Judges have ruled that the UK government acted lawfully in blocking Scotland's gender self-ID reforms.
Legislation making it easier for people to change their legally-recognised sex was passed by the Scottish Parliament last year.
The UK government blocked it from becoming law over fears it would impact on equality laws across Great Britain.
The Court of Session in Edinburgh has now rejected a Scottish government legal challenge to the veto.
The Scottish government has 21 days to decide whether it wants to appeal against the ruling, and the case could ultimately end up in the Supreme Court in London.
The legislation received cross-party support in Holyrood, passing by 86 votes to 39 after a highly-charged debate.
Campaigners against the reforms warned the legislation could risk the safety of women and girls in same-sex spaces such as hospital wards and refuges.
Supporters argued it would make the process of obtaining a gender recognition certificate (GRC) easier and less traumatic for trans people.
The legislation would remove the need for trans people to be diagnosed with gender dysphoria by a doctor before they are allowed to change their legally-recognised sex in Scotland, and would lower the age that someone can apply for a GRC from 18 to 16.
The period in which applicants would need to have lived in their acquired gender would be cut from two years to three months.
The UK government stepped in to block the bill from receiving royal assent after it was passed by MSPs, using powers contained in section 35 of the Scotland Act for the first time.
Scottish Secretary Alister Jack raised concerns that the reforms could adversely impact on the 2010 Equality Act, which applies in Scotland, England and Wales and sets out protections for groups including women and transgender people.
The Scottish government challenged the move at the Court of Session - Scotland's highest civil court - with its top law officer, Lord Advocate Dorothy Bain, arguing that Mr Jack did not have "reasonable grounds" to block the bill.
Ms Bain also claimed that if the UK government was successful, Westminster "could veto practically any act of the Scottish Parliament having an impact on reserved matters because he disagreed with it on policy grounds".
But in her written ruling, judge Lady Haldane dismissed the Scottish government's appeal and said the block on the legislation was lawful.
She said Mr Jack followed correct legal procedures when he made his decision to invoke section 35 and that the Scottish government had failed to show that he had made legal errors.
The judge wrote: "I cannot conclude that he (Mr Jack) failed in his duty to take such steps as were reasonable in all the circumstances to acquaint himself with material sufficient to permit him to reach the decision that he did."
Lady Haldane also said that "Section 35 does not, in and of itself, impact on the separation of powers or other fundamental constitutional principle. Rather it is itself part of the constitutional framework."
Welcoming the judgement, Mr Jack said it "upholds my decision to prevent the Scottish government's gender recognition legislation from becoming law".
He added: "I was clear that this legislation would have had adverse effects on the operation of the law as it applies to reserved matters, including on important Great Britain-wide equality protections.
"Following this latest court defeat for the Scottish government, their ministers need to stop wasting taxpayers' money pursuing needless legal action and focus on the real issues which matter to people in Scotland - such as growing the economy and cutting waiting lists."
Humza Yousaf decided to proceed with the legal challenge shortly after succeeding Nicola Sturgeon - a passionate supporter of trans rights - as first minister earlier this year.
Writing on X, formerly Twitter, he described the ruling as a "dark day for devolution".
Mr Yousaf said: "Today's judgment confirms beyond doubt that devolution is fundamentally flawed. The court has confirmed that legislation passed by a majority in Holyrood can be struck down by Westminster.
"The only way to guarantee we get true self-government is through independence. Sovereignty should lie with the people of Scotland, not a Westminster government we didn't vote for with the ability to overrule our laws."
He was the only one of the three candidates in the SNP leadership contest who backed taking legal action and the issue has been deeply divisive within the party.
Colin Macfarlane, director of nations at LGBTQ+ charity Stonewall, said the ruling would "mean more uncertainty for trans people in Scotland who will be waiting once again to see whether they will be able to have their gender legally recognised through a process that is in line with leading nations like Ireland, Canada and New Zealand."
Labour's shadow Scottish secretary Ian Murray said it was "disappointing this legalisation ended in the courts but this ruling should be respected".
Shortly after the reforms were passed, double rapist Isla Bryson - who changed gender after being arrested for attacking two women - was remanded to a women's jail.
Bryson was subsequently moved to a male prison after the case sparked widespread anger. The Scottish government said the new legislation had no impact on the decision about where Bryson was held.
As befitting an unprecedented case, this is in Lady Haldane's words a "novel and complex" ruling.
She actually concluded in part that this is a situation where many decisions could have been taken, and that "there is possibly no single right answer" - but that the courts should only intervene in the case of a clear error in law.
The judge concluded that Alister Jack was entitled to make a decision on this, and that he had taken the proper steps to come to a view, without going into the even knottier territory of whether it was the right one.
All of that complexity means there could be room for appeal.
The Scottish government will be combing through the ruling to see if there are grounds to go back to court.
Mr Jack has urged them not to, telling them not to waste public funds on further legal action.
But ministers will perhaps put more weight on the position of the Scottish Greens, their partners in government, who are absolutely furious about the "horrible, heartbreaking and unjust" outcome.
Challenging UK ministers on this has been a red line for the Greens in the past. It may be that Scottish ministers have little choice but to fight on if they are to keep their partnership government together.
