The decision was taken by the Union Cabinet under Section 3 of the Commissions of Inquiry Act which empowers the Centre to set up such a commission.
The commission is likely to be headed by a retired Supreme Court judge and will submit its report within three months.
The Cabinet has decided to constitute the inquiry into the incidents of physical/electronic surveillance in the states of Gujarat, Himachal Pradesh, and Delhi allegedly without authorisation.
The proposal for setting up the probe panel was mooted by the Home Ministry, which had suggested that it should be headed by a sitting or a retired Supreme Court Judge.
The Centre's decision over-rules the contention of the Gujarat government that it was a state matter and it had already appointed a commission for probe into the matter.
The Union Cabinet's decision came against the backdrop of fresh claims that the alleged snooping was conducted beyond the state of Gujarat.
Web portal gulail.com had yesterday claimed that the snooping of the woman allegedly at the behest of Modi was not only confined to Gujarat but extended to Karnataka as well.
The portal, which along with another portal cobrapost.com, had first exposed the matter, alleged that Gujarat police had in 2009 contacted its Karnataka counterpart during the Chief Ministership of B S Yedyurrapa for intercepting the telephone of the woman when she was living in Bangalore.