Gary make the announcement during the first live show of the series on Saturday night, drawing audible gasps from a shocked studio audience.
When the Take That singer's three-piece group Rough Copy closed the show with 'In The Air Tonight', Gary told them: "I'm so glad for my last year on the show, I get to mentor you."
He later expanded on his decision to quit the show in a statement issued on the show's official website.
"I've had an amazing time on 'X Factor' these past three years. A show like this needs to stay fresh and exciting so it's a great opportunity for someone to come in and take the show past its incredible ten year anniversary," he said.
"Next year is looking to be a very busy year for me and 'The X Factor' is a full time job so it felt like the right time to hand over the baton. I've loved being a part of the show and have met and worked with some fantastic people but most importantly, more than ever, I want to go out with the winning act this year. Come on the groups!"
An official announcement is not expected to be made until the future of the US version - which Simon launched after quitting the UK show back in 2010 - is decided, after receiving its lowest ratings ever this series.
A source told the paper: "Simon has done everything he can to make the American version work.
"But the UK show is the biggest X Factor in the world and he'd love to be back."
The insider added that Simon is desperate to persuade Cheryl Cole to return to the show as part of his comeback.