Microsoft will acquire a 10-year exclusive licence to Yahoo's search technologies. Microsoft will also hire Yahoo internet search and search advertising staff.
Microsoft will become the exclusive internet search and search advertising provider used by Yahoo.
In exchange, Microsoft will retain 12 percent of the search revenues generated on Yahoo's and its partners' websites during the first five years of the agreement, paying 88 percent to Yahoo as a traffic acquisition cost.
Microsoft's and Yahoo's activities in internet search and online search advertising are very limited with combined market shares generally below 10 percent.
Google, by contrast, generally enjoys market shares above 90 percent, the Commission said in a statement.
In addition to looking at the search market from the perspective of search users, the Commission also examined the potential impact of the merger on the different market players, namely advertisers, online publishers and distributors of search technology.
The Commission said its investigation shows that market participants expect the Microsoft-Yahoo deal "to increase competition in internet search and search advertising by allowing Microsoft to become a stronger competitor to Google".
Microsoft welcomed the regulatory go-ahead.
"Although we are just at the beginning of this process, we have reached an exciting milestone," Microsoft CEO Steve Ballmer said.
"I believe that together, Microsoft and Yahoo will promote more choice, better value and greater innovation to our customers as well as to advertisers and publishers."
"This breakthrough search alliance means Yahoo can focus even more on our own innovative search experience," said Yahoo CEO Carol Bartz.
"Yahoo gets to do what we do best: combine our science and technology with compelling content to build personally relevant online experiences for our users and customers," she added.
The deal was announced in July of last year. At the time, the companies said it could take them up to two years to fully implement the deal.