Eleven members of May's Conservative party joined with opposition lawmakers to inflict the government's first defeat over the flagship EU (Withdrawal) Bill, sparking huge cheers in the House of Commons.
Ministers had sought to buy off its critics with a last-minute concession, but leading rebel Dominic Grieve, a former attorney general, had warned: "It's too late."
His amendment would require new legislation to implement any divorce deal with Brussels before Britain leaves the EU in March 2019.
It passed by 309 votes to 305, with a twelfth Conservative MP effectively abstaining by voting in both camps.
"Victory on Grieve amendment!" tweeted Keir Starmer, the Labour party's Brexit spokesman, heralding the "courageous Tories" who voted with the opposition.
The vital role played by Conservative rebels dominated British headlines, described as a humiliating "Tory rebellion" by the Guardian and "Mutiny in the Commons" by The Daily Telegraph.
The Daily Mail went further still, decrying "11 self-consumed malcontents" whom it accused of betraying their leader and Brexit voters alike.
The government said it was "disappointed" by the vote, adding: "We will now determine whether further changes are needed to the bill to ensure it fulfils its vital purpose."
Hampering 'Smooth' Brexit
The defeat was a blow to May the day before EU leaders gather in Brussels to approve the terms of an interim Brexit deal struck last week after months of negotiation.
That deal was a rare moment of triumph for the prime minister, who has endured a turbulent few months since losing her parliamentary majority in disastrous snap elections in June.
MPs' success at defeating May in Westminster was described as "A good day for democracy" by Guy Verhofstadt, the European Parliament's Brexit pointman.
"British Parliament takes back control. European and British Parliament together will decide on the final agreement. Interests of the citizens will prevail over narrow party politics," he wrote on Twitter.
The EU (Withdrawal) Bill is intended to formally end Britain's membership of the bloc as well as smooth its exit by transferring thousands of pieces of European legislation onto the UK statute books.
But MPs objected to the fact that these so-called "Henry VIII" powers also extend to the implementation of the final deal on the terms of Brexit and a transition.
Hours before the vote, Brexit Secretary David Davis promised MPs that no withdrawal agreement would be implemented until a vote in parliament.
Parliament would then be asked to approve a further piece of legislation to implement the deal.
But ministers insisted they needed to retain their special powers in the event that this law was not passed in time.
"That could be at a very late stage in the proceedings, which could mean that we are not able to have the orderly and smooth exit from the European Union that we wish to have," May told MPs earlier.
Gina Miller, a campaigner who successfully fought last year for an increased role for MPs in the Brexit process, said after the vote: "Parliamentary sovereignty wins the day!"
After months of wrangling, May secured a deal last week on three priorities of the separation -- Britain's financial settlement, the Irish border and the rights of expatriates.
The European Parliament on Wednesday gave its backing to the deal which, if approved at the summit later this week, should now allow the negotiations to move onto trade.
But the Commons vote spells further domestic trouble ahead for May, as parliament and her Conservative party are divided about Britain's future relationship with the EU.
Grieve had warned that ministers were asking for "a blank cheque to the government to achieve something that, at the moment, we don't know what it is".
The government responded swiftly to sack one of the rebels, Stephen Hammond, from his role as the Conservative party's vice chairman.
Hammond said he had "put country and constituency before party and voted with my principles to give parliament a meaningful vote".
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