The controversial legislation would have forced internet service providers and website owners to monitor every page its users visit, and turn the data over to police, tax officials and other security services if deemed necessary.
However, MPs and Peers from the UK's major political parties condemned the so-called 'snooping bill' in its current form, forcing the government to take it back to the drawing board.
"We recognise this is a difficult issue. We will take account of what the committee said," said a spokesperson for the coalition.
A pre-legislative review committee concluded that the proposed measures are in violation of web users' privacy, would require deeper consultation with service providers, and are likely to cost far more than the predicted £1.8 billion.
"There is a fine but crucial line between allowing our law enforcement and security agencies access to the information they need to protect the country and allowing our citizens to go about their daily business without a fear, however unjustified, that the state is monitoring their every move," said the committee's joint chair Lord Blencathra.
"The coalition government needs to have a fundamental rethink about this legislation. We cannot proceed with this bill and we have to go back to the drawing board."
Despite the backlash, Home Office continues to back the reforms, insisting they are vital to bring "paedophiles, terrorists and other serious criminals" to justice.
A timeframe for the second draft of the Communications Data Bill is yet to be confirmed.