The decision to permit Shamar Rinpoche's body to be brought in from India and cremated at his monastery just outside Kathmandu, Nepal's capital, was made at a Cabinet meeting, Information Minister Minendra Risal said.
Nepal's government had previously stopped Rinpoche's followers from bringing the body into the country, saying the monk was a Bhutanese national.
Some, however, accused the government of fearing anti-China protests by Tibetans during the funeral procession, which is expected to be attended by thousands of Rinpoche's followers.
After the 62-year-old Rinpoche died of a heart attack in Germany last month, his body was flown to India for his followers there to pay their last respects. Nepal's government initially gave permission for the body to then be taken to Nepal, but changed its mind and denied its entry.
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The body, meanwhile, has remained in Kalingpong in northeast India.
Rinpoche's followers in Nepal had been pressuring the government to allow the body in, but a decision was delayed because Prime Minister Sushil Koirala was in the United States for cancer treatment and returned home only last week.
Rinpoche, who built his monastery in the northeastern hills of Kathmandu and preached there for several years, has followers in Nepal, India, Bhutan and European nations. His followers said it was his wish to be cremated at his monastery.
The cremation is expected to take place on Thursday.