The United Nations report details horrific abuses committed during and following Sri Lanka's 26-year civil war.
It states there are "strong" indications both government forces and Tamil Tiger fighters committed war crimes and crimes against humanity.
The report concludes that Sri Lanka's criminal justice system is not yet ready or equipped to conduct an independent and credible investigation.
It recommends the setting up of a special hybrid court integrating international judges, prosecutors, lawyers and investigators.
UN Human Rights Chief Zeid Ra'ad Al Hussein says a purely domestic court procedure will not be able to overcome widespread community suspicion.
"It has to be a court that will meet the expectations of victims and the international community alike. Of course, as well as then propel Sri Lanka into a new future where impunity is not evident everywhere."
Sri Lanka's new unity government has promised dramatic reforms and had been hoping to win UN backing for a domestic probe.
The Australian Tamil Congress, which has been calling for an independent international investigation, welcomes the idea of a hybrid court.
Spokeswoman Dr Sam Pari says the Congress doesn't have faith in Sri Lanka's domestic justice system.
"History has shown us that domestic commissions and investigations have not led to proper prosecutions or justice being given to victims and survivors in the last 20 years in Sri Lanka. So as far as words are said by the government, and pledges and a commissioner are put in place, we know that they don't ultimately lead to perpetrators being brought to justice."
Sri Lanka's government is planning to create a truth and justice commission.
A former Sri Lankan Attorney General who now lives in Australia, Sunil De Silva, says, for wounds to heal, allegations need to be heard out in the open.
But he says any inquiry needs to be carried out with great care if relations between Tamil and Sinhalese communities are to be preserved.
"I also understand that there is a concern that a domestic inquiry needs to be carefully supervised to make sure it is not going to be corrupt or a whitewash. At the same time, it should not be a witchhunt. I mean, you will appreciate that. Neither would help the communities to get together."
A former president of the Sinhalese Cultural Forum in Sydney, Dayantha Jayarathne, says his community wants to see justice, and victims compensated.
But he says the process should not drag on.
"I think, as a community, we are frustrated, because this has been dragging on for too long. And both Singhalese and Tamil communities should be able to get on with their lives and work towards the development of their living standards, and get on with their education, creating jobs, etc."
