The proposed law, which would have given temporary staff rights to paid holiday, sick pay and redundancy terms, alarmed employers groups, who warned that it would discourage firms from hiring contractors and lead to higher costs for businesses.
The Temporary Agency Workers Directive, which is being discussed at a time of record unemployment rates among contract IT staff, is viewed as a low political priority for the next European presidency, and it may now be shelved indefinitely.
Negotiations on the directive came to grief over the failure of the UK and other member states to agree on how long a contractor should work before qualifying for rights, with the UK holding out for three months and France pressing for one day.
John Cridland, deputy director of employers group the CBI, praised the UK government for standing fast against pressure from other European governments. "Failure to resolve this issue is disappointing, but the reason for the failure is that some European politicians have fundamentally misunderstood the needs of the modern labour market," he said.
A spokesman for the Institute of Directors said, "We were opposing the directive's introduction from the beginning. It would certainly have harmed employment levels and damaged our economic performance. It would have simply resulted in employers recruiting fewer temporary workers."
Kevin Barrow, employment lawyer at City law firm Tarlo Lyons, described the French proposals as ludicrous, and said they would have created an unacceptable burden for businesses hiring staff for short periods.
However, Peter Skyte, national organiser at trade union Amicus, said it was vital to have protection for contractors, and legislation was needed to give them the same rights as permanent staff.
"We believe there is still a need for this directive and, more importantly, the protection it would provide to give the same rights to temporary workers as permanent staff. We want to see the end of the exploitation of loopholes to undercut and undermine conditions of employment," he said.
It is not clear how the government planned to enforce the directive in the UK, but the Department of Trade & Industry may have found it difficult to apply it to the personal service companies favoured by IT contractors.
A bigger threat to employers could come from test cases being brought by contractors - who are now taxed as though they are permanent staff - seeking to establish employment rights, said Barrow.