Industries of Europe, which represents 95 per cent of toy manufacturers operating on the continent, took up the case, arguing that the Swedish ban restricted the free movement of advertising services across the European Union.
The companies claim that the commission provided no clear legal justification for not opening infringement proceedings against Sweden.
They also insist that its refusal makes a mockery of the commission's stated aim of bringing consistency to the EU's internal market.
Charlotte Lester, the TIE secretary-general, said: "We are clearly disappointed with the decision. The ad ban was not a proportionate measure, particularly considering that children are surrounded by highly regulated commercial messages in other media and TV channels."
Sweden, which has had a ban in force since 1991, has been at the forefront of efforts to protect children from the perceived harmful effects of advertising.
Greece is the only other EU country to have a ban on TV toy advertising.
Belgium has a partial ban, Ireland has a self-regulatory code restricting advertising to small children, while Spain bans the promotion of war toys.
Other Nordic countries have fairly restrictive guidelines.
In 2001, Sweden tried to use its EU presidency to marshall support for the outlawing of TV advertising to 64 million children across Europe.
Brown said: "Although the move was rejected by the commission, it doesn't necessarily mean it wants to force the Swedes to drop their domestic ban.
"This is all about political sensitivities. The commission doesn't want to be seen as too pro-industry and be accused of losing its nerve. But good law is made by hard cases."
However, some industry lobbyists believe the toy industry is fighting a losing battle and will need to change tactics if it is to stem the tide of advertising restrictions.