The deal had been delayed by several months over concerns that the deep-sea port could be used by the Chinese navy.
Cash-rich China has invested millions of dollars in Sri Lanka's infrastructure since the end of a brutal civil war in 2009.
As part of the deal, the stake in the loss-making port has been sold to China's state-run conglomerate China Merchant Port Holdings (CMPort). Sri Lanka's Minister of Ports and Shipping Mahinda Samarasinghe and China's envoy to Colombo Yi Xianliang were present when the Concession Agreement was signed.
Under the 99-year lease agreement, CMPort is to invest up to US $1.1 billion in the port and marine-related activities. "This is a very favourable agreement compared with the plan in 2014," Mr Samarasinghe said, referring to the original plan laid out during former president Mahinda Rajapaksa's tenure.
The agreement was open for further amendments, he said. The deal may raise security concerns in India.
According to the new deal, only Sri Lankan Navy will be responsible for the security of the deep-sea port, and the port will not be allowed to become a base for any foreign navy.
The new provision is seen as an attempt to allay India's concerns over Chinese navy's possible presence in Sri Lanka. The port, overlooking the Indian Ocean, is expected to play a key role in China's Belt and Road initiative, which will link ports and roads between China and Europe.
The Sri Lankan government had to face huge opposition to the deal from trade unions, who called it a sellout of the country's national assets to China.
Last week, petroleum workers brought the country to a standstill for two days by stopping fuel distribution. They But Sri Lankan Prime Minister Ranil Wickremesinghe yesterday said: "We are giving the country a better deal without any debt."
The accumulated loss from the port was more than US $300 million and the money realised from deal will set off the debts owed to China, he said.
Sri Lanka's Cabinet had on July 25 approved the transfer of stake in the port to the Chinese firm, tweaking the deal after the initial agreement sparked protests in the country.
The initial 80:20 share distribution has been revised to 69.55 per cent to CMPort and 30.45 per cent to Sri Lanka Port Authority.