The legal wranglings were seen as a test case for Malaysia's wider Christian community, but the government later clarified that the verdict was confined to the Catholic newspaper at the centre of the controversy. Worshippers can still use "Allah" to refer to God in church, the government added.
The divisive case, in which the Catholic Church challenged a government ban on its long-time use of the Arabic word, comes as minorities raise concerns that their rights are under threat from increasing Islamisation in Malaysia.
The government had previously banned the use of "Allah" in the local Malay-language edition of the Church's Herald newspaper. The use of the word had angered Muslims, who say Christians are overstepping religious boundaries.
A seven-judge panel in Malaysia's administrative capital Putrajaya on Monday upheld a lower court decision siding with the government.
But a government spokesman later clarified: "The ruling only applies to the Herald newspaper's use of the word 'Allah'. Malaysian Christians can still use the word 'Allah' in church."
Christians had argued that they had used the word to refer to God in Malay for centuries.
"The Christian community continues to have the right to use the word 'Allah' in our Bibles, church services and Christian gatherings... as we have done all this while," said Eu Hong Seng, chairman of the Christian Federation of Malaysia.
Lawyers for the Catholic Church said they would explore further ways to challenge the ban, expressing fears that Monday's ruling could be used as a precedent to curtail religious freedom in other cases.
Outside the court, which was cordoned off, around a hundred Muslim activists cheered the news of the verdict. Earlier, they had shouted "Allahu Akbar" (God is great) and waved banners that read, "Uniting to defend the name of Allah".
"We must defend 'Allah' because this is our religious obligation. I hope other communities, including Christians, understand this," Ibrahim Ali, head of Muslim rights group Perkasa, told AFP.
- Danger of conversion? -
The dispute first erupted in 2007 when Malaysia's home ministry threatened to revoke the Herald's publishing permit for using the Arabic word in its Malay-language edition.
The Church launched a court case to challenge the directive, arguing that "Allah" had been used for centuries in Malay-language Bibles and other literature to refer to "God" outside of Islam.
But authorities say using "Allah" in non-Muslim literature could confuse Muslims and entice them to convert -- a crime in Malaysia.
In 2009 a court ruled in favour of the Church, sparking a spate of attacks on houses of worship. Last October, an appeals court reinstated the ban.
Malaysia has largely avoided overt religious conflict in recent decades, but tensions have been growing.
Two petrol bombs were thrown at a Malaysian church in January, causing minor damage.
Also in January, Islamic authorities seized hundreds of Bibles, which contained the word "Allah", from a Christian group.
Around 2.6 million people among the Southeast Asian nation's 28 million people are Christians, who come from mostly ethnic Chinese, Indian or indigenous backgrounds, while 60 percent are Muslim ethnic Malay.
Minorities have long resented a decades-old positive discrimination policy which favours Malays in education, housing and employment.
Prime Minister Najib Razak, who took office in 2009, has increasingly rolled back his initial reformist and conciliatory rhetoric in a bid to please hardliners of his United Malays National Organisation, which has ruled the country virtually uninterrupted since independence in 1957.
"The idea is to use this as a political weapon to raise tensions," James Chin, a political science professor at Monash University, told AFP.
"They (the ruling party) feel that this is a vote-winner for the next election." (AFP)
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