"The Berlusconi government has never authorised nor has it allowed any form of payment toward members of the Taliban insurgence," a statement from the prime minister's office said.
Admiral Christophe Prazuck, a spokesman for the French military, also dismissed the report as "baseless".
"These are rumours, and it is not the first time we have heard them," he said.
But Jean-Marc Ayrault, leader of the opposition Socialists, called for a review of the Afghan mission, in which 2,900 French troops are serving.
The Times report said that because the French were not informed of the alleged deal they made a "catastrophically incorrect threat assessment" of the area.
It said US intelligence officials had discovered through intercepted phone conversations that the Italians had been buying off fighters in Herat province, western Afghanistan.
The paper continued that a number of high-ranking Nato officers had told it that payments were discovered to have been made in the Sarobi area as well.
Following the ambush in August 2008, in which the French troops were killed, reports emerged that the soldiers had been poorly equipped, and only had one radio, which went dead, leaving them unable to call for help.
However, the French military have denied these reports.
Prazuck said French, Italian and Turkish troops, all of whom oversee the Kabul region, had a relationship of "trust, full transparency".
"We share information constantly with the Italians, the Turks and the French in Kabul, daily, regularly," he said.