Expressing regret in a statement issued on Sunday, Sharon said he intended “to lead Israel” despite the result.
Israeli radio and television declared an overwhelming defeat for his Gaza plan earlier in the evening.
According to public television reports hours after the vote, 61% of Likud members had rejected the PM’s withdrawal.
Sharon had proposed to evacuate all Israeli settlements in the Gaza Strip, but only four of its 120 colonies in the West Bank.
The Palestinian Authority criticised the vote saying the Likud had no right to decide on the fate of Palestinians.
Palestinian cabinet Minister Saib Uraiqat said: “It’s a frustrating day for us to see these Likud members taking themselves seriously to determine our fate.
“They have no right to overrule signed agreements.”
The rejection of the PM’s policy may also prove a slap in the face to US President George Bush.
Locals inspect damage to homes
Bush supported the pullout plan and even backed Tel Aviv’s ambitions to retain illegal settlements in the West Bank and end any hope of Palestinians ejected from homes in 1948 and 1967 returning home.
The White House commented on Sunday’s results saying they stood by the Israeli Prime Minister’s Gaza pullout plan.
“Our own view has not changed: The president welcomed Prime Minister Sharon’s plan to withdraw settlements from Gaza and a part of the West Bank as a courageous and important step toward peace,” White House spokesman Scott McClellan said in a statement.
“We will be in consultation with the prime minister and the government of Israel about how to move forward,” McClellan added.
The Likud referendum is not binding and Sharon had vowed that even if he lost among the party’s 193,000 voters he would ultimately present the plan to parliament where he would have a greater chance of winning approval.
As party members voted, Israeli gunships attacked a 14-storey building in occupied Gaza which Israeli occupation officials said housed a radio station linked to resistance group Hamas.
Four Palestinians also died when their car was targeted in a missile strike in Nablus. Israeli aircraft were seen hovering nearby.
There have been no official statements for Palestinian or Israeli sources, but Aljazeera’s correspondent said all three were believed to be members of Al-Aqsa Martyrs Brigades resistance movement.
Nadir Abu Lail and Hashim Abu Hamdan are believed to be two of the victims.
Earlier on Sunday, Islamic Jihad killed a Jewish settler and her four daughters in the Gaza Strip in an attack that analysts said would dim Sharon’s chances of winning his party’s support for a withdrawal.