Michael Campbell was sentenced to 12 years in prison in 2011, but has long insisted he was framed by British intelligence.
An appeals court judge in Vilnius today struck down the sentence, and said there was no evidence linking Campbell with the Real IRA.
"State institutions have not provided evidence that would rule out his (Campbell's) claim that he was framed by MI5 agents", Judge Viktoras Kazys said, before ordering Campbell's release from custody.
Lithuanian prosecutors however said Wednesday they would appeal the verdict with the supreme court.
After the ruling, a smiling Campbell told AFP he planned "to go home" to Ireland, but refused further comment.
"The court defended the basic principle that the state cannot create a crime and then convict a person for it," his lawyer Ingrida Botyriene told AFP.
Campbell was sentenced to 12 years behind bars by a district court in 2011 for attempted smuggling, aiding a terrorist group and illegal possession of arms.
The 41-year-old Irishman has also long denied being a member of the Real IRA, a hardline splinter group of the IRA -- once the main armed group opposed to British rule in Northern Ireland.
His brother Liam was one of four Real IRA leaders found liable by a civil court for a 1998 bombing in Omagh, Northern Ireland that killed 29 people.
Michael Campbell was arrested in 2008 in Vilnius when he met a Lithuanian agent posing as an arms dealer.
The Real Irish Republican Army broke with the Provisional IRA in 1997 over its support for a peace deal with London.
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