The government has suffered an embarrassing Commons defeat on its policy of allowing only limited numbers of Gurkhas to settle in the UK.
MPs voted by 267 to 246 in opposition to the government's proposals, despite Home Office promises that veterans would not be deported and that a review of the rules would begin by the summer.
Earlier, Gordon Brown came under fire from Conservative and Liberal Democrat leaders over the policy.
The latest Home Office decision was branded unfair by David Cameron, while Nick Clegg slammed the prime minister's abandonment of "British decency".
Campaigners have been urging the government to think again on a policy decision which they say will allow fewer than 100 of the Nepalese soldiers to settle in Britain.
Ministers, however, said it would ease restrictions for around 4,000 Gurkhas and a further 6,000 of their family members.
Cameron called for a "fair" plan to be introduced rapidly and said the government's proposals were too restrictive.
The Conservative leader said the immigration system should allow for a new category of those who served in the armed forces.
"We owe them a debt of gratitude," he told the Commons. And he added that many people "don't believe that the government is playing fair".
Cameron added that MPs "right across the House" would support an easing of restrictions.
Defending the policy, the prime minister said that 6,000 Gurkhas had successfully applied to enter the UK, equal pay had been introduced and pensions had been doubled for those who stay in Nepal.
He said the issue was "a matter of great concern" but insisted that the government would not "base our offer on money that we cannot afford".
But leaving the door open to further policy changes, he said that ministers will "continue to review the position over the next period of time".
"This is an advance on where we were," Brown added. "Within the public spending constraints that we face, we are taking a big step forward."
He added: "We are determined to honour the service that the Gurkhas gave."
But for the Lib Dems, Clegg slammed the prime minister's answers as "deeply evasive".
"How is it honest or decent to say that Gurkha soldiers who served 20 years can come and live in this country when he knows full well that the majority only served for 15?" he asked.
There is "a simple moral principle at stake", said the Lib Dem leader. "If someone is prepared to die for this country, surely they deserve to live in this country."
The prime minister responded that he did "take seriously" the issue and the numbers who can come into the UK had been increased under Labour.
"There is more justice for Gurkhas than there ever was before 1997," said Brown. But he added that it could cost around £1.4bn to take the policy further.
Clegg said that was "the answer of a man who knows he is doing a shameful thing but hasn't got the guts to change it".
And he insisted that "British decency" required a new line on Gurkha settlement.
The prime minister said that was why the government had acted over recent years, but noted that demand on resources is "a problem that we have to face".
Conservative MP Sir Nicholas Winterton also told the Commons that there are "huge numbers" of people who want an easing of restrictions on Gurkhas.
And Labour's Martin Salter urged justice for Gurkhas "at last".
Brown said the government would continue to review its position and would look again at the treatment of riflemen.
Dods Parliamentary Communications Ltd