A report by the Public Accounts Committee (PAC) said the Charity Commission did not carry out sufficient checks on the Cup Trust charity.
The charity took huge donations but made only small charitable payouts.
The commission said it was discussing better ways to tackle abuses of charitable status.
In a statement, PAC chairwoman Margaret Hodge said the Cup Trust episode had caused “damage to the reputation of the commission and charity sector”.
“The Charity Commission’s approach to regulation and enforcement lacks rigour,” she said.
“It has carried out few enforcement visits, rarely mounts prosecutions, and removes very few trustees.”
The Cup Trust was given charitable status by the commission in 2009.
The PAC said it then received £176m in income, but gave away just £55,000 to charitable causes.
The trust’s sole trustee was a company called Mountstar – based in the British Virgin Islands and whose directors were already known to UK authorities as being involved in tax avoidance.
In the meantime, The Cup Trust tried to claim gift aid of £46m, money that otherwise should have been paid to the government in tax.
And although the Charity Commission began to investigate the Trust in March 2010, it has still not published a report.
But the Commission explained that it had been unable to de-register the trust, because it was legally structured as a charity.
Ms Hodge said the trust’s purpose “was to avoid tax”.
She said the commission failed to carry out basic checks.
“The trust’s true purpose might have been easily detected by the Charity Commission had they carried out more checks before registration, including with HM Revenue & Customs.”
She added: “HMRC told us that it investigates 300 similar schemes a year. This strongly suggests that the Cup Trust case is just the tip of the iceberg.”
The commission has now appointed an interim manager to take control of the trust while its investigations continue.
In a statement the commission said: “We regularly share information with HMRC and run joint operations where there are shared concerns about abuse of charity.
“Together we are discussing better ways to share information and work together to tackle abuse of charity – such as a joint application portal for registration.”
In the last 25 years, the Public Accounts Committee and the National Audit Office have investigated the Charity Commission repeatedly, and found “severe shortcomings”, according to the MPs.
In 2001 it was told to make more use of its statutory powers.
“Yet still the Commission hardly uses these powers at all,” said the committee.
The PAC said it will now carry out a new enquiry, to establish whether it is fit for purpose.