Terms were agreed in June 2019, which would have seen Air Canada pay C$18 per Transat share.
However, this valuation was revised down to just C$5 per share last October owing to the effects of the Covid crisis.
The deal was approved by the Canadian government in February, subject to approval by competition authorities in Canada and the European Commission.
At the weekend, though, it was announced the deal was off.
"The parties have reached this agreement after having been advised by the European Commission that it would not approve the transaction," said Transat.
"This transaction, first contemplated more than two years ago, was complicated by the pandemic, and, ultimately, Air Canada reached its limit in terms of concessions it was willing to provide the European Commission to satisfy their competition law concerns," said Jean-Marc Eustache, president and chief executive of Transat.
Air Canada will pay Transat a one-off C$12.5 million termination fee.
Eustache added the decision left Transat free to take any necessary steps required to ensure "a successful, long-term future" for the budget operation, starting with securing new long-term financing running to around C$500 million this year.
It will continue to take measures to preserve cash and currently has access to a C$250 million credit facility, available until 30 June.
Transat said it was in "advanced" talks with the Canadian government over longer-term financing facilities, and expected to secure "satisfactory" financing in the coming weeks.
One option available to Transat is an outstanding C$5 per share offer from investment company Gestion.
In a statement, Air Canada confirmed the deal had been terminated by mutual agreement.
It said the remedies required to meet the European Commission’s competition stance "went beyond the commercially reasonable efforts required of Air Canada" and beyond those "traditionally" accepted by the commission.
"Following recent discussions with the EC, it has become evident the EC will not approve the acquisition based on the currently offered remedy package," said Air Canada.
