The protester, Mustafa Tamimi, 28, was killed during a clash between troops and Palestinian stone throwers in the West Bank village of Nabi Saleh in December 2011.
Tamimi was hurling rocks at an army jeep when a soldier inside opened the rear door and fired at him from just a few yards away, according to witnesses and a series of Associated Press photographs. Tamimi fell to the ground and was taken to an Israeli hospital where he died a day later.
Lt. Col. Peter Lerner, an army spokesman, said Tamimi's death was an "individual tragedy, with an awful outcome."
He said the soldiers operated "within their realm of responsibility," and that Tamimi put himself at unnecessary risk by running toward the jeep.
Lerner said the case was complex and that a Palestinian who witnessed the incident refused to testify.
B'Tselem said the shooting was well documented and that the fact that it took two years to reach a decision "clearly demonstrates the failures of the military investigation system."
Residents of several villages in the West Bank, including Nabi Saleh, have been holding weekly demonstrations to protest the construction of Jewish settlements and an Israeli separation barrier that eats up Palestinian farmland along parts of its route.
Among those struck by tear gas canisters in such protests were Palestinian Bassem Abu Rahmeh, who was killed in 2009, and Tristan Anderson of Oakland, Calif., who suffers from brain damage, paralysis and seizures after being struck in the head in 2009.