Sherwood moved up from his role in Spurs' youth setup to replace the sacked Andre Villas-Boas in December, eventually leading the club to sixth in the Premier League.
However, his tenure has been littered with rumours he would be replaced at the end of the campaign, despite signing an 18-month contract at White Hart Lane.
Club chairman, Daniel Levy, said: "We appointed Tim mid-season as someone who knew both the players and the club.
"We agreed an 18-month contract with a break clause at the end of the season and we have now exercised that option.
"On behalf of the club, I should like to state our thanks for all his efforts during his years with us. We wish him great success in his managerial career.
"Moving forward, now the season is over, we shall embark on the process of finding a new head coach. We have a talented squad and exciting young players coming through. We need to build on this season, develop our potential and inspire the kind of performances that we associate with our great club."
Sherwood enjoyed a fine start to management, winning five and drawing one of his first six Premier League games in charge.
Hammerings at the hands of Manchester City, Chelsea and Liverpool left Sherwood frustrated at his side's defensive frailties, but a strong finish to the season helped lift spirits around White Hart Lane.
Sherwood guided the team to four wins and a draw in their final six matches, as Spurs sealed sixth and a place in the UEFA Europa League next season.
His future at Tottenham had come under increasing scrutiny in recent weeks, with current Ajax boss Frank de Boer quoted as saying that the club had made an approach for his services, and Sherwood hinted at a 'lack of respect' which he felt had been shown to him during his time in charge.
He remained defiant in his insistence that he wanted to stay on, but suggested recently that some of the players knew more about his situation than he did.
Sherwood, a Premier League winner as a player with Blackburn Rovers in 1995, spent four years as a Spurs player between 1999 and 2003, and joined Harry Redknapp's coaching staff in 2008.
