The Home Affairs select committee said the programme, which gathers information on all travellers entering or leaving the UK, "may be illegal on intra-EU routes under the EU treaty".
Committee chair Keith Vaz said, "The programme is intended to cost the taxpayer £1.2bn and may be illegal. It is shocking that money has already been spent on a programme which could never be implemented."
The treaty says that an EU member state cannot require anything other than production of a valid ID document on an EU citizen, other than in exceptional circumstances. The e-Borders programme would require more than this.
There are other potential problems with complying with other countries' data protection laws, the Committee said.
The UK Border Authority (UKBA), which is running the system, must now speak to the European Commission and relevant organisations in other countries, and report back to the Committee about the legality of the programme by the end of February.
The data issue is just one of several problems the Committee found. A lack of communication meant the contractor, Trusted Borders, developed IT systems that did not comply with airline industry standards and practices, a situation that was further complicated by the fact that different airlines have different IT systems.
Delays in the roll out of the scheme led to it going live during the peak holiday period, instead of during quieter winter months. The original plan was to begin the roll-out in October 2008, finishing by the end of 2009, but the process only started in May 2009. The report said, "Completion was still set for the end of 2009, thus severely curtailing the plan and making it impossible to sort out any teething problems in the off-season."
Further problems occurred because the UKBA gave inconsistent instructions on when and how data should be transmitted. Some airlines invested in developing systems, only to have the authority change its instructions.
There are other problems with different parts of the transport industry, including ferry companies which say implementation of the scheme will lead to delays.
Vaz said, "UKBA has made some progress in some areas, particularly with the airlines after our intervention, but seems to be having greater problems co-ordinating with the way some of the other modes of transport in and out of the UK work."