The watchdog also confessed that its initial ban had the reverse effect that it wished, and the image got spread like wild fire in Internet circles after the ban. As part of IWF's initial ban on December 5, some people could not see any pages on Wikipedia at all, while others were unable to edit pages on the user-generated encyclopaedia.
The picture, from the 1976 album cover Virgin Killer by the German rock band Scorpions, showed a nude girl with a crack in the camera lens obscuring her genitals.
On their defence, the band said that their record company made the choice of picture, which was later changed.
After the Internet censorship authority in the UK banned the Wikipedia page, the Wikimedia organisation launched a protest against the IWF.
This led the IWF into an unprecedented reconsideration of its earlier ban on December 8.
And after more than a day of consideration, the IWF has issued a press release in which it says that it has lifted the ban, after considering the "context" of the image.
Earlier, the IWF said that the 'context' would not affect the legitimacy of an image.
"The procedure is now complete and has confirmed that the image in question is potentially in breach of the Protection of Children Act 1978," The Guardian quoted the statement as saying.
The statement added: "However, the IWF Board has today (9 December 2008) considered these findings and the contextual issues involved in this specific case and, in light of the length of time the image has existed and its wide availability, the decision has been taken to remove this webpage from our list."
The IWF said that copies of the image hosted abroad, such as on the US shopping site Amazon, will not be subject to a ban.
However, it added "any further reported instances of this image which are hosted in the UK will be assessed in line with IWF procedures," meaning that an image could be considered pornographic in the UK but not the US.
The IWF also acknowledged that its efforts had had the reverse effect that it had intended.
"IWF's overriding objective is to minimise the availability of indecent images of children on the internet, however, on this occasion our efforts have had the opposite effect. We regret the unintended consequences for Wikipedia and its users," it said in the statement.