The decision came in an affidavit sent on Wednesday by the government's top lawyer to the Supreme Court.
Law officer Ranjit Kumar wrote in the affidavit that the government "does not support commercial surrogacy," but would still allow Indian couples to take advantage of the services.
The move comes amid accusations that India's booming surrogacy industry is exploiting lower-class women.
Sometimes referred to as the "surrogacy capital" of the world, India has been one of the top destinations for infertile foreign couples seeking someone to carry their child.
Some calling it counter-productive
The decision has drawn criticism from some corners of Indian society, including those who say the law, which will take some time to go into affect, will turn out to be counter-productive.
"Banning commercial surrogacy will send some couples onto the black market and deprive other couples of the chance of children," said Centre for Social Research Director Ranjana Kumari in an interview with the AFP news agency.
Others have criticized the law for being discriminatory.
The surrogacy industry in India is a multi-billion dollar business that has been growing at a rate of 20 percent per year.
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blc/jil (AFP, dpa)