Police have dropped their inquiries into Grant Shapps, the Conservative party chairman, saying legal advice initially concluded his former firm's sale of software "may constitute an offence of fraud" but they decided not to launch a criminal investigation following a full assessment.

The Metropolitan Police (MPS) looked into the activities of How To Corp, which was founded by Shapps and his wife in 2005, after receiving a complaint from Steve McCabe, a Labour MP. The force wrote to Shapps two weeks ago to tell him that the matter is now closed, having been considered by its special enquiry team.

Michael Duthie, commander of homicide and serious crime, wrote in the letter: "Legal advice was sought which concluded that the selling of the software may constitute an offence of fraud, amongst others. However, upon the conclusion of the assessment process the MPS have decided not to instigate a criminal investigation and have now closed this matter."

Duthie added that he "must advise" Shapps that Google, the Federation Against Software Theft, the Intellectual Property Office and the Publishers Association were all contacted in the course of the assessment and made aware of the nature of the allegation.

The police also wrote to McCabe thanking him for providing them with information, saying it was "useful but did not overcome evidential barriers that we face".

The letter to McCabe added: "Please be assured that we have conducted a thorough and proportionate assessment and have consulted with a number of organisations, such as the Intellectual Property Office and the Publishers Association, before making this decision."

Asked about it by Channel 4 News, Shapps said the letter "makes it absolutely clear, there is absolutely nothing here" and said he had been subject to Labour smears. "I think the MP who wasted police time really has questions to answer," Shapps said.

A Conservative source said none of the organisations mentioned in the letter has contacted Shapps, adding this is "just another example of Labour wasting police time trying to smear an individual".

However, Jon Ashworth, a Labour MP, demanded a full explanation from the police about why they have not decided to prosecute. He said David Cameron should also explain "why he thinks Grant Shapps is a suitable person to hold such a senior position" in the Conservative party.

"It is an extraordinary revelation that the chairman of the Conservative party was linked to business activities that 'may constitute an offence of fraud'," he added.

How To Corp's website was dismantled last year, but before that, it sold software that adds to a website's advertising revenue by copying other people's content. The Guardian first revealed that How To Corp's premier product – a $497 (£313) software package, TrafficPaymaster – created web pages by "spinning and scraping" content and sought to attract advertising, in contravention of Google's code of conduct.

Going under the name Michael Green and casting himself as an internet marketing guru, Shapps claimed in 2007 that audiences could "make $20,000 in 20 days guaranteed or your money back" – if they spent $200 buying his bespoke software. The picture used to illustrate Michael Green on the site is that of a model that can be brought for generic use on websites for as little as $125. In 2008, Shapps transferred his share of the company to his wife, Belinda, and the Tory chairman has said he did not have anything to do with the firm after this point.

Labour's Steve McCabe complained about the company to Keir Starmer, the director of public prosecutions, and the Metropolitan Police in autumn last year, asking them to determine whether an offence had been committed under the Copyright, Designs and Patents Act of 1998 which also "criminalises the communication of copyrighted works in the course of a business".He also invited prosecutors to consider whether the firm is "obtaining, or attempting to obtain, a pecuniary advantage by deception has been committed".

A spokesman for the Metropolitan Police said: "The allegation has now been fully assessed and there will be no further action by police. We're not prepared to discuss the matter further."