The 42-year-old was discovered by a passer-by early on Sunday morning in Hyde Park Corner, who called the emergency services.
Michael was checked by paramedics who arrived at a street near the busy roundabout with the police, but the singer, who has a history of depression, did not need hospital treatment.
Police then searched the singer and allegedly discovered two forms of Class C drug - believed to be Cannabis and GHB, a type of liquid cannabis. He was arrested on suspicion of possession of a controlled drug.
The former member of Wham!, who in recent years has retreated from the limelight following a hugely successful career as a solo artist, is understood to have been taken to West End Central police station, after the arrest at 1.50am, where he was signed in under his real name, Georgios Kyriacos Panayitou.
Michael, who has admitted to using cannabis to combat depression in the past, was also arrested for being unfit to drive despite reports that the results of his breath test were negative. But he was de-arrested for that offence after being examined by a duty doctor.
It is not known how long he was kept at the station, but the singer was released on bail yesterday. Michael, who has a home in Hampstead, north London, and was due to marry his partner, the Texan sportswear salesman Kenny Gloss, early this year, will have to report back to the police station next month.
Despite the reclassification of cannabis, possessing the drug remains a criminal offence, punishable by up to two years in prison. Tests will now be carried out on the substances allegedly found in the singer's possession.
A Metropolitan Police spokesman said last night: "We were called at 1.50am by a member of the public to a man seen slumped over the steering wheel of a car on the street close to Hyde Park Corner.
"An ambulance attended, but the man was not suffering from any injuries so was not conveyed to hospital. Police attended and spoke to the man, aged 42. A search of the man revealed what was believed to be controlled substances."
The arrest comes some eight years after Michael was apprehended in a public toilet in Los Angeles by an off-duty police officer. In his subsequent court case, he was accused of engaging in lewd conduct. He was fined £450 and ordered to carry out 80 hours of community service.
The incident prompted the singer to finally reveal his true sexuality. The manner in which he chose to do so - by penning the song "Outside", and parodying LAPD officers in the video which accompanied it - was observed by many as marking the beginning of a political awakening. That was further developed in a recent documentary, A Different Story, in which he outlined his opposition to the invasion of Iraq.
In an interview with The Independent in December, Michael described how he sunk into depression in the early 1990s following the death of his partner, the Brazilian dress-designer Anselmo Feleppa, which was closely followed by that of his mother. He admitted to using both cannabis and ecstasy at the time in an attempt to take the edge off of his grief and added: "It got to a point where I was smoking 25 joints a day." The singer's management were unable to comment on the arrest last night.Reuse content