'An injustice righted'
Joanna Lumley, the British actress who headed the campaign and whose father fought with the Gurkhas as an officer, said the announcement would "be received in Nepal today with the greatest joy and gratitude".
"This is a day for celebration, a great injustice has been righted," she said.
Alan Fisher, Al Jazeera's correspondent in London, said the move would allow 15,000 Gurkhas to live in the UK along with their spouses and school-age children.
"The announcement gives them the same rights as any branch of the British army," he said.
The government's change in policy came after it has seen its popularity eroded by a string of reports of excessive and inappropriate expenses being claimed by members of parliament.
Britain's major political parties were shaken after the Daily Telegraph newspaper published details of politician's expense claims which included charging taxpayers for moat-cleaning and claiming for mortgage payments on homes where the loans had been paid off.
The revelations prompted a series of suspensions and resignations of MPs.
Iain Duncan Smith, a former opposition leader, said: "It's a great day for the House in the midst of all these sleaze inquiries and everything else; it's one moment when
MPs here can hold their heads up and say: 'This is what we should have been doing every day of the week'."
Gurkhas have fought for Britain for the last 200 years, with hundreds of thousands fighting in the two world wars and around 3,500 Gurkhas currently serving in places such as Iraq and Afghanistan.
Since 2004, Gurkhas who served more than four years in the military had been allowed to settle in the UK after they retired, so long as they retired after 1997.
All others had to apply on a case-by-case basis, which campaigners have fought strongly against.
The government had said those who retired before 1997, when the Ghurkas' base was in Hong Kong, had weak links to Britain.
It revised immigration guidelines after a high court judge ruled last October that the policy was unlawful, but was forced to change its stance further after suffering a defeat in the UK's House of Commons last month.