A demonstration project of up to six turbines will be built in the water between Orkney and the Scottish mainland following the decision by the Scottish Government.
Energy Minister Fergus Ewing said: “Today we have granted consent to MeyGen Limited to develop the largest tidal turbine array in Europe and the first commercial project off these shores.
“This is a major step forward for Scotland’s marine renewable energy industry. When fully operational, the 86 megawatt array could generate enough electricity to power the equivalent of 42,000 homes - around 40% of homes in the Highlands.
“This exciting development in the waters around Orkney is just the first phase for a site that could eventually yield up to 398 megawatts.”
Speaking before the Scottish Renewables Marine Conference, Mr Ewing also announced that developers Aquamarine Power Limited and Pelamis Wave Power are to share a slice of a £13 million wave “first array” support programme, part of the Scottish Government’s Marine Renewables Commercialisation Fund.
Mr Ewing said the tide is turning for the wave sector.
“We must tackle climate change. We need to reduce our reliance on fossil fuels through better and more efficient uses of energy. Marine energy - a home-grown technology with huge potential - is part of the solution,” he said.
The Carbon Trust has estimated that wave and tidal resources could provide 20% of the UK’s electricity if fully developed.
The announcement comes as the UK Energy Secretary revealed plans to offer cash incentives to build more turbines on Scottish islands.
Ed Davey wants a higher subsidy for projects on Shetland, Orkney and the Western Isles than on the mainland.
He hopes the draft deal, which would be worth £115 per mega watt hour (MWh) for onshore wind, will help harness the “amazing green energy sources” on the islands.
It could lead to hundreds more turbines generating an additional 400 MWh for the grid.
“People have been waiting for this decision to be taken, no one has taken it before, and we are delivering it,” he said.
“We think it’s going to be extremely good news.
“It’s going to enable them to develop these windfarms, to sell that electricity, that green energy, and they will create jobs and economic activity.”
The so-called strike price of £115 is higher than the £100 proposed for the UK mainland in 2014-15.
Mr Ewing said: “Having established the inter-governmental group to take forward work to evidence the need for island support, I am keen that we reach a successful outcome for the islands.
“Mr Davey specifically mentioned Orkney, Shetland and the Western Isles in today’s speech, it is therefore incumbent upon him to find a solution that benefits all of our island communities, and the Scottish Government will hold him to account to ensure that is delivered.
“I also find the timing of this announcement surprising given the UK and Scottish governments have not concluded discussions over the detail of the proposals.
“We will continue to engage with the UK Government on this issue to ensure we get the correct incentive to release the huge potential for electricity generation from the islands.”