The UN Security Council has demanded that Israel create an impartial and transparent investigation into the attack by Israeli commandos on May 31.
The raid on the flotilla, which was trying to deliver aid to the Gaza Strip, left nine Turkish activists dead.
Mahmoud Abbas, the president of the Palestinian Authority, said the setting up of an internal committee by Israel did not comply with the UN's demands.
"The proposition made today for the inquiry committee does not correspond to the request of the Security Council," Abbas said in Paris on Monday after meeting Nicolas Sarkozy, the French president.
Turkey had also demanded a UN-led probe and threatened to review its ties with Israel if it did not heed calls for an independent inquiry.
'Uncovering the facts'
The committee set up to investigate the legal aspects of the raid will be chaired by Yaakov Tirkel, 75, a retired Israeli supreme court judge who will work alongside Amos Horev, 86, a retired major general, and Shabtai Rosen, 93, a professor of international law.
It will also include two international observers: David Trimble, 65, an Irish Nobel Peace Prize winner; and Ken Watkin, 55, former judge advocate general of the Canadian military.
It was not clear what powers Trimble and Watkin would have and a statement from Binyamin Netanyahu, the Israeli prime minister, said they would not be able "to vote in relation to the proceedings and conclusions of the commission".
The two men could also be denied access to information that could "cause substantial harm to national security or to the state's foreign relations," the statement said.
The inquiry will run alongside another internal military probe into the events of May 31, which began last week under Giora Eiland, a retired brigadier general.
Israel has made clear the investigation announced at the weekend will not hear any direct testimony from troops involved in the raid.
"I am convinced that uncovering the facts will prove that Israel acted in an appropriately defensive fashion in accordance with the highest standards," Netanyahu told cabinet members on Monday.
"The committee will clarify to the world that Israel acts according to law with responsibility and full transparency," he said.