The party members voted 83-71 against the controversial proposal at the party conference in Växjö in southern Sweden. The decision is a setback for the party hierarchy which first announced the idea in March 2008.
"Of course I am disappointed, I wanted the proposal to go through," integration minister Nyamko Sabuni said.
The proposal to introduce mandatory citizenship courses for immigrants met with fierce opposition at the conference. Many voiced a fear that if adopted it would risk the party being associated with the far-right Sweden Democrats.
"It is silly to connect integration policy with the Sweden Democrats, that is to ascribe them power which they do not hold," Sabuni said.
The course is proposed to be obligatory for all applicants for Swedish citizenship and would be held by county councils at no cost to the applicant. Many speakers questioned what exactly the course is supposed to teach.
Gunnar Nordmark from Växjö considered the proposal to indicate that the Sweden does not trust immigrants and warned that racist organisations are starting to brutalize the integration debate.
"We unintentionally risk dancing with the wolves," he said.
Those who defended the proposal argued that teaching the shared founding principles of Swedish society is important not least for the boys and girls who are forced to live within honour cultures.
Others pointed out that the Liberal Party must have clear goals with its integration policies and have the confidence to address the problems so as not to leave an open playing field for the Sweden Democrats.
The Liberal Party conference comes to a close on Sunday at Växjö concert house.