Iceland's group Hatari brandished scarves with Palestinian flags when the final results were being announced at the end of the event, which was held last May in Tel Aviv.
Contest organizers the European Broadcasting Union said Saturday in a statement sent to AFP that the gesture infringed their rules banning political gestures.
They declined to say how much they had fined Iceland's public broadcaster, but said it was "in line with the rules of the competition."
The fine had also been upheld following an appeal it said.
Hatari is known for their opposition to the Israeli occupation of the Palestinian territories.
Rule 2.6 of the competition stipulates that participants should do nothing to use it for political ends.
During the same event guest performer Madonna also provoked controversy when her dancers carried Israeli and Palestinian flags on their costumes.
"It was a mistake," said Culture Minister Miri Regev at the time.
"You cannot mix politics at a cultural event, with all due respect to Madonna."
Israel hosted this year's event because of the victory of their singer Netta Barzilai the previous year.
This competition in Tel Aviv was more political than usual, held against the backdrop of a campaign by the anti-Israel Boycott, Divestment, Sanctions (BDS) movement that urged artists, fans and broadcasters to shun the event to protest against Israeli policies in the West Bank and Gaza.
But no singers or broadcasters pulled out, and only a small crowd of protesters turned up outside the venue, carrying signs in Hebrew, Arabic and English reading "No Pride in Occupation" and "Feminists for Gaza."