The Supreme Court decision sparked a call for an urgent change in the law from former children's secretary Ed Balls, who removed Ms Shoesmith as Haringey Council's director of children's services after a damning report on the death of Peter Connolly.
Mr Balls warned that the ruling will make it harder for ministers to act swiftly to protect children in future.
The Department for Education said it was "very disappointed" at the decision and insisted that the Government still believes Ms Shoesmith's removal was "right in principle".
Ms Shoesmith's career was left in ruins after she was removed from her £133,000-a-year post by Mr Balls and then fired by the north London council without compensation in December 2008, after a report from regulator Ofsted exposed how her department had failed to protect 17-month-old Peter - then known publicly as Baby P.
Her lawyers argued that she was the victim of "a flagrant breach of natural justice" fuelled by a media witch-hunt.
And in May, the Appeal Court concluded she was unfairly sacked because Mr Balls and Haringey did not give her a proper chance to put her case before her removal.
The Department for Education and Haringey sought permission to attempt to overturn the ruling in the Supreme Court, but a court spokesman said that their applications had been refused.
The decision clears the way for Ms Shoesmith to receive compensation which employment law expert Philip Henson, of City firm Bargate Murray, has predicted could total as much as £1 million.
Ms Shoesmith's lawyers, Beachcroft, said they were "pleased" at today's ruling, and were discussing its implications with her.
But Mr Balls said he was "very surprised and concerned" and urged the Government to consider changing the law to clarify ministers' powers.
"I fear that the Appeal Court judgment will now make it very difficult for ministers to act swiftly in the public interest to use their statutory powers when children are at risk, as I did in this case," said the former children's secretary.
"This judgment creates a serious and worrying constitutional ambiguity which now requires urgent action from the Government to resolve."
Peter died in Tottenham, north London, on August 3 2007 at the hands of his mother Tracey Connelly, her lover Steven Barker and their lodger Jason Owen.
He had suffered more than 50 injuries despite being on the at-risk register and receiving 60 visits from social workers, police and health professionals over the final eight months of his life.
A series of reviews identified missed opportunities when officials could have saved his life if they had acted properly on the warning signs in front of them.
Mr Balls said that the Ofsted report into Peter's death catalogued "catastrophic management failures" on such a devastating scale that Haringey's council leader and lead member for children's services resigned their posts.
"My clear responsibility and duty as Secretary of State was to do everything in my power to keep children safe in Haringey and across the country," he said.
"I judged on the basis of that independent report - and on the advice of departmental officials and lawyers - that the right and responsible course of action was for me to use my statutory powers to remove the director of children's services from her position with immediate effect."
Mr Balls insisted that he had been acting within his powers under the Education Act and in line with the advice of civil servants and government lawyers.
Their advice was that it would not be "appropriate" for him to meet Ms Shoesmith to hear her side of the story before removing her from her post, he said.
"Ministers need to be able to exercise their legal duties and make judgments in the public interest based on independent analysis and advice," said Mr Balls. "That is what I did - and I am concerned that this judgment will make it harder for ministers to do so in future...
"I believe it is now essential that the Government acts swiftly to resolve this ambiguity, through primary legislation if necessary, to ensure that ministers can act swiftly and within the law when children are at risk."
A DfE spokesman said: "We believe that the Supreme Court should have heard this case as we believe there are questions of constitutional importance involved, beyond the specific question about whether Ed Balls should have had a meeting with Shoesmith before she was removed from her post as director of children's services.
"We will consider seriously the implications of today's decision and we will now reflect on what steps need to be taken."
Haringey Council said it was "bitterly disappointed" by the decision, adding: "We believe we have acted properly throughout the process and stand by everything we have done. We now need to work through consequent steps to resolve the matter."
PA
