Watson, who has been detained in Greenland since July, has been released, his lawyer told news agency AFP.
"He is free. We've just been informed by the Ministry of Justice, he's not going to be extradited," Watson's lawyer Julie Stage told AFP, adding that Watson would be able to leave the Nuuk jail in Greenland, where he had been held for almost five months awaiting a decision.
Justice Minister Peter Hummelgaard has confirmed the decision to release Watson.
"The decision has been made based on a comprehensive assessment of the circumstances in the specific case," Hummelgaard said in a statement.
The anti-whaling activist, a dual American-Canadian citizen, can now return to his home in France.
His detention drew international attention including from French president Emmanuel Macron, who urged Denmark not to extradite Watson to Japan.
The Danish Ministry of Justice received a formal extradition request from Japan on August 1st after detaining Watson on July 21st. It extended his preliminary detention on several occasions before Tuesday's decision to reject Japan's request.
Watson, who turned 74 while in custody, was detained on a 2012 Japanese arrest warrant, which accuses him of causing damage to a whaling ship in the Antarctic in 2010 and injuring a whaler.
The activist, who featured in the reality TV series "Whale Wars", founded Sea Shepherd and the Captain Paul Watson Foundation (CPWF) and is known for radical tactics including confrontations with whaling ships at sea.
He was arrested on July 21st when his ship docked to refuel in Nuuk on its way to "intercept" a new Japanese whaling factory vessel in the North Pacific, according to the CPWF.
Tokyo accuses Watson of injuring a Japanese crew member with a stink bomb intended to disrupt the whalers' activities during a Sea Shepherd clash with the Shonan Maru 2 vessel in 2010.
Watson's lawyers have said they have video footage proving the crew member was not on deck when the stink bomb was thrown.
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