The decision has sparked outrage among patriotic Brits who say they have been unfairly penalised for displaying the St George’s Cross.
An image posted on social media showed a man with a young girl on his shoulders strolling past the Houses of Parliament carrying the terror group’s black banner.
But police decided he was not breaking the law and let him walk free.
And labourer Ben Smith also got in hot water with police when he claimed they told him to remove the flag on his parcel shelf because it was offensive to immigrants.
Ben, from Melksham, Wilts, said he was threatened with a £30 fine if he refused to remove it from view.
Father-of-one Steven Rolfe was also ordered to paint over the St George’s Cross on his front door because it could be “offensive”.
The decorator, from Preston, Lancs, said: “I’ve had this flag on my door for 10 years. I am really angry.
“I am not in any sort of racist group. I’m just proud of England. I don’t see how anyone can be offended.”
A car was also spotted outside an Asda store in Wembley Park, north London, bearing the flag of terrorist organisation Hezbollah.
But police again said it was “within the law”.
Scotland Yard said: “While support of and membership of Isis is unlawful it is not a criminal offence to advocate the creation of an independent state.”
A Home Office spokesman said: “We cannot comment on individual cases.”